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Current Liabilities and Payroll. Chapter 10. Learning Objectives. Describe and illustrate current liabilities related to accounts payable, current portion of long-term debt, and notes payable.

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Learning objectives
Learning Objectives

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.

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


Learning Objectives

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

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

Describe and illustrate the use of the quick ratio in analyzing a company’s ability to pay its current liabilities.


Learning Objective 1

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


Current liabilities
Current Liabilities

When a company or a bank advances credit, it is making a loan.

The company or bank is called a creditor (or lender).

The individuals or companies receiving the loans are called debtors (or borrowers).

Long-term liabilities are debts due beyond one year.

Current liabilities are debts that will be paid out of current assets and are due within one year.

LO 1


Accounts payable
Accounts Payable

LO 1

Accounts payable transactionsarise from purchasing goods or services for use in a company’s operations or from purchasing merchandise for resale.


Current portion of long term debt
Current Portion of Long-Term Debt

Long-term liabilities are often paid back in periodic payments, called installments. Installmentsthat are due within the coming year must be classified as a current liability. The installments due after the coming year are classified as a long-term liability.

LO 1


Short term notes payable
Short-Term Notes Payable

LO 1

Nature’s Sunshine Company issues a 90-day, 12% note for $1,000, dated August 1, 2011 to Murray Co. for a $1,000 overdue account.


LO 1

Short-Term Notes Payable

When the note matures, the entry to record the payment of $1,000 plus $30 interest ($1,000 x 12% x 90/360) is as follows:

Interest Expense appears on the income statement as an “Other Expense.”


Bowden Co. (Borrower)

Description Debit Credit

LO 1

Short-Term Notes Payable

On May1, Bowden Co. (borrower) purchased merchandise on account from Coker Co. (creditor), $10,000, 2/10, n/30. The merchandise cost Coker Co. $7,500.

Coker Co. (Creditor)

Description Debit Credit

Accounts Receivable 10,000

Sales 10,000

Cost of Mdse. Sold 7,500

Mdse. Inventory 7,500

Mdse. Inventory 10,000

Accounts Payable 10,000


Bowden Co. (Borrower)

Description Debit Credit

Accounts Payable10,000

Notes Payable 10,000

Coker Co. (Creditor)

Description Debit Credit

Notes Receivable 10,000

Accounts Receivable 10,000

LO 1

Short-Term Notes Payable

On May31, Bowden Co. issued a 60-day, 12% note for $10,000 to Coker Co. on account.


Bowden Co. (Borrower)

Description Debit Credit

Notes Payable 10,000

Interest Expense 200

Cash 10,200

Coker Co. (Creditor)

Description Debit Credit

Cash 10,200

Interest Revenue 200

Notes Receivable 10,000

LO 1

Short-Term Notes Payable

On July 30, Bowden Co. paid Coker Co. the amount due on the note of May 31, the face amount of $10,000 plus interest of $200 ($10,000 x 12% x 60/360).


LO 1

Short-Term Notes Payable

On September 19, Iceburg Company borrowed cash from First National Bank by issuing a $4,000, 90-day, 15% note to the bank.


LO 1

Short-Term Notes Payable

On December 18, Iceburg Company paid First National Bank $4,000 plus interest of $150 ($4,000 x 15% x 90/360).


Short term notes payable1
Short-Term Notes Payable

A discounted note has the following characteristics:

The interest rate on the note is called the discount rate.

The amount of interest on the note, called the discount, is computed by multiplying the discount rate times the face amount of the note.

The debtor (borrower) receives the face amount of the note less the discount, called theproceeds.

The debtor must repay the face amount of the note on the due date.

LO 1


LO 1

Short-Term Notes Payable

On August 10, Cary Company issues a $20,000, 90-day discounted note to Western National Bank. The discount rate is 15%, and the amount of the discount is $750 ($20,000 x 15% x 90/360).

proceeds


LO 1

Short-Term Notes Payable

The entry when Cary Company pays the discounted note on November 8 is as follows:


Learning Objective 2

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


Payroll and payroll taxes
Payroll and Payroll Taxes

In accounting, payroll refers to the amount paid to employees for services they provided during the period. A company’s payroll is important for the following reasons:

Payroll and related payroll taxes significantly affect the net income of most companies.

Payroll is subject to federal and state regulations.

Good employee morale requires payroll to be paid timely and accurately.

LO 2


Liability for employee earnings
Liability for Employee Earnings

Salary usually refers to payment for managerial and administrative services. Salary is normally expressed in terms of a month or a year.

Wages usually refers to payment for employee manual labor. The rate of wages is normally stated on an hourly or weekly basis.

LO 2


LO 2

Liability for Employee Earnings

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. His earnings are computed as follows:

Earnings at regular rate (40 x $34) $1,360

Earnings at overtime rate (2 x $51) 102

Total earnings $1,462


Deductions from employee earnings
Deductions from Employee Earnings

The total earnings of an employee for a payroll period, including any overtime pay, are called gross pay.

From this amount is subtracted one or more deductions to arrive at the net pay.

LO 2



LO 2

Deductions from Employee Earnings

John T. McGrath made $1,462 for the week ending December 27. McGrath’s W-4 (previous slide) claims one withholding allowance of $70. Thus, the wages used to determine McGrath’s withholding bracket in Exhibit 3 (next slide) are $1,392 ($1,462 – $70).


LO 2

Deductions from Employee Earnings


Deductions from employee earnings2
Deductions from Employee Earnings

The Federal Insurance Contributions Act (FICA) tax withheld contributes to the following two federal programs.

Social security, which provides payments for retirees, survivors, and disability insurance. (Assume 6% on all earnings.)

Medicare, which provides health insurance benefits for senior citizens. (Assume 1.5% on all earnings.)

LO 2


Deductions from employee earnings3
Deductions from Employee Earnings

LO 2

John T. McGrath’s earnings for the week ending December 27 are $1,462. Total FICA tax to be withheld is calculated as follows:

Earnings subject to 6% social security tax $1,462

Social security tax rate x 6%

Social security tax $ 87.72

Earnings subject to 1.5% Medicare tax $1,462

Medicare tax rate x 1.5%Medicare tax 21.93

Total FICA tax $109.65


Computing employee net pay
Computing Employee Net Pay

LO 2

John T. McGrath’s Net Pay:

Gross earnings for the week $1,462.00 Deductions:

Social security tax $ 87.72

Medicare tax 21.93

Federal income tax 258.90

Retirement savings 20.00

United Fund 5.00

Total deductions 393.55

Net pay $1,068.45


Liability for employer s payroll taxes
Liability for Employer’s Payroll Taxes

Employers are subject to the following payroll taxes for amounts paid their employees:

FICA Tax

Federal Unemployment Compensation Tax (FUTA)

State Unemployment Compensation Tax (SUTA)

LO 2



Learning objective 3
Learning Objective 3

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


Accounting systems for payroll and payroll taxes
Accounting Systems for Payroll and Payroll Taxes

Payroll systems should be designed to:

Pay employees accurately and timely.

Meet regulatory requirements of federal, state, and local agencies.

Provide useful data for management decision-making needs.

LO 3


Payroll register
Payroll Register

The payroll register is a multicolumn report used for summarizing the data for each payroll period. Exhibit 5 illustrates a payroll register for McDermott Supply Co.

LO 3


LO 3

Payroll Register

(left side, continued)


LO 3

Payroll Register

(right side)



LO 3

Recording and Paying Payroll Taxes

Employers must match the employee’s social security and Medicare tax contributions. In addition, the employer must pay SUTA tax of 5.4% and FUTA tax of 0.8% (assume on $2,710). For McDermott Supply’s payroll of December 27, these payroll taxes are computed as follows:

Social security tax $ 834.12 ($13,902 x 6%)

Medicare tax 208.53 ($13,902 x 1.5%)

SUTA 146.34 ($2,710 x 5.4%)

FUTA 21.68 ($2,710 x 0.8%)

Total payroll taxes $1,210.67


LO 3

Recording and Paying Payroll Taxes

The entry to journalize the payroll tax expense for Exhibit 5 is shown below.


Employee s earnings record
Employee’s Earnings Record

A detailed payroll record must be kept for each employee. This record is called an employee’s earnings record. Exhibit 6 (next two slides) shows a portion of John T. McGrath’s employee’s earnings record.

LO 3


LO 3

(continued)




Payroll checks
Payroll Checks

At the end of each payroll period, payroll checks are prepared. Each check includes a detachable statement showing the details of how the net pay was computed.

LO 3


LO 3

Payroll Checks


Payroll system design
Payroll System Design

The inputs into a payroll system may be classified as:

Constants, which are data that remain unchanged from payroll to payroll.

Employee names

Social security numbers

Variables, which are data that change from payroll to payroll.

Number of hours or days worked

Accrued sick leave

LO 3


Internal controls for payroll systems
Internal Controls for Payroll Systems

Some examples of payroll controls include:

If a check-signing machine is used, blank payroll checks and access to the machine should be restricted to prevent their theft or misuse.

The hiring and firing of employees should be properly authorized and approved in writing.

All changes in pay rates should be properly authorized and approved in writing.

Employees should be observed when arriving for work to verify that employees are “checking in” for work only once and only for themselves.

LO 3


LO 3

Internal Controls for Payroll Systems

  • Payroll checks should be distributed by someone other than employee supervisors.

  • A special payroll bank account should be used.


Learning Objective 4

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


Employees fringe benefits
Employees’ Fringe Benefits

Many companies provide their employees benefits in addition to salary and wages earned. Such fringe benefits may include:

Vacation pay (sometimes called compensated absences)

Medical benefits

Retirement benefits

LO 4


Vacation pay
Vacation Pay

LO 4

Assume that employees earn one day of vacation for each month worked. The estimated vacation pay for the year ending December 31 is $325,000. The adjusting entry for the accrued vacation is shown below.


Pensions
Pensions

A pension is a cash payment to retired employees. Pension rights are accrued by employees as they work, based on the employer’s pension plan. Two types of pension plans are:

Defined contribution plan

Defined benefit plan

LO 4


In a defined contribution plan, the company invests contributions on behalf of the employee during the employee’s working years.

Normally, the employee and employer contribute to the plan.

The employee’s pension depends on the total contributions and the investment returns earned on those contributions.

LO 4

Pensions


Pensions1
Pensions

LO 4

Heaven Scent Perfumes Company contributes 10% of employee monthly salaries to an employee 401K plan. Assuming $500,000 of monthly salaries, the journal entry to record the monthly contribution is shown below.


LO 4

Pensions

  • In a defined benefit plan, the employer is obligated to pay for (fund) the employee’s future pension benefits.

    • Many companies are replacing their defined benefit plans with defined contribution plans.

    • A retired employee receives a specific amount based on his or her salary history and years of service.


LO 4

Pensions

The defined benefit plan of Hinkle Co. requires an annual pension cost of $80,000. The annual contribution is based on estimates of Hinkle’s future pension liability. On December 31, Hinkle Co. pays $60,000 to the pension fund. The entry to record the payment and unfunded liability is shown below.


Postretirement benefits other than pensions
Postretirement Benefits Other than Pensions

Employees may earn rights to other postretirement benefits, such as dental care, eye care, medical care, life insurance, tuition assistance, tax services, and legal services.

LO 4



Learning Objective 5

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


Contingent liabilities
Contingent Liabilities

Some liabilities may arise from past transactions if certain events occur in the future. These potential obligations are called contingent liabilities. The accounting for contingent liabilities depends on the following two factors:

Likelihood of occurring: probable, reasonably possible, or remote

Measurement: estimable or not estimable

LO 5


LO 5

Contingent Liabilities

During June, a company sold a product for $60,000 that includes a 36-month warranty for repairs. The average cost of repairs over the warranty period is 5% of the sales price. The entry to record the estimated product warranty expense for June is shown below.


LO 5

Contingent Liabilities

If a $200 part is replaced under warranty on August 16, the entry is as follows:



Learning Objective 6

Describe and illustrate the use of the quick ratio in analyzing a company’s ability to pay its current liabilities.


Quick ratio
Quick Ratio

Current position analysis helps creditors evaluate a company’s ability to pay its current liabilities. It is based on:

Working capital, the excess of current assets over current liabilities

Current ratio, determined by dividing the current assets by the current liabilities

Quick ratio, an indicator of a company’s short-term liquidity

LO 6


Quick ratio1
Quick Ratio

The quick ratio measures the “instant” debt-paying ability of a company and is computed as follows:

LO 6

Quick Assets

Current Liabilities

Quick Ratio =

  • Quick assets are cash and other current assets that can be easily converted to cash.


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