Definition: Aging of accounts receivable is the process of sorting receivables by their due dates in an effort to estimate the amount of uncollectible accounts. In other words, the aging process classifies the existing past due receivables into categories based on their past due date in an attempt to estimate an allowance to each account. The older receivables are obviously less likely to be collected than the newer ones and consequently get higher allowance estimates.
What Does Aging Accounts Receivable Mean?
Typically the aging of accounts receivable method uses both the current and past information about each account to estimate the allowances. A standard aging schedule splits receivables into five different categories: not current due, 1 – 30 days past due, 31 – 60 days past due, 61 – 90 day past due, and over 90 days past due. Based on these categories management establishes an allowance for each account.
Let’s look at an example.
KPMM, LLC is a public accounting firm that bills clients after a tax return has been prepared. The clients are required to pay their invoice with 30 days of receiving it. KPMM has five different clients with a 100 balance owed—one in each category listed above.
Management wants to remove bad debts from the books in an effort to clean up the accounts receivable system. Based on their past experience, they estimate that the following percentages of receivables will be uncollected from each category: 2%, 5%, 10%, 25%, and 40%. This means that the client who is over 90 days past due will most likely not pay 40% of his original invoice.
The total estimated uncollectable amount for all five clients equals $82. The allowance for doubtful accounts would be adjusted to reflect this new uncollectible estimate. Management usually goes through this process at the end of each accounting cycle to ensure that the allowance and accounts receivable accounts are accurately stated on the financial statements.