Chapter 09 – Reporting and Analyzing Current Liabilities
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
under IFRS to refer to “liability” (GAAP).
B. Known (Determinable) Liabilities – GAAP and IFRS require
companies to record current liabilities in a similar manner.
C. Estimated Liabilities – for known current obligations that involve
an uncertain amount, both GAAP and IFRS require similar
treatment.
VI. Decision Analysis—Times Interest Earned Ratio
A. The times interest earned ratio is a measure of risk that a
business will not earn sufficient income to cover interest.
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 – Reporting and Analyzing Current Liabilities
9-8
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 – Reporting and Analyzing Current Liabilities
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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
(for the difference).
4. Temporary differences can also cause corporations to pay
income taxes before they are reported on the income statement
as an expense. The corporation then reports a Deferred Income
Tax Asset on its balance sheet.
Chapter 09 – Reporting and Analyzing Current Liabilities
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 – Reporting and Analyzing Current Liabilities
9-11
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