Accounting 1

Instructor Notes

CHAPTER 11

CURRENT LIABILITIES AND PAYROLL

We talked about note receivable in a previous chapter, now let’s talk about current Liabilities and
notes payable. Have you every purchased an automobile by taking out a loan? That is an
example of a notes payable. Paying off a purchase to the bank (or another lender) over time. In
many cases, the asset purchased (like you automobile) serves as collateral. This means if you
don't make the payments, the lender will take the automobile back from you and sell it off to
someone else.
You may use credit card to make a purchase, then hopefully pay it off by the due date. This
would be an example of short term credit and if paid off by due date, no interest is charged.
Panera Bread uses short term credit, or accounts payable, to purchase ingredients for making
bread products in its bakeries. This give Panera control over cash payments by separating the
purchase function from the payment function. The employee responsible for purchasing the
bakery ingredients is separated from the employee responsible for paying for the purchase (a
control measure). This separation of duties can help prevent unauthorized purchases or
payments.
Panera would also have other current liabilities like payroll, payroll taxes, and employee
benefits. We will discuss these current liabilities in this chapter.

SHORT TERM NOTES PAYABLE

Notes payable is handled similar to Notes Receivable. Be sure to look at the examples
in the book. Notice that a Notes Payable can be for an extension of an Accounts
Payable or it can be for purchase of Merchandise. It can also be for a cash loan. In any
case, it is now Interest expense to your company because you now owe the money.

There are also two different types of notes payable. Interest bearing and non-interest
bearing (or called discounted note). In either case, the amount of interest expense is
calculated the same:

Principle * interest rate * number of days/360.

A. Interest bearing note

This example is an extension of AP, so first do the following to move it out of AP to NP.
Interest will be recorded when note is paid:

Accounts payable 1,000

Notes Payable 1,000

(or it could be a loan for cash, in that case you would

debit cash instead of Accounts Payable, still credit
Notes Payable).

With an interest bearing note, you calculate and record the interest when it is paid using
the following formula:

Principle * interest * days/360

Let’s assume the above 1,000 note payable is for 90 days at 10%

Interest would be: 90/360 * 1,000 * .10

(on your calculator it might be easier to go backwards by dividing 90 by 360 first, then
take it times .10 and then times 1,000). You end up with $25.

Journalize the payment of the Notes Payable as follows (notice the interest expense is
recorded when note is paid):

NP 1,000
Interest Exp 25
Cash 1,025
B. Discounted Notes Payable (non interest bearing)

Sometimes a creditor will issue a discounted note rather than an interest bearing note.
The amount of interest expense is actually calculated the same. Let us assume the
same 1,000 note above but will be discounted at 10% of 90 days. Notice it says the
word “discounted” to signify it is a discounted note. Interest expense is the same, $25,
but it needs to be recorded at the time the note is taken out. Let us assume a cash loan.

When it is taken out:

Cash (1000-25) 975

Interest Exp. 25
NP 1,000

At the time of payback, record the following:

NP 1,000
Cash 1,000

Notice the borrow gets less (only 975 instead of 1,000) yet pays the same amount of
interest expense ($25).

It could have been for another asset such as Equipment or Merchandise. In that case
the entry will be:

Merchandise Inv. 975

Interest Exp. 25
NP 1,000

Payment of note:

NP 1,000
Cash 1,000

CONTINGENT LIABILITIES
These are for liabilities that are unknown or the amount is unknown. For
example, if the outcome of a lawsuit maybe unknown. For a company that
offers a warranty on its’ product, the amount of repair work at the time of sale is
unknown. In order to match the Expense (of warranty repair) with the Revenue
(the sale itself), a company should estimate the expected warranty work and
journalize the following.

Estimated warranty work to be done on January’s sales is $20,000.

Product Warranty expense 20,000

Product warranty payable 20,000

It records it as an expect liability and an expense when done at the end of January.

PAYROLL AND PAYROLL TAXES

Payroll refers to the total amount paid to employees for a certain period.

Salary - applies to payment for managerial and administrative or similar services

Wages - manual labor, skilled and unskilled

DETERMINATION OF EMPLOYEE EARNINGS

Earnings = Hours * Rate
This gives us what we call Gross Pay. After all of the following deductions below are
taken out, we call it net pay (the actually amount of cash the employee takes home).

A. ITEMS TAKEN OUT OF EMPLOYEE’S PAYCHECK:

1. FICA - withheld contribution for Social Security benefits, insurance benefits after
retirement (sometimes taken out separately as Medicare), FICA has a maximum
amount that will be taxed.

2. Federal and State Income tax.

3. Other possible deductions
Union Dues
Medical Insurance
Retirement Plans
United Way Elective

When these deductions are taken out, they are treated as a payable, just like Sales Tax
Payable. Because the company does not keep the money, the company deducts the
amounts and sends them on to the appropriate places.

Example Journal Entry for deductions taken out of employee’s paycheck:

Salaries and Wages Payable 10,000

(gross amount, these two can be
separate accounts)
FICA Payable 1,000
Medicare Payable 300
Federal Income Tax Payable 500
State Income Tax Payable 700
Medical Insurance Payable 400
Retirement plan Payable 100
Salaries and Wages Payable (net amount) 7,000

B. ITEMS TAKEN OUT OF THE EMPLOYERS FUNDS:

There may be additional items taken out of the employer’s funds on top of what is
deducted from the employee’s paycheck. They are Unemployment taxes (federal and
state), maybe the company contributes to a retirement fund or help with medical
insurance. The additional amounts go to Payroll tax expense.

Payroll tax expense 3,000

FICA Payable 1,000
Medical Insurance Payable 500
Retirement plan payable 1,000
Federal unemployment tax payable 300
State unemployment tax payable 200
FRINGE BENEFITS

Liability for Vacation Pay - accrue as the privilege is earned. Under the matching
principle must record expense in the period the vacation is earned, not necessarily
taken or paid.

Vacation Pay Expenses 1,000

Vacation Pay Payable 1,000

LIABILITY FOR PENSIONS

Company invests money on behalf of the employee to use later for retirement.

Pension Expense 2,000

Cash 2,000

If not all of the obligation is invested right now, it may look like the following.

Pension Expense 2,000

Cash 1,500
Unfunded Pension Liability 500

You are now ready for Test Number 4 over chapters 9-11

The following should be covered:

How to journalize for the issuance and payment of NR (including Interest Revenue)
Uncollectable Accounts Receivable (allowance and direct write off method)
Dishonored NR .
How to value an asset (capitalize or expense)
Sale or exchange of an asset
Straight line, Double declining, and Units of Production methods for determining
Depreciation expense
Know how to journalize for accrued vacations.
Journalize for the transfer AP to NP
Journalize for paying notes payable and calculate interest expense
Journalize for product warranty.
Know how to calculate the discount on a discounted note payable (non-interest note
payable) and journalize.