Current Liabilities Payroll LongTerm Liabilities Chapter 10 Learning

Current Liabilities, Payroll & Long-Term Liabilities Chapter 10

Learning Objective 1 Account for current liabilities of known amount

Current Liabilities of Known Amount Accounts Payable Amounts owed for products and services purchased on account Short-Term Notes Payable Common form of financing; company incurs interest expense Sales Tax Payable Tax levied by state on retail sales; company collects from customer and remits to government Copyright (c) 2009 Prentice Hall. All rights reserved. 3

Current Liabilities of Known Amount Continued Current portion of Long-Term Notes Payable Principal portion of long-term debt due in the next year Accrued Expenses Expense incurred, but not yet paid; often an adjusting entry. Examples: salaries & interest payable Unearned revenues Customers make payment before receiving product or service Copyright (c) 2009 Prentice Hall. All rights reserved. 4

Exercise 10 -21 GENERAL JOURNAL DATE DESCRIPTION DEBIT CREDIT 2011 3 1 Equipment 16, 000 Notes payable 16, 000 Purchase equipment by signing a note payable 12 31 Interest expense 1, 200 Interest payable 1, 200 Accrued interest on note payable $16, 000 x 9% x 10/12 Copyright (c) 2009 Prentice Hall. All rights reserved. 5

Exercise 10 -21 (continued) GENERAL JOURNAL DATE DESCRIPTION DEBIT CREDIT 2012 3 1 Interest payable 1, 200 Interest expense 240 Notes payable 16, 000 Cash 17, 440 To record payment of note and interest $16, 000 x 9% x 2/12 Copyright (c) 2009 Prentice Hall. All rights reserved. 6

Learning Objective 2 Account for current liabilities that must be estimated

Estimated Warranty Payable Companies guarantee products through warranty agreements Warranty expense is estimated in same period as sale of product ◦ Matching principle JOURNAL Date Accounts Debit Warranty Expense $$$$ Estimated Warranty Payable Credit $$$$ Copyright (c) 2009 Prentice Hall. All rights reserved. 8

Contingent Liabilities Potential liability Depends on a future event Accounting treatment depends on likelihood that the future event will create a liability: Remote Reasonably possible Probable Copyright (c) 2009 Prentice Hall. All rights reserved. 9

Accounting for Contingent Liabilities Likelihood of Loss How to Report Remote No disclosure required Reasonably possible Describe in notes to the financial statements Probable Record an expense and liability based on estimated amounts Copyright (c) 2009 Prentice Hall. All rights reserved. 10

Learning Objective 3 Calculate payroll and payroll tax amounts

Payroll Terms Salary Pay stated at annual, monthly, or weekly rate Wages Pay stated at an hourly rate Commission Pay stated as percentage of sales amount Bonus Pay over and above base salary Benefits Extra compensation not paid in cash, such as health insurance or retirement contributions Copyright (c) 2009 Prentice Hall. All rights reserved. 12

Payroll Terms Straight time ◦ base rate paid for a set number of hours Overtime ◦ additional time worked for which employees receive a higher rate ◦ usually 1. 5 times the straight time rate Copyright (c) 2009 Prentice Hall. All rights reserved. 13

Gross pay • Total amount earned during a pay period • Expense to the

Payroll Withholding Deductions Gross pay Income & Social Security taxes Required deductions Insurance, retirement plans, charitable contributions Optional deductions Net pay Copyright (c) 2009 Prentice Hall. All rights reserved. 15

Income Tax Withholdings Government requires employers to deduct income tax from employees’ gross pay Amount depends on: ◦ Gross pay ◦ The number of withholding allowances employee claims on Form W-4 Each allowance lowers amount of tax withheld Number of allowances depends on marital status and number of children and/or dependents Copyright (c) 2009 Prentice Hall. All rights reserved. 16

FICA Tax (Social Security) Two components: ◦ Old age, survivors’ and disability insurance (OASDI) 6. 2% of pay up to a wage base which increases each year In 2008, wage base = $102, 000 ◦ Health insurance (Medicare) 1. 45% of pay with no maximum wage base Copyright (c) 2009 Prentice Hall. All rights reserved. 17

Employer Payroll Taxes In addition to employee withholdings, employers pay at least three taxes based on payroll: ◦ Social Security (FICA) tax Employer matches amount withheld from employees’ pay ◦ State unemployment compensation tax (SUTA) In many states, 5. 4% of first $7, 000 paid to each employee ◦ Federal unemployment compensation tax Frequently, 0. 8% of the first $7, 000 paid to each employee Copyright (c) 2009 Prentice Hall. All rights reserved. 18

Learning Objective 4 Journalize basic payroll transactions

Payroll Entries Salaries expense Employee benefits Employer Payroll Taxes Copyright (c) 2009 Prentice Hall.

Salary Expense GENERAL JOURNAL DATE DESCRIPTION DEBIT CREDIT Salary expense Employee income tax payable FICA tax payable Payable to health insurance Payable to United Way Salary payable Copyright (c) 2009 Prentice Hall. All rights reserved. 21

Benefits Expense GENERAL JOURNAL DATE DESCRIPTION DEBIT CREDIT Health insurance expense Life insurance expense Retirement plan expense Employee benefits payable Copyright (c) 2009 Prentice Hall. All rights reserved. 22

Payroll Tax Expense GENERAL JOURNAL DATE DESCRIPTION DEBIT CREDIT Payroll tax expense FICA tax payable Federal unemployment tax payable State unemployment tax payable Copyright (c) 2009 Prentice Hall. All rights reserved. 23

Exercise 10 -25 Hours Pay Total rate 40 $14 $560 22 $21 62 462 $1, 022 GENERAL JOURNAL DATE DESCRIPTION DEBIT Salary expense CREDIT 1, 022 Employee income tax payable 73 FICA tax payable 78 Payable to United Fund 10 Salary payable 861 Copyright (c) 2009 Prentice Hall. All rights reserved. 24

Internal Control over Payroll Controls to Safeguard Payroll Disbursements Controls for efficiency Use of two payroll bank accounts Use of computer processing Hiring and firing separate from accounting Use of photo IDs & time clocks Copyright (c) 2009 Prentice Hall. All rights reserved. 25

Separation of Duties Human Resources • Hire & fire Accounting • Records payroll transactions Payroll • Keep employee earnings records Treasurer • Distributes paychecks Copyright (c) 2009 Prentice Hall. All rights reserved. 26

Learning Objective 5 Describe bonds payable

Bonds Payable Large companies issue bonds to public to raise money ◦ Multiple lenders = bondholders Each bondholder receives bond certificate that shows Amount borrowed (principal) Maturity date Interest rate Company pays interest (usually semi-annually) to bondholders ◦ Bondholders receive interest Copyright (c) 2009 Prentice Hall. All rights reserved. 28

Bond Terms Principal or Maturity value • Amount borrower must pay back on maturity date Maturity date • Date on which borrower must pay principal to the bondholders Stated interest rate • Annual rate of interest borrower pays to bondholders Copyright (c) 2009 Prentice Hall. All rights reserved. 29

Types of Bonds Term bonds ◦ All mature at same date Serial bonds ◦ Mature in installments at regular intervals Secured bonds ◦ Bondholder has right to assets if company fails to pay principal or interest Debenture ◦ Unsecured; not backed by company’s assets Copyright (c) 2009 Prentice Hall. All rights reserved. 30

Bond Pricing Maturity(par) value Discount • $1, 000 bond issued for $1, 000 • No discount or premium • $1, 000 bond issued for $980 • Issued below maturity value Premium • $1, 000 bond issued for $1, 015 • Issued above maturity value Copyright (c) 2009 Prentice Hall. All rights reserved. 31

Bond Prices Quoted as a percent of maturity value A $1, 000 bond quoted a price of 101. 5 would sell for $1, 015 A $1, 000 bond quoted a price of 89. 75 would sell for $897. 50 Issue price determines cash company receives Company must pay maturity value at maturity date Copyright (c) 2009 Prentice Hall. All rights reserved. 32

Present Value Money earns income over time Investors will pay less than $1, 000 now to receive $1, 000 in the future 2009 Present value: Today’s price $750 2012 Present value is always less than future value Future value: Maturity value $1, 000 Copyright (c) 2009 Prentice Hall. All rights reserved. 33

Bond Interest Rates Stated interest rate Determines amount of cash interest borrower pays each year Remains constant Stated interest rate Market interest rate Rate investors demand for loaning money Varies daily Market interest rate Issue price of bonds payable 9% = 9% Maturity value 9% < 10% Discount (below maturity value) 9% > 8% Premium (above maturity value) Copyright (c) 2009 Prentice Hall. All rights reserved. 34

Learning Objective 6 Measure interest expense on bonds using the straight-line amortization method

Accounting for Bonds Issued at Maturity Value GENERAL JOURNAL DATE Issue date DESCRIPTION DEBIT Cash CREDIT 100, 000 Bonds payable 100, 000 To record issuance of 8% bonds at maturity value Int. pmt dates Interest expense $100, 000 x 8% x 1/2 4, 000 Cash 4, 000 To record semi-annual interest payment Copyright (c) 2009 Prentice Hall. All rights reserved. 36

Accounting for Bonds Issued at Maturity Value (continued) GENERAL JOURNAL DATE DESCRIPTION DEBIT Maturity Bond payable date Cash CREDIT 100, 000 To record payment of bonds at maturity Copyright (c) 2009 Prentice Hall. All rights reserved. 37

Accounting for Bonds Issued at a Discount GENERAL JOURNAL DATE DESCRIPTION DEBIT Issue Cash date Discount on bonds payable CREDIT 98, 000 2, 000 Bonds payable 100, 000 To record issuance of $100, 000, 10 -year, 8% bonds at 98 Contra account to Bonds payable Copyright (c) 2009 Prentice Hall. All rights reserved. 38

Carrying Value of Bonds Payable Long-term liabilities Bonds payable $100, 000 Less: Discount on bonds payable ( $2, 000) $98, 000 Carrying value Copyright (c) 2009 Prentice Hall. All rights reserved. 39

Accounting for Bonds Issued at a Discount $2, 000/10 x 6/12 GENERAL JOURNAL DATE DESCRIPTION DEBIT Int. pmt Interest expense date Discount on bonds payable CREDIT 4, 100 Cash 4, 000 $100, 000 x 8% x 6/12 Copyright (c) 2009 Prentice Hall. All rights reserved. 40

Accounting for Bonds Issued at a Premium GENERAL JOURNAL DATE DESCRIPTION DEBIT Issue Cash date Premium on bonds payable CREDIT 104, 000 Bonds payable 100, 000 To record issuance of $100, 000, 10 -year, 8% bonds at 98 Companion account to Bonds payable Copyright (c) 2009 Prentice Hall. All rights reserved. 41

Carrying Value of Bonds Payable Long-term liabilities Bonds payable $100, 000 Plus: Premium on

Accounting for Bonds Issued at a Premium GENERAL JOURNAL DATE DESCRIPTION Int. pmt Interest expense date Premium on bonds payable $4, 000/10 x 6/12 DEBIT CREDIT 3, 800 200 Cash 4, 000 $100, 000 x 8% x 6/12 Copyright (c) 2009 Prentice Hall. All rights reserved. 43

Carrying Value Bonds payable $100, 000 Premium $200 $4, 000 $3, 800 Carrying value

Adjusting Entries for Bonds Payable Interest payments seldom occur at year-end ◦ Interest must be accrued GENERAL JOURNAL DATE 12 DESCRIPTION $2, 000/10 x 3/12 DEBIT 31 Interest expense CREDIT 2, 050 Discount on bonds payable Interest payable 50 2000 (100, 000 x 8% x 3/12) Copyright (c) 2009 Prentice Hall. All rights reserved. 45

Adjusting Entries for Bonds Payable The following interest payment entry will take into account the adjusting entry previously made GENERAL JOURNAL DATE 3 DESCRIPTION x 3/12 DEBIT $2, 000/10 CREDIT 31 Interest payable 2, 000 Interest expense 2, 050 Discount on bonds payable 50 Cash 4, 000 (100, 000 x 8% x 1/12) Copyright (c) 2009 Prentice Hall. All rights reserved. 46

Issuing Bonds Between Interest Payment Dates $100, 000 x 8% x 6/12 = $4, 000 Accrued interest Cash interest payment $2, 000 (100, 000 x 8% x 3/12) January 1: bond date April 1: issue date Interest expense June 20: 1 st interest payment Copyright (c) 2009 Prentice Hall. All rights reserved. 47

Issuing Bonds Between Interest Payment Dates GENERAL JOURNAL DATE 4 1 DESCRIPTION Cash DEBIT 102, 000 Bonds payable 100, 000 Interest payable 6 30 CREDIT 2, 000 Interest expense 2, 000 Interest payable 2, 000 Cash 4, 000 Copyright (c) 2009 Prentice Hall. All rights reserved. 48

Learning Objective 7 Report liabilities on the balance sheet

Copyright (c) 2009 Prentice Hall. All rights reserved. 50

Learning Objective 8 Compare issuing bonds to issuing stock

Bonds versus Stock Issuing bonds Must pay interest and principal to bondholders Reduces net income Issuing stock ◦ Interest expense Can increase earnings per share Does not have to be “paid off” Does not affect net income Increases number of shares outstanding ◦ Leverage Copyright (c) 2009 Prentice Hall. All rights reserved. 52

End of Chapter 10