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, Lloyds 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 10,000.00
Interest Payable
86.11
Interest Expense 163.89
Cash 10,250.00

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, Denniss 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 $1,000,000
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 Lloyds 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 employees 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 employees 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