CHAPTER 11

CURRENT LIABILITIES AND PAYROLL

ACCOUNTING

LEARNING OBJECTIVES

1. EXPLAIN HOW TO ACCOUNT FOR CURRENT

LIABILITIES.

2. DISCUSS HOW CURRENT LIABILITIES ARE

REPORTED AND ANALYZED.

3. EXPLAIN HOW TO ACCOUNT FOR PAYROLL.

*4. DISCUSS ADDITIONAL FRINGE BENEFITS ASSOCIATED

WITH EMPLOYEE COMPENSATION.

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 CHAPTER REVIEW
Current Liabilities
1. (L.O. 1) A current liability is a debt that a company expects to pay within one year or the
operating cycle, whichever is longer. Current liabilities include notes payable, accounts payable,
unearned revenues, and accrued liabilities.

Notes Payable
2. Notes payable are obligations in the form of written notes that usually
require the borrower to pay interest. Notes due for payment within one year of the balance sheet
date are usually classified as current liabilities.
3. When an interest-bearing note is issued, the assets received generally equal the face value of
the note:
a. During the term of the note, it is necessary to accrue interest expense.
b. At maturity, Notes Payable is debited for the face value of the note and Interest Payable is
debited for accrued interest.

Sales Taxes Payable

4. A sales tax is expressed as a percentage of the sales price on goods sold to customers. The
entry by the selling company to record sales taxes is as follows:
Cash.................................................................................................. XXXX
Sales Revenue........................................................................... XXXX
Sales Taxes Payable................................................................. XXXX
When sales taxes are not rung up separately on the cash register, total receipts are divided by
100% plus the sales tax percentage to determine the sales.

Unearned Revenues
5. Unearned Revenues (advances from customers) are recorded by a debit to Cash and a credit to
a current liability account identifying the source of the unearned revenue. When the revenue is
recognized, an unearned revenue account is debited and a revenue account is credited.

Current Maturities of Long-Term Debt

6. Another item classified as a current liability is current maturities of long-term debt. Current
maturities of long-term debt are often identified on the balance sheet as long-term debt due within
one year.

Statement Presentation and Analysis

7. (L.O. 2) Current liabilities is the first category under liabilities on the balance sheet.
a. Each of the principal types of current liabilities is listed separately.
b. Current liabilities are usually reported in order of magnitude with the largest obligations being
listed first. However, many companies, as a matter of custom, show notes payable first, and
then accounts payable, regardless of amount.
8. The excess of current assets over current liabilities is working capital. The current ratio is current
assets divided by current liabilities.

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Contingent Liabilities

9. A contingent liability is a potential liability that may become an actual liability in the future. The
accounting guidelines require that:
a. If the contingency is probable (likely to occur) and the amount can be reasonably estimated,
the liability should be recorded in the accounts.
b. If the contingency is only reasonably possible (could happen), then it needs to be disclosed
only in the notes that accompany the financial statements.
c. If the contingency is remote (unlikely to occur), it need not be recorded or disclosed.
10. Product warranties are an example of a contingent liability. They are recorded by estimating the
cost of honoring product warranty contracts and expensing the amount in the period in which the
sale occurs. Warranty expense is reported under selling expenses in the income statement, and
estimated warranty liability is classified as a current liability on the balance sheet.

Payroll Accounting

11. (L.O. 3) The term payroll pertains to both salaries and wages of employees. Payments made to
professional individuals who are independent contractors are called fees. Government regulations
relating to the payment and reporting of payroll taxes apply only to employees.

Gross Earnings

12. Gross earnings is the total compensation earned by an employee. It consists of wages or
salaries, plus any bonuses and commissions.
a. Total wages are determined by applying the hourly rate of pay to the hours worked.
b. Most companies are required by law to pay a minimum of one and one-half times the regular
hourly rate for overtime work.

Payroll Deductions

13. Mandatory payroll deductions consist of FICA taxes and income taxes.
a. These deductions do not result in payroll tax expense to the employer.
b. FICA taxes are designed to provide workers with supplemental retirement, employment
disability, and medical benefits.
c. FICA taxes are also known as Social Security taxes.
14. Income taxes are required to be withheld from employees each pay period and the amount is
determined by three variables: (a) the employees’ gross earnings: (b) the number of allowances
claimed by the employee; and (c) the length of the pay period.
15. Voluntary deductions pertain to withholdings for charitable, retirement, and other purposes.
Voluntary deductions are at the option of the employee.
16. Net pay is determined by subtracting payroll deductions from gross earnings.

Recording the Payroll

17. The employee earnings record provides a cumulative record of each employee’s gross
earnings, deductions, and net pay during the year. This record is used by the employer in:
a. Determining when an employee has earned the maximum earnings subject to FICA taxes.
b. Filing state and federal payroll tax returns.
c. Providing each employee with a statement of gross earnings and tax withholdings for the
year.

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18. Many companies use a payroll register to accumulate the gross earnings, deductions, and net
pay by employee for each period. In some companies, this record is a journal or book of original
entry.

19. The typical journal entry to record a payroll is as follows:

Salaries and Wages Expense............................................................... XXX

FICA Taxes Payable...................................................................... XXX
Federal Income Taxes Payable..................................................... XXX
State Income Taxes Payable......................................................... XXX
United Fund Contributions Payable............................................... XXX
Union Dues Payable...................................................................... XXX
Salaries and Wages Payable........................................................ XXX

20. When the payroll is paid, Salaries and Wages Payable is debited and Cash is credited. Each
payroll check is usually accompanied by a detachable statement of earnings document that
shows the employee’s gross earnings, payroll deductions, and net pay.

Employer Payroll Taxes

21. There are three taxes imposed on employers by government agencies that result in payroll tax
expense.
a. FICA Taxes. The employer must match each employee’s FICA contribution.
b. Federal Unemployment Taxes. The employer is required to pay a tax on the first $7,000 of
gross wages paid to each employee during a calendar year.
c. State Unemployment Taxes. All states have unemployment compensation programs that
require the employer to pay a tax on the first $7,000 of gross wages paid to each employee
during a calendar year.

22. The typical entry for recording payroll tax expense is as follows:

Payroll Tax Expense............................................................................. XXXX

FICA Taxes Payable..................................................................... XXXX
Federal Unemployment Taxes Payable........................................ XXXX
State Unemployment Taxes Payable............................................ XXXX

23. Preparation of payroll tax returns is the responsibility of the payroll department; payment of the
taxes is made by the treasurer’s department.

24. The employer is required to provide each employee with a Wage and Tax Statement (Form W-2)
by January 31 following the end of a calendar year. This statement shows gross earnings, FICA
taxes withheld, and income taxes withheld for the year.

Internal Control for Payroll

25. The objectives of internal accounting control concerning payroll are (a) to safeguard company
assets from unauthorized payments of payrolls, and (b) to ensure the accuracy and reliability of
the accounting records pertaining to payrolls.

26. The payroll activities consist of four functions (a) hiring employees, (b) timekeeping, (c) preparing
the payroll, and (d) paying the payroll. These four functions should be assigned to different
departments or individuals.

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 Additional Fringe Benefits

*27. (L.O. 4) When the payment for paid absences (paid vacations, sick pay benefits, and paid
holidays) is probable and the amount can be reasonably estimated, a liability should be accrued.
The entry to record the liability will include a debit to Vacation Benefits Expense and a credit to
Vacation Benefits Payable. When the amount cannot be reasonably estimated, the potential
liability should be disclosed.

*28. Postretirement benefits are benefits that employers provide to retired employees for (a)
pensions, and (b) health care and life insurance.

*29. A pension plan is an agreement whereby employers provide benefits (payments) to employees
after they retire. The most popular type of pension plan is the 401(k) plan. When a company
makes a contribution to the 401(k) plan on behalf of the employee, it debits Pension
Expense and credits Cash for the amount contributed.

*30. A defined-contribution plan defines the contribution an employer will make but not the benefit
that the employee will receive at retirement. A 401(k) plan is an example of a defined-contribution
plan. In a defined-benefit plan, the employer agrees to pay a defined amount to
retirees, based on employees meeting certain eligibility standards.

*31. Companies estimate and expense postretirement costs during the working years of the employee
because the company benefits from the employee’s services during this period. The company
rarely sets up funds to meet the cost of the future benefits.

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 LECTURE OUTLINE

A. Accounting for Current Liabilities.

1. A current liability is a debt that a company expects to pay within one year
or the operating cycle, whichever is longer.

2. Current liabilities include notes payable, accounts payable, unearned

revenues, and accrued liabilities such as taxes, salaries and wages, and
interest payable.

a. Companies record obligations in the form of written notes as notes

payable. Companies frequently issue notes payable to meet short-
term financing needs. Notes payable usually require the borrower to
pay interest. Notes due for payment within one year of the balance
sheet date are usually classified as current liabilities.

When a company issues an interest-bearing note, the amount of

assets it receives upon the issuance of the note generally equals
the note’s face value. Interest accrues over the life of the note, and
the company must periodically record that accrual.

b. Sales taxes are expressed as a percentage of the sales price. The

selling company collects the tax from the customer when the sale
occurs, and periodically (monthly) remits the collections to the state’s
department of revenue.

c. Cash received from customers before goods are delivered or services

are rendered is called unearned revenues. When a company receives
the advance payment, it debits Cash, and credits a current liability
account identifying the source of the unearned revenue. When the
company recognizes revenue, it debits an unearned revenue account
and credits a revenue account.

d. Companies often identify current maturities of long-term debt in the

balance sheet as long-term debt due within one year. At the
balance sheet date, all obligations due within one year are
classified as current, and all other obligations are long-term.

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 3. Statement Presentation and Analysis.

a. Companies usually list current liabilities by order of magnitude, with

the largest ones first.

b. As a matter of custom, many companies show notes payable first

and then accounts payable, regardless of amount.

c. The excess of current assets over current liabilities is working capital,

which is a measure of liquidity. Liquidity is the ability to pay maturing
obligations and meet unexpected needs for cash.

d. The current ratio is also a measure of liquidity and permits analysts

to compare the liquidity of different-sized companies. It is computed
by dividing current assets by current liabilities.

4. A contingent liability is a potential liability that may become an actual liability

in the future.

a. If the contingency is probable (likely to occur) and the amount can be

reasonably estimated, the liability should be recorded in the accounts.
(Both conditions required for recording.)

b. If the contingency is only reasonably possible (it could happen),

then it needs to be disclosed only in the notes that accompany the
financial statements.

c. If the contingency is remote (unlikely to occur), it need not be recorded

or disclosed.

d. Product warranties are an example of a contingent liability that

companies should record in the accounts. The accounting for warranty
costs is based on the expense recognition principle; therefore,
companies should recognize the estimated cost of honoring product
warranty contracts as an expense in the period in which the sale
occurs.

Copyright © 2015 John Wiley & Sons, Inc. Weygandt, Accounting Principles, 12/e, Instructor’s Manual (For Instructor Use Only) 11-7
 e. When it is probable that a company will incur a contingent liability but
it cannot reasonably estimate the amount, or when the contingent
liability is only reasonably possible, only disclosure of the contingency
is required.

f. Contingencies that may require disclosures are:

(1) Pending or threatened lawsuits.

(2) Assessment of additional income taxes pending an IRS audit of

the tax return.

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ACCOUNTING ACROSS THE ORGANIZATION

Contingent liabilities abound in the real world. Life and health insurance companies
and their stockholders wonder how big the cost of diabetes, Alzheimer’s, and
AIDS really are and what damage they might do in the future.

Why do you think most companies disclose, but do not record, contingent liabilities?

Answer: In many cases, it is probable that companies have a contingent liability

but the amount of the liability is often difficult to determine. If it cannot
be determined, the company is not required to accrue it as a liability.

B. Payroll Accounting.

1. Payroll accounting involves maintaining payroll records for each

employee, filing and paying payroll taxes, and complying with state and
federal employee compensation tax laws.

2. The term “payroll” refers to both salaries and wages of employees. It

does not apply to payments made for services of professionals such as
CPAs and attorneys.

3. Professionals such as CPAs are independent contractors and payment to

them are not subject to payroll taxes.

C. Gross Earnings.

1. Gross earnings consist of: wages or salaries, plus any bonuses and
commissions.

2. Companies determine total wages for an employee by multiplying the

hourly rate of pay by the hours worked. An employee’s salary is generally
based on a monthly or yearly rate rather than on an hourly basis.

3. Many companies have bonus agreements for employees. Bonus arrange-

ments may be based on such factors as increased sales or net income.

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D. Payroll Deductions and Net Pay.

1. Payroll deductions do not result in payroll tax expense to the employer

because the company is merely a collection agent for the government.
Mandatory deductions are required by law and consist of FICA taxes
and income taxes.

a. FICA taxes are designed to provide workers with supplemental retire-

ment, employment disability, and medical benefits. FICA taxes are
commonly referred to as Social Security taxes.

b. Under the U.S. pay-as-you-go system of federal income taxes, em-

ployers are required to withhold income taxes from employees each
pay period. Three variables determine the amount to be withheld:

(1) The employee’s gross earnings.

(2) The number of allowances claimed by the employee.

(3) The length of the pay period.

2. Employees may voluntarily authorize withholdings for charitable, retirement,

and other purposes. All voluntary deductions from gross earnings should
be authorized in writing by the employee.

3. Companies determine net (or take-home) pay by subtracting payroll deduc-

tions from gross earnings.

E. Maintaining Payroll Department Records.

1. To comply with state and federal laws, an employer must keep a cumulative
record of each employee’s gross earnings, deductions, and net pay during
the year.

2. The record that provides employee information is the employee earnings

record.

11-10 Copyright © 2015 John Wiley & Sons, Inc. Weygandt, Accounting Principles, 12/e, Instructor’s Manual (For Instructor Use Only)
 3. The employer uses the cumulative payroll data on the earnings record to:

a. Determine when an employee has earned the maximum earnings

subject to FICA taxes.

b. File state and federal payroll tax returns.

c. Provide each employee with a statement of gross earnings and tax

withholdings for the year.

4. The journal entry that companies make to record payroll includes a debit
to Salaries and Wages Expense for the gross earnings and credits for
the mandatory and voluntary deductions and Salaries and Wages
Payable.

F. Employer Payroll Taxes.

1. Payroll tax expense results from three taxes that governmental agencies
levy on employers. These taxes are FICA, federal unemployment tax
(FUTA), and state unemployment tax (SUTA).

2. FICA, FUTA, SUTA, plus items such as paid vacations and pensions are
collectively referred to as fringe benefits.

a. Employers must match each employee’s FICA contribution. Thus, the

employer’s tax is subject to the same rate and maximum earnings
as the employee’s.

b. The Federal Unemployment Tax Act (FUTA) is another feature of

the federal Social Security program. Federal unemployment taxes
provide benefits for a limited period of time to employees who lose
their jobs through no fault of their own. The employer bears the entire
federal unemployment tax.

c. All states have unemployment compensation programs under state

unemployment tax acts (SUTA). This tax is levied only on the employer.

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 3. Companies usually record employer payroll taxes at the same time
they record the payroll. Payroll Tax Expense is debited and the separate
liability accounts are credited because these liabilities are payable to
different taxing authorities at different dates.

4. Preparation of payroll tax returns is the responsibility of the payroll depart-

ment; the treasurer’s department makes the tax payment.

G. Internal Control for Payroll.

1. The objectives of internal control for payrolls are:

a. To safeguard company assets against unauthorized payments of

payrolls.

b. To ensure the accuracy and reliability of the accounting records

pertaining to payrolls.

2. Payroll activities involve four functions: hiring employees, timekeeping,

preparing the payroll, and paying the payroll. Companies should assign
these four functions to different departments or individuals for effective
internal control.

3. Posting job openings, screening and interviewing applicants, and hiring

employees are responsibilities of the human resources department.

4. Another area in which internal control is important is timekeeping. Hourly

employees are normally required to record time worked by “punching” a
time clock.

5. The payroll is prepared in the payroll department on the basis of two inputs:
human resources department authorizations and approved time cards.

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 6. The payroll is paid by the treasurer’s department. Payment by check
minimizes the risk of loss from theft, and the endorsed check provides
proof of payment.

*H. Additional Fringe Benefits.

1. Additional fringe benefits associated with wages are paid absences (paid
vacations, sick pay benefits, and paid holidays) and postretirement
benefits (pensions and health care and life insurance).

2. Employees often are given rights to receive compensation for absences

when certain conditions of employment are met.

a. When the payment for such absences is probable and the amount
can be reasonably estimated, the company should accrue a liability
for paid future absences.

b. When the amount cannot be reasonably estimated, the company

should instead disclose the potential liability.

3. Postretirement benefits are benefits provided by employers to retired

employees for pensions and health care and life insurance.

a. A pension plan is an arrangement whereby an employer provides

benefits (payments) to employees after they retire. In a defined-
contribution 401(K) plan, the plan defines the employer’s
contribution but not the benefit that employee will receive at
retirement.

b. Companies estimate and expense postretirement health-care costs

during the working years of the employee because the company
benefits from the employee’s services. Companies follow a pay-as-
you-go basis for these costs since they do not receive a tax deduction
until they actually pay the medical bill.

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 IFRS
A Look at IFRS

IFRS and GAAP have similar definitions of liabilities. The general recording
procedures for payroll are similar although differences occur depending on the
types of benefits that are provided in different countries. For example, companies
in other countries often have different forms of pensions, unemployment benefits,
welfare payments, and so on.

KEY POINTS

Following are the key similarities and differences between GAAP and IFRS
related to current liabilities and payroll.

 The basic definition of a liability under GAAP and IFRS is very similar. In a
more technical way, liabilities are defined by the IASB as a present
obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying
economic benefits.
 Under IFRS, liabilities are classified as current if they are expected to be
paid within 12 months.
 Companies using IFRS sometimes show liabilities before assets. Also, they
will sometimes show long-term liabilities before current liabilities.
 Under IFRS, companies sometimes will net current liabilities against
current assets to show working capital on the face of the statement of
financial position. The accounting for current liabilities such as notes
payable, unearned revenue, and payroll taxes payable is similar between
IFRS and GAAP.
 Under GAAP, some contingent liabilities are recorded in the financial
statements, others are disclosed, and in some cases no disclosure is
required. Unlike GAAP, IFRS reserves the use of the term contingent
liability to refer only to possible obligations that are not recognized in the
financial statements but may be disclosed if certain criteria are met.
 For those items that GAAP would treat as recordable contingent liabilities,
IFRS instead uses the term provisions. Provisions are defined as liabilities
of uncertain timing or amount. Examples of provisions would be provisions
for warranties, employee vacation pay, or anticipated losses. Under IFRS,
the measurement of a provision related to an uncertain obligation is based
on the best estimate of the expenditure required to settle the obligation.

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LOOKING TO THE FUTURE

The FASB and IASB are currently involved in two projects, each of which has
implications for the accounting for liabilities. One project is investigating
approaches to differentiate between debt and equity instruments. The other
project, the elements phase of the conceptual framework project, will evaluate
the definitions of the fundamental building blocks of accounting. The results of
these projects could change the classification of many debt and equity securities.

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 20 MINUTE QUIZ

Circle the correct answer.

True/False

1. A current liability to the state arises when a business sells an item and collects a state
sales tax on it.
True False

2. An unearned revenue arises when payment is accepted in advance of the goods being
delivered.
True False

3. A refrigerator is sold in year 1, and a repair is made in year 2. The company’s entry upon
making the repair would include a debit to Warranty Liability.
True False

4. The excess of current assets over current liabilities is called the current ratio.
True False

5. Current maturities of long-term debt are identified on the balance sheet as long-term debt
due within one year.
True False

6. With an interest-bearing note, the amount of cash received upon issuance of the note will
be less than the note’s face value.
True False

7. A contingent liability is recorded if it is reasonably possible and the amount can be reasonably
estimated.
True False

8. The separation of the payroll activities of hiring, timekeeping, preparing payroll, and paying
the payroll weakens internal control over the payroll transactions.
True False

9. Net pay is determined by applying the hourly rate of pay to the hours worked less payroll
deductions.
True False

*10. Vacation pay is properly charged as an expense in the month in which the employee
takes the vacation.
True False

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Multiple Choice

1. The account Unearned Subscription Revenue

a. is considered a miscellaneous revenue account.
b. has a normal debit balance.
c. is a contra account to Subscription Revenue.
d. is a current liability.

2. Which of the following is not a contingent liability?

a. Product warranties
b. Pending or threatened lawsuits
c. Current maturities of long-term debt
d. Assessment of additional income taxes pending an audit

3. Payroll Tax Expense includes all of the following except

a. federal income tax payable.
b. federal unemployment tax payable.
c. FICA tax payable.
d. state unemployment tax payable.

4. Which of the following is not an estimated liability?

a. Vacation pay
b. Sales taxes
c. Product warranties
d. Income taxes

5. Recording estimated warranty expense in the year of the sale best follows which accounting
principle?
a. Revenue recognition
b. Full disclosure
c. Expense recognition
d. Historical cost

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 ANSWERS TO QUIZ

True/False

1. True 6. False
2. True 7. False
3. True 8. False
4. False 9. True
5. True *10. False

Multiple Choice

1. d.
2. c.
3. a.
4. b.
5. c.

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