Ch10 wrd12e instructor_final

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Current Current

Liabilities and

Liabilities and

PayrollPayroll

Chapter 10Chapter 10Chapter 10Chapter 10

Learning ObjectivesLearning Objectives

1.1. Describe and illustrate current liabilities Describe and illustrate current liabilities related to accounts payable, current related to accounts payable, current portion of long-term debt, and notes portion of long-term debt, and notes payable.payable.

2.2. Determine employer liabilities for payroll, Determine employer liabilities for payroll, including liabilities arising from employee including liabilities arising from employee earnings and deductions from earnings.earnings and deductions from earnings.

3.3. Describe payroll accounting systems that Describe payroll accounting systems that use a payroll register, employee earnings use a payroll register, employee earnings records, and a general journal.records, and a general journal.

Learning ObjectivesLearning Objectives

4.4. Journalize entries for employee fringe Journalize entries for employee fringe benefits, including vacation pay and benefits, including vacation pay and pensions.pensions.

5.5. Describe the accounting treatment for Describe the accounting treatment for contingent liabilities and journalize contingent liabilities and journalize entries for product warranties.entries for product warranties.

6.6. Describe and illustrate the use of the Describe and illustrate the use of the quick ratio in analyzing a company’s quick ratio in analyzing a company’s ability to pay its current liabilities.ability to pay its current liabilities.


Learning Learning Objective

ObjectiveDescribe and illustrate current

Describe and illustrate current

liabilities related to accounts

liabilities related to accounts

payable, current portion of long-

payable, current portion of long-

term debt, and notes payable

term debt, and notes payable

11


Current LiabilitiesCurrent Liabilities

o When a company or a bank advances When a company or a bank advances creditcredit, it is making a loan., it is making a loan.

o The company or bank is called a The company or bank is called a creditorcreditor (or (or lenderlender).).

o The individuals or companies receiving The individuals or companies receiving the loans are called the loans are called debtorsdebtors (or (or borrowersborrowers).).


Current LiabilitiesCurrent Liabilities

o Long-term liabilities Long-term liabilities are debts due beyond are debts due beyond one year.one year.

o Current Liabilities Current Liabilities are debts that will be are debts that will be paid out of current assets and are due paid out of current assets and are due within one year.within one year.


Accounts PayableAccounts Payable

o Accounts payable transactions arise from Accounts payable transactions arise from purchasing goods or services for use in a purchasing goods or services for use in a company’s operations or from purchasing company’s operations or from purchasing merchandise for resale.merchandise for resale.

ACCOUNTS ACCOUNTS PAYABLEPAYABLE


Current Portion of Long-Term DebtCurrent Portion of Long-Term Debt

o Long-term liabilities are often paid back in Long-term liabilities are often paid back in periodic payments, called periodic payments, called installmentsinstallments. . InstallmentsInstallments that are due that are due withinwithin the the coming year must be classified as a coming year must be classified as a current liability. The installments due current liability. The installments due afterafter the coming year are classified as a long-the coming year are classified as a long-term liability. term liability.


Short-Term Notes PayableShort-Term Notes Payable

o Nature’s Sunshine Company issues a 90-Nature’s Sunshine Company issues a 90-day, 12% note for $1,000, dated August 1, day, 12% note for $1,000, dated August 1, 2011 to Murray Co. for a $1,000 overdue 2011 to Murray Co. for a $1,000 overdue account.account.


Interest Expense Interest Expense appears appears on the income statement on the income statement as an “Other Expense.”as an “Other Expense.”


o When the note matures, the entry to When the note matures, the entry to record the payment of $1,000 plus $30 record the payment of $1,000 plus $30 interest ($1,000 x 12% x 90/360) is as interest ($1,000 x 12% x 90/360) is as follows:follows:



o On May 1, Bowden Co. (borrower) On May 1, Bowden Co. (borrower) purchased merchandise on account from purchased merchandise on account from Coker Co. (creditor), $10,000, 2/10, n/30. Coker Co. (creditor), $10,000, 2/10, n/30. The merchandise cost Coker Co. $7,500.The merchandise cost Coker Co. $7,500.

DescriptionDescription Debit Debit CreditCredit

Bowden Co. (Borrower)

Mdse. Inventory 10,000Accounts Payable 10,000

Coker Co. (Creditor)

DescriptionDescription Debit Debit CreditCredit

Accounts Receivable10,000Sales

10,000

Cost of Mdse. Sold 7,500Mdse. Inventory 7,500

SHORT-TERM SHORT-TERM NOTES PAYABLENOTES PAYABLE



o On May 31, Bowden Co. issued a 60-day, On May 31, Bowden Co. issued a 60-day, 12% note for $10,000 to Coker Co. on 12% note for $10,000 to Coker Co. on account.account.

Accounts Payable10,000Notes Payable 10,000

DescriptionDescription DebitDebit CreditCredit


Notes Receivable 10,000Accounts Receivable

10,000

Coker Co. (Creditor)DescriptionDescription DebitDebit CreditCredit




o On July 30, Bowden Co. paid Coker Co. the On July 30, Bowden Co. paid Coker Co. the amount due on the note of May 31, the amount due on the note of May 31, the face amount of $10,000 plus interest of face amount of $10,000 plus interest of $200 ($10,000 x 12% x 60/360).$200 ($10,000 x 12% x 60/360).

Notes Payable 10,000Interest Expense 200

Cash 10,200

DescriptionDescription DebitDebit CreditCredit


Cash 10,200Interest Revenue 200Notes Receivable 10,000

Coker Co. (Creditor)DescriptionDescription DebitDebit CreditCredit




o On September 19, Iceburg Company On September 19, Iceburg Company borrowed cash from First National Bank by borrowed cash from First National Bank by issuing a $4,000, 90-day, 15% note to the issuing a $4,000, 90-day, 15% note to the bank.bank.



o On December 18, Iceburg Company paid On December 18, Iceburg Company paid First National Bank $4,000 plus interest of First National Bank $4,000 plus interest of $150 ($4,000 x 15% x 90/360).$150 ($4,000 x 15% x 90/360).



o A A discounted note discounted note has the following has the following characteristics:characteristics: The interest rate on the note is called the The interest rate on the note is called the discount discount

raterate.. The amount of interest on the note, called the The amount of interest on the note, called the

discountdiscount, is computed by multiplying the discount , is computed by multiplying the discount rate times the face amount of the note.rate times the face amount of the note.

The debtor (borrower) receives the face amount of The debtor (borrower) receives the face amount of the note less the discount, called the the note less the discount, called the proceedsproceeds..

The debtor must repay the face amount of the The debtor must repay the face amount of the note on the due date.note on the due date.


proceeds


o On August 10, Cary Company issues a On August 10, Cary Company issues a $20,000, 90-day discounted note to $20,000, 90-day discounted note to Western National Bank. The discount rate Western National Bank. The discount rate is 15%, and the amount of the discount is is 15%, and the amount of the discount is $750 ($20,000 x 15% x 90/360).$750 ($20,000 x 15% x 90/360).



o The entry when Cary Company pays the The entry when Cary Company pays the discounted note on November 8 is as discounted note on November 8 is as follows:follows:



ObjectiveDetermine employer liabilities

Determine employer liabilities

for payroll, including liabilities

for payroll, including liabilities

arising from employee earnings

arising from employee earnings

and deductions from earnings.

and deductions from earnings.

22


Payroll and Payroll TaxesPayroll and Payroll Taxes

o In accounting, In accounting, payrollpayroll refers to the amount refers to the amount paid to employees for services they paid to employees for services they provided during the period. A company’s provided during the period. A company’s payroll is important for the following payroll is important for the following reasons:reasons: Payroll and related payroll taxes significantly Payroll and related payroll taxes significantly

affect the net income of most companies.affect the net income of most companies. Payroll is subject to federal and state Payroll is subject to federal and state

regulations.regulations. Good employee morale requires payroll to Good employee morale requires payroll to

be paid timely and accuratelybe paid timely and accurately..


Liability for Employee EarningsLiability for Employee Earnings

o SalarySalary usually refers to payment for usually refers to payment for managerial and administrative services. managerial and administrative services. Salary is normally expressed in terms of a Salary is normally expressed in terms of a month or a year.month or a year.


(concluded)


o Wages usually refers to payment for Wages usually refers to payment for employee manual labor. The rate of wages employee manual labor. The rate of wages is normally stated on an hourly or weekly is normally stated on an hourly or weekly basis.basis.


Earnings at regular rate (40 x $34) $1,360Earnings at overtime rate (2 x $51) 102Total earnings $1,462


o John T. McGrath is employed by John T. McGrath is employed by McDermott Supply Co. at the rate of $34 McDermott Supply Co. at the rate of $34 per hour, plus 1.5 times the normal hourly per hour, plus 1.5 times the normal hourly rate for hours over 40 per week. For the rate for hours over 40 per week. For the week ended December 27, McGrath week ended December 27, McGrath worked 42 hours. His earnings are worked 42 hours. His earnings are computed as follows:computed as follows:


Deductions from Employee EarningsDeductions from Employee Earnings

o The total earnings of an employee for a The total earnings of an employee for a payroll period, including any overtime payroll period, including any overtime pay, are called pay, are called gross paygross pay..

o From this amount is subtracted one or From this amount is subtracted one or more more deductionsdeductions to arrive at the to arrive at the net paynet pay..

DEDUCTIONS DEDUCTIONS FROM FROM

EMPLOYEE EMPLOYEE EARNINGSEARNINGS



o John T. McGrath made $1,462 for the week John T. McGrath made $1,462 for the week ending December 27. McGrath’s W-4 ending December 27. McGrath’s W-4 (previous slide) claims one withholding (previous slide) claims one withholding allowance of $70. Thus, the wages used to allowance of $70. Thus, the wages used to determine McGrath’s withholding bracket determine McGrath’s withholding bracket in Exhibit 3 (next slide) are $1,392 ($1,462 in Exhibit 3 (next slide) are $1,392 ($1,462 – $70).– $70).

DEDUCTIONS DEDUCTIONS FROM FROM

EMPLOYEE EMPLOYEE EARNINGSEARNINGS



o The The Federal Insurance Contributions ActFederal Insurance Contributions Act (FICA) tax(FICA) tax withheld contributes to the withheld contributes to the following two federal programs.following two federal programs. Social securitySocial security, which provides payments for , which provides payments for

retirees, survivors, and disability insurance. retirees, survivors, and disability insurance. (Assume 6% on all earnings.)(Assume 6% on all earnings.)

MedicareMedicare, which provides health insurance , which provides health insurance benefits for senior citizens. (Assume 1.5% on benefits for senior citizens. (Assume 1.5% on all earnings.)all earnings.)



o John T. McGrath’s earnings for the week John T. McGrath’s earnings for the week ending December 27 are $1,462. Total FICA ending December 27 are $1,462. Total FICA tax to be withheld is calculated as follows:tax to be withheld is calculated as follows: Earnings subject to 6% Earnings subject to 6%

social security tax social security tax $1,462$1,462

Social security tax rateSocial security tax rate x 6% x 6%

Social security taxSocial security tax $ 87.72 $ 87.72

Earnings subject to 1.5% Medicare taxEarnings subject to 1.5% Medicare tax $1,462 $1,462

Medicare tax rate x 1.5% Medicare taxMedicare tax rate x 1.5% Medicare tax 21.93 21.93Total FICA taxTotal FICA tax $109.65$109.65


Computing Employee Net PayComputing Employee Net Pay

o John T. McGrath’s Net PayJohn T. McGrath’s Net Pay


Liability for Employer’s Payroll TaxesLiability for Employer’s Payroll Taxes

o Employers are subject to the following Employers are subject to the following payroll taxes for amounts paid their payroll taxes for amounts paid their employees:employees: FICA TaxFICA Tax

Federal Unemployment Compensation Tax Federal Unemployment Compensation Tax (FUTA)(FUTA)

State Unemployment Compensation Tax State Unemployment Compensation Tax (SUTA)(SUTA)

LIABILITY FOR LIABILITY FOR EMPLOYER’S EMPLOYER’S

PAYROLL TAXESPAYROLL TAXES



ObjectiveDescribe payroll accounting

Describe payroll accounting

systems that use a payroll

systems that use a payroll

register, employee earnings

register, employee earnings

records, and a general journal.

records, and a general journal.

33


Accounting Systems for Payroll and Payroll Accounting Systems for Payroll and Payroll TaxesTaxes

o Payroll systems should be designed to:Payroll systems should be designed to: Pay employees accurately and timely.Pay employees accurately and timely.

Meet regulatory requirements of federal, Meet regulatory requirements of federal, state, and local agencies.state, and local agencies.

Provide useful data for management decision-Provide useful data for management decision-making needs.making needs.


Payroll RegisterPayroll Register

o The The payroll registerpayroll register is a multicolumn is a multicolumn report used for summarizing the data for report used for summarizing the data for each payroll period. Exhibit 5 illustrates a each payroll period. Exhibit 5 illustrates a payroll register for McDermott Supply Co.payroll register for McDermott Supply Co.

(left side, continued)

PAYROLL PAYROLL REGISTERREGISTER

(right side)

PAYROLL PAYROLL REGISTERREGISTER

RECORDING RECORDING EMPLOYEES’ EMPLOYEES’ EARNINGSEARNINGS


Social security tax $ 834.12 ($13,902 x 6%)Medicare tax 208.53 ($13,902 x 1.5%)SUTA 146.34 ($2,710 x 5.4%)FUTA 21.68 ($2,710 x 0.8%) Total payroll taxes $1,210.67

Recording and Paying Payroll TaxesRecording and Paying Payroll Taxes

o Employers must match the employee’s Employers must match the employee’s social security and Medicare tax social security and Medicare tax contributions. In addition, the employer contributions. In addition, the employer must pay SUTA tax of 5.4% and FUTA tax must pay SUTA tax of 5.4% and FUTA tax of 0.8% (assume on $2,710). For of 0.8% (assume on $2,710). For McDermott Supply’s payroll of December McDermott Supply’s payroll of December 27, these payroll taxes are computed as 27, these payroll taxes are computed as follows:follows:


Recording and Paying Payroll TaxesRecording and Paying Payroll Taxes

o The entry to journalize the payroll tax The entry to journalize the payroll tax expense for Exhibit 5 is shown below.expense for Exhibit 5 is shown below.


Employee’s Earnings RecordEmployee’s Earnings Record

o A detailed payroll record must be kept for A detailed payroll record must be kept for each employee. This record is called an each employee. This record is called an employee’s earnings recordemployee’s earnings record. Exhibit 6 . Exhibit 6 ((next two slidesnext two slides) shows a portion of John ) shows a portion of John T. McGrath’s employee’s earnings record.T. McGrath’s employee’s earnings record.

EARNINGS EARNINGS RECORDRECORD

EARNINGS EARNINGS RECORDRECORD

EMPLOYEE’S EMPLOYEE’S EARNINGS EARNINGS RECORDRECORD


Payroll ChecksPayroll Checks

o At the end of each payroll period,At the end of each payroll period, payrollpayroll checkschecks are prepared. Each check includes are prepared. Each check includes a detachable statement showing the a detachable statement showing the details of how the net pay was computed.details of how the net pay was computed.

PAYROLL PAYROLL CHECKCHECK


Payroll System DesignPayroll System Design

o The inputs into a payroll system may be The inputs into a payroll system may be classified as:classified as: ConstantsConstants, which are data that remain , which are data that remain

unchanged from payroll to payroll.unchanged from payroll to payroll.• Employee namesEmployee names

• Social security numbersSocial security numbers

VariablesVariables, which are data that change from , which are data that change from payroll to payroll.payroll to payroll.• Number of hours or days workedNumber of hours or days worked

• Accrued sick leaveAccrued sick leave


Internal Controls for Payroll SystemsInternal Controls for Payroll Systems

o Some examples of payroll controls include Some examples of payroll controls include the following:the following: If a check-signing machine is used, blank If a check-signing machine is used, blank

payroll checks and access to the machine payroll checks and access to the machine should be restricted to prevent their theft or should be restricted to prevent their theft or misuse.misuse.

The hiring and firing of employees should be The hiring and firing of employees should be properly authorized and approved in writing.properly authorized and approved in writing.

(continued)


(continued)

Internal Controls for Payroll SystemsInternal Controls for Payroll Systems

All changes in pay rates should be properly All changes in pay rates should be properly authorized and approved in writing.authorized and approved in writing.

Employees should be observed when arriving Employees should be observed when arriving for work to verify that employees are “checking for work to verify that employees are “checking in” for work only once and only for themselves.in” for work only once and only for themselves.

Payroll checks should be distributed by Payroll checks should be distributed by someone other than employee supervisors.someone other than employee supervisors.

A special payroll bank account should be used.A special payroll bank account should be used.



ObjectiveJournalize entries for employee

Journalize entries for employee

fringe benefits, including

fringe benefits, including

vacation pay and pensions.

vacation pay and pensions.

44


Employees’ Fringe BenefitsEmployees’ Fringe Benefits

o Many companies provide their employees Many companies provide their employees benefits in addition to salary and wages benefits in addition to salary and wages earned. Such earned. Such fringe benefitsfringe benefits may include: may include: Vacation pay (sometimes called Vacation pay (sometimes called compensated compensated

absencesabsences) )

Medical benefitsMedical benefits

Retirement benefitsRetirement benefits


Vacation PayVacation Pay

o Assume that employees earn one day of Assume that employees earn one day of vacation for each month worked. The vacation for each month worked. The estimated vacation pay for the year estimated vacation pay for the year ending December 31 is $325,000. The ending December 31 is $325,000. The adjusting entry for the accrued vacation is adjusting entry for the accrued vacation is shown below.shown below.


PensionsPensions

o A A pensionpension is a cash payment to retired is a cash payment to retired employees. Pension rights are accrued by employees. Pension rights are accrued by employees as they work, based on the employees as they work, based on the employer’s pension plan. Two types of employer’s pension plan. Two types of pension plans are:pension plans are: Defined contribution planDefined contribution plan

Defined benefit planDefined benefit plan


PensionsPensions

o In a In a defined contribution plandefined contribution plan, the , the company invests contributions on behalf company invests contributions on behalf of the employee during the employee’s of the employee during the employee’s working years.working years. Normally, the employee and employer Normally, the employee and employer

contribute to the plan.contribute to the plan.

The employee’s pension depends on the total The employee’s pension depends on the total contributions and the investment returns contributions and the investment returns earned on those contributions.earned on those contributions.


PensionsPensions

o Heaven Scent Perfumes Company Heaven Scent Perfumes Company contributes 10% of employee monthly contributes 10% of employee monthly salaries to an employee 401K plan. salaries to an employee 401K plan. Assuming $500,000 of monthly salaries, Assuming $500,000 of monthly salaries, the journal entry to record the monthly the journal entry to record the monthly contribution is shown below.contribution is shown below.


PensionsPensions

o In a In a defined benefit plandefined benefit plan, the employer is , the employer is obligated to pay for (fund) the employee’s obligated to pay for (fund) the employee’s future pension benefits.future pension benefits. Many companies are replacing their defined Many companies are replacing their defined

benefit plans with defined contribution plans.benefit plans with defined contribution plans.

A retired employee receives a specific amount A retired employee receives a specific amount based on his or her salary history and years of based on his or her salary history and years of service.service.


PensionsPensions

o The defined benefit plan of Hinkle Co. The defined benefit plan of Hinkle Co. requires an annual pension cost of requires an annual pension cost of $80,000. The annual contribution is based $80,000. The annual contribution is based on estimates of Hinkle’s future pension on estimates of Hinkle’s future pension liability. On December 31, Hinkle Co. pays liability. On December 31, Hinkle Co. pays $60,000 to the pension fund. The entry to $60,000 to the pension fund. The entry to record the payment and unfunded liability record the payment and unfunded liability is shown below.is shown below.


Postretirement Benefits Other than Postretirement Benefits Other than PensionsPensions

o Employees may earn rights to other Employees may earn rights to other postretirement benefits, such as dental postretirement benefits, such as dental care, eye care, medical care, life care, eye care, medical care, life insurance, tuition assistance, tax services, insurance, tuition assistance, tax services, and legal services.and legal services.

CURRENT CURRENT LIABILITIES ON LIABILITIES ON THE BALANCE THE BALANCE

SHEETSHEET



ObjectiveDescribe the accounting

Describe the accounting

treatment for contingent

treatment for contingent

liabilities and journalize entries

liabilities and journalize entries

for product warranties.

for product warranties.

55


Contingent LiabilitiesContingent Liabilities

o Some liabilities may arise from past Some liabilities may arise from past transactions if certain events occur in the transactions if certain events occur in the future. These potential obligations are future. These potential obligations are called contingent liabilities. The called contingent liabilities. The accounting for contingent liabilities accounting for contingent liabilities depends on the following two factors:depends on the following two factors: Likelihood of occurring: Probable, reasonably Likelihood of occurring: Probable, reasonably

possible, or remotepossible, or remote

Measurement: Estimable or not estimableMeasurement: Estimable or not estimable



o During June, a company sold a product for During June, a company sold a product for $60,000 that includes a 36-month $60,000 that includes a 36-month warranty for repairs. The average cost of warranty for repairs. The average cost of repairs over the warranty period is 5% of repairs over the warranty period is 5% of the sales price. The entry to record the the sales price. The entry to record the estimated product warranty expense for estimated product warranty expense for June is shown below.June is shown below.



o If a $200 part is replaced under warranty If a $200 part is replaced under warranty on August 16, the entry is as follows:on August 16, the entry is as follows:

CONTINGENT CONTINGENT LIABILITIESLIABILITIES



ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

the quick ratio in analyzing a

the quick ratio in analyzing a

company’s ability to pay its

company’s ability to pay its current liabilities.

current liabilities.

66


Quick RatioQuick Ratio

o Current position analysisCurrent position analysis helps creditors helps creditors evaluate a company’s ability to pay its evaluate a company’s ability to pay its current liabilities. It is based on:current liabilities. It is based on: Working capital, the excess of current assets Working capital, the excess of current assets

over current liabilitiesover current liabilities

Current ratio, determined by dividing the Current ratio, determined by dividing the current assets by the current liabilitiescurrent assets by the current liabilities

Quick ratio, an indicator of a company’s short-Quick ratio, an indicator of a company’s short-term liquidityterm liquidity


Quick RatioQuick Ratio

o The quick ratio measures the “instant” The quick ratio measures the “instant” debt-paying ability of a company and is debt-paying ability of a company and is computed as follows:computed as follows:

o Quick assets Quick assets are cash and other current are cash and other current assets that can be easily converted to assets that can be easily converted to cash.cash.

Quick Ratio =Quick Assets

Current Liabilities


Current Current

Liabilities and

Liabilities and

PayrollPayroll

The EndThe EndThe EndThe End

Ch10 wrd12e instructor_final

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learning objectives1

learning objectives4

o current liabilities

current liability

current liabilitiesowhen

current assets