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ACCT 201

Current Liabilities and Payroll

Chapter 11

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Objective 1

Account for current liabilitiesof known amount.

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Accounts Payable...…are amounts owed to suppliers for goods

or services purchased on account.• Accounts payable do not bear interest

expense for the debtor.

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Accounts Payable Example• Suppose that on June 3, Lloyd’s Sporting

Store purchased $1,000 of goods on account from Patti Wholesaler.

• What is the journal entry?

Inventory 1,000 Accounts Payable 1,000

Purchase on account

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Short-Term Notes Payable...…are promissory notes payable due within

one year.• In addition to recording the note payable,

the business must also pay interest expense.

• If interest expense is accrued at the end of the period, interest payable must also be recorded.

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Short-Term Notes Payable Example

• On April 30, Patti purchased inventory for $10,000 by issuing a 90-day, 10% note payable.

• What is the journal entry?

Inventory 10,000Notes Payable 10,000

Purchase inventory on a 90-day, 10% note

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Short-Term Notes Payable Example

• Assume the accounting period ended May 31.

• How much interest was accrued as of May 31?

• $10,000 × 10% × 31/360 = $86.11• How does Patti record the payment at

maturity?

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Short-Term Notes Payable Example

July 29Note Payable 10,000.00Interest Payable 86.11Interest Expense 163.89

Cash 10,250.00

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Sales Tax Payable Example• Most states levy a sales tax on retail sales.• Suppose that a store sold $3,000 worth of

merchandise on a given Saturday.• The business collected an additional 5%

in sales tax.• How much is the sales tax liability?• $150

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Accrued Expenses (Liabilities)...

– are expenses that have been incurred but not recorded.

– salaries– taxes withheld– interest– utilities

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Payroll Liabilities

Salary Expense 10,000Employee Income Tax Payable 1,200FICA Tax Payable 800Employee Union Dues Payable 140Salary Payable 7,860

To record salary expense

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Unearned Revenue Example• Assume that on June 1, Dennis’s

Landscaping collected $1,500 for services to be provided during the months of June, July, and August.

June 1Cash 1,500

Unearned Revenue 1,500Received cash in advance

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Unearned Revenue Example• What entry does Dennis record on June

30?

June 30Unearned Revenue 500

Service Revenue 500Earned service revenue that was collectedin advance

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Objective 2

Account for Current LiabilitiesThat Must be Estimated.

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Estimated Warranty Payable• The matching principle demands that the

company record the warranty expense in the same period that the business recognizes sales revenue.

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Estimated Warranty Payable Example

• Patti Wholesaler made sales of $1,000,000 subject to product warranties.

• In the past years, claims have averaged 2%.

Warranty Expense 20,000Estimated Warranty Payable 20,000

To accrue warranty expense

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Estimated Warranty Payable Example

• On January 28, a customer returned a defective product and was given a $300 refund.

Estimated Warranty Payable 300Cash 300

To record refund under warranty

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Estimated Vacation PayLiability Example

• Suppose Lloyd’s Sporting Store has a March payroll of $10,000 and vacation pay adds 4% (2 weeks of annual vacation divided by 50 workweeks each year).

• How much vacation pay should be accrued?

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Estimated Vacation PayLiability Example

March 31Vacation Pay Expense 400

Estimated Vacation Pay Liability 400To accrue vacation expense

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Contingent Liability• Report a contingent liability in the notes to

the financial statement if it is reasonably possible that a loss or expense will occur.

• The FASB says to record an actual liability if it is probable that the business has suffered a loss and its amount can be reasonably estimated.

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Contingent vs. Current Liability

• Suppose a hospital has lost a court case for uninsured malpractice.

• The hospital estimates that the liability will fall between $1.5 and $2.5 million.

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Contingent vs. Current Liability

• The hospital must record a loss and a liability of $1.5 million.

• The hospital must disclose in a note the possibility of an additional $1.0 million loss.

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Objective 3

Compute Payroll Amounts.

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Payroll• Straight time is the base rate paid to

employees for a set number of hours.• Overtime is additional time worked by

employees for which they received a higher rate (usually 1.5 times the straight time rate).

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Gross Pay and Net Pay

Gross Pay Deductions Net Pay

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FICA Tax

• The FICA tax has two components:1 Old age, survivors’, and disability insurance

(6.2% applied to the first $87,000 of employee earnings in a year)

2 Health insurance (1.45% applied to all employee earnings)

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Employer Payroll Taxes• Social Security (FICA) tax• State unemployment compensation tax• Federal unemployment compensation tax

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Unemployment Compensation Taxes

• Employers paid 5.4% to the states and 0.8% to the federal government on the first $7,000 of each employee’s annual earnings.

• The state government uses the money to pay unemployment benefits to people who are out of work.

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Breakdown of Payroll Costs

Employer disburses $1,200

Employer cost of healthcare to insurance co.

$90

Employer payroll taxesto government

$110

Net pay toemployee

$750

Employee payrolltaxes to government

$230

Employeeunion dues

$20

Employee Gross Pay – $1,000

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Objective 4

Record Basic Payroll Transactions.

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Salary Expense• Salary expense to the employer is the

gross salary of all employees.• Employees pay their own income and

FICA taxes as well as union dues.• The employer serves as a collecting agent

and sends these amounts to the government and union.

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To Record Salaries Expense:

Salary ExpenseEmployee Income Tax PayableFICA Tax PayableEmployees Union Dues PayableSalary Payable to Employees (take-home pay)

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To Record Salaries Expense:

Payroll Tax ExpenseFICA Tax PayableState Unemployment Tax PayableFederal Unemployment Tax Payable

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To Record Salaries Expense:

Health Insurance Expense for EmployeesLife Insurance Expense for EmployeesPension Expense

Employee Benefits Payable

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Objective 5

Use a Payroll System.

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Payroll System Components– payroll record– special payroll bank account– payroll checks– earnings record for each employee

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Payroll Record...– is also referred to as the payroll journal.• It lists payroll data for each employee.• It serves as a check register.• It provides information for recording payroll

expenses and related withholdings.

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Payroll Bank Account• When companies use a payroll bank

account, the company draws a check for the net amount of salary payable to employees on its regular bank account.

• The company deposits this check in the special payroll bank account.

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Payroll Bank Account• The company writes paychecks to

employees out of the payroll account.• When the paychecks clear the bank, the

payroll account has a zero balance.• Disbursing paychecks from a separate

bank account isolates net pay for analysis and control.

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Recording Cash Disbursements

• When the employer pays the employees, the company debits Salary Payable to Employees and credits Cash.

• The liabilities to the government, unions, and other parties is also debited when cash is paid.

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Recording Cash Disbursements

• Assume the following journal entry was made at the end of an accounting period:

Salary Expense 180,000Employee Income Tax Payable 45,000FICA Tax Payable 11,160Employee Union Dues Payable 840Salary Payable to Employees 123,000

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Recording Cash Disbursements

• What is the journal entry when the employer pays these liabilities?

Employee Income Tax Payable 45,000FICA Tax Payable 11,160Employee Union Dues Payable 840Salary Payable to Employees 123,000

Cash 180,000

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Internal Control over Payrolls– controls for efficiency– controls for safeguarding payroll

disbursements

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Controls for Efficiency– making payroll disbursements from one

payroll account in one month and from another the next

– following established policies for hiring and firing employees

– complying with government regulations– testing employees for their interest in the

job and their skills to perform the job

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Controls for SafeguardingPayroll Disbursements

• Large organizations must establish controls to ensure that payroll disbursements are made only to legitimate employees.

• Duties of hiring and firing should be separated from the duties of accounting for payroll and distributing paychecks.

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Controls for SafeguardingPayroll Disbursements

• Requiring an identification badge bearing an employee’s photograph also helps internal control.

• A formal time-keeping system helps ensure that employees have actually worked.

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Objective 6

Report Current Liabilitieson the Balance Sheet.

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Report Current Liabilities• Companies report current liabilities on the

balance sheet.– Current liabilities of known amount

(payroll)– Current liabilities that must be estimated

(warranties)

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Report Current Liabilities• At the end of the year, companies report

the amount of payroll liabilities owed to all parties.

• The liability at year end is the amount of the payroll expense that is still unpaid.

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Liabilities Known When Recorded

– accounts payable– short-term notes payable– sales tax payable– current portion of long-term debt– accrued expenses payable– unearned revenues

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Liabilities EstimatedWhen Recorded

– warranty payable– income tax payable– vacation pay liability

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REVISION QUESTIONS

Chapter 11

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Dina Company issued a 60-day note payable on December 1. What adjusting entry should be

prepared on December 31?1. Debit cash, credit note payable2. Debit interest expense, credit note payable3. Debit interest expense, credit interest payable4. Debit interest payable, credit interest expense

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Answer: 3

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Emmett Company has a year-end of December 31 and issued a 60-day note payable on December 1. The entry to record the payment of the

note in January would include

1. A debit to interest payable2. A credit to note payable3. A debit to cash4. A credit to interest expense

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Answer: 1

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The adjusted trial balance for Young Company has the following liabilities:

Accounts payable $1,000Interest payable 500Notes Payable $5,000

The notes payable requires monthly principal payments of $100. What is the amount of total current liabilities?

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Answer: Current liabilitiesAccounts payable $1,000Interest payable 500

Currently maturing portion of Notes Payable ($100 X 12) 1,200 Total $2,700

The rest of the notes payable is reported under long-term liabilities.

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On Sept. 1, Revale Company collected $600 for six months’ rent in advance. The $600 was credited to Unearned

Rent. What is the December 31 adjusting entry?

1. Debit Cash $600, credit Unearned Rent $6002. Debit Rent Receivable $600, credit Rent Revenue $6003. Debit Unearned Rent $400, credit Rent Revenue $4004. Debit Rent Receivable $400, credit Rent Revenue $400

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Answer: 3Rent revenue for four months

= $400

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Warranty expense should be recorded:

1. In the period when the warranty claims are paid

2. In the period when the sale was recorded3. On the day of the sale4. When the warranty period expires

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Answer: 2 The matching principle dictates that the

expenses related to a sale be recognized in the same

accounting period as the sale.

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When recording Warranty Expense, what account is

credited?1. Cash2. Sales3. Estimated Warranty Revenue4. Estimated Warranty Payable

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Answer: 4

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When it is reasonably possible that a contingent liability will result in a realized loss, how

is it reported?

1. It is not reported2. Describe the situation in a note to the financial

statements3. Record an expense and liability based on

estimated amounts

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Answer: 2

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Which of the following is not a required payroll deduction?

1. Employee income tax2. FICA old age, survivors’, and disability

insurance tax3. FICA medicare tax4. Pension contribution

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Answer: 4

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The employer pays all of the following payroll taxes except:

1. FICA tax2. State unemployment tax3. Income tax4. Federal unemployment tax

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Answer: 3 Income tax is withheld from the employee’s paycheck. It is not

a tax paid by the employer.

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Which of these taxes has no maximum annual tax?

1. FICA old age, survivors’, and disability insurance tax

2. FICA medicare tax3. Federal unemployment tax4. State unemployment tax

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Answer: 2