Chapter 09 – Current Liabilities
Chapter 09
Current Liabilities
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems
(A &B set)**
Beyond the
Numbers
Conceptual objectives:
C1. Describe current and long-term
liabilities and their
characteristics.
1, 14
9-1, 9-14
9-1
TTN
C2. Identify and describe known
current liabilities.
15, 16, 17
9-2, 9-3,
9-4
9-2
TIA
C3. Explain how to account for
contingent liabilities.
1, 11
9-4
9-3
CIP
Analytical objectives:
A1. Compute the times interest
earned ratio and use it to
analyze liabilities.
9-11
9-12
9-5
RIA, CA,
TTN, ED,
GD
Procedural objectives:
P1. Prepare entries to account for
short-term notes payable.
9-5
9-4, 9-5
9-1
TIA
P2. Compute and record employee
payroll deductions and
liabilities.
5, 6, 7, 8
9-6
9-6, 9-7,
9-15, 9-16
9-2, 9-3, 9-6
HTR
P3. Compute and record employer
payroll expenses and liabilities.
5, 9
9-7
9-6, 9-8,
9-15, 9-16
9-2, 9-3, 9-6
P4. Account for estimated
liabilities, including warranties
and bonuses.
2, 3, 10
9-8, 9-9,
9-10, 9-13
9-9, 9-10,
9-11, 9-13,
9-18
9-4
RIA, EC
P5. Identify and describe the details
of payroll reports, records, and
procedures. (Appendix 9A)
12, 13
9-12
9-14, 9-17
9-6
Notes appear on next page.
Chapter 09 – Current Liabilities
* Assignment materials that can be completed by students using:
Sage 50 and QuickBooks Pro 2013 templates – Problems 9-1A and
9-4A, and the Comprehensive Problem for Bug-Off Exterminators, which covers various
learning objectives in chapters 1 through 9.
Excel template – Problem 9-1A and 9-2A.
** The Serial Problem for Success Systems, which covers numerous learning objectives, can be
most of the chapters. Even if previous segments were not assigned, students can begin the segment
of the serial problem that is included in this chapter. It is most readily solved if students use the
Working Papers that accompany the book.)
Synopsis of Chapter Revisions
• SmartIT Staffing: NEW opener with new entrepreneurial assignment
• Revised unearned revenues example based on Rihanna ticket sales
• Added explanation on the role of sellers as tax collection ‘agents’ for the government
• New information on franchise costs and how they are accounted for
• Added select formulas to enhance the exhibit on payroll deductions
• Updated payroll rates to 2012 with discussion on likely adjustments for 2013 and 2014
• Added discussion on maximum withholding allowances claimed
• New discussion on IRS actions against companies that fail to pay employment taxes
• New evidence on payroll fraud, its median loss, and time taken to uncover such frauds
PowerPoint® Slides
Chapter Learning Objective
C1
C2
P1
P2
P3
C3
P4
A1
Chapter 09 – Current Liabilities
Chapter Outline
Notes
I. Characteristics of Liabilities
A. Defining Liabilities
A liability is a probable future payment 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. Past transaction or event.
2. Present obligation.
3. Future payment of assets or services.
B. Classifying Liabilities
1. Current liabilities (also called short-term liabilities)—
Obligations due within one year or the company’s operating
cycle, whichever is longer.
2. Long-term liabilities—Obligations not expected to be paid
within the longer of one year or the company’s operating
cycle.
C. Uncertainty in Liabilities—answers to the following questions are
often decided when a liability is incurred; however, one or more
may be uncertain for some liabilities:
1. Whom to pay?
2. When to pay?
3. How much to pay?
II. Known Liabilities—Set by agreements, contracts, or laws and are
measurable. 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; also known as trade accounts
payable.
B. Sales Taxes Payable
Amounts the seller has collected as sales taxes from customers
when sales occur, which have not yet been remitted to the proper
governmental agency.
1. Entry (by seller) to record cash sale subject to sales tax: debit
Cash, credit Sales, credit Sales Taxes Payable.
2. Entry (by seller) when sales taxes are remitted: debit Sales
Tax Payable, credit Cash.
Chapter 09 – Current Liabilities
Chapter Outline
Notes
C. Unearned Revenues
Amounts received in advance from customers for future products
or services; also known as deferred revenues, collections in
advance and prepayments.
1. Entry to record receipt of amounts in advance for future
products or services: debit Cash, credit Unearned Revenue.
2. Entry to record revenue for that portion earned: debit
Unearned Revenue, credit Revenue.
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. Note given to extend credit period; interest-bearing note is
substituted for an overdue account payable.
a. Entry to record partial payment on account and
substitution of note payable for overdue amount: debit
Accounts Payable, credit Cash, credit Notes Payable.
b. Entry to record payment when note becomes due: debit
Note Payable, debit Interest Expense, credit Cash.
2. Note given to borrow from bank
Entries (by borrower) to record:
a. Receipt of cash when note is signed: debit Cash, credit
Note Payable.
b. Payment of principal and interest: debit Note Payable,
debit Interest Expense, credit Cash.
c. Accrual of interest when notes payable are outstanding at
the end of a period: debit Interest Expense, credit Interest
Payable.
d. Payment of note when interest has been accrued: debit
Interest Expense (amount incurred since accrual date),
debit Interest Payable (amount previously accrued), debit
Notes Payable, credit Cash (for full amount paid).
E. Payroll Liabilities
An employer incurs several expenses and liabilities from salaries
and wages earned, from employee benefits, and from payroll taxes
levied on the employer.
1. Gross pay—total compensation an employee earns
(includes wages, salaries, commissions, bonuses).
2. Net pay—gross pay less all deductions; also called take-
home pay.
Chapter 09 – Current Liabilities
Chapter Outline
Notes
3. Employee Payroll Deductions—amounts withheld from an
employee’s gross pay, either required or voluntary; commonly
called withholdings. The employer withholds payroll
deductions from employees’ pay and is obligated to remit to
the designated organizations.
a. Employee FICA taxes (Social Security and Medicare
taxes) equal current rate times gross wages subject to tax.
(For year 2005, Social Security tax is 6.2% of the first
$90,000 earned by the employee in the calendar year and
Medicare tax is 1.45% of all amounts earned by the
employee).
b. Employee income tax withholding is determined from
tables published by the IRS based on employee’s annual
earnings rate and the number of withholding allowances
claimed.
c. Employee voluntary deductions (charitable contributions,
medical insurance premiums, pension contributions, and
union dues) are withheld and reported as part of the
employer’s current liabilities until paid.
4. Illustrative entry (by employer) to accrue payroll expenses and
liabilities: debit Salaries Expense, credit FICA-Social
Securities Taxes Payable, credit FICA-Medicare Taxes
Payable, credit Employee Federal Income Taxes Payable,
credit Employee Medical Insurance Payable, credit Employee
Union Dues Payable, credit Salaries Payable (for the amount
of the net pay).
5. Employer Payroll Taxes are recorded as expenses and
current liabilities. Employer taxes include:
a. Employer FICA taxes—employers must pay FICA taxes
equal in amount to the FICA taxes withheld from their
employees.
b. Federal and state unemployment taxes—Employers must
pay a federal unemployment tax on wages and salaries
paid to their employees. (For year 2008, employers were
required to pay FUTA taxes of as much as 6.2% on the
first $7,000 earned by each employee; this tax can be
reduced by a credit of up to 5.4% for taxes paid to a state
program.) All states place a payroll tax for unemployment
insurance on employers; the amounts vary.
Chapter 09 – Current Liabilities
Chapter Outline
Notes
c. Illustrative entry (by employer) to record payroll tax
expense and related liabilities: debit Payroll Tax Expense,
credit FICA-Social Securities Taxes Payable, credit FICA-
Medicare Taxes Payable, credit State Unemployment
Taxes Payable, credit Federal Unemployment Taxes
Payable.
F. Multi-Period Known Liabilities—often include unearned revenues
and notes payable that extend over multiple periods.
III. Estimated Liabilities—Known obligations of uncertain amounts that
can be reasonably estimated. Examples are:
A. Health and Pension Benefits
1. Employers often pay all or part of medical, dental, life, and
disability insurance, and many employers also contribute to
pension plans.
2. Illustrative entry to record these benefits: debit Employee
Benefits Expense, credit Employee Medical Insurance
Payable, credit Retirement Program Payable.
B. Vacation Benefits—Estimated and recorded by the employer
during the weeks the employees are working and earning the
vacation time.
1. Many employers offer paid vacations.
2. Entry to record: debit Vacation Benefits Expense, credit
Vacation Benefits Payable. When employees take
vacation, employer reduces (debits) the Vacation Benefits
Payable and credits Cash.
C. Bonus Plans
1. Many companies offer bonuses to employees; many bonuses
depend on net income.
2. The related expense and liability are recorded in a year-end
adjusting entry.
D. Warranty Liabilities
1. A warranty is a seller’s obligation to replace or correct a
product (or service) that fails to perform as expected within a
specified period.
2. To comply with the full disclosure and matching principles,
the seller reports the expected warranty expense in the period
when revenue from the sale of the product or service is
reported. The warranty obligation is reported as a liability
even though the amount, payee, and date are uncertain. The
costs are probably and the amount can be estimated based on
past experience.
E. Multi-Period Estimated Liabilities
payment will be made.
Chapter 09 – Current Liabilities
website, in whole or part. 9-7
Chapter Outline
Notes
IV. Contingent Liabilities—Potential obligation that depends on a future
event arising from past transactions.
A. Accounting for Contingent Liabilities – depends on the likelihood
that a future event will occur and the ability to estimate the future
amount owed if this event occurs. Three categories of contingent
liabilities:
1. Future event is probable and the amount can be reasonably
estimated. Record as a liability.
2. Future event is remote. Do not record or disclose in notes.
3. Future event is reasonably possible. Disclose in notes.
B. Reasonably Possible Contingent Liabilities – 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 is
less than probable but reasonably possible, disclose in notes.
2. Debt guarantees (of a debt owed by another company)—
require disclosure if potential liabilities are reasonably
possible.
3. Other contingencies (e.g., environmental damages, possible
tax assessments, insurance losses, and government
investigations)—require disclosure if potential liabilities are
reasonably possible.
4. Uncertainties that are Not Contingencies – are not contingent
liabilities because they are future events not arising from past
transactions. They are not disclosed.
V. Global View
A. Characteristics of Liabilities – the definitions of current liabilities
are similar for both GAAP and IFRS. “Provision” is typically used
companies to record current liabilities in a similar manner.
treatment.
B. It is calculated by dividing income before interest expense and
income taxes by interest expense.
VII. Payroll Reports, Records, and Procedures (Appendix 9A)
A. Payroll Reports—employers are required to prepare and submit
the following reports:
Chapter 09 – Current Liabilities
Chapter Outline
Notes
1. Reporting FICA and Income Taxes. 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.
2. Reporting FUTA and SUTA Taxes. 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.
3. Reporting Wages and Salaries. Wage and Tax Statement
(Form W-2) must be given to employees 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.
B. Payroll Records
1. 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.
2. Payroll Check
Generally accompanied with a detachable statement of
earnings showing gross pay, deductions, and net pay.
3. Employee’s Earnings Report.
A record of an employee’s hours worked, gross earnings,
deductions, net pay, and certain personal information about
the employee; contains the data the employer needs to prepare
a Form W-2.
C. Payroll Procedures
1. Computing Federal Income Taxes
Computed using a wage bracket withholding table based on
gross pay, number of personal exemptions, the employee’s tax
status, and pay period.
a. 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.
b. Form W-4—withholding allowance certificate form. Filed
by employee with employer to identify personal
exemptions claimed.
2. Payroll Bank Account
A separate payroll bank account is used in a company with
many employees.
Chapter 09 – Current Liabilities
Chapter Outline
Notes
a. 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.
b. Individual payroll checks are drawn on payroll account.
c. Helps with internal control and reconciling the regular
bank account.
3. Who Pays What Payroll Taxes and Benefits—who pays which
employee benefits and what portion, is subject to agreements
between companies and their workers. Self-employed
workers must pay both the employer and employee FICA
taxes for social security and Medicare.
VIII. Corporate Income Taxes (Appendix 9B)
A. Income Tax Liabilities
1. Corporations (but not sole proprietorships or partnerships) are
subject to income taxes and must estimate their tax liability
when preparing financial statements.
2. Entry to record estimated income tax liability: debit Income
Taxes Expense, credit Income Taxes Payable.
B. Deferred Income Tax Liabilities
1. Income tax laws and GAAP are different.
2. Temporary differences arise when the tax return and the
income statement report a revenue or expense in different
years. When temporary differences exist, corporations
compute income taxes expense on the income reported on the
income statement; the result is that the income taxes expense
is different from the amount payable to the government; this
difference is the deferred income tax liability.
3. Entry to record estimated income tax liability when there are
temporary differences: debit Income Taxes Expense, credit
Income Taxes Payable, credit Deferred Income Tax Liability
4. Temporary differences can also cause corporations to pay
income taxes before they are reported on the income statement
Chapter 09 – Current Liabilities
website, in whole or part. 9-10
Chapter 9 – Alternate Demonstration Problem #1
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 is equal to the principal of
the loan. Prepare the general journal entries to record issuing the
note, accrual of interest at the end of 2013 and the payment of the
note at maturity.
2. Assume that the face value of the note ($204,500) includes both the
principal of the loan and the interest to be paid at maturity. Prepare
the general journal entries to record issuing the note, accrual of
interest at the end of 2013 and the payment of the note at maturity.
Chapter 09 – Current Liabilities
Solution: Chapter 9 – Alternate Demonstration Problem #1
1.
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)
Maturity date:
1/30/14
Notes Payable …………………………..
200,000
Interest Expense ……………………….
1,500
Interest Payable ………………………..
3,000
Cash ……………………………………
204,500
2.
Issuance:
11/1/13
Cash …………………………………………
200,000
Discount on Notes Payable ……….
4,500
Notes Payable ……………………..
204,500
Year end accrual:
12/31/13
Interest Expense ……………………….
3,000
Discount on Notes Payable. …
3,000
($200,000 X 9% X 60/360 = $3,000)
Maturity date:
1/30/14
Notes Payable …………………………..
204,500
Cash ……………………………………
204,500
1/30/14
Interest Expense ……………………….
1,500
Discount on Notes Payable ….
1,500