Chapter Nine Accounting for Current Liabilities and Payroll McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Notes Payable and the Going Concern Assumption Do companies estimate the amount of payables that they are going to pay? Under the going concern assumption, companies expect to pay their obligations in full. 9-1

On September 1, 2013, Herrera Supply Company (HSC) borrowed $90,000 from the National Bank. 1.Increase assets (cash). 2.Increase liabilities (notes payable). 9-2

On December 31, 2013, HSC must accrue (recognize) four months of interest expense. 1.Increase liabilities (interest payable). 2.Decrease equity (interest expense). 9-3

On August 31, 2014, the maturity date of the note, three events are recognized. First, $5,400 of interest expense has accrued since January 1, Increase liabilities (interest payable). 2.Decrease stockholders’ equity (retained earnings). 9-4

Second, cash is paid for $8,100, the total amount of interest due on the note. 1.Decrease assets (cash). 2.Decrease liabilities (interest payable). 9-5

Third, HSC must recognize the repayment of the $90,000 principal of the note. 1.Decrease assets (cash). 2.Decrease liabilities (notes payable). 9-6

Sales Tax Most states require retailers to collect sales tax on goods sold to their customers. Retailers collect the tax from customers and remit the tax to the state at regular intervals. 9-7

9-8

Warranty Obligations Generally within the warranty period, the seller promises to replace or repair defective products without charge to the customer. Event 1 Sale of Merchandise HSC sells $7,000 of merchandise for cash. The merchandise had cost the company $4,

Warranty Obligations Event 2 Recognition of Warranty Expense The company estimates that warranty expense associated with the current sale will be $

Warranty Obligations Event 3 Settlement of Warranty Obligation The company pays $40 cash to repair defective merchandise returned by a customer. 9-11

Identifying Employees People who perform work for your business are employees. Correct? Not necessarily. When a business supervises, directs, and controls an individual’s work, the individual is an employee of the business. When a business pays an individual for specific services, but the individual supervises and controls the work, then that individual is an independent contractor. 9-12

Social Security and Medicare (FICA) Taxes The Federal Insurance Contributions Act (FICA) provided funding for Social Security and Medicare programs. Approximately 7 ½% of each employee’s gross pay is withheld for FICA tax, and the employer pays an additional 7 ½ %. 9-13

Payroll Taxes Payroll taxes only apply to employees. Companies are not required to withhold taxes from or pay taxes on work done by independent contractors. Employers withhold federal, state, and sometimes local income taxes, as well as FICA (Social Security and Medicare) taxes from employees, and then remit those taxes to the taxing authorities. They also pay unemployment taxes and the employer portion of FICA taxes. 9-14

Recording Payroll Account TitleDebitCredit Salary Expense 6,000 Employee Income Tax Payable 450 FICA Tax - Social Security Payable 360 FICA Tax - Medicare Payable 90 Medical Insurance Premiums Payable 320 American Cancer Society Payable 25 Cash 4,

Payroll Tax Expense FICA tax expense—Social Security ($6,000 X 6%) $360 FICA tax expense—Medicare ($6,000 X 1.5%) 90 Federal unemployment tax expense ($1,000 X.8%) 8 State unemployment tax expense ($1,000 X 5.4%) 54 Total payroll tax expense $

Fringe Benefits Account TitleDebitCredit Vacation Pay Expense 200 Employee Medical Insurance Expense 250 Employee Pension Expense 150 Vacation Pay Payable 200 Employee Medical Insurance Payable 250 Employee Pension Liability

Current Versus Noncurrent Current assets are expected to be converted to cash or consumed within one year or an operating cycle, whichever is longer. Current assets include: CashCash Marketable SecuritiesMarketable Securities Accounts ReceivableAccounts Receivable Short-Term Notes ReceivableShort-Term Notes Receivable Interest ReceivableInterest Receivable InventoryInventory SuppliesSupplies PrepaidsPrepaids CashCash Marketable SecuritiesMarketable Securities Accounts ReceivableAccounts Receivable Short-Term Notes ReceivableShort-Term Notes Receivable Interest ReceivableInterest Receivable InventoryInventory SuppliesSupplies PrepaidsPrepaids 9-18

Current Versus Noncurrent Current liabilities are due within one year or an operating cycle, whichever is longer. Current liabilities include: Accounts PayableAccounts Payable Short-Term Notes PayableShort-Term Notes Payable Wages PayableWages Payable Taxes PayableTaxes Payable Interest PayableInterest Payable Accounts PayableAccounts Payable Short-Term Notes PayableShort-Term Notes Payable Wages PayableWages Payable Taxes PayableTaxes Payable Interest PayableInterest Payable 9-19

Current Ratio = Current Asset Current Liabilities For Limbaugh Company the current ratio is: Current Ratio = $288,600 $193, :1 = 1.49:1 9-20

Liquidity vs. Solvency Liquidity describes the ability to generate sufficient short-term cash flows to pay obligations as they come due. Solvency is the ability to repay liabilities in the long run. Liquidity is often measured by the current ratio. Solvency is often measured by the debt to assets ratio. 9-21

Discount Notes Discount notes are ones in which the interest is withheld from the proceeds when the note is issued. The face value of the note is the amount that will be repaid at maturity. 9-22

End of Chapter Nine 9-23