Current Liabilities and Payroll: Prepared By: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University

Current Liabilities and Payroll
Chapter 11
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
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Learning Objectives
1. Describe and illustrate current liabilities related to

accounts payable, current portion of long-term debt,
and notes payable.
2. Determine employer liabilities for payroll, including
liabilities arising from employee earnings and
deductions from earnings.
3. Describe payroll accounting systems that use a
payroll register, employee earnings records, and a
general journal.
Learning Objectives
4. Journalize entries for employee fringe benefits,
including vacation pay and pensions.
Learning Objectives
5. Describe the accounting treatment for contingent
liabilities and journalize entries for product
warranties.
Learning Objectives
warranties.
6. Describe and illustrate the use of the quick ratio in
analyzing a company’s ability to pay its current
liabilities.
Learning Objectives
and notes payable.
LO 1
Current Liabilities
 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).
LO 1
Current Liabilities
 Long-term liabilities are debts due beyond one
year.
 Current Liabilities are debts that will be paid out
of current assets and are due within one year.
LO 1
Accounts Payable
 Accounts payable transactions arise from

purchasing goods or services for use in a
company’s operations or from purchasing
merchandise for resale.
LO 1
Accounts Payable
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
Nature’s 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

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:
Interest Expense appears

on the income statement
as an “Other Expense.”
LO 1

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.
LO 1

Bowden Co. (Borrower)
Description Debit Credit
Mdse. Inventory 10,000
Accounts Payable 10,000
Coker Co. (Creditor)

Accounts Receivable 10,000

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

On May 31, Bowden Co. issued a 60-day, 12% note
for $10,000 to Coker Co. on account.
LO 1

Accounts Payable 10,000

Notes Payable 10,000

Notes Receivable 10,000

Accounts Receivable 10,000
LO 1

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).
LO 1

Notes Payable 10,000

Interest Expense 200
Cash 10,200

Cash 10,200
Interest Revenue 200
Notes Receivable 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
 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.
(continued)
LO 1

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)
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).
proceeds
LO 1

The entry when Cary Company pays the
discounted note on November 8 is as follows:
EE 11-1
Learning Objectives
and notes payable.
LO 2
Payroll and Payroll Taxes
 In accounting, payroll refers to the amount paid to

employees for services they provided during the
period. A company’s 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
 Salary usually refers to payment for managerial

and administrative services. Salary is normally
expressed in terms of a month or a year.
LO 2

 Wages usually refers to payment for employee
manual labor. The rate of wages is normally
stated on an hourly or weekly basis.
(concluded)
LO 2

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) $1,360
Earnings at overtime rate (2 x $51) 102
Total earnings $1,462
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.
LO 2
LO 2
John T. McGrath made $1,462 for the week ending

December 27. McGrath’s W-4 (previous slide) claims
one withholding allowance of $70. Thus, the wages
used to determine McGrath’s withholding bracket in
Exhibit 3 (next slide) are $1,392 ($1,462 – $70).
LO 2
EE 11-2
LO 2
 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. McGrath’s 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 $1,462
Social security tax rate x 6%
Social security tax $
87.72
Earnings subject to 1.5%
Medicare tax $1,462
Medicare tax rate x 1.5%
Total FICA tax
Medicare tax $109.65
21.93
LO 2
Computing Employee Net Pay
John T. McGrath’s Net Pay

Gross earnings for the week $1,462.00
Deductions:
Social security tax $ 87.72
Medicare tax 21.93
Federal income tax 258.90
Retirement savings 20.00
United Fund 5.00
Total deductions 393.55
Net pay $1,068.45
EE 11-3
LO 2
Liability for Employer’s Payroll Taxes
 Employers are subject to the following payroll

taxes for amounts paid their employees:
 FICA Tax
 Federal Unemployment Compensation Tax
(FUTA)
 State Unemployment Compensation Tax (SUTA)
LO 2
Liability for Employer’s Payroll Taxes
Learning Objective 3

and notes payable.
3. Describe payroll accounting systems that use a
payroll register, employee earnings records, and a
general journal.
LO 3
Accounting Systems for Payroll and Payroll Taxes
 Payroll systems should be designed to:

 Pay employees accurately and timely.
 Meet regulatory requirements of federal, state,
and local agencies.
 Provide useful data for management decision-
making needs.
LO 3
Payroll Register
 The payroll register is a multicolumn report used

for summarizing the data for each payroll period.
Exhibit 5 illustrates a payroll register for
McDermott Supply Co.
LO 3
Payroll Register
(left side, continued)
LO 3
Payroll Register
(right side)
LO 3
Recording Employees’ Earnings
EE 11-4
LO 3
Recording and Paying Payroll Taxes

Employers must match the employee’s 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 Supply’s payroll of December 27, these
payroll taxes are computed as follows:
Social security tax $ 834.12 ($13,902 x 6%)
Medicare tax 208.53 ($13,902 x 1.5%)
SUTA 146.34 ($2,710 x 5.4%)
FUTA 21.68 ($2,710 x 0.8%)
Total payroll taxes $1,210.67
LO 3
Recording and Paying Payroll Taxes

The entry to journalize the payroll tax expense for
Exhibit 5 is shown below.
EE 11-5
LO 3
Employee’s Earnings Record
 A detailed payroll record must be kept for each

employee. This record is called an employee’s
earnings record. Exhibit 6 (next two slides) shows
a portion of John T. McGrath’s employee’s
earnings record.
LO 3
(continued)
LO 3
LO 3
Employee’s Earnings Record
LO 3
Payroll Checks
 At the end of each payroll period, payroll checks

are prepared. Each check includes a detachable
statement showing the details of how the net pay
was computed.
LO 3
LO 3
Payroll System Design
 The inputs into a payroll system may be classified

as:
 Constants, which are data that remain unchanged
from payroll to payroll.
• Employee names
• Social security numbers
 Variables, which are data that change from payroll
to payroll.
• Number of hours or days worked
• Accrued sick leave
LO 3
Internal Controls for Payroll Systems
 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

 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.
(continued)
LO 3

 A special payroll bank account should be used.
(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
 A pension is a cash payment to retired employees.

Pension rights are accrued by employees as they
work, based on the employer’s pension plan. Two
types of pension plans are:
 Defined contribution plan
 Defined benefit plan
LO 4
Pensions
 In a defined contribution plan, the company
invests contributions on behalf of the employee
during the employee’s working years.
 Normally, the employee and employer contribute
to the plan.
 The employee’s pension depends on the total
contributions and the investment returns earned
on those contributions.
LO 4
Pensions
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.
LO 4
Pensions
In a defined benefit plan, the employer is
obligated to pay for (fund) the employee’s future
pension benefits.
 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 Hinkle’s
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.
EE 11-6
LO 4
Postretirement Benefits Other than Pensions
 Employees may earn rights to other

postretirement benefits, such as dental care, eye
care, medical care, life insurance, tuition
assistance, tax services, and legal services.
LO 4
Current Liabilities on the Balance Sheet
warranties.
LO 5
Contingent Liabilities
 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:
1. Likelihood of occurring: Probable, reasonably
possible, or remote
2. Measurement: Estimable or not estimable
LO 5
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.
LO 5
If a $200 part is replaced under warranty on
August 16, the entry is as follows:
EE 11-7
LO 5
warranties.
6. Describe and illustrate the use of the quick ratio in
analyzing a company’s ability to pay its current
liabilities.
LO 6
Quick Ratio
 Current position analysis helps creditors evaluate

a company’s ability to pay its current liabilities. It
is based on:
 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 company’s short-
term liquidity
Quick Ratio
The quick ratio measures the “instant” debt-

paying ability of a company and is computed as
follows:
Quick Assets
Quick Ratio =
Current Liabilities
 Quick assets are cash and other current assets
that can be easily converted to cash.
EE 11-8
(continued)
EE 11-8
Current Liabilities and Payroll
The End
Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting
Pepperdine University

Current Liabilities and Payroll: Prepared By: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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Current Liabilities and Payroll: Prepared By: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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Current Liabilities and Payroll

1. Describe and illustrate current liabilities related to

 When a company or a bank advances credit, it is

 Accounts payable transactions arise from

 Long-term liabilities are often paid back in

Nature’s Sunshine Company issues a 90-day, 12%

Short-Term Notes Payable

Interest Expense appears

Short-Term Notes Payable

Short-Term Notes Payable

Coker Co. (Creditor)

Accounts Receivable 10,000

Short-Term Notes Payable

Short-Term Notes Payable

Accounts Payable 10,000

Coker Co. (Creditor)

Notes Receivable 10,000

Short-Term Notes Payable

Short-Term Notes Payable

Notes Payable 10,000

Coker Co. (Creditor)

Short-Term Notes Payable

Short-Term Notes Payable

 A discounted note has the following

Short-Term Notes Payable

Short-Term Notes Payable

Short-Term Notes Payable

 In accounting, payroll refers to the amount paid to

 Salary usually refers to payment for managerial

Liability for Employee Earnings

Liability for Employee Earnings

 The total earnings of an employee for a payroll

Deductions from Employee Earnings

John T. McGrath made $1,462 for the week ending

Deductions from Employee Earnings

 The Federal Insurance Contributions Act (FICA)

John T. McGrath’s earnings for the week

John T. McGrath’s Net Pay

 Employers are subject to the following payroll

1. Describe and illustrate current liabilities related to

 Payroll systems should be designed to:

 The payroll register is a multicolumn report used

(left side, continued)

Recording and Paying Payroll Taxes

Recording and Paying Payroll Taxes

 A detailed payroll record must be kept for each

 At the end of each payroll period, payroll checks

 The inputs into a payroll system may be classified

 Some examples of payroll controls include the

Internal Controls for Payroll Systems

Internal Controls for Payroll Systems

 Many companies provide their employees benefits

Assume that employees earn one day of vacation

 A pension is a cash payment to retired employees.

Heaven Scent Perfumes Company contributes

Postretirement Benefits Other than Pensions

 Employees may earn rights to other

Current Liabilities on the Balance Sheet

 Some liabilities may arise from past transactions

 Current position analysis helps creditors evaluate

The quick ratio measures the “instant” debt-

Prepared by: C. Douglas Cloud

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