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Chapter 11 – Current Liabilities and Payroll Accounting

CHAPTER 11

CURRENT LIABILITIES AND PAYROLL ACCOUNTING

Related Assignment Materials

Student Learning Objectives Questions

Quick

Studies* Exercises* Problems*

Beyond the

Numbers

Conceptual objectives:

C1. Describe current and long-term

liabilities and their

characteristics.

1 11-1, 11-14 11-1 11-5

C2. Identify and describe known

current liabilities.

3, 4, 16, 17 11-2, 11-3,

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11-2 11-6

C3. Explain how to account for

contingent liabilities.

11 11-10 11-13 11-4

Analytical objectives:

A1. Compute times interest earned

ratio and use it to analyze

liabilities.

11-11 11-14 11-5 11-1, 11-2,

11-5, 11-7,

11-9

Procedural objectives:

P1. Prepare entries to account for

short-term notes payable.

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P2. Compute and record employee

payroll deductions and

liabilities.

5, 6, 8, 12,

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11-8, 11-9

11-2, 11-3,

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11-8

P3. Compute and record employer

payroll expenses and liabilities.

5, 7, 9 11-6 11-5, 11-7,

11-8, 11-9

11-2, 11-3,

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P4. Account for estimated liabilities,

including warranties and

bonuses

2, 10, 15 11-7, 11-8,

11-9, 11-13

11-10, 11-11,

11-12, 11-15,

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11-4 11-1, 11-3

P5AIdentify and describe the details

of payroll reports, records, and

procedures (Appendix 11A)

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12, 14

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*See additional information on next page that pertains to these quick studies, exercises and problems.

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Chapter 11 – Current Liabilities and Payroll Accounting

Additional Information on Related Assignment Material

The Serial Problem for Success Systems continues in this chapter. A Comprehensive Problem for

Bug-off Exterminators is also available. Problems 11-1A and 11-3A can be completed using Excel.

Problems 11-1A and 11-4A can be completed with Sage 50 Software or QuickBooks.

Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all

Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or

Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used

in practice, homework, or exam mode.

Synopsis of Chapter Revisions

Skai Blue Media: NEW opener with new entrepreneurial assignment

Updated payroll rates to 2014

New explanation of Additional Medicare Tax

Updated FUTA rate

Clarified bonus explanation and computations

Enhanced payroll reports and exhibits

New evidence on payroll fraud.

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Chapter 11 – Current Liabilities and Payroll Accounting

Chapter Outline Notes

I. Characteristics of Liabilities

A. Defining Liabilities

Probable future payments of assets or services that a company is

presently obligated to make as a result of past transactions or

events. Note three crucial factors:

1. Due to past transaction or event.

2. Present obligation.

3. Future payment of assets or services.

B. Classifying Liabilities

1. Current liabilities (short-term liabilities)—Obligations due

within one year or the company’s operating cycle, whichever

is longer. Expected to be paid using current assets or by

creating other current liabilities.

2. Long-term liabilities—Obligations not expected to be paid

within the longer of one year or operating cycle.

C. Uncertainties in Liabilities—requires addressing three important

questions that are sometime uncertain at the time liability is

incurred:

1. Whom to pay? (Ex. A note “Payable to Bearer”)

2. When to pay? (Ex. Unearned revenues—may not know when

service will be provided to satisfy)

3. How much to pay? (Ex. Accrued expense that needed to be

estimated prior to receipt of bill)

II. Known Liabilities—Set by agreements, contracts, or laws and are

measurable. (also called definitely determinable liabilities) Examples

of these liabilities in the current classification include:

A. Accounts Payable

Amounts owed to suppliers (also called vendors) for products or

services purchased with credit.

B. Sales Taxes Payable

Amounts the retailer (seller) collects as sales taxes from customers

when sales occur, and currently owes to the government until

remitted.

C. Unearned Revenues— also known as deferred revenues,

collections in advance and prepayments.

Amounts received in advance from customers for future products

or services.

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Chapter 11 – Current Liabilities and Payroll Accounting

Chapter Outline Notes

D. Short-Term Notes Payable

Written promise to pay a specified amount on a definite future date

within one year or the company’s operating cycle, whichever is

longer. Can arise from many transactions; two common examples:

1. Creditor requires the substitution of an interest-bearing note

for an overdue account payable that does not bear interest.

(Dr Accounts Payable, Cr Notes Payable)

2. Note given to borrow money from bank.

Ex. Face value equals amount borrowed (principal) and at

maturity a larger amount is repaid. The difference between

amount borrowed and repaid is the interest. The note is

recorded at and reported at face value.

( Dr Cash, Cr Notes Payable)

In both examples above, interest is recorded as incurred. This

may be when paid with note or as end-of -period accrued

interest adjustment.

(Dr Interest Expense and Note Payable, Cr Cash) if interest is

being recorded as note is paid at maturity.

(Dr Interest Expense and Cr Interest Payable) if accrued

interest is being recorded at end-of-period adjustment.

E. Payroll Liabilities

1. Gross pay—total compensation an employee earns. (Includes

wages, salaries, commissions, bonuses). Gross pay amount is

recorded as Salaries Expense (Dr).

2. Net pay—gross less all deductions; also called take-home pay

Net pay is recorded as Salaries Payable (Cr).

3. Payroll deductions—amounts withheld from an employee’s

gross pay, either involuntary or voluntary; also called

withholdings. Each is recorded as a separate liability (Cr).

a. FICA (Federal Insurance Contributions Act) taxes can be

separated into two groups—Social Security and Medicare

taxes. FICA tax is computed as current rate multiplied by

gross wages subject to tax. For year 2014, Social Security

tax is 6.2% of the first $117,000 earned by the employee

in the calendar year and Medicare tax is 1.45% of all

wages earned by the employee. A 0.9% additional

Medicare tax is imposed on the employee for pay in

excess of $200,000 – this additional tax is not imposed on

the employer.

b. Employee Income tax payable is determined from chart

based on their gross pay, pay period, marital status and

number of withholding allowances the employee claims.

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Chapter 11 – Current Liabilities and Payroll Accounting

Chapter Outline Notes

c. Voluntary deductions (charitable contributions, health

insurance premiums, union dues) result in various

payables.

(Note: All the payroll components, gross pay, each

deduction and net pay, are recorded in one journal entry.)

4 Employer Payroll Taxes—payroll taxes in addition to those

required of employees. These taxes result in expenses (Dr)

and current liabilities (Cr).

a. FICA taxes—employers must pay and amount equal to

employee contribution. The taxes are credited to the same

FICA taxes payable account used to record the amounts

withheld from the employees.

b. Unemployment taxes—(state and federal) current tax rate

multiplied by wages subject to tax. The total rate is up to

6.0% of the first $7000 earned by each employee. The

federal rate can be reduced by a credit of up to 5.4% for

taxes paid to a state program—as a result a net FUTA rate

is often only 0.6%

c. Recording Employer Payroll Taxes: additional expense

beyond Wages and Salaries Expense. Debit Payroll Tax

Expense for the Total and Credit the individual liability

accounts for the individual taxes.

F. Multi-Period Known Liabilities—known liabilities that extend

over many periods. Ex. Unearned Revenues and Notes Payable.

Classification is based upon period in which they will be satisfied.

1. Current Liability—portion that will be fulfilled in next year.

2. Long- term Liability—portion that will be fulfilled after next

year.

III. Estimated Liabilities—Known obligations of uncertain amounts that

can be reasonably estimated. Recorded as expenses (Dr) and payables

(Cr).Examples are:

A. Health and Pension Benefits—benefits beyond salaries and wages

provided by business. Appropriate proportion accrued at time of

each payroll.

B. Vacation Benefits—estimated and recorded by the employer

during the weeks the employees are working and earning the

vacation time. Appropriate proportion accrued at time of each

payroll.

C. Bonus Plans—employee bonuses must be estimated and recorded

in year-end adjusting entries.

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Chapter 11 – Current Liabilities and Payroll Accounting

Chapter Outline Notes

D. Warranty Liabilities—reported to comply with the full disclosure

and matching principles. Seller reports the expected warranty

expense (Dr) and liability (Cr) in the period when revenue from

the sales of the product is reported. When warranty liabilities are

settled the liability is removed and the asset used (Ex. Parts

Inventory) is reduced.

E. Note: Estimated liabilities can also be current or long-term and

must be classified based upon when they will be satisfied.

IV. Contingent liabilities—Contingent liability is a potential liability that

depends on a future event arising from a past transaction.

A. Accounting for Contingent Liabilities—depends on likelihood that

a future event will occur and the ability to estimate the future

amount. (Accounting motivated by full-disclosure principle.)

Three categories and appropriate accounting for each:

1. Probable (likely)—record if amount can be reasonably

estimated; if cannot be estimated, disclose in footnotes to

financial statements.

2. Possible (could occur)—disclose in financial statement notes

3. Remote (unlikely)—omit (do not record or footnote).

B. (Reasonably) Possible Contingent Liabilities (category 2 above).

Examples:

1. Potential legal claims—recorded in the accounts only if

payment for damages is probable and the amount can be

reasonably estimated. If can’t be reasonably estimated or less

than probable but reasonably possible, disclose in notes.

2. Debt guarantees (of a debt owed by another company)—

require disclosure in financial statement notes if potential

liabilities are reasonably possible.

3. Other Contingencies (e.g., environmental damages, possible

tax assessments, insurance losses, and government

investigations)—require disclosure in notes if potential

liabilities are reasonably possible.

Note: Uncertainties (ex. Natural disasters) are not contingent

liabilities because they are future events not arising from past

transactions.

V. Global View—Compares U.S. GAAP to IFRS

A. Characteristics of liabilities—both systems are broadly similar in

their definitions and characteristics of current liabilities.

B. Known (determinable) liabilities—Both systems are similar for

known liabilities with the exception of tax regulatory related

liabilities since the rates and levels are different in each county.

C. Estimated liabilities—both systems require recording of estimated

expenses related to these obligations when they can reasonably

estimate the amounts.

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Chapter 11 – Current Liabilities and Payroll Accounting

Chapter Outline Notes

VI. Decision Analysis—Times Interest Earned Ratio

A. Used to describe the risk of covering interest commitments when

income varies.

B. Calculated as income before interest expense and income taxes

divided by interest expense.

Appendix 11A—Payroll Reports, Records and Procedures

VII. Payroll Reports—employers are required to prepare and submit the

following reports:

A. Employer’s Quarterly Federal Tax Return (IRS Form 941)

Filed within one month after the end of each calendar quarter to

report FICA and income withholding taxes owed and remitted.

B. Annual Federal Unemployment Tax Return (IRS Form 940)

Must be mailed on or before January 31 following the end of each

tax year to report an employer’s FUTA taxes.

C. Wage and Tax Statement (Form W-2)

Must be mailed on or before January 31 following the year

covered by the report; employers must give each employee an

annual report of the employee’s wages subject to FICA and federal

income taxes and the amounts of these taxes withheld.

VIII. Payroll Records

A. Payroll Register

A record for a pay period that shows the pay period dates and the

hours worked, gross pay, deductions, and net pay of each

employee; contains all the data needed to record payroll (for each

pay period) in the General Journal.

B. Payroll Check

Generally accompanied with a detachable statement of earnings

showing gross pay, deductions, and net pay.

C. Employee’s Earnings Report

A cumulative record of an employee’s hours worked, gross pay,

deductions, net pay, and certain personal information about the

employee; contains the data the employer needs to prepare a Form

W-2.

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Chapter 11 – Current Liabilities and Payroll Accounting

Chapter Outline Notes

IX. Payroll Procedures

A. Federal Income Tax Withholdings

Computed using a wage bracket withholding table based on gross

pay, number of personal exemptions, the employee’s tax status,

and pay period.

1. Withholding allowance—a number that is used to reduce the

amount of federal income tax withheld from an employee’s

pay, and which corresponds to the personal exemptions the

employee is allowed to subtract from annual earnings in

calculating taxable income.

2. Form W-4—withholding allowance certificate form. Filed by

employee with employer to identify personal exemptions

claimed.

B. Payroll Bank Account

A separate payroll bank account used in a company with many

employees.

1. One check for total payroll is drawn on the regular bank

account or an electronic funds transfer for this amount is

executed to provide deposit for the payroll bank account.

2. Individual payroll checks are drawn on payroll account.

3. Helps with internal control and reconciling the regular bank

account.

Appendix 11B—Corporate Income Taxes

X. Income Tax Liabilities

A. Corporations (not sole proprietorships or partnerships) are subject

to income taxes and must estimate their income tax liability when

preparing financial statements. Adjusting entry: Dr Income Taxes

Expense, Cr Income Taxes Payable. Quarterly payments remove

(Dr) the liability, and credit Cash.

B. Deferred Income Tax Liabilities

Arise from temporary differences between GAAP and income tax

rules. This results in temporary differences between the tax return

and the income statement. This difference results in a deferred

income tax liability. Adjusting entry: Dr Income Taxes Expense,

Cr Deferred Income Tax Liability.

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Chapter 11 – Current Liabilities and Payroll Accounting

Alternate Demonstration Problem

Chapter Eleven

On November l, 2013, Orleaon Co. borrowed $200,000 for 90 days at 9% by

signing a note.

Required:

1. Assume that the face value of the note equals the principal of the loan.

Prepare the general journal entries to record issuing the note, accrual

of interest at the end of 2011 and the payment of the note at maturity.

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Chapter 11 – Current Liabilities and Payroll Accounting

Solution: Alternate Demonstration Problem

Chapter Eleven

Issuance:

11/1/13 Cash………………………………………. 200,000

Notes Payable……………………. 200,000

Year end accrual:

12/31/13 Interest Expense……………………… 3,000

Interest Payable…………………. 3,000

($200,000 X 9% X 60/360 = $ 3,000 accrued interest)

Maturity date:

1/30/14 Notes Payable…………………………. 200,000

Interest Expense……………………… 1,500

Interest Payable………………………. 3,000

Cash………………………………….. 204,500

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