How to Calculate Bad Debt Expense Using the Aging Method

Bad debt expense represents money owed to a business that is unlikely to be collected. Businesses extend credit to customers, anticipating payment. However, some customers may face financial difficulties, making their outstanding balances uncollectible. Accounting for bad debt is a necessary practice to accurately reflect a company’s financial health; without such accounting, a company’s financial statements might overstate its assets and revenue. The aging method is a widely used technique to estimate this uncollectible amount, ensuring financial reports provide a more realistic picture.

Understanding Accounts Receivable Aging

Accounts receivable represents the money customers owe a business for products or services purchased on credit. To effectively manage these outstanding amounts and estimate potential uncollectible balances, businesses utilize a process called accounts receivable aging. This involves categorizing outstanding invoices based on how long they have been due.

Aging involves sorting unpaid customer invoices into distinct timeframes or categories. Common age categories include current (not yet due or within 30 days), 1-30 days past due, 31-60 days past due, 61-90 days past due, and over 90 days past due. This categorization is crucial because the probability of collecting an invoice generally decreases as it ages.

Creating an aging schedule involves listing each customer’s outstanding balance and placing it into the appropriate age category. For example, a simplified aging schedule might look like this:

Accounts Receivable Aging Schedule Example

| Customer | Total Due | Current (0-30 days) | 31-60 Days Past Due | 61-90 Days Past Due | Over 90 Days Past Due |
| :——- | :——– | :—————— | :—————— | :—————— | :——————- |
| Alpha Co. | $15,000 | $10,000 | $5,000 | | |
| Beta Inc. | $8,000 | $3,000 | | $5,000 | |
| Gamma LLC | $7,000 | | $2,000 | | $5,000 |
| Total | $30,000 | $13,000 | $7,000 | $5,000 | $5,000 |

This schedule organizes the data, highlighting which accounts are current and which are increasingly overdue. It serves as the foundational document for the next step, where specific uncollectibility percentages will be applied to each category.

Estimating Uncollectible Accounts

Once accounts receivable have been organized into an aging schedule, the next step involves estimating the portion of each age category that is likely to be uncollectible. This is achieved by assigning a different percentage of uncollectibility to each age category. These percentages are derived from a business’s historical collection experience, industry averages, and management’s judgment regarding current economic conditions and customer solvency.

The calculation begins by multiplying the total amount in each age category by its assigned uncollectibility percentage. Summing these estimated uncollectible amounts across all age categories provides the total estimated uncollectible accounts. This total represents the desired ending balance for the Allowance for Doubtful Accounts, a contra-asset account on the balance sheet.

Estimated Uncollectible Accounts Calculation

| Age Category | Total Amount | Uncollectibility % | Estimated Uncollectible Amount |
| :——————- | :———– | :—————– | :—————————– |
| Current (0-30 days) | $13,000 | 1% | $130 |
| 31-60 Days Past Due | $7,000 | 5% | $350 |
| 61-90 Days Past Due | $5,000 | 15% | $750 |
| Over 90 Days Past Due | $5,000 | 40% | $2,000 |
| Total | $30,000 | | $3,230 |

In this example, the total estimated uncollectible accounts amount to $3,230. This figure is the target balance for the Allowance for Doubtful Accounts. This target balance differs from the bad debt expense for the current period. The bad debt expense is the amount needed to adjust the existing balance in the Allowance for Doubtful Accounts to reach this target.

For instance, if the Allowance for Doubtful Accounts currently has a credit balance of $500, the bad debt expense for the period would be $2,730 ($3,230 target balance – $500 existing credit balance). If there was a debit balance, the expense would be higher to cover both the debit and reach the target credit balance.

Recording the Expense

After calculating the bad debt expense, the next step involves formally recording this amount through a journal entry. The standard journal entry to record bad debt expense involves a debit to Bad Debt Expense and a credit to Allowance for Doubtful Accounts.

For example, if the calculated bad debt expense is $2,730, the journal entry would be:

Debit: Bad Debt Expense $2,730
Credit: Allowance for Doubtful Accounts $2,730

Impact on Financial Statements

The Bad Debt Expense is an income statement account, and the debit increases this expense, thereby reducing the company’s net income. The Allowance for Doubtful Accounts is a contra-asset account, reducing the gross accounts receivable on the balance sheet. Crediting this account increases its balance, which in turn decreases the net realizable value of accounts receivable.

The impact of this entry extends to both the income statement and the balance sheet. On the income statement, the Bad Debt Expense is shown within operating expenses. On the balance sheet, the Allowance for Doubtful Accounts is directly subtracted from the Accounts Receivable, providing a net accounts receivable figure.