Accounts Receivable Aging Method

Accounts receivable aging is a technique to estimate bad debts expense by classifying accounts receivable of a business according to of length of time for which they have been outstanding and then estimating the probability of noncollection for each category. The classification of accounts receivable in the accounts receivable aging schedule also helps the business to identify the customers who take longer to pay so that they can restrict sales to those customers to reduce risk of bad debts.

Typically receivables are categorized into periods which are multiples of payment terms. For example if company sells at payment terms of n/20, the typical classification in aging schedule will be 0 to 20 days, 20 to 40 days, 40 to 60 days and so on.

The next step is to calculate the probability of noncollection for each of the above category which is then multiplied with the sum of accounts receivable from each category. This returns the amount of accounts receivable which are expected to become bad in each category. The sum of estimated noncollected accounts receivable from each category is fixed as the ending balance of allowance for bad debts account. Bad debts expense is calculated as provided in percentage of receivables method of bad debts estimation.

Example

Age CategoryAmountProbability of NoncollectionUncollectible Amount
1-20 days$64,2002%$1,284
20-40 days11,9004%476
40-60 days5,2007%364
60-80 days35012%42
   $2,166

Written by Irfanullah Jan