Final answer:
Smart Touch Learning's bad debts expense is correctly calculated at $1,000 by applying 2% to its net credit sales of $50,000. The provided example illustrates how mental accounting can sometimes lead to counterintuitive financial decisions.
Step-by-step explanation:
The statement that Smart Touch Learning's bad debts expense for the year is $1,000 based on a rate of 2% of its net credit sales of $50,000 is false. To calculate the bad debts expense using the percent-of-sales method, we multiply the percentage rate by the net credit sales. Therefore, 2% of $50,000 equals $1,000, which in fact makes the statement true and not false. Businesses typically account for the possibility of bad debts by incorporating a percentage of their credit sales as bad debts expense, much like banks account for the risk of loan defaults.
This understanding of accounting for potential losses is illustrated by the practice of mental accounting, which can lead to seemingly illogical financial behavior like carrying high-interest credit card debt while holding a low-interest savings account. In the provided example, paying more interest on debt than receiving from savings results in a net financial loss, pointing to the importance of considering the cost of capital when managing personal finances.