Prepared by: C. Douglas Cloud Professor Emeritus of AccountingPepperdine University
Current Liabilities and Payroll
Chapter 10
Learning Objectives1. 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.
3. Describe payroll accounting systems that use a payroll register, employee earnings records, and a general journal.
Learning Objectives4. Journalize entries for employee fringe
benefits, including vacation pay and pensions.5. Describe the accounting treatment for
contingent liabilities and journalize entries for product warranties.
6. Describe and illustrate the use of the quick ratio in analyzing a company’s ability to pay its current liabilities.
Learning Objective 1
Describe and illustrate current liabilities
related to accounts payable, current
portion of long-term debt, and notes
payable.
Current Liabilities
When a company or a bank advances credit, it is making a loan.
The company or bank is called a creditor (or lender).
The individuals or companies receiving the loans are called debtors (or borrowers).
Long-term liabilities are debts due beyond one year.
Current liabilities are debts that will be paid out of current assets and are due within one year.
LO 1LO 1
Accounts PayableLO 1LO 1
Accounts payable transactions arise from purchasing goods or services for use in a company’s operations or from purchasing merchandise for resale.
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. The installments due after the coming year are classified as a long-term liability.
LO 1LO 1
Short-Term Notes PayableNature’s Sunshine Company issues a 90-day, 12% note for $1,000, dated August 1, 2011 to Murray Co. for a $1,000 overdue account.
LO 1LO 1
Short-Term Notes PayableWhen the note matures, the entry to record the payment of $1,000 plus $30 interest ($1,000 x 12% x 90/360) is as follows:
LO 1LO 1
Interest Expense Interest Expense appears on the income appears on the income statement as an “Other statement as an “Other
Expense.”Expense.”
Description Debit Credit
Bowden Co. (Borrower)
Mdse. Inventory 10,000Accounts Payable 10,000
Coker Co. (Creditor)Description Debit Credit
Accounts Receivable10,000Sales
10,000Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500
Short-Term Notes PayableLO 1LO 1
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.
Short-Term Notes PayableLO 1LO 1
Accounts Payable10,000Notes Payable 10,000
Description Debit Credit
Bowden Co. (Borrower)
Notes Receivable 10,000Accounts Receivable
10,000
Coker Co. (Creditor)Description Debit Credit
On May 31, Bowden Co. issued a 60-day, 12% note for $10,000 to Coker Co. on account.
Short-Term Notes PayableLO 1LO 1
Notes Payable 10,000Interest Expense 200
Cash 10,200
Description Debit Credit
Bowden Co. (Borrower)
Cash 10,200Interest Revenue 200Notes Receivable 10,000
Coker Co. (Creditor)Description Debit Credit
On July 30, Bowden Co. paid Coker Co. the amount due on the note of May 31, the face amount of $10,000 plus interest of $200 ($10,000 x 12% x 60/360).
Short-Term Notes PayableLO 1LO 1
On September 19, Iceburg Company borrowed cash from First National Bank by issuing a $4,000, 90-day, 15% note to the bank.
Short-Term Notes PayableLO 1LO 1
On December 18, Iceburg Company paid First National Bank $4,000 plus interest of $150 ($4,000 x 15% x 90/360).
Short-Term Notes Payable A discounted note has the following
characteristics:1. The interest rate on the note is called the
discount rate.2. The amount of interest on the note, called the
discount, is computed by multiplying the discount rate times the face amount of the note.
The debtor (borrower) receives the face amount of the note less the discount, called the proceeds.
The debtor must repay the face amount of the note on the due date.
LO 1LO 1
Short-Term Notes PayableLO 1LO 1
On August 10, Cary Company issues a $20,000, 90-day discounted note to Western National Bank. The discount rate is 15%, and the amount of the discount is $750 ($20,000 x 15% x 90/360).
proceeds
Short-Term Notes PayableLO 1LO 1
The entry when Cary Company pays the discounted note on November 8 is as follows:
Learning Objective 2
Determine employer liabilities for payroll,
including liabilities arising from employee earnings
and deductions from earnings.
Payroll and Payroll Taxes In accounting, payroll refers to the
amount paid to employees for services they provided during the period. A company’s payroll is important for the following reasons: Payroll and related payroll taxes significantly
affect the net income of most companies. Payroll is subject to federal and state
regulations. Good employee morale requires payroll to be
paid timely and accurately.
LO 2LO 2
LO 2LO 2
Liability for Employee Earnings Salary usually refers to payment for
managerial and administrative services. Salary is normally expressed in terms of a month or a year.
Wages usually refers to payment for employee manual labor. The rate of wages is normally stated on an hourly or weekly basis.
LO 2LO 2
Liability for Employee EarningsJohn 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. His earnings are computed as follows:
Earnings at regular rate (40 x $34) $1,360Earnings at overtime rate (2 x $51) 102Total earnings $1,462
Deductions from Employee Earnings The total earnings of an employee for
a payroll period, including any overtime pay, are called gross pay.
From this amount is subtracted one or more deductions to arrive at the net pay.
LO 2LO 2
Deductions from Employee Earnings
LO 2LO 2
Deductions from Employee Earnings
LO 2LO 2
John T. McGrath made $1,462 for the week ending December 27. McGrath’s W-4 (previous slide) claims one withholding allowance of $70. Thus, the wages used to determine McGrath’s withholding bracket in Exhibit 3 (next slide) are $1,392 ($1,462 – $70).
Deductions from Employee Earnings
LO 2LO 2
Deductions from Employee Earnings The Federal Insurance Contributions
Act (FICA) tax withheld contributes to the following two federal programs. Social security, which provides payments
for retirees, survivors, and disability insurance. (Assume 6% on all earnings.)
Medicare, which provides health insurance benefits for senior citizens. (Assume 1.5% on all earnings.)
LO 2LO 2
LO 2LO 2Deductions from Employee Earnings
John T. McGrath’s earnings for the week ending December 27 are $1,462. Total FICA tax to be withheld is calculated as follows:
Earnings subject to 6% social security tax $1,462Social security tax rate x 6%
Social security tax $ 87.72Earnings subject to 1.5% Medicare tax $1,462Medicare tax rate x 1.5%Medicare tax 21.93
Total FICA tax $109.65
John T. McGrath’s Net Pay:Gross earnings for the week $1,462.00 Deductions:
Social security tax $ 87.72Medicare tax 21.93Federal income tax 258.90Retirement savings 20.00United Fund 5.00 Total deductions 393.55
Net pay $1,068.45
Computing Employee Net PayLO 2LO 2
Liability for Employer’s Payroll Taxes Employers are subject to the
following payroll taxes for amounts paid their employees: FICA Tax Federal Unemployment Compensation Tax
(FUTA) State Unemployment Compensation Tax
(SUTA)
LO 2LO 2
Liability for Employer’s Payroll Taxes
LO 2LO 2
Learning Objective 3
Describe payroll accounting systems
that use a payroll register, employee
earnings records, and a general journal.
Accounting Systems for Payroll and Payroll Taxes
Payroll systems should be designed to: Pay employees accurately and timely. Meet regulatory requirements of federal,
state, and local agencies. Provide useful data for management
decision-making needs.
LO 3LO 3
Payroll Register The payroll register is a multicolumn
report used for summarizing the data for each payroll period. Exhibit 5 illustrates a payroll register for McDermott Supply Co.
LO 3LO 3
Payroll RegisterLO 3LO 3
(left side, continued)
Payroll RegisterLO 3LO 3
(right side)
Recording Employees’ Earnings
LO 3LO 3
Recording and Paying Payroll Taxes
LO 3LO 3
Employers must match the employee’s social security and Medicare tax contributions. In addition, the employer must pay SUTA tax of 5.4% and FUTA tax of 0.8% (assume on $2,710). For McDermott Supply’s payroll of December 27, these payroll taxes are computed as follows:
Social security tax $ 834.12 ($13,902 x 6%)Medicare tax 208.53 ($13,902 x 1.5%)SUTA 146.34 ($2,710 x 5.4%)FUTA 21.68 ($2,710 x 0.8%) Total payroll taxes $1,210.67
Recording and Paying Payroll Taxes
LO 3LO 3
The entry to journalize the payroll tax expense for Exhibit 5 is shown below.
Employee’s Earnings Record A detailed payroll record must be
kept for each employee. This record is called an employee’s earnings record. Exhibit 6 (next two slides) shows a portion of John T. McGrath’s employee’s earnings record.
LO 3LO 3
(continued)
LO 3LO 3
LO 3LO 3
Employee’s Earnings RecordLO 3LO 3
Payroll Checks At the end of each payroll period,
payroll checks are prepared. Each check includes a detachable statement showing the details of how the net pay was computed.
LO 3LO 3
LO 3LO 3
Payroll Checks
Payroll System Design The inputs into a payroll system may
be classified as: Constants, which are data that remain
unchanged from payroll to payroll.• Employee names• Social security numbers
Variables, which are data that change from payroll to payroll.• Number of hours or days worked• Accrued sick leave
LO 3LO 3
Internal Controls for Payroll Systems Some examples of payroll controls include:
If a check-signing machine is used, blank payroll checks and access to the machine should be restricted to prevent their theft or misuse.
The hiring and firing of employees should be properly authorized and approved in writing.
All changes in pay rates should be properly authorized and approved in writing.
Employees should be observed when arriving for work to verify that employees are “checking in” for work only once and only for themselves.
LO 3LO 3
Internal Controls for Payroll Systems
Payroll checks should be distributed by someone other than employee supervisors.
A special payroll bank account should be used.
LO 3LO 3
Learning Objective 4
Journalize entries for employee fringe
benefits, including vacation pay and
pensions.
Employees’ Fringe Benefits Many companies provide their
employees benefits in addition to salary and wages earned. Such fringe benefits may include: Vacation pay (sometimes called
compensated absences) Medical benefits Retirement benefits
LO 4LO 4
Vacation Pay
Assume that employees earn one day of vacation for each month worked. The estimated vacation pay for the year ending December 31 is $325,000. The adjusting entry for the accrued vacation is shown below.
LO 4LO 4
Pensions A pension is a cash payment to
retired employees. Pension rights are accrued by employees as they work, based on the employer’s pension plan. Two types of pension plans are:
Defined contribution plan Defined benefit plan
LO 4LO 4
PensionsLO 4LO 4
In a defined contribution plan, the company invests contributions on behalf of the employee during the employee’s working years. Normally, the employee and employer
contribute to the plan. The employee’s pension depends on the
total contributions and the investment returns earned on those contributions.
Heaven Scent Perfumes Company contributes 10% of employee monthly salaries to an employee 401K plan. Assuming $500,000 of monthly salaries, the journal entry to record the monthly contribution is shown below.
PensionsLO 4LO 4
PensionsLO 4LO 4
In a defined benefit plan, the employer is obligated to pay for (fund) the employee’s future pension benefits. Many companies are replacing their
defined benefit plans with defined contribution plans.
A retired employee receives a specific amount based on his or her salary history and years of service.
LO 4LO 4
The defined benefit plan of Hinkle Co. requires an annual pension cost of $80,000. The annual contribution is based on estimates of Hinkle’s future pension liability. On December 31, Hinkle Co. pays $60,000 to the pension fund. The entry to record the payment and unfunded liability is shown below.
Pensions
Postretirement Benefits Other than Pensions
Employees may earn rights to other postretirement benefits, such as dental care, eye care, medical care, life insurance, tuition assistance, tax services, and legal services.
LO 4LO 4
Current Liabilities on the Balance Sheet
LO 4LO 4
Learning Objective 5
Describe the accounting treatment
for contingent liabilities and
journalize entries for product warranties.
Contingent Liabilities Some liabilities may arise from past
transactions if certain events occur in the future. These potential obligations are called contingent liabilities. The accounting for contingent liabilities depends on the following two factors:1. Likelihood of occurring: probable,
reasonably possible, or remote2. Measurement: estimable or not
estimable
LO 5LO 5
Contingent LiabilitiesLO 5LO 5
During June, a company sold a product for $60,000 that includes a 36-month warranty for repairs. The average cost of repairs over the warranty period is 5% of the sales price. The entry to record the estimated product warranty expense for June is shown below.
Contingent LiabilitiesLO 5LO 5
If a $200 part is replaced under warranty on August 16, the entry is as follows:
Contingent LiabilitiesLO 5LO 5
Learning Objective 6
Describe and illustrate the use of the quick ratio in analyzing a company’s ability to
pay its current liabilities.
Quick Ratio Current position analysis helps
creditors evaluate a company’s ability to pay its current liabilities. It is based on: Working capital, the excess of current
assets over current liabilities Current ratio, determined by dividing the
current assets by the current liabilities Quick ratio, an indicator of a company’s
short-term liquidity
LO 6LO 6
Quick RatioThe quick ratio measures the
“instant” debt-paying ability of a company and is computed as follows:
Quick Ratio =Quick Assets
Current Liabilities
Quick assets are cash and other current assets that can be easily converted to cash.
LO 6LO 6
Top Related