12.6: Summary

12.1 Identify and Describe Current Liabilities

• Current liabilities are debts or obligations that arise from past business activities and are due for payment within a company’s operating period (one year). Common examples of current liabilities include accounts payable, unearned revenue, the current portion of a noncurrent note payable, and taxes payable.
• Accounts payable is used to record purchases from suppliers on credit. Accounts payable typically does not include interest payments.
• Unearned revenue is recorded when customers pay in advance for products or services before receiving their benefits. The company maintains the liability until services or products are rendered.
• Notes payable is a debt to a lender with specific repayment terms, which can include principal and interest. Interest accrued can be computed with the annual interest rate, principal loan amount, and portion of the year accrued.
• Employers withhold taxes from employees and customers for payment to government agencies at a later date, but within the business operating period. Common taxes are sales tax and federal, state, and local income taxes.

12.2 Analyze, Journalize, and Report Current Liabilities

• When the merchandiser initially pays the supplier on credit, it increases both Accounts Payable (a credit) and the appropriate merchandise Inventory account (a debit). When the amount due is later paid, it decreases both Accounts Payable (a debit) and Cash (a credit).
• When the company collects payment from a customer in advance of providing a product or service, it increases both Unearned Revenue (a credit) and Cash (a debit). When the company provides the product or service, Unearned Revenue decreases (a debit), and Revenue increases (a credit) to realize the amount earned.
• To recognize payment of the current portion of a noncurrent note payable, both Notes Payable and Cash would decrease, resulting in a debit and a credit, respectively. To recognize interest accumulation, both Interest Expense and Interest Payable would increase, resulting in a debit and a credit, respectively.
• To recognize sales tax in the initial sale to a customer, Cash or Accounts Receivable increases (a debit), and Sales Tax Payable increases (a credit), as does Sales (a credit). When the company remits the sales tax payment to the governing body, Sales Tax Payable decreases (a debit), as does Cash (a credit).

12.3 Define and Apply Accounting Treatment for Contingent Liabilities

• Contingent liabilities arise from a current situation with an uncertain outcome that may occur in the future. Contingent liabilities may include litigation, warranties, insurance claims, and bankruptcy.
• Two FASB recognition requirements must be met before declaring a contingent liability. There must be a probable likelihood of occurrence, and the loss amount is reasonably estimated.
• The four contingent liability treatments are probable and estimable, probable and inestimable, reasonably possible, and remote.
• Recognition in financial statements, as well as a note disclosure, occurs when the outcome is probable and estimable. Probable and not estimable and reasonably possible outcomes require note disclosures only. There is not recognition or note disclosure for a remote outcome.

12.4 Prepare Journal Entries to Record Short-Term Notes Payable

• Short-term notes payable is a debt created and due within a company’s operating period (less than a year). This debt includes a written promise to pay principal and interest.
• If a company does not pay for its purchases within a specified time frame, a supplier will convert the accounts payable into a short-term note payable with interest. When the company pays the amount owed, short-term notes payable and Cash will decrease, while interest expense increases.
• A company may borrow from a bank because it does not have enough cash on hand to pay for a capital expenditure or cover temporary expenses. The loan will consist of short-term repayment with interest, affecting short-term notes payable, cash, and interest expense.

12.5 Record Transactions Incurred in Preparing Payroll

• An employee’s net income (pay) results from gross income (pay) minus any involuntary and voluntary deductions. Employee payroll deductions may include federal, state, and local income taxes; FICA Social Security; FICA Medicare; and voluntary deductions such as health insurance, retirement plan contributions, and union dues.
• When recording employee payroll liabilities, Salaries Expense, Salaries Payable, and all payables for income taxes, Social Security, Medicare, and voluntary deductions, are reported. When the company pays the accrued salaries, Salaries Payable is reduced, as is cash.
• Employers are required to match employee withholdings for Social Security and Medicare. They must also remit FUTA and SUTA taxes, as well as voluntary deductions and benefits provided to employees.
• When recording employer payroll liabilities, Employer Payroll Taxes Expense and all payables associated with FUTA, SUTA, Social Security, Medicare, and voluntary deductions are required. When the company pays all employer liabilities, each payable and cash account decreases.

Key Terms

account payable

account for financial obligations to suppliers after purchasing products or services on credit

Additional Medicare Tax

requirement for employers to withhold 0.9% from employee pay for individuals who exceed an income threshold based on their filing status

contingency

current situation, where the outcome is unknown or uncertain and will not be resolved until a future point in time

contingent liability

uncertain outcome to a current condition that could produce a future debt or negative obligation for the company

current liability

debt or obligation due within one year or, in rare cases, a company’s standard operating cycle, whichever is greater

current portion of a note payable

portion of a long-term note due during the company’s current operating period

defined contribution plans

money set aside and held in account for employee’s retirement with possible contribution from employers

federal income tax withholding

amount withheld from employee pay based on employee responses given on Form W-4

Federal Insurance Contribution Act (FICA) tax

involuntary tax mandated by FICA that requires employers to withhold taxes from employee wages “to provide benefits for retirees, the disabled, and children”

Federal Unemployment Tax Act (FUTA)

response to a law requiring employers to pay into a federal unemployment insurance system that covers employees in case of job disruption due to factors outside of their control

gross income (pay)

amount earned by the employee before any reductions in pay occur due to involuntary and voluntary deductions

interest

monetary incentive to the lender, which justifies loan risk; interest is paid to the lender by the borrower

involuntary deduction

withholding that neither the employer nor the employee have control over, and is required by law

likelihood of occurrence

contingent liability must be recognized and disclosed if there is a probable liability determination before the preparation of financial statements has occurred

local income tax withholding

applied to those living or working within a jurisdiction to cover schooling, social services, park maintenance, and law enforcement

measurement requirement

company’s ability to reasonably estimate the amount of loss

Medicare tax rate

currently 1.45% of employee gross income with no taxable earnings cap

net income (pay)

(also, take home pay) remaining employee earnings balance after involuntary and voluntary deductions from employee pay

note payable

legal document between a borrower and a lender specifying terms of a financial arrangement; in most situations, the debt is long-term

principal

initial borrowed amount of a loan, not including interest; also, face value or maturity value of a bond (the amount to be paid at maturity)

probable and estimable

contingent liability is likely to occur and can be reasonably estimated

probable and inestimable

contingent liability is likely to occur but cannot be reasonably estimated

reasonably possible

contingent liability could occur but is not probable

remote

contingent liability is unlikely to occur

short-term note payable

debt created and due within a company’s operating period (less than a year)

Social Security tax rate

currently 6.2% of employees gross wage earnings with a maximum taxable earnings amount of $127,200 in 2017 and $128,400 in 2018

state income tax withholding

reduction to employee pay determined by responses given on Form W-4, or on a state withholdings certificate

State Unemployment Tax Act (SUTA)

response to a law requiring employers to pay into a state unemployment insurance system that covers employees in case of job disruption due to factors outside of their control

taxes payable

liability created when a company collects taxes on behalf of employees and customers

unearned revenue

advance payment for a product or service that has yet to be provided by the company; the transaction is a liability until the product or service is provided

vacation compensation

stipend provided by the employer to employees when they take time off for vacation

voluntary deduction

not required to be removed from employee pay unless the employee designates reduction of this amount