CURRENT LIABILITIES

NON-CURRENT LIABILITIES
CURRENT LIABILITIES
& PAYROLL ACCOUNTING

CHAPTER 11-15
Learning Objectives
✓ Explain how to account for current liabilities.

✓ Explain how to account for payroll

LIABILITIES ✓ Discuss how current liabilities are reported and analyzed.

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LEARNING Explain how to account for current What Is a Current Liability?

OBJECTIVE
1
liabilities.

Question
What Is a Current Liability?
To be classified as a current liability, a debt must be
A debt that a
expected to be paid within:
◆ company expects to pay within one year or
a. one year.
◆ the operating cycle, whichever is longer.
b. the operating cycle.

Current liabilities include notes payable, accounts payable, c. 2 years.

unearned revenues, and accrued liabilities such as taxes payable, d. (a) or (b), whichever is longer
salaries and wages payable, and interest payable.

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Current Liabilities Notes Payable

Notes Payable Illustration: First National Bank agrees to lend $100,000 on

September 1, 2017, if Cole Williams Co. signs a $100,000,
◆ Written promissory note.
12%, four-month note maturing on January 1.
◆ Frequently issued to meet short-term financing Instructions
needs.
a) Prepare the entry on September 1st.
◆ Requires the borrower to pay interest.
b) Prepare the adjusting entry on December 31st, assuming
◆ Issued for varying periods. monthly adjusting entries have not been made.

c) Prepare the entry required on January 1, 2018, the

maturity date.

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 Notes Payable Notes Payable

Illustration: First National Bank agrees to lend $100,000 on Illustration: First National Bank agrees to lend $100,000 on
September 1, 2017, if Cole Williams Co. signs a $100,000, September 1, 2017, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1. 12%, four-month note maturing on January 1, 2018.

a) Prepare the entry on September 1st. c) Prepare the entry at maturity.

Cash 100,000 Notes Payable 100,000

Notes Payable 100,000 Interest Payable 4,000
Cash 104,000
b) Prepare the adjusting entry on December 31st.
Interest Expense 4,000
Interest Payable 4,000
$100,000 x 12% x 4/12 = $4,000
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Current Liabilities Sales Taxes Payable

Sales Taxes Payable Illustration: The March 25 cash register reading for Cooley
Grocery shows sales of $10,000 and sales taxes of $600 (sales
◆ Sales taxes are expressed as a stated percentage of
tax rate of 6%), the journal entry is:
the sales price.

◆ Selling company (retailer) Mar. 25 Cash 10,600

Sales Revenue 10,000
► collects tax from the customer.
Sales Tax Payable 600
► enters tax separately in cash register or includes in
total receipts.

► remits the collections to the state’s department of

revenue.

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Sales Taxes Payable Current Liabilities

Sometimes companies do not enter sales taxes separately in Unearned Revenue

the cash register.
Revenues received before the company
Illustration: Cooley Grocery enters total receipts of $10,600.
◆ delivers goods or
Because the amount received from the sale is equal to the
sales price 100% plus 6% of sales, (sales tax rate of 6%), the ◆ provides services. Illustration 11-2
Unearned revenue and
journal entry is: revenue accounts

Mar. 25 Cash 10,600

Sales revenue 10,000 *

Sales tax payable 600

* $10,600 ÷ 1.06 = $10,000

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 Unearned Revenue Current Liabilities

Illustration: Superior University sells 10,000 season football Current Maturities of Long-Term Debt
tickets at $50 each for its five-game home schedule. The entry
◆ Portion of long-term debt that comes due in the current
for the sale of season tickets is:
year.
Aug. 6 Cash 500,000 ◆ No adjusting entry required.
Unearned Ticket Revenue 500,000
Illustration: Wendy Construction issues a five-year, interest-bearing
As each game is completed, Superior records the recognition of $25,000 note on January 1, 2017. This note specifies that each January 1,
revenue with the following entry. starting January 1, 2018, Wendy should pay $5,000 of the note. When the
company prepares financial statements on December 31, 2017,
Sept. 7 Unearned Ticket Revenue 100,000 $5,000
1. What amount should be reported as a current liability? ___________
Ticket Revenue 100,000 $20,000
2. What amount should be reported as a long-term liability? _________

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DO IT! 1 Current Liabilities DO IT! 1 Current Liabilities

You and several classmates are studying for the next accounting You and several classmates are studying for the next accounting
examination. They ask you to answer the following questions. examination. They ask you to answer the following questions.

1. If cash is borrowed on a $50,000, 6-month, 12% note on 2. How is the sales tax amount determined when the cash register
September 1, how much interest expense would be incurred by total includes sales taxes?
December 31?
Solution
Solution
First, divide the total cash register receipts by 100% plus the sales
$50,000 x 12% x 4/12 = $2,000 tax percentage to find the sales revenue amount.

Second, subtract the sales revenue amount from the total cash
register receipts to determine the sales taxes.

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Illustration 11-4

DO IT! 1 Current Liabilities Balance sheet reporting

of current liabilities

You and several classmates are studying for the next accounting
examination. They ask you to answer the following questions.

3. If $15,000 is collected in advance on November 1 for 3 months’

rent, what amount of rent revenue should be recognized by
December 31?

Solution

$15,000 x 2/3 = $10,000

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 Analysis of Current Liabilities
Illustration 11-5
Liquidity refers to the
ability to pay maturing
obligations and meet
unexpected needs for
cash.
Current ratio permits Illustration 11-6
DO IT! 2 Reporting and Analyzing
Lepid Company has the following account balances at December
31, 2017. Notes payable ($80,000 due after 12/31/18) $200,000,
unearned service revenue $75,000, other long-term debt ($30,000
due in 2018) $150,000, salaries and wages payable $22,000, other
accrued expenses $15,000, and accounts payable $100,000. In
addition, Lepid is involved in a lawsuit. Legal counsel feels it is

us to compare the probable Lepid will pay damages of $38,000 in 2018.

liquidity of different-
sized companies and a. Prepare the current liabilities section of Lepid’s December 31,
of a single company at 2017, balance sheet.
different times.
b. Lepid’s current assets are $504,000. Compute Lepid’s working
capital and current ratio.
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DO IT! 2 Reporting and Analyzing DO IT! 2 Reporting and Analyzing

a. Prepare the current liabilities section of Lepid’s December 31, b. Lepid’s current assets are $504,000. Compute Lepid’s working
2017, balance sheet. capital and current ratio.

Current liabilities Working capital = Current assets - Current liabilities =

Notes payable $120,000 $504,000 - $400,000 = $104,000
Accounts payable 100,000
Current ratio = Current assets ÷ Current liabilities =
Unearned service revenue 75,000
Lawsuit liability 38,000 $504,000 ÷ $400,000 = 1.26:1
Salaries and wages payable 22,000
Other accrued expenses 15,000
Long-term debt due within one year 30,000
Total current liabilities $400,000

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LEARNING
2 Explain how to account for payroll. Determining the Payroll
OBJECTIVE

GROSS EARNINGS
“Payroll” pertains to both:
Total compensation earned by an employee (wages or
Salaries - managerial, administrative, and sales personnel salaries, plus any bonuses and commissions).
(monthly or yearly rate).

Wages - store clerks, factory employees, and manual

laborers (rate per hour).

Determining the Payroll

Illustration 11-7
Computation of total wages
Involves computing three amounts: (1) gross earnings, (2)
payroll deductions, and (3) net pay.

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 PAYROLL DEDUCTIONS Determining the Payroll

PAYROLL DEDUCTIONS
Mandatory: Voluntary:
◆ FICA tax ◆ Charity
◆ Federal income tax ◆ Insurance
◆ State income tax ◆ Union dues
◆ Pension plans

Illustration 11-8
Payroll deductions
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Determining the Payroll Determining the Payroll

PAYROLL DEDUCTIONS PAYROLL DEDUCTIONS

Mandatory: Social Security and Medicare tax Mandatory:
◆ Employers are required to
◆ FICA tax Supplemental retirement, ◆ FICA tax withhold income taxes from
employment disability, and medical employees’ pay.
◆ Federal income tax benefits. ◆ Federal income tax
◆ Withholding amounts are based
◆ State income tax ◆ State income tax
Illustration 11-9 on gross wages and the number
FICA tax rate and tax base
of allowances claimed.

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Determining the Payroll Determining the Payroll

PAYROLL DEDUCTIONS NET PAY

Mandatory: Gross earnings minus payroll deductions.
Illustration 11-12
Computation of net pay
◆ FICA tax
◆ Federal income tax Most states (and some cities)
require employers to withhold
◆ State income tax
income taxes from employees’
earnings.

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 Recording the Payroll Recording the Payroll

RECOGNIZING PAYROLL EXPENSES AND RECORDING PAYMENT OF THE PAYROLL

LIABILITIES
Illustration: Prepare the entry Academy Company would make to
Illustration: Prepare the entry Academy Company would make to record the payment of the payroll.
record the payroll for the week ending January 14.
Salaries and Wages Payable 11,522.73
Salaries and Wages Expense 17,210.00
Cash 11,522.73
FICA Taxes Payable 1,316.57
Federal Income Taxes Payable 3,490.00
State Income Taxes Payable 344.20
United Fund Contributions Payable 421.50
Union Dues Payable 115.00
Salaries and Wages Payable 11,522.73
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DO IT! 3a Payroll Internal Control for Payroll

In January, gross earnings in Ramirez Company were $40,000. All
earnings are subject to 7.65% FICA taxes. Federal income tax
withheld was $9,000, and state income tax withheld was $1,000. (a)
Calculate net pay for January, and (b) record the payroll.
(a) Net pay: $40,000 - (7.65% x $40,000) - $9,000 - $1,000 =
$26,940
As applied to payrolls, the objectives of internal control are
1. to safeguard company assets against unauthorized
payments of payrolls, and
2. to ensure the accuracy and reliability of the accounting
records pertaining to payrolls.

(b) Salaries and Wages Expense 40,000

FICA Taxes Payable 3,060
Federal Income Taxes Payable 9,000
State Income Taxes Payable 1,000
Salaries and Wages Payable 26,940
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Internal Control for Payroll APPENDIX

LONG-TERM LIABILITIES

Learning Objectives
✓ Describe the major characteristics of bonds.

✓ Explain how to account for bond transactions.

✓ Explain how to account for long-term notes payable.

Illustration 11-18
Internal control for payroll ✓ Discuss how long-term liabilities are reported and analyzed.
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 LEARNING Describe the major characteristics of Types of Bonds
OBJECTIVE
1
bonds.

Long-term liabilities are obligations that are expected to

be paid after one year.

Bonds are a form of interest-bearing notes payable.

◆ Sold in small denominations (usually $1,000 or multiples
of $1,000).

◆ Attract many investors.

◆ Corporation issuing bonds is borrowing money.

◆ Person who buys the bonds (the bondholder) is investing

in bonds.

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Bonds Bonds

Issuing Procedures Issuing Procedures

◆ State laws grant corporations the power to issue bonds. ◆ Represents a promise to pay:

◆ Board of directors and stockholders must approve bond
issues.
◆ Board of directors must stipulate number of bonds to be
authorized, total face value, and contractual interest
rate.
◆ Bond terms set forth in legal document known as a bond
indenture.
◆ Bond certificate, typically a $1,000 face value.
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► sum of money at designated maturity date, plus
► periodic interest at a contractual (stated) rate on the
maturity amount (face value).
◆ Interest payments usually made semiannually.
◆ Issued to obtain large amounts of long-term capital.
◆ Investment company sells the bonds for the issuing
company.
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Determining the Market Value of a Bond

Current market price (present value) is a function of the three

factors:

1. dollar amounts to be received,

2. length of time until the amounts are received, and

3. market rate of interest.

The market interest rate is the rate investors demand for

loaning funds.

Illustration 15-1
Bond certificate

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 LEARNING Explain how to account for bond
OBJECTIVE
2 Bond Discount or Premium
transactions.

Corporation records bond transactions when it

Bond Sets Market Sets
◆ issues (sells), Contract Market Contract rate > Market rate Bonds sell at
Rate Rate Premium
◆ redeems (buys back) bonds, and

◆ when bondholders convert bonds into common stock.

Contract rate = Market rate Bonds sell at Par

NOTE: If bondholders sell their bond investments to other investors,

Contract rate < Market rate Bonds sell at
the issuing company receives no further money on the transaction, nor
Discount
does the issuing company journalize the transaction.

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Accounting for Bond Transactions Accounting for Bond Transactions

Issue at Face Value, Discount, or Premium? Question

Illustration 15-4
Interest rates and bond prices
The rate of interest investors demand for loaning funds to a
corporation is the:

a. contractual interest rate.

Bond b. face value rate.

Contractual
Interest c. market interest rate.
Rate 10%
d. stated interest rate.

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Accounting for Bond Transactions Issuing Bonds at Face Value

Question Illustration: On January 1, 2017, Candlestick, Inc. issues

Karson Inc. issues 10-year bonds with a maturity value of $200,000. $100,000, five-year, 10% bonds at 100 (100% of face value).
If the bonds are issued at a premium, this indicates that: The entry to record the sale is:

a. the contractual interest rate exceeds the market interest rate. Jan. 1 Cash 100,000
b. the market interest rate exceeds the contractual interest rate. Bonds Payable 100,000
c. the contractual interest rate and the market interest rate are
the same.

d. no relationship exists between the two rates.

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 Issuing Bonds at Face Value Issuing Bonds at Face Value

Illustration: On January 1, 2017, Candlestick, Inc. issues Illustration: On January 1, 2017, Candlestick, Inc. issues
$100,000, five-year, 10% bonds at 100 (100% of face value). $100,000, five-year, 10% bonds at 100 (100% of face value).
Assume that interest is payable annually on January 1. At Assume that interest is payable annually on January 1.
December 31, 2017, Candlestick recognizes interest expense Candlestick records the payment on January 1, 2018, as
incurred with the following entry. Assume monthly accruals follows.
have not been made.
Jan. 1 Interest Payable 10,000
Dec. 31 Interest Expense 10,000 Cash 10,000
Interest Payable 10,000

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Issuing Bonds at a Discount Issuing Bonds at a Discount

Illustration 15-5
Illustration: On January 1, 2017, Statement Presentation Statement presentation of
discount on bonds payable
Candlestick, Inc. sells $100,000, five-year,
Carrying value or
10% bonds for $98,000 (98% of face value). book value

Interest is payable annually January 1. The

entry to record the issuance is:

Jan. 1 Cash 98,000

Sale of bonds below face value (discount) =
Discount on Bonds Payable 2,000
total cost of borrowing > interest paid.
Bonds Payable 100,000
Reason: Borrower is required to pay the bond discount at the maturity
date. Therefore, the bond discount is considered to be a increase
Contra-Liability in the cost of borrowing.
Account
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Issuing Bonds at a Premium Issuing Bonds at a Premium

Illustration 15-9
Illustration: On January 1, 2017, Statement Presentation Statement presentation of
discount on bonds payable
Candlestick, Inc. sells $100,000, five-year,
10% bonds for $102,000 (102% of face
value). Interest is payable annually
January 1. The entry to record the issuance
is:
Sale of bonds above face value (premium) =
Jan. 1 Cash 102,000 total cost of borrowing < interest paid.
Bonds Payable 100,000 Reason: Borrower is not required to pay the bond premium at the
Premium on Bonds Payable 2,000 maturity date of the bonds. Therefore, the bond premium is
considered to be a reduction in the cost of borrowing.
Adjunct-Liability
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 LEARNING Discuss how long-term liabilities are Use of Ratios
OBJECTIVE
4
reported and analyzed.
Illustration 15-14
Two ratios that provide information long-run solvency
Presentation Balance sheet presentation
of long-term liabilities
and the ability to meet interest payments as they come
due are:
◆ Debt to Assets Ratio

◆ Times Interest Earned

Companies report the current maturities of long-term debt under

current liabilities if they are to be paid within one year or the
operating cycle, whichever is longer.
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Use of Ratios Use of Ratios

Illustration: Kellogg Company reported total liabilities of $8,925 Illustration: Kellogg Company reported total liabilities of
million, total assets of $11,200 million, interest expense of $295 $8,925 million, total assets of $11,200 million, interest expense
million, income taxes of $476 million, and net income of $1,208 of $295 million, income taxes of $476 million, and net income of
million. $1,208 million. Illustration 15-16
Illustration 15-15 Times interest earned
Debt to assets ratio

The higher the percentage of debt to assets, the greater the

risk that the company may be unable to meet its maturing Times interest earned indicates the company’s ability to meet
obligations. interest payments as they come due.

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Debt and Equity Financing Debt and Equity Financing

Illustration: Microsystems, Inc. is considering two plans for financing the
construction of a new $5 million plant. It is considering two alternatives for
raising an additional $5 million: Plan A involves issuing 200,000 shares of
common stock at the current market price of $25 per share. Plan B involves
issuing $5 million of 8% bonds at face value. Income before interest and
taxes will be $1.5 million; income taxes are expected to be 30%.

Illustration 15-18

Illustration 15-17
Advantages of bond financing
over common stock

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 THE END

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