Chapter 11

1. © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. Chapter 11 Current Liabilities Accounting, 21st Edition Warren Reeve Fess PowerPoint Presentation by Douglas CloudProfessor Emeritus of AccountingPepperdine University

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3. Objectives 1.Define and give examples of current liabilities. 2.Prepare journal entries for short-term notes payable and disclosure for the current portion of long-term debt. 3.Describe the accounting treatment for contingent liabilities and journalize entries for product warranties. 4.Determine employer liabilities for payroll, including liabilities arising from employee earnings and deductions from earnings. After studying this chapter, you should be able to:

4. Objectives 5.Describe payroll accounting systems that use a payroll register, employee earnings record, and a general journal. 6.Journalize entries for employee fringe benefits, including vacation pay and pensions. 7.Use the quick ratio to analyze the ability of a business to pay its current liabilities.

5. The Nature of Current Liabilities Liabilities that are to be paid out of current assets and are due within a short time, usually within one year, are called current liabilities. • Accounts payable • Notes payable • Unearned rent • Taxes payable • Wages payable • Current portion of long term debt Examples:

6. Short-Term Notes Payable A firm issues a 90-day, 12% note for $1,000, dated August 1, 2006 to Murray Co. for a $1,000 overdue account. Aug. 1 Accounts Payable—Murray Co. 1 000 00 Notes Payable 1 000 00 Issued a 90-day, 12% note on account.

7. Short-Term Notes Payable On October 30, when the note matures, the firm pays the $1,000 principal plus $30 interest ($1,000 x .12 x 90/360). Oct. 30 Notes Payable 1 000 00 Interest Expense 30 00 Appears on the income statement as an “Other Expense.” Cash 1 030 00 Issued a 90-day, 12% note on account.

8. Bowden Co. (Borrower) Coker Co. (Creditor) Description Debit Credit Description Debit Credit Short-Term Notes Payable Mdse. Inventory 10,000 Accounts Payable 10,000 Accounts Receivable 10,000 Sales 10,000 Cost of Mdse. Sold 7,500 Mdse. Inventory 7,500 May 31. Bowden Co. purchased merchandise on account from Coker Co., $10,000, 2/10, n/30. The merchandise cost Coker Co. $7,500.

9. Coker Co. (Creditor) Description Debit Credit Short-Term Notes Payable Bowden Co. (Borrower) Coker Co. (Creditor) Description Debit Credit Mdse. Inventory 10,000 Accounts Payable 10,000 Accounts Receivable 10,000 Sales 10,000 Cost of Mdse. Sold 7,500 Mdse. Inventory 7,500 Accounts Receivable 10,000 Sales 10,000 Cost of Mdse. Sold 7,500 Mdse. Inventory 7,500 Accounts Payable 10,000 Notes Payable 10,000 Notes Receivable 10,000 Accounts Receivable 10,000 May 31. Bowden Co. issued a 60-day, 12% note for $10,000 to Coker on account.

10. Short-Term Notes Payable Bowden Co. (Borrower) Coker Co. (Creditor) Description Debit Credit Description Debit Credit July 30. Bowden Co. paid Coker Co. the amount due on the note of May 31. Interest: $10,000 x 12% x 60/360 = $200. Mdse. Inventory 10,000 Accounts Payable 10,000 Accounts Receivable 10,000 Sales 10,000 Cost of Mdse. Sold 7,500 Mdse. Inventory 7,500 Accounts Payable 10,000 Notes Payable 10,000 Notes Receivable 10,000 Accounts Receivable 10,000 Notes Payable 10,000 Interest Expense 200 Cash 10,200 Cash 10,200 Interest Revenue 200 Notes Receivable 10,000

11. Discounted Notes Payable On August 10, Cary Company issues a $20,000, 90-day note to Rock Company in exchange for inventory. Rock discounts the note at 15%. Aug. 10 Merchandise Inventory 19 250 00 Interest Expense 750 00 Proceeds Discount: $20,000 x .15 x 90/360 Notes Payable 20 000 00 Issued a 90-day, note to Rock Co. discounted at 15%. Discount rate

12. Discounted Notes Payable On November 8 the note is paid in full. Nov. 8 Notes Payable 20 000 00 Cash 20 000 00 Paid note due.

13. Contingent Liabilities

14. Product Liability On June 30, a company sells a product for $60,000 on which there is a 36-month warranty. Past experience indicates that repairs of defects cost 5% of the sales price over the warranty period. June 30 Product Warranty Expense 3 000 00 Product Warranty Liability 3 000 00 Warranty expenses projected for June, 5% of $60,000.

15. Product Liability On August 16, a customer needed a defective part replaced. Cost to the company was $200 for the part. Aug. 16 Product Warranty Payable 200 00 Supplies 200 00 Replaced defective part under warranty.

16. Record Liability Estimable Probable Not Estimable Disclose Liability Disclose Liability Possible Accounting Treatment of Contingent Liabilities Likelihood of Occurring Accounting Treatment Measurement Contingency

17. Payroll and Payroll Taxes

18. Liability for Employee Earnings Payroll is the amount paid to employees for services provided. Payrolls are important because-- 1.Good employee relationsdemand that payrolls be calculated accurately and paid as scheduled. 2. Payroll expenditures are subject to a variety of federal, state, and local taxes. 3. Total payroll expense (gross payroll plus payroll taxes) has a major impact on net income.

19. Earnings at base rate (40 x $34) $1,360 Earnings at overtime rate (2 x $51) 102 Total earnings $1,462 Gross Pay Calculation 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.

20. FICA Tax Employers are required to withhold a portion of the earnings of each of the employees. The amount is matched by the employer and serves to provide the employee with social security and Medicare benefits upon retirement.

21. FICA Tax Calculation Assume that John T. McGrath’s annual earnings prior to the current period total $99,038. His current period earnings are $1,462. Earnings subject to 6% social security tax ($100,000 – $99,038) $962 Social security tax rate x 6% Social security tax $57.72 Earnings subject to 1.5% Medicare tax Current earnings $1,462 Medicare tax rate x 1.5% Medicare tax 21.93 Total FICA tax $79.65

22. Withholding Taxes, Other Deductions • Employers are required to withholdfederal income tax from each employee based on the withholding table and information provided by the employee’s W-4 form. • Federal income taxand FICA taxmust be withheld from the pay of each employee. • Deductions for other purposesmay be withheld by mutual agreement.

23. Gross earnings for the week $1,462.00 Deductions: Social security tax tax $ 57.72 Medicare tax 21.93 Federal income tax 279.51 Retirement savings 20.00 United Way 5.00 Total deductions 384.16 Net pay$1,077.84 Employee Net Pay Calculation John T. McGrath is single, has declared one withholding allowance, and had gross pay of $1,462 for the week ended December 27.

24. BUSINESS EMPLOYEE Social security tax Medicare tax Federal unemployment compensation tax State unemployment compensation tax Social security tax Medicare tax Federal withholding tax GOVERNMENT Responsibility for Tax Payments

25. Corporate income tax Estate, gift, and other FICA and FUTA 8% 8% 38% 46% Personal income tax Federal Income

26. Physical, human, and community development Interest on debt Social programs 8% 13% National defense 19% 24% 33% 3% Social security and Medicare Law enforcement and general government Federal Outlays

27. Payroll Register It’s a multicolumn form used to help assemble and summarize the data needed for each payroll period. What is the purpose of a payroll register?

28. Payroll Register Summary Earnings: Regular $13,328.00 Overtime 574.00 Total $13,902.00 Deductions: Social security tax $ 643.07 Medicare tax 208.53 Federal income tax 3,332.00 Retirement savings 680.00 United Way 470.00 Accounts receivable 50.00 Total 5,383.60 Net amount paid $ 8,518.40 Accounts debited: Sales Salaries Expense $11,122.00 Office Salaries Expense 2,780.00 Total (as above) $13,902.00

29. Recording Employees’ Earnings Dec. 27 Sales Salaries Expense 11 122 00 Office Salaries Expense 2 780 00 Social Security Tax Payable 643 07 Medicare Tax Payable 208 53 Employees Federal Inc. Tax Pay. 3 332 00 Retirement Savings Ded. Payable 680 00 United Way Deductions Payable 470 00 Accounts Receivable—Fred Elrod 50 00 Salaries Payable 8 518 40 Payroll for week ended December 27.

30. Employer Taxes for the Week Ended December 27 Social security tax $ 643.07 Medicare tax 208.53 State unemployment compensation tax (5.4% x $2,710) 146.34 Federal unemployment compensation tax (0.8% x $2,710) 21.68 Total payroll tax expense $1,019.62 Recording Employer’s Payroll Taxes

31. Recording Employer’s Payroll Taxes Dec. 27 Payroll Tax Expense 1 019 62 Social Security Tax Payable 643 07 Medicare Tax Payable 208 53 State Unemployment Tax Payable 146 34 Federal Unemployment Tax Pay. 21 68 Payroll taxes for week ended December 27.

32. Wage and Tax Statements W-2 W-2 EMPLOYEES’ EARNINGS RECORDS Current Period’s Variables (hours worked) Payroll Tax Returns Updated Variables (cumulative earnings, taxes) PAYROLL REGISTER Payroll Checks and Statements Constant Data (rates of pay, tax, etc.) Financial Statements GENERAL LEDGER Flow of Data in a Payroll System

33. Employees’ Fringe Benefits

34. Benefit Dollars as a Percent of Total Other 2% Retirement and savings plans 18% Vacation and sick pay 29% 25% Social security and Medicare 26% Medical

35. Employees’ Fringe Benefits Vacation payVacation pay becomes the employer’s liability as the employee earns vacation rights. PensionsCash payment to retired employees. Could be a defined contribution plan or a defined benefit plan Postretirement BenefitsIn addition to pension benefits, employees may earn rights to other postretirement benefits such as dental care, eye care, life insurance, etc. Amount is recorded by debiting Postretirement Benefits Expense and crediting cash.

36. Pensions Defined contribution planUnder this plan, a fixed amount of money is invested on the employee’s behalf during the employee’s working years. Example: 401K Defined benefit planUnder this plan, the pension benefits are based on a formula and the employer bears the investment risk in funding a future retirement income benefit.

37. Quick assets Current liabilities Solvency Measures — Quick Ratio Noble Co. Hart Co. Quick assets: Cash $ 100,000 $ 55,000 Cash equivalents 47,000 65,000 Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000 Current liabilities $220,000 $740,000

38. Solvency Measures — Quick Ratio Noble Co. Hart Co. Quick assets: Cash $ 100,000 $ 55,000 Cash equivalents 47,000 65,000 Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000 Current liabilities $220,000 $740,000 Quick assets Current liabilities $231,000 Noble Company $220,000 Quick ratio = 1.05

39. Solvency Measures — Quick Ratio Noble Co. Hart Co. Quick assets: Cash $ 100,000 $ 55,000 Cash equivalents 47,000 65,000 Accounts receivable (net) 84,000 472,000 Total $231,000 $592,000 Current liabilities $220,000 $740,000 Quick assets Current liabilities $592,000 Hart Company $740,000 Quick ratio = 0.80 Use: To indicate instant debt-paying ability

40. Chapter 11 The End