1. Current Liabilities and Payroll
Chapter 11
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall

2. Liabilities Best described as: Three primary characteristics:
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.
All companies have debts and obligations that represent claims of outside parties against the assets of the company. These debts and obligations are referred to as Liabilities. Included in these obligations are amounts borrowed from banks, unpaid bills, accrued obligations, and obligations that are contingent upon the outcome of a future event.
All liabilities have three primary characteristics:
They occur as a result of a past transaction or event. For example, if a company purchased inventory on account, a liability to pay for that inventory is created.
They create a present obligation for future payments. For example, if a company purchased inventory on account in the past, there is a obligation right now to pay that liability when the due date comes in the future.
They are an unavoidable obligation. For example, no company is ever REQUIRED to pay dividends to its shareholders. However, once the Board of Directors publicly states its intention to pay a dividend, the obligation to pay that dividend becomes unavoidable and must be paid.

3. Long-Term Liabilities
Two Major Categories
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.
Generally, liabilities can be divided into Current Liabilities and Long-Term Liabilities. Current Liabilities are those obligations that must be fulfilled within one year or one operating cycle, whichever is longer. Long-Term Liabilities include any obligations that are due and payable outside that 1-year period or one operating cycle.

4. Current Liabilities(examples)
Accounts payable
Short-term notes payable
Sales tax payable
Current portion of long-term notes payable
Accrued liabilities
Unearned revenues
The amounts of most liabilities are known. Recall that current liabilities are those debts due to be paid within one year, or within the entity’s operating cycle if that cycle is longer than a year. Let’s begin with current liabilities of a known amount.
Amounts owed for products or services purchased on account are accounts payable. Since these are due on average in 30 days, they are current liabilities. Short-term notes payable are a common form of financing. Short-term notes payable are promissory notes that must be paid within one year.

6. Eastman Chemical Footnote Disclosure

7. Accounts Payable(example)
For products and services purchased on account
Integrated accounts payable and inventory systems
Paid later within a discount period or not
Usually due in 30 days
Amounts owed for products or services purchased on account are accounts payable. Since these are due on average in 30 days, they are current liabilities. With accounts payable and inventory systems integrated, a company records the purchase of inventory on account, using the perpetual system. Then, when the company pays the liability, it takes advantage of the purchase discount.

9. Sales Tax Payable Tax levied by state on retail sales
Record sales, with the taxes, as follows:
Record and forward the sales tax to the state
Most states assess sales tax on retail sales. Retailers collect the sales tax in addition to the price of the item sold. Sales tax payable is a current liability because the retailer must pay the state in less than a year. Sales tax collected is owed to the state. As sales are made, the tax is added to the sales amount and is collected by the retailer.
Companies forward the sales tax to the state at regular intervals. They normally submit it monthly, but they could file it at other intervals, depending on the state and the amount of the tax. To pay the tax, the company debits Sales tax payable and credits Cash.

11. Incurred $1,500 wages/salaries expense which has not been paid
Accrued Expenses
Expense incurred, but not yet paid
Often an adjusting entry
Debit expense and credit an accrued liability
Examples:
Salaries
Interest payable
Incurred $1,500 wages/salaries expense which has not been paid
We learned that an accrued expense is any expense that has been incurred, but has not yet been paid. When an expense is accrued (debited), it often has a related unpaid bill, or an accrued liability (credited). Accrued liabilities typically occur with the passage of time, such as interest on a note payable.

12. Unearned(deferred) Revenues
Cash received in advance of performing work
Obligation to provide goods or services
Revenue earned as goods delivered or work performed
Debit liability and credit revenues as earned
Unearned revenue is also called deferred revenue. Unearned revenue arises when a business has received cash in advance of performing work and, therefore, has an obligation to provide goods or services to the customer in the future. If you receive cash before you do the work, you owe the work (unearned service revenue). An adjusting entry is made to decreased the liability and increased the revenue as word performed or goods delivered.

14. Unearned(deferred) Revenues

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16. Current portion Long-Term Debt
©2014 Pearson Education, Inc. Publishing as Prentice Hall

17. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

18. Accounting for Payroll
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.
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.
A significant cost to any business is the cost of the company’s employees. However, those employees are not paid continuously as they work. Typically, employees work for a period of time (one week, two weeks, one month) and then are paid at the end of the period for their work during the period. Until they are paid, the company has a liability that must be recorded.
When employees are paid, they do not receive payment for all of their earned wages (gross wages). Before employees receive any payment, the company will withhold certain amounts that are subsequently forwarded to other third parties.
The amount that the employees receive is referred to as “net pay.”

19. Accounting for Payroll
Gross Pay
OASDI Taxes
Medicare Taxes
Federal Income Tax
State and Local Income Taxes
Voluntary Deductions
FICA
The deductions that are withheld from an employees pay include OASDI (old age, survivors, and disability insurance—otherwise referred to as social security), Medicare, Federal Income Tax, State and Local Income Taxes, and other voluntary deductions.
Net Pay

20. Withholding for Employee Income Tax
Federal Income Tax
State and Local Income Taxes
Top rate of 39.6% on income > $400,000
For example, in some states the state income tax rate is 5%.
Federal income tax is withheld from the employees pay and forwarded to the federal government on behalf of the employees. This creates a certain amount of efficiency. For example, if a company has 1,000 employees, it is much more efficient for the company to send a single check for all of the withholdings from all 1,000 employees than it would be for each employee to send in a separate check for their taxes.
Some states and municipalities also collect income taxes. State income tax expenses can be as high as 7% of gross earnings.
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.

21. Withholding for Employee Social Security and Medicare(FICA Taxes)
OASDI Taxes
Medicare Taxes
6.2% as of 2013
4.2%
Applied to first $110,100 of earned income
1.45%
Applied to 100% of income
OASDI and Medicare taxes are also withheld from the employee’s check. The OASDI taxes are equal to 6.2% of the first $110,100 of income earned. OASDI taxes are not computed on any income amounts in excess of $110,100. While the 6.2% amount has remained constant (except for periods when the federal government declares a payroll tax holiday. From 2009 until 2012, for example, the OASDI rate was only 4.2%. In addition, the $110,100 limit increases periodically.) Following the textbook writing, we are using 4.2% for OASDI taxes.
Medicare taxes are 1.45% of all earned income.
These amounts are due to the federal government following withholding.

22. 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.
Union Dues
Savings Accounts
Pension Contributions
Insurance Premiums
Charities
In addition to the required withholdings, employees may elect to have additional amounts withheld for various reasons. Option withholdings include union dues, savings accounts, Christmas Club accounts, pension contributions, health insurance premiums, life insurance premiums, or charities. Regardless of whether the withholding is mandated by government or an optional employee requested withholding, the employer has an obligation to forward the payment to the appropriate designated party.
It is interesting that in many cases involving companies in financial distress, one of the first places that symptoms of that financial distress is in the failure of companies to make the required payments related to payroll withholdings. One of the first signs an employee may have is that they discover that their health insurance has lapsed due to failure by the employer to make the payments.

23. 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.
At the end of each pay period, the company must make a journal entry to record the payment to employees and the payables related to the withholdings. For December, Smart Touch Learning records gross payroll of $28,580. Withholdings include $961 to OASDI, $414 to Medicare, $5,716 to the IRS, $645 for health insurance premiums, and $60 to other voluntary withholdings. Record the payroll entry for December.

24. Recording Payroll
Typically, the payroll checks will be drawn against a separate payroll checking account that is only used for payroll.
The entry will require a debit to Salaries and Wages Expense for $28,580. Credits will be made to FICA-OASDI, FICA-Medicare, Income Taxes Payable, Health Insurance Payable, Other Payables, and Salaries and Wages Payable.

25. Employer Payroll Taxes
Employers are also required to pay taxes separate from the taxes withheld from employee paychecks.
Employers must “match” the FICA amounts withheld from employee paychecks.
State & Federal Unemployment Compensation Taxes
7.65% of earnings up to $110,100; 1.45% of earnings in excess of $110,100
In addition to the withholdings from the employees payroll, the companies themselves also must pay taxes as a consequence of having employees. There are two primary payroll taxes that all employers pay; a FICA match and unemployment compensation taxes.
Any amounts withheld from employee paychecks must be matched by the employer. For each employee, the company must pay (out of its own pocket) 7.65% of employee earnings up to $110,100 per employee. When earnings exceed $110,100 for each employee, the employer must pay 1.45% for Medicare.
6.2% of first $7,000 of employee earnings

26. Unemployment Taxes
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).
The rate varies with each company’s employment history.
Unemployment is a fact of the US economy. It is generally accepted that when an employee loses a job (through no fault of their own), they will receive unemployment checks for a specified period of time. Those checks come from the Unemployment Insurance Fund. So where does this fund get the money to send out to unemployed workers? The money comes from Unemployment Taxes paid by every employer. Employers must pay 6.2% of the first $7,000 paid to each employee each year. Although the specific split differs from state to state, most states see 5.6% go to the state unemployment fund and 0.6% goes to the federal unemployment fund.
In normal times, the funds paid in are sufficient to cover the amounts paid out. However, in times like the American economy has experienced since 2009, with high unemployment rates nationally, the funds had insufficient funds to make the necessary payments due to all eligible, unemployed workers. In such times, Congress will often authorize additional federal funds to be allocated to fill the deficiency.

27. 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.
$22,880 * 6.2%
$22,580 * 1.45%
$4,000 * .6%
The entry requires a debit to Payroll Tax Expense of $2,081. Credits were made to FICA-OASDI Taxes Payable, FICA-Medicare Taxes Payable, FUTA Payable, and SUTA Payable.
$4,000 * 5.6%

28. 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.
Any function related to cash disbursements is often a target for thieves and fraudsters. To lessen the likelihood of cash “leakage” from the system, strong internal controls should be in place. These controls include separation of duties between those who approve payroll, those who prepare the payroll checks, and those who distribute the payroll checks. Many companies require employees to present IDs before they can receive their paychecks. In addition, time clocks are used to verify hours worked, and direct deposit is used to make sure the checks are not going to “fake” employees.

29. Accounting for Estimated Liabilities
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.
Some liabilities are estimated
Bonus Accruals
Vacation and Sick Leave Accruals
Pension expense Accrual
Warranties expense
Some liabilities, such as bonus accruals or vacation and sick leave accruals, are estimates. In order to meet the requirements of the Matching Principle, companies record these expenses in the current period, even though the actual payment for those expenses may not occur for several months.

30. Dell Warranty Disclosure

32. Contingent Liabilities
A contingent liability is a POTENTIAL liability that depends on a future event.
How do we disclose a liability that might arise in the FUTURE as a result of something that has occurred in the PRESENT?
In many cases, things happen currently that do not immediately create a liability, but that may lead to the creation of a liability in the future. For example, a lawsuit filed against the company today, may not even be heard in court for months, or even years. Any potential liability that depends on a future event is referred to as a Contingent Liability. Because the presence of a contingent liability embodies information that may impact the value of a company, the question arises as to how or when contingent liabilities should be disclosed to creditors and investors.

33. Contingent Liabilities
The type of disclosure of a contingent liability depends on two issues:
How likely is the future event?
Can the amount of the liability be reasonably estimated?
In order to determine the form of disclosure that is required by any contingent liability, a two-step decision process is used. First, we ask how likely it is that the event that triggers a contingent liability will actually happen. For example, how likely is it that we will lose any lawsuit? Second, can the amount of the contingent liability be reasonably estimated?

34. Contingent Liabilities
This table can be used to determine the proper disclosure treatment of a contingent liability.
Amount . . .
This table can be conveniently used to define the proper treatment for any contingent liability. For any contingent liability where the likelihood of a negative outcome is remote, there is no disclosure requirement under GAAP. If the likelihood of a negative outcome is probable AND the amount of that contingent liability can be reasonably estimated, then the contingent liability must be recorded as an expense and a liability on the books of the company. All other situations require disclosure in the notes to the financial statements, but do not require the creation of a liability on the books.

36. 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.
The Times-Interest-Earned Ratio is used to evaluate a business’s ability to pay interest expense. The ratio is computed by adding Net Income, Income Tax Expense, and Interest Expense and then dividing that total by Interest Expense. An alternative way to state this ratio is to divide EBIT (Earnings before Interest and Taxes) by Interest Expense.
When the ratio is high, it is a strong indication that the company is able to easily meet their interest obligations.
There is a warning about this ratio. For companies that have little or no debt, this ratio will appear very large. In such cases, the ratio may not be meaningful.

37. Times-Interest-Earned Ratio
Using data for Green Mountain, compute the Times-Interest-Earned Ratio for 2011.

38. Times-Interest-Earned Ratio
For Green Mountain, the Times-Interest-Earned Ratio is 6.22 for 2011.
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