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Chapter 11-1 CHAPTER 11 CURRENT LIABILITIES AND PAYROLL ACCOUNTING Accounting Principles, Eighth Edition Chapter 11-2 Study Study Objectives Objectives 1. Explain a current liability, and identify the major types of current liabilities. 2. Describe the accounting for notes payable. 3. Explain the accounting for other current liabilities. 4. Explain the financial statement presentation and analysis of current liabilities. 5. Describe the accounting and disclosure requirements for contingent liabilities. 6. Compute and record the payroll for a pay period. 7. Describe and record employer payroll taxes. 8. Discuss the objectives of internal control for payroll. Chapter 11-3 Current Current Liabilities Liabilities and and Payroll Payroll Accounting Accounting Accounting for Current Liabilities Chapter 11-4 Notes payable Sales taxes payable Unearned revenues Current maturities of long-term debt Statement presentation and analysis Contingent Liabilities Payroll Accounting Recording Disclosure Determining payroll Recording payroll Employer payroll taxes Filing and remitting payroll taxes Internal control for payroll Accounting Accounting for for Current Current Liabilities Liabilities Current liability is debt with two key features: 1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities. 2. Company will pay the debt within one year or the operating cycle, whichever is longer. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries payable, and interest payable. Chapter 11-5 LO 1 Explain a current liability, and identify the major types of current Accounting Accounting for for Current Current Liabilities Liabilities Question To be classified as a current liability, a debt must be expected to be paid: a. out of existing current assets. b. by creating other current liabilities. c. within 2 years. d. both (a) and (b). Chapter 11-6 LO 1 Explain a current liability, and identify the major types of current Accounting Accounting for for Current Current Liabilities Liabilities Notes Payable Written promissory note. Require the borrower to pay interest. Issued for varying periods. Chapter 11-7 LO 2 Describe the accounting for notes Accounting Accounting for for Current Current Liabilities Liabilities E11-2 On June 1, Melendez Company borrows $90,000 from First Bank on a 6-month, $90,000, 12% note. Instructions a) Prepare the entry on June 1. b) Prepare the adjusting entry on June 30. c) Prepare the entry at maturity (December 1), assuming monthly adjusting entries have been made through November 30. d) What was the total financing cost (interest expense)? Chapter 11-8 LO 2 Describe the accounting for notes Accounting Accounting for for Current Current Liabilities Liabilities E11-2 On June 1, Melendez Company borrows $90,000 from First Bank on a 6-month, $90,000, 12% note. a) Prepare the entry on June 1. Cash 90,000 Notes payable 90,000 b) Prepare the adjusting entry on June 30. $90,000 x 12% x 1/12 = $900 Interest expense Interest payable Chapter 11-9 900 900 LO 2 Describe the accounting for notes Accounting Accounting for for Current Current Liabilities Liabilities E11-2 On June 1, Melendez Company borrows $90,000 from First Bank on a 6-month, $90,000, 12% note. c) Prepare the entry at maturity (December 1), assuming monthly adjusting entries have been made through November 30. Notes payable Interest payable 90,000 5,400 Cash 95,400 d) What was the total financing cost (interest expense)? $5,400 Chapter 11-10 LO 2 Describe the accounting for notes Accounting Accounting for for Current Current Liabilities Liabilities Sales Tax Payable Sales taxes are expressed as a stated percentage of the sales price. Either rung up separately or included in total receipts. Retailer collects tax from the customer. Retailer remits the collections to the state’s department of revenue. Chapter 11-11 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities E11-3 In providing accounting services to small businesses, you encounter the following situations pertaining to cash sales. 1. Warkentinne Company rings up sales and sales taxes separately on its cash register. On April 10, the register totals are sales $30,000 and sales taxes $1,500. 2. Rivera Company does not segregate sales and sales taxes. Its register total for April 15 is $23,540, which includes a 7% sales tax. Instructions: Prepare the entry to record the sales transactions and related taxes for each client. Chapter 11-12 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities E11-3 1. Warkentinne Company rings up sales and sales taxes separately on its cash register. On April 10, the register totals are sales $30,000 and sales taxes $1,500. Cash Sales Sales tax payable Chapter 11-13 31,500 30,000 1,500 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities E11-3 2. Rivera Company does not segregate sales and sales taxes. Its register total for April 15 is $23,540, which includes a 7% sales tax. Cash Sales Sales tax payable Chapter 11-14 $23,540 / 1.07 = $22,000 23,540 22,000 1,540 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities Unearned Revenue Revenues that are received before the company delivers goods or provides services. 1. Company debits Cash, and credits a current liability account (unearned revenue). 2. When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account. Chapter 11-15 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities E11-4 Guyer Company publishes a monthly sports magazine, Fishing Preview. Subscriptions to the magazine cost $20 per year. During November 2008, Guyer sells 12,000 subscriptions beginning with the December issue. Guyer prepares financial statements quarterly and recognizes subscription revenue earned at the end of the quarter.The company uses the accounts Unearned Subscriptions and Subscription Revenue. Instructions: (a) Prepare the entry in November for the receipt of the subscriptions. (b) Prepare the adjusting entry at December 31, 2008. (c) Prepare the adjusting entry at March 31, 2009. Chapter 11-16 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities E11-4 (a) Prepare the entry in November for the receipt of the subscriptions. (b) Prepare the adjusting entry at December 31, 2008. (c) Prepare the adjusting entry at March 31, 2009. Nov. 30 Cash (12,000 x $20) 240,000 Unearned subscriptions Dec. 31 1 month Mar. 31 3 months Unearned subscriptions 240,000 Subscriptions revenue 20,000 20,000 subscriptions Unearned Subscriptions revenue 60,000 Chapter 11-17 LO60,000 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities Current Maturities of Long-Term Debt Portion of long-term debt that comes due in the current year. No adjusting entry required. Chapter 11-18 LO 3 Explain the accounting for other current liabilities. Accounting Accounting for for Current Current Liabilities Liabilities Statement Presentation and Analysis Chapter 11-19 Illustration 11-3 LO 4 Explain the financial statement presentation and analysis of current Accounting Accounting for for Current Current Liabilities Liabilities Question Working capital is calculated as: a. current assets minus current liabilities. b. total assets minus total liabilities. c. long-term liabilities minus current liabilities. d. both (b) and (c). Chapter 11-20 LO 4 Explain the financial statement presentation and analysis of current Accounting Accounting for for Current Current Liabilities Liabilities Statement Presentation and Analysis Illustration 11-4 The current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times. Chapter 11-21 Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash. Illustration 11-5 LO 4 Explain the financial statement presentation and analysis of current Contingent Contingent Liabilities Liabilities The likelihood that the future event will confirm the incurrence of a liability can range from probable to remote. FASB uses three areas of probability: Probable. Reasonably possible. Remote. Chapter 11-22 LO 5 Describe the accounting and disclosure requirements for Contingent Contingent Liabilities Liabilities Chapter 11-23 Probability Accounting Probable Accrue Reasonably Possible Footnote Remote Ignore LO 5 Describe the accounting and disclosure requirements for Contingent Contingent Liabilities Liabilities Question A contingent liability should be recorded in the accounts when: a. it is probable the contingency will happen, but the amount cannot be reasonably estimated. b. it is reasonably possible the contingency will happen, and the amount can be reasonably estimated. c. it is probable the contingency will happen, and the amount can be reasonably estimated. Chapter 11-24 d. it is reasonably possible the contingency will happen, but the amount cannot be reasonably LO 5 Describe the accounting and estimated. disclosure requirements for Contingent Contingent Liabilities Liabilities Recording a Contingent Liability Product Warranties Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs. Chapter 11-25 LO 5 Describe the accounting and disclosure requirements for Contingent Contingent Liabilities Liabilities BE11-6 On December 1, Diaz Company introduces a new product that includes a one-year warranty on parts. In December, 1,000 units are sold. Management believes that 5% of the units will be defective and that the average warranty costs will be $80 per unit. Prepare the adjusting entry at December 31 to accrue the estimated warranty cost. 1,000 units x 5% x $80 = $4,000 Dec. 31 Warranty expense Warranty liability Chapter 11-26 4,000 4,000 LO 5 Describe the accounting and disclosure requirements for Payroll Payroll Accounting Accounting The term “payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. Chapter 11-27 Determining Determining the the Payroll Payroll Gross Earnings Total compensation earned by an employee (wages or salaries, plus any bonuses and Illustration 11-8 commissions). Chapter 11-28 LO 6 Compute and record the payroll for a pay Determining Determining the the Payroll Payroll Payroll Deductions Mandatory: Voluntary: FICA tax Charity Federal income tax Retirement State income tax Union dues Health and life insurance Pension plans Chapter 11-29 LO 6 Compute and record the payroll for a pay Determining Determining the the Payroll Payroll Payroll Deductions Mandatory:  Supplemental retirement, employment disability, and medical benefits. FICA tax Federal income tax State income tax Chapter 11-30 Social Security taxes  In 2006, the rate was 7.65% (6.2% Social Security plus 1.45% Medicare) on the first $94,200 of gross earnings for each employee. For purpose of illustration, assume a rate of 8% on the first $90,000 of gross LO 6 Computeearnings, and recordmaximum the payrollof for a pay $7,200. Determining Determining the the Payroll Payroll Payroll Deductions  Employers are required to Mandatory: withhold income taxes from employees pay. FICA tax Federal income tax State income tax Chapter 11-31  Withholding amounts are based on gross wages and the number of allowances claimed. LO 6 Compute and record the payroll for a pay Determining Determining the the Payroll Payroll Payroll Deductions Mandatory: FICA tax Federal income tax State income tax Chapter 11-32  Most states (and some cities) require employers to withhold income taxes from employees’ earnings. LO 6 Compute and record the payroll for a pay Determining Determining the the Payroll Payroll Net Pay Gross earnings minus payroll deductions. Illustration 11-11 Chapter 11-33 LO 6 Compute and record the payroll for a pay Recording Recording the the Payroll Payroll Maintaining Payroll Department Records Employer required by law to keep a cumulative record of each employee’s gross earnings, deductions, and net pay during the year. Illustration 11-12 Employee earnings record Chapter 11-34 LO 6 Compute and record the payroll for a pay Recording Recording the the Payroll Payroll Maintaining Payroll Department Many companies find it useful to prepare a Records payroll register. This record accumulates the gross earnings, deductions, and net pay by employee for each pay period. Illustration 11-13 Payroll register Chapter 11-35 LO 6 Compute and record the payroll for a pay Recording Recording the the Payroll Payroll Recognizing Payroll Expenses and Liabilities E11-10 Joyce Kieffer’s regular hourly wage rate is $15, and she receives a wage of 1.5 times the regular hourly rate for work in excess of 40 hours. During a March weekly pay period Joyce worked 42 hours. Her gross earnings prior to the current week were $6,000. Joyce is married and claims three withholding allowances. Her only voluntary deduction is for group hospitalization insurance at $25 per week. For state income tax, assume a 2.0% rate. Instructions: Record Joyce’s pay, assuming she is an office computer operator. Chapter 11-36 LO 6 Compute and record the payroll for a pay Recording Recording the the Payroll Payroll E11-10 Record Joyce’s pay, assuming she is an office computer operator. * 645.00 Wages expense FICA tax payable ** 51.60 Federal tax payable *** 55.00 State tax payable **** 12.90 Insurance payable 25.00 Wages payable 500.50 * (40 x $15) + (2 x $22.50) = $645 *** Table, next slide ** $645 x 8% = $51.60 Chapter 11-37 **** $645 x 2% = $12.90 LO 6 Compute and record the payroll for a pay Recording Recording the the Payroll Payroll E11-10 Joyce is married and claims three withholding allowances. Illustration 11-10 Federal Tax Withholding Chapter 11-38 LO 6 Compute and record the payroll for a pay Recording Recording the the Payroll Payroll Recording Payment of the Payroll Using the facts from E11-10. Wages payable Cash Chapter 11-39 500.50 500.50 LO 6 Compute and record the payroll for a pay Employer Employer Payroll Payroll Taxes Taxes Payroll tax expense results from three taxes that governmental agencies levy on employers.  Same rate and maximum These taxes are: earnings as the employee’s. FICA tax Federal unemployment tax State unemployment tax Chapter 11-40  In 2006, the rate was 7.65% (6.2% Social Security plus 1.45% Medicare) on the first $94,200 of gross earnings for each employee. LO 7 Describe and record employer payroll taxes. Employer Employer Payroll Payroll Taxes Taxes Payroll tax expense results from three taxes that governmental agencies levy on employers.  FUTA tax rate is 6.2% of These taxes are: first $7,000 of taxable wages. FICA Federal unemployment tax State unemployment tax Chapter 11-41  Employers who pay the state unemployment tax on a timely basis will receive an offset credit of up to 5.4%. Therefore, the net federal tax rate is generally 0.8%. LO 7 Describe and record employer payroll taxes. Employer Employer Payroll Payroll Taxes Taxes Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: FICA Federal unemployment tax State unemployment tax Chapter 11-42  SUTA basic rate is usually 5.4% on the first $7,000 of wages paid. LO 7 Describe and record employer payroll taxes. Employer Employer Payroll Payroll Taxes Taxes E11-14 According to a payroll register summary of Ruiz Company, the amount of employees’ gross pay in December was $850,000, of which $90,000 was not subject to FICA tax and $750,000 was not subject to state and federal unemployment taxes. Instructions: Prepare the journal entry to record December payroll tax expense. Use the following rates: FICA 8%, state unemployment 5.4%, federal unemployment 0.8%. Chapter 11-43 LO 7 Describe and record employer payroll taxes. Employer Employer Payroll Payroll Taxes Taxes E11-14 Prepare the journal entry to record December payroll tax expense. Use the following rates: FICA 8%, state unemployment 5.4%, federal unemployment 0.8%. Payroll tax expense 67,000 * 60,800 FICA tax payable State unemployment tax payable Federal unemployment tax payable * $760,000 x 8% = $60,800 ** $100,000 x 5.4% = $5,400 Chapter 11-44 ** 5,400 *** 800 *** $100,000 x .8% = $5,400 LO 7 Describe and record employer payroll taxes. Employer Employer Payroll Payroll Taxes Taxes Question Employer payroll taxes do not include: a. Federal unemployment taxes. b. State unemployment taxes. c. Federal income taxes. d. FICA taxes. Chapter 11-45 LO 7 Describe and record employer payroll taxes. Filing Filing and and Remitting Remitting Payroll Payroll Taxes Taxes Companies must report FICA taxes and federal income taxes withheld no later than one month following the close of each quarter. Companies generally file and remit federal unemployment taxes annually on or before January 31 of the subsequent year. Companies usually file and pay state unemployment taxes by the end of the month following each quarter. Employers must provide each employee with a Wage and Tax Statement (Form W-2) by January 31. Chapter 11-46 LO 7 Describe and record employer payroll taxes. Internal Internal Control Control for for Payroll Payroll As applied to payroll, 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. Chapter 11-47 LO 8 Discuss the objectives of internal control for Additional Additional Fringe Fringe Benefits Benefits In addition to the three payroll-tax fringe benefits, employers incur other substantial fringe benefit costs. Two of the most important fringe benefits include: Paid absences Post-retirement benefits Chapter 11-48 LO 9 Identify additional fringe benefits associated with employee compensation. Paid Absences •Employees often are given rights to receive compensation for absence when they meet certain conditions of employment. •The compensation may be for paid vacations, sick pay benefits, and paid holidays. •When the payment for such absences is probable and the amount can be reasonably estimated, the company should accrue a liability for paid future absences. Chapter 11-49 •When the amount cannot be reasonably estimated, the company should instead disclose the potential liability. LO 9 Identify additional fringe benefits associated with employee compensation. Post-Retirement Benefits Post-retirement benefits are benefits that employers provide to retired employees for (1) pensions and (2) health care and life insurance. Companies account for post-retirement benefits on the accrual basis. The cost of post-retirement benefits is getting steep. Chapter 11-50 LO 9 Identify additional fringe benefits associated with employee compensation. Pensions A pension plan is an agreement whereby employers provide benefits to employees after they retire. There are two types of pension plans: In a defined-contribution plan, the plan defines the contribution that an employer will make but not the benefit that the employee will receive at retirement. This is often referred to as a 401 (k) plan. In a defined-benefit plan, the employer agrees to pay a defined amount to retirees, based on employees meeting certain eligibility standards. Chapter 11-51 LO 9 Identify additional fringe benefits associated with employee compensation. Copyright Copyright “Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Chapter 11-52