Management uses the percentage-of-sales approach method to calculate the allowance for doubtful debts.Management calculated the allowance for doubtful debts on the basis of 2% of sales.However,by year-end it was aware that the rate should have really been 3% of sales.Management does not adjust the allowance for doubtful debts at year-end.As a result:

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The allowance for doubtful debts is an estimate of the amount of receivables that may not be collected. By not adjusting the allowance for the correct rate, management is not properly accounting for the potential bad debts. This results in an overstatement of assets (as accounts receivable are overstated) and an overstatement of net profit (as bad debt expense is understated).

Management Uses the Percentage-Of-Sales Approach Method to Calculate the Allowance