1. Current Liabilities and Payroll Accounting
Chapter 11
Chapter 11: Current Liabilities and Payroll Accounting

2. Defining Liabilities C 1
A liability is a probable future payment of assets or services that a company is presently obligated to make as a result of past transactions or events. This definition includes three crucial factors:
1. A past transaction or event.
2. A present obligation.
3. A future payment of assets or services.

3. Classifying Liabilities
Not expected to be paid within one year or the company’s operating cycle, whichever is longer.
Long-Term Liabilities
Expected to be paid within one year or the company’s operating cycle, whichever is longer.
Current Liabilities
Current liabilities are expected to be paid within one year or the normal operating cycle of the company, whichever is longer. Current liabilities are usually extinguished by payment of current assets.
Long-term liabilities are not expected to be paid or extinguished within one year. In this chapter, we will concentrate on current liabilities.

4. Current and Long-Term Liabilities
Current Liabilities as a Percent of Total Liabilities
The relationship between total liabilities and current liabilities depends upon the nature of business operations. Six Flags, an amusement park, has a relatively low percentage of current liabilities as a percentage of total liabilities, especially when compared to Columbia Sportswear or Apple Computer.

5. Uncertainty of Liabilities
Uncertainty in Whom to Pay
Uncertainty in When to Pay
Uncertainty in How Much to Pay
Before we can determine the nature of a liability and properly classify it, we must examine three major uncertainties. First, we must determine whether we know who will be paid to extinguish the liability. Second, we must know when the amount must be paid, and third, we must know exactly how much must be paid to extinguish the liability. If we don’t know all three, we do not have a determinable liability.

6. Short-Term Notes Payable Multi-Period Known Liabilities
C 2
Accounts Payable
Sales Taxes Payable
Unearned Revenues
Short-Term Notes Payable
Most liabilities arise from situations with little uncertainty. They are set by agreements, contracts, or laws and are measurable. These liabilities are known liabilities, also called definitely determinable liabilities. Known liabilities include accounts payable, notes payable, payroll liabilities, sales taxes payable, unearned revenues, and leases.
Payroll Liabilities
Multi-Period Known Liabilities

7. Sales Tax Payable
C 2
On August 31, Home Depot sold materials for $6,000 that are subject to a 5% sales tax.
$6,000 × 5% = $300
On August 31, Home Depot sold materials for $6,000 cash that are subject to a 5% sales tax. Home Depot is responsible for collecting and paying the tax to the state government. The company will debit Cash for $6,300, the amount of the sale and the tax collected. Home Depot will credit Sales for $6,000, and credit the current liability account, Sales Taxes Payable, for $300. The sales tax is 5% of the total sale of $6,000. Home Depot will later debit the Sales Taxes Payable account when payment is made to the taxing authority.

8. Unearned Revenues
C 2
On June 30, Rihanna sells $5,000,000 in tickets for eight concerts.
On Oct. 31, Rihanna performs a concert.
We previously studied unearned revenues in the chapter on adjusting entries. Unearned revenues are amounts received in advance from customers for future products or services. Advance ticket sales for sporting events or music concerts are examples. To illustrate, assume that Rihanna sells $5 million in tickets for eight concerts; the entry is to debit Cash and credit Unearned Ticket Revenue. On October 31, Rihanna performs a concert. Rihanna’s accountant will debit, or reduce, the Unearned Ticket Revenue, and credit, or increase, Ticket Revenue for $625,000.
$5,000,000 / 8 = $625,000

9. Short-Term Liabilities
P 1
A written promise to pay a specified amount on a definite future date within one year or the company’s operating cycle, whichever is longer.
Let’s spend some time looking at short-term, or current, notes payable. A note payable is a written promise to pay a specific amount at a definite future date. Short-term notes normally bear interest.

10. Note Given to Extend Credit Period
On August 23, Brady Company asks McGraw to accept $100 cash and a 60-day, 12% $500 note to replace its existing $600 Account Payable.
Let’s assume that on August 23, Brady Company asks to extend its past-due $600 account payable to McGraw. After some negotiations, McGraw agrees to accept $100 cash and a 60-day, 12%, $500 note payable to replace the account payable. In Brady’s accounting records, for the journal entry on August 23, Brady would debit, or reduce, its Accounts Payable to McGraw and decrease Cash for $100 and credit, or increase, Notes Payable for $500 to McGraw.

11. Note Given to Extend Credit Period
On October 22, Brady pays the note plus interest to McGraw.
On October 22, Brady pays the note and all interest to McGraw.
To prepare the journal entry on the books of Brady, we debit, or decrease, the Notes Payable to McGraw for $500 and debit interest expense for $10. The $10 is interest at a 12% annual rate for 60 days. Finally, we will credit, or decrease, the cash account for the total of $510.
Interest expense = $500 × 12% × (60 ÷ 360) = $10

12. Note Given To Borrow From Bank
P 1
A bank nearly always requires a borrower to sign a promissory note when making a loan. When the note matures, the borrower repays the note with an amount larger than the amount borrowed. The difference between the amount borrowed and the amount repaid is interest. This is a typical promissory note. Notice that we have a definite payee, National Bank in Boston, a determinable amount of the payment, $2,000 plus interest at 12% for 60 days.

13. Note Given To Borrow From Bank
P 1
On Sept. 30, a company borrows $2,000 from a bank at 12% interest for 60 days.
On Nov. 29, the company repays the principal of the note plus interest.
On September 30, a company needs $2,000 for a project and borrows this money from a bank at 12% annual interest. The loan is due in 60 days.
On the date the note was signed, the company will debit the Cash account for $2,000 and credit the current liability, Notes Payable, for the same amount.
On November 29, the company repays the principal of the note plus interest.
The company will debit, or reduce, the Note Payable. It will also debit Interest Expense for $40, the amount of the interest for the 60-day period. Cash will be credited for $2,040.
Interest expense = $2,000 × 12% × (60 ÷ 360) = $40

14. End-of-Period Adjustment to Notes
Note Date
End of Period
Maturity Date
An adjusting entry is required to record Interest Expense incurred to date.
If a short-term note payable is issued in one accounting period but is not payable until the following accounting period, it is necessary to make an adjusting entry at year-end to record the Interest Expense. Let’s look at a specific example.

15. End-of-Period Adjustment to Notes
On Dec. 16, 2013, a company borrows $2,000 from a bank at 12% interest for 60 days. An adjusting entry is needed on December 31.
On Feb. 14, 2014, the company repays this principal and interest on the note.
To illustrate, let’s return to the previous note, but assume that the company borrows $2,000 cash on December 16, 2013, instead of September 30. This 60-day note matures on February 14, 2014, and the company’s fiscal year ends on December 31. Thus, we need to record interest expense for the final 15 days in December. This means that one-fourth (15 days/60 days) of the $40 total interest is an expense of year The entry is to debit the Interest Expense account and credit a liability account, Interest Payable, for $40.
Now let’s complete our example by making the entry to record the payment of the note and interest on February 14. The Interest Expense is debited for $30, which is interest for 45 days. The Interest Payable and the Note Payable are both debited, or decreased, and Cash is credited for $2,040.

16. Employers incur expenses and liabilities from having employees.
Payroll Liabilities
P 2
Employers incur expenses and liabilities from having employees.
Most of you have probably worked at some time in your life. You know that amounts are withheld from your paycheck, and you may have wondered how this money is handled by your employer. You may not know that your employer pays payroll tax expenses in connection with having you on the payroll. These are not amounts withheld from your paycheck but are costs to your employer.

17. Employee Payroll Deductions
Gross pay is the amount you actually earn during a pay period. Out of your gross pay, amounts are withheld for federal income taxes, state and local income taxes, FICA taxes (Social Security and Medicare), and for voluntary deductions such as retirement plans or medical reimbursement accounts.
Your gross pay less all withholdings, mandatory and voluntary, is your net pay. This is the amount of cash you can put in the bank.

18. Employee FICA Taxes Federal Insurance Contributions Act (FICA)
FICA Taxes — Soc. Sec.
2012: 6.2% of the first $110,100 earned in the year (Max = $6,826.20).
FICA Taxes — Medicare
2012: 1.45% of all wages earned in the year.
Law requires employers to withhold FICA taxes from each employee’s salary or wages on each payday. The rate of withholding for FICA taxes and Medicare taxes varies from year to year, but in 2012, the FICA rate was 6.2 percent on the first $110,100 of gross pay in the calendar year, or a maximum of $6, The Medicare rate of 1.45 percent was applied on all of your gross pay in 2012, with no maximum limit.
Your employer is required to match the amounts withheld for FICA and Medicare on a dollar-for-dollar basis. For every $10 of FICA taxes withheld from your paycheck, your employer must also pay $10 on your behalf to the Internal Revenue Service. Employers must pay all FICA taxes to the Internal Revenue Service. Until they are paid, they are reported as a current liability on the employer’s balance sheet.
Employers must pay withheld taxes to the Internal Revenue Service (IRS).

19. State and Local Income Taxes
Employee Income Tax
P 2
Federal Income Tax
State and Local Income Taxes
Amounts withheld depend on the employee’s earnings, tax rates, and number of withholding allowances.
The amount of income taxes withheld from your gross pay usually depends on how much you earn during the pay period and the number of withholding allowances you claimed on the W4 form you completed when you first went to work. Most states and many local governments require employers to withhold income taxes from employees’ pay and to remit them promptly to the proper government agency. Until they are paid, withholdings are reported as a current liability on the employer’s balance sheet.
Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency.

20. Employee Voluntary Deductions
Amounts withheld depend on the employee’s request.
Examples include union dues, savings accounts, pension contributions, insurance premiums, and charities.
The amount withheld from gross pay for voluntary deductions depends upon which plans you participate in at your place of employment. Examples include union dues, savings accounts, pension contributions, insurance premiums, and charities. Your employer makes payments to the proper designated agencies for amounts you have withheld as voluntary deductions.
Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency.

21. Recording Employee Payroll Deductions
An entry to record payroll expenses and deductions for an employee might look like this.
Here is an example of a typical payroll entry to record the employees’ withholdings and net pay. Salaries Expense (debit) shows that the employee earns a gross salary of $2,000. The first five payables (credits) show the liabilities the employer owes on behalf of this employee to cover FICA taxes, income taxes, medical insurance, and union dues. The Salaries Payable account (credit) records the $1,524 net pay the employee receives from the $2,000 gross pay earned. When the employee is paid, another entry is required to record the check written and distributed. The entry to record the cash payment to this employee is to debit Salaries Payable and credit Cash for $1,524.
*Amounts taken from employee’s employment records

22. Employer Payroll Taxes
Federal and State Unemployment Taxes
FICA Taxes
Medicare Taxes
Employers pay amounts equal to that withheld from the employee’s gross pay.
Employers must pay payroll taxes in addition to those required of employees. Employer taxes include FICA and unemployment taxes. Your employer must match your contributions for FICA and Medicare taxes, and in addition, must pay both federal and state unemployment taxes.

23. Federal and State Unemployment Taxes
2012: 6.2% on the first $7,000 of wages paid to each employee. A credit up to 5.4% is given for SUTA paid, therefore the net rate is 0.8%.
Federal Unemployment Tax (FUTA)
2012: Basic rate of 5.4% on the first $7,000 of wages paid to each employee. Merit ratings may lower SUTA rates.
State Unemployment Tax (SUTA)
In addition to matching your contributions for FICA and Medicare, your employer must pay all federal and state unemployment taxes.
The federal and state unemployment tax rates are subject to change. In 2012, the federal rate was a maximum of 6.2 percent on the first $7,000 of earnings for each employee. This federal tax can be reduced by a credit of up to 5.4% for taxes paid to a state program. As a result, the net federal unemployment tax is often only 0.8%.
All states support their unemployment insurance programs by placing a payroll tax on employers. In most states, the base rate for SUTA taxes is 5.4% of the first $7,000 paid each employee. Most states reduce this rate to employers with excellent employment records.

24. Recording Employer Payroll Taxes
An entry to record the employer payroll taxes for January might look like this.
Employer payroll taxes are often recorded in an entry separate from the one recording payroll expenses and deductions. To illustrate, assume that the $2,000 recorded salaries expense from the previous example is earned by an employee whose earnings have not yet reached $5,000 for the year. This means the entire salaries expense for this period is subject to tax because year-to-date pay is under $7,000. Also assume that the federal unemployment tax rate is 0.8% and the state unemployment tax rate is 5.4%. Consequently, the FICA portion of the employer’s tax is $153, computed by multiplying both the 6.2% and 1.45% by the $2,000 gross pay. Moreover, state unemployment (SUTA) taxes are $108 (5.4% of the $2,000 gross pay), and federal unemployment (FUTA) taxes are $16 (0.8% of $2,000).
SUTA: $2,000 x 5.4% = $108
FUTA: $2,000 x (6.2% - 5.4) = 16
FICA amounts are the same as that withheld from the employee’s gross pay.

25. Multi-Period Known Liabilities
C 2
Includes Unearned Revenues and Notes Payable
Unearned Revenues from magazine subscriptions often cover more than one accounting period. A portion of the earned revenue is recognized each period and the Unearned Revenue account is reduced.
Notes Payable often extend over more than one accounting period. A three-year note would be classified as a current liability for one year and a long-term liability for two years.
When a known liability extends over multiple accounting periods, a portion will be classified as current and a portion as a long-term liability. We must make adjusting entries at the end of each accounting period for these multi-period liabilities. Two common multi-period liabilities include subscriptions and long-term notes payable that have a portion maturing each year.
The current portion of long-term debt refers to that part of long-term debt due within one year or the operating cycle, whichever is longer.

26. Estimated Liabilities
P 4
An estimated liability is a known obligation of an uncertain amount, but one that can be reasonably estimated.
In addition to our known liabilities, we also have to estimate certain liabilities. To estimate a liability, we must know that we have an obligation, but we are uncertain as to exactly how much will have to be paid or when it will be paid. The amounts involved must be subject to reasonable estimation before we may actually record an estimated liability.

27. Health and Pension Benefits
Employer expenses for pensions or medical, dental, life, and disability insurance
Assume an employer agrees to pay an amount for medical insurance equal to $8,000, and contribute an additional 10% of the employees’ $120,000 gross salary to a retirement program.
An employer may agree to pay a portion of your medical, dental, life, or disability insurance. In this case, the employer agrees to pay $8,000 toward employee medical insurance coverage and 10% of gross salaries for a pension program. The employee may have to make contributions to each of these plans, but at this time, we are interested in the employer costs. Let’s look at the journal entry we make in connection with the employer’s payments. We debit, or increase, the Employee Benefits Expense for $20,000, credit Employee Medical Insurance Payable for $8,000, and credit the Employee Retirement Program Payable for $12,000. Contributions made by the employer are an additional cost of having you as an employee.

28. Vacation Benefits
P 4
Assume an employee earns $20,800 per year and earns two weeks of paid vacation each year.
$20,800 ÷ 50 weeks = $416
$20,800 ÷ 52 weeks = $400
Weekly vacation benefit
$ 16
Many employers offer paid vacation benefits. To illustrate, assume that salaried employees earn 2 weeks’ vacation per year. This benefit increases employers’ payroll expenses because employees are paid for 52 weeks but work for only 50 weeks. Total annual salary is the same, but the cost per week worked is greater than the amount paid per week. For example, if an employee is paid $20,800 for 52 weeks but works only 50 weeks, the total weekly expense to the employer is $416 ($20,800 divided by 50 weeks), instead of the $400 cash paid weekly to the employee ($20,800 divided by 52 weeks). The $16 difference between these two amounts is recorded weekly as follows: Debit the Vacation Benefits Expense account for $16 per week and credit the Vacation Benefits Payable for the same amount. When the employee takes paid vacation days, the employer will reduce the Vacation Benefits Payable liability and credit Cash.

29. Bonus Plans
P 4
Assume that a bonus will be paid to employees equal to 5% of the company’s annual net income of $210,000.
B = .05 ($210,000 - B)
B = $10, B
1.05B = $10,500
B = $10,500 / 1.05
*B = $10,000
Many companies offer bonuses to employees, and many of the bonuses depend on net income. To illustrate, assume that an employer offers a bonus to its employees equal to 5% of the company’s annual net income (to be equally shared by all). The company’s expected annual net income is $210,000.
To calculate the amount of the bonus, we can set up the basic bonus equation which states that your bonus (B) is equal to 5% of the net income minus the bonus. Solving the equation, we find that the bonus is $10,000.
Once the bonus has been calculated, the company will debit the Employee Bonus Expense account, and credit the Bonus Payable, for $10,000. When the bonus is paid to you, the company will debit, or eliminate, the Bonus Payable balance, and credit Cash.

30. Warranty Liabilities
P 4
Seller’s obligation to replace or correct a product (or service) that fails to perform as expected within a specified period. To comply with the full disclosure and matching principles, the seller reports expected warranty expense in the period when revenue from the sale is reported.
Many products sold are covered by a warranty. A warranty is a seller’s obligation to replace or correct a product (or service) that fails to perform as expected within a specified period. Most new cars, for instance, are sold with a warranty covering parts for a specified period of time. To comply with the full disclosure and matching principles, the seller reports the expected warranty expense in the period when revenue from the sale of the product or service is reported. The seller reports this warranty obligation as a liability, although the existence, amount, payee, and date of future sacrifices are uncertain. This is because such warranty costs are probable and the amount can be estimated using, for instance, past experience with warranties.

31. Warranty Liabilities
P 4
On Dec. 1, 2013, a dealer sells a car for $16,000 with a maximum one-year or 12,000 mile warranty covering parts. Past experience indicates warranty expenses average 4% of a car’s selling price.
To illustrate, a dealer sells a used car for $16,000 on December 1, 2013, with a maximum one-year or 12,000-mile warranty covering parts. In this case, a dealer’s experience shows that warranty expense averages about 4% of a car’s selling price, or $640 ($16,000 x 4%). The dealer records the estimated expense and liability related to this sale with a journal entry to debit Warranty Expense for $640 and to credit Estimated Warranty Liability for $640. With this entry, the estimated warranty expense is reported on the 2013 income statement and the warranty liability is reported on the 2013 balance sheet.
Suppose the customer returns the car for warranty repairs on January 9, The dealer performs this work by replacing parts costing $200. The entry to record partial settlement of the estimated warranty liability is to debit Estimated Warranty Liability for $200 and to credit Auto Parts Inventory for $200. But, what happens if total warranty expenses are more or less than the estimated 4%, or $640? The answer is that management should monitor actual warranty expenses to see whether the 4% rate is accurate. If experience reveals a large difference from the estimate, the rate for current and future sales should be changed. Differences are expected, but they should be small.
On Jan. 9, 2014, the customer returns the car for repairs. The dealer replaces parts costing $200.

32. Accounting for Contingent Liabilities
Accounting for contingent liabilities depends on the likelihood that a future event will occur and the ability to estimate the future amount owed if this event occurs. Three different possibilities are identified in the chart shown: A company may be required to record the liability, disclose it in the notes, or not to disclose it at all.
The likelihood of occurrence is considered to be either probable, possible, or remote. If the contingent liability is both probable and the amount can be estimated, then a liability should be recorded. If the contingent liability is probable, but an amount cannot be estimated, then the contingency is disclosed in the notes. If the likelihood for the contingent liability to occur is possible, then it must be disclosed in the notes. If the likelihood of occurrence is believed to be remote, no disclosure is required.

33. Reasonably Possible Contingent Liabilities
Potential Legal Claims – A potential claim is recorded if the amount can be reasonably estimated and payment for damages is probable.
Debt Guarantees – The guarantor usually discloses the guarantee in its financial statement notes. If it is probable that the debtor will default, the guarantor should record and report the guarantee as a liability.
If the likelihood of occurrence is determined to be reasonably possible, then the contingency must be disclosed in the notes to the financial statements. Two common examples are potential legal claims resulting from lawsuits made against the company and debt guarantees. When a company guarantees the debt of an affiliated company, it may eventually have to pay the obligation. If the original debtor fails to pay, the obligation becomes the responsibility of the guarantor.

34. Global View Characteristics of Liabilities
Accounting definitions and characteristics of current liabilities are similar for U.S. GAAP and IFRS. Sometimes IFRS will use the word “provision” to refer to a “liability.”
Known (Determinable) Liabilities
Both U.S. GAAP and IFRS require companies to treat known (or determinable) liabilities in a similar manner. Examples would be accounts payable, unearned revenues, and payroll liabilities.
The definitions and characteristics of current liabilities are broadly similar for both U.S. GAAP and IFRS. Although differences exist, the similarities vastly outweigh any differences. Remembering that “provision” is typically used under IFRS to refer to “liability” under U.S. GAAP, Nokia describes its recognition of liabilities as follows: “Provisions” are recognized when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and a reliable estimate of the amount can be made.
When there is little uncertainty surrounding current liabilities, which is the case for known or determinable liabilities, both U.S. GAAP and IFRS require companies to record them in a similar manner. This correspondence in accounting applies to accounts payable, sales taxes payable, unearned revenues, short-term notes, and payroll liabilities. Of course, tax regulatory systems of countries are different, which implies use of different rates and levels. Still, the basic approach is the same.
Regarding estimated liabilities, when a known current obligation that involves an uncertain amount, but one that can be reasonably estimated, both U.S. GAAP and IFRS require similar treatment. This treatment extends to many obligations such as those arising from vacations, warranties, restructurings, pensions, and health care. Both accounting systems require that companies record estimated expenses related to these obligations when they can reasonably estimate the amounts.
Estimated Liabilities
Regarding estimated liabilities, when a known current obligation that involves an uncertain amount, but one that can be reasonably estimated, both U.S. GAAP and IFRS require similar treatment.

35. Income before interest and income taxes
Times Interest Earned
A 1
Income before interest and income taxes
Times interest earned =
Interest expense
If income before interest and taxes varies greatly from year to year, fixed interest charges can increase the risk that an owner will not earn a positive return and be unable to pay interest charges.
Companies that loan money to a business want to be assured that the principal and interest will be paid when due. One measure that helps creditors assess the risk of a loan is the Times Interest Earned ratio. We calculate the ratio by dividing income before interest and income taxes by interest expense. Income before interest and income taxes is sometimes referred to as operating income. A high Times Interest Earned ratio usually means that the risk of nonpayment is low.

36. Appendix 11A: Payroll Reports, Records, and Procedures
IRS Form 941
IRS Form 940
W-2
Payroll Records
Payroll Register
Payroll Checks
Employee Earnings Report
Appendix 11A: Payroll Reports, Records, and Procedures
This appendix focuses on payroll accounting and its reports, records, and procedures. Employers are required to prepare and submit numerous reports explaining payroll computations. These include IRS Form 941, the Employer’s Quarterly Federal Tax Return, required by The Federal Insurance Contributions Act (FICA) to be submitted within one month after the end of each calendar quarter. IRS Form 940, the Annual Federal Unemployment Tax Return reports the employer’s federal unemployment taxes (FUTA) and must be mailed on or before January 31 following the end of each tax year. Requirements for paying and reporting state unemployment taxes (SUTA) vary depending on the laws of each state. Employers are required to give each employee an annual report of his or her wages subject to FICA and federal income taxes along with the amounts of these taxes withheld. This report is called a Wage and Tax Statement, or Form W-2, and it must be given to employees before January 31 following the year covered by the report.
Companies also prepare a variety of payroll records. A payroll register usually shows the pay period dates, hours worked, gross pay, deductions, and net pay of each employee for each pay period. Payment of payroll is usually done by check or electronic funds transfer. Each check (or EFT transfer) is typically accompanied with a statement of earnings showing gross pay, deductions, and net pay. An employee earnings report is a cumulative record of an employee’s hours worked, gross earnings, deductions, and net pay.
One aspect of payroll procedures is to compute federal income tax for payroll purposes. To compute the amount of taxes withheld from each employee’s wages, we need to determine both the employee’s wages earned and the employee’s number of withholding allowances. Each employee records the number of withholding allowances claimed on a withholding allowance certificate, Form W-4, filed with the employer. The amount withheld is based on marital status, number of allowances, and amount of pay.
Payroll Procedures
Withholding Tables
W-4

37. Appendix 11B: Corporate Income Taxes
Corporations must pay taxes on income.
Deferred Income Tax Liabilities
Example: Assume that a corporation computes $25,000 of income taxes expense and determines that only $21,000 is currently due and $4,000 is deferred to future years (a timing difference).
Appendix 11B: Corporate Income Taxes
This appendix explains current liabilities involving income taxes for corporations. Corporations are subject to income taxes and must estimate their income tax liability when preparing financial statements. Since income tax expense is created by earning income, a liability is incurred when income is earned. This tax must be paid quarterly under federal regulations. An income tax liability for corporations can arise when the amount of income before taxes that the corporation reports on its income statement is not the same as the amount of income reported on its income tax return. This difference occurs because income tax laws and GAAP measure income differently. Some differences between tax laws and GAAP are temporary. Temporary differences arise when the tax return and the income statement report a revenue or expense in different years. As an example, companies are often able to deduct higher amounts of depreciation in the early years of an asset’s life and smaller amounts in later years for tax reporting in comparison to GAAP. When temporary differences exist between taxable income on the tax return and the income before taxes on the income statement, corporations compute income taxes expense based on the income reported on the income statement. The result is that income taxes expense reported in the income statement is often different from the amount of income taxes payable to the government. This difference is the deferred income tax liability.
Assume that in recording its usual quarterly income tax payments, a corporation computes $25,000 of income taxes expense. It also determines that only $21,000 is currently due and $4,000 is deferred to future years (a timing difference). The company will record Income Taxes Expense as $25,000. Income Taxes Payable, a current liability, will be credited for $21,000, and Deferred Income Tax Liability will be credited for $4,000.

38. End of Chapter 11
End of Chapter 11.