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Current Liabilities
Key Topics to Know
Accounting for Current Liabilities
- Liabilities are probable future payments for which there are current obligations to pay due to the occurrence of past events.
- Classify liabilities as current or long-term
- Three different types of current liabilities: o Determinable - known and determinable in amount o Estimated – known and the amount can be reasonably estimated o Contingent - depends upon a probable future event occurring; amount may be known or reasonably estimated Notes Payable
- Computing the interest expense, term, maturity date and maturity value of a note
- Journal entries to record issuance of a note and honoring the note at maturity date
- Accruing interest expense at the end of a period prior to maturity date. Current Maturities of Long-Term Debt
- Portion of long-term debt, such as bonds payable, mortgages payable and installment notes payable due within one year Accounts Payable
- Current liability account used for invoices received from vendors and suppliers Unearned Revenue
- Results from payments received in advance of services performed or goods sold
- Creates a liability to perform the services, sell the goods or refund the payment Payroll and Payroll Taxes Payable
- Gross wages or salaries earned does not equal net pay paid to employees
- Differences is payroll taxes withheld from employees’ pay
- Withholdings are recorded as liabilities owed to government agencies levying the taxes
- Employers are also obligated for certain payroll taxes not withheld from employees’ compensation
Sales Taxes payable
- Companies are required by law to collect sales tax on retail sales.
- Companies are merely a conduit for the taxes collected, recording a liability when collected and paying off the liability when the taxes are remitted to the appropriate government agency Contingent liabilities
- Result from future events with uncertain outcomes that may result in liabilities.
- Contingent liabilities are recorded if the liability is probable and the amount can be reasonably estimated.
- Contingent liabilities are disclosed in the footnotes to the financial statements if the liability is probable and the amount cannot be reasonably estimated.
- Contingent liabilities are not recorded or disclosed when the future event is unlikely to occur. Analysis
- Solvency Ratios o Times interest earned ratio measures the ability to meet interest payments as they occur. o Debt to assets ratio measures the proportion of assets acquired using debt
- Liquidity ratios o Current ratio measures the ability to use current assets to pay current liabilities in the short-term. o Working Capital is the excess of current assets over current liabilities o Neither of these measures considers the quality of the current assets or how easy it would be to actually use them to pay a liability.
Problem #4 - Ratios S Company had income before interest expense and income taxes of $12,581 million and interest expense of $1,063 million. V Company had net income of $1,613 million, income taxes of $840 million and interest expense of $1,143 million. Calculate the times interest earned for each company and comment on the results. Required: Calculate the times interest earned for each company Problem #5 – Payroll Liabilities An employee earns $9,500 for the current period. FICA tax (Social security tax of 6.2% and Medicare tax of 1.45%) of 7.65% applies to all earnings. Federal income tax will be 15% of earnings and state income tax will be 3% of earnings. Federal unemployment tax rate is 0.8% and state unemployment tax rate is 3.0%. Required: Prepare the journal entries that your company would use to record the payroll. Consider both employee and employer payroll taxes.
Multiple Choice Questions
1. Which of the following represents the correct journal entry to record a taxable
cash sale of $800 if the sales tax rate is 5%? a) A debit to cash for $840, a debit to sales tax expense for $40, and a credit to sales revenue for $800. b) A debit to cash for $840, a credit to sales tax payable for $40, and a credit to sales revenue for $800. c) A debit to cash for $800, a credit to sales tax payable for $40, and a credit to sales revenue for $ d) None of the above.
2. Under what condition^ should a pending lawsuit be recognized as a liability on a
company's balance sheet? a) The outcome is reasonably possible. b) The outcome is probable. c) The amount can be reasonably estimated. d) Both B and C.
3. M Company^ has been named as a plaintiff in a $5 million lawsuit filed by a
customer over the addictive nature of the company's french fries. M Company’s attorneys have advised them that the likelihood of a future obligation from the suit is remote. As a result of the lawsuit, M Company should: a) Disclose the lawsuit in the footnotes to the financial statements. b) Recognize a $5 million liability on its balance sheet for the contingency. c) Ignore the lawsuit in its financial statements. d) Settle with the customer immediately for $5 million to avoid harmful publicity.
4. How many of the following statements are true?
- Solvency measures the ability to survive in the short-term
- Liquidity measures the ability to meet all liabilities as they come due
- A line of credit provides additional liquidity to a company
- The times interest earned ratio measures a company’s ability to pay for interest payments out of current earnings
- The higher the debt-to-equity ratio, the less risk the company has a) None b) One c) Two d) Three
9. During one pay period, Y Company^ distributes $130,500 to employees as net
pay. The income tax withholdings were $19,000 and the FICA withholdings were $5,000. The total compensation expense to the company for this pay period, excluding any unemployment taxes, was: a) $149, b) $130, c) $154, d) $159,
10. Accounts payable are:
a) Long-term liabilities. b) Not usually due on specific dates. c) Amounts owed to suppliers for products and/or services purchased on credit. d) Always payable within 30 days.
11. Which of the following do not^ apply to unearned revenues?
a) Amounts to be received in the future from customers for delivery of products or services in the current period. b) Also called collections in advance. c) Also called deferred revenues. d) Amounts received in advance from customers for future delivery of products or services.
12. Contingent liabilities must be recorded if:
a) The future event is remote. b) The future event is probable and the amount owed can be reasonably estimated. c) The future event is reasonably possible but not estimable. d) The future event is probable but not estimable.
13. Times interest earned is calculated by:
a) Dividing interest expense by income before interest expense. b) Dividing income before interest expense and income taxes by interest expense. c) Multiplying interest expense by income before interest expense. d) Dividing income before interest expense by interest expense and income taxes.
14. The entry to accrue payroll expenses and liabilities for^ employees^ will not
include: a) Liabilities to federal and state governments. b) Expenses for gross wages and salaries. c) Expenses for state unemployment. d) Expenses for the employee portion of any medical insurance.
15. Employer payroll taxes:
a) Are added expenses beyond that for the wages and salaries earned by employees. b) Represent the federal taxes withheld from employees. c) Represent the social security taxes withheld from employees. d) Are paid by the employee.
Problem #4 - Ratios
- S Company $12, - 1, - = 11.
- V Company $3, - 1, - = 3.
- Wages and salaries payable 9,500. Problem #5 – Payroll Liabilities
- Federal income taxes payable 1,425.
- State income taxes payable 285.
- FICA taxes payable 726.
- Cash 7,063.
- Payroll tax expense 1,087.
- FICA taxes payable 726.
- Federal unemployment tax payable 76.
- State unemployment tax payable 285.
Solutions to Multiple Choice Questions
1. B
2. D
3. C
4. C
5. C
6. A
7. B
8. D
9. D
10. C
11. A
12. B
13. B
14. C
15. A
