63756 051 10SS p01-14 - Washtenaw Community Collegecourses.wccnet.edu/~cdgracie/wcc/acc111/Chapter... · Instructor’s Edition Special Section Page 1 of 38 | Chapter 10 CHAPTER 10

Instructor’s Edition Special Section Page 1 of 38 | Chapter 10

CHAPTER 10

Current Liabilities, Payroll, and Long-Term Liabilities

Chapter Overview

Chapter 10 begins with the definitions of current and long-term liabilities. Accounting for current liabilities is first discussed and illustrated. The current liabilities of known amount covered in this chapter are (1) accounts payable, (2) short-term notes payable, (3) sales tax payable, (4) current portion of long-term debt, (5) accrued expenses (accrued liabilities), (6) unearned revenues, and (7) payroll liabilities. The chapter then explains current liabilities that must be estimated, using warranties as an example. The guidelines for the three categories of contingent liabilities—probable, reasonably possible, and remote—are discussed. The chapter highlights ethical issues concerning current and contingent liabilities. Decision guidelines answer important questions about current liabilities. A mid-chapter summary problem reviews the various concepts covered in this part of the chapter. Accounting for payroll is then presented. Gross pay and net pay, payroll deductions, FICA tax, and withholding are discussed. Employer payroll taxes are explained. The journal entries for payroll and the payment of the payroll, taxes, and fringe benefits are illustrated. A W-4 form is illustrated. The chapter includes a discussion of internal controls over payroll. Decision guidelines answer important questions about payroll. A summary problem allows the student to practice making payroll calculations and journal entries. This chapter introduces the student to long-term liabilities, particularly bonds payable, as a way to finance operations. General background information is given as to bond terminology, types of bonds, interest rates, and bond quotations. The concept of how bond prices are related to present value is briefly explained. Entries are illustrated for issuing bonds at par, paying semi-annual interest, and paying bonds at maturity. Next, students learn about bonds issued at a discount. Straight-line amortization of the discount is presented. Decision guidelines review many of the concepts presented in the first part of the chapter’s discussion of bonds payable. The second portion of the bonds payable section begins with a presentation of bonds issued at a premium including straight-line amortization of the bond premium. Adjusting entries to accrue interest and amortize premium or discount at year-end are discussed and illustrated. The concept of selling bonds between interest dates at par value plus accrued interest is explained. Retirement and conversion of bonds payable prior to maturity is discussed. The chapter includes a discussion of financial reporting of current and long-term liabilities on the balance sheet. Comparisons of financing by borrowing or by issuing stock helps the student understand the advantages and disadvantages of borrowing. Ethical issues in the reporting of liabilities is also covered. The Decision guidelines offer answers to important questions about long-term liabilities. A summary problem tests students’ understanding of journal entries for various bond transactions. An appendix on the time value of money covers present value and the effective-interest method of amortizing the discount or premium on bonds payable. This section teaches the student how to compute the present value of a single payment and an annuity, and how to calculate the market price of a bond.

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Chapter 10 | Instructor’s Edition Special Section Page 2 of 38

Chapter 10: Teaching Outline

1) Distinguish current liabilities from long-term liabilities.

a) Exhibit 10-1 Classified Balance Sheet in Account Form (Reproduced from Exhibit 4-12)

2) Discuss the various current liabilities of a known amount:

a) Accounts Payable

b) Short-Term Notes Payable

i) Accrual of Interest Expense

c) Sales Tax Payable

d) Current Portion of Long-Term Notes Payable

e) Accrued Expenses (Accrued Liabilities)

f) Unearned Revenue

3) Discuss the accounting for current liabilities that must be estimated:

a) Estimated Warranty Payable

b) Contingent Liabilities

i) Exhibit 10-2 Contingent Liabilities: Three Categories

4) Illustrate the calculations involved in recording payroll and payroll taxes:

a) Gross Pay and Net (Take-Home) Pay

b) Payroll Withholding Deductions

i) Required Withholding for Employee Income Tax

ii) Required Withholding for Employee Social Security (FICA) Tax

iii) Exhibit 10-3 W4 for Ryan Oliver

iv) Optional Withholding Deductions

c) Employer Payroll Taxes

i) Employer FICA Tax

ii) State and Federal Unemployment Compensation Taxes

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iii) Exhibit 10-4 Typical Breakdown of Payroll Costs for One Employee

5) Illustrate the entries to record basic payroll transactions.

a) Exhibit 10-5 Payroll Accounting by the Employer—James Kolen’s pay

6) Discuss the internal control concerns over payroll.

a) Controls for Efficiency

b) Controls to Safeguard Payroll Disbursements

7) Describe bonds payable and define related terms.

a) Principal Amount

b) Maturity Date

c) Stated Interest Rate

d) Exhibit 10-6 Bond Certificate

8) Identify the types of bonds.

a) Term Bonds

b) Serial Bonds

c) Secured Bonds

d) Debentures

9) Discuss the various issue prices for bonds.

a) Par Value

b) Discount

c) Premium

d) Exhibit 10-7 Bond Price Information for Smart Touch Learning (SMT)

10) Discuss how the time value of money affects bond prices.

11) Distinguish a bond’s stated interest rate from the market interest rate.

a) Exhibit 10-8 Interaction of the Stated Interest Rate and the Market Interest Rate to Determine the

Price of a Bond

12) Illustrate the accounting for bonds issued at par value.

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13) Illustrate the accounting for bonds issued at a discount:

a) The Discount on bonds payable is a contra account to Bonds payable

b) Carrying amount of the bonds is Bonds payable minus the bond discount

c) Interest expense and amortization of the bond discount

14) Illustrate the accounting for bonds issued at a premium:

a) The Premium account is a companion account to Bonds payable

b) Carrying amount of the bonds is Bonds payable plus the bond premium

c) Interest expense and amortization of the bond premium

15) Discuss the need to accrue interest expense at year end.

16) Illustrate the issuance of Bonds payable between interest dates.

17) Discuss the reporting of current and long-term liabilities on the balance sheet.

a) Exhibit 10-9 Liabilities Portion of Balance Sheet

18) Discuss the financing alternatives available to a company.

a) Exhibit 10-10 Earnings-per-Share Advantage of Borrowing Versus Issuing Stock

19) Discuss the ethical challenges in reporting liabilities.

20) Appendix 10A:

a) Discuss the Time Value of Money

b) Exhibit 10A-1 Present Value of $1

c) Exhibit 10A-2 Present Value of Annuity of $1

d) Illustrate the use of present value to determine the market price of a bond

e) Explain the effective-interest method of amortization of a bond discount or bond premium

f) Exhibit 10A-3 Effective-Interest Amortization of a Bond Discount

g) Exhibit 10A-4 Effective-Interest Amortization of a Bond Premium

21) Appendix 10B:

a) Illustrate the accounting for the retirement of bonds payable

b) Illustrate the accounting for the conversion of bonds payable to common stock

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Chapter 10: Summary Handout for Students

1. Current liabilities—due within one year or within the company’s operating cycle if longer than a year.

o Current liabilities whose amount is known:

Accounts Payable

Short-term Notes Payable and Related Accrued Interest

Sales Tax Payable

Current Portion of Long-Term Notes Payable

Accrued Expenses (Accrued Liabilities)

Unearned Revenues

o Current liabilities that must be estimated:

Estimated warranty payable must be recorded in period of sale to meet the matching principle.

The likelihood of loss determines the accounting treatment of contingent liabilities:

* Probable, and amount of loss can be estimated—record

* Reasonably probable—disclose in the notes to the financial statements

* Remote—ignore

2. Long-term liabilities—due beyond one year or operating cycle if longer than a year.

3. Recording the Period’s Payroll creates accrued expenses.

o Gross Pay and Net (Take-Home) Pay:

Gross pay is the debit to salary and/or wages expense when recording the period’s payroll

Net pay is the credit to salary payable and/or wages payable in the entry

o Payroll withholding deductions are liabilities when recording a period’s payroll.

Required withholding for employee income tax

Required withholding for employee Social Security (FICA) Tax

Optional withholding deductions

The specific withholding accounts are credited when recording a period’s payroll

o Employers must pay certain payroll taxes:

Employer FICA Tax

State and Federal Unemployment Compensation Taxes

The related expense account is debited in the journal entry recording employer’s payroll

taxes; a credit is made to the related payable account

o The employer must also record benefits paid such as health and life insurance.

4. Bonds payable are groups of long-term notes payable issued to multiple lenders, called bondholders.

o Bonds are issued at par value (equal to principal), at a discount (below par value), or at a premium

(above par value).

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The cash proceeds of a bond issuance = the par value of the bond × the price quote.

The price is based on the difference between the stated interest rate of the bond and the

market interest rate.

o Interest is generally paid semi-annually at the stated interest rate on the bond.

o The maturity date is the date the borrower must pay back the principal amount to bondholders.

5. For bonds issued at par (maturity) value, debit cash and credit bonds payable.

6. For bonds issued at a discount, debit Cash for the proceeds received, credit Bonds payable for the par

(maturity) value, and debit Discount on bonds payable for the difference.

7. For bonds issued at a premium, debit Cash for the proceeds received, credit Bonds payable for the par

(maturity) value, and credit Premium on bonds payable for the difference.

8. Record interest expense on the bonds on the semi-annual interest payment dates:

o The interest expense is increased by the amortization of the bond discount for bonds issued at a

discount.

o The interest expense is decreased by the amortization of the bond premium for bonds issued at a

premium.

o The effective interest method is the preferred method for amortization of the discount or premium;

the straight-line method may also be used.

o Interest must be accrued at year end if the interest payment date does not occur at year end.

9. The carrying value of a bond on the balance sheet equals

o Bonds payable – Discount on bonds payable; the Discount is a contra account to bonds payable.

o Bonds payable + Premium on bonds payable; the Premium is a companion account to bonds payable.

10. Callable bonds may be retired at a specified price.

o For bonds originally issued at a discount: debit Bonds payable for the par (maturity) value of those

bonds called; credit the Discount on bonds payable attributable to the portion called; credit Cash;

credit Gain or Loss on retirement of bonds payable to balance.

11. Convertible bonds may be converted into common stock at the option of the investor.

o For bonds originally issued at a discount, debit Bonds payable for the par (maturity) value of those

bonds converted, credit the Discount on bonds payable attributable to the portion converted, credit

Common stock for par value of the stock shares issued, and credit Paid-in capital in excess of par for

any excess needed to balance.

12. Work sheets to print for in-class practice (bookmatch), as specified by your instructor.

13. Myaccountinglab.com homework algorithmic assignments:

o E10-24; E10-25; E10-27; E10-30; E10-31; E10-33; P10-34A; P10-36A; P10-39A. Appendices: P10A-

2A; P10A-3A; P10A-7A; E10B-3; E10B-4

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Lecture Outline Tips: Key Topics

Current liabilities—known amounts:

When discussing short-term notes payable, remind students that the interest rate is expressed annually and needs adjusting to the appropriate time period (principal * rate * time). Sales tax is not an expense of the company. It is collected and remitted to the appropriate agency at certain due dates. The collected amounts are liabilities while being held by the company.

Current liabilities—estimated:

Warranty expense is recorded in the year of sale by using an estimate, similar to the accounting for bad debts under the allowance method. The expense is “matched” to the revenue in the same time period. This results in a corresponding warranty liability until the related warranty work is done over time. Only probable contingent liabilities (that can be estimated) are recorded. Reasonably possible contingencies are disclosed in the notes. Point out to students that important information is contained in the notes and that these should be read in conjunction with the financial statements when analyzing a company.

When discussing payroll, point out that gross pay is the expense amount (debit), net pay is the salary/wages payable amount (credit), and the various withholdings represent individual payable accounts (credit). The journal entry should always balance! The various withholding amounts are tracked in separate accounts and can be due on different dates. They are not expenses of the company—they are collected and remitted similar to sales tax. There are three journal entries with payroll: recording the paychecks, recording the payroll tax expense, and remitting withholdings as they come due. Students that are working should be familiar with FICA tax, but may not be aware there are two parts. OASDI is 6.2% and has a ceiling; Medicare is 1.45% and is unlimited. The ceiling difference may generate some discussion in class, especially with all of the news coverage the social security system is currently receiving. Students are generally surprised to find out that employers also pay FICA tax and unemployment taxes. A company must consider these taxes as well as salary/wages and benefits when determining the total cost of an employee. The concept of bonds is foreign to many students. An introductory financial accounting course may be their first exposure to the topic. A discussion of notes payable may be a good starting point because students may have experience with auto and personal loans. Then, add to this explanation by discussing the difference in sales proceeds and face value for bonds payable, and the resulting premium or discount. It may also be helpful to approach bonds from an investor’s standpoint. An investor can choose to invest in a company’s stock or bonds (or both), depending on his or her goals. You acquire ownership with a stock investment, whereas you let the company borrow your money for a certain time period (with interest) with a bond investment. There are three transactions associated with bonds: the issuance, the interest payment, and the amortization of any premium/discount. When issuing bonds, note that the journal entry must balance. The premium/discount is a “plug” in the entry. The bond payable is recorded at face value because this is

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the amount that the company will re-pay at maturity. The cash proceeds can be more or less than the face value. The chapter uses the straight-line method for amortization, similar to the straight-line method for depreciation. An equal amount of amortization is recorded at each interest payment date. Remind students that the interest payment is computed using the bond rate, not the market rate. The premium/discount balance will decrease over time and will be zero after the last interest payment date. The amortization is recorded to interest expense, whether a debit or credit. After the last interest payment, the company will repay the face value of the bonds, which is the balance in the bond payable account. The bond payable account is recorded at face value and never changes until repayment. The book value of the bonds changes over time as the premium/discount is amortized. The book value always moves to the face value. Therefore a discounted bond will increase to face value and a premium bond will decrease to face value. When retiring bonds, do not forget to remove any premium or discount balance. Point out that the entry always balances, so there may be a gain or loss at retirement. Unlike retirement, conversion to stock does not produce a gain or loss. The book value of the bonds is transferred to the appropriate stock accounts.

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ASSIGNMENT GRID

Estimated Level Learning Time in of Assignment Topic(s) Objective(s) Minutes Difficulty Short Exercises S10-1 Accounting for a note payable 1 10 Easy S10-2 Accounting for warranty expense and warranty payable 2 10 Medium S10-3 Interpreting a company’s contingent liabilities 2 5–10 Easy S10-4 Computing an employee’s total pay 3 10 Easy S10-5 Computing the payroll expense of an employer 3 10 Easy S10-6 Computing payroll amounts late in the year 3 10 Easy S10-7 Journalizing payroll 4 10 Easy S10-8 Determining bond prices 5 5 Easy S10-9 Pricing bonds 5 5 Easy S10-10 Maturity value of a bond 5 5 Easy S10-11 Journalizing bond transactions 6 10 Easy S10-12 Determining bond amounts 6 5 Easy S10-13 Determining bond interest rates 6 5 Easy S10-14 Journalizing bond transactions 6 10 Easy S10-15 Journalizing bond transactions 6 10 Easy S10-16 Journalizing bond transactions 6 10 Easy S10-17 Journalizing bond transactions—issuance between interest payment dates 6 10 Easy S10-18 Preparing the liabilities section of the balance sheet 7 5 Easy S10-19 Comparing issuing bonds to issuing stock 8 10–15 Medium Exercises E10-20 Recording sales tax 1 5–15 Easy E10-21 Recording note payable transactions 1 5–10 Easy E10-22 Recording and reporting current liabilities 1 10–15 Easy E10-23 Journalizing current liabilities 1 15 Easy E10-24 Accounting for warranty expense and warranty payable 2 5–15 Easy E10-25 Computing and recording gross pay and net pay 3, 4 10–15 Easy E10-26 Recording a payroll 4 10–15 Easy E10-27 Determining bond prices 5 5–10 Medium E10-28 Journalizing bond issuance and interest payments 6 10 Medium E10-29 Journalizing bond transactions 6 15–20 Medium E10-30 Journalizing bond transactions—year end interest accrual 6 10 Easy E10-31 Reporting current and long-term liabilities 7 5–15 Easy

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E10-32 Reporting liabilities 7 10 Medium E10-33 Analyzing alternative plans to raise money 8 15–20 Medium Problems (Group A) P10-34A Journalizing liability transactions 1, 2 30–40 Easy P10-35A Journalizing, posting, and reporting liabilities 1, 3, 7 35–45 Medium P10-36A Computing and journalizing payroll amounts 3, 4 25–35 Medium P10-37A Analyzing and journalizing bond transactions 5, 6 30–40 Medium P10-38A Analyzing, journalizing, and reporting bond transactions 5, 6, 7 30 Medium P10-39A Journalizing and reporting bond transactions 5, 6, 7 20–25 Medium P10-40A Reporting liabilities 7 5–10 Easy P10-41A Analyzing alternative plans to raise money 8 15–20 Medium Problems (Group B) P10-42B Journalizing liability transactions 1, 2 30–40 Easy P10-43B Journalizing, posting, and reporting liabilities 1, 3, 7 35–45 Medium P10-44B Computing and journalizing payroll amounts 3, 4 25–35 Medium P10-45B Analyzing and journalizing bond transactions 5, 6 30–40 Medium P10-46B Analyzing, journalizing, and reporting bond transactions 5, 6, 7 30 Medium P10-47B Journalizing and reporting bond transactions 5, 6, 7 20–25 Medium P10-48B Reporting liabilities 7 5–10 Easy P10-49B Analyzing alternative plans to raise money 8 15–20 Medium Continuing Exercise E10-50 Computing and recording gross pay and net pay 3, 4 10–15 Easy Continuing Problem E10-51 Analyzing and journalizing bond transactions 5, 6 15–20 Medium Decision Cases Case 1 Identifying internal control weaknesses and their solution 4 10–15 Medium Case 2 Contingent liabilities 2 10–15 Medium Case 3 Analyzing bond transactions 5, 6 10–15 Medium Case 4 Analyzing alternative plans to raise money 8 15–20 Medium Ethical Issue Financial Statement Case Current and long-term liabilities 1, 6, 7 25–35 Medium Team Projects (2 projects) Appendix A Problems P10A-1A Calculating present value 15–25 Easy P10A-2A Calculating the value of bonds when stated

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rate and market rate are different 40–50 Medium P10A-3A Journalizing bond transactions 20–30 Medium P10A-4A Calculating and recording bonds when stated rate and market rate are different 15–20 Medium P10A-5A Calculating and recording bonds when stated rate and market rate are different 15–20 Medium P10A-6A Calculating and recording bonds when stated rate and market rate are different 20–25 Medium P10A-7A Calculating and recording bonds when stated rate and market rate are different 15–20 Medium P10A-8A Calculating and recording bonds when stated rate and market rate are different 30–40 Medium P10A-9B Calculating present value 15–25 Easy P10A-10B Calculating the value of bonds when stated rate and market rate are different 40–50 Medium P10A-11B Journalizing bond transactions 20–30 Medium P10A-12B Calculating and recording bonds when stated rate and market rate are different 15–20 Medium P10A-13B Calculating and recording bonds when stated rate and market rate are different 15–20 Medium P10A-14B Calculating and recording bonds when stated rate and market rate are different 20–25 Medium P10A-15B Calculating and recording bonds when stated rate and market rate are different 15–20 Medium P10A-16B Calculating and recording bonds when stated rate and market rate are different 30–40 Medium Appendix B Short Exercises S10B-1 Retiring bonds payable 10 Medium S10B-2 Converting bonds payable 5–10 Medium Appendix B Exercises E10B-3 Retiring bonds payable 15–20 Medium E10B-4 Converting bonds payable 15–20 Medium E10B-5 Retiring and converting bonds payable 10–15 Medium Comprehensive Problem for Chapters 7-10 180 Difficult

End of Chapter Exercises and Problems Available in Alternate Accounting Software Programs: Excel Templates: P10-34A; P10-37A; P10-39A QuickBooks: P10-34A; P10-37A; P10-39A Peachtree: P10-34A; P10-37A; P10-39A General Ledger: P10-34A; P10-37A; P10-39A

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Pre-Test Questions on MyAccountingLab: S10-1 (1); S10-2 (2); S10-4 (3); S10-7 (4); S10-8 (5); S10-11 (6); S10-18 (7); S10-19 (8). For Appendices: P10A-4A; P10A-5A; S10B-1; S10B-2. Post-Test Questions on MyAccountingLab: P10-42B (1, 2); P10-47B (5, 6, 7). For Appendices: P10A-10B; E10B-5.

Answer Key to Chapter 10 Quiz

1. D 2. A 3. B 4. B 5. A

6. C 7. B 8. D 9. B 10. C

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Name Date Section

CHAPTER 10 TEN-MINUTE QUIZ

Circle the letter of the best response. 1. Which of the following is not a current liability of known amount?

A. Accrued interest payable B. Accounts payable C. Unemployment taxes that have not been paid D. Liability for warranty repairs

2. On April 1, Tribbiani, Inc., borrowed $25,000 on a three month, 8% note payable to purchase inventory. The entry to record the issuance of the note should include a A. credit to Notes payable for $25,000. B. credit to Interest payable for $6,000. C. credit to Notes payable for $25,600. D. credit to Interest payable for $1,500.

3. A $20,000, 9%, 90-day note payable was issued on December 1. If interest is paid at maturity, the adjusting entry on December 31 will include a A. debit to Interest expense for $450. B. debit to Interest expense for $150. C. credit to Cash for $150. D. credit to Cash for $1,800.

4. Warranty expense should be recorded in the period: A. that the product is repaired. B. the product is sold. C. the product is paid for. D. the product is used.

Table 10-1 LeBlanc, Co., has a monthly payroll of $150,000. Income taxes withheld from employees amount to $45,000. The FICA tax rate is 8% and the FUTA tax is 6.2% on the first $7,000, with 5.4% paid to the state and .8% paid to the federal government. Health insurance premiums of $6,000 were deducted from the employees’ pay and will be remitted to the insurance company by LeBlanc. All wages are subject to all taxes.

5. Refer to Table 10-1. The credit to Salary payable for the monthly payroll should be A. $87,000 . C. $150,000. B. $77,700 . D. $86,566.

6. Refer to Table 10-1. The debit to Payroll tax expense should be A. $12,000 . C. $21,300. B. $434. D. $12,434.

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7. Following is a list of account balances at the end of the year: Estimated warranty payable $ 1,000 Notes payable (due in three annual installments) 6,000 Retained earnings 15,000 Interest payable 200 Accounts payable 11,500 Payroll tax expense 2,500 Unearned commissions 4,500

The correct amount of current liabilities that would be reported on the balance sheet is A. $14,700 . B. $21,700 . C. $19,200. D. $18,700.

8. Which of the following statements about bonds is false?

A. Bonds represent a liability of the corporation. B. A bondholder is a creditor of the corporation. C. The carrying amount of the bond is determined by adding the premium to the maturity

value. D. The straight-line method of amortization is the preferred method of amortizing a

premium or discount.

9. The Hunter Corporation issued 10-year term bonds on January 1 with a face value of $1,000,000. The stated interest rate is 8% and interest is payable semi-annually on June 30 and December 31. The bonds were issued for $875,378 to yield an effective annual rate of 10%. The straight-line method of amortization is to be used. What amount of discount should be amortized for the first interest period? (Rounded) A. $14,985 B. $6,231 C. $4,985 D. $3,769

Table 10-2 The Simpson Corporation issued 8%, 10-year term bonds on January 1, 20X9, with a maturity value of $1,000,000. Interest is payable semi-annually on June 30 and December 31. The bonds were issued for $875,378, a price to yield the investor 10%. Simpson uses the straight line method.

10. Refer to Table 10-1. The journal entry to record the issuance of the bonds will include a A. credit to Bonds payable for $875, 378.

B. debit to Cash for $1,000,000. C. debit to Discount on bonds payable for $124,622. D. debit to Interest payable $124,622.

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63756 051 10SS p01-14 - Washtenaw Community Collegecourses.wccnet.edu/~cdgracie/wcc/acc111/Chapter... · Instructor’s Edition Special Section Page 1 of 38 | Chapter 10 CHAPTER 10