Today, you’ll learn how to calculate bad debt expense using the aging method.
In financial accounting, you can calculate bad debt expense by using the aging method. It helps estimate the amount of accounts receivable (AR) that you expect to be uncollectible.
This method involves categorizing accounts receivable by their age and applying different estimation percentages to each category. In this post, we will explain how you can calculate bad debt expense using the aging method.
How to Find Bad Debt Expense Aging Method
To find bad debt expense expense in the Aging Method, you estimate the expense by calculating the percentages from aged receivables.
Take an example below.
|Aging Category||Current (0-30 days)||31-60 days overdue||61-90 days overdue||Over 90 days overdue||Total|
|Bad Debt Estimate (%)||1%||3%||5%||10%|
|Estimated Bad Debt ($)||$1,000||$1,500||$1,500||$2,000||$6,000|
1. Understanding the Aging Method
To use the aging method, you need to determine the likelihood of customers defaulting on their payments based on the length of time their accounts have remained outstanding.
You classify accounts receivable into separate age groups and estimate the proportion of receivables that may eventually become uncollectible.
This method considers historical data and assigns higher percentages to older balances, which are considered more risky.
2. Categorizing Accounts Receivable by Age
Start by categorizing your accounts receivable balances based on their age.
Define categories such as current (outstanding less than 30 days), 31-60 days, 61-90 days, 91-120 days, and over 120 days.
This categorization provides a clear overview of your outstanding balances at any given time.
3. Determining the Estimation Percentages
Next, determine estimation percentages for each age group based on your historical collection experience.
For example, if you have historical data showing that on average, 2% of receivables in the 31-60-day range become uncollectible, use that percentage for that group.
4. Applying the Estimation Percentages
Multiply the estimation percentages by the total accounts receivable balance in each category to calculate the bad debt expense.
For instance, if the total accounts receivable balance in the 31-60-day category is $100,000 and the estimation percentage is 2%, the bad debt expense would be $100,000 multiplied by 2%, resulting in $2,000.
5. Summing the Estimations
Sum up the individual estimations for each category to determine the total bad debt expense.
This sum represents the estimated amount of accounts receivable that will become uncollectible.
Record this total as an expense on your income statement and as a contra-asset on your balance sheet, effectively reducing your overall accounts receivable balance.
6. Consideration of Additional Factors
While applying the aging method, keep in mind that other factors can impact the accuracy of your estimation.
Economic conditions, changes in industry trends, and specific customer circumstances should be considered.
Regularly review and update your estimation percentages to ensure they remain reliable in changing economic and market conditions.