CHAPTER 11
Current Liabilities and Payroll
Chapter Overview
Chapter 11 begins with the definitions of current and long-term liabilities. Accounting for current liabilities is then discussed and illustrated. The current liabilities of known amount included in this chapter are (1) accounts payable, (2) short-term notes payable, (3) short-term notes payable issued at a discount, (4) sales tax payable, (5) current portion of long-term debt, (6) accrued expenses (liabilities), (7) payroll liabilities and (8) unearned revenue.
The chapter then explains current liabilities that must be estimated and uses warranties, vacation pay, and income taxes for corporations as examples. An explanation of contingent liabilities builds on the definition given in the discussion of discounted notes in Chapter 8. The guidelines for the three categories of contingent liabilities--probable, reasonably possible, and remote--are discussed. Two different presentations of contingencies are discussed--using an explanatory note only or using an explanatory note and a short presentation in the body of the balance sheet. The chapter highlights ethical issues concerning current and contingent liabilities. Decision guidelines answer important questions about current and contingent liabilities. A mid-chapter summary problem reviews the various concepts covered in this part of the chapter.
Accounting for payroll is then presented. Gross and net pay, payroll deductions, FICA tax, and withholding are discussed. Employer payroll taxes are explained. The journal entries for payroll and the payment of the payroll, taxes, and fringe benefits are illustrated. The components of a payroll system--the payroll register, the payroll bank account, payroll checks, and the employee earnings records are explained. Payroll documents such as Form 941 and a W-2 are illustrated. The chapter briefly mentions another payroll-related item--postretirement benefits such as medical insurance and pensions. The chapter concludes with a discussion of internal controls over payroll and financial reporting of payroll expenses and liabilities. Decision guidelines answer important questions about payroll. A summary problem allows the student to practice making payroll calculations and journal entries.
Learning Objectives
After studying Chapter 11, your students should be able to:
2. Account for current liabilities that must be estimated
3. Compute payroll amounts
4. Record basic payroll transactions
5. Use a payroll system
6. Report current liabilities on the balance sheet
Chapter Outline
Objective 1: Account for current liabilities of known amount
A. A current liability is a liability due within the longer of one year or the operating cycle. All other liabilities are classified as long-term. Exhibit 11-1 gives an example of how an actual company reports current liabilities.
B. The amount of some current liabilities is known.
1. Accounts payable are amounts owed to suppliers for goods or services purchased on open account.
2. Short-term notes payable are promissory notes due within one year; the interest is paid at maturity.
a. Credit Note Payable for the principle of the note and the cash received is equal to the principle.
Inventory (Cash) XX
Note Payable XX
b. If the payment of the note occurs in the next accounting period, then an adjusting entry must be recorded to accrue the interest at the end of the current period.
Interest Expense XX
Interest Payable XX
c. The following entry is required when the note is paid in the next accounting period:
Note Payable XX
Interest Expense XX
Interest Payable XX
Cash XX
3. When short-term notes payable are issued at a discount, the interest is deducted from the face value of the note.
a. Credit Note Payable for the proceeds from the note; the proceeds is the principle less the interest.
Cash XX
Note Payable XX
b. If the note is paid in the next accounting period, an adjusting entry must be prepared at the end of the current period.
Interest Expense XX
Note Payable XX
c. The following entry is required when the note is paid at maturity. At this time, Note Payable is equal to the maturity value of the note.
Note Payable XX
Cash XX
4. Sales tax payable reports the sales taxes that are collected by retailers and that must be periodically remitted to the taxing authority.
a. Sales taxes may be recorded at each sale.
Accounts Receivable (Cash) XX
Sales Revenue XX
Sales Tax Payable XX
b. If sales taxes are not recorded at each sale, then periodically an entry to adjust Sales Revenue is prepared.
1) The entry to record the sale is:
Accounts Receivable (Cash) XX
Sales Revenue XX
2) The adjusting entry is:
Sales Revenue XX
Sales Tax Payable XX
5. The current portion of long-term debt is the principal portion of a long-term installment debt that is payable within one year.
6. Accrued expenses (accrued liabilities) are expenses incurred but not yet paid. Examples discussed in this chapter include accrued interest and accrued payroll liabilities.
7. Payroll (employee compensation) is a major expense for many companies. Employers often have liabilities to the employee for the employee’s net pay as well as liabilities to the government for income tax and social security taxes withheld. Exhibit 11-2 illustrates a basic payroll entry. Payroll is discussed in detail in the second half of the chapter.
8. Unearned revenues, also called deferred revenues, customer prepayments, and revenues collected in advance, are accounts indicating that cash has been collected before the revenue has been earned. Unearned Revenue is a liability account. As the revenue is earned, the liability account decreases.
Objective 2: Account for current liabilities that must be estimated
A. Some current liabilities must be estimated if the amount is not known.
B. When an estimated liability is recorded as a credit, the corresponding debit is usually to an expense. The expense must be recorded to properly match revenues and expenses.
1. Warranty agreements are guarantees that companies make concerning defects in their products. Because some warranty agreements last several years, the exact amount of repairs required under the warranty may not be known for several years.
a. The matching principle requires that the warranty expense relating to sales in any period be estimated and deducted from the sales revenue. A liability, Estimated Warranty Payable, for the estimated repairs must be reported on the balance sheet. The journal entry is:
Warranty Expense XX
Estimated Warranty Payable XX
b. The entry to record the actual repair or replacement of defective merchandise is:
Estimated Warranty Payable XX
Cash or Inventory XX
2. Companies that grant paid vacations to their employees must expense the benefit as the employee works to match revenue and expenses properly, rather than expense the vacation when taken.
a. The entry to estimate the vacation pay expense is:
Vacation Pay Expense XX
Estimated Vacation Pay Liability XX
b. When employee takes a vacation, the entry is:
Estimated Vacation Pay Liability XX
Cash XX
3. Corporations must estimate their income tax quarterly and make quarterly tax payments based on this estimate.
a. When the quarterly payments are made, the entry is:
Income Tax Expense XX
Cash XX
b. When the income tax expense is accrued at year-end, the entry is:
Income Tax Expense XX
Income Tax Payable XX
4. A contingent liability is a potential liability that may become an actual liability depending on the resolution of future events. Contingent liabilities may be reported in a short presentation on the balance sheet, in a footnote to the financial statements, or both.
C. Ethical issues are involved in accounting for liabilities. Owners and managers may be tempted to overlook some accrued expenses and contingent liabilities in order to report lower expenses and higher income.
D. Decision guidelines provide answers to important questions related to current and contingent liabilities.