ACCTG 230: Chapter 8
FICA is the acronym for the
Federal Insurance Contribution Act.
• Note signed by a firm promising to repay the amount borrowed are ______ ________
notes payable
Social Security and Medicare taxes withheld from employees' paychecks are collectively referred to as ________.
FICA taxes
Accounting for Warranties: Assume warranty costs are estimated to be 3% of sales. December sales are $1.5 million and customers make warranty claims of $12,000 in January of the following year.
DEC 31 DEBIT: Warranty Expense 45,000 CREDIT: Warranty Liability 45,000 JAN 31 DEBIT: Warranty Liability 12,000 CREDIT: Cash 12,000
Which of the following may be classified as contingent liabilities?
Future litigation losses Product warranties Frequent flier program awards
Operating cycle:
The time it takes to produce revenue. If a company has an operating cycle longer than one year, its current liabilities are defined by the operating cycle rather than by the length of a year. For some companies (a winery, for example), it takes longer than a year to perform the activities that produce revenue.
The journal entry to record employer payroll taxes affects ______.
liabilities and stockholders equity
Accounts payable:
• Amounts owed to suppliers of merchandise or services • Sometimes called trade accounts payable • Most accounts payable are current liabilities, but they could be long-term liabilities, depending on the due date.
Current Portion of Long-Term Debt:
• Debt that will be paid within one year from the balance sheet date.
Liquidity: - Lack of liquidity can result in:
refers to having sufficient cash or other current assets to pay currently maturing debts - financial difficulties or even bankruptcy
A company with a 3-month operating cycle would classify current liabilities as those due within one year.
A company with a 15-month operating cycle would classify current liabilities as those due within 15 months.
Which of the following are included in FICA taxes?
A 6.2% social security tax A 1.45% Medicare tax
KEY POINT:
Sales taxes collected from customers by the seller are not an expense. Instead, they represent current liabilities payable to the government.
By law, an employer is required to pay which of the following amounts as payroll taxes?
Social Security contributions Medicare contributions Federal unemployment tax
common mistake:
Some students think the balance in the Warranty Liability account is always equal to Warranty Expense. Remember, the Warranty Liability account is increased when the estimated warranty liability is recorded, but then is reduced over time by actual warranty expenditures.
Current Ratio formula:
Current Ratio= Current assets / Current Liabilities
Acid-Test Ratio formula:
Acid-test ratio= (Cash + Current Investments + Accounts Receivable) / Current liabilities
Contingent Liabilities:
An existing uncertain situation that MIGHT result in a loss depending on the outcome of a future event
Taylor Company's attorney informs its client that it is possible, but not probable, that the company will lose a currently litigated lawsuit. No reliable estimate of the potential loss is currently available. How should Taylor accrue and/or disclose this potential loss?
Disclose the contingency and state that an estimate cannot be made.
Which payroll tax is paid equally by the employee and the employer?
FICA
Sales Tax formula
Sales Tax= Total cash paid - (Total Cash Paid / 1 + Sales Tax Rate)
True or False: If a state has an unemployment tax program, no FUTA tax must be paid.
false
• Interest on notes is calculated as:
Interest= Face value x Annual interest rate x Fraction of the year
Deductions from employee pay for contributions toward retirement savings plans and contributions for charitable organizations are examples of:
voluntary employee deductions
Effect of Various Changes on the Liquidity Ratios: Current Ratio
Changes that Increase the Ratio: • Increase in current assets •Decrease in current liabilities Changes that Decrease the Ratio: •Decrease in current assets •Increase in current liabilities
Current vs. Long-Term Liabilities: Long-Term=
• Payable IN MORE THAN ONE YEAR from the balance sheet date
A contingent liability is recorded ONLY IF:
1. A loss is probable AND, 2. The amount is reasonably estimable
Criteria for Reporting a Contingent Liability:
1. The likelihood of payment is a. PROBABLE—likely to occur; b. REASONABLY POSSIBLE—more than remote but less than probable; or c. REMOTE—the chance is slight. 2. The amount of payment is a. REASONABLY ESTIMABLE; or b. NOT REASONABLY ESTIMABLE
• For example, a 20-year mortgage is split and reported as the portions that are due:
1. Within the next year (current liability) 2. After the next year (long-term liability)
Which of the following represent the correct accounting treatment for loss contingencies that do not meet the criteria for recording a liability but are at least reasonably possible?
A disclosure must describe the contingency. An estimate of the potential loss should be made (if possible) and disclosed.
COMMON MISTAKE:
As a general rule, a higher current ratio is better. However, a high current ratio is not always a positive signal. Companies having difficulty collecting receivables or holding excessive inventory will also have a higher current ratio. Managers must balance the incentive for strong liquidity (yielding a higher current ratio) with the need to minimize levels of receivables and inventory (yielding a lower current ratio).
Effect of Various Changes on the Liquidity Ratios: Acid-Test
Changes that Increase the Ratio: •Increase in quick assets •Decrease in current liabilities Changes that Decrease the Ratio: •Decrease in quick assets •Increase in current liabilities
Which of the following are not required payroll withholdings?
Charitable contributions Federal unemployment tax (FUTA) State unemployment tax (SUTA)
Deferred Revenues: • Assume Apple sells iTunes gift cards to a customer for $100
DEBIT: Cash 100 CREDIT: Deferred Revenue 100
Recording Notes Payable: Assume Southwest Airlines borrows $100,000 from Bank of America on September 1, 2021, signing a 6%, six-month note.
DEBIT: Cash 100,000 CREDIT: Notes payable 100,000
Sales Tax Payable- • Assume you buy lunch in the airport for $15 plus 10% sales tax. The airport restaurant records the journal entry as shown.
DEBIT: Cash 16.50 CREDIT: Sales Revenue 15 CREDIT: Sales Tax Payable 1.50
• When the customer purchases and downloads, say, $15 worth of music, Apple records the following:
DEBIT: Deferred Revenue 15 CREDIT: Sales Revenue 15
Recording Interest Payable and Repayment of Notes Payable: Interest for full term of loan: $100,000 x 6% x 6/12 = $3,000 • Year-end adjusting entry for interest payable
DEBIT: Interest Expense 2,000 CREDIT: Interest Payable 2,000
Recording Interest Payable and Repayment of Notes Payable: Interest for full term of loan: $100,000 x 6% x 6/12 = $3,000 • Repayment of note
DEBIT: Notes Payable 100,000 DEBIT: Interest Payable 2,000 DEBIT: Interest Expense 1,000 CREDIT: Cash 103,000
Recording Employer Payroll Taxes- Record employees payroll taxes:
DEBIT: Payroll Tax Expense 13,850 CREDIT: FICA Tax Payable 7,650 CREDIT: Unemployment Tax Payable 6,200
Recording Employer-Provided Fringe Benefits- Record employee-provider fringe benefits:
DEBIT: Salaries Expense (fringe benefits) 15,000 CREDIT: Accounts Payable 5,000 CREDIT: Accounts Payable 10,000
Payroll Example, Hawaiian Travel Agency- Record employee salary expense and withholdings
DEBIT: Salaries Expense 100,000 CREDIT: Income Tax Payable 24,000 CREDIT: FICA Tax Payable 7,650 CREDIT: Salaries Payable 68,350
key point:
Employee salaries are reduced by withholdings for federal and state income taxes, FICA taxes, and the employee portion of insurance and retirement contributions. The employer, too, incurs additional payroll expenses for unemployment taxes, the employer portion of FICA taxes, and employer insurance and retirement contributions.
Which of the following are payroll withholdings that are subtracted from gross pay to arrive at take-home pay?
Federal income taxes Health insurance paid by the employee Employee contributions to retirement plans
KEY POINT: We record interest expense in the period in which we ________ it, rather than in the period in which we _______it.
INCUR IT PAY
Common Mistake
Many people think FICA taxes are paid only by the employee. The employer is required to match the amount withheld for each employee, effectively doubling the amount paid into Social Security.
KEY POINT:
Many short-term loans are arranged under an existing line of credit with a bank, or for larger corporations in the form of commercial paper, a loan from one company to another.
Current Portion of Long-Term Debt: • Long-term obligations are ___________and reported as current liabilities when they become payable within the upcoming year
RE-CLASSIFIED • For example, a note payable that matures in 10 years is reported as a long-term liability for the first 9 years, but as a current liability in the tenth year
KEY POINT:
Unlike contingent liabilities, contingent gains are not recorded until the gain is certain and no longer a contingency.
Working capital formula:
Working Capital = Current Assets - Current Liabilities
KEY POINT:
Working capital is the difference between current assets and current liabilities. The current ratio is equal to current assets divided by current liabilities. The acid-test ratio is equal to quick assets (cash, current investments, and accounts receivable) divided by current liabilities. Each measures a company's liquidity, its ability to pay currently maturing debts.
When an employer withholds items such as charitable organization contributions from an employee's pay, the employer must record the item as
a liability until the amount is paid to the organization.
Which of the following voluntary contributions by employees may employers deduct from their employees' pay?
contributions toward retirement funds employee investments in retirement
John Smith works 40 hours for ABC Corp. for $15 per hour. Required payroll deductions are: Social Security $37.20, Medicare $8.70, federal income tax $58, and state income tax $10. Assuming that John gets paid in cash, ABC would record a journal entry that includes a ______.
credit to FICA (Social Security and Medicare) Payable of $45.90 debit to Wages Expense of $600 credit to Cash of $486.10 credit to State and Federal Income Tax Payable of $68
True or false: An employer pays federal unemployment tax as a percentage of an employee's total pay for the year.
false- Only a portion of the employee's pay is subject to FUTA, or federal unemployment tax.
A contingent event for which the likelihood of payment is properly judged to be remote:
is not required to be disclosed in the financial statement notes
Which of the following are examples of fringe benefits provided by employers to their employees?
payment of insurance premiums on employees behalf contributions to retirement and other savings accounts reduced or no-cost company-provided services
Employer Costs:
• Additional (matching) FICA tax on behalf of the employee • Employers also pay federal and state UNEMPLOYMENT TAXES on behalf of employees ❑ FUTA and SUTA • FRINGE BENEFITS: Additional employee benefits paid for by the employer ❑ Health, dental, disability, and life insurance ❑ Contributions to retirement or savings plans
Contingent Gains:
• An existing uncertain situation that might result in a gain • In a lawsuit, the defendant faces a contingent liability, while the other side—the plaintiff— has a contingent gain • Contingent gains are not recorded until the gain is certain ❑ Example of conservatism
Other Current Liabilities:
• DEFERRED REVENUE: liability account used to record cash received in advance of the sale or service • SALES TAX PAYABLE: sales taxes collected from customers by the seller • Current Portion of Long-Term Debt: debt that will be paid within the next year
Example of Liquidity Management:
• Expected End of Period Current Ratio = $5 mil. / $4 mil. = 1.25 • Company decides to delay receipt of $1 million in goods until the following period. • Current assets and current liabilities are now $1 million lower. • New Current Ratio: $4 / $3 = 1.33
Employee Costs:
• Federal and state income taxes • FICA taxes ❑ 7.65% (6.2% + 1.45%) ❑ Collectively, Social Security and Medicare taxes • Employees may have additional amounts withheld from their paychecks for health, dental, disability, and life insurance • Employees may also have amounts deducted for retirement or employee savings plans
Payroll Costs for Employees and Employers- Employee Costs:
• Federal and state income taxes • Employee portion of Social Security and Medicare (FICA taxes) • Employee contributions for health, dental, disability, and life insurance • Employee investments in retirement or savings plans
Payroll Costs for Employees and Employers Employer Costs:
• Federal and state unemployment taxes • Employer matching portion of Social Security and Medicare • Employer contributions for health, dental, disability, and life insurance • Employer contributions to retirement or savings plans
Sales Tax Payable:
• In some states, companies are required to collect sales tax when selling goods or services and then remitting those back to the state or local government • The collection of cash from the customer ________ __ _______ for the company
Liquidity Management:
• Management can influence the ratios that measure liquidity to some extent. • Example: A company can influence the timing of inventory and accounts payable recognition by asking suppliers to delay delivery schedules from December to January. This would reduce the balances in inventory and accounts payable, thus changing the current ratio.
Working Capital:
• Measure of current assets remaining after paying current liabilities • A large positive working capital is an indicator of liquidity • Not the best measure of liquidity for comparing across companies, because the ratio does not control for the relative size of each company
Acid-Test Ratio:
• The amount of "quick assets" available for every $1 of current liabilities • Quick assets are current assets more readily convertible to cash ❑ Exclude current assets such as inventory and prepaid rent • By excluding less liquid current assets, the acid-test ratio may provide a better overall indication of a company's liquidity
Current Ratio:
• The number of current assets available for every $1 of current liabilities • The higher the current ratio, the greater the company's liquidity • A current ratio of, say, 1.5 indicates that for every dollar of current liabilities, the company has $1.50 of current assets
Current vs. Long-Term Liabilities: Current=
• Usually payable WITHIN ONE YEAR from the balance sheet date
Deferred Revenues:
• When a company receives cash in advance, it debits Cash and credits Deferred Revenue, a current liability account
Line of Credit & Commercial Paper • Commercial Paper:
❑ Borrowing from another company rather than a bank ❑ Sold with maturities ranging from 30 to 270 days ❑ Interest rate is usually lower than on a bank loan
Line of Credit & Commercial Paper- • Line of credit:
❑ Informal agreement ❑ Permits a company to borrow up to a prearranged limit ❑ Recorded similar to notes payable
• What benefits are sacrificed?
❑ Most liabilities require the future sacrifice of cash (accounts payable, notes payable, and salaries payable). ❑ Deferred revenue is a liability that requires giving up inventory or services.
• Three liquidity measures:
❑ Working Capital ❑ Current Ratio ❑ Acid- Test Ratio
• Liabilities have three essential characteristics:
❑ probable FUTURE sacrifices of economic benefits, ❑ arising from PRESENT obligations to other entities, ❑ resulting from PAST transactions or events.
