Current Liabilities and Payroll Chapter 11 ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-1

Learning Objectives 1.Account for current liabilities of known amount 2.Calculate and journalize basic payroll transactions 3.Account for current liabilities that must be estimated ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-2

Learning Objectives 4.Account for contingent liabilities 5.Use the times-interest- earned ratio to evaluate business performance ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-3

Learning Objective 1 Account for current liabilities of known amount ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-4

Liabilities Best described as: –Debts and obligations owed to others. Three primary characteristics: –They occur as a result of a past transaction or event. –They create a present obligation for future payments. –They are an unavoidable obligation. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-5

Current Liabilities Long-Term Liabilities Will be paid from current assets within one year or the company’s operating cycle, whichever is longer. Due after one year or the company’s operating cycle, whichever is longer. Two Major Categories ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-6

Current Liabilities ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-7

On August 10, Swanson Company recorded $4,000 sales of merchandise inventory on account. The sales were subject to 4% sales tax. Ignore cost of goods sold. Prepare the journal entry to record the sale. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-8

On August 10, Swanson Company recorded $4,000 sales of merchandise inventory on account. The sales were subject to 4% sales tax. Ignore cost of goods sold. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-9

On September 30, Swanson Company owes and pays a total of $500 of sales taxes to the state. Prepare the journal entry to record the payment of the sales taxes to the state. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-10

On September 30, Swanson Company owes and pays a total of $500 of sales taxes to the state. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-11

Learning Objective 2 Calculate and journalize basic payroll transactions ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-12

Accounting for Payroll Employees are typically not paid as they work. Employees are typically paid periodically, after accumulating a quantity of work. Any time employees have worked, but not yet been paid, there is a liability that must be recorded. When employees are paid, they do not receive the gross pay that they have earned. Employers withhold amounts that are due to other parties and the employee only receives what is “left over,” the net amount. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-13

Accounting for Payroll OASDI Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Gross Pay Net Pay ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-14

Amounts withheld depend on the employee’s earnings and the tax rates. Employers owe the income tax amounts withheld from employees’ gross pay to the appropriate government agency. Federal Income Tax State and Local Income Taxes Withholding for Employee Income Tax Top rate of 39.6% on income > $400,000 For example, in some states the state income tax rate is 5%. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-15

OASDI Taxes Medicare Taxes These amounts are due to the federal government following withholding. Withholding for Employee Social Security and Medicare 4.2% Applied to first $110,100 of earned income 1.45% Applied to 100% of income ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-16

Union Dues Savings Accounts Pension Contributions Insurance Premiums Charities Union Dues Savings Accounts Pension Contributions Insurance Premiums Charities Optional Withholding Deductions Amounts withheld depend on the employee’s request. Employers must forward the voluntary deductions withheld from employees’ gross pay to the designated agency. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-17

Recording Payroll This table summarizes the payroll and withholdings for Smart Touch Learning for December. As shown in Exhibit 11-2, a Payroll Register is normally used to accumulate this data. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-18

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11-20©2014 Pearson Education, Inc. Publishing as Prentice Hall

Recording Payroll Typically, the payroll checks will be drawn against a separate payroll checking account that is only used for payroll. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-21

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Employer Payroll Taxes Employers are also required to pay taxes separate from the taxes withheld from employee paychecks.Employers are also required to pay taxes separate from the taxes withheld from employee paychecks. 1.Employers must “match” the FICA amounts withheld from employee paychecks. 2.State & Federal Unemployment Compensation Taxes 7.65% of earnings up to $110,100; 1.45% of earnings in excess of $110, % of first $7,000 of employee earnings ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-24

Unemployment Taxes Unemployment checks are paid out of the Unemployment Insurance Fund.Unemployment checks are paid out of the Unemployment Insurance Fund. Companies pay into the fund monthly (5.6% to the state and 0.60% to the federal government).Companies pay into the fund monthly (5.6% to the state and 0.60% to the federal government). The rate varies with each company’s employment history.The rate varies with each company’s employment history. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-25

Recording Payroll In December, Smart Touch Learning had wages subject to OASDI of $22,880 (one employee went over the $110,000 limit). Wages subject to Medicare were $28,580. FUTA and SUTA were due on $4,000 of wages paid to a new employee. Prepare the journal entry to record the employer’s payroll taxes. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-26

Recording Payroll In December, Smart Touch Learning had wages subject to OASDI of $22,880 (one employee went over the $110,000 limit). Wages subject to Medicare were $28,580. FUTA and SUTA were due on $4,000 of wages paid to a new employee. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-27

Internal Controls for Payroll Efficiency Controls –Payroll is usually automated, rather than prepared by hand. Disbursement Controls –Employees sign for checks or present ID’s. –Hiring and firing is separated from payroll preparation. –Time clocks and direct deposit are also used. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-28

Learning Objective 3 Account for current liabilities that must be estimated ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-29

Accounting for Estimated Liabilities Some liabilities are estimatedSome liabilities are estimated –Bonus Accruals –Vacation and Sick Leave Accruals –Pension expense Accrual –Warranties expense Many liabilities are estimated at year- end, even though actual amounts will not be known until some time after year- end. This is in accordance with the Matching Principle. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-30

O’Conner guarantees its vacuums for four years. Company experience indicates that warranty costs will be approximately 6% of sales. Assume that O’Conner has sales of $200,000 during Prepare the journal entry to record warranty expense. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-31

O’Conner guarantees its vacuums for four years. Company experience indicates that warranty costs will be approximately 6% of sales. Assume that O’Conner has sales of $200,000 during ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-32

Learning Objective 4 Account for contingent liabilities ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-33

Contingent Liabilities POTENTIALA contingent liability is a POTENTIAL liability that depends on a future event. FUTURE PRESENTHow do we disclose a liability that might arise in the FUTURE as a result of something that has occurred in the PRESENT? Suppose Smart Touch Learning is sued because of alleged patent infringement on one of its learning videos. This may need to be disclosed to investors and creditors. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-34

Contingent Liabilities The type of disclosure of a contingent liability depends on two issues:The type of disclosure of a contingent liability depends on two issues: 1.How likely is the future event? 2.Can the amount of the liability be reasonably estimated? If the lawsuit against Smart Touch Learning is frivolous, it does not need to be disclosed. If Smart Touch Learning is likely to lose the lawsuit, then it should be disclosed. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-35

Amount... Contingent Liabilities This table can be used to determine the proper disclosure treatment of a contingent liability. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-36

Other kinds of Contingent Liabilities Co-signing note Lawsuits Guarantees Environmental Clean-up Costs Forward Contracts Contingent Payments in an Acquisition ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-37

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©2014 Pearson Education, Inc. Publishing as Prentice Hall11-39

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©2014 Pearson Education, Inc. Publishing as Prentice Hall11-42

Learning Objective 5 Use the times- interest-earned ratio to evaluate business performance ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-43

Times-Interest-Earned Ratio This ratio is used to evaluate a business’s ability to pay interest expense. A high ratio indicates that the company is better able to pay its interest. ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-44

Times-Interest-Earned Ratio ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-45

Times-Interest-Earned Ratio ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-46

End of Chapter 11 ©2014 Pearson Education, Inc. Publishing as Prentice Hall11-47