Chapter Chapter 1010Current LiabilitiesCurrent Liabilities

Financial and Managerial Accounting

8th Edition

Warren Reeve Fess

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1. Define and give examples of current liabilities.2. Prepare journal entries for short-term notes

payable and disclosure for the current portion of long-term debt.

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

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

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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.

ObjectivesObjectivesObjectivesObjectives

The Nature of Current LiabilitiesThe Nature of Current LiabilitiesThe Nature of Current LiabilitiesThe Nature of Current Liabilities

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.

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.

Examples:

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

term debt

Short-Term Notes PayableShort-Term Notes PayableShort-Term Notes PayableShort-Term Notes Payable

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, 2006 to Murray

Co. for a $1,000 overdue account.

A firm issues a 90-day, 12% note for $1,000, dated August 1, 2006 to Murray

Co. for a $1,000 overdue account.

Oct. 30 Notes Payable 1 000 00

Interest Expense 30 00

Issued a 90-day, 12% note on

account.

Cash 1 030 00

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

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

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

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

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

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

Short-Term Notes PayableShort-Term Notes PayableShort-Term Notes PayableShort-Term Notes Payable

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

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

The merchandise cost Coker Co. $7,500.

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

The merchandise cost Coker Co. $7,500.

Short-Term Notes PayableShort-Term Notes PayableShort-Term Notes PayableShort-Term Notes Payable

Description Debit Credit

Accounts Receivable 10,000Sales 10,000

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

Bowden Co. (Borrower) Coker Co. (Creditor)

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

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

Accounts Payable 10,000Notes Payable 10,000

Notes Receivable 10,000Accounts Receivable 10,000

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

Short-Term Notes PayableShort-Term Notes PayableShort-Term Notes PayableShort-Term Notes Payable

Description Debit Credit

Mdse. Inventory 10,000Accounts Payable 10,000

Accounts Receivable 10,000Sales 10,000

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

Bowden Co. (Borrower) Coker Co. (Creditor)

Description Debit Credit

July 30. Bowden Co. paid Coker Co. the amount due on the note of May 31. Interest:

$10,000 x 12% x 60/360 = $200.

July 30. Bowden Co. paid Coker Co. the amount due on the note of May 31. Interest:

$10,000 x 12% x 60/360 = $200.

Accounts Payable 10,000Notes Payable 10,000

Notes Receivable 10,000Accounts Receivable 10,000

Notes Payable 10,000Interest Expense 200

Cash 10,200

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

Short-Term Notes PayableShort-Term Notes PayableShort-Term Notes PayableShort-Term Notes Payable

Discounted Notes PayableDiscounted Notes PayableDiscounted Notes PayableDiscounted Notes Payable

Aug.10 Merchandise Inventory 19 250 00

Interest Expense 750 00

Issued a 90-day, note to Rock

Co. discounted at 15%.

Notes Payable 20 000 00

On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for

inventory. Rock discounts the note at 15%.

On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for

inventory. Rock discounts the note at 15%.

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

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

ProceedsProceedsProceedsProceeds

Discount rateDiscount rateDiscount rateDiscount rate

Discounted Notes PayableDiscounted Notes PayableDiscounted Notes PayableDiscounted Notes Payable

Nov. 8 Notes Payable 20 000 00

Paid note due.

Cash 20 000 00

On November 8 the note is paid in full.On November 8 the note is paid in full.

Contingent Liabilities

Product LiabilityProduct LiabilityProduct LiabilityProduct Liability

On June 30, a company sells a product for $60,000 on which there is a 36-month warranty. Past

experience indicates that repairs of defects cost 5% of the sales price over the warranty period.

On June 30, a company sells a product for $60,000 on which there is a 36-month warranty. Past

experience indicates that repairs of defects cost 5% of the sales price over the warranty period.

June 30 Product Warranty Expense 3 000 00

Warranty expenses projected for

June, 5% of $60,000.

Product Warranty Liability 3 000 00

On August 16, a customer needed a defective part replaced. Cost to the

company was $200 for the part.

On August 16, a customer needed a defective part replaced. Cost to the

company was $200 for the part.

Aug.16 Product Warranty Payable 200 00

Replaced defective part under

warranty.

Supplies 200 00

Product LiabilityProduct LiabilityProduct LiabilityProduct Liability

Accounting Treatment of Accounting Treatment of Contingent LiabilitiesContingent Liabilities

Accounting Treatment of Accounting Treatment of Contingent LiabilitiesContingent Liabilities

Likelihood of

Occurring MeasurementAccounting Treatment

Probable Estimable Record Liability

Not Estimable

Disclose Liability

Disclose Liability

Contingency

Possible

Payroll and Payroll Taxes

Liability for Employee EarningsLiability for Employee EarningsLiability for Employee EarningsLiability for Employee Earnings

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.

Payroll is the amount paid to employees for services provided. Payrolls are important because--

Gross Pay CalculationGross Pay CalculationGross Pay CalculationGross Pay Calculation

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.

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

FICA TaxFICA TaxFICA TaxFICA Tax

Employers are required to withhold a portion of the earnings of each of the

employees. The amount is matched by the employer and serves to provide the

employee with social security and Medicare benefits upon retirement.

Employers are required to withhold a portion of the earnings of each of the

employees. The amount is matched by the employer and serves to provide the

employee with social security and Medicare benefits upon retirement.

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

Social security tax $57.72

FICA Tax CalculationFICA Tax CalculationFICA Tax CalculationFICA Tax CalculationAssume 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 1.5% Medicare taxCurrent earnings $1,462Medicare tax rate x 1.5% Medicare tax 21.93

Total FICA tax $79.65

Withholding Taxes, Other DeductionsWithholding Taxes, Other DeductionsWithholding Taxes, Other DeductionsWithholding 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.

Gross earnings for the week $1,462.00Deductions:

Social security tax tax $ 57.72Medicare tax 21.93Federal income tax 279.51Retirement savings 20.00United Way 5.00

Total deductions 384.16Net pay $1,077.84

John T. McGrath is single, has declared one John T. McGrath is single, has declared one withholding allowance, and had gross pay of withholding allowance, and had gross pay of

$1,462 for the week ended December 27.$1,462 for the week ended December 27.

Employee Net Pay CalculationEmployee Net Pay Calculation

RESPONSIBILITY FOR RESPONSIBILITY FOR TAX PAYMENTSTAX PAYMENTS

RESPONSIBILITY FOR RESPONSIBILITY FOR TAX PAYMENTSTAX PAYMENTS

EMPLOYEE BUSINESS

GOVERNMENTGOVERNMENT

Social security tax Medicare tax

Federal withholding tax

Social security tax Medicare tax

Federal unemployment compensation tax

State unemployment compensation tax

FEDERAL INCOMEFEDERAL INCOME

Personal income tax

46%46%

Estate, gift, and other

8%

Corporate income tax

8%8%FICA and

FUTA38%38%

FEDERAL OUTLAYSFEDERAL OUTLAYS

Social security and

Medicare

33%

Interest on debt

8%

Physical, human, and community

development13%13%

Social programs

24%24%National defense

19%

Law enforcement and general government

3%3%

Payroll RegisterPayroll RegisterPayroll RegisterPayroll Register

What is the purpose of a

payroll register?

What is the purpose of a

payroll register?

It’s a multicolumn form used to help assemble and summarize the data needed for each payroll period.

It’s a multicolumn form used to help assemble and summarize the data needed for each payroll period.

Earnings:Regular $13,328.00Overtime 574.00

Total $13,902.00Deductions:

Social security tax $ 643.07Medicare tax 208.53Federal income tax 3,332.00Retirement savings 680.00United Way 470.00Accounts receivable 50.00

Total 5,383.60Net amount paid $ 8,518.40

Accounts debited:Sales Salaries Expense $11,122.00Office Salaries Expense 2,780.00

Total (as above) $13,902.00

Payroll Register SummaryPayroll Register Summary

Recording Employees’ EarningsRecording Employees’ EarningsRecording Employees’ EarningsRecording Employees’ Earnings

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

Recording Employer’s Payroll TaxesRecording Employer’s Payroll TaxesRecording Employer’s Payroll TaxesRecording Employer’s Payroll Taxes

Employer Taxes for the Week Ended December 27Employer Taxes for the Week Ended December 27

Social security tax$ 643.07

Medicare tax208.53

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

146.34Federal unemployment compensation

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

Social security tax$ 643.07

Medicare tax208.53

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

146.34Federal unemployment compensation

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

RecordingRecording Employer’s Payroll Taxes Employer’s Payroll TaxesRecordingRecording Employer’s Payroll Taxes Employer’s Payroll Taxes

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

Wage and TaxStatements

W-2 W-2

Flow of Data in a Payroll SystemFlow of Data in a Payroll System

Updated VariablesUpdated Variables(cumulative (cumulative

earnings, taxes)earnings, taxes)

Constant DataConstant Data(rates of pay,(rates of pay,

tax, etc.)tax, etc.)

Current Period’sCurrent Period’sVariablesVariables

(hours worked)(hours worked)

Payroll Checksand Statements

Payroll TaxReturns

FinancialStatements

PAYROLL PAYROLL REGISTER REGISTER

GENERALGENERALLEDGERLEDGER

EMPLOYEES’EMPLOYEES’EARNINGSEARNINGSRECORDSRECORDS

Employees’ Fringe BenefitsEmployees’ Fringe Benefits

Benefit Dollars as a Percent of TotalBenefit Dollars as a Percent of Total

26%

Vacation and sick pay29%29%

Medical

2%Other

18%18%

Retirement and savings

plans

25%25%Social security and Medicare

Employees’ Fringe BenefitsEmployees’ Fringe Benefits

Vacation pay Vacation pay becomes the employer’s liability as the employee earns vacation rights.

Pensions 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.

PensionsPensions

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 RatioSolvency Measures — Quick RatioNoble Co. Hart Co.

Quick assets:Cash $ 100,000 $ 55,000Cash equivalents 47,000 65,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

Quick assets

Current liabilities

Solvency Measures — Quick RatioSolvency Measures — Quick RatioNoble Co. Hart Co.

Quick assets:Cash $ 100,000 $ 55,000Cash equivalents 47,000 65,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

Quick assets

Current liabilitiesNoble Company

$231,000

$220,000 Quick ratio = 1.05

Solvency Measures — Quick RatioSolvency Measures — Quick RatioNoble Co. Hart Co.

Quick assets:Cash $ 100,000 $ 55,000Cash equivalents 47,000 65,000Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000

Current liabilities $220,000 $740,000

Quick assets

Current liabilitiesHart Company

$592,000

$740,000 Quick ratio = 0.80

Use: To indicate instant debt-paying abilityUse: To indicate instant debt-paying ability

The EndThe End

Chapter 10Chapter 10