How does the aging of accounts receivable determine bad debts expense?

Definition of Aging of Accounts Receivable

The aging of accounts receivable sorts the amounts that a company is owed (from customers who had purchased goods or services on credit) into columns with headings such as: current, 1-30 days past due, 31-60 days past due, etc.

A receivable that is current (not past due) is usually not a problem. However, when customers are past due it is a sign that they are experiencing some financial difficulties. The greater the amount of time they are past due, the greater the possibility they will not pay the amount they owe the company.

Good accounting requires the company to have an Allowance for Doubtful Accounts to report a credit balance for the estimated amount of the accounts receivable that will not be collected. When a company needs to adjust the credit balance in the Allowance account to a larger amount, the company will debit Bad Debts Expense and credit Allowance for Doubtful Accounts for the amount necessary to have a sufficient credit balance.

Example of the Aging of Accounts Receivable and Bad Debts Expense

Assume that a company has a debit balance in Accounts Receivable of $120,000 and has a credit balance of $1,000 in Allowance for Doubtful Accounts. This indicates that the net realizable value of its accounts receivable is $119,000.

When reviewing an aging of the accounts receivable, the company discovers it has more past due customers and estimates that $8,000 of the accounts receivable will never be collected. Therefore, the company must increase the credit balance in the Allowance account by $7,000 with an accounting entry that debits Bad Debt Expense for $7,000 and credits Allowance for Doubtful Accounts for $7,000.

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