Accounting Chapter 11: Current Liabilities and Payroll Review Questions

What is the difference between gross pay and net pay?

*Gross pay:* The total amount of salary, wages, commissions, and any other employee compensation before taxes and other deductions. Whereas, *Net pay* Gross pay minus all deductions. The amount of compensation that the employee actually takes home.

What is a current liability? Provide some examples of current liabilities.

-A liability that must be paid with cash or with goods and services within one year or within the entity's operating cycle if the cycle is longer than a year. -Some examples are: Accounts Payable, Notes Payable due within one year, Salaries Payable, etc. -Any portion of a long-term liability that is due within the next year is also reported as a current liability.

What are the three main characteristics of liabilities?

1. They occur because of a past transaction or event. 2. They create a present obligation for future payment of cash or services. 3. They are an unavoidable obligation.

What are the two main controls for payroll? Provide an example of each.

1.Controls for efficiency 2. Controls to safeguard payroll disbursements

What is a contingent liability? Provide some examples of contingencies.

A contingent liability is a potential, rather than an actual, liability because it depends on a future event. For a contingent liability to be paid, some event (the contingency) must happen in the future. For example, suppose Smart Touch Learning is sued because of alleged patent infringement on one of its online learning videos. The company, therefore, faces a contingent liability, which may or may not become an actual liability. If the outcome of this lawsuit is unfavorable, it could hurt Smart Touch Learning by increasing its liabilities. Therefore, it would be unethical to withhold knowledge of the lawsuit from investors and creditors.

How might a business use a payroll register?

A schedule that summarizes the earnings, withholdings, and net pay for each employee.

What do short-term notes payable represent?

A written promise made by the business to pay a debt, usually involving interest, within one year or less.

Curtis Company is facing a potential lawsuit. Curtis's lawyers think that it is reasonably possible that it will lose the lawsuit. How should Curtis report this lawsuit?

If a contingency is probable, it means that the future event is likely to occur. Only contingencies that are probable and can be estimated are recorded as a liability and an expense is accrued. An example of an estimable probable contingency is a warranty. Contingencies that are probable but cannot be estimated are disclosed in the notes to the financial statements. A liability is not recorded because the amount of the contingency cannot be estimated. Exhibit 11-4 summarizes the rules for contingent liabilities.

What payroll taxes is the employer responsible for paying?

In addition to income tax and FICA tax, which are withheld from employee paychecks, employers must pay at least three payroll taxes. These taxes are not withheld from employees' gross earnings but instead are paid by the employer: 1. Employer FICA tax (OASDI and Medicare) 2. State unemployment compensation tax (SUTA) 3. Federal unemployment compensation tax (FUTA)

How is the times-interest-earned ratio calculated, and what does it evaluate?

Investors can use the times-interest-earned ratio to evaluate a business's ability to pay interest expense. This ratio measures the number of times earnings before interest and taxes (EBIT) can cover (pay) interest expense. The times-interest-earned ratio is also called the interest-coverage ratio. A high interest-coverage ratio indicates a business's ease in paying interest expense; a low ratio suggests difficulty. The times-interest-earned ratio is calculated as EBIT (Net income +Income tax expense+Interest expense) divided by Interest expense.

Coltrane Company has a $5,000 note payable that is paid in $1,000 installments over five years. How would the portion that must be paid within the next year be reported on the balance sheet?

Long-term notes payable are typically reported in the long-term liability section of the balance sheet. If, however, the long-term debt is paid in installments, the business will report the current portion of notes payable (also called current maturity) as a current liability. The *current portion* of notes payable is the principal amount that will be paid within one year of the balance sheet date. The remaining portion of the note will be classified as long-term.

When do businesses record warranty expense, and why?

Many corporations guarantee their products against defects under warranty agreements. The time period of warranty agreements varies. The matching principle requires businesses to record Warranty Expense in the same period that the company records the revenue related to that warranty. The expense, therefore, is incurred when the company makes a sale, not when the company pays the warranty claims. At the time of the sale, the company does not know the exact amount of warranty expense but can estimate it.

How is sales tax recorded? Is it considered an expense of a business? Why or why not?

Most states assess sales tax on retail sales. Retailers collect the sales tax in addition to the price of the item sold. Sales Tax Payable is a current liability because the retailer must pay the state in less than a year. Sales tax is usually calculated as a percentage of the amount of the sale.

List the required employee payroll withholding deductions, and provide the tax rate for each.

Required deductions, such as employee federal and state income tax, Social Security tax, and other deductions required by federal, state, or local laws. For example, employees pay their income tax and Social Security tax through payroll deductions. Optional deductions, including insurance premiums, retirement plan contributions, charitable contributions, and other amounts that are withheld at the employee's request. Tax rate= 0.062% for OASDI and 0.0145% for Medicare OASDI—6.2% tax on the first $118,500 earnings. Medicare—1.45% tax on the first $200,000; 2.35% on earnings over $200,000.

How do unearned revenues arise?

Unearned revenue is also called deferred revenue. Unearned revenue arises when a business has received cash in advance of providing goods or performing work and, therefore, has an obligation to provide goods or services to the customer in the future.