11 1 CHAPTER 11 Current Liabilities and Payroll

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CHAPTER 11 Current Liabilities and Payroll Accounting 11 -2

Previewof. CHAPTER 11 11 -3

Accounting for Current Liabilities Current liability is debt with two key features: 1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities. 2. Company will pay the debt within one year or the operating cycle, whichever is longer. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries payable, and interest payable. 11 -4 SO 1 Explain a current liability, and identify the major types of current liabilities.

Accounting for Current Liabilities Question To be classified as a current liability, a debt must be expected to be paid: a. out of existing current assets. b. by creating other current liabilities. c. within 2 years. d. both (a) and (b). 11 -5 SO 1 Explain a current liability, and identify the major types of current liabilities.

Accounting for Current Liabilities Notes Payable 11 -6 u Written promissory note. u Requires the borrower to pay interest. u Issued for varying periods. SO 2 Describe the accounting for notes payable.

Accounting for Current Liabilities Illustration: First National Bank agrees to lend $100, 000 on September 1, 2012, if Cole Williams Co. signs a $100, 000, 12%, four-month note maturing on January 1. Instructions a) Prepare the entry on September 1 st. b) Prepare the adjusting entry on Dec. 31 st, assuming monthly adjusting entries have not been made. c) Prepare the entry at maturity (Jan. 1, 2013). 11 -7 SO 2 Describe the accounting for notes payable.

Accounting for Current Liabilities Illustration: First National Bank agrees to lend $100, 000 on September 1, 2012, if Cole Williams Co. signs a $100, 000, 12%, four-month note maturing on January 1. a) Prepare the entry on Sept. 1 st. Cash 100, 000 Notes payable 100, 000 b) Prepare the adjusting entry on Dec. 31 st. Interest expense 4, 000 Interest payable 4, 000 $100, 000 x 12% x 4/12 = $4, 000 11 -8 SO 2 Describe the accounting for notes payable.

Accounting for Current Liabilities Illustration: First National Bank agrees to lend $100, 000 on September 1, 2012, if Cole Williams Co. signs a $100, 000, 12%, four-month note maturing on January 1. c) Prepare the entry at maturity. Notes payable Interest payable Cash 11 -9 100, 000 4, 000 104, 000 SO 2 Describe the accounting for notes payable.

Accounting for Current Liabilities Sales Tax Payable 11 -10 u Sales taxes are expressed as a stated percentage of the sales price. u Either rung up separately or included in total receipts. u Retailer collects tax from the customer. u Retailer remits the collections to the state’s department of revenue. SO 3 Explain the accounting for other current liabilities.

Accounting for Current Liabilities Illustration: The March 25 cash register reading for Cooley Grocery shows sales of $10, 000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Cash 10, 600 Sales revenue Sales tax payable 11 -11 10, 000 600 SO 3 Explain the accounting for other current liabilities.

Accounting for Current Liabilities Unearned Revenues received before the company u delivers goods or u provides services. Illustration 11 -2 11 -12 SO 3 Explain the accounting for other current liabilities.

Accounting for Current Liabilities Illustration: University sellsfive 10, 000 As the school. Superior completes each of the homeseason games, football it would tickets at each for its five-game home schedule. The record the$50 revenue earned. university makes the following entry for the sale of season tickets: Aug. 6 Sept. 7 11 -13 Cash Unearned ticket revenue 500, 000 Unearned ticket revenue Ticket revenue 100, 000 500, 000 100, 000 SO 3 Explain the accounting for other current liabilities.

Accounting for Current Liabilities Current Maturities of Long-Term Debt 11 -14 u Portion of long-term debt that comes due in the current year. u No adjusting entry required. SO 3 Explain the accounting for other current liabilities.

Accounting for Current Liabilities Statement Presentation and Analysis 11 -15 Illustration 11 -3 SO 4

Accounting for Current Liabilities Question Working capital is calculated as: a. current assets minus current liabilities. b. total assets minus total liabilities. c. long-term liabilities minus current liabilities. d. both (b) and (c). 11 -16 SO 4 Explain the financial statement presentation and analysis of current liabilities.

Accounting for Current Liabilities Statement Presentation and Analysis Illustration 11 -4 Current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times. 11 -17 Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash. Illustration 11 -5 SO 4 Explain the financial statement presentation and analysis of current liabilities.

Contingent Liabilities Potential liability that may become an actual liability in the future. Three levels of probability: 11 -18 u Probable. u Reasonably possible. u Remote. SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities 11 -19 Probability Accounting Probable Accrue Reasonably Possible Footnote Remote Ignore SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Question A contingent liability should be recorded in the accounts when: a. it is probable the contingency will happen, but the amount cannot be reasonably estimated. b. it is reasonably possible the contingency will happen, and the amount can be reasonably estimated. c. it is probable the contingency will happen, and the amount can be reasonably estimated. d. it is reasonably possible the contingency will happen, but the amount cannot be reasonably estimated. 11 -20 SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Recording a Contingent Liability Product Warranties Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs. 11 -21 SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

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Contingent Liabilities Illustration: Denson Manufacturing Company sells 10, 000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2012, the company honors warranty contracts on 300 units, at a total cost of $24, 000. At December 31, compute the estimated warranty liability. Illustration 11 -6 Computation of estimated product warranty liability 11 -23 SO 5

Contingent Liabilities Illustration: Denson Manufacturing Company sells 10, 000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2012, the company honors warranty contracts on 300 units, at a total cost of $24, 000. At December 31, compute the estimated warranty liability. Make the required adjusting entry. Warranty expense Warranty liability 11 -24 40, 000 SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Illustration: Prepare the entry to record the repair costs incurred in 2012 to honor warranty contracts on 2012 sales. Warranty liability 24, 000 Repair parts 24, 000 Assume that the company replaces 20 defective units in January 2013, at an average cost of $80 in parts and labor. Warranty liability 1, 600 Repair parts 11 -25 1, 600 SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Contingent Liabilities Disclosure of Contingent Liabilities 11 -26 SO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Payroll Accounting “Payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the Payroll Involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. 11 -27

Determining the Payroll Gross Earnings Total compensation earned by an employee (wages or salaries, plus any bonuses and commissions). Illustration 11 -8 11 -28 SO 6 Compute and record the payroll for a pay period.

Determining the Payroll Deductions Mandatory: 11 -29 Voluntary: u FICA tax u Charity u Federal income tax u Insurance u State income tax u Union dues u Pension plans SO 6 Compute and record the payroll for a pay period.

Determining the Payroll Deductions Social Security taxes u Supplemental retirement, employment disability, and medical benefits. u In 2010, the rate was 7. 65% (6. 2% Social Security plus 1. 45% Medicare) on the first $106, 800 of gross earnings for each employee. For Mandatory: u FICA tax u Federal income tax u State income tax purpose of illustration, assume a rate of 8% on the first $100, 000 of gross earnings, maximum of $8, 000. 11 -30 SO 6 Compute and record the payroll for a pay period.

Determining the Payroll Deductions Mandatory: 11 -31 u FICA tax u Federal income tax u State income tax u Employers are required to withhold income taxes from employees’ pay. u Withholding amounts are based on gross wages and the number of allowances claimed. SO 6 Compute and record the payroll for a pay period.

Determining the Payroll Deductions Mandatory: 11 -32 u FICA tax u Federal income tax u State income tax u Most states (and some cities) require employers to withhold income taxes from employees’ earnings. SO 6 Compute and record the payroll for a pay period.

Determining the Payroll Net Pay Gross earnings minus payroll deductions. Illustration 11 -11 11 -33 SO 6 Compute and record the payroll for a pay period.

Recording the Payroll Maintaining Payroll Department Records An employer must keep a cumulative record of each employee’s gross earnings, deductions, and net pay during the year. Illustration 11 -12 11 -34 SO 6

Recording the Payroll Maintaining Payroll Department Records Many companies find it useful to prepare a payroll register. Illustration 11 -13 11 -35 SO 6

Recording the Payroll Recognizing Payroll Expenses and Liabilities Illustration: Prepare the entry Academy Company would make to record the payroll for the week ending January 14. Salaries and wages expense FICA tax payable 1, 376. 80 Federal income tax payable 3, 490. 00 State income tax payable 344. 20 United Way payable 421. 50 Union dues payable 115. 00 Salaries and wages payable 11 -36 17, 210. 00 11, 462. 50 SO 6 Compute and record the payroll for a pay period.

Recording the Payroll Recording Payment of the Payroll Illustration: Prepare the entry Academy Company would make to record the payment of the payroll. Salaries and wages payable Cash 11 -37 11, 462. 50 SO 6 Compute and record the payroll for a pay period.

Recording the Payroll Illustration 11 -14 Paycheck and statement of earnings 11 -38 SO 6 Compute and record the payroll for a pay period.

Employer Payroll Taxes Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: u 11 -39 FICA tax u Federal unemployment tax u State unemployment tax u Same rate and maximum earnings as the employee’s. u In 2010, the rate was 7. 65% (6. 2% Social Security plus 1. 45% Medicare) on the first $106, 800 of gross earnings for each employee. For purpose of illustration, assume a rate of 8% on the first $100, 000 of gross earnings, maximum of $8, 000. SO 7 Describe and record employer payroll taxes.

Employer Payroll Taxes Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: 11 -40 u FICA tax u Federal unemployment tax u State unemployment tax u FUTA tax rate is 6. 2% of first $7, 000 of taxable wages. u Employers who pay the state unemployment tax on a timely basis will receive an offset credit of up to 5. 4%. Therefore, the net federal tax rate is generally 0. 8%. SO 7 Describe and record employer payroll taxes.

Employer Payroll Taxes Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: u FICA tax u Federal unemployment tax u 11 -41 State unemployment tax u SUTA basic rate is usually 5. 4% on the first $7, 000 of wages paid. SO 7 Describe and record employer payroll taxes.

Employer Payroll Taxes Illustration: Academy records the payroll tax expense associated with the January 14 payroll with the following entry. Use the following rates: FICA 8%, state unemployment 5. 4%, federal unemployment 0. 8%. Payroll tax expense 2, 443. 82 FICA tax payable 1, 376. 80 * State unemployment tax payable 929. 34 ** Federal unemployment tax payable 137. 68 *** * $ 17, 210. 00 x 8% = $1, 376. 80 ** $17, 210. 00 x 5. 4% = $929. 34 11 -42 *** $17, 210 x. 8% = $137. 68 SO 7 Describe and record employer payroll taxes.

Employer Payroll Taxes Question Employer payroll taxes do not include: a. Federal unemployment taxes. b. State unemployment taxes. c. Federal income taxes. d. FICA taxes. 11 -43 SO 7 Describe and record employer payroll taxes.

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Filing and Remitting Payroll Taxes Companies must report FICA taxes and federal income taxes withheld no later than one month following the close of each quarter. Companies generally file and remit federal unemployment taxes annually on or before January 31 of the subsequent year. Companies usually file and pay state unemployment taxes by the end of the month following each quarter. Employers must provide each employee with a Wage and Tax Statement (Form W-2) by January 31. 11 -45 SO 7 Describe and record employer payroll taxes.

Internal Control for Payroll As applied to payroll, the objectives of internal control are 1. to safeguard company assets against unauthorized payments of payrolls, and 2. to ensure the accuracy and reliability of the accounting records pertaining to payrolls. 11 -46 SO 8 Discuss the objectives of internal control for payroll.

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APPENDIX 11 A APPENDIX Additional Fringe Benefits In addition to the three payroll-tax fringe benefits, employers incur other substantial fringe benefit costs. Two important fringe benefits include: 11 -48 u Paid absences u Post-retirement benefits SO 9 Identify additional fringe benefits associated with employee compensation.

Paid Absences 11 -49 u Employees often are given rights to receive compensation for absence when they meet certain conditions of employment. u The compensation may be for paid vacations, sick pay benefits, and paid holidays. u When the payment for such absences is probable and the amount can be reasonably estimated, the company should accrue a liability for paid future absences. u When the amount cannot be reasonably estimated, the company should instead disclose the potential liability. SO 9 Identify additional fringe benefits associated with employee compensation.

Post-Retirement Benefits APPENDIX Post-retirement benefits are benefits that employers provide to retired employees for 1. pensions and 2. health care and life insurance. Companies account for post-retirement benefits on the accrual basis. 11 -50 SO 9 Identify additional fringe benefits associated with employee compensation.

Post-Retirement Benefits Pensions A pension plan is an agreement whereby employers provide benefits to employees after they retire. Two types of pension plans: 1. In a defined-contribution plan, the plan defines the contribution that an employer will make but not the benefit that the employee will receive at retirement. This is often referred to as a 401 (k) plan. 2. In a defined-benefit plan, the employer agrees to pay a defined amount to retirees, based on employees meeting certain eligibility standards. 11 -51 SO 9 Identify additional fringe benefits associated with employee compensation.

Key Points u 11 -52 The basic definition of a liability under GAAP and IFRS is very similar. In a more technical way, liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an out flow from the entity of resources embodying economic benefits. Liabilities may be legally enforceable via a contract or law but need not be; that is, they can arise due to normal business practice or customs.

Key Points 11 -53 u IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions). When current liabilities (also called short-term liabilities) are presented, they are generally presented in order of liquidity. u Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months. u Companies sometimes show liabilities before assets. Also, they will sometimes show long-term liabilities before current liabilities.

Key Points 11 -54 u Under IFRS, companies sometimes will net current liabilities against current liabilities to show working capital on the face of the statement of financial position. (This is evident in the Zetar financial statements in Appendix C. ) u Under GAAP, some contingent liabilities are recorded in the financial statements, others are disclosed, and in some cases no disclosure is required. Unlike GAAP, IFRS reserves the use of the term contingent liability to refer only to possible obligations that are not recognized in the financial statements but may be disclosed if certain criteria are met.

Key Points 11 -55 u For those items that GAAP would treat as recordable contingent liabilities, IFRS instead uses the term provisions. Provisions are defined as liabilities of uncertain timing or amount. Examples of provisions would be provisions for warranties, employee vacation pay, or anticipated losses. Under IFRS, the measurement of a provision related to a uncertain obligation is based on the best estimate of the expenditure required to settle the obligation. u IFRS and GAAP separate plans into defined benefit and defined contribution. The IASB and FASB are working on a joint project on pensions that will dramatically change the approach used by both.

Looking to the Future The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities. One project is investigating approaches to differentiate between debt and equity instruments. The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting. The results of these projects could change the classification of many debt and equity securities. 11 -56

IFRS Self-Test Questions Which of the following is false? a) Under IFRS, current liabilities must always be presented before non-current liabilities. b) Under IFRS, an item is a current liability if it will be paid within the next 12 months. c) Under IFRS, current liabilities are shown in order of liquidity. d) Under IFRS, a liability is only recognized if it is a present obligation. 11 -57

IFRS Self-Test Questions Under IFRS, a contingent liability is: a) disclosed in the notes if certain criteria are met. b) reported on the face of the financial statements if certain criteria are met. c) the same as a provision. d) not covered by IFRS. 11 -58

IFRS Self-Test Questions Under IFRS, obligations related to warranties are considered: a) contingent liabilities. b) provisions. c) possible obligations. d) None of these. 11 -59

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