this presentation is for chapter 13 current liabilities and contingencies in this chapter we will cover the nature valuation and reporting of current liabilities many of these topics you will be familiar with from your previous accounting courses we will also cover classification issues associated with short-term debt that is expected to be refinanced in the period following the current reporting period in the second part of the presentation for this chapter we will cover gain and loss contingencies and presentation and analysis of liabilities and contingencies in the first learning objective we will discuss the nature valuation and reporting of current liabilities on this slide is the definition of a liability we often skim over definitions but they are important an important tool that is used in accounting to determine what is and isn't a liability there are certain criteria that must be met in order to record an amount as a liability one is that there must be at least a probable chance that the amount will be due you in the future also in order to record the amount in the balance sheet it must be a present obligation in the event that created the liability has to have already occurred we will see in the discussion of loss contingencies that this definition is critical to the determination of whether or not we record disclosed or ignore an event if you remember from your previous accounting courses current assets are those that we expect to convert into cash sale or consumed in our operations within a single operating cycle or within a year this definition is important in classification of not only current assets but also currently abilities as we can see current liabilities are those that will result in the use of current assets are the creation of other current liabilities it is important to note that not every business has a short operating cycle some like a whiskey distillery may have an operating cycle that extends over many years our restaurant may have a very short operating cycle because the food may be purchased the same day as the mill is prepared and sold and the cash received therefore we normally set one year as the cutoff for current assets and liabilities but if the company has a longer operating cycle the definitions allow for a longer period of time this slide shows the typical current liabilities that you will encounter and these are the ones that we will be discussing in this presentation many of these you will already be familiar with but some of this information may be new to you accounts payable or trade accounts payable as they are commonly referred to or the balances that a business owes to its suppliers for goods and services purchased on account a company will generally have an open account with its suppliers that will allow it to order items or services as needed and have the goods delivered our services provided with payment do generally in 30 days there may be discounts that are given for payment as noted in the terms of the sale such as a 2% discount if the amount is paid within 10 days of the invoice are the amounts may be due in 30 days or by the end of the month notes payable or more formal than accounts payable because they are written promises to pay a certain amount at a specified future date usually these notes arise from either purchase or financing transactions and can be either short or long term most of these will be for larger amounts which is one of the reasons why they require the more formal process being in writing and they will either have an interest rate stated or they will be discounted notes that are also called zero interest bearing in this slide we will record an interest bearing note payable castle national bank agrees to lend a hundred thousand dollars on March first 2020 to landscape company if landscape signs a hundred thousand dollars six percent four months note landscape records the cash received by debiting cash and crediting notes payable for one hundred thousand dollars if landscape prepares its financial statements at the end of June it would accrue the interest on the note for four months March April May and June to determine the amount of interest you would multiply the principal one hundred thousand dollars times the annual interest rate of 6% and multiply by four divided by twelve this gives you the interest of two thousand dollars and you would record this by debiting interest expense and crediting interest payable for the two thousand dollars the note payable would actually mature the next day July 1st and landscape would debit notes payable for the principal of one hundred thousand debit interest payable for two thousand and credit cash for the total amount do you of one hundred and two thousand dollars we will look at this same note but instead of having an interest rate of 6% on the note this note is a zero interest bearing note or a discounted note on March first landscape issued a one hundred and two thousand dollar for month zero interest bearing note to Castle national bank to record the note and receipt of the cash landscape would debit cash for one hundred thousand debit discount own notes payable for two thousand and credit notes payable for one hundred and two thousand dollars the discount on notes payable will be the interest expense for the note the note payable would be shown net of the discount on the balance sheet as we see in this slide the discount on the note is a contra account - notes payable and as we mentioned it represents the cost of borrowing it will be amortized to interest expense over the life of the note another common current liability is dividends payable dividends or amounts that are owed to the common shareholders once they are authorized by the Board of Directors because they are generally paid within a short period of time from the date of declaration they are a current liability as the slide notes undeclared dividends on cumulative preferred stock are not recognized as dividends they are disclosed in the notes to the financial statements stock dividends are additional shares of stock and are reported in stockholders equity companies may require that customers pay a returnable cash deposit to guarantee performance of a contract or service or as a guarantee to cover payment of expected future obligations you may have been required to pay a deposit when you rented an apartment these deposits can be either current or long-term liabilities based on the time period of the contract many companies require payment prior to the delivery of goods or services the amounts that the company collects prior to performance are recorded as unearned revenues until the company satisfies its performance obligation some common examples of unearned revenues are shown in this slide when the cash is collected the unearned revenue is credited and then when the performance obligation is satisfied the unearned account is debited and the revenue account is credited for example if all state university sells 10,000 season football tickets for $50 each for its five home game schedule the university would debit cash for $500,000 and credit unearned sales revenue for the same amount as each game is completed all state would debit unearned sales revenue for $100,000 and credit sales revenue for the same amount retail companies that sell goods are responsible for collecting sales tax from their customers these amounts are not expenses of the companies but rather are payments that they collect and then remit to the proper governmental authorities since they are usually due in a relatively short time from collection they are considered to be current liabilities this slide illustrates the recording of sales tax if a company makes a cash sale of three thousand dollars which is subject to a sales tax of four percent they would need to collect the sales tax of a hundred and twenty dollars from the customer to record the sale they would debit cash for three thousand one hundred and twenty dollars and credit sales revenue for three thousand and sales tax payable for one hundred and twenty dollars some companies may not segregate the sales tax when they record the sales transaction if this is the case they would need to determine the sales amount and then debit sales revenue for the amount of sales tax collected if a company recorded 150 thousand dollars in sales which are subject to a four percent sales tax rate they would divide the 150 thousand by one point zero four and this would give the amount of sales 144 thousand two hundred thirty dollars and seventy seven cents the difference between the 150,000 dollars collected and the 144,000 230 dollars and seventy seven cents of sales is the sales tax of five thousand seven hundred sixty nine dollars and twenty three cents to record the sales tax payable the company would debit else revenue and credit sales tax payable for the five thousand seven hundred sixty nine dollars and twenty three cents another common current liability is income taxes payable that the company owes on their own income companies are required to make periodic estimated tax payments throughout the year two taxing authorities these amounts are then used to offset the income taxes to you when the tax return is prepared for the year any difference between the income tax payable on the return and the estimated tax payments made would be a current liability frequently there are timing differences that result from differences in income tax laws and accounting income recorded using GAAP and we will cover these in chapter 19 later in the course employees are owed salaries or wages that are reported as current liabilities as well as the amounts that are deducted from their pay also any amounts to the employees based on compensated absences and bonuses are accrued and reported as current liabilities the most common types of payroll deductions are taxes insurance premiums employee savings and union dues there are two components of the Social Security tax one of the components of Social Security tax is the federal old-age survivor and disability insurance or OASDI tax that provides benefits for certain individuals and their families this tax is levied on both employers and employees the rate is 6.2 percent and there is a cap of a hundred and thirty seven thousand seven hundred dollars as of 2020 the OASDI tax is often referred to as fic IFI CA the other portion of the Social Security tax is the Medicare tax that provides federal health insurance to the aged population this tax like the OASDI is levied on both the employer and the employee at a rate of one point four or five percent of the employees compensation but there is no income cap on this portion together the OASDI and federal hospital insurance taxes are referred to as the social security tags the federal and employment tax are fut a is levied only on employers the rate is six percent of the first $7,000 of compensation paid to each employee during the calendar year if the employer is subject to a state unemployment tax of 5.4 percent or more the employer receives a tax credit not to exceed 5.4 percent and only pays point 6 percent tax to the federal government most states grant discounts to employers based on their history of unemployment claims even if the employer receives discounts such that it does not pay 5.4 percent the employer will still receive the full 5.2 percent credit toward the fut a thus an employer could pay the state 4% unemployment tax and still pay only 0.6 percent to the federal government the states have various compensation laws that differ from the federal law and employers must refer to the unemployment tax laws in each state in which they pay wages and salaries to determine the proper amount due to the individual States employers are also required to withhold income taxes D for state and federal taxes from their employees pay these amounts are in addition to the fi CA taxes that we just discussed the employer will match the fi CA taxes for their employees and also pay the state and federal unemployment taxes that are D to illustrate the payroll deductions that we have just discussed in the previous slides this slide shows the journal entry for a weekly payroll of $10,000 that is entirely subject to both fi CA and Medicare taxes at seven point six five percent federal unemployment at point six percent and state unemployment at four percent the income tax withholding is one thousand three hundred and twenty dollars in union to use eighty eight dollars the journal entry includes a debit to sales and wages expense for ten thousand for the gross pay and credits to withholding taxes fi CA and union dues and then cash for the net pay of seven thousand eight hundred twenty seven dollars we also need to record the employer's payroll tax expense for this same payroll remember that the employer must match the employee's fi see a tax of seven hundred and sixty-five dollars the federal and state unemployment taxes are also do you as shown for a total of one thousand two hundred and twenty five dollars the debit for this entry is to payroll tax expense and the credits are shown for the FI CA Fu TA and su TA as we mentioned before employees are often compensated for absences for vacation illness and holidays whether the company needs to accrue for these absences depends on whether they vest or accumulate to this for a benefit means that you will be paid for them when you leave employment to accumulate means that the benefits carry over from one period to the next most vacation days accumulate up to a certain amount and vast however many sickly benefits only accumulate to a maximum amount but do not vest if the benefits do not vest then the employer would need to determine if it is probable that the benefits will be used and also if the amount can be reasonably estimated since sick leave is based on whether an employee gets sick some companies do not accrue sick leave but because vacation pay usually vast most employers will accrue an expense and liability for vacation pay to illustrate recording for compensated absences we will consider the case of armitron Inc which has 10 employees and pays each one four hundred and eighty dollars per week employees earn twenty unused vacation weeks in 2020 in 2021 the employees used the vacation weeks but they earn five hundred and forty dollars per week in 2020 armitron would record the salaries and wages expense for the vacation pay by debiting salaries and wages expense for 900 9600 dollars and crediting salaries and wages payable for the same amount in 2020 when the employees take the vacation imma Tron Inc would debit salaries and wages payable for the $9,600 accrued and debit salaries and wages expense for twelve hundred dollars the difference in the pay now that the employees are earning five hundred and forty dollars per week and credit cash for ten thousand eight hundred dollars the $1200 difference is considered to be a change in estimate armitron ain't made the best estimate of the amount of salaries and wages expense in 2020 when they accrued the nine thousand six hundred dollars bonuses are another example of an employee related liability bonuses are required to be recorded as an operating expense in the period in which they are earned these are normally current liabilities because they are not paid until the next period to illustrate the recording of a bonus agree we will assume that Palmer Inc had income of $100,000 and bonuses to you of ten thousand seven hundred for 2020 which they paid in January 2021 to record the bonus expenses Palmer would debit salaries and wages expense for ten thousand seven hundred dollars in credit salaries and wages payable for the same amount in 2020 when the bonuses are paid in 2021 they would debit salaries and wages payable and credit cash for ten thousand seven hundred dollars when long-term liabilities mature within the next fiscal year they become current liabilities if they require the use of current assets are the creation of a current liability however if the long term portion maturing will be paid out of assets that are not current refinanced are retired from the proceeds of a new debt issue are converted into capital stock they may continue to be classified as long term in this learning objective we will cover the classification issues associated with short-term debt expected to be refinanced when short-term obligations are refinanced and the liability is contractually due to be settled and the entity has a contractual right to the first settlement of the liability for at least one year are the operating cycle after the balance sheet date then the obligation can be excluded from current liabilities to illustrate this we will consider the scenario involving Mantova and Winery who issued a note payable of $1,000,000 on November 30th 2020 this note is to you on February 28 2021 and the balance sheet date is December 31st 2020 the financial statements are issued on March 1st 2021 how Vermont Obon plans to extend the maturity date on the loan to June 15 2000 22 now we will consider the classification of the note depending on whether the refinancing is completed on January 15th 2021 or if it is completed by December 31st 2020 if the refinancing is not completed until January 15th 2021 the note would be classified as short-term however if it is completed by December 31st 2020 it would be presented as long-term rather than short-term and this is the conclusion of the first part of the presentation for chapter 13