Current Liabilities

Chapter 11 Current Liabilities Accounting, 21st Edition Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

Some Some of of the the action action has has been been automated, automated, so so click click the themouse mouse when when you you see see this this lightning lightning bolt bolt in in the thelower lower right-hand right-hand corner corner of of the the screen. screen. You You can can point point and and click click anywhere anywhere on on the the screen. screen.

Objectives Objectives 1. Define and give examples of current liabilities. 2. Prepare journal entries for short-term notes After studying this After studying this payable and disclosure for the current portion of chapter, chapter, you you should should long-term debt. be to: 3. Describe the accounting for contingent be able abletreatment to: liabilities and journalize entries for product warranties. 4. Determine employer liabilities for payroll, including liabilities arising from employee earnings and deductions from earnings.

Objectives Objectives 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.

The The Nature Nature of of Current Current Liabilities Liabilities Liabilities Liabilities that that are are to to be be paid paid out out of of current current assets assets and and are are due due within within aa short short time, time, usually usually within within one one year, year, are are called called current current liabilities. liabilities.

Examples:

     

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

Short-Term Short-Term Notes Notes Payable Payable A A firm firm issues issues aa 90-day, 90-day, 12% 12% note note for for $1,000, $1,000, dated dated August August 1, 1, 2006 2006 to to Murray Murray Co. Co. for for aa $1,000 $1,000 overdue overdue account. account. Aug. 1 Accounts Payable—Murray Co. Notes Payable Issued a 90-day, 12% note on account.

1 000 00 1 000 00

Short-Term Short-Term Notes Notes Payable Payable On On October October 30, 30, when when the the note note matures, matures, the the firm firm pays pays the the $1,000 $1,000 principal principal plus plus $30 $30 interest interest ($1,000 ($1,000 xx .12 .12 xx 90/360). 90/360). Oct. 30 Notes Payable Interest Expense Cash Issued a 90-day, 12% note on

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

1 000 00 30 00 1 030 00

Short-Term Short-Term Notes Notes Payable Payable Bowden Co. (Borrower) Description

Debit Credit

Mdse. Inventory 10,000 Accounts Payable 10,000

Coker Co. (Creditor) Description

Debit Credit

Accounts Receivable Sales

10,000

Cost of Mdse. Sold Mdse. Inventory

7,500

10,000

May May 31. 31. Bowden Bowden Co. Co. purchased purchased merchandise merchandise on on account account from from Coker Coker Co., Co., $10,000, $10,000, 2/10, 2/10, n/30. n/30. The The merchandise merchandise cost cost Coker Coker Co. Co. $7,500. $7,500.

7,500

Short-Term Short-Term Notes Notes Payable Payable Bowden Co. (Borrower) Description

Debit Credit

Mdse. Inventory 10,000 Accounts Payable 10,000

Accounts Payable Notes Payable

10,000 10,000

Coker Co. (Creditor) Description

Debit Credit

Accounts Receivable Sales

10,000

Cost of Mdse. Sold Mdse. Inventory

7,500

10,000 7,500

Notes Receivable 10,000 Accounts Receivable 10,000

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

Short-Term Short-Term Notes Notes Payable Payable Bowden Co. (Borrower) Description

Debit Credit

Coker Co. (Creditor) Description

Debit Credit

July July 30. 30. Bowden Bowden Co. Co. paid paid Coker Coker Co. Co. the the Accounts Receivable 10,000 amount due on the note May amount due on the note of ofSales May 31. 31. Interest: Interest: 10,000 $10,000 60/360 == $200. $10,000 xx 12% 12% xxCost 60/360 $200. 7,500 of Mdse. Sold

Mdse. Inventory 10,000 Accounts Payable 10,000

Mdse. Inventory Accounts Payable Notes Payable

Notes Payable Interest Expense Cash

10,000 10,000

10,000 200 10,200

7,500

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

10,200 200 10,000

Discounted Discounted Notes Notes Payable Payable On On August August 10, 10, Cary Cary Company Company issues issues aa $20,000, $20,000, 90-day 90-day note note to to Rock Rock Company Company in in exchange exchange for for inventory. inventory. Rock Rock discounts discounts the the note note at at 15%. 15%. Aug.10 Merchandise Inventory Interest Expense

19 250 00 750 00

Notes Payable Issued a 90-day, note to Rock Co. discounted at 15%.

Discount Discount rate rate

Proceeds Proceeds 20 000 Discount: Discount: $20,000 $20,000 xx.15 .15xx90/360 90/360

00

Discounted Discounted Notes Notes Payable Payable On On November November 88 the the note note isis paid paid in in full. full. Nov. 8 Notes Payable Cash Paid note due.

20 000 00 20 000 00

Contingent Liabilities

Product Product Liability Liability On On June June 30, 30, aa company company sells sells aa product product for for $60,000 $60,000 on on which which there there isis aa 36-month 36-month warranty. warranty. Past Past experience experience indicates indicates that that repairs repairs of of defects defects cost cost 5% 5% of of the the sales sales price price over over the the warranty warranty period. period. June 30 Product Warranty Expense Product Warranty Liability Warranty expenses projected for June, 5% of $60,000.

3 000 00 3 000 00

Product Product Liability Liability On On August August 16, 16, aa customer customer needed needed aa defective defective part part replaced. replaced. Cost Cost to to the the company company was was $200 $200 for for the the part. part. Aug.16 Product Warranty Payable Supplies Replaced defective part under warranty.

200 00 200 00

Accounting Accounting Treatment Treatment of of Contingent Contingent Liabilities Liabilities Likelihood of Occurring

Measurement

Probable

Estimable

Record Liability

Not Estimable

Disclose Liability

Contingency

Possible

Accounting Treatment

Disclose Liability

Payroll and Payroll Taxes

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

Gross Gross Pay Pay Calculation Calculation John John T. T. McGrath McGrath isis employed employed by by McDermott McDermott Supply Supply Co. Co. at at the the rate rate of of $34 $34 per per hour, hour, plus plus 1.5 1.5 times times the the normal normal hourly hourly rate rate for for hours hours over over 40 40 per per week. week. For For the the week week ended ended December December 27, 27, McGrath McGrath worked worked 42 42 hours. hours.

Earnings at base rate (40 x $34) Earnings at overtime rate (2 x $51) Total earnings

$1,360 102 $1,462

FICA FICA Tax Tax Employers Employers are are required required to to withhold withhold aa portion portion of of the the earnings earnings of of each each of of the the employees. employees. The The amount amount isis matched matched by by the the employer employer and and serves serves to to provide provide the the employee employee with with social social security security and and Medicare Medicare benefits benefits upon upon retirement. retirement.

FICA FICA Tax Tax Calculation Calculation Assume 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 6% social security tax ($100,000 – $99,038) $962 Social security tax rate x 6% Social security tax $57.72 Earnings subject to 1.5% Medicare tax Current earnings $1,462 Medicare tax rate x 1.5% Medicare tax 21.93 Total FICA tax $79.65

Withholding Withholding Taxes, Taxes, Other Other Deductions 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.

Employee Net Pay Calculation Gross earnings for the week $1,462.00 Deductions: Social security tax tax $ 57.72 Medicare tax 21.93 Federal income tax 279.51 Retirement savings 20.00 United Way 5.00 Total deductions 384.16 Net pay $1,077.84

John T. McGrath is single, has declared one withholding allowance, and had gross pay of $1,462 for the week ended December 27.

Responsibility Responsibility for for Tax Tax Payments Payments EMPLOYEE

Social security tax Medicare tax Federal withholding tax

GOVERNMENT

BUSINESS

Social security tax Medicare tax Federal unemployment compensation tax State unemployment compensation tax

Federal Income Corporate Estate, gift, income tax and other 8% 8% 46%

Personal income tax

FICA and FUTA 38%

Federal Outlays

National defense

Physical, human, and Interest on community Social debt development programs 8% 13% 19% 24% 33% 3% Social security and Medicare

Law enforcement and general government

Payroll Payroll Register Register It’s It’s aa multicolumn multicolumn form form used used to to help help What What isis the theassemble assemble and and summarize summarize the the data data purpose purpose of of aa needed needed for for each each payroll payroll period. period. payroll payroll register? register?

Payroll Register Summary Earnings: Regular Overtime Total Deductions: Social security tax Medicare tax Federal income tax Retirement savings United Way Accounts receivable Total Net amount paid Accounts debited: Sales Salaries Expense Office Salaries Expense Total (as above)

$13,328.00 574.00 $13,902.00 $ 643.07 208.53 3,332.00 680.00 470.00 50.00 5,383.60 $ 8,518.40 $11,122.00 2,780.00 $13,902.00

Recording Recording Employees’ Employees’ Earnings Earnings Dec. 27 Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Inc. Tax Pay. Retirement Savings Ded. Payable United Way Deductions Payable Accounts Receivable—Fred Elrod Salaries Payable Payroll for week ended December 27.

11 122 00 2 780 00 643 208 3 332 680 470 50 8 518

07 53 00 00 00 00 40

Recording Recording Employer’s Employer’s Payroll Payroll Taxes Taxes Employer Employer Taxes Taxes for for the the Week Week Ended Ended December December 27 27 Social $$ 643.07 Social security security tax tax 643.07 Medicare 208.53 Medicare tax tax 208.53 State State unemployment unemployment compensation compensation tax tax (5.4% 146.34 (5.4% xx $2,710) $2,710) 146.34 Federal Federal unemployment unemployment compensation compensation tax 21.68 tax (0.8% (0.8% xx $2,710) $2,710) 21.68 Total $1,019.62 Total payroll payroll tax tax expense expense $1,019.62

Recording Recording Employer’s Employer’s Payroll Payroll Taxes Taxes Dec. 27 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Pay. Payroll taxes for week ended December 27.

1 019 62 643 208 146 21

07 53 34 68

Flow of Data in a Payroll System Wage and Tax Statements Current Period’s Variables (hours worked) Updated Variables (cumulative earnings, taxes) Constant Data (rates of pay, tax, etc.)

EMPLOYEES’ EARNINGS RECORDS

PAYROLL REGISTER

GENERAL LEDGER

W-2

W-2

Payroll Tax Returns

Payroll Checks and Statements Financial Statements

Employees’ Employees’ Fringe Fringe Benefits Benefits

Benefit Benefit Dollars Dollars as as aa Percent Percent of of Total Total Retirement and savings plans

Other 2% 18% 29%

Vacation and sick pay

25% Social security and Medicare

26% Medical

Employees’ Employees’ Fringe Fringe Benefits 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.

Pensions Pensions 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 Ratio Noble Co. Quick assets: Cash Cash equivalents Accounts receivable (net) Total Current liabilities

Quick assets Current liabilities

$ 100,000 47,000 84,000 $231,000 $220,000

Hart Co. $ 55,000 65,000 472,000 $592,000 $740,000

Solvency Measures — Quick Ratio Noble Co. Quick assets: Cash Cash equivalents Accounts receivable (net) Total Current liabilities

$ 100,000 47,000 84,000 $231,000 $220,000

Hart Co. $ 55,000 65,000 472,000 $592,000 $740,000

$231,000 Quick assets Noble Company Current liabilities Quick ratio = 1.05 $220,000

Solvency Measures — Quick Ratio Noble Co. Quick assets: Cash Cash equivalents Accounts receivable (net) Total Current liabilities

$ 100,000 47,000 84,000 $231,000 $220,000

Hart Co. $ 55,000 65,000 472,000 $592,000 $740,000

$592,000 Quick assets Hart Company Current liabilities Quick ratio = 0.80 $740,000 Use: Use: To To indicate indicateinstant instant debt-paying debt-paying ability ability

Chapter 11 The The End End