Accounts receivable aging is a technique in accounting used to estimate bad debts under the allowance method and to improve control over unpaid invoices. The idea behind this technique is classification of accounts receivables into an aging schedule. It helps identify customers who have a great proportion of accounts past due and reduce credit risk by limiting sales on credit to them.
The accounts receivable aging report or schedule is a table where accounts of each customer are categorized into periods in accordance with payment terms. For example, credit terms of “net 30” means that the customer has 30 days to pay an invoice. When this period expires, accounts receivable becomes past due and should be classified into periods 1–30 days, 31–60 days, 61–90 days, and 91+ days.
Here is a sample report of accounts receivable aging submitted by RetailX LTD as of December 31, assuming that all sales were made at credit terms of “net 30.”
The accounts receivable aging method is widely used to estimate the amount of uncollectable debts used as an ending balance of Allowance for Doubtful Accounts.
Let’s transform the sample report above as follows:
Estimating the probability that accounts receivable of a specific age will not be collected is usually based on previous experience and management’s judgment. As we can see, the older the past due account, the higher the probability of not being collected.
To estimate the amount of uncollectable debts, we should add the amount of accounts receivable in each age category by the corresponding probability of not collecting. The total amount of $5,222.6 is the ending balance of Allowance for Doubtful Accounts.
At the end of each accounting period, the adjusting entry should be made in the general journal to record bad debts expense. This amount should be calculated as follows:
If Allowance for Doubtful Accounts has a credit (CR) balance before adjustment:
Bad Debts Expense = Ending Balance of Allowance for Doubtful Accounts – CR Balance of Allowance for Doubtful Accounts before Adjustment
If Allowance for Doubtful Accounts has a debit (DR) balance before adjustment:
Bad Debts Expense = Ending Balance of Allowance for Doubtful Accounts + DR Balance of Allowance for Doubtful Accounts before Adjustment
The adjusting entry should be made by debiting the Bad Debts Expense account and crediting Allowance for Doubtful Accounts.
Let’s assume that the credit balance of Allowance for Doubtful Accounts before adjusting is $628.4.
Bad Debts Expense = $5,222.6 - $628.4 = $4,594.2
The adjusting entry debits Bad Debts Expense and credits Allowance for Doubtful Accounts for $4,594.2.