ACCOUNTING FOR

LIABILITIES

CURRENT LIABILITIES
NON-CURRENT LIABILITIES

11-1
 11 Current Liabilities and Payroll
Accounting

Learning Objectives
1 Explain how to account for current liabilities.

Discuss how current liabilities are

2 reported and analyzed.

3 Explain how to account for payroll.

11-2
 LEARNING Explain how to account for current
1
OBJECTIVE liabilities.

What Is a Current Liability?

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 such as taxes payable,
salaries and wages payable, and interest payable.

11-3 LO 1
 What Is a Current Liability?

Question
To be classified as a current liability, a debt must be
expected to be paid within:
a. one year.
b. the operating cycle.
c. 2 years.
d. (a) or (b), whichever is longer

11-4 LO 1
 Current Liabilities

Notes Payable
 Written promissory note.
 Frequently issued to meet short-term financing
needs.
 Requires the borrower to pay interest.
 Issued for varying periods.

11-5 LO 1
 Notes Payable

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2017, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1.
Instructions
a) Prepare the entry on September 1st.
b) Prepare the adjusting entry on December 31 st, assuming
monthly adjusting entries have not been made.
c) Prepare the entry required on January 1, 2018, the
maturity date.

11-6 LO 1
 Notes Payable

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2017, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1.
a) Prepare the entry on September 1st.

Cash 100,000
Notes Payable

100,000
b) Prepare the adjusting entry on December 31 st.
Interest Expense 4,000
Interest Payable
$100,000 x 12% x 4/12 = $4,000
4,000
11-7 LO 1
 Notes Payable

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2017, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1, 2018.
c) Prepare the entry at maturity.

Notes Payable 100,000

Interest Payable 4,000
Cash

104,000

11-8 LO 1
 Current Liabilities

Sales Taxes Payable

 Sales taxes are expressed as a stated percentage of
the sales price.
 Selling company (retailer)
► collects tax from the customer.
► enters tax separately in cash register or includes in
total receipts.
► remits the collections to the state’s department of
revenue.

11-9 LO 1
 Sales Taxes Payable

Illustration: The March 25 cash register reading for Cooley

Grocery shows sales of $10,000 and sales taxes of $600 (sales
tax rate of 6%), the journal entry is:

Mar. 25 Cash 10,600

Sales Revenue 10,000
Sales Tax Payable

600

11-10 LO 1
 Sales Taxes Payable

Sometimes companies do not enter sales taxes separately in

the cash register.

Illustration: Cooley Grocery enters total receipts of $10,600.

Because the amount received from the sale is equal to the
sales price 100% plus 6% of sales, (sales tax rate of 6%), the
journal entry is:

Mar. 25 Cash 10,600

Sales revenue 10,000 *

Sales tax payable

600
* $10,600 ÷ 1.06 = $10,000
11-11 LO 1
 Current Liabilities

Unearned Revenue
Revenues received before the company
 delivers goods or
 provides services. Illustration 11-2
Unearned revenue and
revenue accounts

11-12 LO 1
 Unearned Revenue

Illustration: Superior University sells 10,000 season football

tickets at $50 each for its five-game home schedule. The entry
for the sale of season tickets is:

Aug. 6 Cash 500,000

Unearned Ticket Revenue

As each game500,000
is completed, Superior records the recognition of
revenue with the following entry.

Sept. 7 Unearned Ticket Revenue 100,000

Ticket Revenue

11-13
100,000 LO 1
 Current Liabilities

Current Maturities of Long-Term Debt

 Portion of long-term debt that comes due in the current
year.
 No adjusting entry required.

Illustration: Wendy Construction issues a five-year, interest-bearing

$25,000 note on January 1, 2017. This note specifies that each January 1,
starting January 1, 2018, Wendy should pay $5,000 of the note. When the
company prepares financial statements on December 31, 2017,
$5,000
1. What amount should be reported as a current liability? ___________
$20,000
2. What amount should be reported as a long-term liability? _________

11-14 LO 1
 DO IT! 1 Current Liabilities

You and several classmates are studying for the next accounting
examination. They ask you to answer the following questions.

1. If cash is borrowed on a $50,000, 6-month, 12% note on

September 1, how much interest expense would be incurred by
December 31?

Solution

$50,000 x 12% x 4/12 = $2,000

11-15 LO 1
 DO IT! 1 Current Liabilities

You and several classmates are studying for the next accounting
examination. They ask you to answer the following questions.

2. How is the sales tax amount determined when the cash register
total includes sales taxes?

Solution

First, divide the total cash register receipts by 100% plus the sales
tax percentage to find the sales revenue amount.

Second, subtract the sales revenue amount from the total cash
register receipts to determine the sales taxes.

11-16 LO 1
 DO IT! 1 Current Liabilities

You and several classmates are studying for the next accounting
examination. They ask you to answer the following questions.

3. If $15,000 is collected in advance on November 1 for 3 months’

rent, what amount of rent revenue should be recognized by
December 31?

Solution

$15,000 x 2/3 = $10,000

11-17 LO 1
 Illustration 11-4
Balance sheet reporting
of current liabilities

11-18 LO 2
 Analysis of Current Liabilities

Illustration 11-5
Liquidity refers to the
ability to pay maturing
obligations and meet
unexpected needs for
cash.

Current ratio permits Illustration 11-6

us to compare the
liquidity of different-
sized companies and
of a single company at
different times.

11-19 LO 2
 DO IT! 2 Reporting and Analyzing

Lepid Company has the following account balances at December

31, 2017. Notes payable ($80,000 due after 12/31/18) $200,000,
unearned service revenue $75,000, other long-term debt ($30,000
due in 2018) $150,000, salaries and wages payable $22,000, other
accrued expenses $15,000, and accounts payable $100,000. In
addition, Lepid is involved in a lawsuit. Legal counsel feels it is
probable Lepid will pay damages of $38,000 in 2018.

a. Prepare the current liabilities section of Lepid’s December 31,

2017, balance sheet.

b. Lepid’s current assets are $504,000. Compute Lepid’s working

capital and current ratio.
11-20 LO 2
 DO IT! 2 Reporting and Analyzing

a. Prepare the current liabilities section of Lepid’s December 31,

2017, balance sheet.

Current liabilities
Notes payable $120,000
Accounts payable 100,000
Unearned service revenue 75,000
Lawsuit liability 38,000
Salaries and wages payable 22,000
Other accrued expenses 15,000
Long-term debt due within one year 30,000
Total current liabilities $400,000

11-21 LO 2
 DO IT! 2 Reporting and Analyzing

b. Lepid’s current assets are $504,000. Compute Lepid’s working

capital and current ratio.

Working capital = Current assets - Current liabilities =

$504,000 - $400,000 = $104,000

Current ratio = Current assets ÷ Current liabilities =

$504,000 ÷ $400,000 = 1.26:1

11-22 LO 2
 LEARNING
OBJECTIVE
2 Explain how to account for payroll.

“Payroll” pertains to both:

Salaries - managerial, administrative, and sales personnel
(monthly or yearly rate).

Wages - store clerks, factory employees, and manual

laborers (rate per hour).

Determining the Payroll

Involves computing three amounts: (1) gross earnings, (2)
payroll deductions, and (3) net pay.

11-23 LO 3
 Determining the Payroll

GROSS EARNINGS
Total compensation earned by an employee (wages or
salaries, plus any bonuses and commissions).

Illustration 11-7
Computation of total wages

11-24 LO 3
 PAYROLL DEDUCTIONS

Illustration 11-8
Payroll deductions
11-25 LO 3
 Determining the Payroll

PAYROLL DEDUCTIONS
Mandatory: Voluntary:
 FICA tax  Charity
 Federal income tax  Insurance
 State income tax  Union dues
 Pension plans

11-26 LO 3
 Determining the Payroll

PAYROLL DEDUCTIONS
Mandatory: Social Security and Medicare tax

 FICA tax Supplemental retirement,

employment disability, and medical
 Federal income tax benefits.
 State income tax
Illustration 11-9
FICA tax rate and tax base

11-27 LO 3
 Determining the Payroll

PAYROLL DEDUCTIONS
Mandatory:  Employers are required to
 FICA tax withhold income taxes from
 Federal income tax employees’ pay.

 State income tax

 Withholding amounts are based
on gross wages and the number
of allowances claimed.

11-28 LO 3
 Determining the Payroll

PAYROLL DEDUCTIONS
Mandatory:
 FICA tax
 Federal income tax Most states (and some cities)
 State income tax require employers to withhold
income taxes from employees’
earnings.

11-29 LO 3
 Determining the Payroll

NET PAY
Gross earnings minus payroll deductions.
Illustration 11-12
Computation of net pay

11-30 LO 3
 Recording the Payroll

RECOGNIZING PAYROLL EXPENSES AND

LIABILITIES
Illustration: Prepare the entry Academy Company would make to
record the payroll for the week ending January 14.

Salaries and Wages Expense 17,210.00

FICA Taxes Payable 1,316.57
Federal Income Taxes Payable 3,490.00
State Income Taxes Payable 344.20
United Fund Contributions Payable 421.50
Union Dues Payable 115.00
Salaries and Wages Payable 11,522.73
11-31 LO 3
 Recording the Payroll

RECORDING PAYMENT OF THE PAYROLL

Illustration: Prepare the entry Academy Company would make to
record the payment of the payroll.

Salaries and Wages Payable 11,522.73

Cash 11,522.73

11-32 LO 3
 DO IT! 3a Payroll

In January, gross earnings in Ramirez Company were $40,000. All

earnings are subject to 7.65% FICA taxes. Federal income tax
withheld was $9,000, and state income tax withheld was $1,000. (a)
Calculate net pay for January, and (b) record the payroll.

(a) Net pay: $40,000 - (7.65% x $40,000) - $9,000 - $1,000 =

$26,940

(b) Salaries and Wages Expense 40,000

FICA Taxes Payable
3,060
Federal Income Taxes Payable 9,000
State Income Taxes Payable 1,000
11-33
Salaries and Wages Payable 26,940 LO 3
 Internal Control for Payroll

As applied to payrolls, the objectives of internal control are

1. to safeguard company assets against unauthorized
payments of payrolls, and

2. to ensure the accuracy and reliability of the accounting

records pertaining to payrolls.

11-34 LO 3
 Internal Control for Payroll APPENDIX

Illustration 11-18
Internal control for payroll

11-35 LO 3
 15 Long-Term Liabilities
Learning Objectives
1 Describe the major characteristics of bonds.

2 Explain how to account for bond transactions.

3 Explain how to account for long-term notes payable.

Discuss how long-term liabilities are reported and

4 analyzed.
15-36
 LEARNING Describe the major characteristics of
1
OBJECTIVE bonds.

Long-term liabilities are obligations that are expected to

be paid after one year.

Bonds are a form of interest-bearing notes payable.

 Sold in small denominations (usually $1,000 or multiples
of $1,000).
 Attract many investors.
 Corporation issuing bonds is borrowing money.
 Person who buys the bonds (the bondholder) is investing
in bonds.

15-37 LO 1
 Types of Bonds

15-38 LO 1
 Bonds

Issuing Procedures
 State laws grant corporations the power to issue bonds.
 Board of directors and stockholders must approve bond
issues.
 Board of directors must stipulate number of bonds to be
authorized, total face value, and contractual interest
rate.
 Bond terms set forth in legal document known as a bond
indenture.
 Bond certificate, typically a $1,000 face value.
15-39 LO 1
 Bonds

Issuing Procedures
 Represents a promise to pay:
► sum of money at designated maturity date, plus
► periodic interest at a contractual (stated) rate on the
maturity amount (face value).
 Interest payments usually made semiannually.
 Issued to obtain large amounts of long-term capital.
 Investment company sells the bonds for the issuing
company.

15-40 LO 1
 Illustration 15-1
Bond certificate

15-41
LO 1
 Determining the Market Value of a Bond

Current market price (present value) is a function of the three

factors:

1. dollar amounts to be received,

2. length of time until the amounts are received, and

3. market rate of interest.

The market interest rate is the rate investors demand for

loaning funds.

15-42 LO 1
 LEARNING Explain how to account for bond
2
OBJECTIVE transactions.

Corporation records bond transactions when it

 issues (sells),
 redeems (buys back) bonds, and
 when bondholders convert bonds into common stock.

NOTE: If bondholders sell their bond investments to other investors,

the issuing company receives no further money on the transaction,
nor does the issuing company journalize the transaction.

15-43 LO 2
 Accounting for Bond Transactions

Issue at Face Value, Discount, or Premium?

Illustration 15-4
Interest rates and bond prices

Bond
Contractual
Interest
Rate 10%

15-44 Run slide show to reveal “Bonds Sell at.” LO 2

 Accounting for Bond Transactions

Question
The rate of interest investors demand for loaning funds to a
corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.

15-45 LO 2
 Accounting for Bond Transactions

Question
Karson Inc. issues 10-year bonds with a maturity value of $200,000.
If the bonds are issued at a premium, this indicates that:
a. the contractual interest rate exceeds the market interest rate.
b. the market interest rate exceeds the contractual interest rate.
c. the contractual interest rate and the market interest rate are
the same.
d. no relationship exists between the two rates.

15-46 LO 2
 Issuing Bonds at Face Value

Illustration: On January 1, 2017, Candlestick, Inc. issues

$100,000, five-year, 10% bonds at 100 (100% of face value).
The entry to record the sale is:

Jan. 1 Cash 100,000

Bonds Payable 100,000

15-47 LO 2
 Issuing Bonds at Face Value

Illustration: On January 1, 2017, Candlestick, Inc. issues

$100,000, five-year, 10% bonds at 100 (100% of face value).
Assume that interest is payable annually on January 1. At
December 31, 2017, Candlestick recognizes interest
expense incurred with the following entry. Assume monthly
accruals have not been made.

Dec. 31 Interest Expense 10,000

Interest Payable 10,000

15-48 LO 2
 Issuing Bonds at Face Value

Illustration: On January 1, 2017, Candlestick, Inc. issues

$100,000, five-year, 10% bonds at 100 (100% of face value).
Assume that interest is payable annually on January 1.
Candlestick records the payment on January 1, 2018, as
follows.

Jan. 1 Interest Payable 10,000

Cash 10,000

15-49 LO 2
 Issuing Bonds at a Discount

Illustration: On January 1, 2017,

Candlestick, Inc. sells $100,000, five-year,
10% bonds for $98,000 (98% of face value).
Interest is payable annually January 1. The
entry to record the issuance is:

Jan. 1 Cash 98,000

Discount on Bonds Payable 2,000
Bonds Payable 100,000

15-50 LO 2
 Issuing Bonds at a Discount
Illustration 15-5
Statement Presentation Statement presentation of
discount on bonds payable

Carrying value or
book value

Sale of bonds below face value (discount) =

total cost of borrowing > interest paid.
Reason: Borrower is required to pay the bond discount at the maturity
date. Therefore, the bond discount is considered to be a increase
in the cost of borrowing.

15-51 LO 2
 Issuing Bonds at a Premium

Illustration: On January 1, 2017,

Candlestick, Inc. sells $100,000, five-year,
10% bonds for $102,000 (102% of face
value). Interest is payable annually
January 1. The entry to record the issuance
is:

Jan. 1 Cash 102,000

Bonds Payable 100,000
Premium on Bonds Payable 2,000

15-52 LO 2
 Issuing Bonds at a Premium
Illustration 15-9
Statement Presentation Statement presentation of
discount on bonds payable

Sale of bonds above face value (premium) =

total cost of borrowing < interest paid.
Reason: Borrower is not required to pay the bond premium at the
maturity date of the bonds. Therefore, the bond premium is
considered to be a reduction in the cost of borrowing.

15-53 LO 2
 LEARNING Discuss how long-term liabilities are
4
OBJECTIVE reported and analyzed.
Illustration 15-14
Presentation Balance sheet presentation
of long-term liabilities

Companies report the current maturities of long-term debt under

current liabilities if they are to be paid within one year or the
operating cycle, whichever is longer.
15-54 LO 4
 Use of Ratios

Two ratios that provide information long-run solvency

and the ability to meet interest payments as they come
due are:
 Debt to Assets Ratio
 Times Interest Earned

15-55 LO 4
 Use of Ratios

Illustration: Kellogg Company reported total liabilities of $8,925

million, total assets of $11,200 million, interest expense of $295
million, income taxes of $476 million, and net income of $1,208
million.
Illustration 15-15
Debt to assets ratio

The higher the percentage of debt to assets, the greater the

risk that the company may be unable to meet its maturing
obligations.

15-56 LO 4
 Use of Ratios

Illustration: Kellogg Company reported total liabilities of

$8,925 million, total assets of $11,200 million, interest expense
of $295 million, income taxes of $476 million, and net income of
$1,208 million. Illustration 15-16
Times interest earned

Times interest earned indicates the company’s ability to meet

interest payments as they come due.

15-57 LO 4
 Debt and Equity Financing

Illustration 15-17
Advantages of bond financing
over common stock

15-58 LO 4
 Debt and Equity Financing
Illustration: Microsystems, Inc. is considering two plans for financing the
construction of a new $5 million plant. It is considering two alternatives for
raising an additional $5 million: Plan A involves issuing 200,000 shares of
common stock at the current market price of $25 per share. Plan B involves
issuing $5 million of 8% bonds at face value. Income before interest and
taxes will be $1.5 million; income taxes are expected to be 30%.

Illustration 15-18

15-59