Aging Method of Accounts Receivable/Uncollectible Accounts (2024)

What Is the Aging Method?

The aging method involves determining the desired balance in the Allowance for Uncollectible Accounts.

The aim is to estimate what percentage of outstanding receivables at year-end will not be collected. This amount becomes the desired ending balance in the Allowance for Uncollectible Accounts.

A credit entry is made to Allowance for Uncollectible Accounts, thereby adjusting the previous balance to the new, desired balance. The debit part of the entry is made to the Uncollectible Accounts Expense account.

The aging method is often referred to as the balance sheet approach because the accountant attempts to measure, as accurately as possible, the net realizable value of Accounts Receivable, which is a balance sheet figure.

The method used to estimate the desired balance in the allowance account is called the aging of accounts receivable.

It involves dividing the balance in the Accounts Receivable account into age categories based on the length of time they have been outstanding.

Categories such as current, 31—60 days, 61—90 days, and over 90 days are often used.

On the assumption that the longer an account is outstanding, the less likely its ultimate collection is, an increasing percentage is applied to each of these categories.

The total of these figures represents the desired balance in the account Allowance for Uncollectible Accounts.

Example

To demonstrate the application of the aging method, we will use the data from the Porter Company.

At the end of 2019, the balance in Accounts Receivable was $200,000, and an aging schedule of the accounts is presented below.

For the sake of simplicity, let's assume that the entire $200,000 balance in Accounts Receivable consists of only 5 customers.

Based on the data shown above, the Porter Company makes the following adjusting entry on 31 December 2019 to record the Uncollectable Accounts Expense:

After the entry is posted, the T-accounts appear as follows:

A number of points should be highlighted about this illustration.

• First, the dollar amount of the required journal entry is the amount needed to bring the Allowance account to the desired balance of $19,700.

  Given that the Allowance account had a $2,000 credit balance prior to adjustment, the required entry is for $17,700, or the difference between $19,700 and $2,000.

  In some situations, the Allowance account may have a debit balance before the adjustment.

  This may occur if during the year more accounts were written off as uncollectible than had been estimated for in the prior year.

  In this situation, the debit balance should be added to the desired credit balance in the Allowance account to figure the correct amount of the entry.

  For example, if Porter Company's Allowance account had a $300 debit balance before the entry for the uncollectible accounts expense, the Allowance account would require a credit entry of $20,000 to establish the necessary ending balance of $19,700.

• The second issue relates to the question of how the accountant determines the appropriate percentages to apply to each age category.

  Generally, these percentages are based on past experience adjusted for the current economic and credit conditions.

  These percentages should be evaluated on a regular basis and adjusted when necessary.

• Finally, in some cases, the aging of accounts receivable will indicate that a particular account has no possibility of collection.

  When this happens, the account should be written off by debiting the Allowance account and crediting Accounts Receivable before figuring out the desired ending balance in the Allowance account.

  In effect, this particular account is eliminated from the aging process because it is already considered uncollectible.

Comparison of Percentage of Net Sales Method and Aging Method

Both the percentage of net sales and aging methods are generally accepted accounting methods in that they both attempt to match revenues and expenses.

The percentage of net sales method aims to determine the amount of uncollectible accounts expense, while the aging method focuses on calculating the balance in the account Allowance for Uncollectible Accounts.

These methods, therefore, show different balances in both the expense and contra-asset accounts.

This is illustrated below using data from the Porter Company example shown above.

These differences show that management can choose from various methods when applying generally accepted accounting principles and that these choices influence the firm's financial statements.

Once a method of estimating bad debts is chosen, it should be followed consistently. This will enhance the comparability of the financial statements.

Both the aging and percentage of net sales methods, as well as other methods, are used in practice.

While the percentage of net sales method is easier to apply, the aging method forces management to analyze the status of their accounts receivable and credit policies annually.

Some firms use both methods. For example, in these firms, the percentage of net sales method is typically used to prepare monthly and quarterly statements, whereas the aging method is used to make the final adjustment at year-end.