Chapter 9: Current Accounting for Liabilities & Payroll
Chapter 9: Current Accounting for Liabilities & Payroll
Current Liabilities
Definition: Current liabilities are obligations that are due:
(i) within one year, or
(ii) within the operating cycle, whichever is longer.
Learning Objectives & Outline
Learning Objectives (LO):
LO 9-1: Notes payable and interest expense.
LO 9-2: Accounting for sales tax liabilities.
LO 9-3: Contingent liabilities: What are they? How do we report them?
LO 9-4: Accounting for warranty obligations.
LO 9-5: Accounting for payroll taxes & related liabilities:
Employee withholdings (NOT expenses).
Employer payroll-related taxes (expenses).
Employer-paid employee benefits (expenses).
LO 9-6: Current vs. Noncurrent Assets & Liabilities, Classified Balance Sheet.
LO 9-7: Liquidity vs. Solvency: The current ratio vs. the debt-to-assets ratio.
LO 9-8: (Ch 9 Appendix) NOT COVERED/NOT ON EXAM.
Notes Payable
Relationship between Chapters:
Chapter 7: Notes Receivable (perspective of the lender).
Chapter 9: Notes Payable (perspective of the borrower).
Reporting Differences:
Receivables reported at net realizable value.
Payables reported at gross amount (face value).
Going Concern Assumption
Definition: Companies expect to pay all obligations in full as they come due, indicating a stable financial position.
Example of Notes Payable
Transaction Details:
Date: September 1, Year 1.
Company: Herrera Supply Company (HSC).
Amount Borrowed: $90,000 from the National Bank at a 9% interest rate for a 1-year term.
Initial Recording of Borrowing
Transaction entries:
Debit: Cash $90,000
Credit: Notes Payable $90,000
Accruing Interest Expense
Date: December 31, Year 1.
Interest Calculation: 4 months of interest for accrued expenses.
Interest Expense Calculation:
Interest Expense = Principal × Rate × Time
Interest Expense = $90,000 × 0.09 × (4/12) = $2,700
Transaction entries:
Debit: Interest Expense $2,700
Credit: Interest Payable $2,700
Maturity and Interest Payment
Date of Maturity: August 31, Year 2.
Interest Accrual from January 1, Year 2:
Total Interest Accrued = $5,400.
Final Journal Entries on Maturity Date
Total Interest Paid:
Cash Total = $90,000 + $8,100 (Total Interest due) = $98,100.
Entries for repayment:
Debit: Interest Payable $2,700
Debit: Interest Expense $5,400
Credit: Cash $98,100
Credit: Notes Payable $90,000
Example 9-1A: Notes Payable & Accrued Interest Expense
Transaction Context: Abardeen Corporation borrows $9,000 on October 1, Year 1, at an 8% annual interest rate, maturing on March 31, Year 2.
Questions:
Cash paid for interest in Year 1?
Interest expense recognized on Year 1 income statement?
Total liabilities on December 31, Year 1?
Total cash paid to the bank on March 31, Year 2 for principal and interest?
Answers to Example 9-1A
Interest Accrued in Year 1:
Interest = $1,800 ($9,000 × 0.08 × 3/12).
Total liabilities per balance sheet = $10,800 ($9,000 + $1,800).
Cash paid to the bank = $10,800 on March 31, Year 2.
Sales Tax Liabilities
Retailers collect sales tax from customers and remit it to the state.
Accounting of Sales Tax:
Sales tax does not affect revenue or expense; it is collected on top of the set price.
Example of Collecting Sales Tax
Event: HSC sells merchandise for $2,000 at a 6% sales tax rate.
Total Transactions:
Sales Tax Calculation: $2,000 × 0.06 = $120.
Total Collected: $2,120.
Transaction entries:
Debit: Cash $2,120.
Credit: Sales Tax Payable $120.
Credit: Sales Revenue $2,000.
Contingent Liabilities
Definition: A contingent liability is a potential obligation depending on a future event.
Classification Required by Accounting Standards:
Probable and estimable: Recognize in financial statements.
Reasonably possible: Disclose in notes.
Remote: No accounting entries required.
Warranty Obligations
Definition: A warranty obligates the seller to repair or replace defective products within a specified warranty period.
Recognition of Warranty Expense:
HSC sells $4,000 worth of merchandise for $7,000 cash.
Estimated warranty expense = $100.
Transaction entries:
Debit: Cash $7,000.
Credit: Sales Revenue $7,000.
Debit: Cost of Goods Sold $4,000.
Credit: Inventory $4,000.
Debit: Warranty Expense $100.
Credit: Warranties Payable $100.
Settling Warranty Obligations
When HSC pays $40 to repair defective goods returned:
Debit: Warranties Payable $40.
Credit: Cash $40.
Payroll Expenses and Related Taxes
FICA Tax: Employees contribute 7.5% for Social Security and Medicare, with the employer matching.
Payroll-related taxes include:
Employee withholdings (NOT an expense to employer, but gross salary is a Salary Expense).
Employer payroll-related expenses.
Payroll Example
Gross Salary: $2,000; FICA withholding of 7.5% results in a payable of $300 to the IRS.
Conclusion on Payroll Tax Expense Calculations
For employees earning $6,000 monthly:
Gross Earnings: $6,000.
Deductions: varied including federal income tax, FICA, and net pay.
Example computed entries reflect accurate payroll processing.
Liquidity vs. Solvency
Liquidity: Ability to meet short-term obligations, measured by the current ratio.
Solvency: Ability to meet long-term obligations, typically assessed via the debt-to-assets ratio.
Current Ratio Formula
Higher ratios indicate a stronger liquidity position.
Debt-to-Assets Ratio Formula
Indicates long-term financial stability.
This concludes the comprehensive notes on Chapter 9 covering Current Accounting for Liabilities and Payroll, including detailed examples, definitions, and relevant formulas. Adjustments and distinguishing entries illustrate the practical application of concepts in cash flow and liability management.