CHAPTER 10 CURRENT LIABILITIES AND PAYROLL

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1 1. No. A discounted note payable has no stated interest rate, but provides interest by discounting the note proceeds. The discount, which is the difference between the proceeds and the face of the note, is the interest and is accounted for as such. 2. a. Employee s federal income taxes, social security, and Medicare b. Employees Federal Income Tax Payable, Social Security Tax Payable, and Medicare Tax Payable 3. The deductions from employees earnings are for amounts owed (liabilities) to others for such items as federal taxes, state and local income taxes, and contributions to pension plans a 2. c 3. c 4. b 5. b CHAPTER 10 CURRENT LIABILITIES AND PAYROLL DISCUSSION QUESTIONS 5. An advantage of using a separate payroll bank account is that reconciling the bank statements is simplified. In addition, a payroll bank account establishes control over payroll checks and, thus, prevents their theft or misuse. 6. a. Constants are data that remain unchanged from payroll to payroll. These include employee names, social security numbers, marital status, number of income tax withholding allowances, rates of pay, tax rates, and withholding tables. b. Variables are data that change from payroll to payroll. These include number of hours or days worked for each employee, accrued days of sick leave, vacation credits, total earnings to date, and total taxes withheld. 7. The vacation pay expense should be recorded during the period in which the vacation privilege is earned. 8. In a defined contribution plan, the company invests contributions on behalf of the employee during the employee s working years. Normally, the employee and employer contribute to the plan. The employee s pension depends on the total contributions and the investment returns earned on those contributions. 9. To match revenues and expenses properly, the liability to cover product warranties should be recorded in the period during which the sale of the product is recorded. 10. When the defective product is repaired, the repair costs would be recorded by debiting Product Warranty Payable and crediting Cash, Supplies, or another appropriate account. 10-1

2 PRACTICE EXERCISES PE 10 1A a. $70,000 b. $69,650 [$70,000 ($70,000 30/360 6%)] PE 10 1B a. $150,000 b. $148,125 [$150,000 ($150,000 45/360 10%)] PE 10 2A Total wage payment $2, One allowance (provided by IRS) $70.00 Multiplied by allowances claimed on Form W Amount subject to withholding $2, Initial withholding from wage bracket in Exhibit 3 $ Plus additional withholding: 28% of excess over $1,648* Federal income tax withholding $ *($2,460 $1,648) 28% PE 10 2B Total wage payment $1, One allowance (provided by IRS) $70.00 Multiplied by allowances claimed on Form W Amount subject to withholding $1, Initial withholding from wage bracket in Exhibit 3 $ Plus additional withholding: 25% of excess over $704* Federal income tax withholding $ *($1,330 $704) 25% 10-2

3 PE 10 3A Total wage payment $2, Less: Federal income tax withholding $ Social security tax ($2,600 6%) Medicare tax ($2, %) Net pay $1, PE 10 3B Total wage payment $1, Less: Federal income tax withholding $ Social security tax ($1,400 6%) Medicare tax ($1, %) Net pay $1, PE 10 4A Salaries Expense 220,000 Social Security Tax Payable 13,200 Medicare Tax Payable 3,300 Employees Federal Income Tax Payable 43,560 Salaries Payable 159,940 PE 10 4B Salaries Expense 90,000 Social Security Tax Payable 5,400 Medicare Tax Payable 1,350 Employees Federal Income Tax Payable 17,820 Retirement Savings Deductions Payable 5,400 Salaries Payable 60,

4 PE 10 5A Payroll Tax Expense 18,670 Social Security Tax Payable 13,200 Medicare Tax Payable 3,300 State Unemployment Tax Payable* 1,890 Federal Unemployment Tax Payable** 280 * $35, % ** $35, % PE 10 5B Payroll Tax Expense 7,370 Social Security Tax Payable 5,400 Medicare Tax Payable 1,350 State Unemployment Tax Payable* 540 Federal Unemployment Tax Payable** 80 * $10, % ** $10, % PE 10 6A a. Vacation Pay Expense 19,500 Vacation Pay Payable 19,500 Vacation pay accrued for the period. b. Pension Expense 15,600 Cash 15,600 To record pension contribution, 6% $260,000. PE 10 6B a. Vacation Pay Expense 35,000 Vacation Pay Payable 35,000 Vacation pay accrued for the period. b. Pension Expense 201,250 Cash 175,000 Unfunded Pension Liability 26,250 To record pension cost and funding. 10-4

5 PE 10 7A a. Feb. 28 Product Warranty Expense 12,000 Product Warranty Payable 12,000 To record warranty expense for February, 6% $200,000. b. July 24 Product Warranty Payable 92 Supplies 60 Wages Payable 32 PE 10 7B a. July 31 Product Warranty Expense 14,625 Product Warranty Payable 14,625 To record warranty expense for July, 4.5% $325,000. b. Nov. 11 Product Warranty Payable 220 Cash 220 PE 10 8A a. December 31, 2014 Quick Ratio = Quick Assets Current Liabilities Quick Ratio = ($650 + $1,500 + $700) $2,375 Quick Ratio = 1.2 December 31, 2013 Quick Ratio = Quick Assets Current Liabilities Quick Ratio = ($680 + $1,550 + $770) $2,000 Quick Ratio = 1.5 b. The quick ratio of Nabors Company has declined from 1.5 in 2013 to 1.2 in This decrease is the result of a large increase in accounts payable compared to decreases in the three types of quick assets (cash, temporary investments, and accounts receivable). 10-5

6 PE 10 8B a. December 31, 2014 Quick Ratio = Quick Assets Current Liabilities Quick Ratio = ($1,000 + $1,200 + $800) $1,875 Quick Ratio = 1.6 December 31, 2013 Quick Ratio = Quick Assets Current Liabilities Quick Ratio = ($1,140 + $1,400 + $910) $2,300 Quick Ratio = 1.5 b. The quick ratio of Adieu Company has improved from 1.5 in 2013 to 1.6 in This increase is the result of a small decrease in the three types of quick assets (cash, temporary investments, and accounts receivable) compared to the larger decrease in the current liability, accounts payable. 10-6

7 Ex Current liabilities: Federal income taxes payable* $ 336,000 Advances on magazine subscriptions** 1,593,750 Total current liabilities $1,929,750 * $840,000 40% ** 25,000 $85 9/12 = $1,593,750 EXERCISES The nine months of unfilled subscriptions are a current liability because Bon Nebo received payment prior to providing the magazines. Ex a. 1. Merchandise Inventory 792,000 Interest Expense* 8,000 Notes Payable 800, Notes Payable 800,000 Cash 800,000 b. 1. Notes Receivable 800,000 Sales 792,000 Interest Revenue* 8, Cash 800,000 Notes Receivable 800,000 * $800,000 6% 60/

8 Ex a. $240,000 8% 60/360 = $3,200 for each alternative. b. (1) $240,000 simple-interest note: $240,000 proceeds (2) $240,000 discounted note: $240,000 $3,200 interest = $236,800 proceeds c. Alternative (1) is more favorable to the borrower. This can be verified by comparing the effective interest rates for each loan as follows: Situation (1): 8% effective interest rate ($3, /60) $240,000 = 8% Situation (2): 8.11% effective interest rate ($3, /60) $236,800 = 8.11% The effective interest rate is higher for the discounted note because the creditor lent only $236,800 in return for $3,200 interest over 60 days. In the undiscounted note, the creditor must lend $240,000 for 60 days to earn the same $3,200 interest. Ex a. Accounts Payable 150,000 Notes Payable 150,000 b. Notes Payable 150,000 Interest Expense* 875 Cash 150,875 * $150,000 7% 30/360 Ex a. Accounts Payable 89,100 Interest Expense* 900 Notes Payable 90,000 b. Notes Payable 90,000 Cash 90,000 * $90,000 8% 45/

9 Ex a. June 30 Building 450,000 Land 350,000 Note Payable 400,000 Cash 400,000 b. Dec. 31 Note Payable 20,000 Interest Expense ($400,000 6% 1/2) 12,000 Cash 32,000 c. June 30 Note Payable 20,000 Interest Expense ($380,000 6% 1/2) 11,400 Cash 31,400 Ex a. $1,276 is the amount disclosed as the current portion of long-term debt. b. The current liabilities increased by $1,225 ($1,276 $51). c. $14,041 ($15,317 $1,276) Ex a. Regular pay (40 hrs. $50) $2,000 Overtime pay (10 hrs. $100) 1,000 Gross pay $3,000 b. Gross pay $3,000 Less: Social security tax (6% $3,000) $180 Medicare tax (1.5% $3,000) 45 Federal withholding Net pay $2,

10 Ex Regular earnings $3, $1, $1, Overtime earnings 1, Gross pay $3, $2, $2, Less: Social security tax $ $ $ Medicare tax Federal income tax withheld $1, $ $ Net pay $2, $1, $1, % $3, = $ % $2, = $ % $2, = $ % $3, = $ % $2, = $ % $2, = $39.60 Consultant Computer Programmer Administrator 3 6 Withholding supporting calculations: Gross weekly pay $3, $2, $2, Number of withholding allowances Multiplied by: Value of one allowance $70.00 $70.00 $70.00 Amount to be deducted $ $ $ Amount subject to withholding $3, $2, $2, Initial withholding from wage bracket in Exhibit 3 $ $ $ Plus: Bracket percentage over bracket excess Amount withheld $ $ $ % ($3,660 $3,394) 8 28% ($2,660 $1,648) 9 28% ($2,570 $1,648) Computer Consultant Programmer Administrator

11 Ex a. Summary: (1) $460,000; (3) $540,000; (8) $6,750; (12) $135,000 Net amount paid $338,850 Total deductions 201,150 (3) Total earnings $540,000 Overtime 80,000 (1) Regular $460,000 Total deductions $201,150 Social security tax $ 32,400 Medicare tax 8,100 Income tax withheld 135,000 Medical insurance 18, ,400 (8) Union dues $ 6,750 Total earnings $540,000 Factory wages $285,000 Office salaries 120, ,000 (12) Sales salaries $135,000 b. Factory Wages Expense 285,000 Sales Salaries Expense 135,000 Office Salaries Expense 120,000 Social Security Tax Payable 32,400 Medicare Tax Payable 8,100 Employees Income Tax Payable 135,000 Medical Insurance Payable 18,900 Union Dues Payable 6,750 Salaries Payable 338,850 c. Salaries Payable 338,850 Cash 338,

12 Ex a. Social security tax (6% $880,000) $52,800 Medicare tax (1.5% $880,000) 13,200 State unemployment tax (5.4% $40,000) 2,160 Federal unemployment (0.8% $40,000) 320 $68,480 b. Payroll Tax Expense 68,480 Social Security Tax Payable 52,800 Medicare Tax Payable 13,200 State Unemployment Tax Payable 2,160 Federal Unemployment Tax Payable 320 Ex a. Salaries Expense 1,250,000 Social Security Tax Payable 58,750 Medicare Tax Payable 18,750 Employees Federal Income Tax Payable 250,000 Salaries Payable 922,500 b. Payroll Tax Expense 91,450 Social Security Tax Payable 58,750 Medicare Tax Payable 18,750 State Unemployment Tax Payable* 12,150 Federal Unemployment Tax Payable** 1,800 * 5.4% $225,000 ** 0.8% $225,

13 Ex a. Wages Expense 240,000 Social Security Tax Payable* 14,400 Medicare Tax Payable** 3,600 Employees Federal Income Tax Payable 48,000 Wages Payable 174,000 * 6.0% $240,000 ** 1.5% $240,000 b. Payroll Tax Expense 20,170 Social Security Tax Payable 14,400 Medicare Tax Payable 3,600 State Unemployment Tax Payable* 1,890 Federal Unemployment Tax Payable** 280 * 5.4% $35,000 ** 0.8% $35,000 Ex Big Howie s Hot Dog Stand does have an internal control procedure that should detect the payroll error. Before funds are transferred from the regular bank account to the payroll account, the owner authorizes the total amount of the week s payroll. The owner should catch the error, since the extra 60 hours will cause the weekly payroll to be substantially higher than usual. The owner should sign the paychecks, thereby restricting access to cash by employees who are responsible for record keeping. Ex a. Appropriate. All changes to the payroll system, including wage rate increases, should be authorized by someone outside the Payroll Department. b. Inappropriate. Each employee should record his or her own time out for lunch. Under the current procedures, one employee could clock in several employees who are still out to lunch. The company would be paying employees for more time than they actually worked. c. Inappropriate. Payroll should be informed when any employee is terminated. A supervisor or other individual could continue to clock in and out for the terminated employee and collect the extra paycheck. d. Inappropriate. Access to the check-signing machine should be restricted. e. Appropriate. The use of a special payroll account assists in preventing fraud and makes it easier to reconcile the company s bank accounts

14 Ex a. Vacation Pay Expense 3,500 Vacation Pay Payable 3,500 Vacation pay accrued for January, $42,000 1/12. b. Vacation pay payable is reported as a current liability on the balance sheet. If employees are allowed to accumulate their vacation pay, then the estimated vacation pay payable that will not be taken in the current year will be reported as a long-term liability. When employees take vacations, the liability for vacation pay is decreased. Ex a. Dec. 31 Pension Expense 365,000 Unfunded Pension Liability 365,000 To record quarterly pension cost. Jan. 15 Unfunded Pension Liability 365,000 Cash 365,000 b. In a defined contribution plan, the company invests contributions on behalf of the employee during the employee s working years. Normally, the employee and employer contribute to the plan. The employee s pension depends on the total contributions and the investment return on those contributions. In a defined benefit plan, the company pays the employee a fixed annual amount based on a formula. The employer is obligated to pay for (fund) the employee s future pension benefits. Ex The $4,267 million unfunded pension liability is the approximate amount of the pension obligation that exceeds the value of the net assets of the pension plan. Apparently, Procter & Gamble has underfunded its plan relative to the obligation that has accrued over time. This can occur when the company contributes less to the plan than the annual pension cost. The obligation grows yearly by the amount of the periodic pension cost. Thus, the $538 million periodic pension cost is a measure of the amount of pension earned by employees during the year. The annual pension cost is determined by making assumptions about employee life expectancies, employee turnover, expected compensation levels, and interest

15 Ex a. Product Warranty Expense 22,400 Product Warranty Payable 22,400 To record warranty expense for June, 4% $560,000. Product Warranty Payable 235 Supplies 140 Wages Payable 95 Ex a. The warranty liability represents estimated outstanding automobile warranty claims. Of these claims, $2,965 million is estimated to be due during Year 2, while the remainder ($4,065 million) is expected to be paid after Year 2. The distinction between short- and long-term liabilities is important to creditors in order to accurately evaluate the near-term cash demands on the business, relative to the quick current assets and other longer-term demands. b. Product Warranty Expense Product Warranty Payable $7,030 + X $3,000 = $6,789 X = $6,789 $7,030 + $3,000 X = $2,759 million 2,759,000,000 2,759,000,000 c. In order for a product warranty to be reported as a liability in the financial statements, it must qualify as a contingent liability. Contingent liabilities are only reported as liabilities on the balance sheet if it is probable that the liability will occur and the amount of the liability is reasonably estimable

16 Ex a. Damage Awards and Fines 365,000 EPA Fines Payable 240,000 Litigation Claims Payable 125,000 Note to Instructors: The damage awards and fines would be disclosed on the income statement under Other expenses. b. The company experienced a hazardous materials spill at one of its plants during the previous period. This spill has resulted in a number of lawsuits to which the company is a party. The Environmental Protection Agency (EPA) has fined the company $240,000, which the company is contesting in court. Although the company does not admit fault, legal counsel believes that the fine payment is probable. In addition, an employee has sued the company. A $125,000 out-ofcourt settlement has been reached with the employee. The EPA fine and out-ofcourt settlement have been recognized as an expense for the period. There is one other outstanding lawsuit related to this incident. Counsel does not believe that the lawsuit has merit. Other lawsuits and unknown liabilities may arise from this incident. Ex a. Quick Ratio = December 31, 2013: Quick Assets Current Liabilities $500,000 + $200,000 $500,000 = 1.4 $486,000 + $210,000 December 31, 2014: = 1.2 $580,000 b. The quick ratio decreased between the two balance sheet dates. The major reason is a significant increase in inventory which likely drove the increase in accounts payable. Cash also declined, possibly to purchase the inventory. As a result, quick assets actually declined, while the current liabilities increased. The quick ratio for December 31, 2014, is not yet at an alarming level. However, the trend suggests that the company s current asset (working capital) management should be watched closely

17 Ex a. Apple Inc. Dell, Inc. Quick Ratio Quick Ratio = Quick Assets Current Liabilities Apple Inc. (in millions): Quick Ratio = $11,261 + $14,359 + $11,560 $20,722 = 1.8 Dell, Inc. (in millions): Quick Ratio = $13,913 + $452 + $10,136 $19,483 = 1.3 b. It is clear that Apple Inc. s short-term liquidity is stronger than Dell s. Apple s quick ratio is 38% [( ) 1.3] higher. Apple has a much stronger relative cash and short-term investment position than does Dell. Apple s cash, accounts receivable, and short-term investments are over 89% of total current assets, compared to Dell s 84% of total current assets. In addition, Dell s relative accounts payable position is larger than Apple s, indicating the possibility that Dell has longer supplier payment terms than does Apple. A quick ratio of 1.8 for Apple suggests ample flexibility to make strategic investments with its excess cash, while a quick ratio of 1.3 for Dell indicates an efficient, but tight, quick asset management policy

18 Prob. 10 1A PROBLEMS 1. Feb. 3 Merchandise Inventory 410,000 Accounts Payable Onifade Co. 410,000 Mar. 3 Accounts Payable Onifade Co. 410,000 Notes Payable 410,000 Apr. 17 Notes Payable 410,000 Interest Expense ($410,000 45/360 6%) 3,075 Cash 413,075 June 1 Cash 250,000 Notes Payable 250,000 July 21 Tools 296,000 Interest Expense ($300,000 60/360 8%) 4,000 Notes Payable 300, Notes Payable 250,000 Interest Expense ($250,000 60/ %) 3,125 Notes Payable 250,000 Cash 3,125 Aug. 30 Notes Payable 250,000 Interest Expense ($250,000 30/360 9%) 1,875 Cash 251,875 Sept. 19 Notes Payable 300,000 Cash 300,000 Dec. 1 Office Equipment 340,000 Notes Payable 300,000 Cash 40, Litigation Loss 165,000 Litigation Claims Payable 165, Notes Payable 30,000 Interest Expense ($30,000 30/360 8%) 200 Cash 30,

19 Prob. 10 1A (Concluded) 2. a. Product Warranty Expense 32,500 Product Warranty Payable 32,500 Warranty expense for the current year. b. Interest Expense 1,800 Interest Payable 1,800 Interest on notes, $30, % 30/

20 Prob. 10 2A 1. a. Dec. 30 Sales Salaries Expense 350,000 Warehouse Salaries Expense 180,000 Office Salaries Expense 145,000 Employees Income Tax Payable 118,800 Social Security Tax Payable 40,500 Medicare Tax Payable 10,125 Bond Deductions Payable 14,850 Group Insurance Payable 12,150 Salaries Payable 478,575 b. Dec. 30 Payroll Tax Expense 52,795 Social Security Tax Payable 40,500 Medicare Tax Payable 10,125 State Unemployment Tax Payable 1 1,890 Federal Unemployment Tax Payable $35, % 2 $35, % 2. a. Dec. 30 Sales Salaries Expense 350,000 Warehouse Salaries Expense 180,000 Office Salaries Expense 145,000 Employees Income Tax Payable 118,800 Social Security Tax Payable 1 40,500 Medicare Tax Payable 2 10,125 Bond Deductions Payable 14,850 Group Insurance Payable 12,150 Salaries Payable 478,575 1 $675,000 6% 2 $675, % b. Jan. 5 Payroll Tax Expense 92,475 Social Security Tax Payable 40,500 Medicare Tax Payable 10,125 State Unemployment Tax Payable 3 36,450 Federal Unemployment Tax Payable 4 5,400 3 $675, % 4 $675, % 10-20

21 Prob. 10 3A 1. Gross Federal Income Social Security Medicare Employee Earnings Tax Withheld Tax Withheld Tax Withheld Arnett $ 8, $ 1, $ $ Cruz 57, , , Edwards 24, , , Harvin 6, , Nicks 110, , , , Shiancoe 116, , , , Ward 7, , $19, $4, a. Social security tax paid by employer $19, b. Medicare tax paid by employer 4, c. Earnings subject to unemployment compensation tax, $10,000 for all employees except Arnett, Harvin, and Ward. Thus, total earnings subject to SUTA and FUTA are $62,080 [(4 $10,000) + $8,250 + $6,000 + $7,830]. State unemployment compensation tax: $62, % 3, d. Federal unemployment compensation tax: $62, % e. Total payroll tax expense $28,

22 Prob. 10 4A 1. PAYROLL FOR WEEK ENDING December 7, 2014 EARNINGS DEDUCTIONS PAID ACCOUNT DEBITED Social Federal U.S. Sales Office Total Security Medicare Income Savings Net Ck. Salaries Salaries Employee Hours Regular Overtime Total Tax Tax Tax Bonds Total Pay No. Expense Expense Aaron 46 2, , , , , Cobb 41 2, , , , Clemente 48 2, , , , , DiMaggio 35 1, , , , Griffey, Jr. 45 2, , , , Mantle 1, , , Robinson 36 1, , , , Williams 2, , , Vaughn 42 2, , , , , , , , , , , , , Sales Salaries Expense 19, Office Salaries Expense 3, Social Security Tax Payable 1, Medicare Tax Payable Employees Federal Income Tax Payable 4, Bond Deductions Payable Salaries Payable 15,

23 Prob. 10 5A 1. Dec. 2 Bond Deductions Payable 3,400 Cash 3,400 2 Social Security Tax Payable 9,273 Medicare Tax Payable 2,318 Employees Federal Income Tax Payable 15,455 Cash 27, Operations Salaries Expense 43,200 Officers Salaries Expense 27,200 Office Salaries Expense 6,800 Social Security Tax Payable 4,632 Medicare Tax Payable 1,158 Employees Federal Income Tax Payable 15,440 Employees State Income Tax Payable 3,474 Bond Deductions Payable 1,700 Medical Insurance Payable 4,500 Salaries Payable 46, Salaries Payable 46,296 Cash 46, Payroll Tax Expense 6,265 Social Security Tax Payable 4,632 Medicare Tax Payable 1,158 State Unemployment Tax Payable 350 Federal Unemployment Tax Payable Social Security Tax Payable 9,264 Medicare Tax Payable 2,316 Employees Federal Income Tax Payable 15,440 Cash 27, Medical Insurance Payable 31,500 Cash 31,

24 Prob. 10 5A (Concluded) Dec. 27 Operations Salaries Expense 42,800 Officers Salaries Expense 28,000 Office Salaries Expense 7,000 Social Security Tax Payable 4,668 Medicare Tax Payable 1,167 Employees Federal Income Tax Payable 15,404 Employees State Income Tax Payable 3,501 Bond Deductions Payable 1,700 Salaries Payable 51, Salaries Payable 51,360 Cash 51, Payroll Tax Expense 6,135 Social Security Tax Payable 4,668 Medicare Tax Payable 1,167 State Unemployment Tax Payable 225 Federal Unemployment Tax Payable Employees State Income Tax Payable 20,884 Cash 20, Bond Deductions Payable 3,400 Cash 3, Pension Expense 60,000 Cash 45,000 Unfunded Pension Liability 15,000 To record pension cost and unfunded liability. 2. a. Dec. 31 Operations Salaries Expense 8,560 Officers Salaries Expense 5,600 Office Salaries Expense 1,400 Salaries Payable 15,560 Accrued wages for the period. b. 31 Vacation Pay Expense 15,000 Vacation Pay Payable 15,000 Vacation pay accrued for the period

25 Prob. 10 1B 1. Apr. 15 Cash 225,000 Notes Payable 225,000 May 1 Equipment 310,400 Interest Expense ($320, /360 6%) 9,600 Notes Payable 320, Notes Payable 225,000 Interest Expense ($225,000 30/360 6%) 1,125 Notes Payable 225,000 Cash 1,125 July 14 Notes Payable 225,000 Interest Expense ($225,000 60/360 8%) 3,000 Cash 228,000 Aug. 16 Merchandise Inventory 90,000 Accounts Payable Exige Co. 90,000 Sept. 15 Accounts Payable Exige Co. 90,000 Notes Payable 90,000 Oct. 28 Notes Payable 320,000 Cash 320, Notes Payable 90,000 Interest Expense ($90,000 45/360 6%) 675 Cash 90,675 Nov. 16 Store Equipment 450,000 Notes Payable 400,000 Cash 50,000 Dec. 16 Notes Payable 20,000 Interest Expense ($20,000 30/360 9%) 150 Cash 20, Litigation Loss 87,500 Litigation Claims Payable 87,

26 Prob. 10 1B (Concluded) 2. a. Product Warranty Expense 26,800 Product Warranty Payable 26,800 Warranty expense for the current year. b. Interest Expense 4,275 Interest Payable 4,275 Interest on notes, $20,000 9% 45/

27 Prob. 10 2B 1. a. Dec. 30 Sales Salaries Expense 625,000 Warehouse Salaries Expense 240,000 Office Salaries Expense 320,000 Employees Income Tax Payable 232,260 Social Security Tax Payable 71,100 Medicare Tax Payable 17,775 Bond Deductions Payable 35,500 Group Insurance Payable 53,325 Salaries Payable 775,040 b. Dec. 30 Payroll Tax Expense 90,735 Social Security Tax Payable 71,100 Medicare Tax Payable 17,775 State Unemployment Tax Payable 1 1,620 Federal Unemployment Tax Payable $30, % 2 $30, % 2. a. Dec. 30 Sales Salaries Expense 625,000 Warehouse Salaries Expense 240,000 Office Salaries Expense 320,000 Employees Income Tax Payable 232,260 Social Security Tax Payable 1 71,100 Medicare Tax Payable 2 17,775 Bond Deductions Payable 35,500 Group Insurance Payable 53,325 Salaries Payable 775,040 1 $1,185,000 6% 2 $1,185, % b. Jan. 4 Payroll Tax Expense 162,345 Social Security Tax Payable 71,100 Medicare Tax Payable 17,775 State Unemployment Tax Payable 3 63,990 Federal Unemployment Tax Payable 4 9,480 3 $1,185, % 4 $1,185, % 10-27

28 Prob. 10 3B 1. Gross Federal Income Social Security Medicare Employee Earnings* Tax Withheld Tax Withheld Tax Withheld Addai $44,880 $ 9,372 $ 2, $ Kasay 25,200 3,731 1, McGahee 67,410 12,999 4, , Moss 55,200 9,396 3, Stewart 4, Tolbert 4, Wells 84,000 18,872 5, , $17, $4, * The gross earnings are determined by multiplying the monthly earnings by the number of months of employment based on the date of hire. 2. a. Social security tax paid by employer $17, b. Medicare tax paid by employer 4, c. Earnings subject to unemployment compensation tax, $10,000 for all employees except Stewart and Tolbert. Thus, total earnings subject to SUTA and FUTA are $59,375 [(5 $10,000) + $4,500 + $4,875]. State unemployment compensation tax: $59, % 3, d. Federal unemployment compensation tax: $59, % e. Total payroll tax expense $25,

29 Prob. 10 4B 1. PAYROLL FOR WEEK ENDING December 7, 2014 EARNINGS DEDUCTIONS PAID ACCOUNT DEBITED Social Federal U.S. Sales Office Total Security Medicare Income Savings Net Ck. Salaries Salaries Employee Hours Regular Overtime Total Tax Tax Tax Bonds Total Pay No. Expense Expense Carlton 52 2, , , , Grove 4, , , , Johnson 36 1, , , , Koufax 45 2, , , , Maddux 37 1, , , , Seaver 3, , , , Spahn 46 2, , , , Winn 48 2, , , , Young 43 2, , , , , , , , , , , , , Sales Salaries Expense 16, Office Salaries Expense 7, Social Security Tax Payable 1, Medicare Tax Payable Employees Federal Income Tax Payable 5, Bond Deductions Payable Salaries Payable 16,

30 Prob. 10 5B 1. Dec. 1 Medical Insurance Payable 2,520 Cash 2,520 1 Social Security Tax Payable 2,913 Medicare Tax Payable 728 Employees Federal Income Tax Payable 4,490 Cash 8,131 2 Bond Deductions Payable 2,300 Cash 2, Sales Salaries Expense 14,500 Officers Salaries Expense 7,100 Office Salaries Expense 2,600 Social Security Tax Payable 1,452 Medicare Tax Payable 363 Employees Federal Income Tax Payable 4,308 Employees State Income Tax Payable 1,089 Bond Deductions Payable 1,150 Medical Insurance Payable 420 Salaries Payable 15, Salaries Payable 15,418 Cash 15, Payroll Tax Expense 2,220 Social Security Tax Payable 1,452 Medicare Tax Payable 363 State Unemployment Tax Payable 315 Federal Unemployment Tax Payable Social Security Tax Payable 2,904 Medicare Tax Payable 726 Employees Federal Income Tax Payable 4,308 Cash 7,

31 Prob. 10 5B (Concluded) Dec. 26 Sales Salaries Expense 14,250 Officers Salaries Expense 7,250 Office Salaries Expense 2,750 Social Security Tax Payable 1,455 Medicare Tax Payable 364 Employees Federal Income Tax Payable 4,317 Employees State Income Tax Payable 1,091 Bond Deductions Payable 1,150 Salaries Payable 15, Salaries Payable 15,873 Cash 15, Payroll Tax Expense 2,009 Social Security Tax Payable 1,455 Medicare Tax Payable 364 State Unemployment Tax Payable 150 Federal Unemployment Tax Payable Employees State Income Tax Payable 6,258 Cash 6, Bond Deductions Payable 2,300 Cash 2, Pension Expense 65,500 Cash 55,400 Unfunded Pension Liability 10,100 To record pension cost and unfunded liability. 2. Dec. 31 Sales Salaries Expense 4,275 Officers Salaries Expense 2,175 Office Salaries Expense 825 Salaries Payable 7,275 Accrued wages for the period. 31 Vacation Pay Expense 13,350 Vacation Pay Payable 13,350 Vacation pay accrued for the period

32 COMPREHENSIVE PROBLEM 3 1. Jan. 3 Petty Cash 4,500 Cash 4,500 Feb. 26 Office Supplies 1,680 Miscellaneous Selling Expense 570 Miscellaneous Administrative Expense 880 Cash 3,130 Apr. 14 Merchandise Inventory 31,300 Accounts Payable 31,300 May 13 Accounts Payable 31,300 Cash 31, Cash 21,200 Cash Short and Over 40 Sales 21,240 June 2 Notes Receivable 180,000 Accounts Receivable Ryanair 180,000 Aug. 1 Cash 182,400 Notes Receivable 180,000 Interest Revenue 2,400 ($180,000 8% 60/360 = $2,400). 24 Cash 7,600 Allowance for Doubtful Accounts 1,400 Accounts Receivable Finley 9,000 Sept. 15 Accounts Receivable Finley 1,400 Allowance for Doubtful Accounts 1,400 Cash 1,400 Accounts Receivable Finley 1,

33 Comp. Prob. 3 (Continued) Sept. 15 Land 654,925 Interest Expense 15,075 Notes Payable 670,000 ($670,000 90/360 9%). Oct. 17 Cash 135,000 Notes Receivable 100,000 Accumulated Depreciation Office Equipment 64,000 Loss on Sale of Office Equipment 21,000 Office Equipment 320,000 Nov. 30 Sales Salaries Expense 135,000 Office Salaries Expense 77,250 Employees Income Tax Payable 39,266 Social Security Tax Payable 12,735 Medicare Tax Payable 3,184 Salaries Payable 157, Payroll Tax Expense 16,229 Social Security Tax Payable 12,735 Medicare Tax Payable 3,184 State Unemployment Tax Payable* 270 Federal Unemployment Tax Payable** 40 *$5, % **$5, % Dec. 14 Notes Payable 670,000 Cash 670, Pension Expense 190,400 Cash 139,700 Unfunded Pension Liability 50,700 Pension cost of $190,400 funded at $139,

34 Comp. Prob. 3 (Continued) 2. KORNETT COMPANY Bank Reconciliation December 31, 2014 Balance according to bank statement $283,000 Add deposit in transit, not recorded by bank 29,500 $312,500 Deduct outstanding checks 68,540 Adjusted balance $243,960 Balance according to company s records $245,410 Deduct: Bank service charges 750 Error in recording check 700 Adjusted balance $243, Miscellaneous Expense 750 Accounts Payable 700 Cash 1, a. Bad Debt Expense 18,000 Allowance for Doubtful Accounts 18,000 To record estimated uncollectible accounts, $16,000 + $2,000. b. Cost of Merchandise Sold 3,300 Merchandise Inventory 3,300 To record inventory shrinkage. c. Insurance Expense 22,820 Prepaid Insurance 22,820 To record expired insurance. d. Office Supplies Expense 3,920 Office Supplies 3,920 To record supplies used during the period

35 Comp. Prob. 3 (Continued) e. Depreciation Expense Buildings 36,000 Depreciation Expense Office Equipment 44,000 Depreciation Expense Store Equipment 5,000 Accumulated Depreciation Buildings 36,000 Accumulated Depreciation Office Equipment 44,000 Accumulated Depreciation Store Equipment 5,000 To record depreciation for the period. Computations: Buildings ($900, %) $36,000 Office Equipment [20% ($246,000 $26,000)] 44,000 Store Equipment [1/2 10% ($112,000 $12,000)] 5,000 f. Amortization Expense Patents 6,000 Patents 6,000 To record patent amortization, $48,000 8 years. g. Depletion Expense 30,000 Accumulated Depletion 30,000 To record depletion, ($546, ,000 tons) 50,000 tons. h. Vacation Pay Expense 10,500 Vacation Pay Payable 10,500 To record vacation pay for the period. i. Product Warranty Expense 76,000 Product Warranty Payable 76,000 To record product warranty for the period, $1,900, %. j. Interest Receivable 1,875 Interest Revenue 1,875 To record interest earned on note receivable, $100,000 75/360 9%

36 Comp. Prob. 3 (Continued) 5. KORNETT COMPANY Balance Sheet December 31, 2014 Assets Current assets: Petty cash $ 4,500 Cash 243,960 Notes receivable 100,000 Accounts receivable $470,000 Less allowance for doubtful accounts 16, ,000 Merchandise inventory at cost 320,000 Interest receivable 1,875 Prepaid insurance 45,640 Office supplies 13,400 Total current assets $1,183,375 Property, plant, and equipment: Land $654,925 Buildings $900,000 Less accumulated depreciation 36, ,000 Office equipment $246,000 Less accumulated depreciation 44, ,000 Store equipment $112,000 Less accumulated depreciation 5, ,000 Mineral rights $546,000 Less accumulated depletion 30, ,000 Total property, plant, and equipment 2,343,925 Intangible assets: Patents 42,000 Total assets $3,569,

37 Comp. Prob. 3 (Concluded) Liabilities Current liabilities: Social security tax payable $ 25,470 Medicare tax payable 4,710 Employees federal income tax payable 40,000 State unemployment tax payable 270 Federal unemployment tax payable 40 Salaries payable 157,000 Accounts payable 131,600 Interest payable 28,000 Product warranty payable 76,000 Vacation pay payable (current portion) 7,140 Notes payable (current portion) 70,000 Total current liabilities $ 540,230 Long-term liabilities: Vacation pay payable $ 3,360 Unfunded pension liability 50,700 Notes payable 630,000 Total long-term liabilities 684,060 Total liabilities $1,224,290 Stockholders Equity Capital stock $ 500,000 Retained earnings 1,845,010 Total stockholders equity 2,345,010 Total liabilities and stockholders equity $3,569,

38 CASES & PROJECTS CP 10 1 The firm has no implicit or explicit contract to pay any bonus. The bonus is discretionary, even if the firm paid a two-week bonus for 10 straight years. The firm is not behaving unethically for reducing the bonus to one week regardless of the reason. Tonya Latirno, on the other hand, has taken things into her own hands. Sensing that she is being cheated, she tries to rectify the situation to her own advantage by working overtime that isn t required. This behavior could be considered fraudulent, even though Tonya is actually present on the job during the overtime hours. The point is that the overtime is not required by the firm. Tonya is incorrect in thinking that her behavior is justified because she did not receive the full two-week bonus. In fact, this behavior would not be justified even if she had a legitimate claim against the company. If she had a claim or grievance against the firm, then it should be handled by other procedural or legal means. CP 10 2 Sumana s interpretation of the pension issue is correct. The employee earns the pension during the working years. The pension is part of the employee s compensation that is deferred until retirement. Thus, Felton should record an expense equal to the amount of pension benefit earned by the employee for the period. This gives rise to the rather complex issue of estimating the amount of the pension expense. Francie indicates that the complexity of this calculation makes determining the annual pension expense impossible. This is not so. There are a number of mathematical and statistical approaches (termed actuarial approaches) that can reliably estimate the amount of benefits earned by the workforce for a given year. As a side note, Francie s perspective can be summarized as pay as you go. In her interpretation, there is no expense until a pension is paid to the retiree. Failing to account for pension promises when they are earned is not considered sound accounting

39 CP 10 3 a. The so-called underground economy hides transactions from IRS scrutiny by conducting business with cash (not check or credit card, which leaves an audit trail). The intent in many such transactions is to evade income tax illegally. However, just because a transaction is in cash does not exempt it from taxation. Tina Song also appears to perform construction services on a cash basis to evade reporting income while paying employees with cash to avoid paying social security and Medicare payroll taxes. The IRS reports that nearly 86% of the persons convicted of evading employment taxes were sentenced to an average of 17 months in prison and ordered to make restitution to the government for the taxes evaded, plus interest and penalties. b. Marvin should respond that he would rather receive a payroll check as a normal employee does. Receiving cash as an employee, rather than a payroll check, subverts the U.S. tax system. That is, such cash payments do not include deductions for payroll taxes, as required by law. That is why, for example, cash tips must be formally reported to the IRS and subjected to payroll tax deductions by the employer. In addition, if Marvin followed Tina s advice, Marvin not only would be avoiding payroll deductions, but would also be underreporting income. This would subject Marvin to potential fines and possible criminal prosecution for underreporting income. CP 10 4 The purpose of this activity is to familiarize students with retrieving and using IRS forms. Students should be able to find the three required forms without much difficulty. Encourage students to retrieve the forms from the IRS Web site, since this is a useful source for any IRS form or publication that they might need. IRS Web site forms come in.pdf format, which means an Adobe Acrobat Reader is necessary to open and print the file. This software is available as a free plug-in on most Internet browser software. However, some students may need to download a free version in order to open the forms. This is also a useful exercise, since many sophisticated forms on the Web require an Acrobat Reader. The W-2 form is the Annual Wage and Tax Statement transmitted by the employer to the IRS. The IRS uses this information to reconcile the taxpayer s reported income and withholding taxes with the taxpayer s tax return. Copies of the W-2 are provided for the employee s own records and for submitting with state and federal tax returns. Form 940 is the Employer s Annual Federal Unemployment Tax Return. The FUTA tax is reported annually, while the 941 payroll taxes are reported quarterly to the IRS. Form 941 is the Employer s Quarterly Federal Tax Return. This return is used to report federal withholding payroll taxes collected from employees and FICA taxes (both employee and employer portions) for the quarter

40 CP 10 5 This activity does not require the student to research the contingency notes for Altria Group. The contingency disclosure is extensive and complicated. Rather, the student should identify Altria Group s main business, and from this information determine the likely cause of the contingency disclosures. a. Altria Group is a holding company for a number of businesses including Philip Morris. Thus, Altria s primary business is in the manufacture and distribution of tobacco products. b. The health concerns surrounding tobacco products give rise to numerous lawsuits and legal actions against Altria. The notes to the financial statements include an extensive section describing the scope and status of these actions. As of December 31, 2011, Altria had over 109 cases pending, including 18 class actions and 1 health care recovery action (by state and federal governments). Altria s Form 10-K provides a section describing some of these actions

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