Chapter 10 PPT

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McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 10

Reporting and Interpreting Liabilities

PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA

Charles W. Caldwell, D.B.A., CMA

Jon A. Booker, Ph.D., CPA, CIA

Fred Phillips, Ph.D., CA

10-3

Learning Objective 1

Explain the role of liabilities in financing a business.

10-4

The Role of Liabilities

Liabilities are created when a company:

Buys goods and services on credit

Obtains short-term loans

Issues long-term debt

Current liabilities are short-term obligations that will be paid with current assets within the company’s current operating cycle or within one year of the balance sheet date, whichever is longer .

10-5

The Role of Liabilities

The liability section of the General Mills 2007 and 2008 comparative balance sheets.

10-6

Learning Objective 2

Explain how to account for common types of current liabilities.

10-7

Measuring Liabilities

Initial Amount of the Liability Cash Value

Additional Liability Amounts Increase Liability

Cash Payments Made Decrease Liability

10-8

Current Liabilities

Accounts Payable

Decreases

(Debited)

Increases

(Credited) when a company pays on its account when a company receives goods or services on credit

Accrued Liabilities

Liabilities that have been incurred but not yet paid.

10-9

Calculating Payroll

Payroll Liabilities

Payroll deductions are either required by law or voluntarily

1. Payroll Deductions company. Examples include:

2. Employer Payroll Taxes

2. FICA tax

3. Other deductions (charitable donations, union dues, etc.)

Calculating Payroll

10-10

Gross Pay

Payroll Deductions:

Federal Income Taxes

FICA Taxes

Other

Total Payroll Deductions

Net Pay

$ 58.00

48.80

10.00

$ 600.00

116.80

$ 483.20

10-11

Recording Payroll

Adam Palmer earned gross pay of $600 in the current payroll period.

General Mills withheld $58 in Federal income taxes, $48.80 for FICA, and

$10 for United Way, resulting in net pay of $483.20.

1

Analyze

Assets

Cash (-A) -$483.20

= Liabilities

FIT Withheld (+L) +$58.00

FICA Payable (+L) +$48.80

United Way (+L) +$10.00

+ Stockholders' Equity

Payroll Expense

(+E, -SE) -$600.00

2

Record

Wages and Salaries Expense (+E, -SE)

Withheld Income Taxes Payable (+L)

FICA Payable (+L)

United Way Payable (+L)

Cash (-A)

600.00

58.00

48.80

10.00

483.20

10-12

Payroll Taxes

Employer Payroll Taxes

Employers have other liabilities related to payroll.

1.

FICA tax (a “matching” contribution)

2. Federal unemployment tax

3. State unemployment tax

Assume General Mills was required to contribute $16,400 for FICA, $250 for federal unemployment tax, and $1,350 for state unemployment tax.

1

Analyze

Assets = Liabilities

FICA Payable (+L) +16,400

FUTA Payable (+L) +250

SUTA Payable (+L) +1,350

+ Stockholders' Equity

Payroll Tax Expense

(+E, -SE) -18,000

2

Record

Payroll Tax Expense (+E, -SE)

FICA Tax Payable (+L)

Federal Unemployment Tax Payable (+L)

State Unemployment Tax Payable (+L)

18,000

16,400

250

1,350

10-13

Accrued Income Taxes

Corporations calculate taxable income by subtracting tax-allowed expenses from revenues. This taxable income is then multiplied by a tax rate, which for most large corporations is about 35 percent.

General Mill calculated taxable income to be $1,000,000, and is subject to a 35% tax rate, so income taxes owed are $350,000 ($1,000,000

× 35%)

1

Analyze

Assets = Liabilities

Income Tax Payable

(+L) +350,000

+ Stockholders' Equity

Income Tax Expense

(+E, -SE) +350,000

2

Record

Income Tax Expense (+E, -SE)

Income Tax Payable (+L)

350,000

350,000

10-14

Notes Payable

Four key events occur with any note payable:

1. establishing the note,

2. accruing interest incurred but not paid,

3. recording interest paid, and

4. recording principal paid.

10-15

Notes Payable

1. Establish the note on November 1, 2009.

Assume that on November 1, 2009, General Mills borrowed $100,000 cash on a one-year note that required General Mills to pay 6 percent interest and

$100,000 principal, both on October 31, 2010.

1

Analyze

Assets

Cash (+A) $100,000

= Liabilities

Notes Payable (+L) $100,000

+ Stockholders' Equity

2

Record

Cash (+A)

Notes Payable (+L)

100,000

100,000

10-16

Notes Payable

Accrue interest owed but not paid on December 31, 2009.

$100,000

× 6% ×

2/12

P x I x T

= $1,000 accrued interest

1

Analyze

Assets = Liabilities

Interest Payable (+L) $1,000

+ Stockholders' Equity

Interest Expense

(+E, -SE) $1,000

2

Record

Interest Expense (+E, -SE)

Interest Payable (+L)

1,000

1,000

10-17

Notes Payable

Record interest accrued in 2010

$100,000

× 6% × 10/12 = $5,000 interest

P x I x T

1

Analyze

Assets = Liabilities

Interest Payable (-L) +$5,000

+ Stockholders' Equity

Interest Expense

(+E, -SE) $5,000

2

Record

Interest Expense (+E)

Interest Payable (+L)

5,000

5,000

10-18

Notes Payable

4. Record principal paid of $100,000 on October 31, 2010.

1

Analyze

Assets

Cash (-A) -$106,000

= Liabilities

NotePayable (-L) -$100,000

Interest Payable (-L) -6,000

+ Stockholders' Equity

2

Record

Interest Payable (-L)

Note Payable (-L)

Cash (-A)

6,000

100,000

106,000

10-19

Current Portion of

Long-Term Debt

Long-Term Debt

Current Portion of

Long-term Debt

Noncurrent Portion of Long-term Debt

Borrowers must report in Current Liabilities the portion of long-term debt that is due to be paid within one year.

10-20

Additional Current Liabilities

Sales Tax

Payable

Payments collected from customers at time of sale create a liability that is due to the state government.

Unearned

Revenue

Cash received in advance of providing services creates a liability of services due to the customer .

10-21

Additional Current Liabilities

Best Buy sells a television for $1,000 cash plus 5 percent sales tax.

$1,000

× 5% = $50 sales tax collected

1

Analyze

Assets

Cash (+A) +$1,050

= Liabilities

Sales Tax Payable (+L) +$50

+ Stockholders' Equity

Sales Revenue

(+R, +SE)

2

Record

Cash (+A)

Sales Tax Payable (+L)

Sales Revenue (+R, +SE)

1,050

50

1,000

When Best Buy pays the sales tax to the state government, its accountants will reduce Sales Tax Payable (with a debit) and reduce Cash (with a credit).

10-22

Additional Liabilities

On October 1 IAC, an internet provider, received $30 cash for threemonths of internet access, paid in advance.

1

Analyze

Assets

Cash (+A) +$30

= Liabilities

Unearned Revenue (+L) $30

+ Stockholders' Equity

2

Record

Cash (+A)

Unearned Revenue (+L)

30

30

10-23

Additional Liabilities

At the end of October, IAC provided one month of internet service to its customer.

$30

÷ 3 months = $10 per month

1

Analyze

Assets = Liabilities

Unearned Revenue (-L) $10

+ Stockholders' Equity

Subscription Revenue

(+R, +SE) $10

2

Record

Unearned Revenue (-L)

Subscription Revenue (+R, +SE)

10

10

10-24

Learning Objective 3

Analyze and record bond liability transactions.

10-25

Long-Term Liabilities

Common Long-Term Liabilities

1. Long-term notes payable

2. Deferred income taxes

3. Bonds payable

Bonds are financial instruments that outline the future payments a company promises to make in exchange for receiving a sum of money now.

Bonds

Key Elements of a Bond

1. Maturity date

2. Face value

3. Stated interest rate

Interest Computation

$1,000

× 6% ×

12

12

= $60

10-26

Bond Pricing

The bond price involves present value computations and is the amount that investors are willing to pay on the issue date for the bonds.

10-27

Bonds

Balance Sheet Reporting of Bond Liability

Relationships between Interest Rates and Bond Pricing

10-28

Bonds

Bonds Issued at Face Value

General Mills receives $100,000 cash in exchange for issuing

100 bonds at their $1,000 face value, so the bonds are issued at total face value (1,000

× $1,000 = $100,000).

1

Analyze

Assets

Cash (+A) +$100,000

= Liabilities

Bonds Payable (+L) $100,000

+ Stockholders' Equity

2

Record

Cash (+A)

Bonds Payable (+L)

100,000

100,000

10-29

Bonds

Bonds Issued at a Premium

General Mills issues 100 of its $1,000 bonds at a price of

107.26 (percent) of face value, the company will receive

$107,260 (100

× $1,000 × 1.0726).

1

Analyze

Assets

Cash (+A) +$107,260

= Liabilities

Bonds Payable (+L) $100,000

Premium on Bonds Payable

(+L) $7,260

+ Stockholders' Equity

2

Record

Cash (+A) (100,000 x 1.0726)

Bonds Payable (+L) face value

Premium on Bonds Payable (+L)

107,260

100,000

7,260

10-30

Bonds

Bonds Issued at a Discount

General Mills receives $93,376 for bonds with a total face value of

$100,000,sold at 93.376 the cash-equivalent amount is $93,376, which represents the liability on that date. These bonds are issued at a discount because the cash received is less than the face value of the bonds.

1

Analyze

Assets = Liabilities + Stockholders' Equity

Discount on Bonds Payable

(+xL, -L) <$6,624>

2

Record

Cash (+A) (100,000 x 93.376)

Discount on Bonds Payable (+xL)

Bonds Payable (+L) face value

93,376

6,624

100,000

10-31

Interest on Bonds Issued at Face Value

General Mills issues bonds on January 1, 2010, at their total face value of $100,000. The bonds have an annual stated interest rate of

6 percent payable in cash on December 31 of each year, General

Mills will need to accrue an expense and liability for interest at the end of each accounting period. The end of the first accounting period is January 31, 2010.

1

Analyze

Assets

$100,000

× 6% × 1/12 = $500 interest

= Liabilities + Stockholders' Equity

Interest Payable (+L) $500 Interest Expense (+E, -SE) $500

2

Record

Interest Expense (+E, -SE)

Interest Payable (+L)

500

500

10-32

Interest on Bonds Issued at a Premium

Cash proceeds > Face value

Cash proceeds

– Face value = Premium

Interest expense < Cash interest paid

Interest expense = Cash interest paid

– Premium amortization

10-33

Interest on Bonds Issued at a Discount

Cash proceeds < Face value

Face value

– Cash proceeds = Discount

Interest expense > Cash interest paid

Interest expense = Cash interest paid+ Discount amortization

10-34

Bond Retirement

The early retirement of bonds has three financial effects. The company

1.

2.

3.

pays cash, eliminates the bond liability, and reports either a gain or a loss.

Assume that in 2000, General Mills issued $100,000 of bonds at face value.

Ten years later, in 2010, the company retired the bonds early. At the time, the bond price was 103, so General Mills made a payment of $103,000.

1

Analyze

Assets

Cash Payment $103,000

= Liabilities

Carrying Value 100,000

+ Stockholders' Equity

Cash (-A) -$103,000 Bonds Payable (-L) $100,000

Loss on Retirement $3,000

Loss on Bond

Retirement (+E, -SE)

$3,000

2

Record

Bonds Payable (-L) face value

Loss on Bond Retirement (+E, -SE)

Cash (-A)

100,000

3,000

103,000

10-35

Learning Objective 4

Describe how to account for contingent liabilities.

10-36

Contingent Liabilities

Contingent liabilities are potential liabilities that arise from past transactions or events, but their ultimate resolution depends

(is contingent) on a future event.

10-37

Learning Objective 5

Calculate and interpret the quick ratio and the times interest earned ratio.

10-38

Evaluate the Results

Two financial ratios are commonly used to assess a company’s ability to generate resources to pay future amounts owed:

1. Quick ratio

2. Times interest earned ratio

Quick Ratio =

(Cash + Short-term Investments + Accounts Receivable, Net)

Current Liabilities

Times Interest

Earned Ratio

=

(Net Income + Interest Expense + Income Tax Expense)

Interest Expense

10-39

Evaluate the Results

In 2008, General Mills reported $661 million of cash and cash equivalents, no short-term investments, and $1,082 million of net accounts receivable. The company reported $4,856 million in total current liabilities.

Quick Ratio =

(Cash + Short-term Investments + Accounts Receivable, Net)

Current Liabilities

$661 + 0 + 1,082

4,856

=

0.359

A quick ratio of 0.359 implies that General Mills would be able to pay only 35.9 percent of its current liabilities, if forced to pay them immediately. However, not all current liabilities are to be paid immediately.

Evaluate the Results

In 2008, General Mills reported net income of $290 million and interest expense of $100 million, and income tax expense of $230 million. Let’s calculate the times interest earned for 2008.

10-40

Times Interest

Earned Ratio

=

(Net Income + Interest Expense + Income Tax Expense)

Interest Expense

$290 + $100 + $230

$100

=

6.20 times

The ratio means that General Mills generates $6.20 of income

(before the costs of financing and taxes) for each dollar of interest expense. No doubt this ratio is part of the reason that

General Mills has earned a favorable credit rating of BBB+.

Chapter 10

Supplement 10A

Straight-Line Method of Amortization

10-42

Bond Premium

Bond premium or discount decreases each year, until it is completely eliminated on the bond’s maturity date. This process is called amortizing the bond premium or discount. The straight-line method of amortization reduces the premium or discount by an equal amount each period.

Recall our example when General Mills received $107,260 on the issue date

(January 1, 2010) but repays only $100,000 at maturity (December 31, 2013).

Under the straight-line method, this $7,260 is spread evenly as a reduction in interest expense over the four years ($7,260

÷ 4 =

$1,815 per year).

1

Analyze

Assets Liabilities

Cash (-A) -$6,000

Amortization of Premium

2

Record

Interest Expense (+E, -SE)

Premium on Bonds Payable (-L)

Cash (-A)

4,185

1,815

6,000

Bond Premium

Amortization Schedule of Bonds Issued at a Premium

$7,260 - $1,815 = $5,445

$7,260

÷ 4 = $1,815

$100,000

× 6% × 12/12 = $6,000 face value x stated int x T

$107,260

– $1,815 = $105,445

$6,000 - $1,815 = $4,185

Notice that each of these amounts would plot as a straight-line!

10-43

10-44

Bond Discount

Recall our example where General Mills received $93,376 for four-year bonds with a total face value of $100,000, implying a discount of $6,624.

The annual amortization of the discount is $1,656 ($6,624

÷ 4).

1

Analyze

Assets Liabilities

Cash (-A) -$6,000

Amortization of Discount

2

Record

Interest Expense (+E, -SE)

Discount on Bonds Payable (-xL, +L)

Cash (-A)

7,656

1,656

6,000

Bond Discount

Amortization Schedule of Bonds Issued at a Discount

$6,624

÷ 4 = $1,656

$100,000

× 6% × 12/12 = $6,000

Face value x stated int x T

$6,624 - $1,656 = $4,968

$93,376 + $1,656 = $95,032

$6,000 + $1,656 = $7,656

10-45

Chapter 10

Supplement 10B

Effective-Interest Method of

Amortization

10-47

Effective Interest Amortization

The effective-interest method of amortization is considered a conceptually superior method of accounting for bonds because it correctly calculates interest expense by multiplying the market interest rate times the carrying value of the bonds.

When General Mills adds this $7,260 premium to the $100,000 face value, it reports a carrying value of $107,260 ($100,000 + $7,260) on January 1,

2010. The proceeds indicates that the market interest rate was 4 percent.

Interest (I) = Principal (P)

× Rate (R) × Time (T)

Interest Expense = Carrying Value

× Market Rate × n/12

$4,290 = $107,260

× 4% × 12/12

10-48

Effective Interest Amortization

General Mills issued 6% stated rate bonds for $107,260. The market rate of interest on these bonds is 4%. The face amount of the bonds,

$100,000, results in cash interest is $6,000 ($100,000

× 6%). Let’s amortize the premium on the bonds at the first interest payment date.

1

Analyze

Interest (I) = Principal (P)

× Rate (R) × Time (T)

Interest Expense = Carrying Value

× Market Rate × n/12

$4,290 = $107,260

× 4% × 12/12

2

Record

Cash Interest $ 6,000

Effective Interest 4,290

4,290

1,710

Amortization of Premium $1,710

Cash (-A) 6,000

Effective Interest Amortization

$6,000 - $4,290 = $1,710 $7,290 - $1,710 = $5,550

Effective Interest Amortization of Bonds Issued at a Premium

$107,260

× 4% × 12/12 = $4,290

$100,000

× 6% × 12/12 = $6,000

Face value x stated int x time

$107,260 - $1,710 = $105,550

Interest Expense decreases and Premium Amortization increases each period. Cash interest is unchanged.

10-49

10-50

Effective Interest Amortization

General Mills issued $100,000 face value, 6%, 4-year bonds at a market price to yield investors 8%. The bonds were issued at a discount of $6,624.

Let’s determine the effective interest for the first interest payment period.

1

Analyze

Interest (I) = Principal (P)

Cash (-A) -$6,000

× Rate (R) × Time (T)

Interest Expense = Carrying Value

$7,470 = $93,376

× Market Rate × n/12

× 8% × 12/12

2

Record

Cash Interest $ 6,000

Effective Interest 7,470

7,470

Amortization of Discount $ 1,470

Cash (-A)

1,470

6,000

Effective Interest Amortization

$7,470 - $6,000 = $1,470 $7,470 - $1,470 = $5,154

Effective Interest Amortization of Bonds Issued at a Discount

$93,376

× 8% × 12/12 = $7,470

$100,000

× 6% × 12/12 = $6,000

Face value x stated int x time

$93,376 + $1,470 = $94,846

Both Interest Expense and Discount Amortization increase each period. Cash interest is unchanged.

10-51

Chapter 10

Solved Exercises

M10-5, E10-2, E10-3, E10-8, E10-10,

PA10-3

10-53

M10-5 Reporting Current and Noncurrent Portions of Long-Term

Debt

Assume that on December 1, 2010, your company borrowed $14,000, a portion of which is to be repaid each year on November 30.

Specifically, your company will make the following principal payments:

2011, $2,000; 2012, $3,000; 2013, $4,000; and 2014, $5,000. Show how this loan will be reported in the December 31, 2011 and 2010 balance sheets, assuming that principal payments will be made when required.

Current Liabilities:

Current Portion of Long-term Debt

Long-term Debt

Total Liabilities

As of December 31,

2011 2010

$ 3,000 $ 2,000

9,000

$ 12,000

12,000

$ 14,000

10-54

E10-2 Recording a Note Payable through Its Time to Maturity

Many businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. Target

Corporation is one of America’s largest general merchandise retailers.

Each Christmas, Target builds up its inventory to meet the needs of

Christmas shoppers. A large portion of Christmas sales are on credit.

As a result, Target often collects cash from the sales several months after Christmas. Assume that on November 1, 2010, Target borrowed

1.

2.

3.

$6 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 7.5 percent payable at maturity. The accounting period ends December 31.

Required:

Give the journal entry to record the note on November 1, 2010.

Give any adjusting entry required on December 31, 2010.

Give the journal entry to record payment of the note and interest on the maturity date, April 30, 2011, assuming that interest has not been recorded since December 31, 2010.

E10-2 Recording a Note Payable through Its Time to Maturity

November 1, 2010:

Borrowed on 6-month, 7.5%, note payable.

December 31, 2010 (end of the accounting period):

Adjusting entry for 2 months’ accrued interest ($6,000,000 x 7.5% x 2/12 = $75,000).

April 30, 2011 (maturity date):

Paid note plus interest at maturity.

10-55

10-56

E10-3 Recording Payroll Costs with Discussion

McLoyd Company completed the salary and wage payroll for March

2010. The payroll provided the following details:

Salaries and wages earned

Employee income taxes withheld

FICA taxes withheld

$ 230,000

50,200

16,445

Unemployment taxes 1,600

Required:

1.

Considering both employee and employer payroll taxes, use the preceding information to calculate the total labor cost for the company.

2.

3.

Prepare the journal entry to record the payroll for March, including employee deductions (but excluding employer payroll taxes).

Prepare the journal entry to record the employer’s FICA taxes and unemployment taxes.

E10-3 Recording Payroll Costs with Discussion

Req. 1

The total labor cost was $248,045, made up of the $230,000 in gross salaries and wages plus the $16,445 for employer FICA taxes and

$1,600 for unemployment taxes.

Req. 2 March 31, 2010

dr

Salaries and Wages Expense (+E, -SE) 230,000

cr cr cr

Withheld Income Taxes Payable (+L)

FICA Taxes Payable

—employees (+L)

Cash (-A)

Payroll for March including employee deductions.

50,200

16,445

163,355

Req. 3

March 31, 2010

dr cr

Payroll Tax Expense (+E,-SE)

FICA Taxes Payable

—employer (+L)

cr

Unemployment Taxes Payable (+L)

Employer payroll taxes on March payroll.

18,045

16,445

1,600

10-57

10-58

E10-8 Preparing Journal Entries to Record Issuance of

Bonds at Face Value, Payment of Interest, and Early

Retirement

On January 1, 2010, Innovative Solutions, Inc., issued $200,000 in bonds at face value. The bonds have a stated interest rate of

6 percent. The bonds mature in 10 years and pay interest once per year on December 31.

Required:

1.

2.

Prepare the journal entry to record the bond issuance.

Prepare the journal entry to record the interest payment on

December 31, 2010. Assume no interest has been accrued earlier in the year.

3.

Assume the bonds were retired immediately after the first interest payment at a quoted price of 102. Prepare the journal entry to record the early retirement of the bonds.

E10-8 Preparing Journal Entries to Record Issuance of Bonds at Face Value, Payment of Interest, and Early Retirement

Req. 1

dr

Cash (+A)

cr

Bonds Payable (+L)

200,000

200,000

Req. 2

dr

Interest Expense (+E, -SE)

cr

Cash (-A)

($200,000 x 6% x 12/12) = $12,000

12,000

12,000

Req. 3

dr

Bonds Payable (-L)

dr

Loss on Bonds Retired (+E, -SE)

cr

Cash (-A)

200,000

4,000

204,000

($200,000 x 102%) = $204,000

10-59

10-60

E10-10 Calculating and Interpreting the Quick Ratio and Times

Interest Earned Ratio

According to its Web site, Kraft Foods Inc. sells enough Kool-

Aid® mix to make 1,000 gallons of the drink every minute during the summer and over

560 million gallons each year. At December 31, 2008, the company reported no short-term investments but did report the following amounts (in millions) in its financial statements:

Cash and Cash Equivalents

Accounts Receivable, Net

Total Current Liabilities

Interest Expense

Income Tax Expense

Net Income

2008

$ 1,244

4,704

11,044

1,240

728

2,901

2007

$ 567

5,197

17,086

604

1,002

2,590

Required:

1.

2.

Compute the quick ratio and times interest earned ratio (to two decimal places) for 2008 and 2007.

Did Kraft appear to have increased or decreased its ability to pay current liabilities and future interest obligations as they become due?

How can you explain the seemingly conflicting findings of your ratio analysis?

E10-10 Calculating and Interpreting the Quick Ratio and Times

Interest Earned Ratio

Req. 1

Req. 2

10-61

E10-10 Calculating and Interpreting the Quick Ratio and Times

Interest Earned Ratio

Req. 3

The times interest earned ratio has decreased from 6.95 to 3.93, suggesting a decline in Kraft’s ability to cover its interest through profitable operations. The quick ratio has increased from 0.34 in

2007 to 0.54 in 2008, suggesting Kraft is in a better position to quickly pay its current liabilities at the end of 2008. These findings seem to conflict, but can be explained as follows. In 2008, when the economy was suffering, Kraft realized that it could no longer rely as much on obtaining short-term financing to cover cash needs.

Consequently, Kraft borrowed more funds through long-term debt, which doubled the amount the company held in Cash and Cash

Equivalents. Obtaining more long-term debt financing came at a cost, however, as indicated by the doubling of Interest Expense. The results of these shifts were an increase in the quick ratio (associated with the increase in Cash) and a decrease in the times interest earned ratio (associated with the increase in Interest Expense).

10-62

10-63

PA10-3 Recording and Reporting Current Liabilities

During 2010, Lakeview Company completed the following two transactions. The annual accounting period ends December 31.

a.

On December 31, 2010, calculated the payroll, which indicates gross earnings for wages ($80,000), payroll deductions for income tax ($8,000), payroll deductions for FICA ($6,000), payroll deductions for American Cancer Society ($2,000), employer contributions for FICA (matching), state unemployment taxes ($500), and federal unemployment taxes ($100). Employees were paid in cash, but these payments and the corresponding payroll deductions and employer taxes have not b.

yet been recorded.

Collected rent revenue of $3,600 on December 10, 2010, for office space that

Lakeview rented to another business. The rent collected was for 30 days from

December 11, 2010, to January 10, 2011, and was credited in full to Rent

Revenue.

Required:

1. Give the journal entries to record payroll on December 31, 2010.

2. Give ( a ) the journal entry for the collection of rent on December 10, 2010, and

( b )

the adjusting journal entry on December 31, 2010.

3. Show how any liabilities related to these items should be reported on the company’s balance sheet at December 31, 2010.

4. Explain why the accrual basis of accounting provides more relevant information to financial analysts than the cash basis.

PA10-3 Recording and Reporting Current Liabilities

Req. 1

dr cr cr

Wage Expense (+E, -SE)

Withheld Income Tax Payable (+L)

FICA Payable (+L)

cr cr

American Cancer Society Payable (+L)

Cash (-A)

80,000

8,000

6,000

2,000

64,000

dr cr cr cr

Payroll Tax Expense (+E, -SE)

FICA Payable (+L)

State Unemployment Tax Payable (+L)

Federal Unemployment Tax Payable (+L)

6,600

6,000

500

100

Req. 2

(a)

dr

December 10, 2010:

Cash (+A)

cr

Rent Revenue (+R, +SE)

Collection of rent revenue for one month.

3,600

3,600

(b)

dr

Rent Revenue (-R, -SE)

cr

December 31, 2010:

Unearned Rent Revenue (+L)

1,200

1,200

Earned 20 days of rent but initially recorded as if all was earned. Need to reduce revenue for 10 days unearned (10/30 x $3,600 = $1,200).

10-64

PA10-3 Recording and Reporting Current Liabilities

Req. 3 Balance sheet at December 31, 2010:

Current Liabilities:

Withheld Income Taxes Payable

FICA Payable

American Cancer Society Payable

State Unemployment Tax Payable

Federal Unemployment Tax Payable

Unearned Rent Revenue

8,000

12,000

2,000

500

100

1,200

10-65

Req. 4

Accrual basis accounting is beneficial to financial analysts because it records revenues when they are earned and expenses when they are incurred, regardless of when the related cash is received or paid. Cash basis accounting only records revenues when they are received and expenses when they are paid. A financial analyst is looking towards the future of the company, so it is helpful to know how much cash will be coming into and out of the company at later dates. Cash basis accounting limits financial analysts to only what has happened in prior periods and tells them very little about future events and cash flows that will affect the financial health of the company.

End of Chapter 10

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