chapter
10
Current Liabilities and
Payroll
______________________________________________
OPENING COMMENTS
Chapter 10 covers a variety of obligations included in the Current Liabilities section of the balance sheet:
notes payable, payroll, employee fringe benefits, and contingent liabilities. The quick ratio is introduced
in the Financial Analysis and Interpretations portion of this chapter as a tool to analyze the level of
current liabilities held by a business.
After studying the chapter, your students should be able to:
2. Determine employer liabilities for payroll, including liabilities arising from employee earnings and
deductions from earnings.
4. Journalize entries for employee fringe benefits, including vacation pay and pensions.
6. Describe and illustrate the use of the quick ratio in analyzing a company’s ability to pay its current
liabilities.
KEY TERMS
contingent liabilities
current position analysis
190 Chapter 10 Current Liabilities and Payroll
defined benefit plan
defined contribution plan
employee’s earnings record
FICA tax
fringe benefits
gross pay
net pay
payroll
payroll register
pension
quick assets
quick ratio
STUDENT FAQS
• Why does it make a difference if liabilities are divided properly between current and long-term
liabilities? What is the current operating cycle again, and why can’t we just always use one year?
• Why is correct payroll calculation so important?
OBJECTIVE 1
Describe and illustrate current liabilities related to accounts payable, current portion of
long-term debt, and notes payable.
SYNOPSIS
When a bank or vendor extends credit, they are essentially giving the business a loan. The bank or vendor
is called a creditor, and the business receiving credit is called a debtor. Businesses record debts as
Chapter 10 Current Liabilities and Payroll 191
liabilities. Three types of current liabilities are discussed in this section. Account payable transactions
usually involve purchases on account and are normally the largest current liability. Long-term liabilities
Relevant Examples Exercises and Exhibits
• Example Exercise 10-1 Proceeds from Notes Payable
• Exhibit 1 – Accounts Payable as a Percent of Total Current Liabilities
SUGGESTED APPROACH—Current Liability Identification
Transparency Master (TM) 10-1 lists current liability accounts already discussed in previous chapters.
Ask your students what these accounts have in common. Hopefully, they will realize that these are all
debts that are settled within one year. You may want to add the following new accounts, which are
introduced in Chapter 10, to this list:
Product Warranty Payable
Social Security Tax Payable
Medicare Tax Payable
SUGGESTED APPROACH—Notes Payable
The entries for notes payable are parallel to the entries discussed in Chapter 8 for notes receivable.
Therefore, it is helpful to use this objective to review the entries for notes receivable and show their
relationship to notes payable.
192 Chapter 10 Current Liabilities and Payroll
GROUP LEARNING ACTIVITY—Short-Term Notes Payable
TM 10-2 presents three transactions related to a promissory note issued as a time extension on an open
account. Ask your class to record these entries on the accounting records of the seller. This will force
students to review entries for notes receivable from Chapter 8.
DEMONSTRATION PROBLEM—Discounted Notes Payable
Many of your students will be familiar with the saying, “There’s no such thing as a free lunch!” Notes
that truly have no interest charged are just as rare. For example, if a company borrows cash from a bank
by signing a discounted note, the interest is simply deducted from the cash proceeds received on the note.
At maturity, only the face value of the note is repaid. Therefore, interest is deducted up front, rather than
paid at the end. Tell students that discounted notes are also referred to as noninterest-bearing notes.
You can explain the steps to account for a discounted note as follows:
STEP 2: Calculate the Cash Proceeds Received on the Note
The cash that Wycoff Company will receive is computed by subtracting the discount from the face
amount of the note. After the bank deducts the discount, Wycoff Company will receive $7,275 ($7,500 –
$225).
STEP 3: Record the Liability Resulting from the Note and the Cash Received
Chapter 10 Current Liabilities and Payroll 193
Cash…………………….. 7,275
Interest Expense………… 225
Notes Payable.….. 7,500
STEP 4: Record Payment When the Note Matures
Wycoff will repay the full $7,500 when the note becomes due. Since the interest on the note has already
been recorded, the journal entry at that time is:
OBJECTIVE 2
Determine employer liabilities for payroll, including liabilities arising from employee
earnings and deductions from earnings.
SYNOPSIS
Payroll refers to the amount paid to employees for services they provide during the period. Wages refers
to the earnings of employees who receive a paycheck based on the number of hours they work. Salary
usually refers to the earnings of those employees in administrative or managerial positions and is
expressed in terms of a month or a year. Companies engaged in interstate trade must obey rules set down
by the Fair Labor Standards Act. Gross pay is the total earnings of the employee for the period, including
194 Chapter 10 Current Liabilities and Payroll
Key Terms and Definitions
• FICA Tax – Federal Insurance Contributions Act tax used to finance federal programs for old-age
and disability benefits (social security) and health insurance for the aged (Medicare).
Relevant Example Exercises and Exhibits
• Example Exercise 10-2 Federal Income Tax Withholding
• Example Exercise 10-3 Employee Net Pay
• Exhibit 2 – Employee’s Withholding Allowance Certificate (W-4 Form)
• Exhibit 3 – Wage Bracket Withholding Table
• Exhibit 4 – Responsibility for Tax Payments
SUGGESTED APPROACH
Payroll is the largest expense for most service businesses, such as public accounting firms, law firms, and
LECTURE AID—Calculation of Gross Pay
The Fair Labor Standards Act specifies that all employers engaged in interstate commerce must pay their
workers one-and-a-half times the regular wage rate for all hours worked in excess of 40 per week.
Executive, administrative, and certain supervisory positions are exempt from this requirement. As a
result, some employers simply refer to a position as “exempt” or “nonexempt.” Workers in nonexempt
CLASS DISCUSSION—Gross Pay and Deductions from Gross Pay
Begin by asking your students to define gross pay and state how it is calculated (hours worked wage
rate). Next, ask them to name items that can be deducted from an employee’s gross pay. List these items
Chapter 10 Current Liabilities and Payroll 195
Once the list is compiled, the following items will merit further explanation.
FICA — Federal Insurance Contributions Act. This represents the amount withheld for social security and
Medicare. These tax rates are set by Congress, and they change frequently. The textbook uses a social
security rate of 6 percent and a Medicare rate of 1.5 percent on all earnings. (In addition to mentioning the
rates used in the text, you may want to announce the current social security and Medicare tax rates.)
GROUP LEARNING ACTIVITY—Calculation of Net Pay
Ask your students to determine net pay (or take-home pay) for Blake Edwards, an employee described on
TM 10-5. They will need to use the federal income tax withholding table included in Exhibit 3 in the
textbook. See TM 10-6 for the solution.
Once this activity is complete, ask your students to determine Blake’s net pay as a percentage of his gross
pay. Instruct your students to do the same using their own paychecks. Students are often surprised how
large deductions are when expressed as a percent of gross pay.
LECTURE AID—Employer’s Payroll Taxes
Employers must pay the payroll taxes listed below. These taxes are considered an operating expense.
Employer payroll taxes are a significant expense for most businesses.
FICA Tax — The employer must match the amount paid by the employee for social security and
Medicare.
196 Chapter 10 Current Liabilities and Payroll
Employers who have stable employment histories are permitted by most states to pay reduced
unemployment compensation tax rates. Some states SUTA tax includes a component paid by the
employee.
INTERNET ACTIVITY—SUTA
OBJECTIVE 3
Describe payroll accounting systems that use a payroll register, employee earnings records,
and a general journal.
SYNOPSIS
The major elements used in a payroll system are a payroll register, an employee’s earnings record, and
payroll checks. A payroll register is a multicolumn form that summarizes all payroll data for a specific
time period, usually a payroll period. The payroll transaction is recorded by using the information from
the payroll register. The entry shown on page 512 uses the information from Exhibit 5. The second entry
Key Terms and Definitions
• Employee’s Earnings Record – A detailed record of each employee’s earnings.
• Payroll Register – A multicolumn report used to assemble and summarize payroll data at the end
of each payroll period.
Relevant Example Exercises and Exhibits
• Example Exercise 10-4 Journalize Period Payroll
• Example Exercise 10-5 Journalize Payroll Tax
• Exhibit 5 – Payroll Register
Chapter 10 Current Liabilities and Payroll 197
SUGGESTED APPROACH
Review the accounts used in the journal entries to record payroll and payroll taxes. Next, use the group
learning activity below to ask your students to complete a payroll register. They will need to follow the
example in text Exhibit 5 and the instructions on TM 10-7. Using the data from the payroll register, ask
your students to prepare payroll journal entries. The solution is provided on TM 10-8 and 10-9.
LECTURE AID—Journal Entries for Payroll
The journal entry to record employee paychecks is:
Salaries Expense (gross pay)…………………… .. XXX
Social Security Tax Payable…………….. XXX
Medicare Tax Payable ………………… XXX
The journal entry to record employer payroll taxes is:
Payroll Tax Expense…………………………. XXX
Social Security Tax Payable………… XXX
CLASS DISCUSSION—Internal Controls over Payroll
Objective 3 also discusses internal controls related to payroll. TMs 10-11 and 10-12 summarize internal
controls related to payroll. To stimulate class discussion, ask your students to identify the internal control
implications of using direct deposits to pay employees through electronic funds transfers.
198 Chapter 10 Current Liabilities and Payroll
WRITING EXERCISE—Internal Controls over Payroll
Ask your students to write answers to one or both of the following questions (TM 10-13):
1. How might the owner of a construction company determine whether a supervisor who distributes
payroll and has authority to hire and fire employees has fictitious employees on the payroll and is
cashing the related payroll checks?
2. Why is it desirable to have at least two officials approve pay rate changes?
Possible response: To minimize the temptation and ability to accomplish fraud against the business.
OBJECTIVE 4
Journalize entries for employee fringe benefits, including vacation pay and pensions.
SYNOPSIS
Employer-provided fringe benefits include vacation, medical, and retirement. The estimated costs of
fringe benefits are recorded as expenses during the period in which they are earned. The liability of
earned vacation could be recorded at the end of each pay period; however, most companies record it as an
adjusting entry at the end of the year. Employees may be required to take all accrued vacation within the
year. If employees are allowed to accumulate vacation pay from year to year, any vacation pay not taken
within the year is reported as a long-term liability. Pension is defined as a cash payment to retired
Key Terms and Definitions
• Defined Benefit Plan – A pension plan that promises employees a fixed annual pension benefit at
retirement, based on years of service and compensation levels.
• Defined Contribution Plan – A pension plan that requires a fixed amount of money to be
invested on the employee’s behalf during the employee’s working years.
Chapter 10 Current Liabilities and Payroll 199
• Fringe Benefits – Benefits provided to employees in addition to wages and salaries.
• Pension – A cash payment to retired employees.
SUGGESTED APPROACH
When covering this objective, be sure to point out the relationship between the matching concept and
accounting requirements for accruing fringe benefits.
CLASS DISCUSSION—Fringe Benefits
Begin this discussion by asking your class to name fringe benefits they are eligible for through their jobs.
After you have exhausted that list, ask students to name any fringe benefits provided to their family
members or friends.
LECTURE AID—Journalizing Entries for Vacation Benefits
The matching concept is the key concept directing the accounting entries for fringe benefits. This concept
dictates that the cost of providing fringe benefits must be recorded in the same accounting period as they
are earned. This may be a different accounting period from the one in which the benefit is actually paid.
LECTURE AID—Journalizing Entries for Pension Benefits
Pensions are another benefit that may be earned and paid at different times. Employees earn their
pensions over the period that they work for a company. That pension is not paid until retirement. The
matching concept dictates that the cost of pension benefits that will be paid after retirement must be
accrued as they are earned.
200 Chapter 10 Current Liabilities and Payroll
In a defined contribution plan, the employer has an obligation to make annual payments into a pension
fund. This annual payment is the extent of the employer’s liability for pensions, since these plans do not
make specific promises regarding the pension benefits a retiree will receive. The accounting for a defined
contribution plan is straightforward. The annual contribution is shown as an expense as follows:
Pension Expense……………….… XXX
Cash……………………… XXX
Defined benefit plans, on the other hand, promise employees a specified amount of pension payments
based on each employee’s years of service and salary level. Calculating the cost of the pension benefits to
be accrued under a defined benefit plan is a complicated task. It is necessary to project what employees
will be earning when they retire, how many years they will receive benefits (life expectancy), and how
much income can be earned on pension contributions. The experience of actuaries is used extensively in
making these projections. Once this cost is determined, it is recorded as follows:
WRITING EXERCISE—Fringe Benefits
Ask your students to respond to the following scenario (see TM 10-14).
ComExpress Airlines provides the following fringe benefits to its employees. For each benefit, state
whether or not an accounting entry would be needed at the end of the year to accrue the cost of the
benefit. State your justification for each answer.
1. Each employee earns two days of paid sick leave for each 160 hours he or she works for the
2. Each employee is also permitted to fly free of charge on any ComExpress flight that is not fully
booked with customers. The employee may take as many flights in the course of a year as he or she
wishes.
Chapter 10 Current Liabilities and Payroll 201
OBJECTIVE 5
Describe the accounting treatment for contingent liabilities and journalize entries for
product warranties.
SYNOPSIS
Contingent liabilities are those that may arise if certain events occur. The likelihood the event creating the
liability occurs can be classified as probable, reasonably probable, or remote. If a contingent liability is
probable and the amount can be reasonably estimated, it is recorded and disclosed. The example shown is
a warranty expense that is estimated at 5% of sales. It is recorded at the same time as the sale to match the
expense to the related revenue. If a contingent liability is probable or reasonably probable but cannot be
estimated, it must be disclosed in the financial statements. If a contingent liability is considered remote,
no disclosure need be made.
Key Terms and Definitions
• Contingent Liabilities – Liabilities that may arise from past transactions if certain events occur in
the future.
Relevant Example Exercises and Exhibits
• Example Exercise 10-7 Estimated Warranty Liability
• Exhibit 9 – Accounting Treatment of Contingent Liabilities
SUGGESTED APPROACH
Begin coverage of this objective by defining a contingent liability. A contingent liability is an obligation
that (1) resulted from a past transaction but is (2) contingent on a future event. Exhibit 8 shows that
contingent liabilities are only recorded in the accounting records if they are probable and the amount can
be estimated. Other contingent liabilities are simply disclosed in the financial statements.
202 Chapter 10 Current Liabilities and Payroll
DEMONSTRATION PROBLEM—Warranties
Explain that the entry to accrue warranty costs is as follows:
Product Warranty Expense…………… XXX
Product Warranty Payable……. XXX
Jet-Clean sold washing machines totaling $1 million. Each washing machine carries a three-year
warranty. Jet-Clean estimates that warranty repairs on the washing machines will cost 1 percent of the
sales price.
1. Record the entry to accrue Jet-Clean’s warranty costs.
Product Warranty Expense……… 10,000
Product Warranty Payable 10,000
OBJECTIVE 6
Describe and illustrate the use of the quick ratio in analyzing a company’s ability to pay its
current liabilities.
SYNOPSIS
Current position analysis is based on three measures: working capital, current ratio, and quick ratio.
Working capital and the current ratio were described in Chapter 4 and are calculated as working capital =
Key Terms and Definitions
• Current Position Analysis – A company’s ability to pay its current liabilities.
Chapter 10 Current Liabilities and Payroll 203
• Quick Assets – Cash and other current assets that can be quickly converted to cash, such as
marketable securities and receivables.
• Quick Ratio – A financial ratio that measures the ability to pay current liabilities with quick
assets (cash, marketable securities, accounts receivable).
Relevant Example Exercises and Exhibits
• Example Exercise 10-8 Quick Ratio
SUGGESTED APPROACH
This chapter introduces the quick ratio, sometimes called the acid-test ratio.
The quick ratio measures the “instant” debt paying ability of a company by comparing quick assets (cash,
cash equivalents, and receivables) to current liabilities. TM 10-15 presents several questions related to the
Type Item Description LO(s) Difficulty Time Est BUSPROG AICPA ACBSP – APC Bloom’s EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytic Measurement Current Liabilities Knowledge
DQ 2 1 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 3 2 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 4 2 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 5 3 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 6 3 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 7 4 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 8 4 Easy 5 min. Analytic Measurement Payroll/Other Compensation Knowledge
DQ 9 5 Easy 5 min. Analytic Measurement Current Liabilities Knowledge
DQ 10 5 Easy 5 min. Analytic Measurement Current Liabilities Knowledge
PE 1A Proceeds from notes payable 1 Easy 5 min. Analytic Measurement Current Liabilities Application x
PE 1B Proceeds from notes payable 1 Easy 5 min. Analytic Measurement Current Liabilities Application x
PE 2A Federal income tax withholding 2 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 2B Federal income tax withholding 2 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 3A Employee net pay 2 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 3B Employee net pay 2 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 4A Journalize period payroll 3 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 5A Journalize tax payroll 3 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 5B Journalize tax payroll 3 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 6A Vacation pay and pension benefits 4 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 6B Vacation pay and pension benefits 4 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
PE 7A Estimated warranty liability 6 Easy 10 min. Analytic Measurement Current Liabilities Application x
PE 7B Estimated warranty liability 6 Easy 10 min. Analytic Measurement Current Liabilities Application x
PE 8A Quick ratio 6 Easy 10 min. Analytic Measurement Financial Statement Analysis Application x x
PE 8B Quick ratio 6 Easy 10 min. Analytic Measurement Financial Statement Analysis Application x x
EX 1 Current liabilities 1 Easy 10 min. Analytic Measurement Current Liabilities Application x
EX 2 Entries for disclosing notes payable 1 Easy 15 min. Analytic Measurement Current Liabilities Application x
EX 3 Evaluate alternative notes 1 Moderate 15 min. Analytic Measurement Current Liabilities Application x x
EX 4 Entries for notes payable 1 Easy 10 min. Analytic Measurement Current Liabilities Application x
EX 5 Entries for discounted note payable 1 Easy 10 min. Analytic Measurement Current Liabilities Application x
EX 7 Current portion of long-term debt 1 Easy 10 min. Analytic Measurement Current Liabilities Application x
EX 8 Calculate payroll 2 Easy 10 min. Analytic Measurement Payroll/Other Compensation Application x
EX 9 Calculate payroll 2 Moderate 15 min. Analytic Measurement Payroll/Other Compensation Application x
EX 10 Summary payroll data 2,3 Moderate 15 min. Analytic Measurement Payroll/Other Compensation Application x
EX 11 Payroll tax entries 3 Easy 10 min. Analytic Measurement Payroll/Other Compensation Application x x
EX 12 Payroll entries 3 Easy 10 min. Analytic Measurement Payroll/Other Compensation Application x
EX 13 Payroll entries 3 Easy 10 min. Analytic Measurement Payroll/Other Compensation Application x
EX 14 Payroll internal control procedures 3 Easy 10 min. Analytic Measurement Payroll/Other Compensation Comprehension x
EX 15 Internal control procedures 3 Moderate 15 min. Analytic Measurement Payroll/Other Compensation Application x
EX 16 Accrued vacation pay 4 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
EX 17 Pension plan entries 4 Easy 10 min. Analytic Measurement Payroll/Other Compensation Application x
EX 18 Defined benefit pension plan terms 4 Easy 5 min. Analytic Measurement Payroll/Other Compensation Application x
EX 19 Accrued product warranty 6 Easy 10 min. Analytic Measurement Current Liabilities Application x
EX 21 Contingent liabilities 6 Moderate 15 min. Analytic Measurement Current Liabilities Application x
EX 22 Quick ratio 6 Easy 10 min. Analytic Measurement Financial Statement Analysis Application x x
EX 23 Quick ratio 6 Easy 10 min. Analytic Measurement Financial Statement Analysis Application x x
PR 1A Liability transactions 1,5 Moderate 45 min. Analytic Measurement Current Liabilities Application x x
PR 2A Entries for payroll and payroll taxes 2,3 Moderate 1 hour Analytic Measurement Payroll/Other Compensation Application x
PR 3A Wage and tax statement data on employer FICA tax 2,3 Challenging 1.5 hours Analytic Measurement Payroll/Other Compensation Application x
PR 5A Payroll accounts and year-end entries 2,3 Challenging 1.5 hours Analytic Measurement Payroll/Other Compensation Application x
PR 1B Liability transactions 1,5 Moderate 45 min. Analytic Measurement Current Liabilities Application x x
PR 2B Entries for payroll and payroll taxes 2,3 Moderate 1 hour Analytic Measurement Payroll/Other Compensation Application x
PR 3B Wage and tax statement data and employer FICA tax 2,3 Challenging 1.5 hours Analytic Measurement Payroll/Other Compensation Application x
PR 4B Payroll register 2,3 Moderate 1 hour Analytic Measurement Payroll/Other Compensation Application x
PR 5B Payroll accounts and year-end entries 2,3 Challenging 1.5 hours Analytic Measurement Payroll/Other Compensation Application x
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