Reporting and Analyzing Current Liabilities
Reporting and Analyzing Current Liabilities 201
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Date Created: 12/09/15
Chapter 9 Book Notes Defining Liabilities o 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. This definition includes three crucial factors: o A past transaction or event o A present obligation o A future payment of assets or services Classifying Liabilities o Current Liabilities Current liabilities, also called short-term liabilities, are obligations due within one year or the company’s operating cycle, whichever is longer. They are expected to be paid using current assets or by creating other current liabilities. Common examples of current liabilities are accounts payable, short-term notes payable, wages payable, warranty liabilities, lease liabilities, taxes payable, and unearned revenues o Long-Term Liabilities A company’s obligations not expected to be paid within the longer of one year or the company’s operating cycle are reported as long-term liabilities. They can include long-term notes payable, warranty liabilities, lease liabilities, and bonds payable. They are sometimes reported on the balance sheet in a single long-term liabilities total or in multiple categories. Uncertainty in Liabilities o Accounting for liabilities involves addressing three important questions: whom to pay? When to pay? How much to pay? Answers to these questions are often decided when a liability is incurred. For example, if a company has a $100 account payable to a specific individual, payable on March 15, the answers are clear. The company knows whom to pay, when to pay, and how much to pay. However, the answers to one or more of these questions are uncertain for some liabilities. Accounts Payable o Accounts payable, or trade accounts payable, are amounts owed to suppliers, also called vendors, for products or services purchased on credit Sales Taxes Payable o Nearly all states and many cities levy taxes on retail sales. Sales taxes are stated as a percent of selling prices. The seller collects sales taxes from customers when sales occur and remits these collections (often monthly) to the proper government agency. Since sellers currently owe these collections to the government, this amount is a current liability. o Sales Taxes Payable is debited and Cash credited when it remits these collections to the government. Sales Taxes Payable is not an expense. It arises because laws require sellers to collect this cash from customers for the government Aug. 31 Cash 6,300 Sales 6.000 Sales Taxes Payable 300 To record cash sales and 5% sales tax o Unearned Revenues 1. Unearned revenues (also called deferred revenues, collections in advance, and prepayments) are received in advance from customers for future products or services. June 30 Cash 5,000,0 00 Unearned Ticket Revenue 5,000,000 To record sale of concert tickets Oct. 31 Unearned Ticket Revenue 625,000 Ticket Revenue 625,000 To record concert ticket revenues earned 2. Short-Term Notes Payable o A short-term note payable is 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. These promissory notes are negotiable (as are checks), meaning they can be transferred from party to party by endorsement. The written documentation provided by notes is helpful in resolving disputes and for pursuing legal actions involving these liabilities. Aug. 23 Accounts Payable - McGraw 600 Cash 100 Notes Payable - McGraw 500 Gave $100 cash and a 60-day, 12% note for payment on account Oct. 22 Notes Payable – McGraw 500 Interest Expense 10 Cash 510 Paid note with interest ($500 * 12% * 60/360) Interest expense is computed by multiplying the principal of the note ($500) by the annual interest rate (12%) for the fraction of the year the note is outstanding (60 days/360 days). 3. Note given to borrow from bank o When the note matures, the borrower repays the note with an amount larger than the amount borrowed. The difference between the amount borrowed and the amount repaid is interest. 2013 Dec. 31 Interest Expense 10 Interest Payable 10 To record accrued interest on note ($2,000 * 12% * 15/360) 2014 Feb. 14 Interest Expense 30 Interest Payable 10 Notes Payable 2,000 Cash 2,040 Paid note with interest ($2,000 * 12% * 45/360) Payroll Liabilities Employee Payroll Deductions o Gross pay is the total compensation an employee earns including wages, salaries, commissions, bonuses, and any compensation earned before deductions such as taxes. o Net pay, also called 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 pension and health contributions, health and life insurance premiums, union dues, and charitable giving. o Employee FICA taxes The federal Social Security system provides retirement, disability, survivorship, and medical benefits to qualified workers. Laws require employers to withhold Federal Insurance Contributions Act (FICA) taxes from employees’ pay to cover costs of the system. Employers usually separate FICA taxes into two groups: Retirement, disability, and survivorship o The Social Security system provides monthly cash payments to qualified workers for the rest of their lives. These payments are often called Social Security benefits. Taxes related to this group are often called Social Security taxes. Medical o The system provides monthly payments to deceased workers’ surviving families and to disabled workers who qualify for assistance. These payments are commonly called Medicare benefits; like those in the first group, they are paid with Medicare taxes (part of FICA taxes). Health and Pension Benefits o Many companies provide employee benefits beyond salaries and wages. An employer often pays all or part of medical, dental, life, and disability insurance. Many employers also contribute to pension plans, which are agreements by employers to provide benefits (payments) to employees after retirement. Many companies also provide medical care and insurance benefits to their retirees. When payroll taxes and charges for employee benefits are totaled, payroll cost often employees’ gross earnings by 25% or more. Vacation Benefits o Many employers offer paid vacation benefits, also called paid absences or compensated absences. Vacation Benefits Expense 16 Vacation Benefits Payable 16 Bonus Plans o Many companies offer bonuses to employees, and many of the bonuses depend on net income. To illustrate, assume than an employer offers a bonus to its employees equal to 5% of the company's annual net income to be equally shared by all. Dec. 31 Employee Bonus Expense 10,000 Bonus Payable 10,000 To record expected bonus costs Warranty Liabilities o A warranty is a seller's obligation to replace or correct a product (or service) that fails to perform as expected within a specified period. Most new cars, for isntance, are sold with a warraty covering parts for a specified period of time. o To illustrate, a dealer sells a used car for $16,000 on December 1, 2013, with a maximum one-year or 12,000-mile warranty covering parts. This dealer's experience shows that warranty expense averages about 4% of a car's selling price, or $640 in this case ($16,000 * 4%). The dealer records the estimated expense and liability related to this sale with this entry. 2013 Dec. 1 Warranty Expense 640 Estimated Warranty Liability 640 To record estimated warranty expense 2014 Jan. 9 Estimated Warranty Liability 200 Auto Parts Inventory 200 To record costs of warranty repairs Accounting for Contingent Liabilities Accounting for contingent liabilities depends on the likelihood that a future event will occur and the ability to estimate the future amount owed if this event occurs. Three different possibilities are identified in the following chart: o Record liability o Disclose in notes o No disclosure Payroll Reports o Most employees and employers are required to pay local, state, and federal payroll taxes. Payroll expenses involve liabilities to individual employees, to federal and state governments, and to other organizations such as insurance companies. Beyond paying these liabilities, employers are required to prepare and submit reports explaining how they computed these payments. Reporting Wages and Salaries o Employers are required to give each employee an annual report of his or her wages subject to FICA and federal income taxes along with the amounts of these taxes withheld. This report is called a Wage and Tax Statement, or Form W-2. It must be given to employees before January 31 following the year covered by the report. Payroll Register o A payroll register usually shows the pay period dates, hours worked, gross pay, deductions, and net pay of each employee for each pay period. Payroll Procedures o Computing Federal Income Taxes Each employee records the number of withholding allowances claimed on a withholding allowance certificate, Form W-4, filed with the employer. When the number of withholding allowances increases, the amount of income taxes withheld decreases. o Payroll Bank Account Companies with few employees often pay them with checks drawn on the company’s regular bank account. Companies with many employees often use a special payroll bank account to pay employees. When this account is used, a company either Draws one check for total payroll on the regular bank account and deposits it in the payroll bank account Executes an electronic funds transfer to the payroll bank account. Individual payroll checks are then drawn on this payroll bank account. Since only one check for the total payroll is drawn on the regular bank account each payday, use of a special payroll bank account helps with internal control. Jan 31 Income Taxes Expense 12,100 Income Taxes Payable 12,100 To accrue January income taxes Apr. 10 Income Taxes Payable 30,000 Cash 30,000 Paid estimated quarterly income taxes based on first quarter income