Chapter 8
Completing the
Operating Cycle
Albrecht, Stice, Stice, Swain
COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
1
Employee Compensation
• Payroll
– Recognize the expense.
– FICA taxes and Federal income withholdings.
• Withholding these taxes for the government.
• They should not be recognized as an expense of
the company.
• Employer payroll taxes
– Employer’s portion of FICA taxes.
– Federal and state unemployment taxes.
– Added to taxes payable to the government.
2
Payroll Journal Entries
Salaries Expense. . . . . . . . . . . . . . . . . . . . . .
FICA Taxes Payable, Employee. . . . . . .
Federal Withholding Taxes Payable . . .
State Withholding Taxes Payable . . . . .
Salaries Payable . . . . . . . . . . . . . . . . . . .
To record employees’ salary.
2,700
180
486
243
1723
Payroll Tax Expense. . . . . . . . . . . . . . . . . . .
278
FICA Taxes Payable, Employer . . . . . . .
180
Federal Unemployment Taxes Payable.
30
State Unemployment Taxes Payable. . .
68
To record liabilities associated with employees’ salary.
3
Other Employee Compensation
• Bonuses
– Recorded just like payroll.
– Many times they are earnings based.
• Good incentive for management improvement but
can also provide incentives to manipulate
earnings.
• Compensated absences
– Recognized as the employee earns the right
to these absences.
4
Other Employee Compensation
• Stock options
– Fair value of the options are recognized over
the period the options are earned.
• Postemployment benefits
– Severance or other benefits.
– Estimated and accrued in the period the
employees are terminated.
5
Other Compensation
Journal Entries
Salaries Expense . . . . . . . . . . . . . . . . . . . . . .
Sick Days Payable. . . . . . . . . . . . . . . . . . .
To recognize accrued sick pay.
125
125
Sick Days Payable . . . . . . . . . . . . . . . . . . . . .
125
Various Taxes Payables. . . . . . . . . . . . . .
35
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
90
To record payment of sick day net of FICA, federal, and
state taxes.
Salaries Expense . . . . . . . . . . . . . . . . . . . . . . 150,000
Various Taxes Payables. . . . . . . . . . . . . .
60,000
Bonus Payable . . . . . . . . . . . . . . . . . . . . .
90,000
To record bonus earned by employees.
6
Pensions
• Defined contribution plan
– Employer contributes specific amount every year to
be paid to employee after retirement.
– Employee receives what was contributed plus the
earnings.
– The employee bears the risk of poor returns.
• Defined benefit plan
– Employee receives amount defined in the plan.
– Usually based on the number of years worked.
– Company sets aside money to cover the obligation,
but the risk of poor returns remains with the company.
7
Pensions
• Pension fund
– Money set aside to fulfill pension obligation.
• Pension benefit obligation
– Estimated liability of retirement payments.
• Pension-related interest cost
– The increase in the pension obligation resulting from
interest on the unpaid obligation.
• Service Cost
– The increase in the pension obligation resulting from
an employee working another year.
• Return on pension fund assets
– The return the company earns on its pension fund.
8
Pensions
Pension Benefit Obligation
– Pension Fund Assets
= Net Pension Liability
Interest Cost
+ Service Cost
– Expected Return on Fund Assets
= Pension Expense
9
Sales Taxes
• Paid by customer, but collected by the
company for the government.
Example: Bonds’s Barbeque sold a 100 sandwiches for
$340. What is the journal entry assuming the state
charges a 5 percent sales tax?
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales Revenue. . . . . . . . . . . . . . . . . .
Sales Tax Payable. . . . . . . . . . . . . . .
357
340
17
From sale of sandwiches, including 5% sales tax.
10
Property Taxes
• Assessed by county.
• Usually paid for a year in advance.
Example: The City of Riverton assesses property taxes on
land and buildings. Bond’s Barbeque pays its property taxes
on a calendar-year basis and paid Riverton $6,200 last year
for the current year. Make Bond’s appropriate journal entry.
12/31 Property Tax Expense . . . . . . . . . 6,200
Prepaid Property Taxes. . . . . .
6,200
To record property tax expense by using up
prepaid property taxes.
11
Income Taxes
• Based off income.
• May be different from actual taxes paid.
Example: Bond’s Barbeque’s pretax income is $385,000.
Its income tax rate for the year for both federal and state is
30 percent. Prepare an adjusting entry at year-end showing
the company’s tax expense.
12/31 Income Tax Expense . . . . . . . . 115,500
Income Tax Payable. . . . . . .
115,500
To record income tax expense and tax liability on
$385,000 pretax income for year using a 30
percent effective tax rate.
12
Deferred Taxes
• Occur because of timing differences in
revenue and expense recognition according
to GAAP rules versus IRS rules.
Example: Bond’s Barbeque’s owes $80,000 in taxes on its
income. It also has gains on a mutual fund that will not be taxed
until the mutual fund is sold. These taxes will be $40,000.
Prepare an entry showing the company’s tax expense.
Income Tax Expense. . . . . . . . .
Income Tax Payable. . . . . . .
Deferred Tax Liability. . . . . .
120,000
80,000
40,000
To record income tax expense and deferred tax
liability due to unrealized gains on mutual funds.
13
Contingencies
• Contingent Liabilities
– Depend on some future event to determine if
a liability actually exists.
• Environmental Liabilities
– Liability definitely exists, but measurement is
difficult.
– Minimum liability established.
– Extensive note disclosure.
14
Accounting for
Contingent Liabilities
Term
Definition
Accounting
Probable
The future event is
likely to occur.
Estimate the amount
of the contingency and
make the appropriate
journal entry; provide
detailed disclosure in
notes.
Possible
The chance of the future
event occurring is more
than remote but less than
likely.
Provide detailed
disclosure of the
possible liability in
the notes.
Remote
The chance of the future
event occurring is slight.
No disclosure
required.
15
Capitalize vs. Expense
• Research and Development
– Expenditures should be expensed when
incurred.
– Uncertainty of future benefits.
• Advertising
– Expenditures should be expensed when
incurred.
– Uncertainty of future benefits.
– Exception for targeted marketing to previous
customers.
16
Income Statement Revisited
• Gross Margin
– Net Sales minus Cost of Goods Sold.
• Other Revenues and Expenses
– Items earned or incurred outside of, or peripheral to,
the normal operations of a firm.
– (i.e. dividends received from investments)
• Extraordinary Items
– Nonoperating gains and losses
• Unusual in nature.
• Infrequent in occurrence.
• Material in amount.
– Reported net of taxes.
– (i.e. losses from floods, fires, earthquakes, etc.)
17
Review the Income
Statement Format
Revenues
– Cost of goods sold
= Gross margin
– Selling expenses
– General and administrative expenses
= Operating income
+/– Other revenues and expenses
=
Income before taxes
– Income tax
= Income after taxes
+/– Extraordinary items
= Net income
18
Earnings Per Share
• Net income divided by shares outstanding.
• Basic Earnings Per Share
– Based on historical information.
• Diluted Earnings Per Share
– Considers the effect on net income and
shares outstanding of stock transactions that
might occur in the future.
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