prepared by coby harmon university of california, santa...

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Prepared byCoby Harmon

University of California, Santa BarbaraWestmont College

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Learning ObjectivesAfter studying this chapter, you should be able to:[1] Explain a current liability, and identify the major types of current liabilities.[2] Describe the accounting for notes payable.[3] Explain the accounting for other current liabilities.[4] Explain the financial statement presentation and analysis of current

liabilities.[5] Describe the accounting and disclosure requirements for contingent

liabilities.[6] Compute and record the payroll for a pay period.[7] Describe and record employer payroll taxes.[8] Discuss the objectives of internal control for payroll.

11 Current Liabilities and Payroll Accounting

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Preview of Chapter 11

Accounting PrinciplesEleventh Edition

Weygandt Kimmel Kieso

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Current liability is debt with two key features:

1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities.

2. Company will pay the debt within one year or the operating cycle, whichever is longer.

LO 1 Explain a current liability, and identify the major types of current liabilities.

Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries and

wages payable, and interest payable.

Current Liabilities

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To be classified as a current liability, a debt must be expected to be paid:

a. out of existing current assets.

b. by creating other current liabilities.

c. within 2 years.

d. both (a) and (b).

Question

LO 1 Explain a current liability, and identify the major types of current liabilities.

Accounting for Current Liabilities

11-6 LO 2 Describe the accounting for notes payable.

Notes Payable Written promissory note.

Requires the borrower to pay interest.

Issued for varying periods.


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Illustration: First National Bank agrees to lend $100,000 on September 1, 2014, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1.

Instructions

a) Prepare the entry on September 1st.

b) Prepare the adjusting entry on Dec. 31st, assuming monthly adjusting entries have not been made.

c) Prepare the entry at maturity (Jan. 1, 2015).

LO 2 Describe the accounting for notes payable.


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Notes Payable 100,000Cash 100,000

Interest Payable 4,000Interest Expense 4,000

$100,000 x 12% x 4/12 = $4,000

b) Prepare the adjusting entry on Dec. 31st.



a) Prepare the entry on Sept. 1st.


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Cash 104,000



c) Prepare the entry at maturity.

Interest Payable 4,000Notes Payable 100,000


11-10 LO 3 Explain the accounting for other current liabilities.

Sales Taxes Payable Sales taxes are expressed as a stated percentage of

the sales price.

Either rung up separately or included in total receipts.

Retailer collects tax from the customer.

Retailer remits the collections to the state’s department of revenue.


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Illustration: The March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is:

Sales Revenue 10,000Cash 10,600

Sales Taxes Payable 600

LO 3 Explain the accounting for other current liabilities.


11-12 LO 3 Explain the accounting for other current liabilities.

Unearned RevenueRevenues received before the company

delivers goods or

provides services. Illustration 11-2


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Illustration: Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The university makes the following entry for the sale of season tickets:


Unearned Ticket Revenue 500,000Cash 500,000Aug. 6

Ticket Revenue 100,000Unearned Ticket Revenue 100,000Sept. 7

As the school completes each of the five home games, it would record the revenue earned.


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Current Maturities of Long-Term Debt Portion of long-term debt that comes due in the current

year.

No adjusting entry required.



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Statement Presentation

Illustration 11-3


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Working capital is calculated as:

a. current assets minus current liabilities.

b. total assets minus total liabilities.

c. long-term liabilities minus current liabilities.

d. both (b) and (c).

Question

LO 4 Explain the financial statement presentation and analysis of current liabilities.


11-17 LO 4 Explain the financial statement presentation and analysis of current liabilities.

Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for

cash.

Current ratio permits us to compare the liquidity of

different-sized companies and of a single company at

different times.

Illustration 11-5

Illustration 11-4

Analysis


11-18 LO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Potential liability that may become an actual liability in the future.

Three levels of probability: Probable.

Reasonably possible.

Remote.

Contingent Liabilities

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AccountingProbability

Accrue

Footnote

Ignore

Probable

ReasonablyPossible

Remote

LO 5 Describe the accounting and disclosure requirements for contingent liabilities.


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A contingent liability should be recorded in the accounts when:a. it is probable the contingency will happen, but the

amount cannot be reasonably estimated.b. it is reasonably possible the contingency will happen,

and the amount can be reasonably estimated.c. it is probable the contingency will happen, and the

amount can be reasonably estimated.d. it is reasonably possible the contingency will happen,

but the amount cannot be reasonably estimated.



Question

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Product Warranties

Promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product.

Recording a Contingent Liability

Estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs.



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Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2014, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, compute the estimated warranty liability.

LO 5

Illustration 11-6Computation of estimatedproduct warranty liability


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Warranty Expense 40,000


Warranty Liability 40,000

Illustration: Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2014, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, compute the estimated warranty liability. Make the required adjusting entry.


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Illustration: Prepare the entry to record the repair costs incurred in 2014 to honor warranty contracts on 2014 sales.



Repair Parts 24,000

Assume that the company replaces 20 defective units in January 2015, at an average cost of $80 in parts and labor.


Repair Parts 1,600


11-26 LO 5 Describe the accounting and disclosure requirements for contingent liabilities.

Disclosure of Contingent Liabilities


Illustration 11-7

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“Payroll” pertains to both:

Salaries - managerial, administrative, and sales personnel (monthly or yearly rate).

Wages - store clerks, factory employees, and manual laborers (rate per hour).

Involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay.

Payroll Accounting

Determining the Payroll

LO 6 Compute and record the payroll for a pay period.

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Total compensation earned by an employee (wages or salaries, plus any bonuses and commissions).

Gross Earnings


Illustration 11-8


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Payroll Deductions


Voluntary: Charity

Insurance

Union dues

Pension plans


Mandatory: FICA taxes

Federal income taxes

State income taxes

11-30 LO 6 Compute and record the payroll for a pay period.

Social Security taxes Supplemental retirement,

employment disability, and medical benefits.

The FICA rate is 7.65%: Social Security (6.2% on

salary and wages up to $110,100).

Medicare (1.45% on all salary and wages without limitation).

Payroll Deductions



State income taxes



Employers are required to withhold income taxes from employees’ pay.

Withholding amounts are based on gross wages and the number of allowances claimed.


Payroll Deductions



State income taxes


Most states (and some cities) require employers to withhold income taxes from employees’ earnings.


Payroll Deductions



State income taxes

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Gross earnings minus payroll deductions.

Net Pay


Illustration 11-13


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An employer must keep a cumulative record of each employee’s gross earnings, deductions, and net pay during the year.

Maintaining Payroll Department Records

Recording the Payroll

LO 6

Illustration 11-14

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Many companies find it useful to prepare a payroll register.

Maintaining Payroll Department Records

Illustration 11-13

LO 6


Illustration 11-15

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Illustration: Prepare the entry Academy Company would make to record the payroll for the week ending January 14.

Recognizing Payroll Expenses and Liabilities


Salaries and Wages Expense 17,210.00

Federal Income taxes Payable 3,490.00

FICA Taxes Payable 1,316.67

State Income Taxes Payable 344.20

United Way Payable 421.50

Union Dues Payable 115.00

Salaries and Wages Payable 11,522.73


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Illustration: Prepare the entry Academy Company would make to record the payment of the payroll.

Recording Payment of the Payroll


Salaries and Wages Payable 11,522.73

Cash 11,522.73



Illustration 11-16Paycheck and statement ofearnings


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Payroll tax expense results from three taxes that governmental agencies levy on employers.

LO 7

These taxes are:

FICA taxes

Federal unemployment taxes

State unemployment taxes

Employer Payroll Taxes

Social Security taxes Supplemental retirement,

employment disability, and medical benefits.

The FICA rate is 7.65%: Social Security (6.2% on

salary and wages up to $110,100).

Medicare (1.45% on all salary and wages without limitation).

11-40 LO 7 Describe and record employer payroll taxes.

FUTA tax rate is 6.2% of first $7,000 of taxable wages.

Employers who pay the state unemployment tax on a timely basis will receive an offset credit of up to 5.4%. Therefore, the net federal tax rate is generally 0.8%.



These taxes are:

FICA taxes



11-41 LO 7 Describe and record employer payroll taxes.

SUTA basic rate is usually 5.4% on the first $7,000 of wages paid.



These taxes are:

FICA taxes



Helpful Hint Both the employer and employee pay FICA taxes. Federal unemployment taxes and (in most states) the state unemployment taxes areborne entirely by the employer.

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Illustration: Academy records the payroll tax expense associated with the January 14 payroll with the following entry. Use the following rates: FICA 7.65%, state unemployment 5.4%, federal unemployment 0.8%.

Payroll Tax Expense 2,383.59

State Unemployment Taxes Payable 929.34

FICA Taxes Payable 1,316.57

** $17,210.00 x 5.4% = $929.34

* $ 17,210.00 x 7.65% = $1,316.57

Federal Unemployment Taxes Payable 137.68

*

*** $17,210 x .8% = $137.68

**

***

LO 7 Describe and record employer payroll taxes.


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Employer payroll taxes do not include:

a. Federal unemployment taxes.

b. State unemployment taxes.

c. Federal income taxes.

d. FICA taxes..

Question



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Companies must report FICA taxes and federal income taxes withheld no later than one month following the close of each quarter.

Companies generally file and remit federal unemployment taxes annually on or before January 31 of the subsequent year. Companies usually file and pay state unemployment taxes by the end of the month following each quarter.

Employers must provide each employee with a Wage and Tax Statement (Form W-2) by January 31.


Filing and Remitting Payroll Taxes

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The Missing ControlHuman Resource Controls. Thorough background checks should be performed. No employees should begin work until they have been approved by the Board of Education and entered into the payroll system. No employees should be entered into the payroll system until they have been approved by a supervisor. All paychecks should be distributed directly to employees at the official school locations by designated employees. Independent internal verification. Budgets should be reviewed monthly to identify situations where actual costs significantly exceed budgeted amounts.Source: Adapted from Wells, Fraud Casebook (2007), pp. 164–171.

Total take: $150,000

ANATOMY OF A FRAUD

Art was a custodial supervisor for a large school district. The district was supposed to employ between 35 and 40 regular custodians, as well as 3 or 4 substitute custodians to fill in when regular custodians were missing. Instead, in addition to the regular custodians, Art “hired” 77 substitutes. In fact, almost none of these people worked for the district. Instead, Art submitted time cards for these people, collected their checks at the district office, and personally distributed the checks to the “employees.” If a substitute’s check was for $1,200, that person would cash the check, keep $200, and pay Art $1,000.

11-47 LO 8 Discuss the objectives of internal control for payroll.

Internal Control for Payroll

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In addition to the three payroll-tax fringe benefits, employers incur other substantial fringe benefit costs.

Two important fringe benefits include:

Paid absences

Post-retirement benefits

LO 9 Identify additional fringe benefits associated with employee compensation.

APPENDIX

Additional Fringe Benefits

APPENDIX 11A Additional Fringe Benefits

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Employees often are given rights to receive compensation for absence when they meet certain conditions of employment.

The compensation may be for paid vacations, sick pay benefits, and paid holidays.

When the payment for such absences is probable and the amount can be reasonably estimated, the company should accrue a liability for paid future absences.

When the amount cannot be reasonably estimated, the company should instead disclose the potential liability.

Paid Absences



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Post-retirement benefits are benefits that employers provide to retired employees for

1. pensions and

2. health care and life insurance.

Companies account for post-retirement benefits on the accrual basis.

APPENDIX


Postretirement Benefits


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A pension plan is an agreement whereby employers provide benefits to employees after they retire.

Two types of pension plans:

1. In a defined-contribution plan, the plan defines the contribution that an employer will make but not the benefit that the employee will receive at retirement. This is often referred to as a 401 (k) plan.

2. In a defined-benefit plan, the employer agrees to pay a defined amount to retirees, based on employees meeting certain eligibility standards.


Pensions


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The basic definition of a liability under GAAP and IFRS is very similar. In a more technical way, liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an out flow from the entity of resources embodying economic benefits. Liabilities may be legally enforceable via a contract or law but need not be; that is, they can arise due to normal business practice or customs.

Key Points

A Look at IFRS

LO 10 Compare the accounting procedures for payroll under GAAP and IFRS.

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IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions). When current liabilities (also called short-term liabilities) are presented, they are generally presented in order of liquidity.

Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months.

Similar to GAAP, items are normally reported in order of liquidity. Companies sometimes show liabilities before assets. Also, they will sometimes show long-term liabilities before current liabilities.

Key Points

A Look at IFRS


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Key Points

A Look at IFRS


Under IFRS, companies sometimes will net current liabilities against current liabilities to show working capital on the face of the statement of financial position. (This is evident in the Zetar financial statements in Appendix F.)

Under GAAP, some contingent liabilities are recorded in the financial statements, others are disclosed, and in some cases no disclosure is required. Unlike GAAP, IFRS reserves the use of the term contingent liability to refer only to possible obligations that are not recognized in the financial statements but may be disclosed if certain criteria are met.

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Key Points

A Look at IFRS


For those items that GAAP would treat as recordable contingent liabilities, IFRS instead uses the term provisions. Provisions are defined as liabilities of uncertain timing or amount. Examples of provisions would be provisions for warranties, employee vacation pay, or anticipated losses. Under IFRS, the measurement of a provision related to a uncertain obligation is based on the best estimate of the expenditure required to settle the obligation.

IFRS and GAAP separate plans into defined benefit and defined contribution. The IASB and FASB are working on a joint project on pensions that will dramatically change the approach used by both.

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Looking to the Future

A Look at IFRS

The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities. One project is investigating approaches to differentiate between debt and equity instruments. The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting. The results of these projects could change the classification of many debt and equity securities.


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Which of the following is false?

a) Under IFRS, current liabilities must always be presented before non-current liabilities.

b) Under IFRS, an item is a current liability if it will be paid within the next 12 months.

c) Under IFRS, current liabilities are shown in order of liquidity.

d) Under IFRS, a liability is only recognized if it is a present obligation.

A Look at IFRS

IFRS Self-Test Questions


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A Look at IFRS



Under IFRS, a contingent liability is:

a) disclosed in the notes if certain criteria are met.

b) reported on the face of the financial statements if certain criteria are met.

c) the same as a provision.

d) not covered by IFRS.

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Under IFRS, obligations related to warranties are considered:

a) contingent liabilities.

b) provisions.

c) possible obligations.

d) None of these.

A Look at IFRS



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prepared by coby harmon university of california, santa...

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