Chapter 11

Current Liabilities
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division

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Professor Emeritus of Accounting
Pepperdine University
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 Objectives
Objectives
1. Define and give examples of current liabilities.
2. Prepare journal entries
After for short-term
studying this notes
After studying this
payable and disclosure for the current portion of
chapter,
long-term debt.chapter, you
you should
should
be
be able
3. Describe the accounting to:
abletreatment
to: 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.
 Objectives
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.
The
The Nature
Nature of
of Current
Current Liabilities
Liabilities
Liabilities
Liabilities that
that are
are to
to be
be paid
paid out
out of
of
current
current assets
assets and
and are
are due
due within
within aa
short
short time,
time, usually
usually within
within one
one
year,
year, are
are called
called current
current liabilities.
liabilities.

 Accounts payable
 Notes payable
Examples:
 Unearned rent
 Taxes payable
 Wages payable
 Current portion of long
term debt
 Short-Term
Short-Term Notes
Notes Payable
Payable
AA firm
firm issues
issues aa 90-day,
90-day, 12%
12% note
note for
for
$1,000,
$1,000, dated
dated August
August 1,1, 2006
2006 to
to Murray
Murray
Co.
Co. for
for aa $1,000
$1,000 overdue
overdue account.
account.

Aug. 1 Accounts Payable—Murray Co. 1 000 00

Notes Payable 1 000 00
Issued a 90-day, 12% note on
account.
 Short-Term
Short-Term Notes
Notes Payable
Payable
On
On October
October 30,30, when
when the
the note
note matures,
matures, the
the
firm
firm pays
pays the
the $1,000
$1,000 principal
principal plus
plus $30
$30
interest
interest ($1,000
($1,000 xx .12
.12 xx 90/360).
90/360).

Oct. 30 Notes Payable 1 000 00

Interest Expense 30 00
Cash 1 030 00
Issued a 90-day, 12% note on
Appears
Appears on
on the
the
account.
income
income statement
statement asas
an
an “Other
“Other Expense.”
Expense.”
 Short-Term
Short-Term Notes
Notes Payable
Payable
Bowden Co. (Borrower) Coker Co. (Creditor)
Description Debit Credit Description Debit Credit

Mdse. Inventory 10,000 Accounts Receivable 10,000

Accounts Payable 10,000 Sales 10,000
Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500

May
May 31.
31. Bowden
Bowden Co.
Co. purchased
purchased merchandise
merchandise onon
account
account from
from Coker
Coker Co.,
Co., $10,000,
$10,000, 2/10,
2/10, n/30.
n/30.
The
The merchandise
merchandise cost
cost Coker
Coker Co.
Co. $7,500.
$7,500.
 Short-Term
Short-Term Notes
Notes Payable
Payable
Bowden Co. (Borrower) Coker Co. (Creditor)
Description Debit Credit Description Debit Credit

Mdse. Inventory 10,000 Accounts Receivable 10,000

Accounts Payable 10,000 Sales 10,000
Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500
Accounts Payable
Notes Payable
10,000
10,000 Notes Receivable 10,000
Accounts Receivable 10,000

May
May 31.
31. Bowden
Bowden Co.
Co. issued
issued aa 60-day,
60-day, 12%
12%
note
note for
for $10,000
$10,000 to
to Coker
Coker on
on account.
account.
 Short-Term
Short-Term Notes
Notes Payable
Payable
Bowden Co. (Borrower) Coker Co. (Creditor)
Description Debit Credit Description Debit Credit
Mdse. Inventory
July
July 30.
10,000 30. Bowden
Bowden Co.
Co. paid
paid Coker
Coker Co.
Co. the
the
Accounts Receivable 10,000
Accounts Payable
amount
amount due on the note of
due on
10,000
the note May
May 31.
ofSales 31. Interest:
Interest: 10,000
$10,000
$10,000 xx 12%
12% xxCost
60/360
60/360 == $200.
$200. 7,500
of Mdse. Sold
Mdse. Inventory 7,500
Accounts Payable
Notes Payable
10,000
10,000 Notes Receivable 10,000
Accounts Receivable 10,000

Notes Payable 10,000 Cash 10,200

Interest Expense 200 Interest Revenue 200
Cash 10,200 Notes Receivable 10,000
 Discounted
Discounted Notes
Notes Payable
Payable
On
On August
August 10,
10, Cary
Cary Company
Company issues
issues aa $20,000,
$20,000,
90-day
90-day note
note to
to Rock
Rock Company
Company in in exchange
exchange for
for
inventory.
inventory. Rock
Rock discounts
discounts the
the note
note at
at 15%.
15%.
Aug.10 Merchandise Inventory 19 250 00
Interest Expense 750 00
Notes Payable
Proceeds
Proceeds 20 000 00
Issued a 90-day, note to Rock Discount:
Discount: $20,000
$20,000
Co. discounted at 15%.
xx.15
.15xx90/360
90/360

Discount
Discount rate
rate
 Discounted
Discounted Notes
Notes Payable
Payable
On
On November
November 88 the
the note
note isis paid
paid in
in full.
full.

Nov. 8 Notes Payable 20 000 00

Cash 20 000 00
Paid note due.
Contingent
Liabilities
 Product
Product Liability
Liability
On
On June
June 30,
30, aa company
company sells sells aa product
product for
for $60,000
$60,000
on
on which
which there
there isis aa 36-month
36-month warranty.
warranty. Past
Past
experience
experience indicates
indicates thatthat repairs
repairs of
of defects
defects cost
cost 5%
5%
of
of the
the sales
sales price
price over
over the
the warranty
warranty period.
period.

June 30 Product Warranty Expense 3 000 00

Product Warranty Liability 3 000 00
Warranty expenses projected for
June, 5% of $60,000.
 Product
Product Liability
Liability
On
On August
August 16,
16, aa customer
customer needed
needed aa
defective
defective part
part replaced.
replaced. Cost
Cost to
to the
the
company
company was
was $200
$200 for
for the
the part.
part.

Aug.16 Product Warranty Payable 200 00

Supplies 200 00
Replaced defective part under
warranty.
 Accounting
Accounting Treatment
Treatment ofof
Contingent
Contingent Liabilities
Liabilities
Likelihood
of Accounting
Occurring Measurement Treatment
Probable Estimable Record
Liability
Contingency Not Disclose
Estimable Liability

Disclose
Possible
Liability
Payroll and
Payroll
Taxes
 Liability
Liability for
for Employee
Employee Earnings
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.
 Gross
Gross Pay
Pay Calculation
Calculation
John
John T.
T. McGrath
McGrath isis employed
employed by by McDermott
McDermott
Supply
Supply Co.
Co. at
at the
the rate
rate of
of $34
$34 per
per hour,
hour, plus
plus 1.5
1.5
times
times the
the normal
normal hourly
hourly rate
rate for
for hours
hours over
over 40
40
per
per week.
week. For
For the
the week
week ended
ended December
December 27, 27,
McGrath
McGrath worked
worked 4242 hours.
hours.

Earnings at base rate (40 x $34) $1,360

Earnings at overtime rate (2 x $51) 102
Total earnings $1,462
 FICA
FICA Tax
Tax
Employers
Employers areare required
required to
to withhold
withhold aa
portion
portion of
of the
the earnings
earnings ofof each
each of
of the
the
employees.
employees. The The amount
amount isis matched
matched by by
the
the employer
employer andand serves
serves to
to provide
provide the
the
employee
employee with
with social
social security
security and
and
Medicare
Medicare benefits
benefits upon
upon retirement.
retirement.
 FICA
FICA Tax
Tax Calculation
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 21.93
Total FICA tax $79.65
 Withholding
Withholding Taxes,
Taxes, Other
Other Deductions
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.
 Employee Net Pay Calculation
Gross earnings for the week $1,462.00
Deductions:
Social security tax tax $ 57.72
Medicare tax 21.93
Federal income tax 279.51
Retirement savings 20.00
United Way 5.00
Total deductions 384.16
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.
 Responsibility
Responsibility for
for Tax
Tax
Payments
Payments
EMPLOYEE BUSINESS

Social security tax

Medicare tax
Social security tax
Federal unemployment
Medicare tax
compensation tax
Federal withholding tax
State unemployment
GOVERNMENT compensation tax
 Federal Income

Estate, gift, Corporate

and other income tax
FICA and
8% 8% FUTA
38%
46%

Personal
income tax
 Federal Outlays
Physical,
human, and
Interest on community
debt development Social
8% 13% programs
National 19% 24%
defense
33%
3%

Social Law
security and enforcement
Medicare and general
government
 Payroll
Payroll Register
Register
It’s
It’s aa multicolumn
multicolumn form
form used
used toto help
help
What
What isis the
theassemble
assemble andand summarize
summarize the
the data
data
purpose
purpose of of aa needed
needed forfor each
each payroll
payroll period.
period.
payroll
payroll register?
register?
Payroll Register Summary
Earnings:
Regular $13,328.00
Overtime 574.00
Total $13,902.00
Deductions:
Social security tax $ 643.07
Medicare tax 208.53
Federal income tax 3,332.00
Retirement savings 680.00
United Way 470.00
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
 Recording
Recording Employees’
Employees’ Earnings
Earnings
Dec. 27 Sales Salaries Expense 11 122 00
Office Salaries Expense 2 780 00
Social Security Tax Payable 643 07
Medicare Tax Payable 208 53
Employees Federal Inc. Tax Pay. 3 332 00
Retirement Savings Ded. Payable 680 00
United Way Deductions Payable 470 00
Accounts Receivable—Fred Elrod 50 00
Salaries Payable 8 518 40
Payroll for week ended
December 27.
 Recording
Recording Employer’s
Employer’s Payroll
Payroll Taxes
Taxes

Employer
Employer TaxesTaxes for
for the
the Week
Week Ended
Ended December
December 27
27
Social
Social security
security tax
tax $$ 643.07
643.07
Medicare
Medicare tax tax 208.53
208.53
State
State unemployment
unemployment compensation
compensation tax
tax
(5.4%
(5.4% xx $2,710)
$2,710) 146.34
146.34
Federal
Federal unemployment
unemployment compensation
compensation
tax
tax (0.8%
(0.8% xx $2,710)
$2,710) 21.68
21.68
Total
Total payroll
payroll tax
tax expense
expense $1,019.62
$1,019.62
 Recording
Recording Employer’s
Employer’s Payroll
Payroll Taxes
Taxes

Dec. 27 Payroll Tax Expense 1 019 62

Social Security Tax Payable 643 07
Medicare Tax Payable 208 53
State Unemployment Tax Payable 146 34
Federal Unemployment Tax Pay. 21 68
Payroll taxes for week ended
December 27.
 Flow of Data in a Payroll System
Wage and Tax
Statements
W-2 W-2
EMPLOYEES’
EARNINGS
Current Period’s
RECORDS Payroll Tax
Variables
Returns
(hours worked)

Updated Variables PAYROLL

(cumulative Payroll Checks
REGISTER and Statements
earnings, taxes)

Constant Data
(rates of pay,
tax, etc.) GENERAL Financial
LEDGER
Statements
Employees’
Employees’ Fringe
Fringe Benefits
Benefits
Benefit
Benefit Dollars
Dollars as
as aa Percent
Percent of
of Total
Total
Other 2%
Retirement
and savings
plans 18% Vacation
29% and sick pay

25%
Social security 26%
and Medicare
Medical
 Employees’
Employees’ Fringe
Fringe Benefits
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.
 Pensions
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.
Solvency Measures — Quick Ratio
Noble Co. Hart Co.
Quick assets:
Cash $ 100,000 $ 55,000
Cash equivalents 47,000 65,000
Accounts receivable (net) 84,000 472,000
Total $231,000 $592,000
Current liabilities $220,000 $740,000

Quick assets
Current liabilities
Solvency Measures — Quick Ratio
Noble Co. Hart Co.
Quick assets:
Cash $ 100,000 $ 55,000
Cash equivalents 47,000 65,000
Accounts receivable (net) 84,000 472,000
Total $231,000 $592,000
Current liabilities $220,000 $740,000

Quick assets
$231,000
Noble Company
Current liabilities Quick ratio = 1.05
$220,000
Solvency Measures — Quick Ratio
Noble Co. Hart Co.
Quick assets:
Cash $ 100,000 $ 55,000
Cash equivalents 47,000 65,000
Accounts receivable (net) 84,000 472,000
Total $231,000 $592,000
Current liabilities $220,000 $740,000

Quick assets
$592,000
Hart Company
Current liabilities Quick ratio = 0.80
$740,000

Use:
Use: To
To indicate
indicateinstant
instant debt-paying
debt-paying ability
ability
Chapter 11

The
The End
End