Chapter 11

Current Liabilities
Accounting, 21st Edition
Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting Pepperdine University

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Objectives Objectives
1. Define and give examples of current liabilities. 2. Prepare journal entries for short-term notes After studying this After studying this payable and disclosure for the current portion of chapter, you should chapter, you should long-term debt. be able to: 3. Describe the accounting treatment for contingent be able to: liabilities and journalize entries for product warranties. 4. Determine employer liabilities for payroll, including liabilities arising from employee earnings and deductions from earnings.

Objectives Objectives
5. Describe payroll accounting systems that use a payroll register, employee earnings record, and a general journal. 6. Journalize entries for employee fringe benefits, including vacation pay and pensions. 7. Use the quick ratio to analyze the ability of a business to pay its current liabilities.

The Nature of Current Liabilities The Nature of Current Liabilities
Liabilities that are to be paid out of Liabilities that are to be paid out of current assets and are due within a current assets and are due within a short time, usually within one short time, usually within one year, are called current liabilities. year, are called current liabilities.
     

Examples:

Accounts payable Notes payable Unearned rent Taxes payable Wages payable Current portion of long term debt

Short-Term Notes Payable Short-Term Notes Payable
A firm issues a 90-day, 12% note for A firm issues a 90-day, 12% note for $1,000, dated August 1, 2006 to Murray $1,000, dated August 1, 2006 to Murray Co. for a $1,000 overdue account. Co. for a $1,000 overdue account.
Aug. 1 Accounts Payable—Murray Co. Notes Payable Issued a 90-day, 12% note on account. 1 000 00 1 000 00

Short-Term Notes Payable Short-Term Notes Payable
On October 30, when the note matures, the On October 30, when the note matures, the firm pays the $1,000 principal plus $30 firm pays the $1,000 principal plus $30 interest ($1,000 x .12 x 90/360). interest ($1,000 x .12 x 90/360).
Oct. 30 Notes Payable Interest Expense Cash Issued a 90-day, 12% note on 1 000 00 30 00 1 030 00

Appears on the account. Appears on the income statement as income statement as an “Other Expense.” an “Other Expense.”

Short-Term Notes Payable Short-Term Notes Payable
Bowden Co. (Borrower)
Description Debit Credit

Coker Co. (Creditor)
Description Debit Credit

Mdse. Inventory 10,000 Accounts Payable 10,000

Accounts Receivable Sales Cost of Mdse. Sold Mdse. Inventory

10,000 10,000 7,500 7,500

May 31. Bowden Co. purchased merchandise on May 31. Bowden Co. purchased merchandise on account from Coker Co., $10,000, 2/10, n/30. account from Coker Co., $10,000, 2/10, n/30. The merchandise cost Coker Co. $7,500. The merchandise cost Coker Co. $7,500.

Short-Term Notes Payable Short-Term Notes Payable
Bowden Co. (Borrower)
Description Debit Credit

Coker Co. (Creditor)
Description Debit Credit

Mdse. Inventory 10,000 Accounts Payable 10,000

Accounts Receivable Sales Cost of Mdse. Sold Mdse. Inventory

10,000 10,000 7,500 7,500

Accounts Payable Notes Payable

10,000 10,000

Notes Receivable 10,000 Accounts Receivable 10,000

May 31. Bowden Co. issued a 60-day, 12% May 31. Bowden Co. issued a 60-day, 12% note for $10,000 to Coker on account. note for $10,000 to Coker on account.

Short-Term Notes Payable Short-Term Notes Payable
Bowden Co. (Borrower)
Description Debit Credit

Coker Co. (Creditor)
Description Debit Credit

Mdse. Inventory 10,000 Accounts Payable 10,000

July 30. Bowden Co. paid Coker Co. the July 30. Bowden Co. paid Coker Co. the amount due on the noteAccounts Receivable 10,000 amount due on the note ofSales 31. Interest: 10,000 of May 31. Interest: May $10,000 x 12% x 60/360 = $200. $10,000 x 12% xCost of Mdse.$200. 7,500 60/360 = Sold
Mdse. Inventory 7,500
10,000 10,000

Accounts Payable Notes Payable

Notes Receivable 10,000 Accounts Receivable 10,000
Cash Interest Revenue Notes Receivable 10,200 200 10,000

Notes Payable Interest Expense Cash

10,000 200 10,200

Discounted Notes Payable Discounted Notes Payable
On August 10, Cary Company issues a $20,000, On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for 90-day note to Rock Company in exchange for inventory. Rock discounts the note at 15%. inventory. Rock discounts the note at 15%.
Aug.10 Merchandise Inventory Interest Expense Notes Payable
Issued a 90-day, note to Rock Co. discounted at 15%.

19 250 00

Proceeds 20 000 Proceeds
Discount: $20,000 Discount: $20,000 x .15 x 90/360 x .15 x 90/360

750 00

00

Discount rate Discount rate

Discounted Notes Payable Discounted Notes Payable
On November 8 the note is paid in full. On November 8 the note is paid in full.
Nov. 8 Notes Payable Cash
Paid note due.

20 000 00 20 000 00

Contingent Liabilities

Product Liability Product Liability
On June 30, a company sells a product for $60,000 On June 30, a company sells a product for $60,000 on which there is a 36-month warranty. Past on which there is a 36-month warranty. Past experience indicates that repairs of defects cost 5% experience indicates that repairs of defects cost 5% of the sales price over the warranty period. of the sales price over the warranty period.
June 30 Product Warranty Expense Product Warranty Liability
Warranty expenses projected for June, 5% of $60,000.

3 000 00 3 000 00

Product Liability Product Liability
On August 16, a customer needed a On August 16, a customer needed a defective part replaced. Cost to the defective part replaced. Cost to the company was $200 for the part. company was $200 for the part.
Aug.16 Product Warranty Payable Supplies
Replaced defective part under warranty.

200 00 200 00

Accounting Treatment of Accounting Treatment of Contingent Liabilities Contingent Liabilities
Likelihood of Occurring
Probable Contingency

Measurement
Estimable Not Estimable

Accounting Treatment
Record Liability Disclose Liability Disclose Liability

Possible

Payroll and Payroll Taxes

Liability for Employee Earnings Liability for Employee Earnings
Payroll is the amount paid to employees for services provided. Payrolls are important because-1. Good employee relations demand that payrolls be calculated accurately and paid as scheduled. 2. Payroll expenditures are subject to a variety of federal, state, and local taxes. 3. Total payroll expense (gross payroll plus payroll taxes) has a major impact on net income.

Gross Pay Calculation Gross Pay Calculation
John T. McGrath is employed by McDermott John T. McGrath is employed by McDermott Supply Co. at the rate of $34 per hour, plus 1.5 Supply Co. at the rate of $34 per hour, plus 1.5 times the normal hourly rate for hours over 40 times the normal hourly rate for hours over 40 per week. For the week ended December 27, per week. For the week ended December 27, McGrath worked 42 hours. McGrath worked 42 hours.

Earnings at base rate (40 x $34) Earnings at overtime rate (2 x $51) Total earnings

$1,360 102 $1,462

FICA Tax FICA Tax
Employers are required to withhold a Employers are required to withhold a portion of the earnings of each of the portion of the earnings of each of the employees. The amount is matched by employees. The amount is matched by the employer and serves to provide the the employer and serves to provide the employee with social security and employee with social security and Medicare benefits upon retirement. Medicare benefits upon retirement.

FICA Tax Calculation FICA Tax Calculation
Assume that John T. McGrath’s annual earnings prior to the current period total $99,038. His current period earnings are $1,462. Earnings subject to 6% social security tax ($100,000 – $99,038) $962 Social security tax rate x 6% Social security tax $57.72 Earnings subject to 1.5% Medicare tax Current earnings $1,462 Medicare tax rate x 1.5% Medicare tax 21.93 Total FICA tax $79.65

Withholding Taxes, Other Deductions Withholding Taxes, Other Deductions
 Employers are required to withhold federal

income tax from each employee based on the withholding table and information provided by the employee’s W-4 form.
 Federal income tax and FICA tax must be

withheld from the pay of each employee.
 Deductions for other purposes may be withheld

by mutual agreement.

Employee Net Pay Calculation
Gross earnings for the week $1,462.00 Deductions: Social security tax tax $ 57.72 Medicare tax 21.93 Federal income tax 279.51 Retirement savings 20.00 United Way 5.00 Total deductions 384.16 Net pay $1,077.84

John T. McGrath is single, has declared one withholding allowance, and had gross pay of $1,462 for the week ended December 27.

Responsibility for Tax Responsibility for Tax Payments Payments
EMPLOYEE BUSINESS

Social security tax Medicare tax Federal withholding tax

GOVERNMENT

Social security tax Medicare tax Federal unemployment compensation tax State unemployment compensation tax

Federal Income
Corporate Estate, gift, income tax and other 8% 8% 46% 38%

FICA and FUTA

Personal income tax

Federal Outlays
Physical, human, and Interest on community Social debt development programs 8% 13% 19% 24% 33% 3% Social security and Medicare Law enforcement and general government

National defense

Payroll Register Payroll Register
It’s a multicolumn form used to help It’s a multicolumn form used to help What is the assemble and summarize the data What is the assemble and summarize the data purpose of a needed for each payroll period. purpose of a needed for each payroll period. payroll register? payroll register?

Payroll Register Summary
Earnings: Regular Overtime Total Deductions: Social security tax Medicare tax Federal income tax Retirement savings United Way Accounts receivable Total Net amount paid Accounts debited: Sales Salaries Expense Office Salaries Expense Total (as above) $13,328.00 574.00 $13,902.00 $ 643.07 208.53 3,332.00 680.00 470.00 50.00 5,383.60 $ 8,518.40 $11,122.00 2,780.00 $13,902.00

Recording Employees’ Earnings Recording Employees’ Earnings
Dec. 27 Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Inc. Tax Pay. Retirement Savings Ded. Payable United Way Deductions Payable Accounts Receivable—Fred Elrod Salaries Payable Payroll for week ended December 27. 11 122 00 2 780 00 643 208 3 332 680 470 50 8 518 07 53 00 00 00 00 40

Recording Employer’s Payroll Taxes Recording Employer’s Payroll Taxes
Employer Taxes for the Week Ended December 27 Employer Taxes for the Week Ended December 27 Social security tax $ 643.07 Social security tax $ 643.07 Medicare tax 208.53 Medicare tax 208.53 State unemployment compensation tax State unemployment compensation tax (5.4% x $2,710) 146.34 (5.4% x $2,710) 146.34 Federal unemployment compensation Federal unemployment compensation tax (0.8% x $2,710) 21.68 tax (0.8% x $2,710) 21.68 Total payroll tax expense $1,019.62 Total payroll tax expense $1,019.62

Recording Employer’s Payroll Taxes Recording Employer’s Payroll Taxes
Dec. 27 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Pay. Payroll taxes for week ended December 27. 1 019 62 643 208 146 21 07 53 34 68

Flow of Data in a Payroll System
Wage and Tax Statements Current Period’s Variables (hours worked) Updated Variables (cumulative earnings, taxes) Constant Data (rates of pay, tax, etc.)
EMPLOYEES’ EARNINGS RECORDS
W-2 W-2

Payroll Tax Returns

PAYROLL REGISTER

Payroll Checks and Statements Financial Statements

GENERAL LEDGER

Employees’ Fringe Benefits Employees’ Fringe Benefits

Benefit Dollars as a Percent of Total Benefit Dollars as a Percent of Total
Retirement and savings plans Other 2% 18% 29% 25% Social security and Medicare 26% Medical Vacation and sick pay

Employees’ Fringe Benefits Employees’ Fringe Benefits
Vacation pay Pensions
Vacation pay becomes the employer’s liability as the employee earns vacation rights. Cash payment to retired employees. Could be a defined contribution plan or a defined benefit plan

Postretirement Benefits

In addition to pension benefits, employees may earn rights to other postretirement benefits such as dental care, eye care, life insurance, etc. Amount is recorded by debiting Postretirement Benefits Expense and crediting cash.

Pensions Pensions
Defined contribution plan
Under this plan, a fixed amount of money is invested on the employee’s behalf during the employee’s working years. Example: 401K

Defined benefit plan

Under this plan, the pension benefits are based on a formula and the employer bears the investment risk in funding a future retirement income benefit.

Solvency Measures — Quick Ratio
Noble Co. Quick assets: Cash Cash equivalents Accounts receivable (net) Total Current liabilities $ 100,000 47,000 84,000 $231,000 $220,000 Hart Co. $ 55,000 65,000 472,000 $592,000 $740,000

Quick assets Current liabilities

Solvency Measures — Quick Ratio
Noble Co. Quick assets: Cash Cash equivalents Accounts receivable (net) Total Current liabilities $ 100,000 47,000 84,000 $231,000 $220,000 Hart Co. $ 55,000 65,000 472,000 $592,000 $740,000

$231,000 Quick assets Noble Company Current liabilities Quick ratio = 1.05 $220,000

Solvency Measures — Quick Ratio
Noble Co. Quick assets: Cash Cash equivalents Accounts receivable (net) Total Current liabilities $ 100,000 47,000 84,000 $231,000 $220,000 Hart Co. $ 55,000 65,000 472,000 $592,000 $740,000

$592,000 Quick assets Hart Company Current liabilities Quick ratio = 0.80 $740,000 Use: To indicate instant debt-paying ability Use: To indicate instant debt-paying ability

Chapter 11 The End The End

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