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Chapter 9. Current Liabilities. Conceptual Learning Objectives. C1: Describe current and long-term liabilities and their characteristics. C2: Identify and describe known current liabilities. C3: Explain how to account for contingent liabilities. 9- 2. Analytical Learning Objectives.

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Chapter 9 l.jpg

Chapter 9

Current Liabilities


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Conceptual Learning Objectives

C1:Describe current and long-term liabilities and their characteristics.

C2: Identify and describe known current liabilities.

C3:Explain how to account for contingent liabilities.

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Analytical Learning Objectives

A1: Compute the times interest earned ratio and use it to analyze liabilities.

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Procedural Learning Objectives

P1: Prepare entries to account for short-term notes payable.

P2: Compute and record employee payroll deductions and liabilities.

P3: Compute and record employer payroll expenses and liabilities.

P4: Account for estimated liabilities, including warranties and bonuses.

NOT COVERED

P5: Appendix 9A: Identify and describe the details of payroll reports, records, and procedures.

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Defining Liabilities

A liability is a probable future payment of assets or services that a company is presently obligated to make as a result of a past transaction or event.

Examples:

TRANSACTIONS:

Accounts payable: Purchase of Inventory;

Wages payable: Employee Services;

Utilities payable: Utility consumption.

EVENTS:

Unearned revenue: Received up-front payments for

goods and services to beprovided in the near future.


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Liability --Three crucial factors:

1. Past transaction or event.

2. Present obligation.

3. Future payment of assets or services.

Thecompanyhas a presentobligation

Because of apast event . . .

. . . For futuresacrifices

Past

Present

Future

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Long-Term Liabilities

Expected not to be paid within one year or the company’s operating cycle, whichever is longer.

Expected to be paid within one year or the company’s operating cycle, whichever is longer.

Classifying Liabilities

C 1

Current Liabilities

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Uncertainty in Whom to Pay

Uncertainty in Whento Pay

OR to Provide services

Uncertainty in How Much to Pay

Uncertainty in Liabilities (pages 357 -58)

Answers to the following questions are often decided when a liability is incurred; however, one or more may be uncertain for some liabilities.

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Known Liabilities

C 2

Accounts Payable

Sales Taxes Payable

Unearned Revenues

Short-Term Notes Payable

Payroll Liabilities

Multi-Period Known Liabilities

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Quick Study 1

Exercise 1


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$7,500 × 6% = $450

Sales Taxes Payable

On May 15, 2009, Max Hardware sold building materials for $7,500 that are subject to a 6% sales tax.

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Quick Study 2


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Unearned Revenues

C 2

On May 1, 2009, A-1 Catering received $3,000 in advance for catering a wedding party to take place on July 12, 2009.

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Quick Study 3

Exercise 2


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Note Given to Extend Credit Period

P1

On August 1, 2009, Matrix, Inc. asked Carter, Co. to accept a 90-day, 12% note to replace its existing $5,000 account payable to Carter. Matrix would make the following entry:

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Interest expense = $5,000 × 12% × (90 ÷ 360) = $150

Note Given to Extend Credit Period

P1

On October 30, 2009, Matrix, Inc. pays the note plus interest to Carter.

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PROMISSORY NOTE

Face Value Date

after date promise to pay to the order of

American Bank

Nashville, TN

Dollars

plus interest at the annual rate of .

$20,000

Sept. 1, 2009

Ninety days

I

Twenty thousand and no/100 - - - - - - - - - - - - - - - - -

6%

Jackson Smith

Note Given to Borrow from Bank

P1

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Face Value Equals Amount Borrowed

P1

On September 1, 2009, Jackson Smith borrows $20,000 from American Bank. The note bears interest at 6% per year. Principal and interest are due in 90 days (November 30, 2009).

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$20,000 × 6% × (90 ÷ 360) = $300

Face Value Equals Amount Borrowed

P1

On November 30, 2009, Smith wouldmake the following entry:

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An adjusting entry is required to record interest expense incurred to date.

End-of-Period Adjustment to Notes

P1

Note Date

End of Period

Maturity Date

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End-of-Period Adjustment to Notes

P1

Dec. 31, 2009

Dec. 16, 2009

Feb. 14, 2010

Note Date

End of Period

Maturity Date

James Burrows borrowed $8,000 on Dec. 16, 2009, by signing a 12%, 60-day note payable.

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End-of-Period Adjustment to Notes

P1

On December 16, 2009, James Burrows would make the following entry:

On December 31, 2009, the adjustment is:

$8,000 × 12% × (15 ÷ 360) = $40

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$8,000 × 12% × (45 ÷ 360) = $120

End-of-Period Adjustment to Notes

P1

On February 14, 2010, James Burrows would make the following entry.

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Quick Study 5Exercise 4

Exercise 5


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Payroll Liabilities

Employers incur expenses and liabilities from having employees.

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Net Pay ($3,126)

Employee Payroll Deductions

P2

Gross Pay ($4,000)

Medicare Taxes

Federal Income Tax

State and Local Income Taxes

Voluntary Deductions

FICA Taxes

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Employee FICA Taxes

P2

Federal Insurance Contributions Act (FICA)

FICA Taxes — Soc. Sec.

FICA Taxes —Medicare

2010: 6.2% of the first $106,800 earned in the year ( Max = $6,621.60).

2010: 1.45% of all wages earned in the year.

Employers must pay withheld taxes to the Internal Revenue Service (IRS).

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Employee Income Tax

P2

State and Local Income Taxes

Federal Income Tax

Amounts withheld depend on the employee’s earnings, tax rates, and number of withholding allowances.

Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency.

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Employee Voluntary Deductions

P2

Voluntary Deductions

Amounts withheld depend on the employee’s request.

Examples include union dues, savings accounts, pension contributions, insurance premiums, and charities

Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency.

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$4,000 ´ 6.2% = $248

$4,000 ´ 1.45% = $58

Recording Employee Payroll Deductions

P2

The entry to record payroll expenses and deductions for an employee might look like this.

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Employers pay amounts equal to that withheld from the employee’s gross pay.

Employer Payroll Taxes

P3

Medicare Taxes1.45%

FICA Taxes6.2%

Federal and State Unemployment Taxes

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2008: 6.2% on the first $7,000 of wages paid to each employee (A credit up to 5.4% is given for SUTA paid, therefore the net rate is .8%.)

Federal Unemployment Tax (FUTA)

2008: Basic rate of 5.4% on the first $7,000 of wages paid to each employee (Merit ratings may lower SUTA rates.)

State Unemployment Tax (SUTA)

Federal and State Unemployment Taxes

P3

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Recording Employer Payroll Taxes

P3

The entry to record the employer payroll taxes for January might look like this:

FICA amounts are the same as that withheld from the employee’s gross pay.

SUTA: $4,000 ´ 5.4% = $216

FUTA: $4,000 ´ (6.2% - 5.4%) = $32

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Quick Study 5 Exercise 6

Exercise 7

Problem 5A


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Multi-Period Known Liabilities

P3

Often include unearned revenues and notes payable.

Unearned revenues from magazine subscriptions often cover more than one accounting period.A portion of the earned revenue is recognized each period and the unearned revenue account is reduced.

Quick Study 3

Notes payable often extend over more than one accounting period. A three-year note payable would be classified as a current liability for one year and a long-term liability for two years.

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Estimated Liabilities

P4

An estimated liability is a known obligationof an uncertain amount, but one that can be reasonably estimated.

A. Health and Pension Benefits

B. Vacation Benefits

C. Bonus Plans

D. Warranty Liabilities

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Health and Pension Benefits

P4

Employer expenses for pensions or medical, dental, life and disability insurance

Assume an employer agrees to pay an amount for medical insurance equal to $8,000, and contribute an additional 10% of the employees’ $120,000 gross salary to a retirement program.

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$62,400 ÷ 52 weeks = $1,200

$62,400 ÷ 50 weeks = $1,248

$ 48

Annual vacation benefit

Vacation Benefits

Employer expenses for paid vacation by employees

Assume an employee earns $62,400 per year and earns two weeks of paid vacation each year.

Quick Study 10

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Bonus Plans

P4

Many bonuses paid to employees are based on reported net income.

Assume the annual yearly bonus (B) to the store manager is equal to 10% of the company’s annual net income minus the bonus. The store earned $100,000 net income (Pre-bonus) this year.

(100,000 – 9,091) = 90,909 * 10% = 9,091

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Bonus Plans

P4

Many bonuses paid to employees are based on reported net income.

Assume the annual yearly bonus to the store manager is equal to 10% of the company’s annual net income minus the bonus. The store earned $100,000 net income this year.

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Quick Study 9

Exercise 9


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Warranty Liabilities

P4

Seller’s obligation to replace or correct a product (or service) that fails to perform as expectedwithin a specified period. To conform with the matching principle, the seller ESTIMATES (reports) expected warranty expense in the period when revenue from the sale is reported.

A dealer sells a car for $32,000, on December 1, 2009, with a warranty for parts and labor for 12 months, or 12,000 miles. The dealership experiences an average warranty cost of 3% of the selling price of each car.

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Warranty Liabilities

P4

Adealer sells a car for $32,000, on December 1, 2009, with a warranty for parts and labor for 12 months, or 12,000 miles. The dealership experiences an average warranty cost of 3% of the selling price of each car.

On February 15, 2010, parts of $200 and labor of $250 covered under warranty were incurred.

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Quick Study 8

Exercise 11


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Contingent Liabilities

Potential obligation that depends on a future event arising out of a past transaction or event.

1. Potential legal claims (lawsuits)

2. Debt guarantees (of a debt owed by another company)

3.Other contingencies:

-Warranty Liability;

-Environmental damages (Oil Spill & BP);

-Possible tax assessments (IRS Audits);

-Insurance losses (Flood Damage); -Government investigations (BP & TOYOTA).

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Amount . . .

Contingent Liabilities

Potential obligation that depends on a future event arising out of a past transaction or event.

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Reasonably Possible Contingent Liabilities

C3

Potential Legal Claims– A potential claim is recorded if the amount can be reasonably estimated and payment for damages is probable.

Debt Guarantees– The guarantor usually discloses the guarantee in its financial statement notes. If it is probable that the debtor will default, the guarantor should record and report the guarantee as a liability.

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Quick Study 9

Exercise 2


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Income before interestand income taxes

Times interestearned

=

Interest expense

Times Interest Earned

A1

If income before interest and taxes varies greatly from year to year, fixed interest charges can increase the risk that an owner will not earn a positive return and be unable to pay interest charges.

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