Chapter 11
Current
Liabilities and
Payroll
Learning Objectives
1. Account for current
liabilities of known
amount
2. Calculate and journalize
basic payroll transactions
3. Account for current
liabilities that must be
estimated
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Learning Objectives
4. Account for contingent
liabilities
5. Use the times-interestearned ratio to evaluate
business performance
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Learning Objective 1
Account for current
liabilities of known
amount
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How Are Current Liabilities of Known
Amounts Accounted For?
• Liabilities are debts that are owed to
creditors.
• Liabilities have three main characteristics:
1. They occur as a result of a past transaction or
event.
2. They create a present obligation for future
payments of cash or services.
3. They are an unavoidable obligation.
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How Are Current Liabilities of Known
Amounts Accounted For?
• Current liabilities must be paid either with
cash or with goods and services within one
year or within the entity’s operating cycle.
• Long-term liabilities do not need to be
paid within one year or within the entity’s
operating cycle.
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How Are Current Liabilities of Known
Amounts Accounted For?
Current
liabilities
Long-term
liabilities
Accounts Payable
Notes Payable
Sales Tax Payable
Mortgage Payable
Unearned
Revenue
Bonds Payable
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Sales Tax Payable
• December’s taxable sales for Smart Touch
Learning totaled $10,000. The company
collected an additional 6% sales tax, which
would equal $600 ($10,000 × 0.06).
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Sales Tax Payable
• Sales tax is not an expense of the
business. It is a current liability.
Companies collect the sales tax and then
forward it to the state at regular intervals.
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Income Tax Payable
• Assume that Smart Touch Learning incurred
federal income tax payable of $3,780.
• When Smart Touch Learning pays the tax, it will
record the following:
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Unearned Revenues
• Suppose Smart Touch Learning received
$900 in advance on May 21 for a month’s
work beginning on that date.
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Unearned Revenue
• During May, Smart Touch Learning
delivered one-third of the work and
earned $300 ($900 × 1/3) of the revenue.
On May 31, the accounting clerk would
record the following entry:
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Short-Term Notes Payable
• Assume on May 1, Smart Touch Learning
purchased merchandise inventory with a
10%, 90-day note payable, for $8,000.
The company uses the perpetual inventory
system.
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Short-Term Notes Payable
• On July 30, when the note is due, Smart
Touch Learning will pay the note plus
interest.
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Current Portion of Long-Term Notes
Payable
• Long-term notes payable are typically
reported in the long-term liability section
of the balance sheet.
• When the long-term debt is paid in
installments, the business reports the
current portion of notes payable as a
current liability.
• The remainder is classified as long-term.
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Learning Objective 2
Calculate and journalize
basic payroll transactions
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How Do Companies Account for and
Record Payroll?
• Payroll, also called
employee
compensation,
creates liabilities
for a business.
• For service
organizations,
payroll is the major
expense.
• There are
numerous ways to
label an
employee’s pay:
•
•
•
•
•
Salary
Compensation
Commission
Bonus
Benefits
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Gross Pay and Net (Take-Home) Pay
• Two pay amounts are important for
accounting purposes:
– Gross pay is the total amount of salary, wages,
commissions, and bonuses earned by the
employee during the pay period.
– Net pay is the amount the employee gets to
keep. Net pay is also called take-home pay.
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Employee Payroll Withholding
Deductions
Required Deductions
Optional Deductions
• Federal and state
income tax
• Social Security tax
• Other deductions
required by federal,
state, or local law
• Insurance
premiums
• Retirement plan
contributions
• Charitable
contributions
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Withholding for Employee Income Tax
• The income tax deducted from gross pay
is called income tax withholding.
• The amount withheld depends on the
employee’s gross pay and the number of
withholding allowances claimed.
– Unmarried taxpayers usually claim one
allowance.
– A childless married couple usually claims two
allowances.
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Withholding for Employee Income Tax
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Withholding for Employee Social
Security Tax (FICA)
• The Federal Insurance Contributions Act
(FICA), also known as the Social Security
Act, created the Social Security tax.
• The law requires employers to withhold
Social Security (FICA) tax from
employees’ paychecks.
• FICA has two components:
– OASDI (old age, survivors, and disability
insurance)
– Medicare (medical benefits)
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Payroll Register
• Many companies use a payroll register to
help summarize the earnings,
withholdings, and net pay for each
employee.
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Journalizing Employee Payroll
• The payroll register is used to record the
payroll journal entry.
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Employer Payroll Taxes
• Employers must pay at least three payroll
taxes, two of which are unemployment
compensation taxes.
• These taxes are not withheld from
employees’ gross earnings but instead are
paid by the employer:
– Employer FICA tax (OASDI and Medicare)
– State unemployment compensation tax (SUTA)
– Federal unemployment compensation tax
(FUTA)
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Employer Payroll Taxes
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Journalizing Employer Payroll Taxes
• Smart Touch Learning records the
employer’s payroll tax expense as a debit
to Payroll Tax Expense and a credit to the
various payable accounts.
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Internal Control Over Payroll
• There are two main controls for payroll:
– Controls for efficiency:
• Payroll is usually automated rather than prepared by
hand.
– Controls to safeguard payroll disbursements:
• Employees sign for checks or present IDs.
• Hiring and firing is separated from payroll
preparation.
• Time clocks and direct deposit are also used.
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Learning Objective 3
Account for current
liabilities that must be
estimated
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How Are Current Liabilities That Must
Be Estimated Accounted For?
• A business may
know that a
liability exists but
not know the exact
amount.
• It must estimate
the amount of the
liability and report
it on the balance
sheet.
• Common examples
of estimated
liabilities:
• Bonus plans
• Vacation pay
• Health and pension
expense benefits
• Warranties
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Bonus Plans
• Assume Smart Touch Learning estimates
that it will pay a 5% bonus on annual net
income after deducting the bonus. The
company reports net income of $315,000
before the calculation of the bonus.
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Vacation, Health, and Pension Benefits
• Businesses typically offer vacation, health,
and pension benefits to employees.
– A pension plan provides benefits to retired
employees.
• Smart Touch Learning estimates the cost
of providing vacation benefits is $1,000
per month.
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Warranties
• Many corporations guarantee their
products against defects under warranty
agreements.
• The time period of warranties varies by
product and company.
• The matching principle requires
businesses to record Warranty Expense in
the same period that the company records
the revenue related to the warranty.
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Warranties
• Assume that Smart Touch Learning made
sales on account of $50,000, costing
$35,000 subject to warranties on June 10,
and estimates warranties at 3% of sales.
• The journal entry to record this
transaction is shown on the next slide.
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Warranties
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Warranties
• Assume that some of Smart Touch
Learning’s customers make claims that
must be honored through the warranty
offered by the company. The warranty
costs total $800 and are made on June 27
as follows:
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Learning Objective 4
Account for contingent
liabilities
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How Are Contingent Liabilities
Accounted For?
• A contingent
liability is a
potential liability
that depends on a
future event.
• For a contingent
liability to be paid,
some event must
happen in the
future.
• How businesses
record contingent
liabilities is based
on the likelihood of
events occurring in
the future:
• Remote
• Reasonably possible
• Probable
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How Are Contingent Liabilities
Accounted For?
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Learning Objective 5
Use the times-interestearned ratio to evaluate
business performance
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How Do We Use the Times-InterestEarned Ratio to Evaluate Business
Performance?
• Investors can use the times-interestearned ratio to evaluate a business’s
ability to pay interest expense.
• A high interest coverage ratio indicates a
business’s ease in paying interest
expense.
• The formula is:
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