344
Ch. 10: Current Liabilities
Chapter 10
Current Liabilities
In this chapter you will learn how current liabilities affect businesses, how they are
controlled, accounted for, and reported in financial statements.
What Are Current Liabilities?
As you remember from previous chapters, one way in which companies obtain resources is to
borrow them. The resources are called assets and the sources of the resources are called liabilities.
If the dollar amount of the borrowed resources must be paid within one year to the company or
person from whom the resources were obtained, the liabilities are considered to be current liabilities.
If, on the other hand, the resources do not have to be paid for within a year, the liabilities are
considered long-term liabilities. For example, if a company borrows $100,000 from a bank on
January 15, the result could be an increase in resources (cash) and an increase in liabilities (notes
payable). If the cash must be repaid to the bank by July 15, six months after it was borrowed, the
notes payable would be considered current liabilities. If the cash must be repaid to the bank by July
15, 18 months after it was borrowed, the notes payable would be considered long-term liabilities.
In terms of the accounting equation, current liabilities are obviously liabilities, as shown
below. The numbers in parentheses refer to the chapters in which the items are discussed.
Assets
=
Liabilities
Current Assets
Current Liabilities (10)
Cash and Cash
Equivalents (6)
Accts. Receivable (7)
Allow. for Uncoll.
Accounts (7)
Merchandise
Inventory (8)
Property, Plant, &
Equipment
Land (9)
Buildings (9)
Accum. Depr., Buildings
(9)
Equipment (9)
Accum. Depr., Equipment
(9)
Autos & Trucks (9)
Accum. Depr., Autos &
Trucks (9)
+
Stockholders' Equity
Revenues
Sales (7)
Sales Returns &
Allowances (7)
Cost of Goods Sold (8)
Operating Expenses
Uncollectible Accts.
Expense (7)
Depreciation Exp. (9)
Bank Service Exp. (6)
Other Revenues &
Expenses
Interest Revenue (6)
Interest Expense (6)
Gain or Loss on Disposal
of Prop., Plt., & Eq. (9)
Ch. 10: Current Liabilities
345
The dollar amount of current liabilities differs from company to company. Exhibit 10-1
presents current liabilities for three merchandising companies and compares them to the companies'
total assets. As Exhibit 10-1 shows, there are many differences among the companies. For example,
on January, 31, 2007, Wal-Mart's current liabilities were approximately $52 billion while Federated
Department Stores’ were approximately $6 billion. The data show current liabilities are sources of
approximately 30% of the resources (assets) of the three companies. Since 30% of the assets of the
companies were obtained through current liabilities, the other 70% must have come from long-term
liabilities, owners' investments, or management operations (net income). These other sources of
resources will be examined in following chapters.
Exhibit 10-1
Current Liabilities and Total Assets ($ millions)
January 31, 2007
Company
Federated Department Stores
Target
Wal-Mart
Current
Liabilities
$6,359
$11,117
$51,754
Total
Assets
$29,559
$37,349
$151,193
Percent
21.5
29.8
34.2
The Nature of Current Liabilities
There are many different current liabilities, all of which have the common characteristic that
they must be paid for within twelve months. Exhibit 10-2 lists the major current liabilities for three
merchandising companies. Once again, there are many differences among the companies. For
example, Wal-Mart's accounts payable were approximately $28 billion while Federated Department
Stores’ were approximately $2 billion.
Exhibit 10-2
Current Liabilities ($ millions)
January 31, 2007
Current Liability
Notes Payable
Accounts Payable
Taxes Payable
Current Portion of Long-term Debt
Other
Totals
Federated
Department
Stores
$641
$2,454
$962
$9
$2,293
$6,359
Target
$0
$6,575
$872
$1,362
$2,308
$11,117
Wal-Mart
$2,570
$28,090
$706
$5,428
$14,960
$51,754
Because there are many different types of current liabilities, it would be difficult to examine
them all in one textbook, let alone one chapter. The following sections of this chapter examine some
of the more important current liabilities. As you proceed through this material you should already be
346
Ch. 10: Current Liabilities
familiar with some of it because specific current liabilities were discussed in previous chapters when
resources were examined. For example, in the following discussion of accounts payable, you will
recognize much material from the Chapter 8 merchandise inventory coverage.
Notes Payable
Notes payable are written promises to pay known dollar amounts, on specific dates, to the
owners of the notes. The dollar amounts to be paid include the amount borrowed (called principal)
and interest. For example, if on January 23, Lowell Merchandising Corporation signed a $78,000,
6%, 90-day note payable to Medford Company, Lowell Merchandising Corporation would have to
pay Medford Company $79,153.97 on April 22. The $79,153.97 is the $78,000 principal borrowed
plus interest of $1,153.97 ($78,000 x .06 x 90/365). The 90/365 fraction represents the number of
days the money was borrowed (90) divided by the number of days in a year (365). The use of this
fraction is necessary because it is common to state interest rates, such as the 6%, on an annual or
365-day basis. It is important to note that on January 23, as soon as the companies agree on the
terms of the $78,000 note, both companies know the Lowell Merchandising Corporation must pay
$79,153.97 to the Medford Company on April 22. Thus, once a note payable is issued, the
companies know the dollar amount borrowed ($78,000), the dollar amount that must be paid
($79,153.97), and the date on which the amount must be paid (April 22).
Notes payable usually arise when companies buy merchandise or property, plant, and
equipment. Continuing the Lowell Merchandising Corporation example, if the company acquired
$78,000 of merchandise inventory from Medford Company by signing a note payable, the effects on
the accounting equation would be as follows.
Total
Resources
Assets
+ $78,000
=
=
=
Sources of
Borrowed
Resources
Liabilities
+ $78,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) increase by $78,000 because they now
have $78,000 more merchandise inventory. Lowell Merchandising Corporation's sources of
resources (liabilities) increase because they owe $78,000 to Medford Company. In terms of a journal
entry, remembering assets increase with debits and debits must equal credits, the following entry
would result.
Date
Jan. 23
Description
Merchandise Inventory
Notes Payable
Merch. inventory purchase
Posting
Ref.
131
211
Debits
78,000
Credits
78,000
As time passes and Lowell Merchandising Corporation uses the merchandise inventory
obtained from Medford Company, the dollar amount Lowell Merchandising Corporation owes to
Medford Company increases. This increase is for interest. For example, if Lowell Merchandising
Ch. 10: Current Liabilities
347
Corporation acquired the $78,000 merchandise inventory from Medford Company on January 23,
and paid for it on the same day, January 23, Lowell Merchandising Corporation would pay only
$78,000. If, however, Lowell Merchandising Corporation waits until April 22, Lowell
Merchandising Corporation would have to pay Medford Company $1,153.97 interest on the $78,000.
Remember, interest is calculated as follows: principal x rate x time = $78,000 x .06 x 90/365 =
$1,153.97. Over 90 days, until Lowell Merchandising Corporation pays Medford Company, the cost
of borrowing affects Lowell Merchandising Corporation's accounting equation as follows.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $1,153.97
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $1,153.97
Lowell Merchandising Corporation's assets do not change because the company has not
acquired additional resources from Medford Company, other than the $78,000 of merchandise
inventory, nor has it paid out any resources. Lowell Merchandising Corporation's liabilities (interest
payable) increase by $1,153.97 because on April 22, they now owe an additional $1,153.97 to
Medford Company. Lowell Merchandising Corporation's stockholders' equity decreases by the
$1,153.97 cost of borrowing (interest expense). In terms of a journal entry, remembering liabilities
increase with credits and debits must equal credits, the following entry would result.
Date
April 22
Posting
Ref.
522
217
Description
Interest Expense
Interest Payable
Interest on Notes Payable
Debits
1,153.97
Credits
1,153.97
The interest expense resulting from notes payable is reported as part of other revenues and
expenses on the income statement. Interest payable is reported on the balance sheet as a current
liability if it must be paid within 12 months.
Since you are familiar with the accounting process, the $1,153.97 in the above journal entry
may be a bit troublesome to you. In fact, although the total interest expense for 90 days is $1,153.97,
it would not all be recorded in April. The adjusting process discussed in Chapter 4 suggests Lowell
Merchandising Corporation would record interest expense in each month it uses the $78,000 of
resources obtained from Medford Company but not repaid to them. Lowell Merchandising
Corporation would record the following amounts of interest expense for each month.
Month
January (9 days: 23rd thru 31st)
February (28 days)
March (31 days)
April (22 days: 1st thru 22nd)
Total (90 days)
$115.40
359.01
397.48
282.08
$1,153.97
Interest Expense
($78,000 x .06 x 9/365)
($78,000 x .06 x 28/365)
($78,000 x .06 x 31/365)
($78,000 x .06 x 22/365)
($78,000 x .06 x 90/365)
348
Ch. 10: Current Liabilities
Each interest expense amount would be recorded through a journal entry like the one shown above.
Once the $282.08 expense is recorded on April 22, the total interest expense and total interest
payable recorded from January 23 through April 22 will be $1,153.97.
When Lowell Merchandising Corporation pays back the amount borrowed from Medford
Company through notes payable ($78,000) and pays the related interest ($1,153.97), the effect is to
reduce Lowell Merchandising Corporation's resources and sources of resources, as follows.
Total
Resources
Assets
- $79,153.97
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $78,000.00
- $1,153.97
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's assets decrease because its cash has been reduced.
Lowell Merchandising Corporation's liabilities decrease because it no longer owes $79,153.97 to
Medford Company. In terms of a journal entry, remembering assets decrease with credits and debits
must equal credits, the following entry would result.
Date
April 22
Description
Notes Payable
Interest Payable
Cash
Notes payable payment
Posting
Ref.
211
217
111
Debits
78,000.00
1,153.97
Credits
79,153.97
A careful review of the above example shows Lowell Merchandising Corporation acquired
$78,000 of merchandise inventory from Medford Company by paying $79,153.97. In total, resources
decreased by $1,153.97 (merchandise inventory increased by $78,000 and cash decreased by
$79,153.97) and stockholders' equity decreased as a result of the $1,153.97 interest expense. The
important question to consider is why would Lowell Merchandising Corporation pay $79,153.97 for
$78,000 of merchandise inventory? The answer, of course, is Lowell Merchandising Corporation
expects to be able to sell the merchandise inventory to its customers at prices resulting in more than
$79,153.97. In effect, by borrowing merchandise inventory from Medford Company and selling it to
customers at higher prices, Lowell Merchandising Corporation expects to increase its resources. For
example, if Lowell Merchandising Corporation can sell the merchandise inventory to customers for
$90,000, Lowell Merchandising Corporation's resources would increase by $10,846.03 ($90,000 $79,153.97). The fact that companies like Lowell Merchandising Corporation can increase resources
through the above process is why such companies are willing to borrow even though it costs them
interest.
In addition to buying merchandise and property, plant, and equipment by issuing notes
payable to suppliers, some large companies borrow cash by issuing notes payable to individuals and
other companies who buy them as investments. Such notes payable having initial maturities of less
than 270 days and minimum denominations of $25,000 are known as commercial paper. For
Ch. 10: Current Liabilities
349
example, for the two-year period ended January 31, 2007, Federated Department Stores reported as a
current liability commercial paper averaging approximately $600 million.
Individuals and companies buy commercial paper, such as Federated Department Stores’, for
the interest they can earn by owning it. Banks are major purchasers of commercial paper. From the
standpoint of the issuing company, such as Federated Department Stores, commercial paper is very
similar to notes payable. When a company issues commercial paper, it receives cash. At some point
in the future, the cash must be repaid along with interest. Certain common practices relating to the
sale of commercial paper have resulted in a few relatively minor differences between the accounting
for notes payable and commercial paper. For the purposes of this text, however, you should be
aware of the following major points with regard to commercial paper. First, commercial paper is a
source of cash resources for many large corporations, such as Federated Department Stores. When
cash is received, resources (assets) and sources of resources (liabilities) increase. Over time, the loan
must be repaid along with interest. The interest expense is recognized in the periods during which
the cash is used. As you noticed, the major points related to commercial paper are the same as those
for notes payable. This would be expected because commercial paper is just a special type of notes
payable.
** You now have the background to do exercises 10.1, 10.2, and 10.3.
Accounts Payable
Accounts payable are dollar amounts owed to suppliers for products or services purchased
from them. For merchandising companies, the vast majority of accounts payable arises through the
purchase of merchandise inventory, as discussed in Chapter 8. Accounts payable and notes payable
have many similarities. They are both current liabilities if they must be paid within one year. The
date by which they must be paid and the dollar amount required to be paid are known at the time they
are created. Remember the previous discussion of the Lowell Merchandising Corporation's January
23, signing of a $78,000, 6%, 90-day note payable to Medford Company. On January 23, as soon as
the companies agreed on the terms of the note, both companies knew the Lowell Merchandising
Corporation must pay $79,153.97 ($78,000 principal + $1,153.97 interest) to the Medford Company
on April 22. Similarly, when companies purchase merchandise or services on account, they
immediately know the dollar amount that must be paid and the date by which the payment must be
made.
The major difference between accounts payable and notes payable relates to interest. If notes
payable are paid on time, interest is part of the required payment. Again, remember the Lowell
Merchandising Corporation example. If the Lowell Merchandising Corporation pays on time, April
22, it will pay $78,000 principal plus $1,153.97 interest. On the other hand, if accounts payable are
paid on time, interest payments are not required. One reason accounts payable do not require interest
payments if paid on time is because accounts payable are usually for very short time periods, often
30 days. On the other hand, if accounts payable are not paid on time, suppliers often charge interest
for the number of days payments are late.
When companies purchase merchandise on account, their resources and sources of resources
increase. For example, if the Lowell Merchandising Corporation purchases $12,000 of merchandise
inventory on account, the effects on the company's accounting equation would be as follows.
Remember, you can always review Chapter 8 if you are unclear about this material.
350
Ch. 10: Current Liabilities
Total
Resources
Assets
+ $12,000
=
=
=
Sources of
Borrowed
Resources
Liabilities
+ $12,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) increase by $12,000 because they now
have $12,000 more merchandise inventory. Lowell Merchandising Corporation's sources of
resources (liabilities) increase because they owe $12,000 to suppliers. In terms of a journal entry,
remembering assets increase with debits and debits must equal credits, the following entry would
result.
Date
Jan. 5
Description
Merchandise Inventory
Accounts Payable
Merch. inventory purchase
Posting
Ref.
131
212
Debits
12,000
Credits
12,000
Purchases on account have payment terms associated with them. For example, it is possible
the Lowell Merchandising Corporation's $12,000 purchase was made with terms of 2/10, n/30. The
first part of the purchase terms, 2/10, means the Lowell Merchandising Corporation can take a 2
percent discount from the $12,000 if payment is made within 10 days of the purchase. Thus, if the
Lowell Merchandising Corporation pays for the merchandise by January 14, it will be allowed to
deduct $240 ($12,000 x .02) from the $12,000 invoice price. As a result, if it pays for the
merchandise by January 14, the Lowell Merchandising Corporation will pay its supplier only
$11,760 ($12,000 - $240). The second part of the purchase terms, n/30, means if the Lowell
Merchandising Corporation does not pay for the merchandise within 10 days, it must pay the full
amount, $12,000, within 30 days of the purchase, which is February 3.
Continuing the Lowell Merchandising Corporation example, if the purchase terms were 2/10,
n/30 and the company took advantage of the 2 percent discount by paying for the purchase on
January 14, the effects on the company's accounting equation would be as follows.
Total
Resources
Assets
- $11,760
- $240
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $12,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
The easier effect to see is the $12,000 decrease in the Lowell Merchandising Corporation's
sources of resources (liabilities). Lowell Merchandising Corporation's liabilities decrease simply
because once they pay their supplier, they no longer owe $12,000. On the other hand, resources
decrease for two reasons. First, the company's cash is reduced by the $11,760 cash payment.
Second, the company's merchandise inventory is reduced by $240. This $240 reduction of
Ch. 10: Current Liabilities
351
merchandise inventory is necessary because it was originally recorded as $12,000 when the
merchandise was purchased on January 5. Since only $11,760 was actually paid for the merchandise,
it should be reported at $11,760 not $12,000. Thus, the $12,000 merchandise inventory must be
reduced by $240 to bring it to $11,760. In terms of a journal entry, remembering assets decrease
with credits and debits must equal credits, the following entry would result.
Date
Jan. 14
Description
Accounts Payable
Cash
Merchandise Inventory
Accounts payable payment
Posting
Ref.
212
111
131
Debits
12,000
Credits
11,760
240
If the Lowell Merchandising Corporation does not pay for the merchandise by January 14, but
instead waits until February 3 to pay, the effects on the company's accounting equation would be as
follows.
Total
Resources
Assets
- $12,000
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $12,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $12,000 cash payment. The company's sources of resources (liabilities) decrease
because once they pay their supplier, they no longer owe $12,000. In terms of a journal entry,
remembering assets decrease with credits and debits must equal credits, the following entry would
result.
Date
Feb. 3
Description
Accounts Payable
Cash
Accounts payable payment
Posting
Ref.
212
111
Debits
12,000
Credits
12,000
When payment for purchases is made after the discount period, an adjustment to merchandise
inventory is not required because the cost of the merchandise originally recorded when the
merchandise was purchased is correct. Remember, on January 4, the Lowell Merchandising
Corporation recorded the cost of the merchandise purchased as $12,000. Since the company actually
paid $12,000 for the merchandise on February 3, the $12,000 merchandise originally recorded is
correct and does not need to be adjusted.
In a manner quite similar to merchandise inventory purchases on account, companies also
often purchase services on account. For example, it is very common for telephone services and
electricity services to be paid for in the month following the use of the services. When companies
purchase services on account and use them up in the same month, their resources remain unchanged
352
Ch. 10: Current Liabilities
and their sources of resources both increase and decrease. For example, consider the Lowell
Merchandising Corporation's January 29, receipt of a $258 invoice from the Merrimack Power
Company for electric power used in January. The effects on the company's accounting equation
would be as follows.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $258
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $258
Lowell Merchandising Corporation's resources remain unchanged because the electric power
purchased was used up by the company. Lowell Merchandising Corporation's sources of resources
(liabilities) increase because they owe $258 to the Merrimack Power Company. Similarly, the
company's sources of resources (stockholders' equity) decrease to recognize the expense related to
using the electric power (utilities expense). As suggested in earlier chapters, it may be easier to
understand this event in two parts. First, the Lowell Merchandising Corporation acquires a resource
(electric power) on account. As a result, resources (assets) increase and sources of resources
(liabilities) increase. As the electricity is used up, resources decrease and stockholders' equity
decreases. By combining these two effects, resources remain unchanged, they increased and
decreased by the same amount. Sources of resources changed as liabilities increased and
stockholders' equity decreased by the same amount. In terms of a journal entry, remembering
liabilities increase with credits and debits must equal credits, the following entry would result.
Date
Jan. 29
Posting
Ref.
513
212
Description
Utilities Expense
Accounts Payable
January electricity
Debits
258
Credits
258
When the Lowell Merchandising Corporation pays for the electricity, the effects on the
company's accounting equation would be as follows.
Total
Resources
Assets
- $258
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $258
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $258 cash payment. The company's sources of resources (liabilities) decrease
because once they pay Merrimack Power Company, they no longer owe them $258. In terms of a
journal entry, remembering assets decrease with credits and debits must equal credits, the following
entry would result.
Ch. 10: Current Liabilities
Date
Feb. 7
Description
Accounts Payable
Cash
Accounts payable payment
Posting
Ref.
212
111
Debits
258
353
Credits
258
** You now have the background to do exercises 10.4 and 10.5.
Taxes Payable
Taxes payable are dollar amounts owed to governments, primarily for services provided by
them. For example, corporations pay income taxes to the U.S. federal government for military
protection and many other services. Corporations operating in many locations throughout the world
usually must be concerned with many different taxes. In this chapter, liabilities for three specific
taxes will be examined: sales taxes, income taxes, and payroll taxes.
Sales taxes payable Sales taxes payable are dollar amounts owed to state governments for certain
products and services sold to customers. Almost all U.S. states have sales taxes. When products and
services are sold, customers are charged for the price of the products and services plus the sales
taxes. Thus, in effect, companies act as sales taxes collectors for state governments.
Assume the Lowell Merchandising Corporation operates in a state having a 6% sales tax. If,
on March 18, the Lowell Merchandising Corporation sells for cash products having a sales price of
$2,000, the company would charge its customers $2,120. The $2,000 is the sales price of the
products and the $120 ($2,000 x .06) is the sales tax. Selling $2,000 of products for cash in a state
with a 6% sales tax affects Lowell Merchandising Corporation's accounting equation as follows.
Total
Resources
Assets
+ $2,120
=
=
=
Sources of
Borrowed
Resources
Liabilities
+ $120
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
+ $2,000
Lowell Merchandising Corporation's assets increase because the company has received
$2,120 cash. Liabilities (sales taxes payable) increase by $120 because once the sale is made, the
company now owes $120 to the state government. Stockholders' equity increases by the $2,000 sales
revenue. In terms of a journal entry, remembering assets increase with debits and debits must equal
credits, the following entry would result.
Date
Mar. 18
Description
Cash
Sales Taxes Payable
Sales
Cash sales
Posting
Ref.
111
214
415
Debits
2,120
Credits
120
2,000
354
Ch. 10: Current Liabilities
In actual business practice, sales taxes can be quite complicated. Although most states have
sales taxes, they do not all tax the same things. Some states tax certain products and services while
other states tax different products and services. Additionally, states do not charge sales taxes on
products sold to companies that, in turn, are going to sell the products to consumers. States charge
sales taxes only on those products sold to consumers. For example, when the Lowell Merchandising
Corporation buys merchandise from the Medford Company, there is no sales tax involved. The sales
tax is charged at the time the Lowell Merchandising Corporation sells the products to its customers,
as shown above.
States establish specific schedules for companies to follow for paying sales taxes. For
example, continuing the Lowell Merchandising Corporation example, assume the state in which the
company operates requires sales taxes to be paid by the 10th day of the month after which a sale is
made. If the Lowell Merchandising Corporation had recorded total sales taxes payable of $3,100
during March, this amount would have to be paid to the state by April 10. When the company pays
the sales taxes to the state, the payment affects Lowell Merchandising Corporation's accounting
equation as follows.
Total
Resources
Assets
- $3,100
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $3,100
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's assets decrease because the company has paid out
$3,100 cash. Liabilities (sales taxes payable) decrease by $3,100 because once the payment is made,
the company no longer owes $3,100 to the state government. In terms of a journal entry,
remembering assets decrease with credits and debits must equal credits, the following entry would
result.
Date
Apr. 10
Description
Sales Taxes Payable
Cash
Sales taxes payment
Posting
Ref.
214
111
Debits
3,100
Credits
3,100
You should note in the above entry Lowell Merchandising Corporation does not record any
sales taxes expense. Sales taxes are collected from customers and paid by the company to the state
government. Thus, in effect, the sales taxes are a cost to the customer, not to Lowell Merchandising
Corporation.
** You now have the background to do exercises 10.6 and 10.7.
Income taxes payable Income taxes payable are dollar amounts owed to governments for services
provided by them. Some of the services are easy to see, such as the daily work of senators or the
activities of the armed forces stationed around the world. Other services are more difficult to see,
such as the work of the Central Intelligence Agency. Corporate income taxes are major sources of
Ch. 10: Current Liabilities
355
funds for governments. In the U.S., corporations pay federal income taxes, state income taxes in
most states, and local income taxes in some cities and towns. Similar to individuals, corporations
pay income taxes if they generate income. Income taxes are not paid by corporations that do not
generate income, that is, if their expenses are greater than their revenues. Companies that are not
incorporated, such as sole proprietorships and partnerships, do not pay income taxes. The income
taxes of such companies are paid by owners.
Although detailed tax regulations may vary from state to state and from locality to locality,
there are many similarities between such taxes and federal income taxes. All income taxes are based
on taxable income. In 2007, for those corporations with taxable income of $18,333,333 or more, the
U.S. federal income tax rate was 35%. For corporations with taxable income less than $18,333,333,
the tax rate varied, depending upon the amount of taxable income. Each year, the federal
government provides companies with several publications that help identify revenues and expenses
included in the calculation of taxable income and show the appropriate tax rates.
The actual calculation of a corporation's income taxes can be very complicated. The tax
code, which is the detailed set of rules to be followed by taxpayers, is administered in the U.S. by the
Internal Revenue Service (IRS). Occasionally, the tax code is modified to make changes specified
by the government. As a result of the complicated nature of income taxes, most corporations employ
their own tax accountants and tax lawyers. Other corporations make use of outside tax experts.
In its simplest form, assuming the Lowell Merchandising Corporation's taxable income for
2007 was $30,000,000, its income taxes expense would be $10,500,000 ($30,000,000 x .35).
Corporations pay their taxes to the federal government according to time schedules specified by the
IRS. In general, however, tax payments are not required to be made on the same day as the income
is earned. As a result of corporations not having to pay income taxes immediately, the effect of
income taxes on the Lowell Merchandising Corporation's accounting equation would be as follows.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $10,500,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $10,500,000
Lowell Merchandising Corporation's resources do not change because the company has not
paid the taxes. Sources of resources (liabilities) increase because the company owes the federal
government $10,500,000. Similarly, the company's sources of resources (stockholders' equity)
decrease to recognize the expense related to using the government's services (income taxes expense).
Once again, it may be easier to understand this event in two parts. First, the Lowell Merchandising
Corporation acquires a resource (governmental protection, for example) on account. As a result,
resources (assets) increase and sources of resources (liabilities) increase. As the protection is used
up, resources decrease and stockholders' equity decreases. By combining these two effects, resources
remain unchanged, they increased and decreased by the same amount, sources of resources changed
as liabilities (income taxes payable) increased and stockholders' equity decreased by the same
amount (by increasing income taxes expense). In terms of a journal entry, remembering liabilities
increase with credits and debits must equal credits, the following entry would result.
356
Ch. 10: Current Liabilities
Date
Dec. 31
Posting
Ref.
551
219
Description
Income Taxes Expense
Income Taxes Payable
Federal income taxes
Debits
10,500,000
Credits
10,500,000
When the Lowell Merchandising Corporation pays its income taxes, the effects on the
company's accounting equation would be as follows.
Total
Resources
Assets
- $10,500,000
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $10,500,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $10,500,000 cash payment. The company's sources of resources (liabilities)
decrease because once they pay the taxes, they no longer owe $10,500,000 to the government. In
terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the
following entry would result.
Date
Jan. 15
Description
Income Taxes Payable
Cash
Income taxes payment
Posting
Ref.
219
111
Debits
10,500,000
Credits
10,500,000
One of the complicating features involved in income tax calculations is that it is legal and
very common for corporations to follow one set of rules for tax purposes and another set of rules in
preparing financial statements. For example, remember the depreciation discussion in Chapter 9? It
is possible for companies to depreciate their property, plant, and equipment on an accelerated basis
for tax purposes while using straight-line depreciation for their financial statements. Similarly, as
you remember from Chapter 8, it is possible for companies to use different inventory methods for tax
and accounting purposes. When companies use accounting methods for tax purposes that differ from
the methods they use for their financial statements, the result usually is the income taxes expense
reported on the company's income statement differs from the income taxes reported on the company's
tax return. Since each company makes actual cash payments for income taxes based on tax returns,
the result is the company’s income taxes expense will differ from its income taxes payable.
Continuing the discussion of the Lowell Merchandising Corporation's $30,000,000 taxable
income reported on its income statement, consider what could happen if by using accelerated
depreciation for federal tax purposes and straight-line depreciation for its financial statements, the
company reports $2,000,000 of higher depreciation expense on its tax return than in its financial
statements. With $2,000,000 higher depreciation expense, the company’s taxable income will be
$2,000,000 lower on its tax return than it will be in its income statement. Using the 35% federal tax
rate, the company would calculate its federal income taxes as follows.
Ch. 10: Current Liabilities
Income
Statement
$30,000,000
$10,500,000
Taxable income
Income taxes expense (35%)
357
Federal
Tax Return
$28,000,000
$9,800,000
The above federal tax return calculations show the Lowell Merchandising Corporation owes only
$9,800,000 to the federal government for income taxes, not the $10,500,000 reported on its income
statement. By following tax rules the company will be able to postpone, or defer, $700,000 of taxes
payments. However, the company knows, as the property, plant, and equipment get older, straightline depreciation expense in later years will be greater than accelerated depreciation expense.
(Remember, you can review this idea in Chapter 9.) When this happens, the income taxes expense
reported on the company's income statement will be less than the income taxes reported on its tax
return. In other words, the Lowell Merchandising Corporation knows eventually it will have to pay
the federal government the full amount of income taxes reported on its income statement. However,
it could take several years for this to happen.
Because it is common for income taxes expense in companies' income statements to differ
from income taxes reported in their tax returns, companies use the following system:
Income taxes expense =
income taxes expense reported on income
statement
Income taxes payable =
income taxes reported on tax return
Deferred taxes =
difference between income taxes expense and
income taxes payable
Deferred taxes are postponed taxes payments. They are liabilities because they will
eventually have to be paid. They are considered current liabilities if they will be paid in the next
twelve months. Usually, however, they are considered long-term liabilities because it may be many
years before they will be paid.
Continuing the Lowell Merchandising Corporation example, the effect of income taxes on
the accounting equation would be as follows.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $9,800,000
+ $700,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $10,500,000
Lowell Merchandising Corporation's assets do not change because the company did not pay
the taxes. Sources of resources (liabilities) increase because the company owes the federal
government $10,500,000. However, because only $9,800,000 of taxes must be paid in the near
358
Ch. 10: Current Liabilities
future, $9,800,000 would be a current liability and $700,000 would be considered a long-term
liability. The company's sources of resources (stockholders' equity) decrease to recognize the
expense related to using the government's services (income taxes expense). In terms of a journal
entry, remembering liabilities increase with credits and debits must equal credits, the following entry
would result.
Date
Dec. 31
Description
Income Taxes Expense
Income Taxes Payable
Deferred Income Taxes Payable
Federal income taxes
Posting
Ref.
551
219
229
Debits
10,500,000
Credits
9,800,000
700,000
When the Lowell Merchandising Corporation pays the current portion of its income taxes, the
effects on the company's accounting equation would be as follows.
Total
Resources
Assets
- $9,800,000
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $9,800,000
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $9,800,000 cash payment. The company's sources of resources (liabilities)
decrease because once they pay the taxes, they no longer owe $9,800,000 to the government. The
$700,000 liability for deferred taxes remains unchanged because this amount has not been paid to the
government and is still owed by the company. In terms of a journal entry, remembering assets
decrease with credits and debits must equal credits, the following entry would result.
Date
Jan. 15
Description
Income Taxes Payable
Cash
Income taxes payment
Ref.
219
111
Debits
9,800,000
Credits
9,800,000
** You now have the background to do exercises 10.8, 10.9, and 10.10.
Payroll taxes payable Payroll taxes payable are dollar amounts owed to federal and state
governments for services related to employees. Such services include general governmental services
provided to all citizens and retirement and medical benefits provided to many citizens. Payroll taxes
payable arise for two reasons. First, to ease the process of governments collecting taxes from
citizens and also to make it easier for citizens to pay their taxes, employers act as governmental
collection agents for certain taxes. This means employers withhold dollar amounts for taxes from
employees' earnings and pay these amounts to governments. For example, consider an employee
who earns $100 and is taxed $10. The employer would withhold $10 from the employee's earnings.
The employee would receive $90 and the employer would pay the $10 to the appropriate
Ch. 10: Current Liabilities
359
governments. Until the employer pays the governments, the $10 would be reported as part of the
liability, payroll taxes payable. The second reason for payroll taxes payable is employers are taxed
by federal and state governments to help fund specific governmental programs relating to employees.
These taxes may be viewed by companies as another cost of doing business in the U.S., similar to the
cost of goods sold, advertising expense, and utilities expense. To understand payroll taxes payable,
the following paragraphs briefly examine payroll systems in which the dollar amounts of payroll
taxes are calculated.
Payroll systems Payroll refers to the dollar amounts earned by employees for services they
provide to the companies where they work. For service companies, such as medical, legal,
accounting, and consulting firms, payroll is often the largest cost of operating. For merchandising
companies, such as grocery stores and clothing stores, payroll costs are often the second largest cost,
with only the cost of goods sold being larger. Payroll systems vary from the relatively simple to the
very complex. For example, a company with only one or two employees can probably use a very
simple payroll system. On the other hand, with 1.9 million employees on January 31, 2007, a
company like Wal-Mart would use a very complicated payroll system. Regardless of the complexity
of payroll systems, the following paragraphs examine four basic concepts important to understanding
payroll: earnings, deductions, net pay, and employer payroll taxes.
Employee earnings The total dollar amount earned by an employee during a given time
period is called the employee's earnings or gross pay. Some employees earn a salary, that is, they
earn the same dollar amount each period. For these employees, gross pay is quite easy to determine:
their gross pay equals their salary. For example, if Lynn Catton earns a weekly salary of $900 from
the Lowell Merchandising Corporation, her weekly gross pay would simply be $900. Many other
employees do not earn salaries but earn wages. Such employees' earnings are based on the number
of hours they work and their wage rates per hour. For example, if the Lowell Merchandising
Corporation's Jorge Munez works 40 hours in a given week and his wage rate is $9 per hour, his
gross pay for the week would be $360 (40 hours x $9 per hour).
Further complicating an employee's gross pay is the fact companies often pay employees a
higher rate if they work more than the normal number of hours expected. This additional pay is
called overtime. For example, assume the Lowell Merchandising Corporation's policy is to pay
hourly employees time and a half (or 150%) for all hours worked in excess of 40 hours per week. If
Jorge Munez worked 46 hours in a given week, his gross pay would be calculated as follows.
Hours
First 40 hours (called straight-time)
6 hours over 40 (called overtime)
Gross pay
Rate
$9
$13.50 ($9 x 1.5)
Gross Pay
$360
$81
$441
In addition to salaries and wages, there are several other ways employees are compensated.
For example, it is common for salespersons to receive a base salary of a small amount and then
receive a commission of a percentage of the sales revenue they generate for the company. For
example, assume the Lowell Merchandising Corporation pays Mark Gearin a weekly salary $500
plus a commission of 1 percent of the sales he generates. If he generates sales of $8,000, his gross
360
Ch. 10: Current Liabilities
pay for the week would be $580. Gearin's gross pay would be his $500 weekly salary plus his sales
commission of $80 ($8,000 x .01).
It is also common for companies to pay bonuses to employees, especially to top executives.
A bonus is an amount paid in addition to regular salaries and wages, and is usually given as a reward
for good performance. For example, for the year ended January 31, 2007, in addition to his $1.3
million salary, the president and chief executive officer of Wal-Mart received incentive payments of
approximately $4.3 million. The gross pay of employees receiving bonuses is equal to their salary or
wages plus their commissions, if any, plus their bonuses.
** You now have the background to do exercise 10.11.
Deductions Payroll deductions are dollar amounts withheld (or deducted) from employees'
gross pay. Dollar amounts deducted from gross pay are not paid to employees, but are eventually
paid to other entities, such as governments, insurance companies, investment funds, and unions.
Employee federal income taxes For most employees, the largest deduction from their gross
pay is federal income taxes. In the U.S., federal income taxes are required to be withheld from most
employees' earnings. The actual dollar amount of federal income taxes withheld from each employee
is based on information provided to employers by the Internal Revenue Service. For example, in
order to encourage families, it has been part of U.S. tax policy to tax large families less than small
families. This is just one example of how U.S. tax policies are used to support programs considered
desirable by the federal government. The dollar amount of federal income taxes withheld from
employees' gross pay is paid to the government by the employer. Although the total dollar amount
withheld influences when payments are made, employers must pay the taxes at least every three
months (quarterly).
Employee state income taxes Similar to federal income taxes, many states also have income
taxes which must be withheld from employees' gross pay. The amount withheld from each employee
is determined according to information provided by the states. Such amounts are paid to the states
according to states’ payment schedules.
Employee FICA taxes Beginning in 1937, employees have had amounts withheld from their
gross pay to help fund the federal government's social security program. The tax is commonly
referred to as FICA because it was created through the Federal Insurance Contributions Act (FICA).
One part of the FICA social security program, referred to as OASDI, provides old age, survivors, and
disability insurance benefits to qualified individuals. In its first year, 1937, the FICA tax was 1
percent of the first $3,000 of gross pay earned by each employee. For example, an employee who
earned $7,000 in 1937 would have had $30 ($3,000 x .01) withheld from her gross pay. Note the
amount of the employee's earnings in excess of $3,000 was not taxed for FICA purposes. Since
1937, both the FICA tax rate and the amount of gross pay on which the tax is based have increased.
For example, in 2007, the OASDI portion of the FICA tax was 6.2 percent of the first $97,500
earned by each employee. Thus, an employee who earned $7,000 in 2007 would have $434 ($7,000
x .062) withheld from her gross pay. Note that since the employee's earnings of $7,000 were well
below the $97,500 limit, all $7,000 of the gross pay was subject to the OASDI FICA tax. Viewed
Ch. 10: Current Liabilities
361
another way, in 1937, the most an employee could have withheld from her pay was $30 ($3,000 x
.01), while in 2007, the maximum amount for OASDI had grown to $6,045 ($97,500 x .062).
A second part of the FICA social security program provides health care insurance to qualified
individuals. This program, which began in 1966, is commonly referred to as the Medicare program.
Similar to the OASDI FICA tax, the Medicare FICA tax has increased over the years. In 2007, the
Medicare tax was 1.45 percent of each employee's gross pay. Thus, the Medicare tax is levied on all
employee earnings. For example, an employee whose gross pay is $8,000 would have $101.50
($8,000 x .0145) withheld from his pay, while an employee whose gross pay is $150,000 would have
$2,175 ($150,000 x .0145) withheld. Like federal income taxes withheld, although the total dollar
amount of FICA taxes (OASDI and Medicare) withheld influences when payments are made,
employers must pay the taxes at least every three months (quarterly).
As an example of how changes in FICA taxes can affect individuals, consider what happened
to Michael Eisner, chairman and chief executive officer of The Walt Disney Company. Prior to
1994, only the first $135,000 of each employee's earnings were subject to Medicare taxes. In 1994,
however, this limit was removed making all earnings subject to Medicare taxes. As a result of this
change, the amount of Medicare taxes on Mr. Eisner's $11 million earnings increased by
approximately $160,000!
** You now have the background to do exercise 10.12.
Other deductions In addition to income taxes and FICA taxes, employees can have many
other deductions from their gross pay. For example, it is common for employees to have union dues,
insurance premiums, contributions, and savings plan payments withheld from their gross pay. Such
dollar amounts are withheld from employees' gross pay and recorded as current liabilities by the
employer.
Net pay Employees' net pay is the dollar amount of earnings the employees actually receive
from their employers. Net pay, also referred to as take-home pay, is calculated by subtracting the
employees' deductions from the employees' gross pay. As examples of net pay, consider the payroll
for the week ended October 31, 2007 for two employees of the Lowell Merchandising Corporation.
One employee, Lisa Gurecki, earns a weekly salary of $2,000, and a second employee, Jaime Simes
earns wages of $12 per hour. For the 43 weeks ended October 24, Lisa Gurecki earned $96,500
(including earnings for special projects) and Jaime Simes, who joined the company in July, earned
$6,720. For the week ended October 31, the net pay for each employee could be calculated as
follows.
Gross pay:
L. Gurecki's gross pay is simply her $2,000 weekly salary.
J. Simes' gross pay is the number of hours he worked multiplied by his wage rate
per hour. If he worked 40 hours during the week, his gross pay would be $480
(40 hours x $12 per hour).
Federal income tax:
Federal income taxes are determined through the use of information
provided by the IRS. For this example, assume that L. Gurecki's federal
income taxes withheld are $390, while J. Simes' are $63.
362
Ch. 10: Current Liabilities
State income tax:
State income taxes are determined through the use of information provided
by the state. For this example, assume that L. Gurecki's state income taxes
withheld are $100, while J. Simes' are $24.00.
FICA OASDI tax: For 2007, the OASDI portion of the FICA tax is 6.2% of the first $97,500
earned by each employee. Since prior to October 31, L. Gurecki had earned
$96,500, only $1,000 ($97,500 - $96,500) of her current week's gross pay is
subject to the OASDI tax. Thus, for the week ended October 31, the OASDI
tax withheld from L. Gurecki's gross pay is $62 ($1,000 x .062).
Remember, only the first $97,500 of an employee's 2007 yearly earnings are
subject to the OASDI tax. The $96,500 of L. Gurecki's previous earnings
had been taxed earlier in 2007, when she earned that part of her salary. For
J. Simes, the OASDI tax withheld is $29.76 ($480 x .062). Note since J.
Simes had earned only $6,720 prior to October 31, his gross pay is not close
to the OASDI limit of $97,500. Thus, the full amount of his $480 weekly
pay is subject to the OASDI tax.
FICA Medicare tax:
Other deductions:
For 2007, the Medicare portion of the FICA tax is 1.45% of gross pay
earned by each employee. L. Gurecki's Medicare tax withheld would be
$29 ($2,000 x .0145) and J. Simes' would be $6.96 ($480 x .0145).
Each week, L. Gurecki has $6 for union dues, $3 for a contribution to the
American charities, and $20 for additional health and life insurance
withheld from her gross pay. Similarly, J. Simes has union dues of $2 and
$4 for insurance withheld from his weekly pay.
Net pay: Employees' net pay is determined by subtracting their deductions from gross pay, as
summarized below. As shown, L. Gurecki had gross pay of $2,000, deductions of
$610, resulting in net pay of $1,390 for the week. Similarly, J. Simes had gross pay of
$480, deductions of $129.72, resulting in net pay of $350.28 for the week.
Item
Gross pay
Deductions:
Federal income tax
State income tax
FICA tax:
OASDI
Medicare
Union dues
American charities
Insurance
Total deductions
Net pay
Lisa
Gurecki
$2,000.00
Jaime
Simes
$480.00
Totals
$2,480.00
$390.00
100.00
$63.00
24.00
$453.00
124.00
62.00
29.00
6.00
3.00
20.00
29.76
6.96
2.00
0.00
4.00
91.76
35.96
8.00
3.00
24.00
610.00
$1,390.00
129.72
$350.28
739.72
$1,740.28
Ch. 10: Current Liabilities
363
Continuing the Lowell Merchandising Corporation example, assuming L. Gurecki and J.
Simes are the company's only two employees, the October 31, 2007 weekly payroll would affect the
company's accounting equation as follows.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $2,480
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $2,480
The company's sources of resources (liabilities) increase because the company owes its
employees for the work they did for the company during the week. In fact, as you know from the
previous paragraphs, the company only owes its employees their net pay ($1,740.28). All the other
dollar amounts withheld from employees' gross pay ($739.72) are owed to other entities. For
example, the federal income taxes withheld ($453) are owed to the federal government, while union
dues withheld ($8.00) are owed to the employees' union. Similarly, the company's sources of
resources (stockholders' equity) decrease to recognize the $2,480 expense related to using the
employees' services.
The journal entry to record payroll depends primarily upon two considerations. First, what
services did the employees provide? For example, if L. Gurecki is an administrator and J. Simes is a
salesperson, Gurecki's gross pay would be considered an administrative expense while Simes' would
be a selling expense. If, on the other hand, both employees were salespersons, both gross pays would
be selling expenses. The second consideration for recording payroll is the number of individual
liability accounts used. Most corporations do not simply record all deductions in the same payroll
taxes account, but prefer to use many separate accounts. Again, assuming L. Gurecki is an
administrator, J. Simes is a salesperson, and the Lowell Merchandising Corporation uses separate
liability accounts, the following journal entry would result.
Date
Oct. 31
Description
Administrative Salaries Expense
Sales Wages Expense
Employees' Federal Inc. Tax. Payable
Employees' State Inc. Tax. Payable
FICA Taxes Payable
Employees' Union Dues Payable
Employees' Amer. Charities Payable
Employees' Insurance Payable
Salaries and Wages Payable
Oct. 25-31 payroll
Posting
Ref.
514
516
231
232
233
234
235
236
214
Debits
2,000.00
480.00
Credits
453.00
124.00
127.72
8.00
3.00
24.00
1,740.28
Although the above journal entry may look intimidating, the major points you should note are
as follows. The company's expense for salaries and wages is equal to employees' gross pay. It is the
gross payroll that the company must eventually pay out in cash. Because employers act as collection
364
Ch. 10: Current Liabilities
agents, however, the gross pay is not the dollar amount employees receive. Employees will receive
their net pay, which is recorded in the above entry as a $1,740.28 credit to the liability, salaries and
wages payable. The liabilities in the above journal entry, other than salaries and wages payable,
represent dollar amounts deducted from employees' gross pay. The liabilities reflect the amounts
owed to varies entities, such as the federal government and state government. Several of the
liabilities include the word "employees" in their account names in order to clearly indicate such
amounts were deducted from employees' gross pay. Finally, FICA Taxes Payable includes both
OASDI and Medicare taxes. The account name does not include the word "employees" because the
account is also used to record FICA taxes on the employer, as discussed later in this chapter.
As the above example illustrates, the calculations and journal entry involved in employee
payroll can be quite detailed. This is one reason payroll systems were some of the first business
applications for computers. Today, virtually all large companies in the U.S. use computers in their
payroll systems. Not only can computers do the calculations faster than humans, but with good
programs they can also do it more accurately.
Employers usually pay their employees after their work is done. It is common for employees
to be paid one or two weeks after they work. When the Lowell Merchandising Corporation pays its
employees for the work they did during the week ended October 31, the effects on the company's
accounting equation would be as follows.
Total
Resources
Assets
- $1,740.28
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $1,740.28
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $1,740.28 cash payment. The company's sources of resources (liabilities) decrease
because once they pay the employees, they no longer owe them $1,740.28. In terms of a journal
entry, remembering assets decrease with credits and debits must equal credits, the following entry
would result.
Date
Nov. 7
Description
Salaries and Wages Payable
Cash
Oct. 31 payroll payment
Posting
Ref.
213
111
Debits
1,740.28
Credits
1,740.28
When a company pays the amounts withheld (deducted) from employees' gross pay, the
effects on the company's accounting equation and the journal entry to record them are similar to the
paying of employees' net pay. For example, when the Lowell Merchandising Corporation pays the
state income taxes withheld, the effects on the company's accounting equation would be as follows.
Total
Resources
=
Sources of
Borrowed
Resources
+
Sources of
Owner Invested
Resources
+
Sources of
Management Generated
Resources
Ch. 10: Current Liabilities
Assets
- $124
=
=
Liabilities
- $124
+
365
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $124 cash payment. The company's sources of resources (liabilities) decrease
because once they pay the state income taxes, they no longer owe the state $124. In terms of a
journal entry, remembering assets decrease with credits and debits must equal credits, the following
entry would result.
Date
Nov. 14
Description
Employees' State Income Tax. Payable
Cash
Employees' SIT payable pmt.
Posting
Ref.
232
111
Debits
124
Credits
124
** You now have the background to do exercises 10.13 and 10.14.
Employer payroll taxes In addition to paying employees their net pay and paying the
amounts withheld from employees' gross pay to federal and state governments, unions, charities, etc.,
companies are also required to pay employer payroll taxes. In effect, employer payroll taxes are
dollar amounts charged to employers for the right to employ workers. These dollar amounts are used
by governments to help fund two employee-related programs: the FICA program and federal and
state unemployment programs.
Employer FICA tax To help fund the federal government's social security program,
employers must pay the same two FICA taxes employees have withheld from their gross pay, as
discussed earlier in this chapter. Employers must pay OASDI tax (old age, survivors, and disability
insurance) and Medicare tax. For 2007, the employer's OASDI portion of FICA taxes was 6.2% of
the first $97,500 earned by each employee. You should note this is the same as the OASDI tax
withheld from each employee. For 2007, the employer's Medicare portion of FICA taxes was 1.45%
of each employee's total earnings. Again, this is the same as the Medicare tax withheld from each
employee.
Continuing the Lowell Merchandising Corporation example, the company's portion of
OASDI tax for the week ended October 31, 2007 payroll would be $91.76 ($62 for L. Gurecki +
$29.76 for J. Simes = $91.76). The company's Medicare tax would be $35.96 ($29 for L. Gurecki +
$6.96 for J. Simes = $35.96). You can verify these numbers by reviewing the detailed calculations
presented in the previous section. The company's total FICA taxes for the October 31 payroll would
be $127.72 ($91.76 OASDI + $35.96 Medicare). The payroll taxes affect the company's accounting
equation as follows.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $127.72
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $127.72
366
Ch. 10: Current Liabilities
Lowell Merchandising Corporation's sources of resources (liabilities) increase because the
company owes the federal government $127.72 for payroll taxes. The company's sources of
resources (stockholders' equity) decrease to recognize the $127.72 payroll taxes expense related to
using the employees' services. In terms of a journal entry, remembering liabilities increase with
credits and debits must equal credits, the following entry would result.
Date
Oct. 31
Posting
Ref.
518
233
Description
Payroll Taxes Expense
FICA Taxes Payable
Employers' FICA tax
Debits
127.72
Credits
127.72
When the Lowell Merchandising Corporation pays the FICA taxes amount to the federal
government, the effects on the company's accounting equation and the journal entry to record them
are identical to the paying of the FICA taxes withheld from employees' gross pay. For example,
when the Lowell Merchandising Corporation pays the $127.72 FICA taxes, the effects on the
company's accounting equation would be as follows.
Total
Resources
Assets
- $127.72
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $127.72
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $127.72 cash payment. The company's sources of resources (liabilities) decrease
because once they pay the FICA taxes, they no longer owe the federal government $127.72. In terms
of a journal entry, remembering assets decrease with credits and debits must equal credits, the
following entry would result.
Date
Nov. 10
Description
FICA Taxes Payable
Cash
FICA tax payable payment
Posting
Ref.
233
111
Debits
127.72
Credits
127.72
In actual practice, the journal entry to record the payment of FICA taxes payable is slightly
different from the above. Complying with IRS rules, companies do not pay FICA taxes separately,
but combine such payments with the amounts withheld from employees gross pay for FICA and
federal income taxes. Since all these dollar amounts go to the same place (the federal government),
companies combine them all in one cash payment.
As a result of charging employees and employers for FICA taxes, the federal government
helps fund FICA programs. For example, since the government collected $127.72 by having it
withheld from employees' earnings and collected another $127.72 by taxing the employer (Lowell
Ch. 10: Current Liabilities
367
Merchandising Corporation), the government obtained a total of $255.44 ($127.72 + $127.72 =
$255.44) for use in its FICA programs.
Employer unemployment taxes The second type of payroll taxes charged to employers helps
fund federal and state unemployment programs. The purpose of these programs is to provide
benefits to qualified unemployed individuals, for a limited time, to help them financially while they
attempt to find new jobs. Unlike FICA taxes that are levied on both employees and employers,
however, most unemployment taxes are charged to employers only, although there are a few states
that charge employees, too. In 2007, employers were charged a federal unemployment tax of .8% of
the first $7,000 earned by each employee. The actual federal unemployment tax rate is 6.2%, but
employers who properly pay their state unemployment tax have the federal rate reduced to .8%.
State unemployment tax rates vary from state to state and employer to employer. States usually
examine each employer annually and adjust the employer’s state unemployment tax rate based on the
employer's employment record. For example, employers who do not lay off many employees will
receive lower state unemployment tax rates than employers who frequently lay off employees.
Although unemployment taxes are collected by federal and state governments, the federal
government does not pay unemployment benefits directly to employees. The federal government
takes the unemployment taxes received from employers and distributes them to the states. The
states, in turn, pay the benefits to the unemployed.
Continuing the Lowell Merchandising Corporation example for payroll for the week ended
October 31, 2007, the company would only pay payroll taxes on J. Simes' earnings. Remember, in
2007, payroll taxes were based on the first $7,000 of each employee's earnings. Since L. Gurecki
had earned $96,500 prior to the October 31 week, her payroll greatly exceeds the $7,000 limit. Thus,
there would not be any payroll taxes on her October 31 earnings of $2,000. Since J. Simes earned
$6,720 prior to the October 31 week, the maximum earnings on which he could be further taxed is
$280 ($7,000 - $6,720 = $280). In fact, the company's payroll taxes would be based on only $280 of
J. Simes' $480 of earnings during the October 31 week. Once the $280 is taxed, the company would
have reached the maximum $7,000 yearly limit on J. Simes' earnings. Assuming the federal
unemployment tax rate is .8% of the first $7,000 and the state unemployment tax rate is 5.4% of the
first $7,000, the company's unemployment taxes would be as follows.
Federal unemployment tax
State unemployment tax
Total unemployment taxes
$2.24 ($280 x .008)
$15.12 ($280 x .054)
$17.36
The effects of unemployment taxes on the company's accounting equation are as follows.
368
Ch. 10: Current Liabilities
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+ $17.36
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
+
- $17.36
Lowell Merchandising Corporation's sources of resources (liabilities) increase because the
company owes the federal and state governments $17.36 for payroll unemployment taxes. The
company's sources of resources (stockholders' equity) decrease to recognize the $17.36 payroll taxes
expense related to using the employees' services. In terms of a journal entry, remembering liabilities
increase with credits and debits must equal credits, the following entry would result.
Date
Oct. 31
Description
Payroll Taxes Expense
Federal Unemployment Tax. Payable
State Unemployment Tax. Payable
Unemployment taxes
Posting
Ref.
518
216
218
Debits
17.36
Credits
2.24
15.12
When the Lowell Merchandising Corporation pays the unemployment taxes to the federal and
state governments, the effects on the company's accounting equation and the journal entry to record
them are similar to the paying of FICA taxes. The effects on the company's accounting equation
would be as follows.
Total
Resources
Assets
- $17.36
=
=
=
Sources of
Borrowed
Resources
Liabilities
- $17.36
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Lowell Merchandising Corporation's resources (assets) decrease because the company's cash
is reduced by the $17.36 cash payments. The company's sources of resources (liabilities) decrease
because once they pay the unemployment taxes, they no longer owe the federal and state
governments $17.36. In terms of a journal entry, remembering assets decrease with credits and
debits must equal credits, the following entry would result.
Date
Nov. 10
Description
Federal Unemployment Tax. Payable
State Unemployment Tax. Payable
Cash
Unemployment tax payment
Posting
Ref.
216
218
111
Debits
2.24
15.12
Credits
17.36
Ch. 10: Current Liabilities
369
Payroll and payroll taxes summarized When companies hire employees, the companies
become responsible for (1) paying employees' earnings and (2) paying governments for payroll taxes
charged to the employers. Thus, an employer's total payroll-related expenses are the sum of its gross
payroll and its payroll taxes. In the case of the Lowell Merchandising Corporation's October 31
payroll, the company's total payroll-related expenses are as follows.
Employees' gross pay
$2,480.00 (L. Gurecki's $2,000 + J. Simes' $480)
Employer's payroll taxes
$145.08 (FICA = $127.72 + unemployment $17.36)
Total payroll-related expenses $2,625.08
It is important to note payroll expenses include more than just the earnings of employees.
Payroll expenses include taxes charged to employers for the right to employ workers. In the case of
the Lowell Merchandising Corporation, even though employees earned $2,480 during the week of
October 31, the company's payroll taxes increased the company's expenses to $2,625.08.
Finally, because of governmental regulations and a willingness to help employees, companies
do not pay employees their gross pay. Dollars are withheld from employees' earnings and paid to
governments, unions, charities, etc. These dollar amounts withheld appear as liabilities in the
accounting records of employers until they are paid to the various institutions.
** You now have the background to do exercise 10.15 and problems 10.1 and 10.2.
Current Portion of Long-term Liabilities
Chapter 11 examines long-term liabilities, which are liabilities that must be paid some time
in the future, but not in the next twelve months. Some liabilities are primarily long-term liabilities
but also have a current liability portion. For example, you are probably aware of the mortgages you,
your parents, relatives, or friends have on their houses. Companies also have mortgages and other
long-term liabilities similar to mortgages. Mortgages are mostly long-term liabilities, but they
usually have amounts that must be paid off each month. The amount of a mortgage or other longterm liability that must be paid off in the next twelve months would be considered a current liability
while the amount that would be paid off later would be a long-term liability. For example, on
January 31, 2007 Wal-Mart had long-term debt of $32 billion. $5 billion of this debt must be paid
before January 31, 2008 and, thus, was reported on Wal-Mart's January 31, 2007 balance sheet as the
current liability, current portion of long-term debt. Since Wal-Mart was not required to pay the other
$27 billion ($33 billion - $5 billion = $27 billion) by January 31, 2007, it was not reported as a
current liability but, instead, was properly reported as a long-term liability.
Reporting the current portion of long-term liabilities as a current liability does not affect a
company’s accounting equation. As discussed in detail in Chapter 11, when a long-term liability is
created, the most likely effects are an increase in resources (cash) and an increase in long-term
liabilities (bonds payable). Reporting part of this bonds payable liability as the current portion of
long-term debt does not change either total resources or sources of resources. It simply reports some
of the liability as a current liability and some as a long-term liability. In fact, in most instances no
journal entries are required in the reporting of the current portion of long-term debt. The accounting
records continue to show the total debt in the bonds payable (long-term liability) account. When the
financial statements are prepared, the portion of the bonds payable due to be paid within the next
370
Ch. 10: Current Liabilities
twelve months will be reported as a current liability and the rest will be reported as a long-term
liability.
Controlling Current Liabilities
Current liabilities are controlled in many ways, depending upon the specific item being
controlled. The control of three current liabilities will be briefly discussed in the following
paragraphs: accounts payable, income taxes payable, and payroll. In addition, the use of ratios to
control current liabilities will be considered.
Accounts Payable The major accounts payable control issues relate to (1) the acquisition of goods
and services resulting in the creation of accounts payable and (2) payment of accounts payable.
As you remember, the largest expense for merchandising companies is the cost of good sold.
When merchandising companies use credit to purchase merchandise, which becomes the cost of
goods sold when merchandise is sold, the purchasing process results in the current asset merchandise
inventory and the current liability accounts payable. As a result, one of the most important ways
merchandising companies control accounts payable is by having sound inventory control systems and
purchasing systems. Such systems involve many specialized areas, such as inventory modeling and
forecasting techniques. Hopefully, you will explore some of these specialized areas in more
advanced courses. At this stage of your education, you should be aware the most important way to
control accounts payable is to control them before they are created. For example, before a company
purchases merchandise on credit, the company should have an inventory control system in place to
assure the proper items and the correct quantity of such items are purchased. Similarly, the company
should have a purchasing system in place to assure the proper quality and quantity of items are
purchased from the right suppliers, at the right prices, in time for the merchandise to arrive when
needed.
In a manner similar to the control of merchandise inventory, companies should have systems
in place to manage other activities giving rise to accounts payable. For example, as discussed in
Chapter 9, companies use cash budgeting techniques to help control the acquisition of property,
plant, and equipment which often results in accounts payable.
Once accounts payable are created, it is important the correct dollar amounts be paid on time,
to the right suppliers. The primary way in which proper payments of accounts payable are assured is
through the use of detailed records. Similar to the Chapter 7 discussion of controlling accounts
receivable through the use of the accounts receivable subsidiary ledger, companies also maintain
detailed accounts payable records called the accounts payable subsidiary ledger. The accounts
payable subsidiary ledger consists of all supplier accounts, the total of which agrees with the
accounts payable account in the general ledger. Companies use detail in the accounts payable
subsidiary ledger to verify how much they owe to individual suppliers and to help determine when
payments should be made to them. In addition to the total amount owed to a supplier, the supplier’s
account in the accounts payable subsidiary ledger would show such detail as the dollar amount of
each purchase made from the supplier, the date of each purchase, the invoice number of each
purchase, and the payment terms required, such as the date and any possible discounts. The
supplier’s account would also show the dates and dollar amounts of all payments made to the
supplier as well as the dates and amounts of any merchandise returned to the supplier.
Ch. 10: Current Liabilities
371
It is important that accounts payable be properly paid for several reasons. As you would
expect, suppliers are not pleased when they receive incorrect payments or late payments. Suppliers
also try to control their cash resources. When they receive improper payments, they must find ways
to modify their plans through such things as borrowing to make up for the improper payments or
possibly postponing some activities. Suppliers who are consistently paid improperly may decrease
their service to the offending customer, increase the prices charged to the customer, charge interest
on improper payments, or even discontinue servicing the customer.
Another reason suppliers should be properly paid is they often offer rewards in the form of
cash discounts for prompt payment. When cash discounts are taken for prompt payment of accounts
payable resulting from merchandise purchases, such discounts are called purchases discounts, as
discussed earlier in this chapter. Because it is often to a company’s advantage to take a purchases
discount, it is important such accounts payable payments be made on time.
Taxes Payable Similar to the control of accounts payable, the major taxes payable control issues
relate to the origin of taxes payable and their elimination through cash payments.
Liabilities for taxes payable can be for sales taxes, income taxes, payroll taxes, and other
taxes, such as property taxes. Each of these liabilities arises for different reasons. For example,
sales taxes payable results when companies sell products to customers in states having sales taxes.
On the other hand, income taxes payable arise when companies generate income in states, cities, or
towns levying income taxes. To control the creation of taxes liabilities, companies must have
systems in place to control factors that give rise to taxes. For example, to control the creation of
payroll taxes payable, companies must have human resource systems and payroll systems in place to
make sure proper employees are employed, trained and evaluated, and their salaries and wages are
accurately determined. Because payroll taxes rates are determined by law, their amounts depend
upon employee earnings, as discussed earlier in this chapter. To help properly control such taxes, the
cost of payroll taxes must be taken into consideration when employment decisions are made.
Similarly, income taxes are a function of the federal, state, city, and town tax codes and
companies’ revenues and expenses. As stated earlier, most companies employ tax accountants and
tax lawyers to determine income taxes payable.
Once taxes payable liabilities are determined, the correct amounts must be paid on time.
Taxing authorities provide companies with detailed instructions of when and where payments are to
be made. Incorrect or untimely payments may result in fines or possibly criminal prosecution.
Payroll As mentioned previously, companies make use of human resource systems to help assure
proper employees are employed, trained, and evaluated. These systems not only assist in control of
payroll taxes payable but, more importantly, they are essential to the control of all payroll costs.
Human resource systems are concerned with all aspects of employee life within companies,
including such things as recruiting, training, job assignments, continuing education, performance
evaluation, promotion, and even termination or retirement. There is a large body of literature on
many topics involved in human resource systems. From an accounting standpoint, you will
experience several issues relating to the control of payroll costs when you enroll in Managerial
Accounting courses.
Once employees are hired, it is the function of the payroll system to make sure they are paid
the correct amounts at the correct times, as discussed earlier. One of the important ways payroll
costs are controlled is through the use of quality payroll systems. Such systems result in accurate
372
Ch. 10: Current Liabilities
calculation of employee earnings and the many deductions from their gross pay, as well as the timely
distribution of net pay to employees.
Ratios As discussed in Chapter 6, managers commonly calculate statistics to assist them in their
duties. Three such calculations discussed in Chapter 6 relate directly to the control of current
liabilities: working capital, current ratio, and quick ratio.
As you remember, working capital is calculated by subtracting current liabilities from current
assets. The current ratio is calculated by dividing current assets by current liabilities. The quick
ratio is calculated by dividing quick assets by current liabilities. All three of these statistics are
concerned with a company’s ability to meet its current obligations. In other words, all three statistics
are concerned with the company’s ability to pay its current liabilities. Managers calculate such
statistics and compare them with performance standards, which are the desired levels of the statistics.
If the statistics differ significantly from the standards, action is taken to try to achieve the standards.
For example, if a company’s current ratio was calculated to be 1.5 while the standard (the desired
current ratio) was 1.75, management would try to increase the current ratio by increasing current
assets, decreasing current liabilities, or some combination of the two. While such statistics are very
rough control techniques, they can prove to be useful by focusing management’s attention on areas
needing consideration.
Ch. 10: Current Liabilities
373
Financial Statement Reporting of Current Liabilities
Current liabilities are reported as liabilities on the balance sheet as shown below.
Assets
Current Assets
Cash
Accounts Receivable
Less: Allowance for Uncollectible Accounts
Merchandise Inventory
Total Current Assets
Property, Plant, and Equipment
Land
Buildings
Less: Accumulated Depreciation
Machinery & Equipment
Less: Accumulated Depreciation
Autos & Trucks
Less: Accumulated Depreciation
Total Property, Plant, & Equipment
Total Assets
Liabilities and Stockholders’ Equity
Liabilities
Current Liabilities
Notes Payable
Accounts Payable
Taxes Payable
Current Portion of Long-term Debt
Total Current Liabilities
$18,330
$75,000
$1,500
$73,500
$210,000
$301,880
$30,000
$120,000
$40,000
$150,000
$50,000
$95,000
$55,000
$80,000
$100,000
$40,000
$250,000
$551,880
$34,500
$84,490
$11,900
$28,000
$158,890
The various activities that gave rise to current liabilities would appear elsewhere on the
financial statements. For example, cash borrowed through the use of notes payable could still be in
the cash account reported as an asset on the balance sheet. Merchandise purchased on account,
which resulted in accounts payable, would be reported on the balance sheet as the asset merchandise
inventory if still on hand or on the income statement as the cost of goods sold if the merchandise
were sold to customers. Salaries and wages, which resulted in payroll taxes reported as part of the
taxes payable liability, would be reported as part of operating expenses on the income statement.
Income taxes, which resulted in income taxes payable reported as part of the taxes payable liability,
would be reported as income taxes expense on the income statement.
374
Ch. 10: Current Liabilities
Sales
$400,000
Cost of Goods Sold
$160,000
Gross Profit
$240,000
Operating Expenses
Salaries and Wages Expense
$103,000
Depreciation Expense
$10,000
Supplies Expense
$3,000
Utilities Expense
$9,000
Rent and Insurance Expense
$14,000
Uncollectible Accounts Expense
$1,000
Total Operating Expenses
$140,000
Income from Operations
$100,000
Other Revenues and (Expenses)
($1,000)
Income Before Taxes
$99,000
Income Taxes Expense
$34,650
Net Income
$64,350
** You now have the background to do exercise 10.16.
Chapter 10 Critical Points
•
•
•
•
•
•
•
•
•
•
•
•
•
One important source of resources is borrowing.
If borrowed resources must be paid for within twelve months, the source of the
resources is considered to be a current liability.
Notes payable that must be repaid in the next twelve months are current liabilities.
Notes payable require payment of principal and interest at specific dates in the future.
Accounts payable are current liabilities usually resulting from purchases of
merchandise or services.
Sales taxes payable are created when products or services are provided to customers
in states that levy sales taxes.
Income taxes payable arise when companies generate taxable income.
Deferred taxes will result when a company’s taxable income in its income statement
differs from its taxable income in its tax return.
Payroll taxes payable result from (1) withholdings from employees’ gross pay and (2)
employers being charged for government services related to employees.
Employee gross pay does not equal net pay because of payroll deductions.
Control of current liabilities focuses on issues that result in current liabilities and their
proper payment.
Current liabilities are reported in a separate section on the balance sheet.
The following major topics have been examined so far.
Ch. 10: Current Liabilities
Assets
=
Liabilities
Current Assets
Current Liabilities
Cash and Cash
Notes Payable (10)
Equivalents (6)
Accounts Payable (10)
Accts. Receivable (7)
Taxes Payable (10)
Allow. for Uncoll.
Current Portion of LongAccounts (7)
term Debt (10)
Merchandise
Inventory (8)
Property, Plant, &
Equipment
Land (9)
Buildings (9)
Accum. Depr., Buildings
(9)
Equipment (9)
Accum. Depr., Equipment
(9)
Autos & Trucks (9)
Accum. Depr., Autos &
Trucks (9)
+
375
Stockholders' Equity
Revenues
Sales (7)
Sales Returns &
Allowances (7)
Cost of Goods Sold (8)
Operating Expenses
Uncollectible Accts.
Expense (7)
Depreciation Exp. (9)
Salaries & Wages
Expense (10)
Payroll Taxes
Expense (10)
Bank Service Exp. (6)
Other Revenues &
Expenses
Interest Revenue (6)
Interest Expense (6)
Gain or Loss on Disposal
of Prop., Plt., & Eq. (9)
Income Taxes
Expense (10)
Chapter Ten Questions
1.
Define the term current liabilities.
2.
Give three examples of current liabilities.
3.
What are notes payable?
4.
When notes payable are paid off, what two dollar amounts must be paid?
5.
State the formula for calculating interest on a note payable.
6.
If part of the formula used to calculate interest on a note payable contained the fraction 60/365,
what would the 365 represent and why is it needed?
376
Ch. 10: Current Liabilities
7.
On which financial statement and in which section of the statement is interest expense
reported?
8.
What are accounts payable?
9.
What is the primary cause of accounts payable for merchandising companies?
10.
What is the major difference between notes payable and accounts payable?
11.
What is a purchases discount?
12.
What are sales taxes payable?
13.
When a company charges its customers sales taxes and later pays the sales taxes to the state,
why doesn’t the company record a sales taxes expense?
14.
What are income taxes payable?
15.
Give three examples of services provided by the federal government.
16.
What are deferred taxes and why do they exist?
17.
What are the two reasons for payroll taxes?
18.
Identify the two largest costs of merchandising companies.
19.
Define the term gross pay.
20.
What is the difference between salaries and wages?
Ch. 10: Current Liabilities
21.
What are payroll deductions?
22.
Give three examples of payroll deductions.
23.
Identify the two parts of the FICA social security program.
24.
Define the term net pay.
25.
Identify four payroll taxes levied on employers.
26.
Identify a difference between FICA taxes and unemployment taxes.
27.
List three types of information contained in an accounts payable subsidiary ledger.
28.
State the formula for the calculation of the current ratio.
29.
On which financial statement are current liabilities reported?
Chapter Ten Exercises
Exercise 10.1: Notes Payable Interest
The Pappalardo Corporation is considering buying merchandise through the use of notes
payable. For each of the three notes payable below, calculate the total interest the Pappalardo
Corporation would pay.
1. $50,000, 8%, 60-day note payable.
2. $60,000, 9%, 90-day note payable.
3. $80,000, 10%, 120-day note payable.
377
378
Ch. 10: Current Liabilities
Exercise 10.2: Notes Payable Journal Entries
The Hartshorn Corporation engaged in several transactions related to notes payable. Prepare
journal entries to record the company's following transactions. Before you prepare each journal
entry, determine the transaction's effects on the company's resources and sources of resources.
March 17
The company purchased $30,000 of merchandise by issuing a 7%, 120-day note.
Total
Resources
Assets
=
=
Date
March 17
March 31
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company recorded the March interest expense related to the $30,000 note
payable.
Total
Resources
Assets
=
=
Date
March 31
April 30
Sources of
Borrowed
Resources
Liabilities
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company recorded the April interest expense related to the $30,000 note payable.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Ch. 10: Current Liabilities
Date
April 30
May 31
Description
=
=
Date
May 31
Sources of
Borrowed
Resources
Liabilities
+
+
Credits
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company recorded the June interest expense related to the $30,000 note payable.
Total
Resources
Assets
=
=
Date
June 30
July 14
Debits
The company recorded the May interest expense related to the $30,000 note payable.
Total
Resources
Assets
June 30
Posting
Ref.
379
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company recorded the July interest expense related to the $30,000 note payable.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
380
Ch. 10: Current Liabilities
Date
July 14
July 14
Description
Debits
Credits
The company paid the note payable and interest.
Total
Resources
Assets
Date
July 14
Posting
Ref.
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Description
Posting
Ref.
Debits
Credits
Exercise 10.3: Using Notes Payable to Purchase Merchandise
The Tucker Corporation received $74,000 from customers for merchandise it sold to them.
The merchandise was purchased by the Tucker Corporation when it issued a $40,000, 8%, 90-day
note payable. The company paid the $40,000 note and interest at the end of 90 days. Determine the
dollar amount by which the Tucker Corporation’s resources increased by using notes payable to
acquire merchandise and then selling the merchandise to customers.
Ch. 10: Current Liabilities
381
Exercise 10.4: Purchases Discounts
The Clark Corporation purchases most of its merchandise inventory on account. For each of
the following purchases, determine the amount of the purchases discount the Clark Corporation can
take if its pays within the discount period.
1.
$20,000 merchandise purchased with terms of 2/10, n/30.
2.
$10,000 merchandise purchased with terms of 1/15, n/30.
3.
$25,000 merchandise purchased with terms of n/15.
Exercise 10.5: Accounts Payable Journal Entries
The Mursjid Corporation engaged in several transactions related to accounts payable.
Prepare journal entries to record the company's following transactions. Before you prepare each
journal entry, determine the transaction's effects on the company's resources and sources of
resources.
May 10
The company purchased $20,000 of merchandise on account from the Antonelli
Company. Purchase terms were 2/10, n/30.
Total
Resources
Assets
Date
May 10
=
=
Sources of
Borrowed
Resources
Liabilities
Description
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Debits
Credits
382
Ch. 10: Current Liabilities
May 13
The company purchased $16,000 of merchandise on account from the Laurenza
Company. Purchase terms were 1/10, n/30.
Total
Resources
Assets
=
=
Date
May 13
May 18
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company paid for merchandise purchased on May 10 from the Antonelli Company.
Total
Resources
Assets
=
=
Date
May 18
May 25
Sources of
Borrowed
Resources
Liabilities
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company purchased $14,000 of merchandise on account from the Brown Company.
Purchase terms were n/30.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Ch. 10: Current Liabilities
Date
May 25
June 10
Description
=
=
Date
June 10
Sources of
Borrowed
Resources
Liabilities
+
+
Credits
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company purchased $10,000 of merchandise for cash from the Antonelli Company.
Total
Resources
Assets
=
=
Date
June 14
June 22
Debits
The company paid for merchandise purchased on May 13 from the Laurenza Company.
Total
Resources
Assets
June 14
Posting
Ref.
383
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
The company paid for merchandise purchased on May 25 from the Brown Company.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
384
Ch. 10: Current Liabilities
Date
June 22
Posting
Ref.
Description
Debits
Credits
Exercise 10.6: Sales Taxes Payable Journal Entries
The DeVelis Corporation operates in a state having a 7% sales tax. Prepare journal entries to
record the company's following transactions. Before you prepare each journal entry, determine the
transaction's effects on the company's resources and sources of resources.
July 1-31 The company had credit sales of $35,000 during July.
Total
Resources
Assets
=
=
Date
July 31
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
July 1-31 The company had cash sales of $49,000 during July.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Ch. 10: Current Liabilities
Date
July 31
Aug. 9
Description
Debits
Credits
The company paid sales taxes due for July sales.
Total
Resources
Assets
Date
Aug. 9
Posting
Ref.
385
=
=
Sources of
Borrowed
Resources
Liabilities
Description
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Debits
Credits
Exercise 10.7: Sales Taxes Payable
The Bithoney Corporation sells its products for cash. The company operates in a state having
a 6% sales tax. During February, the company recorded sales taxes payable of $48,000.
1.
Calculate the dollar amount of cash sales recorded by the Bithoney Corporation in February.
2.
Calculate the dollar amount of cash collected from customers by the Bithoney Corporation in
February.
386
Ch. 10: Current Liabilities
Exercise 10.8: Income Taxes Expense
The 2007 U.S. federal income tax rate schedule for corporations is shown below.
Taxable Income
From
$0
50,001
75,001
100,001
335,001
10,000,001
15,000,001
18,333,334
To
$50,000
75,000
100,000
335,000
10,000,000
15,000,000
18,333,333
Income Taxes Payable
Of taxable
income over
$0 + 15%
$0
$7,500 + 25%
50,000
$13,750 + 34%
75,000
$22,250 + 39%
100,000
$113,900 + 34%
335,000
$3,400,000 + 35%
10,000,000
$5,150,000 + 38%
15,000,000
35%
0
Calculate the Cavaretta Corporation’s 2007 income taxes payable under each of the following
independent conditions.
1. Cavaretta Corporation’s taxable income is $30,000.
2. Cavaretta Corporation’s taxable income is $400,000.
3. Cavaretta Corporation’s taxable income is $12,000,000.
4. Cavaretta Corporation’s taxable income is $30,000,000.
5. Cavaretta Corporation’s taxable income is $3,500,000,000.
Ch. 10: Current Liabilities
387
Exercise 10.9: Income Taxes Expense and Income Taxes Payable
For the year ended December 31, the Campbell Corporation reported taxable income of
$780,000. The company used the same accounting methods for tax purposes and for its financial
statements.
1. Calculate the dollar amount of the company’s income taxes expense and income taxes payable.
For simplification, assume the income taxes rate is 35%.
2. Prepare the journal entry to record the corporation’s income taxes, assuming the taxes are not
paid until the following year. Before you prepare the entry, determine the transaction's effects on
the company's resources and sources of resources.
Total
Resources
Assets
=
=
Date
Dec. 31
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Description
Debits
Credits
3. Prepare the journal entry to record the corporation’s income taxes cash payment made in the
following year. Before you prepare the entry, determine the transaction's effects on the
company's resources and sources of resources.
Total
Resources
Assets
Date
Jan. 12
=
=
Sources of
Borrowed
Resources
Liabilities
Description
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Debits
Credits
388
Ch. 10: Current Liabilities
Exercise 10.10: Deferred Income Taxes
There are several differences between the accounting methods the DAmico Corporation uses
in the preparation of its financial statements and in the preparation of its federal income taxes return.
For the year ended December 31, the company’s taxable income on its income statement was
$175,000, while it was $160,000 for income taxes purposes. For simplification, assume the income
taxes rate is 35%.
1. Calculate the income taxes expense the company would report on its income statement.
2. Calculate the income taxes payable the company would report on its income taxes return.
3. Prepare the journal entry to record the corporation’s income taxes for the year ended December
31, assuming taxes are not paid until the following year. Before you prepare the entry, determine
the transaction's effects on the company's resources and sources of resources.
Total
Resources
Assets
=
=
Date
Dec. 31
Sources of
Borrowed
Resources
Liabilities
Description
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Debits
Credits
Exercise 10.11: Gross Pay
The Sanghani Corporation has four employees. David Lambert and Susan LaMarca are
salaried employees, while Marc Ahdab and Pamela Budd are hourly employees. Lambert’s salary is
$2,000 per week. LaMarca's salary is $1,500 per week. Ahdab and Budd each earn $8 per hour plus
.5% of their weekly sales. During the week ended September 25, Ahdab worked 40 hours and
generated sales of $8,000, while Budd worked 40 hours and generated sales of $7,000. For her
excellent performance, LaMarca earned a $250 bonus.
Ch. 10: Current Liabilities
389
Calculate the gross pay of each of the Sanghani Corporation’s four employees for the week
ended September 25.
Exercise 10.12: FICA Taxes
For 2007, the OASDI FICA tax rate is 6.2% of the first $97,500 of employee earnings and the
Medicare FICA tax is 1.45% of all earnings. Prior to November 8, the Daoulas Corporation’s three
employees had the following gross pay: Stephen Collins $96,300, Reno Defilippis $24,000, and
Joseph Meuse $6,700. During the week ended November 14, Collins earned $2,500, Defilippis
$900, and Meuse $500.
Calculate the dollar amount of OASDI and Medicare taxes withheld from the pay of each of the
Daoulas Corporation’s three employees for the week ended November 14.
Exercise 10.13: Net Pay
For 2007, the OASDI FICA tax rate is 6.2% of the first $97,500 of employee earnings and the
Medicare FICA tax is 1.45% of all earnings. Prior to October 12, Kevin Peters had earned gross pay
of $95,800. During the week ended October 18, Peters earned $3,000. During the week, in addition
to FICA taxes, Peters had federal income taxes of $800, state income taxes of $150, and union dues
of $20 withheld from his pay.
Calculate the dollar amount of Peters’ net pay for the week ended October 18.
390
Ch. 10: Current Liabilities
Exercise 10.14: Payroll Journal Entries
For the week ended June 11, the Laquidara Corporation’s payroll was as follows.
Gross pay
$265,000.00
Deductions
Federal Income Taxes
$78,500.00
State Income Taxes
$13,400.00
OASDI FICA Taxes
$14,200.00
Medicare FICA Taxes
$3,842.50
Union Dues
$950.00
Insurance
$2,400.50
Prepare the journal entry to record the corporation’s payroll for the week ended June 11. Before you
prepare the entry, determine the transaction's effects on the company's resources and sources of
resources.
Total
Resources
Assets
Date
June 11
=
=
Sources of
Borrowed
Resources
Liabilities
Description
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Debits
Credits
Exercise 10.15: Employer Payroll Taxes
Prior to December 14, the Smetana Corporation’s three employees had the following gross
pay: Kevin Shaw $96,900, Melissa Machado $28,000, and Linda Forte $6,800. During the week
ended December 20, Shaw earned $2,900, Machado $1,100, and Forte $800. For 2007, the OASDI
FICA tax rate is 6.2% of the first $97,500 of employee earnings and the Medicare FICA tax is 1.45%
of all employee earnings. The corporation’s federal unemployment tax rate is .8% of the first $7,000
earned by each employee and its state unemployment tax rate is 5.4% of the first $7,000 earned by
each employee.
Ch. 10: Current Liabilities
391
1. Calculate the dollar amount of each of the following payroll taxes for the Smetana Corporation
for the week ended December 20.
A. OASDI FICA tax.
B. Medicare FICA tax.
C. Federal unemployment tax.
D. State unemployment tax.
2. Prepare the journal entry to record the corporation’s payroll taxes for the week ended December
20, assuming taxes are not paid until the following year. Before you prepare the entry, determine
the transaction's effects on the company's resources and sources of resources.
Total
Resources
Assets
Date
Dec. 20
=
=
Sources of
Borrowed
Resources
Liabilities
Description
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Posting
Ref.
Debits
Credits
392
Ch. 10: Current Liabilities
Exercise 10.16: Reporting Current Liabilities
The following account balances were reported by the Sotirakos Corporation on March 31.
Prepare the current liabilities section of the company’s March 31 balance sheet.
Accounts Payable
Accounts Receivable
Accumulated Depreciation, Buildings
Accumulated Depreciation, Equipment
Allowance for Uncollectible Accounts
Buildings
Cash
Common Stock
Current Portion of Long-term Debt
Equipment
Land
Long-term Debt
Merchandise Inventory
Notes Payable
Retained Earnings
Taxes Payable
$18,000
$46,000
$35,000
$85,000
$7,500
$240,000
$9,300
$150,000
$16,500
$459,000
$45,000
$395,000
$57,500
$180,000
$120,300
$11,500
Ch. 10: Current Liabilities
393
Chapter Ten Problems
Problem 10.1: Payroll
Holly Matson's business, Matson Consulting Incorporated, has 5 employees who are paid
each week. As of November 8, each employee's gross earnings were as follows.
Archambault
Cavaretta
Hsu
Norton
Santos
$18,000
$6,900
$96,800
$3,000
$101,000
For this year, the OASDI FICA tax rate is 6.2% of the first $97,500. The Medicare FICA tax rate is
1.45% of gross pay. Federal unemployment tax is .8% of the first $7,000 per employee. State
unemployment tax is 4% of the first $7,000 per employee.
1. Complete the Matson Consulting Incorporated payroll register for the week ended November 15.
Employee
Archambault
Cavaretta
Hsu
Norton
Santos
Totals
Gross
$800.00
$500.00
$1,600.00
$200.00
$2,700.00
$5,800.00
FIT
SIT
$140.00
$42.00
$80.00
$26.00
$350.00
$84.00
$30.00
$11.00
$600.00 $142.00
$_______ $_______
OASDI
$_______
$_______
$_______
$12.40
$_______
$136.40
Medicare
Union
$_______
$7.00
$7.25
$7.00
$_______
$7.00
$_______
$7.00
$_______
$7.00
$_______ $_______
Net
$549.80
$________
$________
$________
$________
$4,039.50
2. Prepare the journal entry to record the payroll for the week ended November 15. Before you
prepare the entry, determine the transaction's effects on the company's resources and sources of
resources.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
394
Ch. 10: Current Liabilities
Date
Description
Nov. 15 Salaries and Wages Expense
____________________
____________________
FICA Taxes Payable
____________________
____________________
_____________________________________
_
Debits
$5,800.00
Credits
$________
$________
$ 220.50
$________
$________
3. Prepare the journal entry to record the payroll taxes for the week ended November 15. Before
you prepare the entry, determine the transaction's effects on the company's resources and sources
of resources.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Date
Description
Nov. 15 Payroll Taxes Expense
____________________
____________________
State Unemployment Tax Payable
_____________________________________
Debits
$234.90
Credits
$________
$________
$ 12.00
Problem 10.2: Payroll
Robert Donaruma's business, Donaruma Investments Incorporated, has 5 employees who are
paid each week. As of September 8, each employee's gross earnings were as follows.
Almeida
Curotto
Forte
LaMarca
Pidgeon
$140,000
96,300
28,000
6,800
2,000
Ch. 10: Current Liabilities
395
For this year, the OASDI FICA tax rate is 6.2% of the first $97,500. The Medicare FICA tax rate is
1.45% of gross pay. Federal unemployment tax is .8% of the first $7,000 per employee. State
unemployment tax is 4% of the first $7,000 per employee.
1. Complete the Donaruma Investments Incorporated payroll register for the week ended September
15.
Employee
Almeida
Curotto
Forte
LaMarca
Pidgeon
Totals
Gross
FIT
SIT
$3,500.00 $700.00 $175.00
$1,500.00 $270.00
$75.00
$700.00 $110.00
$35.00
$400.00
$50.00
$20.00
$300.00
$30.00
$15.00
$6,400.00 $______ $______
OASDI Medicare
$______ $______
$______
$21.75
$______ $______
$24.80 $______
$______ $______
$161.20 $______
Union
$3.00
$3.00
$3.00
$3.00
$3.00
$______
Net
$2,571.25
$________
$________
$________
$________
$4,651.00
2. Prepare the journal entry to record the payroll for the week ended September 15. Before you
prepare the entry, determine the transaction's effects on the company's resources and sources of
resources.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Date
Description
Sept. 15 Salaries and Wages Expense
____________________
____________________
FICA Taxes Payable
____________________
____________________
___________________________________
Debits
$6,400.00
Credits
$________
$________
$ 254.00
$________
$________
396
Ch. 10: Current Liabilities
3. Prepare the journal entry to record the payroll taxes for the week ended September 15. Before
you prepare the entry, determine the transaction's effects on the company's resources and sources
of resources.
Total
Resources
Assets
=
=
Sources of
Borrowed
Resources
Liabilities
+
+
Sources of
Sources of
Owner Invested + Management Generated
Resources
Resources
Stockholders' Equity
Date
Description
Sept. 15 Payroll Taxes Expense
____________________
____________________
State Unemployment Tax Payable
_________________________________
Debits
$278.00
Credits
$________
$________
$ 20.00