Aging Method
The aging method, also known as accounts receivable aging or aging of accounts receivable, is an accounting technique used to categorize accounts receivable (amounts owed to a business by its customers) based on the length of time they have been outstanding. This method helps businesses to identify overdue accounts, evaluate the effectiveness of credit and collection policies, and estimate the likelihood of collecting the receivables.
Accounts receivable are typically grouped into various time periods or aging buckets, such as:
- Current (not yet due)
- 1-30 days past due
- 31-60 days past due
- 61-90 days past due
- Over 90 days past due
By categorizing the receivables in this manner, businesses can quickly identify overdue accounts, which may require more aggressive collection efforts or potentially be written off as bad debts. The aging method also helps businesses determine the allowance for doubtful accounts, which is an estimate of the amount of receivables that may not be collectible. This allowance is used to record a bad debt expense and reduce the carrying value of accounts receivable on the balance sheet.
Example of Aging Method
Let’s consider a hypothetical example of a company using the aging method to analyze its accounts receivable.
Suppose a company has the following accounts receivable balances:
- Customer A: $1,000 – invoice is 15 days past due
- Customer B: $2,500 – invoice is 45 days past due
- Customer C: $3,000 – invoice is 5 days past due (not yet due)
- Customer D: $1,500 – invoice is 75 days past due
- Customer E: $2,000 – invoice is 100 days past due
The company can categorize its accounts receivable into aging buckets as follows:
- Current (not yet due): $3,000 (Customer C)
- 1-30 days past due: $1,000 (Customer A)
- 31-60 days past due: $2,500 (Customer B)
- 61-90 days past due: $1,500 (Customer D)
- Over 90 days past due: $2,000 (Customer E)
By analyzing the aging of accounts receivable, the company can determine which customers have overdue balances and may require additional collection efforts. In this example, Customer B, D, and E have overdue balances. The company might prioritize contacting Customer E, as their invoice is the most overdue.
Furthermore, the company can use this aging information to estimate the allowance for doubtful accounts. For instance, the company might estimate that the likelihood of collecting the receivables decreases as the accounts age:
- Current (not yet due): 99% collectible
- 1-30 days past due: 95% collectible
- 31-60 days past due: 85% collectible
- 61-90 days past due: 60% collectible
- Over 90 days past due: 30% collectible
Using these percentages, the company can estimate the allowance for doubtful accounts:
- Current: $3,000 x 1% = $30
- 1-30 days past due: $1,000 x 5% = $50
- 31-60 days past due: $2,500 x 15% = $375
- 61-90 days past due: $1,500 x 40% = $600
- Over 90 days past due: $2,000 x 70% = $1,400
The total estimated allowance for doubtful accounts would be: $30 + $50 + $375 + $600 + $1,400 = $2,455. This amount would be recorded as a bad debt expense and used to reduce the carrying value of accounts receivable on the balance sheet.
