1. Financial and Managerial Accounting
Chapter 10
Current Liabilities
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.
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PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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3. After studying this chapter, you should be able to:
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
Notes Payable
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
Interest Expense 30 00
Appears on the income statement as an “Other Expense.”
Cash
Issued a 90-day, 12% note on account.

8. Short-Term Notes Payable
Description Debit Credit
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
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. Short-Term Notes Payable
Bowden Co. (Borrower)
Coker Co. (Creditor)
Description Debit Credit
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
Interest Expense
Proceeds
Discount: $20,000 x .15 x 90/360
Notes Payable
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
Cash
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
Product Warranty Liability
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
Supplies
Replaced defective part under warranty.

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

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

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
Total FICA tax $79.65

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

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

24. RESPONSIBILITY FOR TAX PAYMENTS
EMPLOYEE
BUSINESS
GOVERNMENT
Social security tax
Medicare tax
Federal unemployment compensation tax
State unemployment compensation tax
Social security tax
Medicare tax
Federal withholding tax

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

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

27. What is the purpose of a 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
Total $13,902.00
Deductions:
Social security tax $
Medicare tax
Federal income tax 3,332.00
Retirement savings
United Way
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
Office Salaries Expense
Social Security Tax Payable
Medicare Tax Payable
Employees Federal Inc. Tax Pay
Retirement Savings Ded. Payable
United Way Deductions Payable
Accounts Receivable—Fred Elrod
Salaries Payable
Payroll for week ended December 27.

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

31. Recording Employer’s Payroll Taxes
Dec. 27 Payroll Tax Expense
Social Security Tax Payable
Medicare Tax Payable
State Unemployment Tax Payable
Federal Unemployment Tax Pay
Payroll taxes for week ended December 27.

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

33. Employees’ Fringe Benefits

34. Retirement and savings plans Social security and Medicare
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 pay Vacation pay becomes the employer’s liability as the employee earns vacation rights.
Pensions Cash payment to retired employees. Could be a defined contribution plan or a defined benefit plan
Postretirement Benefits In 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 plan Under this plan, a fixed amount of money is invested on the employee’s behalf during the employee’s working years. Example: 401K
Defined benefit plan Under 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. 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
Total $231,000 $592,000
Current liabilities $220,000 $740,000
Quick assets
Current liabilities

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
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
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 10
The End