The aging of accounts receivable method estimates bad debt by:

Question

Accepted Answer

Categorizing receivables by how long they have been outstanding and applying increasing percentages. The aging of accounts receivable method (also called the balance sheet approach) estimates bad debt by categorizing outstanding receivables into age groups  -  typically current, 1-30 days past due, 31-60 days past due, 61-90 days past due, and over 90 days past due. Increasing uncollectibility percentages are applied to each category because older receivables are less likely to be collected. The total estimated uncollectible amount becomes the desired ending balance of the Allowance for Doubtful Accounts.

The first option describes the percentage of sales method (income statement approach), which applies a single percentage to credit sales. The third option describes the direct write-off method, which is not GAAP-compliant for most companies. The fourth option uses historical actual write-offs as a prediction method but is not the aging method.

The aging method is considered more accurate than the percentage of sales method because it examines the actual composition of receivables and applies different risk rates based on how overdue they are. On the CLEP exam, you should know how to perform the aging calculation: multiply each category's balance by its estimated uncollectibility percentage, sum the results to get the desired allowance balance, then compute the adjusting entry as the difference between the desired balance and the existing balance in the allowance account. This balance sheet approach focuses on getting the correct allowance balance, while the percentage of sales method focuses on getting the correct expense amount.

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