Current Liabilities and Payroll Chapter 11 Objective 1
Current Liabilities and Payroll Chapter 11
Objective 1 Account for current liabilities of known amount.
Accounts Payable. . . …are amounts owed to suppliers for goods or services purchased on account. • Accounts payable do not bear interest expense for the debtor.
Accounts Payable Example • Suppose that on June 3, Lloyd’s Sporting Store purchased $1, 000 of goods on account from Patti Wholesaler. • What is the journal entry? Inventory 1, 000 Accounts Payable Purchase on account 1, 000
Short-Term Notes Payable. . . …are promissory notes payable due within one year. • In addition to recording the note payable, the business must also pay interest expense. • If interest expense is accrued at the end of the period, interest payable must also be recorded.
Short-Term Notes Payable Example • On April 30, Patti purchased inventory for $10, 000 by issuing a 90 -day, 10% note payable. • What is the journal entry? Inventory 10, 000 Notes Payable 10, 000 Purchase inventory on a 90 -day, 10% note
Short-Term Notes Payable Example • Assume the accounting period ended May 31. • How much interest was accrued as of May 31? • $10, 000 × 10% × 31/360 = $86. 11 • How does Patti record the payment at maturity?
Short-Term Notes Payable Example July 29 Note Payable Interest Expense Cash 10, 000. 00 86. 11 163. 89
Sales Tax Payable Example • Most states levy a sales tax on retail sales. • Suppose that a store sold $3, 000 worth of merchandise on a given Saturday. • The business collected an additional 5% in sales tax. • How much is the sales tax liability? • $150
Accrued Expenses (Liabilities). . . – are expenses that have been incurred but not recorded. – salaries – taxes withheld – interest – utilities
Payroll Liabilities Salary Expense Employee Income Tax Payable FICA Tax Payable Employee Union Dues Payable Salary Payable To record salary expense 10, 000 1, 200 800 140 7, 860
Unearned Revenue Example • Assume that on June 1, Dennis’s Landscaping collected $1, 500 for services to be provided during the months of June, July, and August. June 1 Cash 1, 500 Unearned Revenue Received cash in advance 1, 500
Unearned Revenue Example • What entry does Dennis record on June 30? June 30 Unearned Revenue 500 Service Revenue 500 Earned service revenue that was collected in advance
Objective 2 Account for Current Liabilities That Must be Estimated.
Estimated Warranty Payable • The matching principle demands that the company record the warranty expense in the same period that the business recognizes sales revenue.
Estimated Warranty Payable Example • Patti Wholesaler made sales of $1, 000 subject to product warranties. • In the past years, claims have averaged 2%. Warranty Expense 20, 000 Estimated Warranty Payable 20, 000 To accrue warranty expense
Estimated Warranty Payable Example • On January 28, a customer returned a defective product and was given a $300 refund. Estimated Warranty Payable 300 Cash 300 To record refund under warranty
Estimated Vacation Pay Liability Example • Suppose Lloyd’s Sporting Store has a March payroll of $10, 000 and vacation pay adds 4% (2 weeks of annual vacation divided by 50 workweeks each year). • How much vacation pay should be accrued?
Estimated Vacation Pay Liability Example March 31 Vacation Pay Expense 400 Estimated Vacation Pay Liability To accrue vacation expense 400
Contingent Liability • Report a contingent liability in the notes to the financial statement if it is reasonably possible that a loss or expense will occur. • The FASB says to record an actual liability if it is probable that the business has suffered a loss and its amount can be reasonably estimated.
Contingent vs. Current Liability • Suppose a hospital has lost a court case for uninsured malpractice. • The hospital estimates that the liability will fall between $1. 5 and $2. 5 million.
Contingent vs. Current Liability • The hospital must record a loss and a liability of $1. 5 million. • The hospital must disclose in a note the possibility of an additional $1. 0 million loss.
Objective 3 Compute Payroll Amounts.
Payroll • Straight time is the base rate paid to employees for a set number of hours. • Overtime is additional time worked by employees for which they received a higher rate (usually 1. 5 times the straight time rate).
Gross Pay and Net Pay Gross Pay Deductions Net Pay
FICA Tax • The FICA tax has two components: 1 Old age, survivors’, and disability insurance (6. 2% applied to the first $87, 000 of employee earnings in a year) 2 Health insurance (1. 45% applied to all employee earnings)
Employer Payroll Taxes • Social Security (FICA) tax • State unemployment compensation tax • Federal unemployment compensation tax
Unemployment Compensation Taxes • Employers paid 5. 4% to the states and 0. 8% to the federal government on the first $7, 000 of each employee’s annual earnings. • The state government uses the money to pay unemployment benefits to people who are out of work.
Breakdown of Payroll Costs Employer payroll taxes to government $110 Employer cost of health care to insurance co. $90 Employer disburses $1, 200 Net pay to employee $750 Employee payroll taxes to government $230 Employee Gross Pay – $1, 000 Employee union dues $20
Objective 4 Record Basic Payroll Transactions.
Salary Expense • Salary expense to the employer is the gross salary of all employees. • Employees pay their own income and FICA taxes as well as union dues. • The employer serves as a collecting agent and sends these amounts to the government and union.
To Record Salaries Expense: Salary Expense Employee Income Tax Payable FICA Tax Payable Employees Union Dues Payable Salary Payable to Employees (take-home pay)
To Record Salaries Expense: Payroll Tax Expense FICA Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable
To Record Salaries Expense: Health Insurance Expense for Employees Life Insurance Expense for Employees Pension Expense Employee Benefits Payable
Objective 5 Use a Payroll System.
Payroll System Components – – payroll record special payroll bank account payroll checks earnings record for each employee
Payroll Record. . . – • • • is also referred to as the payroll journal. It lists payroll data for each employee. It serves as a check register. It provides information for recording payroll expenses and related withholdings.
Payroll Bank Account • When companies use a payroll bank account, the company draws a check for the net amount of salary payable to employees on its regular bank account. • The company deposits this check in the special payroll bank account.
Payroll Bank Account • The company writes paychecks to employees out of the payroll account. • When the paychecks clear the bank, the payroll account has a zero balance. • Disbursing paychecks from a separate bank account isolates net pay for analysis and control.
Recording Cash Disbursements • When the employer pays the employees, the company debits Salary Payable to Employees and credits Cash. • The liabilities to the government, unions, and other parties is also debited when cash is paid.
Recording Cash Disbursements • Assume the following journal entry was made at the end of an accounting period: Salary Expense 180, 000 Employee Income Tax Payable 45, 000 FICA Tax Payable 11, 160 Employee Union Dues Payable 840 Salary Payable to Employees 123, 000
Recording Cash Disbursements • What is the journal entry when the employer pays these liabilities? Employee Income Tax Payable FICA Tax Payable Employee Union Dues Payable Salary Payable to Employees Cash 45, 000 11, 160 840 123, 000 180, 000
Internal Control over Payrolls – controls for efficiency – controls for safeguarding payroll disbursements
Controls for Efficiency – making payroll disbursements from one payroll account in one month and from another the next – following established policies for hiring and firing employees – complying with government regulations – testing employees for their interest in the job and their skills to perform the job
Controls for Safeguarding Payroll Disbursements • Large organizations must establish controls to ensure that payroll disbursements are made only to legitimate employees. • Duties of hiring and firing should be separated from the duties of accounting for payroll and distributing paychecks.
Controls for Safeguarding Payroll Disbursements • Requiring an identification badge bearing an employee’s photograph also helps internal control. • A formal time-keeping system helps ensure that employees have actually worked.
Objective 6 Report Current Liabilities on the Balance Sheet.
Report Current Liabilities • Companies report current liabilities on the balance sheet. – Current liabilities of known amount (payroll) – Current liabilities that must be estimated (warranties)
Report Current Liabilities • At the end of the year, companies report the amount of payroll liabilities owed to all parties. • The liability at year end is the amount of the payroll expense that is still unpaid.
Liabilities Known When Recorded – – – accounts payable short-term notes payable sales tax payable current portion of long-term debt accrued expenses payable unearned revenues
Liabilities Estimated When Recorded – warranty payable – income tax payable – vacation pay liability
End of Chapter 11
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