Click to edit Master title style 1 1 1 11 Current Liabilities and Payroll.

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Click to edit Master title style

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Current Current Liabilities and Liabilities and

PayrollPayroll

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1. Describe and illustrate current liabilities related to accounts payable, current portion of long-term debt, and notes payable.

2. Determine employer liabilities for payroll, including liabilities arising from employee earnings and deductions from earnings.

After studying this chapter, you should be able to:

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3. Describe the payroll accounting systems that use a payroll register, employee earnings records, and a general journal.

4. Journalize entries for employee fringe benefits, including vacation pay and pensions.


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5. Describe the accounting treatment for contingent liabilities and journalize entries for product warranties.


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Describe and illustrate current liabilities related to accounts payable, current portion of long-term debt,

and notes payable.

Objective 1Objective 1Objective 1Objective 1

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Liabilities that are to be paid out of current assets and are due within a

short time, usually within one year, are called current liabilities. Accounts payable Current portion of long-term debt Notes payable

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Accounts Payable

Accounts payable arise from purchasing goods or services for use

in a company’s operations or for purchasing merchandise for resale.

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Current Portion of Long-Term Debt

Long-term liabilities are often paid back in periodic payments, called installments. Installments that are due within the coming year must be

classified as a current liability.

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The total amount of the installments due after the

coming year is classified as a long-term liability.

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1010

Aug. 1 Accounts Payable—Murray Co. 1 000 00

Issued a 90-day, 12% note on

account.

Notes Payable 1 000 00

A firm issues a 90-day, 12% note for $1,000, dated August 1, 2008 to Murray

Co. for a $1,000 overdue account.

Short-Term Notes Payable 11-1

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On October 30, when the note matures, the firm pays the $1,000 principal plus $30

interest ($1,000 x 12% x 90/360).

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Oct. 30 Notes Payable 1 000 00

Interest Expense 30 00

Paid principal and

interest on note.

Cash 1 030 00

Appears on the Appears on the income statement as income statement as an “Other Expense.”an “Other Expense.”

Appears on the Appears on the income statement as income statement as an “Other Expense.”an “Other Expense.”

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On May 1, Bowden Co. (borrower) purchased

merchandise on account from Coker Co. (creditor), $10,000,

2/10, n/30. The merchandise cost Coker Co. $7,500.

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Description Debit Credit

Bowden Co. (Borrower)

Mdse. Inventory 10,000Accounts Payable 10,000

Coker Co. (Creditor)


Accounts Receivable 10,000Sales 10,000

Cost of Mdse. Sold 7,500Mdse. Inventory 7,500

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On May 3, Bowden Co. issued a 60-day, 12% note for $10,000 to

Coker Co. on account.

Accounts Payable 10,000Notes Payable 10,000



Notes Receivable 10,000Accounts Receivable 10,000



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On July 30, Bowden Co. paid Coker Co. the

amount due on the note of May 31. Interest:

$10,000 x 12% x 60/360.

Notes Payable 10,000Interest Expense 200

Cash 10,200



Cash 10,200Interest Revenue 200Notes Receivable 10,000



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On September 19, a firm borrows $4,000 from First National Bank by giving the

bank a 90-day, 15% note.

Sept. 19 Cash 4 000 00

Notes Payable

4 000 00Issued a 90-day, 15% note

to the bank.

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On the due date of the note (December 18), the borrower owes $4,000 plus

interest of $150 ($4,000 x 15% x 90/360).

Dec. 18 Notes Payable 4 000 00

Cash

4 150 00Paid principal and interest

due on note.


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The interest set by the creditor when a note does not specify the rate is

called the discount. The rate used in computing the discount is called the

discount rate. The borrower is given the remainder (face – discount),

called the proceeds.

Discounting a Note 11-1

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On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for

inventory. Rock discounts the note at 15%.

Aug. 10 Merchandise Inventory 19 250 00

Notes Payable

20 000 00Issued a 90-day note to Rock

Co., discounted at 15%.


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On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for

inventory. Rock discounts the note at 15%.

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Aug. 10 Merchandise Inventory 19 250 00

Notes Payable

20 000 00Issued a 90-day note to Rock

Co., discounted at 15%.


Discount: $20,000 Discount: $20,000 x .15 x 90/360x .15 x 90/360

Discount: $20,000 Discount: $20,000 x .15 x 90/360x .15 x 90/360

Discount rateDiscount rateDiscount rateDiscount rate

ProceedsProceedsProceedsProceeds

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On November 8 the note is paid in full.

Nov. 8 Notes Payable 20 000 00

Cash

20 000 00Paid note due.

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Example Exercise 11-1

On July 1, Bella Salon Company issued a 60-day note with a face amount of $60,000 to Delilah Hair Products Company. for merchandise inventory.

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a. Determine the proceeds of the note assuming the note carries an interest rate of 6%.

b. Determine the proceeds of the note assuming the note is discounted at 6%.

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23For Practice: PE 11-1A, PE 11-1B 23

Follow My Example 11-1

a. $60,000

b. $59,400 [$60,000 – ($60,000 x 6% x 60/360)]

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Determine employer liabilities for payroll,

including liabilities arising from employee earnings and deductions from earnings.


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Payroll refers to the amount paid to employees for the services they provide during a period. It is usually significant for several reasons.

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1) Employees are sensitive to payroll errors and irregularities.

2) The payroll is subject to various federal and state regulations.

3) The payroll and related payroll taxes have a significant effect on the net income of most businesses.

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Wages usually refers to payment for manual labor, both skilled and unskilled. The rate of wages is normally stated on

an hourly or weekly basis.

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Salary usually refers to payment for managerial, administrative, or similar

services, normally expressed in terms of a month or a year.

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The total earnings of an employee for a payroll period are called gross pay. From this is subtracted one or more deductions to arrive at the net pay. Net pay is the amount that the employer must pay the employee.

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John T. McGrath is employed by McDermott Supply Co. at the rate of $34 per hour, plus 1.5 times the normal hourly rate for hours over 40 per week. For the week ended December 27,

McGrath worked 42 hours.

Earnings at base rate (40 x $34) $1,360Earnings at overtime rate (2 x $51) 102Total earnings $1,462

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McGrath Illustration

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For this illustration assume the standard withholding allowance of $63*. Thus,

the wages used in determining McGrath’s withholding for the week are

$1,399 ($1,462 – $63).

*The actual IRS standard withholding allowance changes every year and was $63.46 for 2006.

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Wage Bracket Withholding Table

Source: Publication 15, Employer’s Tax Guide, Internal Revenue Service, 2006

McGrath wage bracket

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McGrath Example (Continued)

Initial withholding

$ 78.30

Plus ($1,399 – $620) x 25%

194.75Total federal income taxes

withheld

$273.05

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Karen Dunn’s weekly gross earnings for the present week were $2,250. Dunn has two exemptions. Using the wage bracket withholding table in Exhibit 3 (Slide 31) with a $63 standard withholding allowance for each exemption, what is Dunn’s federal income tax withholding?

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For Practice: PE 11-2A, PE 11-2B


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Total wage payment $2,250One allowance (provided by IRS) $63Multiplied by allowances claimed on W-4 x 2 126Amount subject to withholding $2,124

Initial withholding from wage bracket $275.55Plus additional withholding: 28% of excess

over $1,409 200.20*Federal income tax withholding $475.75

*28% x ($2,124 – $1,409)

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FICA Tax 11-2

The amount of FICA tax withheld is the employees’ contribution to two

federal programs. The first program, called social security, is for old age, survivors, and disability insurance (OASDI). The second program,

called Medicare, is health insurance for senior citizens.

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Earnings subject to 6% social security tax ($100,000 – $99,038) $ 962Social security tax rate x 6%Social security tax

$57.72Earnings subject to 1.5%

Medicare tax $1,462Medicare tax rate x 1.5%

Medicare tax 21.93Total FICA tax$79.65

John T. McGrath’s FICA Tax

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Computing McGrath’s Net Pay 11-2

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John T. McGrath’s net pay:

Gross earnings for the week $1,462.00 Deductions:

Social security tax (Slide 37) $ 57.72Medicare tax (Slide 33) 21.93Federal income tax (Slide 33) 273.05Retirement savings 20.00United Way 5.00 Total deductions 377.70

Net pay $1,084.30

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Karen Dunn’s weekly gross earnings for the week ending Dec. 3rd were $2,250, and her federal income tax withholding was $475.75. Prior to this week Dunn had earned $98,000 for the year. Assuming the social security rate is 6% on the first $100,000 of annual earnings and Medicare is 1.5% of all earnings, what is Dunn’s net pay?

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39For Practice: PE 11-3A, PE 11-3B


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Total wage payment $2,250.00Less: Federal income tax withholding 475.75

Earnings subject to social securitytax ($100,000 – $98,000) $2,000Social security tax rate x 6%Social security tax 120.00Medicare tax ($2,250 x 1.5%) 33.75

Net pay $1,620.50

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Employer’s Federal Payroll Taxes 11-2

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Employers are required to contribute to the social security and Medicare programs for each employee. The employer must

match the employee’s contribution to each program.

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A FUTA tax of 6.2% is levied on employers only to provide for

temporary unemployment to those who become unemployed as a result of layoffs due to economic causes

beyond their control. This tax applies to only the first $7,000 of the earnings

of each covered employee during a calendar year.

Employer’s Federal Unemployment Taxes

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Employer’s State Unemployment Taxes

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Employers in most states also must pay a state unemployment tax for

unemployed workers. A few states require employee contributions. The state plan is designed to reward firms

with stable employment, so the tax rate varies from state to state and

employer to employer.

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Describe payroll accounting systems that use a payroll

register, employee earnings records, and a general journal.


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Payroll Register 11-3

The payroll register is a multicolumn report used for summarizing the data for

each payroll period. The last two columns of the payroll register are used to accumulate the total wages or salaries

to be debited to various expense accounts. The process is usually called

payroll distribution.

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Payroll Register

(Continued)

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(Concluded)

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Recording Employees’ Earnings 11-3

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Dec. 27 Sales Salaries Expense 11 122 00

Office Salaries Expense 2 780 00

Payroll for week ended

December 27.

Social Security Tax Payable 643 07Medicare Tax Payable

208 53Employees’ Federal Inc. Tax Pay. 3 332 00Retirement Savings Ded. Payable 680 00United Way Deductions Payable 470 00Accounts Receivable—Fred Elrod 50 00Salaries Payable 8 518 40

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The payroll register of Chen Engineering Services indicates $900 of social security withheld and $225 of Medicare tax withheld on total salaries of $15,000 for the period. Federal withholding for the period totaled $2,925.

Provide the journal entry for the period’s payroll.

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Salaries Expense 15,000Social Security Tax Payable 900Medicare Tax Payable 225Federal Withholding Tax Payable 2,925Salaries Payable 10,950

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Recording and Paying Payroll Taxes

Everson Company’s fiscal year ends on April 30. Everson Company owes it employees $26,000 of wages on December 31. The following portion of the $26,000 of wages are subject to payroll taxes on December 31:

Social Security Tax (6.0%) $18,000Medicare Tax (1.5%) 26,000State and Federal Unemployment

Compensation Tax 1,000

Earnings Subject to Payroll Taxes

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Data for McDermott Supply Co. payroll for the week ending December 27:

Social security tax $ 643.07Medicare tax 208.53State unemployment compensation

tax (5.4% x $2,710) 146.34Federal unemployment compensation

tax (0.8% x $2,710) 21.68 Total payroll tax expense $1,019.62

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Dec. 27 Payroll Tax Expense 1 019 62

Payroll taxes for week ended December 27.

Social Security Tax Payable 643 07Medicare Tax Payable 208 53State Unemployment Tax Payable 146 34Federal Unemployment Tax Pay. 21 68

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McDermott Supply Co.’s payroll entry on December 27 is recorded as follows:

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The payroll register of Chen Engineering Services indicates $900 of social security withheld and $225 of Medicare tax withheld on total salaries of $15,000 for the period. Assume earnings subject to state and federal unemployment compensation taxes are $5,250, at the federal rate of 0.8% and state tax of 5.4%.

Provide the journal entry to record the payroll tax expense for the period. 54

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Payroll Tax Expense 1,450.50Social Security Tax Payable 900.00Medicare Tax Payable 225.00State Unemployment Tax Payable 283.50*Federal Unemployment Tax Payable 42.00**

*$5,250 x 5.4% **$5,250 x 0.8%

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A detailed payroll record is maintained for each employee. This record is called an

employee’s earnings record.

At the end of each pay period, payroll checks are prepared. Each check includes a detachable statement showing the details

of how the net pay was computed.

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Employee’s Earnings Record

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(Continued)

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(Concluded)

(Concluded)

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Payroll Check

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Journalize entries for employee fringe benefits, including vacation pay

and pensions.


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Many companies provide their employees a variety of benefits in

addition to salary and wages earned. Such fringe benefits may

take many forms, including vacations, medical, and

postretirement benefits, such as a pension plan.

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Benefit Dollars as a Percent of Payroll Costs

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Most employers grant vacation rights, sometimes called compensated absences, to their

employees. The estimated vacation pay for the payroll period ending May 5 is $2,000.

Vacation Pay

May 5 Vacation Pay Expense 2 000 00

Vacation Pay Payable 2 000 00

Vacation pay for week

ended May 5.

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Pensions

A pension represents a cash payment to retired employees. Rights to pension payments are earned by employees during their working years, based on the pension plan

established by the employer.

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In a defined contribution plan, a fixed amount of

money is invested on the employee’s behalf during the employee’s working years.

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The pension plan of Heaven Scent Perfumes Company requires an

employer contribution of 10% of employee monthly salaries. December salaries totaled

$500,000, so $50,000 was sent to the employees’ plan administrator.

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Defined Contribution Plan

Dec. 31 Pension Expense 50 000 00

Cash 50 000 00

Contributed 10% of

monthly salaries to

pension plan.

The entry to record the payment to the plan administrator is—

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Pensions

In a defined benefit plan, employers promise employees a fixed annual pension benefit at retirement, based on years of

service and compensation levels.

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Defined Benefit Plan 11-4

Assume that Hinkle Co. requires an annual pension cost of $80,000 based on an estimate of

the future benefit obligation. Hinkle pays $60,000 into the pension fund.

Dec. 31 Pension Expense 80 000 00

Cash 60 000 00

Unfunded Pension Liability 20 000 00

To record annual

pension cost and

contribution to pension

plan.

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Postretirement Benefits Other Than Pensions

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Employees may earns rights to other postretirement benefits, such as dental care, eye care, medical care, life insurance,

tuition assistance, tax services, and legal services.

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Manfield Service, Inc. provides their employees vacation benefits and a defined contribution pension plan. Employees earned vacation pay of $44,000 for the period. The pension plan requires a contribution to the plan administrator equal to 8% of employee salaries. Salaries were $450,000 during the period.

Provide the journal entry for (a) the vacation pay and (b) pension benefit.

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a. Vacation Pay Expense 44,000Vacation Pay Payable 44,000

Vacation pay accrued for the period.

b. Pension Expense 36,000Cash 36,000

Pension contribution, 8% of$450,000 salary.

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Describe the accounting treatment for contingent liabilities and journalize

entries for product warranties.


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Some past transactions will result in liabilities if certain events occur in the future. These

potential obligations are called contingent liabilities.

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During June, a company sells a product for $60,000 on which there is a 36-month warranty. Past experience

indicates that the average cost to repair defects is 5% of the sales price over the warranty price.

June 30 Product Warranty Expense 3 000 00

Warranty expenses projected

for June, 5% of $60,000.

Product Warranty Payable 3 000 00

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Contingent Liabilities

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If a customer required a $200 part replacement on August 16, the entry would be:

Aug. 16 Product Warranty Payable 200 00

Replaced defective part under

warranty.

Supplies 200 00

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Likelihood of Occurring

Measurement

Accounting Treatment

ProbableProbable Estimable

Record and Disclose Liability

Not Estimable

Disclose Liability

Disclose Liability

Contingency

PossiblePossible

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Accounting Treatment of Contingent Liabilities

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Cook-Rite Co. sold $140,000 of kitchen appliances during August under a 6 month warranty. The cost to repair defects under the warranty is estimated at 6% of the sales price. On September 11 a customer required a $200 part replacement, plus $90 labor under the warranty.

Provide the journal entries for (a) the estimated warranty expense on August 31 and (b) the September 11 warranty work.

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a. Product Warranty Expense 8,400Product Warranty Payable 8,400

To record warranty expense for August, 6% x $140,000.

b. Product Warranty Payable 290Supplies 200Wages Payable 90

Replaced defective part underwarranty.

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Noble Co. Hart Co.Quick assets:

Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

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Quick Ratio

Quick assets

Current liabilitiesQuick Ratio =

The quick ratio or acid-test ratio can be used to evaluate a firm’s ability to pay its current

liabilities within a short period of time.

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Quick Ratio

Quick assets


Quick assets:Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000


Noble Co. Hart Co.

Noble Company =$231,000

$220,000= 1.05

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Quick assets


Quick assets:Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000


Noble Co. Hart Co.

Hart Company =$592,000

$740,000= 0.80

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Interpretation

Noble Company is in a better quick ratio position than Hart Company. By having a quick ratio in excess of 1, Noble Company has quick assets sufficient to cover the company’s current liabilities. This is not true

for Hart Company.

Click to edit Master title style 1 1 1 11 Current Liabilities and Payroll.

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