On December 31, 2010, Carme Company had significant amounts of accounts receivable as a result of credit sales to its customers. Carme Company uses the allowance method based on credit sales to estimate bad debts. Based on past experience, 1% of credit sales normally will not be collected. This pattern is expected to continue.
1. Explain the rationale of using the allowance method based on credit sales to estimate bad debts. Contrast this method with the allowance method based on the balance in the trade receivables accounts.
2. Explain how Carme Company should report the allowance for bad debts account on its balance sheet at December 31, 2010. Also, describe the alternatives, if any, for presentation of bad debt expense in Carme Company’s 2010 income statement.