Liabilities
Chapter 10
Liabilities
• Debt obligations to third parties
• Creditor – the lender who makes the loan
• Debtor – individuals or businesses that
receive the credit
• Current liabilities – obligations that will be
paid out of current assets and are due
within a short time, usually within one year.
• Long term liabilities – are obligations due
for a period of time greater than one year.
Current Liabilities
• Accounts payable
– Arise from purchasing goods or services
for use in a company’s operations or for
purchasing merchandise for resale.
• Current portion of Long-term Debt
– Long-term liabilities are often paid back
in periodic payments, called installments
– Long-term liability installments that are
due within the coming year must be
classified as a current liability.
Current Liabilities
• Short-term Notes Payable
– Notes may be issued when
merchandise or other assets are
purchased.
– Also issued to creditors to
temporarily satisfy an account
payable created earlier.
Example 1:
• Suppose that a business issues
a 60 day, 10% note for $4,000 on
an overdue payable dated May 1,
2007. Record the entry for the
establishment of the note.
Example
Date
May 1
Account
Accounts payable
Notes payable
Debit
Credit
$4,000
$4,000
Example
• Now record the payment on the due
date.
• Interest computation
Principal X Rate X Time = Interest
$4,000 x 10% x 60/360 = $100
Maturity value = Principal + Interest =
$4,000 + $100 = $4,100
Example
Date
July 1
Account
Notes payable
Interest expense
Cash
Debit
Credit
$4,000
100
$4,100
Payroll
• Payroll refers to the amount
paid to employees for the
service they provide during a
period.
Liability for Employee
Earnings
– Salary –
• Refers to payment for managerial,
administrative, or similar services.
• Expressed in terms of month or year.
– Wages –
• Refers to payment for manual labor.
• Expressed in hours or weekly.
– Basic salary can increase or decrease
because of commissions, profit sharing,
or cost of living adjustments.
Earnings
– Some businesses pay managers an
annual bonus in addition to salary
• Based on productivity
– Fair Labor Standards Act
• Requires businesses engaged in
interstate commerce to follow
the requirements
• Minimum wage rate = $5.85
Earnings
• Overtime = 1 ½ for hours over 40 per
week
• Premium rates for overtime or for
working at night, holidays, etc are
fairly common but not required by law.
• http://www.dol.gov/esa/regs/complianc
e/whd/whdfs22.htm
• Overtime - over 40 hours per week are
at 1/1/2 times the regular rate
Computing Gross Pay
• Gross pay - total earnings of an
employee for a payroll period,
including bonuses and overtime pay.
• Wage employee =
= (pay rate x hours worked up to 40)
+(1.5 x pay rate)x(hours over 40)
Example 2:
• Suppose that Sally Money earns a
rate of $10 per hour. During the past
week, she worked 48 hours.
Compute her gross pay.
• (pay rate x hrs up to 40) + (1.5x pay
rate)(actual hrs – 40)
• ($10 x 40) + (1.5 x10)(48-40)
• $400 + $120 = $520
•
Base wage
Overtime pay Total
Example 2
= pay rate x hrs up to 40)
+ (1.5x pay rate)(actual hrs – 40)
= ($10 x 40) + (1.5 x10)(48-40)
= $400 + $120 = $520
Base wage
(GROSS PAY)
Overtime pay
Total earnings
Deductions from
Employee’s Pay
– Gross pay is total earnings of an
employee for the payroll period
– Deductions are subtracted from
the gross pay to arrive at the NET
PAY of the employee (Take home
pay)
Federal Withholding Tax
– Must be withheld on all employees
– Determined by the W-4 completed by the
employee ( see below)
– http://www.irs.gov/pub/irspdf/fw4.pdf?portlet=3
Federal Withholding Tax
– Once the W-4 is completed, the amount
withheld is computed based on the
tables. Please note that must payroll
programs have the tables imbedded in
the software and compute the tax based
on W-4 information.
– Tax tables are found in IRS Publication
15 : Employer’s Tax Guide or at:
http://www.irs.gov/pub/irs-pdf/p15_06.pdf
– Some states also charge state income taxes that
must be withheld on employee’s income.
Federal Withholding Tax
Example 3
• Suppose that Sally Money earns
a rate of $10 per hour. During
the past week, she worked 48
hours. Her gross pay $520.
Compute her federal withholding
if she is a single person.
Example 3
• Table shows
Over
But not
over
$192
$620
The
amount
below
$14.10 plus
25% of
excess
over $192
Example 3
•
•
•
•
$520 – 192 = $328 this is the excess
Federal withholding:
$14.10
$328 x 25%
82.00
$96.10
FICA TAX
– Federal Insurance Contributions Act
– Withholds a portion of the earnings of
each of the employees.
– Actually covers two taxes
• Social security for retirement or disability
• Medicare for health insurance for seniors
– Social security and Medicare taxes have
different rates and only the social
security tax has a wage base limit.
Social Security Tax
– The wage base limit is the
maximum wage that is subject to
the tax for the year.
– The Social Security tax rate is
6.2%.
• Thus the maximum Social Security tax
withheld in 2007 is $6,045.
• Maximum $97,500
Medicare Tax
• The Medicare tax rate is 1.45%
for each year shown above.
• NO limit on the income taxes
Example 4:
• Suppose that Sally Money earns
a rate of $10 per hour. During
the past week, she worked 48
hours. Her gross pay $520.
Compute her FICA taxes
Example 4
Social Security Tax =
Gross pay x Social security rate
$520 x 6.2% = $32.20
Medicare Tax =
Gross pay x Medicare rate
= $520 X 1.45% = $7.54
Example 5
• What happens when an
employee reaches the ceiling for
social security. Suppose that
John has earned to date $96,900
and this week’s gross pay is
$1000. Compute his FICA taxes.
Example 5
Amount available for social security tax =
Social security ceiling – Earnings to date
$97,500 – $96,900 = $600
Therefore, tax is calculated on the $600 and
not the $1000 in gross pay.
$600 X 6.2% = $37.20 Social security
withheld
$1,000 x 1.45% = $14.50 Medicare withheld
Computing Net Pay
Gross Pay
-Federal Income Tax
Withheld
-Social Security Tax
-Medicare Tax
NET PAY
Example 6
Using all the information on Sally, what
is her net pay?
Gross pay
Federal withholding
Social security
Medicare
NET PAY
the amount of her paycheck
$520.00
96.10
32.24
7.54
$384.12
Liability for Employer’s
Payroll Taxes
• Matches the employee’s contribution
• Most employers are also subject to federal and state
payroll taxes.
• These include
– Social security tax
– Medicare tax
– Federal unemployment compensation tax
• FUTA – Federal Unemployment Tax Act provides for temporary
payments for those who become unemployed as a result of layoffs
due to economic causes beyond their control.
• Tax of 6.2% on the first $7,000 wages per employee.
– State unemployment compensation tax
• Varies by state
• Florida rates as high as 5.4% of the first $7,000 of wages per
employee.
» In Florida, Form UCT-6 is filed quarterly to report the tax.
Journal entries:
• To record the salaries paid for the
period:
Account
Salaries Expense
Social security tax payable
Debit
Gross pay
Credit
Employee’s
share
Medicare tax payable
Employee’s
share
Federal income withholding
Cash
Employee’s
Net pay
To record the employer’s share of the
payroll taxes for the period:
Account
Payroll tax expense
Debit
Credit
Total taxes
owed
FICA tax payable
Matches
employees
Medicare tax payable
Matches
employees
FUTA payable
6.2% of the
first $7,000
in wages
SUTA payable
Based on
state regs
Payment of Payroll
taxes
• Companies are required to deposit payroll taxes due
weekly, monthly or quarterly based on the amount
due each payroll period.
• Companies are required to file quarterly reports on
the payroll taxes
– Form 941: Quarterly Federal Payroll Taxes
• http://www.irs.gov/pub/irs-pdf/f941.pdf
– Form 940: FUTA taxes – annually
• http://www.irs.gov/pub/irs-pdf/f940.pdf
– W-3: Report on total wages and taxes collected from
employees
• http://www.irs.gov/pub/irs-pdf/fw3.pdf
– W-2: Wage and Tax Statement for individuals
• http://www.irs.gov/pub/irs-pdf/fw2.pdf