1 1. describe and illustrate current liabilities related to accounts payable, current portion of...

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1. Describe and illustrate current liabilities related to accounts payable, current portion of long-term debt, and notes payable.

2. Determine employer liabilities for payroll, including liabilities arising from employee earnings and deductions from earnings.

After studying this chapter, you should be able to:

Current Liabilities and PayrollCurrent Liabilities and Payroll

3. Describe the payroll accounting systems that use a payroll register, employee earnings records, and a general journal.

5. Describe the accounting treatment for contingent liabilities and journalize entries for product warranties.

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Liabilities that are to be paid out of current assets and are due within a

short time, usually within one year, are called current liabilities. Accounts payable Current portion of long-term debt Notes payable

11-1Objective 1Objective 1Objective 1Objective 1

Describe and illustrate current liabilities related to accounts

payable, current portion of long-term debt, and notes payable.

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11-1

Accounts payable arise from purchasing goods or services for use in a company’s operations

or for purchasing merchandise for resale.

Long-term liabilities are often paid back in periodic payments, called installments.

Installments that are due within the coming year must be classified as a current liability.

The total amount of the installments due after the coming year is classified as a long-term liability.

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Aug. 1 Accounts Payable—Murray Co. 1 000 00

Issued a 90-day, 12% note on

account.

Notes Payable 1 000 00

A firm issues a 90-day, 12% note for $1,000, dated August 1, 2008 to Murray

Co. for a $1,000 overdue account.

Short-Term Notes Payable 11-1

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On October 30, when the note matures, the firm pays the $1,000 principal plus $30

interest ($1,000 x 12% x 90/360).

11-1

Oct. 30 Notes Payable 1 000 00

Interest Expense 30 00

Paid principal and

interest on note.

Cash 1 030 00

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On May 1, Bowden Co. (borrower) purchased

merchandise on account from Coker Co. (creditor), $10,000,

2/10, n/30. The merchandise cost Coker Co. $7,500.

11-1

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Description Debit Credit

Bowden Co. (Borrower)

Mdse. Inventory 10,000Accounts Payable 10,000

Coker Co. (Creditor)

Description Debit Credit

Accounts Receivable 10,000Sales 10,000

Cost of Mdse. Sold 7,500Mdse. Inventory 7,500

11-1

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On May 3, Bowden Co. issued a 60-day, 12% note for $10,000 to

Coker Co. on account.

Accounts Payable10,000Notes Payable 10,000

Description Debit Credit

Bowden Co. (Borrower)

Notes Receivable 10,000Accounts Receivable 10,000

Coker Co. (Creditor)

Description Debit Credit

11-1

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On July 30, Bowden Co. paid Coker Co. the

amount due on the note of May 31. Interest:

$10,000 x 12% x 60/360.

Notes Payable 10,000Interest Expense 200

Cash 10,200

Description Debit Credit

Bowden Co. (Borrower)

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

Coker Co. (Creditor)

Description Debit Credit

11-1

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On September 19, a firm borrows $4,000 from First National Bank by giving the

bank a 90-day, 15% note.

Sept. 19 Cash 4 000 00

Notes Payable

4 000 00Issued a 90-day, 15% note

to the bank.

11-1

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On the due date of the note (December 18), the borrower owes $4,000 plus

interest of $150 ($4,000 x 15% x 90/360).

Dec. 18 Notes Payable 4 000 00

Cash

4 150 00Paid principal and interest

due on note.

Interest Expense 150 00

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11-2

Payroll refers to the amount paid to employees for the services they provide during a period. It is usually significant for several reasons.

11-2

1) Employees are sensitive to payroll errors and irregularities.

2) The payroll is subject to various federal and state regulations.

3) The payroll and related payroll taxes have a significant effect on the net income of most businesses.

Objective 2Objective 2Objective 2Objective 2

Determine employer liabilities for payroll, including liabilities arising

from employee earnings and deductions from earnings.

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11-2

Wages usually refers to payment for manual labor, both skilled and unskilled. The rate of

wages is normally stated on an hourly or weekly basis.

Salary usually refers to payment for managerial, administrative, or similar services, normally

expressed in terms of a month or a year.

The total earnings of an employee for a payroll period are called gross pay. From this is subtracted one or more deductions to arrive at the net pay. Net

pay is the amount that the employer must pay the employee.

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

McGrath worked 42 hours.

Earnings at base rate (40 x $34) $1,360Earnings at overtime rate (2 x $51) 102Total earnings $1,462

11-2

McGrath Illustration

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11-2

*The actual IRS standard withholding allowance changes every year.

McGrath made $1,462 for the week ending December 27. Since McGrath’s W-4 claims one withholding allowance, $67 (the assumed standard withholding allowance) is deducted from his gross pay to arrive at $1,395 ($1,462 – $67).

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2 Wage Bracket Withholding TableExhibit 3

Table for Percentage Method of Withholding WEEKLY Payroll Period

Source: Publication 15, Employer’s Tax Guide, Internal Revenue Service, 2008

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McGrath Example (continued)

Initial withholding

$ 82.95

Plus [25% × ($1,395 – $653)]

185.50Total federal income taxes

withheld

$268.45

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Example Exercise 11-2

Karen Dunn’s weekly gross earnings for the present week were $2,250. Dunn has two exemptions. Using the wage bracket withholding table in Exhibit 3 (Slide 16) with a $67 standard withholding allowance for each exemption, what is Dunn’s federal income tax withholding?

11-2

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Example Exercise 11-2 (continued) 2

For Practice: PE 11-2A, PE 11-2B

Total wage payment $2,250One allowance (provided by IRS) $67Multiplied by allowances claimed on W-4 × 2 134Amount subject to withholding $2,116

Initial withholding from wage bracket in Exh. 3 $302.96Plus additional withholding: 28% of excess

over $1,533 163.24*Federal income tax withholding $466.20

*28% × ($2,116 – $1,533)

Follow My Example 11-2

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FICA Tax 11-2

The amount of FICA tax withheld is the employees’ contribution to two

federal programs. The first program, called social security, is for old age, survivors, and disability insurance (OASDI). The second program,

called Medicare, is health insurance for senior citizens.

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John T. Mcgrath’s annual earnings prior to the payroll period ending on December 27 total $99,038.

Earnings subject to 6% social security tax ($100,000 – $99,038) $ 962Social security tax rate × 6%Social security tax

$57.72Earnings subject to 1.5%

Medicare tax $1,462Medicare tax rate × 1.5%

Medicare tax 21.93Total FICA tax$79.65

John T. McGrath’s FICA Tax

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John T. McGrath’s Net Pay

Gross earnings for the week $1,462.00 Deductions:

Social security tax (Slide 21) $ 57.72Medicare tax (Slide 21) 21.93Federal income tax (Slide 17) 268.45Retirement savings 20.00United Way 5.00 Total deductions 373.10

Net pay $1,088.90

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Example Exercise 11-32

Karen Dunn’s weekly gross earnings for the week ending Dec. 3rd were $2,250, and her federal income tax withholding was $466.19. Prior to this week Dunn had earned $98,000 for the year. Assuming the social security rate is 6% on the first $100,000 of annual earnings and Medicare is 1.5% of all earnings, what is Dunn’s net pay?

Employee Net Pay

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Example Exercise 11-3 (continued) 2

Total wage payment $2,250.00Less: Federal income tax withholding 466.19

Earnings subject to social securitytax ($100,000 – $98,000) $2,000

Social security tax rate × 6%Social security tax 120.00Medicare tax ($2,250 × 1.5%) 33.75

Net pay $1,630.06

For Practice: PE 11-3A, PE 11-3B

Follow My Example 11-3

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Employer’s Federal Payroll Taxes11-211-2

Employers are required to contribute to the social security and Medicare programs for each

employee. The employer must match the employee’s contribution to each program.

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11-211-2

A Federal Unemployment Tax of 6.2% is levied on employers only to provide for temporary unemployment to those who become unemployed as a result of layoffs due to economic causes beyond their control. This tax applies to only the first $7,000 of the earnings of each

covered employee during a calendar year.

Employers in most states also must pay a state unemployment tax for unemployed workers. A few states require employee contributions. The

state plan is designed to reward firms with stable employment, so the tax rate varies from state to

state and employer to employer.

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Describe payroll accounting systems that use a payroll

register, employee earnings records, and a general journal.

Objective 3Objective 3Objective 3Objective 3 11-3

The payroll register is a multicolumn report used for summarizing the data for each payroll period. The last two

columns of the payroll register are used to accumulate the total wages or salaries to be debited to various expense accounts.

The process is usually called payroll distribution.

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3Payroll Register (left side)Exhibit 5

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33 Payroll Register (right side)Exhibit 5

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Recording Employees’ Earnings 11-3

Dec. 27 Sales Salaries Expense 11 122 00

Office Salaries Expense 2 780 00

Payroll for week ended

December 27.

Social Security Tax Payable 643 07Medicare Tax Payable

208 53Employees’ Federal Inc. Tax Pay. 3 332 00Retirement Savings Ded. Payable 680 00United Way Deductions Payable 470 00Accounts Receivable—Fred Elrod 50 00Salaries Payable 8 518 40

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Example Exercise 11-4

The payroll register of Chen Engineering Services indicates $900 of social security withheld and $225 of Medicare tax withheld on total salaries of $15,000 for the period. Federal withholding for the period totaled $2,925.

Provide the journal entry for the period’s payroll.

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For Practice: PE 11-4A, PE 11-4B

Follow My Example 11-4

11-3

Salaries Expense 15,000Social Security Tax Payable 900Medicare Tax Payable 225Federal Withholding Tax Payable 2,925Salaries Payable 10,950

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11-3

Recording and Paying Payroll Taxes

Assume that in Exhibit 5 the earnings subject to state and federal unemployment compensation taxes are $2,710. In addition, assume a SUTA rate of 5.4% and a FUTA rate of 0.8%. What is the rate for each of the following?

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11-3

Data for McDermott Supply Co. payroll for the week ending December 27:

Social security tax $ 643.07Medicare tax 208.53State unemployment compensation

tax (5.4% x $2,710) 146.34Federal unemployment compensation

tax (0.8% x $2,710) 21.68 Total payroll tax expense $1,019.62

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Dec. 27 Payroll Tax Expense 1 019 62

Payroll taxes for week ended December 27.

Social Security Tax Payable 643 07Medicare Tax Payable 208 53State Unemployment Tax Payable 146 34Federal Unemployment Tax Pay. 21 68

11-3

McDermott Supply Co.’s payroll entry on December 27 is recorded as follows:

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Example Exercise 11-53

Journalize Payroll Taxes

The payroll register of Chen Engineering Services indicates $900 of social security withheld and $225 of Medicare tax withheld on total salaries of $15,000 for the period. Assume earnings subject to state and federal unemployment compensation taxes are $5,250, at the federal rate of 0.8% and state tax of 5.4%.

Provide the journal entry to record the payroll tax expense for the period.

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Example Exercise 11-5 (continued) 3

Payroll Tax Expense………………………….. 1,450.50Social Security Tax Payable……………. 900.00Medicare Tax Payable…………………… 225.00State Unemployment Tax Payable ($5,250 × 5.4%)………………………….. 283.50Federal Unemployment Tax Payable ($5,250 × 0.8%)………………………….. 42.00

For Practice: PE 11-5A, PE11-5B

Follow My Example 11-5

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11-3

A detailed payroll record is maintained for each employee. This record is called an

employee’s earnings record.

At the end of each pay period, payroll checks are prepared. Each check includes a detachable statement showing the details

of how the net pay was computed.

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11-3

Employee’s Earnings Record

(Continued)

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11-3

(Concluded)

(Coluded)

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11-3

Payroll Check

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Describe the accounting treatment for contingent liabilities and journalize

entries for product warranties.

Objective 5Objective 5Objective 5Objective 5 11-5

Some past transactions will result in liabilities if certain events occur in the future. These

potential obligations are called contingent liabilities.

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During June, a company sells a product for $60,000 on which there is a 36-month warranty. Past experience

indicates that the average cost to repair defects is 5% of the sales price over the warranty price.

June 30 Product Warranty Expense 3 000 00

Warranty expenses projected

for June, 5% of $60,000.

Product Warranty Payable 3 000 00

11-5

Contingent Liabilities

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If a customer required a $200 part replacement on August 16, the entry would be:

Aug. 16 Product Warranty Payable 200 00

Replaced defective part under

warranty.

Supplies 200 00

11-5

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Noble Co. Hart Co.Quick assets:

Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

11-5

Quick Ratio

Quick assets

Current liabilitiesQuick Ratio =

The quick ratio or acid-test ratio can be used to evaluate a firm’s ability to pay its current

liabilities within a short period of time.

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11-5

Quick Ratio

Quick assets

Current liabilitiesQuick Ratio =

Quick assets:Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

Noble Co. Hart Co.

Noble Company =$231,000

$220,000= 1.05

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11-5

Quick assets

Current liabilitiesQuick Ratio =

Quick assets:Cash $147,000 $120,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

Noble Co. Hart Co.

Hart Company =$592,000

$740,000= 0.80

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11-5

Interpretation

Noble Company is in a better quick ratio position than Hart Company. By having a quick ratio in excess of 1, Noble Company has quick assets sufficient to cover the company’s current liabilities. This is not true

for Hart Company.