Which method is commonly used for estimating bad debts?

The percentage of sales method is commonly used for estimating bad debts as it allows a company to anticipate future uncollectible accounts based on a consistent and systematic percentage of credit sales. This estimation recognizes that a certain proportion of sales will inevitably not be collectible, based on historical data or industry standards. This approach is beneficial because it aligns bad debt expenses with revenues generated in the same period, providing a more accurate representation of financial performance.

Using this method helps businesses budget for potential losses, manage finances effectively, and maintain accurate financial statements. It contrasts with the direct write-off method, which records bad debts only when they are deemed uncollectible, potentially distorting profit reporting in earlier periods. While other methods, such as those examining fixed assets or average costs, focus on different aspects of financial analysis and are not designed specifically for bad debt estimation.