## Aging of accounts receivable and bad debt expense

We have previously discussed various methods of estimating bad debt expense, including percentage of sales and percentage of accounts receivable. In this article, we expand on the percentage of accounts receivable method by incorporating accounts receivable aging.

## 1. Conceptual theory of accounts receivable aging

Setting up an accounts receivable aging schedule is similar to the percentage of accounts receivable method in that the allowance account for uncollectible accounts is adjusted to some target value based on an ending balance sheet account. An aging schedule is arguably more precise than an average percentage because older accounts are assigned a higher percentage of bad debt estimation.

## 2. Example aging schedule

Let’s assume that Friends Company, a fictitious entity, estimates bad debt expense with a periodic accounts receivable aging schedule. For the year ended 20X3, it produced the following table:

 Age of Account Category Dollar Amount Estimated Uncollectible Percentage Estimated Uncollectible Dollar Amount Less than 30 days \$2,500,000 0.5% \$12,500 31-60 days \$1,000,000 1% \$10,000 61-90 days \$500,000 3% \$15,000 91-120 days \$100,000 8% \$8,000 Greater than 120 days \$50,000 11% \$5,500 Totals \$4,150,000 \$51,000

For example, the estimate of uncollectible accounts receivable less than 30 days old is 0.5% and equals \$12,500 (i.e., \$2,5000,000 x 0.5%).

You can see that the estimated uncollectible percentage increases with the accounts receivable age.  As noted, typically older accounts receivable have higher probabilities of being uncollectible. Such percentage are estimated by the company’s management based on past experience and judgment.

An aging schedule is a balance sheet approach to bad debt estimation, meaning that the schedule tells management what should be in the allowance account on the balance sheet. The adjusting entry brings the allowance account in line with the estimated bad debt reserve. Let’s assume now that the allowance account for Friends Company has a credit balance of \$3,000 before adjustment. The following adjusting entry would be made at the end of the period (\$48,000 = \$51,000 - \$3,000):

 Account Names Debits Credits Bad debt expense 48,000 Allowance for uncollectible accounts 48,000

If instead the allowance account had a debit balance of \$3,000, bad debt expense would be \$54,000 (i.e., \$51,000 + \$3,000).

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