Chapter 12 Lecture and Notes

Identify and Describe Current Liabilities

Current liability is a debt or obligation due within a company’s standard operating period, typically a year.

Noncurrent liabilities are long-term obligations with payment typically due in a subsequent operating period (Cover on next chapter).

Examples of Current Liabilities

• Accounts payable 
• Unearned revenue
• Current portion of a note payable
• Taxes payable 

Accounts Payable

• Accounts for financial obligations owed to suppliers after purchasing products or services on credit.
• An account payable is usually a less formal arrangement than a promissory note for a current note payable.
• For some debt, including short-term or current, a formal contract might be created. This contract provides additional legal protection for the lender in the event of failure by the borrower to make timely payments.
• An invoice from the supplier detailing the purchase, credit terms, invoice date, and shipping arrangements will suffice for this contractual relationship.

Unearned Revenue

• Also known as deferred revenue, unearned revenue is a customer’s advance payment for a product or service that has yet to be provided by the company.
• Some common unearned revenue situations include subscription services, gift cards, advance ticket sales, lawyer retainer fees, and deposits for services.
• Under accrual accounting, a company does not record revenue as earned until it has provided a product or service.
• A liability exists until the customer is provided the product or service.
• As soon as the company provides all, or a portion, of the product or service, the value is then recognized as earned revenue.

Current Portion of Note Payable 

• A note payable is a debt to a lender with specific repayment terms, which can include principal and interest.
• A note payable has written contractual terms that make it available to sell to another party.
• The principal on a note refers to the initial borrowed amount, not including interest.
• Interest is a monetary incentive to the lender, which justifies loan risk.

When a note payable is long term but payments are being made each year, the payments that are due in the current year are classified as a current liability, and the remainder of the principal is still a long-term liability.

Taxes Payable

• Taxes payable refers to a liability created when a company collects taxes on behalf of employees and customers.
• It also refers to tax obligations owed by the company, such as sales taxes or income taxes.
• A future payment to a government agency is required for the amount collected.

Sales Taxes Payable

• Sales taxes are expressed as a stated percentage of the sales price.
• Selling company (retailer)
  • collects tax from the customer.
  • enters tax separately in cash register or includes in total receipts.
  • remits the collections to the state’s department of revenue.
    

Analyze, Journalize, and Report Current Liabilities

Accounts payable

 Unearned revenue

Current portion of a note payable

Sales Taxes payable

Define and Apply Accounting Treatment for Contingent Liabilities

 A contingency occurs when a current situation has an outcome that is unknown or uncertain and will not be resolved until a future point in time. The outcome could be positive or negative.

• A contingent liability can produce a future debt or negative obligation for the company.
• Examples of contingent liabilities include the following:

• Pending litigation (legal action)
• Warranties
• Customer insurance claims
• Bankruptcy

The accounting treatment of a contingent liability is based on two requirements:

1.Likelihood of occurrence

2.Whether or not the occurrence is estimable

Here is a video of an example of a contingent liability

Prepare Journal Entries to Record Short-Term Notes Payable

• A short-term note payable is a debt created and due within a company’s operating period (less than a year). Some key characteristics of this written promise to pay include:
• an established date for repayment
• a specific payable amount
• interest terms
• the possibility of debt resale to another party
• A short-term note is classified as a current liability because it is wholly honored within a company’s operating period.

Recording Short-Term Notes Payable Created by a Purchase

A short-term notes payable created by a purchase typically occurs when a payment to a supplier does not occur within the established time frame. The supplier might require a new agreement that converts the overdue accounts payable into a short-term note payable.

Recording Short-Term Notes Payable Created by a Loan

The portion of a note payable that comes due during the year is recorded as a current liability

Record Transactions Incurred in Preparing Payroll

Employee compensation and deductions

• Gross income (pay): the amount earned by the employee before any reductions in pay occur
• Net income (pay) or “take-home-pay”: the remaining balance after deductions occur

Deductions

• Voluntary
• Paid by employee: Retirement contributions (401(k)), life insurance, health insurance
• Paid by employer: Life insurance, health insurance, any match to retirement funds, vacation and sick days
• Involuntary
• Paid by employee: Federal and state income taxes, FICA taxes—Medicare (1.45% of gross income) and Social Security (6.2% of gross income up to cap)
• Paid by employer: Medicare taxes (1.45%), Social security taxes (6.2%), FUTA—federal unemployment taxes, SUTA—state unemployment

Payroll and Payroll Taxes Payable

• The term “payroll” pertains to both:
  •   Salaries - managerial, administrative, and sales personnel (monthly or yearly rate).
  •   Wages - store clerks, factory employees, and manual laborers (rate per hour).

• 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. 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.
• 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.
• 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.