Chapter 11

Current Liabilities and Payroll

Review Questions

1. The three main characteristics of liabilities are:

 They occur because of a past transaction or event.
 They create a present obligation for future payment of cash or services.
 They are an unavoidable obligation.

2. Current liabilities must be paid with cash or with goods and services within one year or within the
entity’s operating cycle if the cycle is longer than a year. Examples of current liabilities include:
Accounts Payable, Notes Payable due within one year, Salaries Payable, Interest Payable, Sales Tax
Payable, and Unearned Revenue.

3. Sales tax is recorded as a liability when it is charged to the customer; it is usually calculated as a
percentage of the amount of the sale. It is not considered an expense to the business, but a current
liability. Companies collect the sales tax and then forward it to the state at regular intervals.

4. Unearned revenue arises when a business has received cash in advance of providing goods or
performing work and, therefore, has an obligation to provide goods or services to the customer in the
future.

5. Short-term notes payable represent a written promise by the business to pay a debt, usually involving
interest, within one year or less.

6. The principal amount that will be paid within one year will be reported in the current liabilities as
current portion of notes payable.

7. Gross pay is the total amount of salary, wages, commissions, and bonuses earned by the employee
during a pay period, before taxes or any other deductions. Gross pay is an expense to the employer.
Net pay is the amount the employee gets to keep. Net pay equals gross pay minus all deductions paid
by the employee such as income tax withheld.

© 2018 Pearson Education, Inc. 11-1

8. Required payroll withholding deductions are:

Withholding Deductions Tax Rate

Federal, State and Local Income Tax The amount withheld depends on the
employee’s gross pay, filing status,
and the number of withholding
allowances he or she claims.
FICA—OASDI (old age, survivors, and For 2016, the OASDI tax applies to the
disability insurance) first $118,500 of employee earnings
in a year. The taxable amount of
earnings is adjusted annually. The
OASDI tax rate at the time of this
writing is 6.2%.
FICA—Medicare (medical benefits) Medicare applies to all employee
earnings—that means that there is
no maximum tax. At the time of
this writing, this tax rate is 1.45%
on the first $200,000 of earnings,
then 2.35% on any earnings above
$200,000.

9. Many companies use a payroll register to help summarize the earnings, withholdings, and net pay for
each employee.

10. The payroll taxes an employer is responsible for paying are:

 Employer FICA tax (OASDI and Medicare)
 State unemployment compensation tax (SUTA)
 Federal unemployment compensation tax (FUTA)

11. There are two main controls for payroll: controls for efficiency and controls to safeguard payroll
disbursements.

Using computer processing for payroll brings efficiency to the process. The payroll data are stored in
a file, and the computer makes the calculations, prints paychecks, and updates all records
electronically. In addition, companies may require direct deposits for employees’ pay so that paper
checks do not have to be written to each employee. Direct deposits also increase efficiency by
reducing the amount of reconciliation needed on outstanding checks.

Controls to safeguard payroll disbursements include: Hiring and firing employees should be
separated from accounting and from passing out paychecks. Photo IDs ensure that only actual
employees are paid. Employees clock in at the start and clock out at the end of the workday to prove
their attendance and hours worked.

© 2018 Pearson Education, Inc. 11-2

12. The matching principle requires businesses to record Warranty Expense in the same period that the
company records the revenue related to that warranty. The expense, therefore, is incurred when the
company makes a sale, not when the company pays the warranty claims.

13. A contingent liability is a potential, rather than an actual, liability because it depends on a future
event. For a contingent liability to be paid, some event (the contingency) must happen in the future.
Some examples of contingencies are lawsuits and co-signing a note for another entity.

14. Contingencies that are reasonably possible have more chance of occurring but are not likely. A
reasonably possible contingency should be described in the notes to the financial statements.

15. The times-interest-earned ratio is calculated as earnings before interest and taxes or EBIT (Net
income + Income tax expense + Interest expense) divided by interest expense. Investors can use the
times-interest-earned ratio to evaluate a business’s ability to pay interest expense. This ratio
measures the number of times earnings before interest and taxes can cover (pay) interest expense.

Short Exercises
S11-1

a. current liability (CL)

b. long-term liability (LTL)
c. current liability (CL)
d. current liability (CL)
e. current liability (CL)
f. current liability (CL)

S11-2
Requirement 1

Date Accounts and Explanation Debit Credit

July 5 Accounts Receivable 57,200
Sales Revenue 55,000
Sales Tax Payable ($55,000 × 0.04) 2,200
To record sales revenue on account and the
related sales tax.

© 2018 Pearson Education, Inc. 11-3

S11-2, cont.
Requirement 2

Date Accounts and Explanation Debit Credit

Aug. 15 Sales Tax Payable 2,200
Cash 2,200
To record cash payment for sales tax payable.

S11-3
Requirement 1

Date Accounts and Explanation Debit Credit

June 1 Cash 63,000
Unearned Revenue 63,000
Collected cash for future services.

Requirement 2

Date Accounts and Explanation Debit Credit

Dec. 31 Unearned Revenue 31,500
Subscription Revenue ($63,000 × 6/12) 31,500
To record subscription revenue earned that was
collected in advance.

S11-4
Requirement 1

Date Accounts and Explanation Debit Credit

2017
Dec. 31 Merchandise Inventory 13,000
Notes Payable 13,000
Purchased merchandise inventory in exchange
for one year, 9% note.

Requirement 2

Date Accounts and Explanation Debit Credit

2018
Jun. 30 Interest Expense ($13,000 × 0.09 × 6/12) 585
Interest Payable 585
Accrued interest expense at year-end.

© 2018 Pearson Education, Inc. 11-4

S11-4, cont.
Requirement 3

Date Accounts and Explanation Debit Credit

2018
Dec. 31 Notes Payable 13,000
Interest Expense ($13,000 × 0.09 × 6/12) 585
Interest Payable 585
Cash 14,170
Paid note and interest at maturity.

S11-5

Irving will report $56,000 as current portion of notes payable in the current liability section. The
remaining $224,000 will show as a notes payable in the long-term liability section.

S11-6
Requirement 1

Straight-time pay for 40 hours ($12 × 40 hours) $ 480

Overtime pay for 20 hours (20 hours × $12 × 1.5) 360
Gross Pay $ 840

Requirement 2

Gross pay $ 840.00

Withholding deductions:
Employee income tax (15%) $ 126.00
Employee OASDI tax (6.2%) 52.08
Employee Medicare tax (1.45%) 12.18
Total withholdings 190.26
Net (take-home) pay $ 649.74

© 2018 Pearson Education, Inc. 11-5

S11-6, cont.
Requirement 3

Date Accounts and Explanation Debit Credit

Wages Expense 840.00
Employee Income Taxes Payable 126.00
FICA—OASDI Taxes Payable 52.08
FICA—Medicare Taxes Payable 12.18
Wages Payable 649.74
To record wages expense and payroll
withholdings.

Wages Payable 649.74

Cash 649.74
To record payment of wages.

S11-7
Requirement 1

Gross pay $ 12,100.00

Withholding deductions:
Employee income tax (10%) $ 1,210.00
Employee OASDI tax (6.2%)* 595.20
Employee Medicare tax (1.45%) 175.45
Employee health insurance 250.00
Employee contribution to United Way (5%) 605.00
Total withholdings 2,835.65
Net (take-home) pay $ 9,264.35

*Calculation of tax for OASDI

Employee earnings subject to tax $ 118,500
Employee earnings prior to the current month – 108,900
Current pay subject to tax 9,600
Tax rate × 0.062
Tax to be withheld from paycheck $ 595.20

© 2018 Pearson Education, Inc. 11-6

S11-7, cont.
Requirement 2

Date Accounts and Explanation Debit Credit

Oct. 31 Salaries Expense 12,100.00
Employee Income Taxes Payable 1,210.00
FICA—OASDI Taxes Payable 595.20
FICA—Medicare Taxes Payable 175.45
Employee Health Insurance Payable 250.00
United Way Payable 605.00
Salaries Payable 9,264.35
To record salaries expense and payroll
withholdings.

Salaries Payable 9,264.35

Cash 9,264.35
To record payment of salaries.

S11-8

Date Accounts and Explanation Debit Credit

Salaries Expense 26,000
FICA—OASDI Taxes Payable (6.2% × $26,000) 1,612
FICA—Medicare Taxes Payable (1.45% × $26,000) 377
Employee Income Taxes Payable 2,000
Salaries Payable 22,011
To record salaries expense and payroll withholdings.

Payroll Tax Expense 3,549

FICA—OASDI Taxes Payable (6.2% × $26,000) 1,612
FICA—Medicare Taxes Payable (1.45% × $26,000) 377
Federal Unemployment Taxes Payable (0.6% × $26,000) 156
State Unemployment Taxes Payable (5.4% × $26,000) 1,404
To record employer's payroll tax expense.

FICA—OASDI Taxes Payable ($1,612 + $1,612) 3,224

FICA—Medicare Taxes Payable ($377 + $377) 754
Employee Income Taxes Payable 2,000
Federal Unemployment Taxes Payable 156
State Unemployment Taxes Payable 1,404
Cash 7,538
Payment of payroll taxes

© 2018 Pearson Education, Inc. 11-7

S11-9
Requirement 1

Date Accounts and Explanation Debit Credit

Dec. 31 Employee Bonus Expense 3,047.62
Employee Bonus Payable 3,047.62
To record employee bonus expense.
(5% × $64,000) / (1.05) = $3,047.62

Requirement 2

Date Accounts and Explanation Debit Credit

Jan. 15 Employee Bonus Payable 3,047.62
Cash 3,047.62
To record payment of employee bonus.

S11-10
Requirement 1

Employees 3 Weekly salary $1,250

× Vacation Days per month × 2 ÷ Days in the week 5
= Total days to accrue 6 = Pay per day = $250
Total amount to accrue 6 days times $250 per day = $1,500 for one month

Requirement 2

Date Accounts and Explanation Debit Credit

Vacation Benefits Expense 1,500
Vacation Benefits Payable 1,500
To record employee vacation benefits expense.

© 2018 Pearson Education, Inc. 11-8

S11-11
Requirement 1

Date Accounts and Explanation Debit Credit

2018 Cash (20% × $600,000) 120,000
Notes Receivable (80% × $600,000) 480,000
Sales Revenue 600,000
To record sales for 2018.

Warranty Expense (5% × $600,000) 30,000

Estimated Warranty Payable 30,000
To accrue warranty payable.

Estimated Warranty Payable 10,000

Cash 10,000
Warranty payments.

Requirement 2

Estimated Warranty Payable

Payments 10,000 30,000 Accrual
20,000 Bal.

S11-12

Situatio Appropriate accounting treatment

n
a. Describe the situation in a note to the financial statements.
b. Do not disclose.
c. Record an expense (or loss) and a liability based on estimated amounts.

S11-13

Times-interest-earned ratio
Net Income $ 45,000
+ Income Tax Expense + 6,750
+ Interest Expense + 3,750
Total $ 55,500
÷ Interest Expense ÷ 3,750
Ratio for 2018 14.80

© 2018 Pearson Education, Inc. 11-9

Exercises
E11-14

Date Accounts and Explanation Debit Credit

Mar. 31 Cash 246,100
Sales Revenue 230,000
Sales Tax Payable ($230,000 × 0.07) 16,100
To record cash sales and the related sales tax.

Apr. 6 Sales Tax Payable 16,100

Cash 16,100
To record cash payment for sales tax payable.

E11-15

Date Accounts and Explanation Debit Credit

2017
Aug. 1 Equipment 16,000
Notes Payable 16,000
Purchased equipment in exchange for one-year,
9% note.

Dec. 31 Interest Expense ($16,000 × 0.09 × 5/12) 600

Interest Payable 600
Accrued interest expense at year-end.

2018
Aug. 1 Notes Payable 16,000
Interest Expense ($16,000 × 0.09 × 7/12) 840
Interest Payable 600
Cash 17,440
Paid note and interest at maturity.

© 2018 Pearson Education, Inc. 11-10

E11-16

Date Accounts and Explanation Debit Credit

2018
Oct. 1 Cash 259
Unearned Revenue 240
Sales Tax Payable ($240 × 8%) 19
To record unearned revenue and the related
sales tax.

Nov. 15 Sales Tax Payable 19

Cash 19
To record cash payment for sales tax payable.

Dec. 31 Unearned Revenue 80

Subscription Revenue 80
To record subscription revenue earned that was
collected in advance. $240 × 2/6.

E11-17

Date Accounts and Explanation Debit Credit

2018
Notes Payable 16,000
Cash 16,000
To record payment of 2017 notes.

Salaries Payable 4,000

Cash 4,000
To record payment for salaries payable.

Cash 16,900
Notes Payable 16,900
To record cash borrowed on notes payable.

Salaries Expense 3,400

Salaries Payable 3,400
To record accrued salaries.

© 2018 Pearson Education, Inc. 11-11

E11-18
Requirement 1

Straight-time pay for 40 hours ($12 × 40 hours) $ 480.00

Overtime pay for 18 hours: (18 × $12 × 1.5) 324.00
Gross Pay $ 804.00

Gross pay $ 804.00

Withholding deductions:
Employee income tax (20%) $ 160.80
Employee OASDI tax (6.2%) 49.85
Employee Medicare tax (1.45%) 11.66
Employee contribution to United Way 5.00
Total withholdings 227.31
Net (take-home) pay $ 576.69

Requirement 2

Date Accounts and Explanation Debit Credit

Wages Expense 804.00
Employee Income Taxes Payable 160.80
FICA—OASDI Taxes Payable 49.85
FICA—Medicare Taxes Payable 11.66
United Way Payable 5.00
Wages Payable 576.69

Requirement 3

Date Accounts and Explanation Debit Credit

Wages Payable 576.69
Cash 576.69

© 2018 Pearson Education, Inc. 11-12

E11-19
Requirement 1

Date Accounts and Explanation Debit Credit

Payroll Tax Expense 6,063.00
FICA—OASDI Taxes Payable (6.2% × $62,000) 3,844.00
FICA—Medicare Taxes Payable (1.45% × $62,000) 899.00
Federal Unemployment Taxes Payable (0.6% × $22,000) 132.00
State Unemployment Taxes Payable (5.4% × $22,000) 1,188.00
To record employer's payroll tax expense.

Employee Benefits Expense 9,530.00

Employee Health Insurance Payable 3,000.00
Employee Life Insurance Payable 330.00
Employee Retirement Benefits Payable (10% × $62,000) 6,200.00
Accrual of employee benefit expenses.

Requirement 2

Salaries Expense $ 62,000.00

Payroll Tax Expense 6,063.00
Employee Benefits Expense 9,530.00
Total $ 77,593.00

© 2018 Pearson Education, Inc. 11-13

 E11-20
Requirement 1

Earnings Withholdings      
Beginning Current Ending Salaries and
Cumulative Period Cumulative Income Health United Total Check Wages
Earnings Earnings Earnings OASDI Medicare Tax Insurance Way Withholdings Net Pay No. Expense
$ 77,000.00 $ 4,500.00 $ 81,500.00 $ 279.00 $ 65.25 $ 900.00 $ 90.00 $ 15.00 $ 1,349.25 $ 3,150.75 801 $ 4,500.00
112,000.00 7,200.00 119,200 403.00* 104.40 1,200.00 144.00 35.00 1,886.40 5,313.60 802 7,200.00
48,000.00 3,300.00 51,300.00 204.60 47.85 600.00 66.00 0.00 918.45 2,381.55 803 3,300.00
61,000.00 3,300.00 64,300.00 204.60 47.85 850.00 66.00 20.00 1,188.45 2,111.55 804 3,300.00
0 4,500.00 4,500.00 279.00 65.25 1,100.00 90.00 0.00 1,534.25 2,965.75 805 4,500.00
$ 298,000.00 $ 22,800.00 $ 320,800.00 $ 1,370.20 $ 330.60 $ 4,650.00 $ 456.00 $ 70.00 $ 6,876.80 $ 15,923.20   $ 22,800.00

*Calculation of tax for OASDI

Employee earnings subject to tax $ 118,500.00
Employee earnings prior to the current month – 112,000.00
Current pay subject to tax $ 6,500.00
Tax rate × 0.062
Employee tax $ 403.00

© 2018 Pearson Education, Inc.

E11-20, cont.
Requirement 2

Date Accounts and Explanation Debit Credit

Salaries and Wages Expense 22,800.00
Employee Income Taxes Payable 4,650.00
FICA—OASDI Taxes Payable 1,370.20
FICA—Medicare Taxes Payable 330.60
Health Insurance Payable 456.00
United Way Payable 70.00
Salaries and Wages Payable 15,923.20
To record salaries and wages expense and
payroll withholdings.

Requirement 3

Date Accounts and Explanation Debit Credit

Payroll Tax Expense 1,970.80
FICA—OASDI Taxes Payable * 1,370.20
FICA—Medicare Taxes Payable 330.60
(1.45% × $22,800)
Federal Unemployment Taxes Payable 27.00
(0.6% × $4,500 (first $7,000 only))
State Unemployment Taxes Payable 243.00
(5.4% × $4,500 (first $7,000 only))
To record employer's payroll tax expense.

*Calculation of tax for OASDI

Employee earnings subject to tax $ 118,500.00
Employee earnings prior to the current month – 112,000.00
Current pay subject to tax $ 6,500.00
Tax rate × 0.062
Employer tax $ 403.00
All others ($22,800 − $7,200) × 6.2% 967.20
$ 1,370.20

© 2018 Pearson Education, Inc.

E11-20, cont.
Requirement 4

Date Accounts and Explanation Debit Credit

Salaries and Wages Payable 15,923.20
Cash 15,923.20
To record payment of salaries and wages.

Requirement 5

Date Accounts and Explanation Debit Credit

Employee Income Taxes Payable 4,650.00
FICA—OASDI Taxes Payable ($1,370.20 + $1,370.20) 2,740.40
FICA—Medicare Taxes Payable ($330.60 + $330.60) 661.20
Health Insurance Payable 456.00
United Way Payable 70.00
Federal Unemployment Taxes Payable 27.00
State Unemployment Taxes Payable 243.00
Cash 8,847.60
To record payment of payroll withholdings and taxes.

© 2018 Pearson Education, Inc.

E11-21
Requirement 1

Date Accounts and Explanation Debit Credit

2018
Warranty Expense (9% × $113,000) 10,170
Estimated Warranty Payable 10,170

Estimated Warranty Payable 7,000

Cash 7,000

Requirement 2
Estimated Warranty Payable
5,000 Beg. Bal.
Payments 7,000 10,170 Accrual
8,170 End Bal.

E11-22

Date Accounts and Explanation Debit Credit

2018
Nov. 1 Warranty Expense (6% × $52,000) 3,120
Estimated Warranty Payable 3,120

Nov. 20 Estimated Warranty Payable 1,600

Cash 1,600

Dec. 31 Vacation Benefits Expense 6,000

Vacation Benefits Payable 6,000

Dec. 31 Employee Bonus Expense (3% × 52,000) / 1.03 1,515

Employee Bonus Payable 1,515

E11-23

Situatio Appropriate accounting treatment

n
a. Do not disclose.
b. Describe the situation in a note to the financial statements.
c. Record an expense and a liability based on estimated amounts.

© 2018 Pearson Education, Inc.

E11-24
Requirement 1

Times-interest-earned ratio
Cash Pennington
Net Income $ 26,070 $ 74,188
+ Income Tax Expense + 9,270 + 27,080
+ Interest Expense + 300 + 2,900
Total $ 35,640 $ 104,168
÷ Interest Expense ÷ 300 ÷ 2,900
Ratio for 2018 118.80 35.92

Requirement 2

Cash is better able to cover its interest expense.

© 2018 Pearson Education, Inc.