Current Liabilities and Payroll Accounting

Teaching Objectives:

Make clear the concepts such as current and long-term liabilities and their characteristics, known liabilities, estimated liabilities, contingent liabilities and payroll accounting.

Teaching Focus: how to define, classify, measure, report, and analyze these liabilities so that this information is useful to business decision makers. What is liability? 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.

Classifying Liabilities

Liabilities can be classified into current liabilities and long-term liabilities according to term of payment.

Current liabilities are obligations due to be paid or settled within one year or the operating cycle, whichever is longer. They are usually settled by paying out current assets such as cash. notes payable, mortgages payable, bonds payable, and lease obligations)

Long-term Liabilities

Long-term liabilities are obligations not due within one year or the operating cycle, whichever is longer. (notes payable, mortgages payable, bonds payable, and lease obligations)

Known Liabilities

Most liabilities arise from situation 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, sales taxes payable, unearned revenues and lease obligations

Known Liabilities— Sales Taxes Payable Sales taxes are stated as a percent of selling prices. The seller collects sales taxes from customers when sales occur and remits these collections to the proper government agency.

Since sellers currently owe these collections to the government, this amount is a current liability.

Example:On May 15, 2009, Max Hardware sold tools and supplies for $7,500 that are subject to a 6% sales tax. $7,500 ? 6% = $450

Known Liabilities—unearned revenues

Unearned Revenues (also called deferred revenues, collections in advance, and prepayments) are amounts received in advance from customers for future products or services.

Example: On May 1, 2009, A-1 Catering received $3,000 in advance for catering a wedding party to take place on July 12, 2009.

Known Liabilities—Short-term Note Payable 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.

 NOTE GIVEN TO EXTEND CREDIT PERIOD

A company can replace an account payable with a note payable. A common example is a creditor that requires the substitution of an interst-bearing note for an overdue account payable that does not bear interest.

Example: On August 1, 2009, Matrix, Inc. asked Carter, Co. to accept a 90-day, 12% note to replace its existing $5,000 account payable to Carter. Matrix would make the following entry: On October 30, 2009, Matrix, Inc. pays the note plus interest to Carter. Interest expense = $5,000 ? 12%  (90 ? 360) = $150

NOTE GIVEN TO BORROW FROM BANK

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.

This difference between the amount borrowed and the amount repaid is interest.

FACE VALUE EQUALS AMOUNT BORROWED

On September 1, 2009, Jackson Smith borrows $20,000 from American Bank. The note bears interest at 6% per year. Principal and interest are due in 90 days (November 30, 2009). On November 30, 2009, Smith would make the following entry: $20,000 ? 6% ? (90 ? 360) = $300

PAYROLL LIABILITIES

Employers incur expenses and liabilities from having employees.  FICA Federal Insurance Contributions Act (FICA)  Medicare Taxes

Employers must pay withheld  taxes to the Internal Revenue Service (IRS)  Federal Income Tax

State and Local Income Taxes Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency? Voluntary Deductions

Amounts withheld depend on the employee’s request. Examples include union dues, savings accounts, pension contributions, insurance premiums, and charities. Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency.

Gross pay is the total compensation an employee earns including wages, salaries, commissions, bonuses, and any compensation earned before deductions.

Wages usually refer to payments to employees at an hourly rate. Salaries usually refer to payments to employees at a montly or yearly rate. Net pay, also called or take-home pay, is gross pay less all deductions. Payroll deductions, commonly called withholdings, are amounts withheld from an employee’s gross pay, either required or voluntary. Required deductions result from laws and include income taxes and Social Security taxes.

Voluntary deductions, at an employee’s option, include pension and health contributions, union dues, and charitable giving.  Withholdings

RECORDING EMPLOYEE PAYROLL DEDUCTIONS

The entry to record payroll expenses and deductions for an employee might look like this. $4,000 ? 6. 20% = $248 $4,000 ? 1. 45% = $58

EMPLOYER PAYROLL TAXES

Employers pay amounts equal to that withheld from the employee’s gross pay.

RECORDING EMPLOYER PAYROLL TAXES

The entry to record the employer payroll taxes for January might look like this