Current Liabilities and Payroll

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11
Current Liabilities and Payroll
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After studying this chapter, you should be able
to

• Describe and illustrate current liabilities
  related to accounts payable, current portion of
  long-term debt, and notes payable.

• Determine employer liabilities for payroll,
  including liabilities arising from employee
  earnings and deductions from earnings.

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After studying this chapter, you should be able
to

• Describe the payroll accounting systems that use
  a payroll register, employee earnings records,
  and a general journal.

• Journalize entries for employee fringe benefits,
  including vacation pay and pensions.

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After studying this chapter, you should be able
to

• Describe the accounting treatment for contingent
  liabilities and journalize entries for product
  warranties.

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11-1
Objective 1
Describe and illustrate current liabilities
related to accounts payable, current portion of
long-term debt, and notes payable.
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11-1
Liabilities that are to be paid out of current
assets and are due within a short time, usually
within one year, are called current liabilities.

• Accounts payable
• Current portion of long-term debt
• Notes payable

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11-1
Accounts Payable
Accounts payable arise from purchasing goods or
services for use in a companys operations or for
purchasing merchandise for resale.
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11-1
Current Portion of Long-Term Debt
Long-term liabilities are often paid back in
periodic payments, called installments.
Installments that are due within the coming year
must be classified as a current liability.
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11-1
The total amount of the installments due after
the coming year is classified as a long-term
liability.
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11-1
Short-Term Notes Payable
A firm issues a 90-day, 12 note for 1,000,
dated August 1, 2008 to Murray Co. for a 1,000
overdue account.
Aug. 1 Accounts PayableMurray Co. 1 000 00
Notes Payable 1 000 00
Issued a 90-day, 12 note on account.
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11-1
On October 30, when the note matures, the firm
pays the 1,000 principal plus 30 interest
(1,000 x 12 x 90/360).
Appears on the income statement as an Other
Expense.
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11-1
On May 1, Bowden Co. (borrower) purchased
merchandise on account from Coker Co. (creditor),
10,000, 2/10, n/30. The merchandise cost Coker
Co. 7,500.
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11-1
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11-1
On May 3, Bowden Co. issued a 60-day, 12 note
for 10,000 to Coker Co. on account.
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11-1
On July 30, Bowden Co. paid Coker Co. the amount
due on the note of May 31. Interest 10,000 x
12 x 60/360.
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11-1
On September 19, a firm borrows 4,000 from First
National Bank by giving the bank a 90-day, 15
note.
Sept. 19 Cash 4 000 00
Notes Payable 4 000 00
Issued a 90-day, 15 note to the bank.
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11-1
On the due date of the note (December 18), the
borrower owes 4,000 plus interest of 150
(4,000 x 15 x 90/360).
Dec. 18 Notes Payable 4 000 00
Interest Expense 150 00
Cash 4 150 00
Paid principal and interest due on note.
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11-1
Discounting a Note
The interest set by the creditor when a note does
not specify the rate is called the discount. The
rate used in computing the discount is called the
discount rate. The borrower is given the
remainder (face discount), called the proceeds.
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11-1
On August 10, Cary Company issues a 20,000,
90-day note to Rock Company in exchange for
inventory. Rock discounts the note at 15.
Aug. 10 Merchandise Inventory 19 250 00
Interest Expense 750 00
Notes Payable 20 000 00
Issued a 90-day note to Rock Co., discounted at
15.
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11-1
On August 10, Cary Company issues a 20,000,
90-day note to Rock Company in exchange for
inventory. Rock discounts the note at 15.
Proceeds
Discount 20,000 x .15 x 90/360
Discount rate
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11-1
On November 8 the note is paid in full.
Nov. 8 Notes Payable 20 000 00
Cash 20 000 00
Paid note due.
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11-1
On July 1, Bella Salon Company issued a 60-day
note with a face amount of 60,000 to Delilah
Hair Products Company. for merchandise inventory.

• Determine the proceeds of the note assuming the
  note carries an interest rate of 6.
• Determine the proceeds of the note assuming the
  note is discounted at 6.

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11-1

• 60,000
• 59,400 60,000 (60,000 x 6 x 60/360)

For Practice PE 11-1A, PE 11-1B
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11-2
Objective 2
Determine employer liabilities for payroll,
including liabilities arising from employee
earnings and deductions from earnings.
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11-2
11-2
Payroll refers to the amount paid to employees
for the services they provide during a period.
It is usually significant for several reasons.

• Employees are sensitive to payroll errors and
  irregularities.
• The payroll is subject to various federal and
  state regulations.
• The payroll and related payroll taxes have a
  significant effect on the net income of most
  businesses.

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11-2
Wages usually refers to payment for manual labor,
both skilled and unskilled. The rate of wages is
normally stated on an hourly or weekly basis.
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11-2
Salary usually refers to payment for managerial,
administrative, or similar services, normally
expressed in terms of a month or a year.
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11-2
The total earnings of an employee for a payroll
period are called gross pay. From this is
subtracted one or more deductions to arrive at
the net pay. Net pay is the amount that the
employer must pay the employee.
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11-2
McGrath Illustration
John T. McGrath is employed by McDermott Supply
Co. at the rate of 34 per hour, plus 1.5 times
the normal hourly rate for hours over 40 per
week. For the week ended December 27, McGrath
worked 42 hours.
Earnings at base rate (40 x 34) 1,360 Earnings
at overtime rate (2 x 51) 102 Total
earnings 1,462
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11-2
For this illustration assume the standard
withholding allowance of 63. Thus, the wages
used in determining McGraths withholding for the
week are 1,399 (1,462 63).
The actual IRS standard withholding allowance
changes every year and was 63.46 for 2006.
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11-2
Wage Bracket Withholding Table
McGrath wage bracket
Source Publication 15, Employers Tax Guide,
Internal Revenue Service, 2006
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11-2
McGrath Example (Continued)
Initial withholding 78.30 Plus (1,399 620)
x 25 194.75 Total federal income taxes
withheld 273.05
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11-2
Karen Dunns weekly gross earnings for the
present week were 2,250. Dunn has two
exemptions. Using the wage bracket withholding
table in Exhibit 3 (Slide 31) with a 63 standard
withholding allowance for each exemption, what is
Dunns federal income tax withholding?
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11-2
Initial withholding from wage bracket
275.55 Plus additional withholding 28 of
excess over 1,409 200.20 Federal income
tax withholding 475.75
28 x (2,124 1,409)
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For Practice PE 11-2A, PE 11-2B
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11-2
FICA Tax
The amount of FICA tax withheld is the employees
contribution to two federal programs. The first
program, called social security, is for old age,
survivors, and disability insurance (OASDI). The
second program, called Medicare, is health
insurance for senior citizens.
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11-2
John T. McGraths FICA Tax
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 1,462 Medicare tax rate x 1.5 Medicare
tax 21.93 Total FICA tax 79.65
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11-2
11-2
Computing McGraths Net Pay
John T. McGraths net pay
Gross earnings for the week 1,462.00
Deductions Social security tax (Slide 37)
57.72 Medicare tax (Slide 33) 21.93 Federal
income tax (Slide 33) 273.05 Retirement
savings 20.00 United Way 5.00 Total
deductions 377.70 Net pay 1,084.30
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11-2
Karen Dunns weekly gross earnings for the week
ending Dec. 3rd were 2,250, and her federal
income tax withholding was 475.75. Prior to
this week Dunn had earned 98,000 for the year.
Assuming the social security rate is 6 on the
first 100,000 of annual earnings and Medicare is
1.5 of all earnings, what is Dunns net pay?
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11-2
Total wage payment 2,250.00 Less Federal
income tax withholding 475.75 Earnings subject
to social security tax (100,000
98,000) 2,000 Social security tax rate x
6 Social security tax 120.00 Medicare tax
(2,250 x 1.5) 33.75 Net pay 1,620.50
For Practice PE 11-3A, PE 11-3B
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11-2
11-2
Employers Federal Payroll Taxes
Employers are required to contribute to the
social security and Medicare programs for each
employee. The employer must match the employees
contribution to each program.
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11-2
11-2
Employers Federal Unemployment Taxes
A FUTA tax of 6.2 is levied on employers only to
provide for temporary unemployment to those who
become unemployed as a result of layoffs due to
economic causes beyond their control. This tax
applies to only the first 7,000 of the earnings
of each covered employee during a calendar year.
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11-2
11-2
Employers State Unemployment Taxes
Employers in most states also must pay a state
unemployment tax for unemployed workers. A few
states require employee contributions. The state
plan is designed to reward firms with stable
employment, so the tax rate varies from state to
state and employer to employer.
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11-2
11-2
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11-3
Objective 3
Describe payroll accounting systems that use a
payroll register, employee earnings records, and
a general journal.
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11-3
Payroll Register
The payroll register is a multicolumn report
used for summarizing the data for each payroll
period. The last two columns of the payroll
register are used to accumulate the total wages
or salaries to be debited to various expense
accounts. The process is usually called payroll
distribution.
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11-3
Payroll Register
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(Continued)
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11-3
(Concluded)
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11-3
Recording Employees Earnings
Dec. 27 Sales Salaries Expense 11 122
00 Office Salaries Expense 2 780 00
Social Security Tax Payable 643 07
Medicare Tax Payable 208 53
Employees Federal Inc. Tax Pay. 3 332 00
Retirement Savings Ded. Payable 680 00
United Way Deductions Payable 470 00
Accounts ReceivableFred Elrod 50 00
Salaries Payable 8 518 40
Payroll for week ended December 27.
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11-3
The payroll register of Chen Engineering Services
indicates 900 of social security withheld and
225 of Medicare tax withheld on total salaries
of 15,000 for the period. Federal withholding
for the period totaled 2,925. Provide the
journal entry for the periods payroll.
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11-3
Salaries Expense 15,000 Social Security Tax
Payable 900 Medicare Tax Payable 225 Federal
Withholding Tax Payable 2,925 Salaries
Payable 10,950
For Practice PE 11-4A, PE 11-4B
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11-3
Recording and Paying Payroll Taxes
Everson Companys fiscal year ends on April 30.
Everson Company owes it employees 26,000 of
wages on December 31. The following portion of
the 26,000 of wages are subject to payroll taxes
on December 31
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11-3
Data for McDermott Supply Co. payroll for the
week ending December 27
Social security tax 643.07 Medicare
tax 208.53 State unemployment compensation tax
(5.4 x 2,710) 146.34 Federal unemployment
compensation tax (0.8 x 2,710) 21.68
Total payroll tax expense 1,019.62
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11-3
McDermott Supply Co.s payroll entry on December
27 is recorded as follows
Dec. 27 Payroll Tax Expense 1 019 62
Social Security Tax Payable 643 07
Medicare Tax Payable 208 53
State Unemployment Tax Payable 146 34
Federal Unemployment Tax Pay. 21 68
Payroll taxes for week ended December 27.
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11-3
The payroll register of Chen Engineering Services
indicates 900 of social security withheld and
225 of Medicare tax withheld on total salaries
of 15,000 for the period. Assume earnings
subject to state and federal unemployment
compensation taxes are 5,250, at the federal
rate of 0.8 and state tax of 5.4. Provide the
journal entry to record the payroll tax expense
for the period.
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11-3
For Practice PE 11-5A, PE 11-5B
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11-3
A detailed payroll record is maintained for each
employee. This record is called an employees
earnings record.
At the end of each pay period, payroll checks
are prepared. Each check includes a detachable
statement showing the details of how the net pay
was computed.
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11-3
Employees Earnings Record
(Continued)
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11-3
(Concluded)
(Concluded)
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11-3
Payroll Check
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11-3
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11-4
Objective 4
Journalize entries for employee fringe benefits,
including vacation pay and pensions.
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11-4
Many companies provide their employees a variety
of benefits in addition to salary and wages
earned. Such fringe benefits may take many
forms, including vacations, medical, and
postretirement benefits, such as a pension plan.
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11-4
Benefit Dollars as a Percent of Payroll Costs
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11-4
Vacation Pay
Most employers grant vacation rights, sometimes
called compensated absences, to their employees.
The estimated vacation pay for the payroll period
ending May 5 is 2,000.
May 5 Vacation Pay Expense 2 000
00 Vacation Pay Payable 2 000 00
Vacation pay for week ended May 5.
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11-4
Pensions
A pension represents a cash payment to retired
employees. Rights to pension payments are earned
by employees during their working years, based on
the pension plan established by the employer.
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11-4
In a defined contribution plan, a fixed amount of
money is invested on the employees behalf during
the employees working years.
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11-4
The pension plan of Heaven Scent Perfumes Company
requires an employer contribution of 10 of
employee monthly salaries. December salaries
totaled 500,000, so 50,000 was sent to the
employees plan administrator.
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Defined Contribution Plan
The entry to record the payment to the plan
administrator is
Dec. 31 Pension Expense 50 000 00 Cash 50
000 00
Contributed 10 of monthly salaries to pension
plan.
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11-4
Pensions
In a defined benefit plan, employers promise
employees a fixed annual pension benefit at
retirement, based on years of service and
compensation levels.
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11-4
Defined Benefit Plan
Assume that Hinkle Co. requires an annual pension
cost of 80,000 based on an estimate of the
future benefit obligation. Hinkle pays 60,000
into the pension fund.
Dec. 31 Pension Expense 80 000 00 Cash 60
000 00 Unfunded Pension Liability 20 000 00
To record annual pension cost and contribution to
pension plan.
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11-4
Postretirement Benefits Other Than Pensions
Employees may earns rights to other
postretirement benefits, such as dental care, eye
care, medical care, life insurance, tuition
assistance, tax services, and legal services.
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11-4
Manfield Service, Inc. provides their employees
vacation benefits and a defined contribution
pension plan. Employees earned vacation pay of
44,000 for the period. The pension plan
requires a contribution to the plan administrator
equal to 8 of employee salaries. Salaries were
450,000 during the period. Provide the journal
entry for (a) the vacation pay and (b) pension
benefit.
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11-4
a. Vacation Pay Expense 44,000 Vacation Pay
Payable 44,000 Vacation pay accrued for the
period.
b. Pension Expense 36,000 Cash 36,000 Pension
contribution, 8 of 450,000 salary.
For Practice PE 11-6A, PE 11-6B
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11-5
Objective 5
Describe the accounting treatment for contingent
liabilities and journalize entries for product
warranties.
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11-5
Some past transactions will result in liabilities
if certain events occur in the future. These
potential obligations are called contingent
liabilities.
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11-5
Contingent Liabilities
During June, a company sells a product for
60,000 on which there is a 36-month warranty.
Past experience indicates that the average cost
to repair defects is 5 of the sales price over
the warranty price.
June 30 Product Warranty Expense 3 000 00
Product Warranty Payable 3 000 00
Warranty expenses projected for June, 5 of
60,000.
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11-5
If a customer required a 200 part replacement on
August 16, the entry would be
Aug. 16 Product Warranty Payable 200 00
Supplies 200 00
Replaced defective part under warranty.
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Accounting Treatment of Contingent Liabilities
10
Accounting Treatment
Likelihood of Occurring
Measurement
Record and Disclose Liability
Probable
Contingency
Possible
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11-5
Cook-Rite Inc. sold 140,000 of kitchen
appliances during August under a 6 month
warranty. The cost to repair defects under the
warranty is estimated at 6 of the sales price.
On September 11, a customer required a 200 part
replacement, plus 90 labor under the
warranty. Provide the journal entries for (a) the
estimated warranty expense on August 31 and (b)
the September 11 warranty work.
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a. Product Warranty Expense 8,400 Product
Warranty Payable 8,400 To record warranty
expense for August, 6 x 140,000.
b. Product Warranty Payable 290 Supplies 200 W
ages Payable 90 Replaced defective part
under warranty.
For Practice PE 11-7A, PE 11-7B
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11-5
Quick Ratio
Noble Co. Hart Co.
Quick assets Cash 147,000 120,000 Accounts
receivable (net) 84,000 472,000
Total 231,000 592,000 Current
liabilities 220,000 740,000
The quick ratio or acid-test ratio can be used to
evaluate a firms ability to pay its current
liabilities within a short period of time.
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11-5
Quick Ratio
Noble Co. Hart Co.
Quick assets Cash 147,000 120,000 Accounts
receivable (net) 84,000 472,000
Total 231,000 592,000 Current
liabilities 220,000 740,000
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11-5
Noble Co. Hart Co.
Quick assets Cash 147,000 120,000 Accounts
receivable (net) 84,000 472,000
Total 231,000 592,000 Current
liabilities 220,000 740,000
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11-5
Interpretation
Noble Company is in a better quick ratio position
than Hart Company. By having a quick ratio in
excess of 1, Noble Company has quick assets
sufficient to cover the companys current
liabilities. This is not true for Hart Company.