Current Liabilities and Payroll Chapter 11 ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-1

Current Liabilities and Payroll

Chapter 11

©2014 Pearson Education, Inc. Publishing as Prentice Hall 11-1

Learning Objectives

1. Account for current liabilities of known amount

2. Calculate and journalize basic payroll transactions

3. Account for current liabilities that must be estimated


Learning Objectives

4. Account for contingent liabilities

5. Use the times-interest-earned ratio to evaluate business performance


Learning Objective 1

Account for Account for current liabilities current liabilities of known amountof known amount


Liabilities

• Best described as:– Debts and obligations owed to

others.

• Three primary characteristics:– They occur as a result of a past

transaction or event.– They create a present

obligation for future payments.– They are an unavoidable

obligation.


Current Liabilities

Long-Term Liabilities

Will be paid from current assets within one year or the company’s operating

cycle, whichever is longer.

Due after one year or the company’s operating cycle,

whichever is longer.

Two Major Categories


Current Liabilities


On August 10, Swanson Company recorded $4,000 sales of merchandise inventory on account.

The sales were subject to 4% sales tax. Ignore cost of goods sold.

Prepare the journal entry to Prepare the journal entry to record the sale.record the sale.


On August 10, Swanson Company recorded $4,000 sales of merchandise inventory on account.

The sales were subject to 4% sales tax. Ignore cost of goods sold.


On September 30, Swanson Company owes and pays a total of $500 of sales taxes to the state.

Prepare the journal entry to Prepare the journal entry to record the payment of the record the payment of the sales taxes to the state.sales taxes to the state.


On September 30, Swanson Company owes and pays a total of $500 of sales taxes to the state.



Calculate and Calculate and journalize basic journalize basic

payroll payroll transactionstransactions


Accounting for Payroll

• Employees are typically not paid as they work.

• Employees are typically paid periodically, after accumulating a quantity of work.

• Any time employees have worked, but not yet been paid, there is a liability that must be recorded.

When employees are When employees are paid, they do not paid, they do not

receive the gross pay receive the gross pay that they have earned.that they have earned.

Employers withhold Employers withhold amounts that are due to amounts that are due to

other parties and the other parties and the employee only receives employee only receives what is “left over,” the what is “left over,” the

net amount.net amount.


Accounting for Payroll

OASDI OASDI TaxesTaxes

Medicare Medicare TaxesTaxes

Federal Federal Income Income

TaxTax

State and State and Local Local

Income Income TaxesTaxes

Voluntary Voluntary DeductionsDeductions

Gross PayGross Pay

Net PayNet Pay


Amounts withheld depend on the employee’s earnings and the tax rates. Employers owe the income tax

amounts withheld from employees’ gross pay to the appropriate government agency.

Federal Federal Income Income

TaxTax

State and State and Local Income Local Income

TaxesTaxes

Withholding for Employee Income Tax

Top rate of 39.6% on income > $400,000

For example, in some states the state income tax rate is

5%.


OASDI OASDI TaxesTaxes

Medicare Medicare TaxesTaxes

These amounts are due to the federal government following withholding.

Withholding for Employee Social Security and Medicare

4.2%Applied to first

$110,100 of earned income

1.45%Applied to 100%

of income


Union DuesUnion Dues

Savings AccountsSavings Accounts

Pension Pension ContributionsContributions

Insurance Insurance PremiumsPremiums

CharitiesCharities

Optional Withholding Deductions

• Amounts withheld depend on the employee’s request.

• Employers must forward the voluntary deductions withheld from employees’ gross pay to the designated agency.


Recording Payroll

• This table summarizes the payroll and withholdings for Smart Touch Learning for December.

• As shown in Exhibit 11-2, a Payroll Register is normally used to accumulate this data.

Gross Pay 28,580$ Withholdings OASDI $961 Medicare 414 Income Tax 5,716 Health Insurance 645 Other 60

Total Withholdings 7,796 Net (take-home) Pay 20,784$


Recording Payroll

Typically, the payroll checks will be drawn Typically, the payroll checks will be drawn against a separate payroll checking account against a separate payroll checking account

that is only used for payroll.that is only used for payroll.©2014 Pearson Education, Inc. Publishing as Prentice Hall 11-19

Employer Payroll Taxes

• Employers are also required Employers are also required to pay taxes separate from the to pay taxes separate from the taxes withheld from employee taxes withheld from employee paychecks.paychecks.1.1. Employers must “match” the Employers must “match” the

FICA amounts withheld from FICA amounts withheld from employee paychecks.employee paychecks.

2.2. State & Federal Unemployment State & Federal Unemployment Compensation TaxesCompensation Taxes

7.65% of earnings

up to $110,100; 1.45% of

earnings in excess of $110,100

6.2% of first $7,000 of employee earnings


Unemployment Taxes

• Unemployment checks are paid out of Unemployment checks are paid out of the Unemployment Insurance Fund. the Unemployment Insurance Fund.

• Companies pay into the fund monthly Companies pay into the fund monthly (5.6% to the state and 0.60% to the (5.6% to the state and 0.60% to the federal government).federal government).

• The rate varies with each company’s The rate varies with each company’s employment history. employment history.


Recording Payroll

In December, Smart Touch Learning had wages subject In December, Smart Touch Learning had wages subject to OASDI of $22,880 (one employee went over the to OASDI of $22,880 (one employee went over the $110,000 limit). Wages subject to Medicare were $110,000 limit). Wages subject to Medicare were

$28,580. FUTA and SUTA were due on $4,000 of wages $28,580. FUTA and SUTA were due on $4,000 of wages paid to a new employee.paid to a new employee.

Prepare the journal entry to Prepare the journal entry to record the employer’s payroll record the employer’s payroll

taxes.taxes.


Recording Payroll

In December, Smart Touch Learning had wages subject In December, Smart Touch Learning had wages subject to OASDI of $22,880 (one employee went over the to OASDI of $22,880 (one employee went over the $110,000 limit). Wages subject to Medicare were $110,000 limit). Wages subject to Medicare were

$28,580. FUTA and SUTA were due on $4,000 of wages $28,580. FUTA and SUTA were due on $4,000 of wages paid to a new employee.paid to a new employee.


Internal Controls for Payroll

• Efficiency Controls– Payroll is usually automated, rather than

prepared by hand.

• Disbursement Controls– Employees sign for checks or present ID’s.– Hiring and firing is separated from payroll

preparation.– Time clocks and direct deposit are also used.



Account for Account for current liabilities current liabilities

that must be that must be estimatedestimated


Accounting for Estimated Liabilities

• Some liabilities are Some liabilities are estimatedestimated– Bonus AccrualsBonus Accruals– Vacation and Sick Vacation and Sick

Leave AccrualsLeave Accruals– Pension expense Pension expense

AccrualAccrual– Warranties expenseWarranties expense

Many liabilities are Many liabilities are estimated at year-estimated at year-end, even though end, even though

actual amounts will actual amounts will not be known until not be known until

some time after year-some time after year-end. This is in end. This is in

accordance with the accordance with the Matching Principle.Matching Principle.


O’Conner guarantees its vacuums for four years. Company experience indicates that warranty costs

will be approximately 6% of sales. Assume that O’Conner has sales of $200,000 during 2014.

Prepare the journal entry to Prepare the journal entry to record warranty expense.record warranty expense.


O’Conner guarantees its vacuums for four years. Company experience indicates that warranty costs

will be approximately 6% of sales. Assume that O’Conner has sales of $200,000 during 2014.



Account for Account for contingent contingent liabilitiesliabilities


Contingent Liabilities

• A contingent liability is a POTENTIALPOTENTIAL liability that depends on a future event.

• How do we disclose a liability that might arise in the FUTUREFUTURE as a result of something that has occurred in the PRESENTPRESENT?

Suppose Smart Suppose Smart Touch Learning is Touch Learning is sued because of sued because of alleged patent alleged patent

infringement on one infringement on one of its learning videos. of its learning videos. This may need to be This may need to be

disclosed to disclosed to investors and investors and

creditors.creditors.



• The type of disclosure The type of disclosure of a contingent liability of a contingent liability depends on two depends on two issues:issues:

1.1. How likely is the How likely is the future event?future event?

2.2. Can the amount of Can the amount of the liability be the liability be reasonably reasonably estimated?estimated?

If the lawsuit against If the lawsuit against Smart Touch Learning Smart Touch Learning is frivolous, it does not is frivolous, it does not need to be disclosed. need to be disclosed.

If Smart Touch If Smart Touch Learning is likely to Learning is likely to

lose the lawsuit, then it lose the lawsuit, then it should be disclosed.should be disclosed.


Probability of future sacrifice . . .

ReasonablyProbable Possible RemoteRecord the Disclose the

Can be contingent liability in the No

Estimated liability. notes to the action.

financial stmts.

Disclose the Disclose the

Cannot be liability in the liability in the No

Estimated notes to the notes to the action.financial stmts. financial stmts.

Am

ou

nt

. . .


This table can be used to determine the proper disclosure treatment of a contingent liability.


Other kinds of Contingent Liabilities

• Co-signing note

• Lawsuits

• Guarantees

• Environmental Clean-up Costs

• Forward Contracts

• Contingent Payments in an Acquisition


Likelihood of Future Event How to Report the Contingency

Remote a. Do not disclose.

Reasonably Possibleb. Record an expense and a liability based on estimated

Probable and the amount of the loss cannot be reasonably estimated.

c. Describe the situation in a not to the financial statements.

Probable and the amount can be reasonably estimated.

Match the likelihood of the future event with the reporting of the contingency. An answer may be selected more than once.




Reasonably PossibleProbable and the amount of the loss cannot be reasonably estimated.Probable and the amount can be reasonably estimated.





Reasonably Possiblec. Describe the situation in a note to the financial statements.

Probable and the amount of the loss cannot be reasonably estimated.Probable and the amount can be reasonably estimated.







c. Describe the situation in a note to the financial statements.







c. Describe the situation in a note to the financial statements.


b. Record an expense and a liability based on estimated




Use the times-Use the times-interest-earned interest-earned ratio to evaluate ratio to evaluate

business business performanceperformance


Times-Interest-Earned Ratio

This ratio is used to evaluate a This ratio is used to evaluate a business’s ability to pay interest business’s ability to pay interest

expense.expense.

A high ratio indicates that the company A high ratio indicates that the company is better able to pay its interest.is better able to pay its interest.


= ( Net Income

+Income Tax

Expense +

Interest Expense

) ÷Interest Expense




= ( Net Income

+Income Tax

Expense +

Interest Expense


Compute the Times-Interest-Earned Ratio for Green Mountain for 2011




= ( Net Income

+Income Tax

Expense +

Interest Expense


= ( 199,501$ + $101,699 + 57,657$ ) ÷ 57,657$

= 358,857$ ÷ $57,657

= 6.22 (rounded)


End of Chapter 11


Documents

Current Liabilities and Payroll Chapter 11 ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-1