Current Liabilities and Payroll

Chapter 11

1

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

2

Accounts payable arise from purchasing goods or services for use in a company’s operations or for purchasing merchandise for resale.

3

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.

4

The total amount of the installments due after the coming year is classified as a long-term liability.

5

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

6

On October 30, when the note matures, the firm pays the $1,000 principal plus $30 interest ($1,000 × 12% × 90/360).

Interest Expense appears on the income statement as an “Other Expense.”

7

On September 19, Iceburg Company issues a $4,000, 90-day, 15% note to First National Bank.

8

On the due date of the note (December 18), Iceburg Company owes $4,000 plus interest of $150 ($4,000 × 15% × 90/360).

9

Discounting a Note

A discounted note has the following characteristics:

1. The creditor (lender) requires an interest rate, called the discount rate.

2. Interest, called the discount, is computed on the face amount of the note.

3. The debtor (borrower) receives the face amount of the note less the discount, called the proceeds.

4. The debtor pays the face amount of the note on the due date.

10

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%.

Proceeds

Discount: $20,000 × .15 × 90/360

Discount rate

11

On November 8 the note is paid in full.

The amount paid is the face amount of the note.

12

Proceeds from Notes Payable

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

Example Exercise 11-1

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%.

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

a. $60,000

13

Some liabilities may arise from past transactions if certain events occur in the future. These potential obligations are called contingent liabilities.

Contingent Liabilities

14

The accounting for contingent liabilities depends on the following two factors:

1. Likelihood of occurring: Probable, reasonably possible, or remote.

2. Measurement: Estimable or not estimable.

15

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 period.

Recording Contingent Liabilities

16

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

17

Accounting Treatment of Contingent LiabilitiesExhibit 10

18

Problem 11-1B

Apr 21: Borrowed $60,000; issued a 45-day, 6% note

Cash 60,000Notes Payable 60,000

Apr 26: Purchased equipment issued a $160,000 180-day note at a discount of 8%

Equipment 153,600Int Exp (160,000 x 180/360 x 8%) 6,400

Notes Payable 160,000

19

11-1B continued

May 16 Pd interest due on note of April 1 and renewed loan by issuing 30-day 10% note

Notes Payable 60,000Int Exp (60000 x 45/360 x 6%) 450

Notes Payable 60,000Cash 450

11-1B continued

Nov 10 Purchased equip for $200,000; paid $60,000 and issued 7 9% notes for $20,000 each coming due at 30-day intervals

Equipment 200,000Cash 60,000Notes Payable 140,000

21

11-1B continued

Dec 10 Paid the amount due on the first note in the series issued on Nov 10

Notes Payable 20,000Int Exp (20, 000 x 30/360 x 9%) 150

Cash 20,150

22

11-1B continued

2. b. Adjusting entry for the 6 remaining notes owed from the Nov 10 transaction

Interest Expense 1530Interest Payable 1530

(20000 x 9% x 51/360 x 6 notes)

23

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

Objective 2

24

Payroll refers to the amount paid to employees for the services they provide during a period. A company’s payroll is important for the following reasons:1. Employees are sensitive to payroll errors and

irregularities.2. Good employee morale requires payroll to be paid

timely and accurately.3. Payroll is subject to various federal and state

regulations.4. Payroll and related payroll taxes significantly affect

the net income of most companies.

25

Salary usually refers to payment for managerial and administrative services. Salary is normally expressed in terms of a month or a year.

26

Wages usually refers to payment for employee manual labor. The rate of wages is normally stated on an hourly or weekly basis.

27

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

Computing Employee’s Earnings

28

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.

29

McGrath made $1,462 for the week ending December 27. Since McGrath’s W-4 claims one withholding allowance, $67 (the assumed standard withholding allowance) is deducted from his gross pay to arrive at $1,395 ($1,462 – $67).

Deductions from Employee’s Earnings:

McGrath Example

30

Wage Bracket Withholding TableExhibit 3

Source: Publication 15, Employer’s Tax Guide, Internal Revenue Service, 2008

31

McGrath Example (continued)

Initial withholding (Slide 30)

$ 82.95Plus [25% × ($1,395 – $653)]

185.50Total federal income taxes

withheld

$268.45

32

Example Exercise 11-2

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 30) with a $67 standard withholding allowance for each exemption, what is Dunn’s federal income tax withholding?

Federal Income Tax Withholding

33

Example Exercise 11-2 (continued)

Total wage payment $2,250One allowance (provided by IRS) $67Multiplied by allowances claimed on W-4 × 2 134Amount subject to withholding $2,116

Initial withholding from wage bracket in Exh. 3 $302.96Plus additional withholding: 28% of excess

over $1,533 163.24*

Federal income tax withholding $466.20*28% × ($2,116 – $1,533)

34

FICA Tax

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, provides health insurance for senior citizens.

35

John T. Mcgrath’s annual earnings prior to the payroll period ending on December 27 total $99,038.

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

$57.72Earnings subject to 1.5%

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

Medicare tax 21.93Total FICA tax$79.65

John T. McGrath’s FICA Tax

36

John T. McGrath’s Net Pay

Gross earnings for the week $1,462.00 Deductions:

Social security tax (Slide 35) $ 57.72Medicare tax (Slide 35) 21.93Federal income tax (Slide 31) 268.45Retirement savings 20.00United Way 5.00 Total deductions 373.10

Net pay $1,088.90

37

Example Exercise 11-3

Karen Dunn’s weekly gross earnings for the week ending Dec. 3rd were $2,250, and her federal income tax withholding was $466.19. 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?

Employee Net Pay

38

Example Exercise 11-3 (continued)

Total wage payment $2,250.00Less: Federal income tax withholding 466.19

Earnings subject to social securitytax ($100,000 – $98,000) $2,000

Social security tax rate × 6%Social security tax 120.00Medicare tax ($2,250 × 1.5%) 33.75

Net pay $1,630.06

39

Liability for Employer’s Payroll Taxes

Employers are subject to the following payroll taxes for amounts paid their employees:1. FICA tax2. Federal Unemployment Compensation

Tax (FUTA)3. State Unemployment Compensation Tax

(SUTA)

40

Employer’s Federal Payroll Taxes

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.

41

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

42

Employer’s State Unemployment Taxes

This employer tax also provides temporary payments to those who become unemployed. The FUTA and SUTA programs are closely coordinated, with the states distributing the unemployment checks. SUTA tax rates and earnings subject to tax vary by state.

43

Responsibility for Tax PaymentsExhibit 4

44

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

Objective 3

45

Payroll systems should be designed to:1. Pay employees accurately and

timely.2. Meet regulatory requirements of

federal, state, and local agencies.3. Provide useful data for

management decision-making needs.

46

Payroll Register

The payroll register is a multicolumn report used for summarizing the data for each payroll period. The right hand columns of the payroll register indicate the accounts debited for the payroll expense. These columns are often referred to as the payroll distribution.

47

Journalize Period Payroll

Example Exercise 11-4

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.

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

48

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.

Employee’s Earnings Record

49

Flow of Data in a Payroll SystemExhibit 8

50

Internal Controls for Payroll Systems

1. If a check-signing machine is used, blank payroll checks and access to the machine should be restricted to prevent their theft.

2. The hiring and firing of employees should be properly authorized and approved in writing.

3. All changes in pay rates should be properly authorized and approved in writing.

(continued)

51

5. Payroll checks should be distributed by someone other than employee supervisors.

6. A special payroll bank account should be used.

4. Employees should be observed when arriving for work to verify they are “checking in” for work only once and only for themselves.

52

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

Objective 4

53

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 retirement benefits.

54

Most employers grant vacation rights, sometimes called compensated absences, to their employees. The estimated vacation pay for the year ending December 31 is $325,000.

Vacation Pay

55

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.

Pension

56

In a defined contribution plan, a fixed amount of money is invested on the employee’s behalf during the employee’s working years.

Defined Contribution Plan

57

Defined Benefit Plan

In a defined benefit plan, employers promise employees a fixed annual pension benefit at retirement, based on years of service and compensation levels.

58

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.

59

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

Objective 5

60

Some liabilities may arise from past transactions if certain events occur in the future. These potential obligations are called contingent liabilities.

Contingent Liabilities

61

The accounting for contingent liabilities depends on the following two factors:

1. Likelihood of occurring: Probable, reasonably possible, or remote.

2. Measurement: Estimable or not estimable.

62

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 period.

Recording Contingent Liabilities

63

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

64

Accounting Treatment of Contingent LiabilitiesExhibit 10

65

Noble Co. Hart Co.

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

Current liabilities $220,000 $740,000

Quick Ratio

Quick assetsCurrent liabilities

Quick 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.

66

Noble Co. Hart Co.

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

Current liabilities $220,000 $740,000

Quick Ratio

Quick assetsCurrent liabilities

Quick Ratio =

Noble Company = $231,000$220,000

= 1.05

67

Noble Co. Hart Co.

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

Current liabilities $220,000 $740,000

Quick Ratio

Quick assetsCurrent liabilities

Quick Ratio =

Hart Company = $592,000$740,000

= 0.80

68

THE END

69