Acct 230 1st Edition Lecture 21Outline of Last Lecture I. Long-Term Assetsa. Asset DispositionOutline of Current Lecture II. Current Liabilities a. Current LiabilitiesCurrent LectureIII. Current Liabilitiesa. Liability - A present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.b. Current liabilities are usually, but not always, due within one year. Notes payable, accounts payable, and payroll liabilities are the three main categories.i. Note: If a company has an operating cycle longer than one year, its current liabilities are defined by the operating cycle rather than by thelength of a year.c. Current liabilities are also sometimes called short-term liabilities.d. Distinguish between current and long-term liabilitiesi. Liabilities have three essential characteristics. Liabilities are: (1) probable future sacrifices of economic benefits; (2) arising from present obligations to other entities; (3) resulting from past transactions or events.ii. The definition of liabilities touches on the present, the future, and thepast. iii. Recall that assets represent probable future benefits. In contrast, liabilities represent probable future sacrifices of benefits. iv. In a classified balance sheet, we categorize liabilities as either current or long-term. In most cases, current liabilities are payable within one year and long-term liabilities are payable more than one year from now.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.v. Reporting Current Liabilities1. Distinguishing between current and long-term liabilities helps investors and creditors assess risk. 2. Companies often prefer to report a liability as long-term because it may cause the firm to appear less risky. 3. Many companies list notes payable first, followed by accounts payable, and then other current liabilities from largest to smallest. e. Account for Notes Payable and Interest Expensei. Notes Payable1. A company borrowing cash (borrower) from a bank is required to sign a note promising to repay the amount borrowed plus interest. 2. The borrower reports its liability as notes payable.3. Notes payable is a liability that creates interest expenseii. Small firms rely heavily on short-term financing. iii. Large companies also use short-term debt as a significant part of theircapital structure.iv. Measuring Interest1. Interest is stated in terms of an annual percentage rate to be applied to the face value of the loan.2. Interest rate is stated as an annual rate.3. When calculating interest for a period less than one year adjust for the fraction of the annual period the loan spans.4. Interest = Face value x Annual interest rate x Fraction of the Yearv. Interest Accrued and Repayment of Note1. The purpose of the adjusting entry is to report four months’ interest (September, October, November, and December) in 2012. Southwest will report the remaining $1,000 of interest (for January and February) in 2013. Since the firm won’t actually pay the 2012 interest until March 1, 2013, its financial statements for the year ended December 31, 2012, will show interest payable of $2,000 along with notes payable of $100,000 as a current liability on the balance sheet, and the “other expenses” section of the income statement will report interest expense of $2,000.2. When the note comes due on March 1, 2013, Southwest Airlines will pay the face value of the loan ($100,000) plus the entire $3,000 interest incurred ($100,000 × 6% × 6/12). The $3,000 represents six months of interest—the four months ofinterest ($2,000) in 2012 previously recorded as interest payable and two months of interest ($1,000) in 2013. Southwest makes the following journal entry on March 1, 2013:3. The journal entry on March 1 does the following:a. Removes the note payable ($100,000).b. Records interest expense for January and February 2013 ($1,000).c. Removes the interest payable recorded in the December 31, 2012, entry ($2,000).d. Reduces cash ($103,000).4. Notice that we record interest expense incurred for four months in 2012 and two months in 2013, rather than recording all six months’ interest expense in 2013 when we pay it. This is consistent with the matching principle.vi. Line of Credit1. An informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and prepare paperwork.a. Similar to notes payable except the company is able to borrow without having to go through a formal loan approval process each time it borrows money.b. Many short-term loans are arranged under an existing line of credit with a bank, or for larger corporations in the form of commercial paper, a loan from one company to another.f. Account for Employee and Employer Payroll Liabilitiesi. Prior to depositing a monthly payroll check, an employer withholds1. Federal and state income taxes,2. Social Security and Medicare,3. Health, dental, disability, and life insurance premiums, and4. Employee investments to retirement or savings plans. ii. As an employer, the costs of hiring an employee are higher than the salary.iii. Significant costs includeiv. Federal and state unemployment taxes,1. The employer portion of Social Security and Medicare,2. Employer contributions for health, dental, disability, and life insurance,3. Employer contributions to retirement or savings plans. v. Summary of Payroll Costs1. vi. Employee Costs1. Employers are required by law to withhold federal and state income taxes from employees’ paychecks and remit these taxes to the government.2. FICA taxes - Collectively, Social Security and Medicare taxes.3. FICA Act requires employers to withhold:a. 6.2% Social Security tax up to a maximum base amount.b. 1.45% Medicare tax with no maximum. c. Total FICA tax is 7.65% (6.2% + 1.45%) on income up to a base amount ($106,800 in 2010) and 1.45% on all income above the base amount.4. Employees may opt to have additional amounts withheld from their paychecks. vii. Employer Costs1. Employer pays an additional (matching) FICA tax on behalf of the employee.2. Employer’s limits on FICA tax are the same as employee’s.3. Employer must also pay federal and state unemployment taxeson behalf of the employees.4. FUTA requires a tax of 6.2% on the first $7,000 earned by each employee. This amount is reduced by a 5.4% (maximum) credit for