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ACCOUNTING FOR
CURRENT LIABILITIES
Key Terms and Concepts to Know
Classification of liabilities
- Current liabilities are due within one year or operating cycle
- Long-term liabilities are due after or beyond one year or operating cycle Characteristics of liabilities
- All liabilities have Past/Present/Future elements o Liabilities result from a past event which o Creates an obligation to pay a third party in the present time which o Will be paid to the third party on some future date
- Liabilities may be uncertain as to o Amount o Payee o Payment date
- Liabilities may be known, estimated or contingent o Known liabilities have a definite payment amount, payment date and payee o Estimated liabilities have a known payment date and payee and a payment amount that can be estimated with reasonable certainty o Contingent liabilities are potential liabilities whose existence and payment amount are dependent on the uncertain occurrence of a future event. Types of Current Liabilities
- Wide variety of different sources or causes: o Notes Payable o Current maturities of long-term debt, such as bond or mortgage payments due within one year o Accounts payable o Unearned revenues o Payroll-related payables and accruals o Non-payroll accruals, such as real estate taxes payable and sales taxes payable o Estimated liabilities o Contingent liabilities
Analysis
- Liquidity ratios measure short-term ability to pay current liabilities o Current ratio and working capital
- Solvency ratios measure the ability to pay short-term and long-term liabilities o Debt to Assets ratio and Times Interest earned ratio
Payroll-Related Payables and Accruals
Payroll-related Payables and Accruals are complex. The essence of payroll is:
- An employer is obligated to pay an employee a certain amount based on the work performed, sometimes as a salary for a period of time, sometimes as hours worked x an hourly wage or sometimes as an amount earned for an accomplishment such as a sales commission based on a percentage of the amount sold.
- From the amount earned, the employer is required by law to deduct various federal and state taxes, called withholdings. Typical withholdings include FICA taxes and federal and state income taxes. Just as with sales taxes, these withholding are not expenses for the employers, as the employer is merely acting as a collection agent for the government.
- From the amount earned, with the employee’s consent, the employer may deduct or withhold amounts for charitable contributions, health or life insurance premiums, payroll or retirement savings plans and many other deductions.
- This is why the net amount of a payroll check (the cash the employee receives) is so much smaller than the gross the employee earns.
- In addition to the liabilities from withholdings, the employer incurs payroll tax liabilities that it must pay and record as an expense. These payroll liabilities include FICA equal to the amount withheld from employees and state and federal unemployment taxes. Example # P Company has a $200,000 gross payroll each week. The FICA tax rate is 7.65%. Federal income taxes withheld total $45,833 and state income taxes withheld total $8,692. Federal unemployment tax rate is 0.8% and the state unemployment tax rate is 2.8%. Payroll is recorded and paid every Friday. Required: Prepare the journal entries required to record and pay the weekly payroll.
Solution # Wages and salaries expense FICA taxes payable
Federal income taxes payable 45, State income taxes payable 8, Wages and salaries payable 130, To record payroll liabilities Payroll tax expense 22, FICA taxes payable 15, Federal unemployment taxes payable 1, State unemployment taxes payable 5, To record employer portion of payroll taxes Wages and salaries payable 130, Cash 130, To record payroll paid
Non-Payroll Accrued Liabilities
Accrued liabilities occur when goods or services have been received or used but an invoice has not been received. Accrued liabilities are typically recorded at the end of the accounting period through adjusting entries. Another type of accrued liability is sales tax payable. Companies are required by law to collect sales tax from customers at the time of sale and periodically remit the sales taxes collected to the appropriate government taxing authority. Sales taxed collected are not expenses for the employer. The employer is merely acting as a collection agent or conduit for the government. Sales taxes are collected, held for a short period of time and then remitted to the appropriate government agency.
At the end of the period in which the goods or services were provided, the following adjusting entry is made: x/x Unearned Revenue xxx Revenue xxx
Estimated Liabilities
Estimated liabilities have a known payee and a known payment date but an uncertain payment amount which can be reasonably estimated. The uncertainty for the amount may arise because the amount to be paid is based on a future event or another amount that has yet to be determined. Examples of estimated liabilities include bonuses, vacation, health and pension benefits and warranty liabilities. An estimated expense is recorded in the same period as the revenue and an estimated liability is recorded for the expected future goods/services to be provided. When payments are made or services provided in the future, the liability is debited and the appropriate balance sheet account is credited.
Contingent Liabilities
The difference between a contingent liability and a known liability is that a contingent liability is a potential liability; uncertain as to whether the future event will occur. The more certainty that is involved, the more information that is recorded or disclosed:
- Contingent liabilities are recorded when the future event is probable and the amount is known or can be reasonably estimated.
- Contingent liabilities are disclosed in the footnotes to the financial statements when the future event is probable and the amount is not known or cannot be reasonably estimated or when the future event is possible and the amount is not known or cannot be reasonably estimated.
- Contingent liabilities are not recorded or disclosed when the future event is unlikely to occur.
Practice Problems
Practice Problem # During a two-week pay period, Y Company's employees earned gross wages and salaries of $67,500. The employees have income tax withholdings of $7,800 and the company owes a total of $10,400 in FICA taxes (includes both the company and employee portions). Required: Prepare the journal entries that your company would use to record the payroll. Consider both employee and employer payroll taxes. Practice Problem # T Company publishes a magazine for the travel industry. Subscriptions cost $60 per year or $100 for two years. During the first year the magazine was published, 720 one- year and 300 two-year subscriptions were sold. All subscriptions were paid for in cash. 25% of the subscriptions were sold on April 1, 50% were sold on July 1 and 25% were sold on October 1. Required: a) How much cash was collected by T Company during the year? b) How much revenue was earned by T Company during the year? c) How much unearned revenue did T Company have on December 31?
True / False Questions
- Commonly, current liabilities are payable within one year, and long- term liabilities are payable more than one year from now. True False
- Interest expense is recorded in the period in which it is paid, rather than in the period incurred. True False
- Accounts payable are amounts the company owes to suppliers of merchandise or services that it has bought on credit. True False
- When a company receives cash in advance, it debits Cash and credits a revenue account called Unearned Revenue. True False
- Airlines do not record revenue when a ticket is sold, but wait to record revenue until the actual flight occurs. True False
- Sales taxes collected from customers by the seller are not an expense, instead they represent current liabilities payable to the government. True False
- If the likelihood of loss is remote, disclosure usually is not required. True False
- A contingent liability is recorded when the likelihood of the loss occurring is reasonably possible and the amount can be reasonably estimated. True False
- Amounts withheld from employees in connection with payroll often represent liabilities to be remitted to third parties. True False
- State and Federal Unemployment Taxes (SUTA and FUTA) must be withheld from employees' wages. True False
Multiple Choice Questions
1. Which^ of^ the^ following^ is^ not^ a^ typical^ current^ liability?
a) Sales Taxes Payable b) Mortgage Payable c) Unearned Revenue d) Interest Payable
2. Sales^ taxes^ collected^ by^ a^ company^ on^ behalf^ of^ the^ state^ and
local (^) governments are recorded by: a) A debit to an expense account. b) A credit to a revenue account. c) A debit to a revenue account. d) A credit to a liability account.
3. The^ current^ portion^ of^ long-term^ debt^ should^ be
a) Reported as a current liability on the balance sheet. b) Reported as a long-term liability on the balance sheet. c) Combined with the rest of the long-term debt on the balance sheet. d) Paid immediately.
4. If^ management^ can^ estimate^ the^ amount^ of^ loss^ that^ will^ occur^ due^ to^ litigation
against the company, and the likelihood of the loss is probable, a contingent liability should be a) Disclosed, but not reported as a liability. b) Disclosed and reported as a liability. c) Neither disclosed nor reported as a liability. d) Reported as a liability, but not disclosed.
5. Which^ of^ the^ following^ may^ create^ employer^ liabilities^ in^ connection^ with^ their
payrolls? a) Employee withholding taxes. b) Employee voluntary deductions. c) Employee fringe benefits. d) All of these answer choices are correct.
Solutions to Practice Problems
- Practice Problem # - Wages and salaries payable 67, - Federal and state income taxes payable 7, - FICA taxes payable 5, - Cash 54, - Payroll tax expense 5, - FICA taxes payable 5,
- Practice Problem # - One-year: 720 x $60 = $43, a)
- Two year: 300 x $100 = 30, - $73,
- April 1: 720 x 25% X $60 x 9/12 = $8, b) - 300 x 25% X $100 x 9/12 = 5,
- July 1: 720 x 50% X $60 x 6/12 = 10, - 300 x 50% x $100 x 6/12 = 7,
- April 1: 720 x 25% X $60 x 3/12 = $2, - 300 x 25% X $100 x 3/12 = 1, - $36, - Cash collected $73, c) - Revenue earned $36, - Unearned revenue $36,
Practice Problem # Current ratio: 22,200 + 169,100 + 68, 49,200 + 68,
Working capital: 22,200 + 169,100 + 68,300 – 49,200 – 68,800 = $141, Times interest earned:
Debt to assets ratio:
Solutions to Multiple Choice Questions
1. B
2. D
3. A
4. B
5. D
6. D
7. A
8. A
9. C
10. D
