11-1. 11-2 CHAPTER11 Current Liabilities and Payroll Accounting.

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CHAPTER11Current Liabilities

and Payroll

Accounting

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PreviewofCHAPTER11

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Current liability is debt with two key features:

1. Company expects to pay the debt from existing

current assets or through the creation of other

current liabilities.

2. Company will pay the debt within one year or the

operating cycle, whichever is longer.

SO 1 Explain a current liability, and identify the SO 1 Explain a current liability, and identify the major types of current liabilities.major types of current liabilities.

Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries

payable, and interest payable.

Accounting for Current Liabilities

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To be classified as a current liability, a debt must be

expected to be paid:

a. out of existing current assets.

b. by creating other current liabilities.

c. within 2 years.

d. both (a) and (b).

Question

SO 1 Explain a current liability, and identify the SO 1 Explain a current liability, and identify the major types of current liabilities.major types of current liabilities.


11-6 SO 2 Describe the accounting for notes payable.SO 2 Describe the accounting for notes payable.

Notes Payable

Written promissory note.

Requires the borrower to pay interest.

Issued for varying periods.


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Illustration: First National Bank agrees to lend $100,000 on

September 1, 2012, if Cole Williams Co. signs a $100,000,

12%, four-month note maturing on January 1.

Instructions

a) Prepare the entry on September 1st.

b) Prepare the adjusting entry on Dec. 31st, assuming

monthly adjusting entries have not been made.

c) Prepare the entry at maturity (Jan. 1, 2013).

SO 2 Describe the accounting for notes payable.SO 2 Describe the accounting for notes payable.


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Notes payable

100,000

Cash 100,000

Interest payable

4,000

Interest expense 4,000

$100,000 x 12% x 4/12 = $4,000

b) Prepare the adjusting entry on Dec. 31st.






a) Prepare the entry on Sept. 1st.

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Cash

104,000






c) Prepare the entry at maturity.

Interest payable 4,000

Notes payable 100,000

11-10 SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.

Sales Tax Payable

Sales taxes are expressed as a stated percentage

of the sales price.

Either rung up separately or included in total

receipts.

Retailer collects tax from the customer.

Retailer remits the collections to the state’s

department of revenue.


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Illustration: The March 25 cash register reading for Cooley

Grocery shows sales of $10,000 and sales taxes of $600 (sales

tax rate of 6%), the journal entry is:

Sales revenue

10,000

Cash 10,600

Sales tax payable

600

SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.


11-12 SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.

Unearned Revenue

Revenues received before the company

delivers goods or

provides services.


Illustration 11-2

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Illustration: Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The university makes the following entry for the sale of season tickets:


Unearned ticket revenue

500,000

Cash 500,000Aug. 6

Ticket revenue

100,000

Unearned ticket revenue 100,000Sept. 7

As the school completes each of the five home games, it would record the revenue earned.


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Current Maturities of Long-Term Debt

Portion of long-term debt that comes due in the

current year.

No adjusting entry required.



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Statement Presentation and AnalysisIllustration 11-3


SO 4SO 4

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Working capital is calculated as:

a. current assets minus current liabilities.

b. total assets minus total liabilities.

c. long-term liabilities minus current liabilities.

d. both (b) and (c).

Question

SO 4 Explain the financial statement presentation SO 4 Explain the financial statement presentation and analysis of current liabilities.and analysis of current liabilities.


11-17SO 4 Explain the financial statement presentation

and analysis of current liabilities.

Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for

cash.

Current ratio permits us to compare the liquidity of different-sized companies and of a single company

at different times.

Illustration 11-5

Illustration 11-4


Statement Presentation and Analysis

11-18SO 5 Describe the accounting and disclosure

requirements for contingent liabilities.

Potential liability that may become an actual liability in the future.

Three levels of probability:

Probable.

Reasonably possible.

Remote.

Contingent Liabilities

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AccountingProbability

Accrue

Footnote

Ignore

Probable

ReasonablyPossible

Remote

SO 5 Describe the accounting and disclosure requirements for contingent liabilities.


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A contingent liability should be recorded in the accounts when:

a. it is probable the contingency will happen, but the amount cannot be reasonably estimated.

b. it is reasonably possible the contingency will happen, and the amount can be reasonably estimated.

c. it is probable the contingency will happen, and the amount can be reasonably estimated.

d. it is reasonably possible the contingency will happen, but the amount cannot be reasonably estimated.

Question



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Product Warranties

Promise made by a seller to a buyer to make good on

a deficiency of quantity, quality, or performance in a

product.

Recording a Contingent Liability

Estimated cost of honoring product warranty contracts

should be recognized as an expense in the period in

which the sale occurs.



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Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2012, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, compute the estimated warranty liability.

SO 5

Illustration 11-6Computation of estimatedproduct warranty liability


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Warranty expense 40,000


Warranty liability 40,000


Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2012, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, compute the estimated warranty liability. Make the required adjusting entry.

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Illustration: Prepare the entry to record the repair costs incurred in 2012 to honor warranty contracts on 2012 sales.



Repair parts 24,000

Assume that the company replaces 20 defective units in January 2013, at an average cost of $80 in parts and labor.


Repair parts 1,600


11-26SO 5 Describe the accounting and disclosure

requirements for contingent liabilities.


Disclosure of Contingent Liabilities

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“Payroll” pertains to both:

Salaries - managerial, administrative, and sales

personnel (monthly or yearly rate).

Wages - store clerks, factory employees, and manual

laborers (rate per hour).

Involves computing three amounts: (1) gross earnings,

(2) payroll deductions, and (3) net pay.

Payroll Accounting

Determining the Payroll

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Total compensation earned by an employee (wages or

salaries, plus any bonuses and commissions).

Gross Earnings

SO 6 Compute and record the payroll for a pay period.

Illustration 11-8


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Mandatory:

FICA tax

Federal income tax

State income tax

Payroll Deductions


Voluntary:

Charity

Insurance

Union dues

Pension plans


11-30 SO 6 Compute and record the payroll for a pay period.

Social Security taxes

Supplemental retirement, employment disability, and medical benefits.

In 2010, the rate was 7.65% (6.2% Social Security plus 1.45% Medicare) on the first $106,800 of gross earnings for each employee. For purpose of illustration, assume a rate of 8% on the first $100,000 of gross earnings, maximum of $8,000.


Payroll Deductions

Mandatory:

FICA tax

Federal income tax

State income tax


Employers are required to withhold income taxes from employees’ pay.

Withholding amounts are based on gross wages and the number of allowances claimed.


Payroll Deductions

Mandatory:

FICA tax

Federal income tax

State income tax


Most states (and some cities) require employers to withhold income taxes from employees’ earnings.


Payroll Deductions

Mandatory:

FICA tax

Federal income tax

State income tax

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Gross earnings minus payroll deductions.

Net Pay


Illustration 11-11


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An employer must keep a cumulative record of each employee’s gross earnings, deductions, and net pay during the year.

Maintaining Payroll Department Records

Recording the Payroll

Illustration 11-12

SO 6

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Many companies find it useful to prepare a payroll register.

Maintaining Payroll Department Records


Illustration 11-13

SO 6

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Illustration: Prepare the entry Academy Company would make to record the payroll for the week ending January 14.

Recognizing Payroll Expenses and Liabilities


Salaries and wages expense 17,210.00

Federal income tax payable3,490.00

FICA tax payable1,376.80

State income tax payable344.20United Way payable421.50Union dues payable115.00Salaries and wages payable

11,462.50


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Illustration: Prepare the entry Academy Company would make to record the payment of the payroll.

Recording Payment of the Payroll


Salaries and wages payable 11,462.50

Cash

11,462.50



Illustration 11-14Paycheck and statement ofearnings


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Payroll tax expense results from three taxes that governmental agencies levy on employers.

SO 7 Describe and record employer payroll taxes.

These taxes are:

FICA tax

Federal

unemployment tax

State

unemployment tax

Same rate and maximum earnings as the employee’s.

In 2010, the rate was 7.65% (6.2% Social Security plus 1.45% Medicare) on the first $106,800 of gross earnings for each employee. For purpose of illustration, assume a rate of 8% on the first $100,000 of gross earnings, maximum of $8,000.

Employer Payroll Taxes

11-40 SO 7 Describe and record employer payroll taxes.

FUTA tax rate is 6.2% of first $7,000 of taxable wages.

Employers who pay the state unemployment tax on a timely basis will receive an offset credit of up to 5.4%. Therefore, the net federal tax rate is generally 0.8%.



These taxes are:

FICA tax

Federal

unemployment tax

State

unemployment tax

11-41 SO 7 Describe and record employer payroll taxes.

SUTA basic rate is usually 5.4% on the first $7,000 of wages paid.



These taxes are:

FICA tax

Federal

unemployment tax

State

unemployment tax

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Illustration: Academy records the payroll tax expense associated with the January 14 payroll with the following entry. Use the following rates: FICA 8%, state unemployment 5.4%, federal unemployment 0.8%.

Payroll tax expense 2,443.82

State unemployment tax payable929.34

FICA tax payable1,376.80

** $17,210.00 x 5.4% = $929.34

* $ 17,210.00 x 8% = $1,376.80

Federal unemployment tax payable 137.68

*

*** $17,210 x .8% = $137.68

**

***



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Employer payroll taxes do not include:

a. Federal unemployment taxes.

b. State unemployment taxes.

c. Federal income taxes.

d. FICA taxes.

Question



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Companies must report FICA taxes and federal income

taxes withheld no later than one month following the close

of each quarter.

Companies generally file and remit federal unemployment

taxes annually on or before January 31 of the subsequent

year. Companies usually file and pay state unemployment

taxes by the end of the month following each quarter.

Employers must provide each employee with a Wage and

Tax Statement (Form W-2) by January 31.


Filing and Remitting Payroll Taxes

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As applied to payroll, the objectives of internal control are

1. to safeguard company assets against unauthorized payments of payrolls, and

2. to ensure the accuracy and reliability of the accounting records pertaining to payrolls.

SO 8 Discuss the objectives of internal control for payroll.

Internal Control for Payroll

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In addition to the three payroll-tax fringe benefits, employers incur other substantial fringe benefit costs.

Two important fringe benefits include:

Paid absences

Post-retirement benefits

SO 9 Identify additional fringe benefits associated with employee compensation.

APPENDIXAPPENDIX11AAdditional Fringe Benefits

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Employees often are given rights to receive compensation

for absence when they meet certain conditions of

employment.

The compensation may be for paid vacations, sick pay

benefits, and paid holidays.

When the payment for such absences is probable and the

amount can be reasonably estimated, the company

should accrue a liability for paid future absences.

When the amount cannot be reasonably estimated, the

company should instead disclose the potential liability.

Paid Absences


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Post-retirement benefits are benefits that employers provide to retired employees for

1. pensions and

2. health care and life insurance.

Companies account for post-retirement benefits on the accrual basis.

APPENDIX


Post-Retirement Benefits

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A pension plan is an agreement whereby employers provide

benefits to employees after they retire.

Two types of pension plans:

1. In a defined-contribution plan, the plan defines the

contribution that an employer will make but not the benefit that

the employee will receive at retirement. This is often referred

to as a 401 (k) plan.

2. In a defined-benefit plan, the employer agrees to pay a

defined amount to retirees, based on employees meeting

certain eligibility standards.


Pensions

Post-Retirement Benefits

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Key Points

The basic definition of a liability under GAAP and IFRS is very similar. In a more technical way, liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an out flow from the entity of resources embodying economic benefits. Liabilities may be legally enforceable via a contract or law but need not be; that is, they can arise due to normal business practice or customs.

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Key Points

IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions). When current liabilities (also called short-term liabilities) are presented, they are generally presented in order of liquidity.

Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months.

Companies sometimes show liabilities before assets. Also, they will sometimes show long-term liabilities before current liabilities.

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Key Points

Under IFRS, companies sometimes will net current liabilities against current liabilities to show working capital on the face of the statement of financial position. (This is evident in the Zetar financial statements in Appendix C.)

Under GAAP, some contingent liabilities are recorded in the financial statements, others are disclosed, and in some cases no disclosure is required. Unlike GAAP, IFRS reserves the use of the term contingent liability to refer only to possible obligations that are not recognized in the financial statements but may be disclosed if certain criteria are met.

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Key Points

For those items that GAAP would treat as recordable contingent liabilities, IFRS instead uses the term provisions. Provisions are defined as liabilities of uncertain timing or amount. Examples of provisions would be provisions for warranties, employee vacation pay, or anticipated losses. Under IFRS, the measurement of a provision related to a uncertain obligation is based on the best estimate of the expenditure required to settle the obligation.

IFRS and GAAP separate plans into defined benefit and defined contribution. The IASB and FASB are working on a joint project on pensions that will dramatically change the approach used by both.

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Looking to the Future

The FASB and IASB are currently involved in two projects, each of

which has implications for the accounting for liabilities. One

project is investigating approaches to differentiate between debt

and equity instruments. The other project, the elements phase of

the conceptual framework project, will evaluate the definitions of

the fundamental building blocks of accounting. The results of

these projects could change the classification of many debt and

equity securities.

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Which of the following is false?

a) Under IFRS, current liabilities must always be presented

before non-current liabilities.

b) Under IFRS, an item is a current liability if it will be paid

within the next 12 months.

c) Under IFRS, current liabilities are shown in order of

liquidity.

d) Under IFRS, a liability is only recognized if it is a present

obligation.

IFRS Self-Test Questions

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Under IFRS, a contingent liability is:

a) disclosed in the notes if certain criteria are met.

b) reported on the face of the financial statements if certain

criteria are met.

c) the same as a provision.

d) not covered by IFRS.


11-59

Under IFRS, obligations related to warranties are considered:

a) contingent liabilities.

b) provisions.

c) possible obligations.

d) None of these.


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11-1. 11-2 CHAPTER11 Current Liabilities and Payroll Accounting.

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