CHAPTER THREE

CURRENT LIABILITIES
LEARNING OBJECTIVES

Explain how to account for current liabilities.

Discuss how current liabilities are reported and
analyzed.
Prepare entries to account for short-term notes
payable.
Compute and record employee payroll deductions and
liabilities.
Compute and record employer payroll expenses and
liabilities.
Characteristics of Liabilities
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 elements:
The Nature of Current Liabilities
A current liability is a debt that a company expects to
pay within one year or the operating cycle, whichever
is longer.
Most current liabilities arise from two basic
transactions:
1. Receiving goods or services prior to making
payment (accounts payable)
2. Receiving payment prior to delivering goods or
services (unearned rent).
Examples of current liabilities are: accounts payable,
short-term notes payable, wages payable, warranty
liabilities, and taxes payable.
 Cont…
Taxes payable—the amount of taxes owed to
governmental units
Interest payable—the amount of interest owed on
borrowed funds
Wages payable—the amount owed to employees
Long-term liabilities are obligations due after one year (or
the company’s operating cycle if longer).
They include:
 long-term notes payable,

 warranty liabilities,

 lease liabilities, and

 bonds payable.
 Cont…
Accounts payable, or trade accounts payable, are amounts
owed to suppliers for products or services purchased on
credit.
Accounts payable are a focus of the merchandising
chapter.
Short-Term Notes Payable
Notes may be issued to purchase merchandise or other
assets.
Notes may also be issued to creditors to satisfy an account
payable created earlier
A short-term note payable is a written promise to pay a
specified amount on a stated future date within one year.
Notes can be sold or transferred.
Most notes payable bear interest.
The written documentation with notes is helpful in
resolving legal disputes.
Two transactions that create notes payable are,
1. Note given to extend credit period
A company can replace an account payable with a note
payable.
A common example is a creditor that requires an interest-
bearing note for an overdue account payable.
Example:
Assume that Nature’s Sunshine Company issued a 90-day,
12% note for $1,000, dated August 1, 2013, to Murray Co.
for a $1,000 overdue account. The entry to record the
issuance of the note is :
 Cont…
When the note matures, the entry to record the payment of
$1,000 plus $30 interest is
I = PXRXT
I= $1,000 × 12% × 90/360
= $ 30
 Cont…
The interest expense is reported in the Other Expense
section of the income statement.
The interest expense account is closed at December 31.
Each note transaction affects a debtor (borrower) and
creditor (lender).
The following illustration shows how the same
transactions are recorded by the debtor and creditor. In
this illustration, the debtor (borrower) is Bowden Co., and
the creditor (lender) is Coker Co.
Example: May 1. Bowden Co. purchased merchandise on
account from Coker Co., $10,000, 2/10, n/30. The
merchandise cost Coker Co. $7,500.
 Cont…

May 31. Bowden Co. issued a 60-day, 12% note for $10,000
to Coker Co. on account.
 Cont…
July 30. Bowden Co. paid Coker Co. the amount due on
the note of May 31.
Interest = $10,000 × 12% × 60/360.
2. Note given to borrow from bank
A bank requires a borrower to sign a note when
making a loan.
When the note comes due, 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.
The amount borrowed is called principal or face value
of the note.
 Cont…
Example
Assume that on September 19 Iceburg Company
borrowed cash from First national Bank by issuing a
$4,000, 90-day, 15% note to the bank. The entry to record
the issuance of the note and the cash proceeds is as
follows:
 Cont…
On the due date of the note (December 18), Iceburg
Company owes First national Bank $4,000 plus interest of
$150.
I= PXRXT
= $4,000 × 15% × 90/360
 The entry to record the payment of the note is :
3/ When Note Extends over Two Periods

When a note is issued in one period but paid in the

next, interest expense is recorded in each period based
on the number of days the note extends over each
period.
Illustration:
Assume a company borrows $2,000 cash on
December 16, 2019, at 12% annual interest. This 60-
day note matures on February 14, 2020, and the
company’s fiscal year ends on December 31. This
means 15 of the 60 days are in 2019 and 45 of the 60
days are in 2020.
 Cont…
Interest for these two periods is:
12/16/2019 to 12/31/2019 = 15 days.
Interest expense = $2,000 × 12% × 15/360 = $10.
1/01/2020 to 02/14/2020 = 45 days.
Interest expense = $2,000 × 12% × 45/360 = $30.
The borrower records the 2019 expense with the
following adjusting entry.
Dec. 31, 2019 Interest Expense ………..….10
Interest Payable ……………..10
(To Record accrued interest ($2,000 ×
12% × 15∕360).)
 Cont…
When this note is paid on February 14, the borrower
records 45 days of interest expense in 2020 and removes
the balances of the two liability accounts.
Feb. 14, 2020 Interest Expense…………30
Interest Payable.…………10
Notes Payable…………2,000

Cash…………………2,040
(Paid note with interest.
*$2,000 × 12% × 45∕360)
4/ Discounted note
A discounted note has the following characteristics:
The interest rate on the note is called the discount rate.
The amount of interest on the note, called the discount, is
computed by multiplying the discount rate times the face
amount of the note.
The debtor (borrower) receives the face amount of the
note less the discount.
The amount of cash received at issuance is called the
proceeds.
The debtor must repay the face amount of the note on the
due date.
 Cont…
Example
Assume that on August 10, Cary Company issues a
$20,000, 90-day discounted note to Western national
Bank. The discount rate is 15%, and the amount of the
discount is $750 ($20,000 × 15% × 90/360). Thus, the
proceeds received by Cary Company are $19,250. The
entry by Cary Company is as follows:
 Cont…
The entry to record the repayment of the discounted note
on November 8 is as follows:
Current Portion of Long-Term Debt
Long-term liabilities are often paid back in periodic
payments, called installments.
Long-term liability installments that are due within
the coming year must be classified as a current
liability.
The total amount of the installments due after the
coming year is classified as a long-term liability.
To illustrate, Starbucks Corp. reported the following
scheduled debt payments in the notes to its September
30, 2022 annual report to shareholders:
 Cont…
Fiscal year ending
2023 …………………..$ 710,000
2024……………………. 722,000
2025……………………. 735,000
2026 ……………………..748,000
2027 ……………………..762,000
Thereafter…………….., 2,109,000
Total principal payments= $5,786,000
The debt of $710,000 due in 2023 would be reported as a
current liability on the September 30, 2022 balance sheet.
The remaining debt of $5,076,000 ($5,786,000 - $710,000)
would be reported as a long-term liability on the balance
sheet.
PAYROLL ACCOUNTING IN THE CONTEXT OF
ETHIOPIA
The Importance of the payroll Accounting
Payroll refers to the amount paid to employees for the
services they provide during a period.
The payroll accounting of a firm has to be given a
significant emphasis for the following reasons:
1. Employees are sensitive to payroll errors and
irregularities. Maintaining good employee morale
requires that the payroll be paid on a timely, accurate
basis.
2. The payroll is subject to various federal and state
regulations.
3. The payroll and related payroll taxes have a significant
effect on the net income of most businesses
 Liability for Employee Earnings
Salary: refers to an amount paid to employees on monthly or
annual basis or compensations to employees on monthly or
annual basis are termed as salaries.
Example: payment for managerial, administrative, or similar
services.
The rate of salary is normally expressed in terms of a month or a
year.
Wages refers to payment for manual labor, both skilled and
unskilled.
The rate of wages is normally stated on an hourly or weekly
basis.
In practice, the terms salary and wages are often used
interchangeably
Deductions from Employee Earnings
The total earnings of an employee for a payroll period,
including any overtime pay, are called gross pay.
From this amount is subtracted one or more deductions to
arrive at net pay.
Deductions include items such as income taxes; medical
insurance; and pension contributions.
 Net pay is the amount the employee receives after
deductions are subtracted from gross pay.
Net Pay = Gross Pay − Deductions
Income Taxes:
Except for certain types of employment, all employers must
withhold a portion of employee earnings for payment of the
employees’ income tax.
 Cont…
Other Deductions
Neither the employer nor the employee has any choice in
deducting taxes from gross earnings. However, employees
may choose to have additional amounts deducted for other
purposes.
Example
Retirement savings(Pension Plan),
Contributions to charitable organizations(donations).
A union contract may also require the deduction of union
dues
Computing Employee Net Pay
Gross earnings less payroll deductions equals the amount
to be paid to an employee for the payroll period. This
amount is the net pay, which is often called the take-home
pay.
Accounting Systems for Payroll and Payroll
Taxes
Although payroll systems differ among businesses, the
major elements common to most payroll systems are
the payroll register,
employee’s earnings record, and
payroll checks
Payroll Register
The entire list of employees of a business along with each
employee’s gross earnings, deductions and net pay or
home take pay for particular payroll period.
 Cont…
The earnings and deduction data are inserted in their
proper columns.
The sum of the deductions for each employee is then
subtracted from the total earnings to yield the amount to
be paid.
The check numbers are recorded in the payroll register as
evidence of payment.
Recognizing Payroll Expenses and Liabilities
The column totals of the payroll register support the
journal entry for payroll.
 The entry based on the payroll register is as follows
Salary Expense ………………………XXX
Income Tax Payable …………………….XX
Pension cont. Payable …………………..XX
Credit asso. Payable……………………..XX
Salaries Payable …………………………XX
(Payroll for month ended December 31)
Recording Payment of the Payroll
Following payment of the payroll, the company enters the
check numbers in the payroll register.
A campany records payment of the payroll as follows:
Salaries Payable………………….…….XX
Cash………………………………………..XX
Internal Control for Payroll
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.
 Irregularities often result if internal control is lax.
 Frauds involving payroll include overstating hours,
using unauthorized pay rates, adding fictitious
employees to the payroll, continuing terminated
employees on the payroll, and distributing duplicate
payroll checks.
 Cont…
Payroll activities involve four functions:
hiring employees,
timekeeping,
preparing the payroll, and
paying the payroll.
For effective internal control, companies should
assign these four functions to different departments or
individuals
 Internal Control for Payroll
 [[[
 Cont…

 .
 Illustration
Keraji & Families Business pays the salary of its
employees according to the Ethiopian Calendar month.
The forth-coming date relates to the month of Tikimt,
2015.

Overtime Duration of Basic

Basic Monthly Hours Overtime Salary
Ser.No. Name of Employee Salary Allowance Worked Work Per Hour
01 Friegenet Abebe 11300 800 10 Up to 10 p.m. 70.63
02 Sifan Berhanu 9056 - 8 10p.m. to 6a.m 56.60
03 Sena Kebede 5200 - 6 Weekly Rest Days 32.50
04 Hayu Lemessa 3400 500 10 Public Holiday 21.25
05 Yerosa Boru 14600 500 - - 91.25
 Cont…
The agency usually expects a worker to work 40-hours in
a week
During Tikimt all workers have done as they have been
expected.
All workers of this agency are permanent employees
except Yerosa Boru.
The monthly allowance of Hayu Lemessa is not taxable.
Sena Kebede agreed to have a monthly Birr 1200 be
deducted and paid to the credit Association of the agency
as a monthly saving.
INSTURCTIONS:
Based on the above information;
1. Compute gross earnings, deductions and net pay of each
employee
2. Prepare a payroll register (or sheet) for the agency for
the month of Tikimt , 2015.
3. Record the payment of salary as of Tikimt 30, 2015 –
using CK. No 22 as a source document.
4. Record the payroll taxes expense for the month of
Tikimt; 2015 Memorandum No. 13.
 Cont…
5. Record the payment of the claim of the credit
association of the agency that arose from Tikimt’s
Payroll assuming that the payment was made on Hidar
3, 2015.
6. Assuming that the withholding taxes and payroll
taxes the month of Tikimt 2015 is been paid on Hidar
5, 2015 Via Ck. No. 28. Record the required journal
entry.
Solution:
Computations of Earnings, Deductions and Net Pay
Gross Earnings: The totals pay to an employee(s) before
deductions for the pay period .It includes the sum total of:
basic salary, allowance, over time, bonus etc.
Basic Salary or Regular Earning: is a flat monthly
salary of an employee that is paid for carrying out the
normal works of employment and subject to change when
the employee is promoted.
Allowance: refers to money paid monthly to an employee
for special reason, which may include: Position
Allowance, House allowance, Hardship Allowance, Desert
Allowance & Transportation (fuel) allowance
 Cont…
Overtime Earnings
Overtime Work – is the work performed by an
employee beyond the regular working hours or days.
Overtime Earning – is the amount payable to an
employee for overtime work done.
In Ethiopia, in this respect, according to Article 68 of
Proclamation No.1156/2019, the following are the
time range and their respective rate of payment for
overtime work.
 [
Cont…
Duration of irregular hours Over time rate
up to 4 pm 1.5
From 4 pm- 6 am 1.75
Weekend days 2
Public holydays 2.5
 Cont…
Over Time Earnings = OT Hrs worked X ordinary
hourly rate X OT Rate
Friegenet Abebe
 OT earning=10 Hrs x 70.63/Hr x 1.50 = Br. 1059.45
Sifan Berhanu
OT earning = 8 Hrs. x 56.60/ Hr x 1.75 = Br. 792.40
Sena Kebede
 OT earning = 6 Hrs. 32.50/ Hr x 2.00= Br. 390
Hayu Lemessa
 OT earning = 10 Hrs. x 21.25/ Hrs x 2.50 = Br. 531.25
Yerosa Boru OT earning = 0
 Cont…
Gross Earnings = Basic Salary + Allowance + OT
Earning

OT
Basic Allowanc Earning Gross
Salary e Earnings
Friegenet
1. Abebe Br. 11300 + Br. 800 + 1059.45 = Br. 13159.45
2. Sifan Berhanu Br. 9056 + Br. 0 + 792.40 = Br. 9,848.40
3. Sena Kebede Br. 5200 + Br. 0 + 390.00 = Br. 5,590.00
4. Hayu Lemessa Br. 3400 + Br. 500 + 531.25 = Br. 4,431.25
5. Yerosa Boru Br. 14600 + Br. 500 + 0 = Br. 15,100
DEDUCTIONS & NET PAYS:
Payroll deductions: All the reductions from the gross
earnings of an employee such as:
withholding taxes,
Pension contribution
union dues,
credit association pays etc
Net pay: The gross earnings after subtracting all the
deductions. It is some times known as take home pay
amount
 Cont…
Employee Income Tax:
In Ethiopia, a progressive income tax system is
applied on the gross earnings of each employee.
According to the income tax proclamation 979/2016,
The first Six hundred (Br.600) incomes from
employment exempted from payment of income tax in
all cases.
The tax on income from employment over six
hundred (Br 600) shall be charged, levied and
collected monthly according to the following
schedule.
 Cont…
Taxable monthly Rate of tax (%) on Every
income (In Birr) Additional income
1 0-600 Non-Taxable
1 601-1,650 Birr 10%
2 1,651 - 3,200 Birr 15%
3 3,201 - 5,250 Birr 20%
4 5,251 - 7,800 Birr 25%
5 7,801 - 10,900 Birr 30%
6 Over 10,900 Birr 35%
 Cont…
Taxable monthly Taxable Rate of tax (%) Income tax
income (In Birr) income on Every
Additional
income
1 0-600 0 Non-Taxable Br. 0
1 601-1,650 Birr 1050 10% Br. 105
2 1,651 - 3,200 Birr 1550 15% Br. 232.5
3 3,201 - 5,250 Birr 2050 20% Br. 410
4 5,251 - 7,800 Birr 2550 25% Br. 637.50
5 7,801 - 10,900 Birr 3100 30% Br. 930.00
6 Over 10,900 Birr Above 10900 35%
 Cont…
Income tax calculation
A. Progressive method
1550 2550
Taxable 600 1050 2050 3100 Above Income
income x0 x 0.1 X .15 X .20 X .25 X .30 .35 tax
1 Firegenet 13159.45 0.00 105.0 232.5 410.00 637.50 930.00 790.80 3105.86
0
2 Sifan 9848.40 0.00 105.0 232.5 410.00 637.50 614.52 _ 1999.52
0
3 0.00 105.0 232.5 410.00 85.00 _ _ 832.50
Sena 5590.00
0
4 0.00 105.0 232.5 146.25 _ _ _ 483.75
Hayu 3931.25
0
5 0.00 105.0 232.5 410.00 637.50 930.00 1570 3885.00
Yerosan 15100.00
0
B. Deduction method
Tax bracket

Deduction
No. Salary Range (ETB) Tax Rate
(ETB)
1. 0 - 600 Birr Non-Taxable -
2. 601-1,650 Birr 10% 60 Birr
3. 1,651 - 3,200 Birr 15% 142.50 Birr
4. 3,201 - 5,250 Birr 20% 302.50 Birr
5. 5,251 - 7,800 Birr 25% 565 Birr
6. 7,801 - 10,900 Birr 30% 955 Birr
7. Over 10,900 Birr 35% 1,500 Birr
Salary Income Tax = (Taxable income X Tax Rate) –
Deduction
Example:
By referring to the above table, we can see that 2,000 birr
falls in the No. 4 row.
So, Tax Rate = 15% and
Deduction = 142.50
Income Tax = (2,000 Birr x 15%) - 142.50 Birr
Income Tax = 300 Birr - 142.50 = 157.50 Birr
N Employe Taxable X _ Deduction = Income tax
Tax
o e name income
rate

1 Firegenet 13189.45 X 35% _ 1,500 Birr = 3116.31

2 Sifan 9848.40 X 30% _ 955 Birr = 1999.52

3 Sena X 25% _ 565 Birr = 832.50

5590.00
4 Hayu X 20% _ 302.50 Birr = 483.75
3931.25
5 Yerosan X 35% _ 1,500 Birr = 3885.00
15100.00
Pension contribution by employees
Pension contributions
A pension is a cash payment to retired employees.
Pension benefits are accrued by employees as they
work, based on the employer’s pension plan.
Permanent employees of an organization are expected
to pay or contribute 7% of their basic (monthly) salary
to the government pension trust fund .
 Cont…
Basic Pensio Pension
salary X n rate = Cntribtion

1 Firegenet Br. 11300 X 7% = 791

2 Sifan Br. 9056 X 7% = 633.92
3 Sena Br. 5200 X 7% = 364
4 Hayu Br. 3400 X 7% = 238
5 Yerosa Br. 14600 Not permanent
 Cont…
Keraji and Families Business
A Payroll Register
For The Month of Tikimt, 2015

Gross Earning Deduction

Name of the Basic Allowa Over Total Income Total Net

No Employee Salary nce Time Earning Tax Pension Others Deduction Payment Sig.

1 Friegenet Abebe Br. 11300 800 Br. 1059.45 13159.45 3105.86 791 - 3896.85 9262.59
2 Sifan Berhanu Br. 9056 - Br. 792.40 9,848.40 1999.52 633.92 - 2633.44 7214.96
3 Sena Kebede Br. 5200 - Br. 390.00 5,590.00 832.50 364.00 1200.00 2396.50 3193.50
4 Hayu Lemessa Br. 3400 500 Br. 531.25 4,431.25 483.75 238.00 - 721.75 3709.50
5 Yerosa Boru Br. 14600 500 - 15,100.00 3885.00 - - 3885.00 11215.00
Total . . . 43556.00 1800.00 2773.10 48159.10 10317.08 2026.92 1200.00 13544 34615.10

Prepared by:__________________Verified by:_______________________Approved by:________________

 Cont…
Recording the Payment of Salary.

2015 Salary Expense . . . . . . . . . .48159.10

Tikimt 30, Employee Income Tax Payable . . . 10317.08
Pension contribution Payable . . 2026.92
Credit Association – ERA . . . . . . 1200.00
Cash . . . . . . . . . . . . . . . . . . . . . ... 34615.10
(Ck.No.22)
 Cont…
4. Recording the Payroll taxes expense for Tikimt, 2015
Payroll Taxes:
Taxes levied against the employer on the payroll of the firm.
It is an additional payroll related expense to an employer.

Total Basic Salary Payroll Tax

Of all permanent Employees * 11 % = Expense
(11300+ 9056+ 5200+ 3400 ) * 11% = Br 3185.16

2005 Payroll Taxes Expense ……… 3185.16

Tahasas 30, Pension cont. Payable……….. 3185.16
(M13)
 Cont…
5. Recording the payment of deduction from Sena Kebede
earnings to the credit association on Tidar 3, 2015.
2015 Credit Association……………..1200
Hidar 3 Cash……………………………….1200
 Cont…
Recording the payment of withholding and payroll
taxes to Inland Revenue Authority on Hidar 5, 2015.
Withholding Taxes:
taxes levied against the earnings of employees of an
organization
withheld by the employer of an organization
The payment is recorded as follows:
Employees Income Tax Payable…… 10317.08
Pension Contribution Payable………...5212.08
Cash …………………………..15529.16
 (Ck. No. 28)
 Presentation of Current
Liabilities on the Balance Sheet
Keraji & families
Balance Sheet
December 31, 2015
Total Assets……………………………………………………….…XX
Liabilities:
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . … . XX
Notes payable (current portion) . . . . . . . . . . . . . . . . . . . . . . . . . . . ...XX
Salaries and wages payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XX
Payroll taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XX
Interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XX
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXX
.

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