Why Is an Accounts Receivable Aging Report Needed for an Audit?

Sometimes assets are an illusion.

Accounts receivable aging lies in the field of accounting that involves keeping track of assets that need to be written off. After a certain point after someone owes you money for a business operation, there is an increasing chance that he will not pay and as such this risk needs to be represented on the financial sheets.

Auditing

Accounting for accounts receivable aging is important for auditing due to the fact that if you do not reflect this value on your financial statements, it is hard to tell what financial state your company is in. A company with fewer accounts receivable that are well within a safe zone is much safer and more financially secure than a company with 10 times as many accounts receivables that have a 95 percent chance of not being paid. This metric avoids the illusion of financial health where it does not exist.

Accounts Receivable

Accounts receivable are a type of "current" (as opposed to long term) asset that reflects the amount of money other business entities or persons owe you for continuing business operations, such as selling them a certain number of T-shirts. Accounts receivable are usually due within a certain number of days which depend on the industry.
Accounts receivable as a category shows up in audits because it indicates how much other entities owe you and, combined with your total revenue and current cash, allows for calculations on how long it takes you to collect on accounts.

Write-offs

At certain points in a business, money will have to be removed from the financial statements due to write-offs. A company that has a consistent amount of write-offs, due to a consistent business cycle, often sets aside a separate asset category to hold a designated amount of cash to cover any write-offs and account for them ahead of time. Companies that do not account for write-offs ahead of time will have to pull them out of their liquid cash or other forms of assets that they may have been planning on using for other purposes. In financial statements and audits, write-offs are calculated in the expense column.

Quantifying Risk

After the due date for the payment of an account receivable, there is a certain period within the collection cycle from which the calculation of how likely the amount of money will be paid at all is made. For instance, if the collection cycle is 30 days, the risk may be 5 percent up to the end of the first 30 days after the money is due, 10 percent from 30 to 60 days and 15 percent from 60 to 90 days. Risk is used to calculate how much money is needed for allowance for bad debt.

Accounting

Once you know the risk of each account receivable not being paid (which depends heavily on the industry's specific collection times and risk values), you multiply the risk amount by the total amount at that risk to receive a value. Once you've summed up the total amount of risk (so 10 percent of $100 is $10, and 5 percent at $200 is $10, and so total would be $20 of estimated risk), you then create an asset category called allowance for bad debt equal to this amount.
As the time and risk increases, this column will also increase. This provides less shock to your financials and planning if the debt is never actually paid off, since you didn't consider that cash or property liquid.

References

• American Association of University Professors: Accounts Receivable