Current Liabilities and Payroll

Learning Objective 1
Current Liabilities and Payroll
Describe and illustrate

current liabilities related
to accounts payable,
current portion of longterm debt, and notes
payable.
Chapter 10
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Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting
Pepperdine University
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LO 1
LO 1
Current Liabilities
Accounts Payable
When a company or a bank advances

credit, it is making a loan.
The company or bank is called a creditor
(or lender).
The individuals or companies receiving the
loans are called debtors (or borrowers).
Current liabilities are debts that will be paid
out of current assets and are due within one
year.
Accounts payable transactions arise from

purchasing goods or services for use in a
companys operations or from purchasing
merchandise for resale.
LO 1
Current Portion of Long-Term Debt

Long-term liabilities are often paid back in
periodic payments, called installments.
Installments that are due within the coming
year must be classified as a current liability.
The installments due after the coming year
are classified as a long-term liability.
LO 1
Short-Term Notes Payable

Natures Sunshine Company issues a 90-day,
12% note for $1,000, dated August 1, 2011 to
Murray Co. for a $1,000 overdue account.
LO 1
LO 1

Bowden Co. (Borrower)
When the note matures, the entry to record the

payment of $1,000 plus $30 interest ($1,000 x
12% x 90/360) is as follows:
Description
Debit Credit
Mdse. Inventory
10,000
Accounts Payable
10,000
On May 1, Bowden Co.

(borrower) purchased
merchandise on account
from Coker Co. (creditor),
$10,000, 2/10, n/30. The
merchandise cost Coker
Co. $7,500.
Interest Expense
appears on the income
statement as an Other
Expense.
Coker Co. (Creditor)

Description
Debit Credit
Accounts Receivable 10,000

Sales
10,000
Cost of Mdse. Sold
Mdse. Inventory
7,500
7,500
LO 1
LO 1

Description
Accounts Payable
Notes Payable
Debit
Credit
10,000
10,000

On May 31, Bowden
Co. issued a 60-day,
12% note for $10,000 to
Coker Co. on account.
Description
Debit Credit
Notes Receivable
10,000
Accounts Receivable
10,000
On July 30, Bowden

Co. paid Coker Co. the
amount due on the
note of May 31, the
face amount of $10,000
plus interest of $200
($10,000 x 12% x
60/360).
Description
Debit
Notes Payable
Interest Expense
Cash
10,000
200
Credit
10,200

Description
Cash
Interest Revenue
Notes Receivable
Debit
Credit
10,200
200
10,000
LO 1

On September 19, Iceburg Company borrowed
cash from First National Bank by issuing a
$4,000, 90-day, 15% note to the bank.
LO 1

On December 18, Iceburg Company paid First
National Bank $4,000 plus interest of $150
($4,000 x 15% x 90/360).
LO 1
LO 1
A discounted note has the following

characteristics:
1. The interest rate on the note is called the
discount rate.
2. The amount of interest on the note, called
the discount, is computed by multiplying the
discount rate times the face amount of the
note.
3. The debtor (borrower) receives the face

amount of the note less the discount, called
the proceeds.
4. The debtor must repay the face amount of
the note on the due date.
(concluded)
(continued)
LO 1
LO 1
On August 10, Cary Company issues a $20,000,

90-day discounted note to Western National
Bank. The discount rate is 15%, and the amount
of the discount is $750 ($20,000 x 15% x
90/360).
The entry when Cary Company pays the

discounted note on November 8 is as follows:
proceeds
LO 2
Determine employer
liabilities for payroll,
including liabilities arising
from employee earnings and
deductions from earnings.
Payroll and Payroll Taxes

In accounting, payroll refers to the amount
paid to employees for services they
provided during the period. A companys
payroll is important for the following reasons:
Payroll and related payroll taxes significantly
affect the net income of most companies.
Payroll is subject to federal and state
regulations.
Good employee morale requires payroll to
be paid timely and accurately.
LO 2
Liability for Employee Earnings
LO 2
Liability for Employee Earnings
Salary usually refers to payment for

managerial and administrative services.
Salary is normally expressed in terms of a
month or a year.
Wages usually refers to payment for
employee manual labor. The rate of wages
is normally stated on an hourly or weekly
basis.
John T. McGrath is employed by McDermott

Supply Co. at the rate of $34 per hour, plus 1.5
times the normal hourly rate for hours over 40 per
week. For the week ended December 27,
McGrath worked 42 hours. His earnings are
computed as follows:
Earnings at regular rate (40 x $34)
Earnings at overtime rate (2 x $51)
Total earnings
$1,360
102
$1,462
LO 2
LO 2
Deductions from Employee Earnings
The total earnings of an employee for a

payroll period, including any overtime pay,
are called gross pay.
From this amount is subtracted one or more
deductions to arrive at the net pay.
The Federal Insurance Contributions Act

(FICA) tax withheld contributes to the
following two federal programs.
Social security, which provides payments for

retirees, survivors, and disability insurance.
(Assume 6% on all earnings.)
Medicare, which provides health insurance
benefits for senior citizens. (Assume 1.5% on
all earnings.)
LO 2

John T. McGraths earnings for the week
ending December 27 are $1,462. Total FICA
tax to be withheld is calculated as follows:
Earnings subject to 6%
social security tax
Social security tax rate
Social security tax
Earnings subject to 1.5%
Medicare tax
Medicare tax rate
Medicare tax
Total FICA tax
$1,462
x 6%
$ 87.72
$1,462
x 1.5%
LO 2
Computing Employee Net Pay

John T. McGraths Net Pay:
Gross earnings for the week
Deductions:
Social security tax
Medicare tax
Federal income tax
Retirement savings
United Fund
Total deductions
Net pay
$1,462.00
$ 87.72
21.93
258.90
20.00
5.00
393.55
$1,068.45
21.93
$109.65
LO 2
Liability for Employers Payroll Taxes

Employers are subject to the following
payroll taxes for amounts paid their
employees:
Describe payroll
accounting systems that
use a payroll register,
employee earnings
records, and a general
journal.
FICA Tax
Federal Unemployment Compensation Tax
(FUTA)
State Unemployment Compensation Tax
(SUTA)
LO 3
Accounting Systems for Payroll and Payroll Taxes

Payroll systems should be designed to:
LO 3
Payroll Register
The payroll register is a multicolumn report
used for summarizing the data for each
payroll period.
Pay employees accurately and timely.

Meet regulatory requirements of federal,
state, and local agencies.
Provide useful data for management
decision-making needs.
LO 3
Recording Employees Earnings
LO 3
Recording and Paying Payroll Taxes

Employers must match the employees social security
and Medicare tax contributions. In addition, the
employer must pay SUTA tax of 5.4% and FUTA tax of
0.8% (assume on $2,710). For McDermott Supplys
payroll of December 27, these payroll taxes are
Social security tax
Medicare tax
SUTA
FUTA
Total payroll taxes
$ 834.12
208.53
146.34
21.68
$1,210.67
($13,902 x 6%)
($13,902 x 1.5%)
($2,710 x 5.4%)
($2,710 x 0.8%)
LO 3
Employees Earnings Record
LO 3
Internal Controls for Payroll Systems
A detailed payroll record must be kept for

each employee. This record is called an
employees earnings record.
Some examples of payroll controls include

the following:
If a check-signing machine is used, blank
payroll checks and access to the machine
should be restricted to prevent their theft or
misuse.
The hiring and firing of employees should be
properly authorized and approved in
writing.
(continued)
LO 3
Internal Controls for Payroll Systems

All changes in pay rates should be properly
authorized and approved in writing.
Employees should be observed when
arriving for work to verify that employees are
checking in for work only once and only
for themselves.
Payroll checks should be distributed by
someone other than employee supervisors.
Journalize entries for

employee fringe
benefits, including
vacation pay and
pensions.
(concluded)
LO 4
Employees Fringe Benefits

Many companies provide their employees
benefits in addition to salary and wages
earned. Such fringe benefits may include:
Vacation pay (sometimes called
compensated absences)
Medical benefits
Retirement benefits
LO 4
Vacation Pay
Assume that employees earn one day of
vacation for each month worked. The estimated
vacation pay for the year ending December 31
is $325,000. The adjusting entry for the accrued
vacation is shown below.
LO 4
Pensions
LO 4
Pensions
A pension is a cash payment to retired

employees. Pension rights are accrued by
employees as they work, based on the
employers pension plan. Two types of
pension plans are:
Defined contribution plan
Defined benefit plan
In a defined contribution plan, the

company invests contributions on behalf of
the employee during the employees
working years.
Normally, the employee and employer
contribute to the plan.
The employees pension depends on the
total contributions and the investment
returns earned on those contributions.
LO 4
Pensions
LO 4
Pensions
In a defined benefit plan, the employer is
obligated to pay for (fund) the employees
future pension benefits.
Heaven Scent Perfumes Company contributes

10% of employee monthly salaries to an
employee 401K plan. Assuming $500,000 of
monthly salaries, the journal entry to record the
monthly contribution is shown below.
Many companies are replacing their defined

benefit plans with defined contribution plans.
A retired employee receives a specific
amount based on his or her salary history and
years of service.
LO 4
Pensions
The defined benefit plan of Hinkle Co. requires an
annual pension cost of $80,000. The annual
contribution is based on estimates of Hinkles
future pension liability. On December 31, Hinkle
Co. pays $60,000 to the pension fund. The entry to
record the payment and unfunded liability is shown
below.
Describe the
accounting treatment
for contingent liabilities
and journalize entries
for product warranties.
LO 5
Contingent Liabilities
LO 5
Some liabilities may arise from past

transactions if certain events occur in the
future. These potential obligations are
called contingent liabilities. The accounting
for contingent liabilities depends on the
following two factors:
During June, a company sold a product for

$60,000 that includes a 36-month warranty for
repairs. The average cost of repairs over the
warranty period is 5% of the sales price. The
entry to record the estimated product warranty
expense for June is shown below.
1. Likelihood of occurring: probable,

reasonably possible, or remote
2. Measurement: estimable or not estimable
LO 5
If a $200 part is replaced under warranty on

August 16, the entry is as follows:
Describe and illustrate

the use of the quick
ratio in analyzing a
companys ability to pay
its current liabilities.
LO 6
Quick Ratio
Quick Ratio
Current position analysis helps creditors

evaluate a companys ability to pay its
current liabilities. It is based on:
The quick ratio measures the instant debtpaying ability of a company and is
Quick Assets
Quick Ratio =
Current Liabilities
Working capital, the excess of current assets

over current liabilities
Current ratio, determined by dividing the
current assets by the current liabilities
Quick ratio, an indicator of a companys
short-term liquidity
Quick assets are cash and other current

assets that can be easily converted to
cash.
Current Liabilities and Payroll
The End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

Current Liabilities and Payroll

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Current Liabilities and Payroll

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Learning Objective 1

Current Liabilities and Payroll

Describe and illustrate

Prepared by: C. Douglas Cloud

When a company or a bank advances

Accounts payable transactions arise from

Current Portion of Long-Term Debt

Short-Term Notes Payable

Short-Term Notes Payable

Short-Term Notes Payable

When the note matures, the entry to record the

On May 1, Bowden Co.

Coker Co. (Creditor)

Accounts Receivable 10,000

Short-Term Notes Payable

Short-Term Notes Payable

Bowden Co. (Borrower)

Bowden Co. (Borrower)

Coker Co. (Creditor)

On July 30, Bowden

Coker Co. (Creditor)

Short-Term Notes Payable

Short-Term Notes Payable

Short-Term Notes Payable

Short-Term Notes Payable

A discounted note has the following

3. The debtor (borrower) receives the face

Short-Term Notes Payable

Short-Term Notes Payable

On August 10, Cary Company issues a $20,000,

The entry when Cary Company pays the

Payroll and Payroll Taxes

Liability for Employee Earnings

Liability for Employee Earnings

Salary usually refers to payment for

John T. McGrath is employed by McDermott

Deductions from Employee Earnings

Deductions from Employee Earnings

The total earnings of an employee for a

The Federal Insurance Contributions Act

Social security, which provides payments for

Deductions from Employee Earnings

Computing Employee Net Pay

Liability for Employers Payroll Taxes

Accounting Systems for Payroll and Payroll Taxes

Pay employees accurately and timely.

Recording Employees Earnings

Recording and Paying Payroll Taxes

Employees Earnings Record

Internal Controls for Payroll Systems

A detailed payroll record must be kept for

Some examples of payroll controls include

Internal Controls for Payroll Systems

Journalize entries for

Employees Fringe Benefits

A pension is a cash payment to retired

In a defined contribution plan, the

Heaven Scent Perfumes Company contributes

Many companies are replacing their defined

Some liabilities may arise from past

During June, a company sold a product for

1. Likelihood of occurring: probable,

If a $200 part is replaced under warranty on

Describe and illustrate