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Chapter 7

Liabilities. Chapter 7. Learning Objectives. Explain the characteristics of a liability. Account for compensated absences . Understand and record payroll taxes and deductions. Record property taxes. Account for warranty costs.

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Chapter 7

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  1. Liabilities Chapter 7

  2. Learning Objectives • Explain the characteristics of a liability. • Account for compensated absences. • Understand and record payroll taxes and deductions. • Record property taxes. • Account for warranty costs. • Explain the terms “probable,” “reasonably possible,” and “remote” related to contingencies. • Record and report a loss contingency. • Disclose a gain contingency.

  3. Learning Objectives 10. Explain the reasons for issuing long-term liabilities. 11. Understand the characteristics of bonds payable. 12. Record the issuance of bonds. 13. Amortize discounts and premiums under the straight-line method. 14. Compute the selling price of bonds. 15. Amortize discounts and premiums under the effective interest method. 16. Explain extinguishment of liabilities. 17. Understand bonds with equity characteristics. 18. Account for long-term notes payable. 19. Understand the disclosure of long-term liabilities.

  4. Liabilities Defined by SFAC No. 6 as: Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

  5. Three Essential Characteristics of a Liability • It involves a present duty or responsibility of the company to one or more entities that will be settled by the probable future transfer or use of assetsat a specified or determinable date, on occurrence of a specific event, or on demand. • The duty or responsibility obligates the company, leaving it littleor no discretion to avoid the future sacrifice. • The transaction or other event obligating the company has already happened.

  6. Liabilities - Implicit Interest • Interest that is not explicitly specified in the terms of the liability. • Need not be recognized.

  7. Current Liabilities Current liabilities are obligations whose liquidation is expected to require the use of existing current assets or the creation of other current liabilities within one year or an operating cycle, whichever is longer.

  8. Accounts payable • Notes payable • Currently maturing portion of long-term debt • Dividends payable • Advances and refundable deposits • Accrued items • Unearned items Type of Current Liabilities Having Contractual Amount

  9. Sales (use) taxes • Payroll taxes • Income taxes • Bonuses Type of Current Liabilities Amount Depends on Operations

  10. Property taxes • Warranties • Premiums and coupons • Other contingencies Type of Current Liabilities Amount Must Be Estimated

  11. Accounts Payable • Obligations arising from the company’s ongoing operations -- includes the acquisition of inventory, supplies, materials and services. • Commonly called trade payables. • Other current payables should be reported separately.

  12. Short-Term Notes Payable • Notes that arise from the same types of transactions as trade payables. • Can be secured or unsecured. • Can be interest-bearing or noninterest-bearing. -- Interest-bearing notes carry a stated rateof interest. -- Noninterest-bearing notes reflect an effective rateof interest or a yield.

  13. Short-Term Notes PayableInterest-Bearing • The rate of interest is specified and is called the stated rate. • The debtor (or borrower) receives cash, other assets, or services. • The debtor repays the face amount of the note plus interest at the stated rate.

  14. Interest-Bearing NotesExample On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 180 days and has a stated interest rate of 9%. Record the borrowing on September 1.

  15. Interest-Bearing NotesExample On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 180 days and has a stated interest rate of 9%. Record the borrowing on September 1.

  16. Interest-Bearing NotesExample How much interest is due to Cooke Bank at year-end, on December 31? a. $2,400 b. $3,600 c. $7,200 d. $87,200

  17. Interest is calculated as: Principal Stated Portion Amount Rate of of Year = of Note Interest Outstanding $80,000 × 9% × 4/12 = $2,400 interest due to Cooke Bank. Interest-Bearing NotesExample How much interest is due to Cooke Bank at year-end, on December 31? a. $2,400 b. $3,600 c. $7,200 d. $87,200

  18. Interest-Bearing NotesExample Assume Eagle Boats’fiscal year-end is December 31. Record the necessary adjustment at year-end.

  19. Interest-Bearing NotesExample Assume Eagle Boats’fiscal year-end is December 31. Record the necessary adjustment at year-end.

  20. Interest-Bearing NotesExample Assume Eagle Boats’fiscal year-end is December 31. Record the necessary journal entry when the note matures on February 28.

  21. Interest-Bearing NotesExample Assume Eagle Boats’fiscal year-end is December 31. Record the necessary journal entry when the note matures onFebruary 28.

  22. Short-Term Notes PayableNoninterest-Bearing • Notes without a stated interest rate carry an implicit, or effective, rate. • The face of the note includes the principal and the interest. • The borrower receives the difference between the face amount and the interest on the note. -- The cash received is the discounted present valueof the face of the note.

  23. Noninterest-Bearing NotesExample On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434. How muchinterest will Batter-Up pay on the note?

  24. Noninterest-Bearing NotesExample On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434. How much interest will Batter-Up pay on the note? Interest = Face Amount - Amount Received = $10,000 - $9,434 = $566

  25. Noninterest-Bearing NotesExample On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434. What is the implicit interest rate on the note?

  26. Noninterest-Bearing NotesExample On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434. What is the implicit interest rate on the note?

  27. Short-Term Liabilities • Scrip Dividends Payable • Accrued Liabilities • Advances and Returnable Deposits • Unearned Revenues

  28. Sales Taxes • Collected from customers on behalf of the state or local governments at the point of sale. Requires a debit to cash and a credit to sales taxes payable. • Held in a liability account until time to make remittance to the taxing authority. Requires a debit to sales taxes payable and a credit to cash.

  29. Sales Taxes Selleroy Company sells merchandise for cash with a retail sales price of $50,000 on which a sales tax of 6% is levied. The company collects $53,000. Cash 53,000 Sales 50,000 Sales Taxes Payable 3,000

  30. Sales Taxes If the sales tax is included in the price charged to the customer Cash 169,000 Sales 169,000 At the end of January the Sales account is adjusted to record the tax on all goods sold [$169,000 - ($169,000 ÷ 1.06)] = $9,600. Sales 9,600 Sales Taxes Payable 9,600

  31. Payroll Taxes • Withholdings from employee pay Employee’s portion of FICA Employee Federal Income Tax Withholdings • Expenses deducted from income Employer portion of FICA Federal Unemployment Tax (FUTA) State Unemployment Tax (SUTA)

  32. Payroll Taxes - EmployeeExamplec Batter-Up, Inc. has 5 employees. Each employee receives a salary of $1,000 per week. The FICA rate is 7.65% and income tax is withheld at the rate of 20%.

  33. Payroll Taxes - EmployeeExample Prepare the journal entry to record the payroll for Batter-Up for the week ending June 14, 2007.

  34. Payroll Taxes - EmployeeExample Prepare the journal entry to record the payroll for Batter-Up for the week ending June 14, 2007.

  35. Payroll Taxes - EmployeeExample Note: The expense to the company is $5,000 while the actual payment to the employees is $3,617.50.

  36. Payroll Taxes - EmployeeExample Note: The employer transfers the tax amounts to the government on the employees’behalf.

  37. Payroll Taxes - EmployerExample Batter-Up, Inc. has also incurred FUTA of $50 and SUTA of $200. Prepare Batter-Up’s journal entry for all of their taxes related to the June 16 payroll.

  38. Payroll Taxes - EmployerExample

  39. Payroll Taxes - EmployerExample Note: The employer matches the FICA that was withheld from the employees’paychecks. In effect, the total FICA tax rate is 15.3%; half is paid by the employee (7.65%) and half is paid by the employer (7.65%).

  40. Property Taxes Ezzell Company closes its books annually each December 31. The fiscal year for the town and county in which the firm is located ends on June 30. The estimated property taxes for the period July 1, 2007, to June 30, 2008, are $7,200. The tax bill is mailed in October with a requirement that the tax be paid before December 31, 2007. The tax bill reported an actual tax of $7,290, and the corporation pays this amount on October 31, 2007.

  41. $7,200 ÷ 12 Property Taxes Three Monthly Entries July 31-September 30, 2007 Property Tax Expense 600 Property Taxes Payable 600 October 31, 2007: Payment of Property Taxes Property Tax Payable 1,800 Prepaid Property Taxes 5,490 Cash 7,290 Three Monthly Entries: October 31-Dec. 31, 2007 Property Tax Expense 610 Prepaid Property Taxes 610

  42. Bonuses Based on Income • Percentage of net income before the bonus -- Multiply the net income before the bonus by the bonus percentage. • Percentage of net income after the bonus -- Algebraically expressed: Bonus = % × (Net Income - Bonus)

  43. BonusExample Linda Ball, Batter-Up’s CEO, Inc. gets a year-end bonus of 15% of net income after deducting her bonus. 2007 Net income is $250,000. Compute Linda’s bonus for 2007.

  44. BonusExample Linda Ball, Batter-Up’s CEO, Inc. gets a year-end bonus of 15% of net income after deducting her bonus. 2007 Net income is $250,000. Compute Linda’s bonus for 2007.

  45. Compensated-Absence Liability • Occurs when unused vacation time is carried over to future years. • An expense/liability must be accrued if four criteria are met: Absence relates to services already performed. Benefits accumulate, or vest. Payment is probable. Amount can be reliably estimated.

  46. Compensated-Absence Liability A vested right exists when an employer has an obligation to make payments to an employee that is not contingent on the employee’s future services.

  47. Compensated-Absence Liability Accumulated rights are those that can be carried forward by the employee to future periods if not taken in the period in which they are earned.

  48. March 31, 2008 Sales Salaries Exp. Compensated Absences 30,000 Office Salaries Exp. Compensated Absences 30,000 Liability for Employees’ Compensation for Future Absences(3/12 x $240,000) 60,000 Compensated-Absence Liability Milton Company has 100 employees who are paid an average of $200 per day. Company policy allows each employee 12 days of paid vacation per year.

  49. Payroll for Time Worked Vacation Taken Sales staff $194,000 $6,000 Office staff 193,000 7,000 Compensated-Absence Liability The $200,000 April 30, 2008, payroll, including paid vacation time taken by the sales and office staff, is as follows: Continued

  50. April 30, 2008 Sales Salaries Expense 194,000 Office Salaries Expense 193,000 Liability for Employees’ Compen- sation for Future Absences 13,000 Cash 400,000 Compensated-Absence Liability

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