Current Liabilities
and Payroll
Chapter 11
Objective 1
Account for current liabilities
of known amount.
Accounts Payable...
…are amounts owed to suppliers for goods
or services purchased on account.
• Accounts payable do not bear interest
expense for the debtor.
Accounts Payable Example
• Suppose that on June 3, Lloyd’s Sporting
Store purchased $1,000 of goods on
account from Patti Wholesaler.
• What is the journal entry?
Inventory
1,000
Accounts Payable
Purchase on account
1,000
Short-Term Notes Payable...
…are promissory notes payable due within
one year.
• In addition to recording the note payable,
the business must also pay interest
expense.
• If interest expense is accrued at the end of
the period, interest payable must also be
recorded.
Short-Term Notes Payable
Example
• On April 30, Patti purchased inventory for
$10,000 by issuing a 90-day, 10% note
payable.
• What is the journal entry?
Inventory
10,000
Notes Payable
10,000
Purchase inventory on a 90-day, 10% note
Short-Term Notes Payable
Example
• Assume the accounting period ended
May 31.
• How much interest was accrued as of
May 31?
• $10,000 × 10% × 31/360 = $86.11
• How does Patti record the payment at
maturity?
Short-Term Notes Payable
Example
July 29
Note Payable
Interest Payable
Interest Expense
Cash
10,000.00
86.11
163.89
10,250.00
Sales Tax Payable Example
• Most states levy a sales tax on retail sales.
• Suppose that a store sold $3,000 worth of
merchandise on a given Saturday.
• The business collected an additional 5%
in sales tax.
• How much is the sales tax liability?
• $150
Accrued Expenses (Liabilities)...
– are expenses that have been incurred but
not recorded.
– salaries
– taxes withheld
– interest
– utilities
Payroll Liabilities
Salary Expense
Employee Income Tax Payable
FICA Tax Payable
Employee Union Dues Payable
Salary Payable
To record salary expense
10,000
1,200
800
140
7,860
Unearned Revenue Example
• Assume that on June 1, Dennis’s Landscaping
collected $1,500 for services to be provided
during the months of June, July, and August.
June 1
Cash
1,500
Unearned Revenue
Received cash in advance
1,500
Unearned Revenue Example
• What entry does Dennis record on June
30?
June 30
Unearned Revenue
500
Service Revenue
500
Earned service revenue that was collected
in advance
Objective 2
Account for Current Liabilities
That Must be Estimated.
Estimated Warranty Payable
• The matching principle demands that the
company record the warranty expense in
the same period that the business
recognizes sales revenue.
Estimated Warranty Payable
Example
• Patti Wholesaler made sales of $1,000,000
subject to product warranties.
• In the past years, claims have averaged
2%.
Warranty Expense
20,000
Estimated Warranty Payable 20,000
To accrue warranty expense
Estimated Warranty Payable
Example
• On January 28, a customer returned a
defective product and was given a $300
refund.
Estimated Warranty Payable 300
Cash
300
To record refund under warranty
Estimated Vacation Pay
Liability Example
• Suppose Lloyd’s Sporting Store has a
March payroll of $10,000 and vacation pay
adds 4% (2 weeks of annual vacation
divided by 50 workweeks each year).
• How much vacation pay should be
accrued?
Estimated Vacation Pay
Liability Example
March 31
Vacation Pay Expense
400
Estimated Vacation Pay Liability
To accrue vacation expense
400
Contingent Liability
• Report a contingent liability in the notes to
the financial statement if it is reasonably
possible that a loss or expense will occur.
• The FASB says to record an actual liability
if it is probable that the business has
suffered a loss and its amount can be
reasonably estimated.
Contingent vs. Current Liability
• Suppose a hospital has lost a court case for
uninsured malpractice.
• The hospital estimates that the liability will
fall between $1.5 and $2.5 million.
Contingent vs. Current Liability
• The hospital must record a loss and a
liability of $1.5 million.
• The hospital must disclose in a note the
possibility of an additional $1.0 million
loss.
Objective 3
Compute Payroll Amounts.
Payroll
• Straight time is the base rate paid to
employees for a set number of hours.
• Overtime is additional time worked by
employees for which they received a
higher rate (usually 1.5 times the straight
time rate).
Gross Pay and Net Pay
Gross Pay
Deductions
Net Pay
FICA Tax
• The FICA tax has two components:
1 Old age, survivors’, and disability
insurance (6.2% applied to the first
$87,000 of employee earnings in a year)
2 Health insurance
(1.45% applied to all employee earnings)
Employer Payroll Taxes
• Social Security (FICA) tax
• State unemployment compensation tax
• Federal unemployment compensation tax
Unemployment Compensation
Taxes
• Employers paid 5.4% to the states and
0.8% to the federal government on the first
$7,000 of each employee’s annual
earnings.
• The state government uses the money to
pay unemployment benefits to people who
are out of work.
Breakdown of Payroll Costs
Employer payroll taxes
to government
$110
Employer cost of health
care to insurance co.
$90
Employer disburses $1,200
Net pay to
employee
$750
Employee payroll
taxes to government
$230
Employee Gross Pay – $1,000
Employee
union dues
$20
Objective 4
Record Basic Payroll
Transactions.
Salary Expense
• Salary expense to the employer is the gross
salary of all employees.
• Employees pay their own income and
FICA taxes as well as union dues.
• The employer serves as a collecting agent
and sends these amounts to the government
and union.
To Record Salaries Expense:
Salary Expense
Employee Income Tax Payable
FICA Tax Payable
Employees Union Dues Payable
Salary Payable to Employees (take-home pay)
To Record Salaries Expense:
Payroll Tax Expense
FICA Tax Payable
State Unemployment Tax Payable
Federal Unemployment Tax Payable
To Record Salaries Expense:
Health Insurance Expense for Employees
Life Insurance Expense for Employees
Pension Expense
Employee Benefits Payable
Objective 5
Use a Payroll System.
Payroll System Components
–
–
–
–
payroll record
special payroll bank account
payroll checks
earnings record for each employee
Payroll Record...
–
•
•
•
is also referred to as the payroll journal.
It lists payroll data for each employee.
It serves as a check register.
It provides information for recording
payroll expenses and related withholdings.
Payroll Bank Account
• When companies use a payroll bank
account, the company draws a check for
the net amount of salary payable to
employees on its regular bank account.
• The company deposits this check in the
special payroll bank account.
Payroll Bank Account
• The company writes paychecks to
employees out of the payroll account.
• When the paychecks clear the bank, the
payroll account has a zero balance.
• Disbursing paychecks from a separate bank
account isolates net pay for analysis and
control.
Recording Cash Disbursements
• When the employer pays the employees,
the company debits Salary Payable to
Employees and credits Cash.
• The liabilities to the government, unions,
and other parties is also debited when cash
is paid.
Recording Cash Disbursements
• Assume the following journal entry was made
at the end of an accounting period:
Salary Expense
180,000
Employee Income Tax Payable
45,000
FICA Tax Payable
11,160
Employee Union Dues Payable
840
Salary Payable to Employees
123,000
Recording Cash Disbursements
• What is the journal entry when the employer
pays these liabilities?
Employee Income Tax Payable
FICA Tax Payable
Employee Union Dues Payable
Salary Payable to Employees
Cash
45,000
11,160
840
123,000
180,000
Internal Control over Payrolls
– controls for efficiency
– controls for safeguarding payroll
disbursements
Controls for Efficiency
– making payroll disbursements from one
payroll account in one month and from
another the next
– following established policies for hiring
and firing employees
– complying with government regulations
– testing employees for their interest in the
job and their skills to perform the job
Controls for Safeguarding
Payroll Disbursements
• Large organizations must establish controls
to ensure that payroll disbursements are
made only to legitimate employees.
• Duties of hiring and firing should be
separated from the duties of accounting for
payroll and distributing paychecks.
Controls for Safeguarding
Payroll Disbursements
• Requiring an identification badge bearing
an employee’s photograph also helps
internal control.
• A formal time-keeping system helps ensure
that employees have actually worked.
Objective 6
Report Current Liabilities
on the Balance Sheet.
Report Current Liabilities
• Companies report current liabilities on the
balance sheet.
– Current liabilities of known amount
(payroll)
– Current liabilities that must be estimated
(warranties)
Report Current Liabilities
• At the end of the year, companies report
the amount of payroll liabilities owed to
all parties.
• The liability at year end is the amount of
the payroll expense that is still unpaid.
Liabilities Known
When Recorded
–
–
–
–
–
–
accounts payable
short-term notes payable
sales tax payable
current portion of long-term debt
accrued expenses payable
unearned revenues
Liabilities Estimated
When Recorded
– warranty payable
– income tax payable
– vacation pay liability
End of Chapter 11