1. Chapter 9 Accounting for Current Liabilities and Payroll
This chapter introduces other liabilities with known amounts due: notes payable, sales tax payable, and payroll liabilities; and contingent liabilities including warranties payable and vacation pay.
Discussion in this chapter is limited to current liabilities, those that are payable within one year or the operating cycle, whichever is longer.

2. LO 9-1: Show how notes payable and related interest expense affect financial statements.
Learning Objective 9-1: Show how notes payable and related interest expense affect financial statements.

3. Notes Payable
In previous chapters, we have examined promissory notes from the perspective of the lender.
We will now look at how a company accounts for notes as a borrower, issuer, or maker.
Previously, we have accounted for promissory notes from the perspective of the lender. Here we are going to examine accounting for notes payable as the borrower, issuer, or maker of the note.

4. 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.
Part I
When we extended credit to others, we estimated an amount that we anticipated would be uncollectible. Do we do the same for our payables? That is, do we estimate an amount that we do not think we will be able to pay?
Part II
The answer is no. Under the going concern in accounting, we assume that our company will continue as a viable entity, and we expect to pay our obligations in full. Let’s look at some transactions involving notes and interest payable.

5. September 1 transaction
On September 1, Year 1, Herrera Supply Company (HSC) borrowed $90,000 from the National Bank with a one-year term and a 9% interest rate. This transaction: (1) increases assets (Cash) and (2) increases liabilities (Notes Payable).
Date
Account Title
Debit
Credit
Sep. 1
Cash
90,000
Notes Payable
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Notes Payable
Interest Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
90,000
n/a FA
Part I
On September 1, Year 1, Herrera Supply Company borrowed $90,000 from National Bank by issuing a 1-year note at 9% interest. This transaction increases the Cash asset account and increases the Notes Payable liability account.
Part II
Here is the effect of this transaction on the financial statements model. This transaction is classified as a financing activity on the statement of cash flows.
Part III
The journal entry would be a debit to Cash and a credit to Notes Payable for $90,000.

6. December 31, Year 1 transaction
HSC must accrue (recognize) four months of interest expense. This transaction: (1) increases liabilities (Interest Payable) and (2) decreases equity (Interest Expense).
Principal ×
Annual interest Rate
Time Outstanding =
Interest Expense
$90,000
0.09
4/12
$2,700
Date
Account Title
Debit
Credit
Dec. 31
Interest Expense
2,700
Interest Payable
Part I
On December 31st, HSC accrues interest expense for the 4 months between September 1st and December 31st. The interest expense is calculated as principal times the annual interest rate times the time outstanding during the accounting period.
Part II
This transaction increases the Interest Payable liability account and decreases the Retained Earnings stockholders’ equity account. Here is the effect of this transaction on the financial statements model.
Part III
The journal entry to record the accrual would be a debit to Interest Expense and a credit to Interest Payable for $2,700.
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Notes Payable
Interest Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
n/a
2,700
(2,700)

7. August 31, Year 2 transaction (a)
On August 31, Year 2, the maturity date of the note, three events are recognized. First, $5,400 of interest expense has accrued since January 1, Year 2.
Principal ×
Annual interest Rate
Time Outstanding =
Interest Expense
$90,000
0.09
8/12
$5,400
Date
Account Title
Debit
Credit
Aug. 31
Interest Expense
5,400
Interest Payable
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Notes Payable
Interest Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
n/a
5,400
(5,400)
Part I
On August 31, Year 2, the maturity date of the note, 3 events are recognized. First, $5,400 of interest expense has accrued since January 1, Year 2.
The interest expense is calculated as principal times the annual interest rate times the time outstanding during the accounting period. That is, 8 months between January 1st and August 31st.
Part II
This transaction increases the Interest Payable liability account and decreases the Retained Earnings stockholders’ equity account. Here is the effect of this transaction on the financial statements model. It has no effect on cash flows.
Part III
The journal entry, like the previous accrual, would be a debit to Interest Expense and a credit to Interest Payable, this time for $5,400.

8. August 31, Year 2 transaction (b)
Second, cash is paid for $8,100, the total amount of interest due on the note. This transaction: (1) decreases assets (Cash) and (2) decreases liabilities (Interest Payable).
Date
Account Title
Debit
Credit
Aug. 31
Interest Payable
8,100
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Notes Payable
Interest Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(8,100)
n/a OA
Part I
On August 31, Year 2, the maturity date of the note, cash is paid for $8,100, the total amount of interest due on the note. This includes 4 months’ interest accrued in Year 1 and 8 months’ accrued in Year 2.
Part II
This transaction decreases the Cash asset account and decreases the Interest Payable liability account. It is considered an operating activity on the statement of cash flows. Here is the effect of this transaction on the financial statements model.
Part III
The journal entry for this part of the transaction is a debit to Interest Payable and a credit to Cash for $8,100.

9. August 31, Year 2 transaction (c)
Third, HSC must recognize the repayment of the $90,000 principal of the note. This transaction: (1) decreases assets (Cash) and (2) decreases liabilities (Notes Payable).
Date
Account Title
Debit
Credit
Aug. 31
Notes Payable
90,000
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Notes Payable
Interest Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(90,000)
n/a FA
Part I
Third, HSC must recognize the repayment of the $90,000 principal of the note.
Part II
This transaction decreases the Cash Asset account and decreases the Notes Payable liability account. Here is the effect of this transaction on the financial statements model. Repayment of principal is a financing activity.
Part III
The journal entry for this part of the transaction is a debit to Notes Payable and a credit to Cash.

10. LO 9-2: Show how sales tax liabilities affect financial statements.
Learning Objective 9-2: Show how sales tax liabilities affect financial statements.

11. 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.
Part I
Most states require retailers to collect sales tax on goods sold to their customers.
Part II
Retailers collect the tax from customers and remit the tax to the state at regular intervals. The tax collected from customers is recorded as a liability called sales tax payable. Let’s look at some transactions that involve sales tax.

12. Collecting Sales Tax
Event 1: Herrera Supply Company (HSC) sells merchandise to a customer for $2,000 cash in a state where the sales tax rate is 6%.
Date
Account Title
Debit
Credit
Event 1
Cash
2,120
Sales Tax Payable
120
Sales Revenue
2,000
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Accum. Deprec.
Sales Tax Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
2,120
n/a
120
2,000 OA
Part I
Event 1. Herrera Supply Company sells merchandise to a customer for $2,000 cash in a state where the sales tax is 6%. Six percent of $2,000, or $120, of tax is collected.
Part II
The journal entry for the transaction is a debit to Cash for the $2,120 collected, a credit to Sales Tax payable for $120, and a credit to Sales Revenue for $2,000. We have intentionally left out the entry to record cost of goods sold.
Part III
Here is the effect of the transaction on Herrera’s financial statements. There is a cash inflow for operating activities recorded for the entire amount.

13. Remitting Sales Tax
Event 2: Herrera remits the tax due to the state taxing authority.
Date
Account Title
Debit
Credit
Event 2
Sales Tax Payable
120
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Van
Accum. Deprec.
Sales Tax Payable 
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
(120)
n/a OA
Part I
Event 2. Herrera remits the tax due to the state taxing authority.
Part II
The journal entry for the transaction is a debit to Sales Tax Payable and a credit to Cash.
Part III
Here is the effect of the transaction on Herrera’s financial statements.

14. LO 9-8: Show how discount notes and related interest charges affect financial statements. (Appendix)
Learning Objective 9-8: Show how discount notes and related interest charges affect financial statements. (Appendix)

15. 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.
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. For example, for a $5,000 one-year discount note with an interest rate of 10%, the proceeds of the note are less than $5,000 because interest will be subtracted from the face value when the money is borrowed. The total of $5,000 will be repaid at maturity.

16. Issuing a Discount Note – Event 1
Event 1: Beacon Management Services was started when it issued a $10,000 face value discount note to State Bank on March 1, Year 1. The one-year note carried a 9% discount rate.
Face value of the note $10,000
Less discount ($10,000 × .09 × 1) (900)
Proceeds (amount borrowed) $ 9,100
Part I
Event 1. Beacon Management Services was started when it issued a $10,000 face value discount note to State Bank on March 1, Year 1. The one-year note carried a 9% discount rate.
Part II
The 9% discount is subtracted from the face value of the note to determine the proceeds of the loan.

17. Issuing a Discount Note – Event 1 (Continued)
Account Title
Debit
Credit
Cash
9,100
Discount on Notes Payable
900
Notes Payable
10,000
Discount on Notes Payable is a contra liability account.
Assets =
Liab. +
Stockholders' Equity
Cash
Notes Payable 
Discount on Notes Payable
Common Stock
Retained Earnings
Revenue −
Expenses
Net Income
Cash Flow
9,100
10,000
(900)
n/a FA
Part I
The journal entry to record the issuance is a debit to Cash for $9,100, a debit to Discount on Notes Payable for $900, and a credit to Notes Payable for $10,000.
Part II
The transaction increases assets, Cash, by $9,100, and increases liabilities by $9,100. The Discount on Notes Payable is a contra-liability account that reduces the carrying value of the liability. The discount will be amortized over the life of the note. Discount on Notes Payable is a contra liability account.

18. Issuing a Discount Note: Event 2
Event 2: Beacon incurred $8,000 of cash operating expenses.
Account Title
Debit
Credit
Operating Expenses
8,000
Cash
Assets =
Liab +
Stockholders' Equity
Cash
Machine
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
(8,000)
n/a
8,000 OA
Event 2. Beacon incurred $8,000 of cash operating expenses.
Paying these expenses reduces both assets and stockholders’ equity. The effect on the income statement is to increase expenses and decrease net income. The cash outflow is reported in the operating activities section of the statement of cash flows.

19. Issuing a Discount Note: Event 3
Event 3: Beacon recognized $12,000 of cash service revenue.
Account Title
Debit
Credit
Cash
12,000
Service Revenue
Assets =
Liab +
Stockholders' Equity
Cash
Machine
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
12,000
n/a OA
Event 3. Beacon recognized $12,000 of cash service revenue.
Recognizing revenue increases both assets and stockholders’ equity. Net income increases. The cash inflow is reported in the operating activities section of the statement of cash flows.

20. Recognizing Interest on a Discount Note: Event 4
Event 4: On December 31, Year 1, Beacon recorded an adjusting entry to recognize interest accrued since March 1.
$900 Discount/12 months = $75
$75 × 10 months = $750
Account Title
Debit
Credit
Interest Expense
750
Discount on Notes Payable
Assets =
Liab +
Stockholders' Equity
Cash
Machine
Discount on Notes Payable 
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
n/a
750
(750)
Part I
On December 31, Year 1, Beacon recorded an adjusting entry to recognize interest accrued since March 1st.
Part II
The interest expense is calculated by dividing the $900 discount by 12 months in the one-year term, and multiplying by 10 months that have passed between March 1st and December 31st.
Part III
The journal entry is a debit to Interest Expense and a credit to Discount on Notes Payable. Because no cash payment is due until the note matures in Year 2, the reduction in equity from recognizing the interest expense is accompanied by an increase in liabilities.
Part IV
Here is the effect of the accrual on Beacon’s financial statements.

21. Exhibit 9.7: Panel A & B – Transactions and Ledger Accounts
Panel A: Transaction Summary
Beacon issued a $10,000 face-value, one-year discount note with a 9 percent discount rate.
Beacon paid $8,000 cash for operating expenses.
Beacon earned cash service revenue of $12,000.
Beacon recognized $750 of accrued interest expense.
Beacon closed the revenue and expense accounts. The letters cl are the posting reference for the closing entry.
Panel B: General Ledger:
Assets =
Liabilities +
Equity
Cash
Notes Payable
Retained Earnings
(1) 9,100
8,000 (2)
10,000 (1)
3,250 (cl)
(3) 12,000
10,000 Bal.
3,250 Bal.
Bal. 13,100
Discount on Notes Payable
Service Revenue
900
(4)
(cl) 12,000
12,000 (3)
Bal
0 Bal.
Operating Expenses
(2) 8,000
8,000 (cl)
Bal. 0
Interest Expense
(2) 750
750 (cl)
Bal. 0
General Ledger T-Accounts Panel A of Exhibit 9.7 summarizes the Year 1 accounting events. Panel B presents the ledger accounts in T-account form. The event numbers are shown in the T-accounts to facilitate your review.

22. Exhibit 9.7: Panel C — Financial Statements
Year 1, Income Statement
12/31/Yr. 1 Balance Sheet
Yr. 1 Statement of Cash Flows
Service Revenue
$12,000
Assets
Operating Activities
Operating Expenses
(8,000)
Cash
$13,10 0
Inflow from customers
Operating Income
4,000
Total assets
Outflow for expenses
Interest Expense
750
Liabilities
Notes Payable
$10,00 0
Net cash inflow from operating activities
Net income
$3,250
Less: Disc on Note
(150)
Investing activities
Total Liabilities
$9,850
Financing activities
Stockholders’ Equity
Inflow from creditors
9,100
Retained Earnings
3,250
Net change in cash
13,100
Total liab. & stck. equity
Plus: Beginning cash balance
Ending cash balance
$13,100
Continued Financial Statements: The final panel C presents the financial statements for Year 1.

23. Accounting Events Affecting Year 2: Repaying a Discount Note
Event 1: Beacon recorded an adjusting entry to recognize interest accrued since Dec. 31.
$900 Discount/12 months = $75
$75 x 2 months = $150
Account Title
Debit
Credit
Interest Expense
150
Discount on Notes Payable
Part I
Beacon repaid the face value of the discount note on March 1, Year 2. The company must first recognize interest expense for the first two months of Year 2.
Part II
The interest expense is calculated by dividing the $900 discount by 12 months in the one-year term, and multiplying by 2 months that have passed between January 1st and March 1st.
Part III
The journal entry is a debit to Interest Expense and a credit to Discount on Notes Payable.
Part IV
Here is the effect of the accrual on Beacon’s financial statements.
Assets =
Liab. +
Stockholders' Equity
Cash
Note Pay. 
Disc. on N/P
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
n/a
(150)
150

24. Repaying a Discount Note
Event 2: Beacon repaid the face value of the discounted note.
Account Title
Debit
Credit
Notes Payable
10,000
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Land
Notes payable
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
(10,000)
n/a
(900)
(9,100) OA FA
Part I
The next step is for Beacon to pay the $10,000 that is owed to the bank.
Part II
Now the carrying value of the liability is $10,000, equal to the face value of the note. Beacon records a debit to Notes Payable and a credit to Cash for $10,000
Part III
When the $10,000 is repaid, there is a cash outflow for financing activities of $9,100, the amount of the principal borrowed. There is also a $900 cash outflow for operating activities for the interest paid.

25. Recognize Cash Service Revenue
Event 3: Beacon recognized $13,000 of cash service revenue.
Account Title
Debit
Credit
Cash
13,000
Service Revenue
Assets =
Liab. +
Stockholders' Equity
Cash
Land
Notes payable
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
13,000
n/a OA
Part I
This step presents Beacon’s transaction for recognizing $13,000 in cash service revenue.
Part II
Beacon records a debit to Cash and a credit to Service Revenue for $13,000
Part III
With the recognition of cash service revenue, there is a cash inflow for operating activities of $13,000.

26. Recognize Cash Operating Expenses
Event 4: Beacon incurred $8,500 of cash operating expenses.
Account Title
Debit
Credit
Operating Expenses
8,500
Cash
Assets =
Liab. +
Stockholders' Equity
Cash
Land
Notes payable
Common Stock
Retained Earnings
Revenue −
Expense
Net Income
Cash Flow
(8,500)
n/a
8,500 OA
Part I
Beacon owes $8,500 in operating expenses that it pays in Cash.
Part II
Beacon records a debit to Operating Expenses and a credit to Cash for $8,500.
Part III
When the $8,500 is repaid, there is a cash outflow for operating activities of $8,500.

27. Exhibit 9.8: Panel A & B – Transactions and Ledger Accounts
Panel A: Transaction Summary
Recognized accrued interest for Year 2.
Paid face value of note.
Recognized revenue.
Recognized operating expenses.
Panel B: General Ledger
Assets =
Liabilities +
Equity
Cash
Notes Payable
Retained Earnings
Bal. 13,100
10,000 (2)
(2) 10,000
10,000 Bal,
3,250 Bal.
(3) 13,000
8,500 (4)
0 Bal.
4,350 (cl.)
7,600 Bal.
Bal. 7,600
Discount on Notes Payable
Service Revenue
Bal
(1)
(cl) 13,000
13,000 (3)
Bal
Operating Expenses
(4) 8,500
8,500 (cl)
Bal. 0
Interest Expense
(1) 150
150 (cl)
Bal. 0
General Ledger T-Accounts Panel A of Exhibit 9.8 summarizes the Year 2 accounting events. Panel B presents the ledger accounts in T-account form. The event numbers are shown in the T-accounts to facilitate your review.

28. Exhibit 9.8: Panel C — Financial Statements
Year 2, Income Statement
12/31/Yr. 2 Balance Sheet
Yr. 2 Statement of Cash Flows
Service Revenue
$13,000
Assets
Operating Activities
Operating Expenses
(8,500)
Cash
$7,600
Inflow from customers
Operating Income
4,500
Total assets
Outflow for expenses
Interest Expense
(150)
Liabilities $
Outflow for interest
(900)
Net income
$4,350
Stockholders’ Equity
Net inflow from operating activities
3,600
Retained Earnings
7,600
Investing activities
Total liab. & stck. equity
Financing activities
Outflow to creditors
(9,100)
Net change in cash
(5,500)
Plus: Beginning cash balance
13,100
Ending cash balance
Continued Financial Statements: The final panel, panel C, presents the financial statements for Year 2.

29. End of Chapter 9
End of Chapter 9. This chapter introduced and examined the effects of liabilities such as notes payable, interest payable, sales tax, payroll taxes, and warranties on financial statements. We also examined the use of a classified balance sheet to assess an entity’s liquidity.