Slide 1 Chapter 11 Current Liabilities and Payroll Accounting Summary 1 Describe current and long term liabilities and their characteristics Liabilities are probable future payments of assets or services that past transactions or events obligate an entity to make Current liabilities are due within one year or the operating cycle whichever is longer All other liabilities are long term 2 Identify and describe known current liabilities Known determinable current liabilities are set by agreements or laws and are measurable with little uncertainty They include accounts payable sales taxes payable unearned revenues notes payable payroll liabilities and the current portion of long term debt 3 Explain how to account for contingent liabilities If an uncertain future payment depends on a probable future event and the amount can be reasonably estimated the payment is recorded as a liability The uncertain future payment is reported as a contingent liability if a the future event is reasonably possible but not probable or b the event is probable but the payment amount cannot be reasonably estimated 4 Compute the times interest earned ratio and use it to analyze liabilities Times interest earned is computed by dividing a company s net income before interest expense and income taxes by the amount of interest expense The times interest earned ratio reflects a company s ability to pay interest obligations 5 Prepare entries to account for short term notes payable Short term notes payable are current liabilities most bear interest When a short term note s face value equals the amount borrowed it identifies a rate of interest to be paid at maturity 6 Compute and record employee payroll deductions and liabilities Employee payroll deductions include FICA taxes income taxes and voluntary deductions such as pensions and charities They make up the difference between gross and net pay 7 Compute and record employer payroll expenses and liabilities An employer s payroll expenses include employee s gross earnings any employee benefits and the payroll taxes levied on the employer Payroll liabilities include employee s net pay amounts withholdings from employee wages any employer promised benefits and the employer s payroll taxes Slide 2 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 1 A past transaction or event 2 A present obligation 3 A future payment of assets or services Slide 3 Current liabilities are expected to be paid within one year or the normal operating cycle of the company whichever is longer Current liabilities are usually extinguished by payment of current assets Long term liabilities are not expected to be paid or extinguished within one year In this chapter we will concentrate on current liabilities Slide 4 The relationship between total liabilities and current liabilities depends upon the nature of business operations Six Flags an amusement park has a relatively low percentage of current liabilities as a percentage of total liabilities especially when compared to Columbia Sportswear or Apple Computer Slide 5 Before we can determine the nature of a liability and properly classify it we must examine three major uncertainties First we must determine whether we know who will be paid to extinguish the liability Second we must know when the amount must be paid and third we must know exactly how much must be paid to extinguish the liability If we don t know all three we do not have a determinable liability Slide 6 Most liabilities arise from situations 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 liabilities sales taxes payable unearned revenues and leases Slide 7 On August 31 Home Depot sold materials for 6 000 cash that are subject to a 5 sales tax Home Depot is responsible for collecting and paying the tax to the state government The company will debit Cash for 6 300 the amount of the sale and the tax collected Home Depot will credit Sales for 6 000 and credit the current liability account Sales Taxes Payable for 300 The sales tax is 5 of the total sale of 6 000 Home Depot will later debit the Sales Taxes Payable account when payment is made to the taxing authority Slide 8 We previously studied unearned revenues in the chapter on adjusting entries Unearned revenues are amounts received in advance from customers for future products or services Advance ticket sales for sporting events or music concerts are examples To illustrate assume that Rihanna sells 5 million in tickets for eight concerts the entry is to debit Cash and credit Unearned Ticket Revenue On October 31 Rihanna performs a concert Rihanna s accountant will debit or reduce the Unearned Ticket Revenue and credit or increase Ticket Revenue for 625 000 Slide 9 Let s spend some time looking at short term or current notes payable A note payable is a written promise to pay a specific amount at a definite future date Short term notes normally bear interest Slide 10 Let s assume that on August 23 Brady Company asks to extend its past due 600 account payable to McGraw After some negotiations McGraw agrees to accept 100 cash and a 60 day 12 500 note payable to replace the account payable In Brady s accounting records for the journal entry on August 23 Brady would debit or reduce its Accounts Payable to McGraw and decrease Cash for 100 and credit or increase Notes Payable for 500 to McGraw Slide 11 On October 22 Brady pays the note and all interest to McGraw To prepare the journal entry on the books of Brady we debit or decrease the Notes Payable to McGraw for 500 and debit interest expense for 10 The 10 is interest at a 12 annual rate for 60 days Finally we will credit or decrease the cash account for the total of 510 Slide 12 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 The difference between the amount borrowed and the amount repaid is interest This is a typical promissory note Notice that we have a definite payee National Bank in Boston a determinable amount of the payment 2 000 plus interest at 12 for 60 days Slide 13 On September 30 a company needs 2 000 for a