HWChap 011

Chapter 11 - Current Liabilities and Payroll Accounting
Chapter 11
Current Liabilities and Payroll Accounting
QUESTIONS
1.
The three questions are: (1) Who must be paid? (2) When is payment due? (3) How
much is to be paid?
2.
A current liability is expected to be paid within one year or the companys operating
cycle, whichever is longer. Any liability that is not current is considered to be long
term.
3.
An estimated liability is an obligation to make a future payment, the exact amount of

which is uncertain, but it is capable of being reasonably estimated.
4.
The amount of the sale for the item only is $950 ($988/1.04).
5.
The combined Social Security tax rate (assuming the maximum wage amount is not
yet reached) is 12.4% (6.2% + 6.2%). The maximum level of earnings [wage base on
which taxes are due] for 2010 is $106,800.
6.
The Medicare tax rate is 1.45%. This rate is applied to all wages earned by an
employeeno maximum limit exists.
7.
An employees gross earnings along with the number of withholding allowances that
an employee claims, as well as whether they are married or single, determine the
amount deducted for federal income taxes.
8.
The employee is responsible for federal income taxes, state income taxes, local
income taxes (if any), and the employee portion of the FICA taxes. The employer is
responsible for both federal and state unemployment taxes and the employer
portion of the FICA taxes.
9.
An unemployment merit rating is based on an evaluation of an employers

experience in creating or avoiding unemployment with its employees. The merit
rating affects the state unemployment taxes that the employer must pay. Merit
ratings cause more of the cost of unemployment benefits to be paid by those who
create more unemployment.
10. The obligation to correct or replace defective products (or services) is created when
the products are sold with the warranties. Even though the seller does not know
with certainty when the obligation will be paid, to whom it will be paid, or the amount
to be paid, past experience shows that some amount will probably be paid. If the
seller can reasonably estimate that amount, the warranty liability must be reported
on the balance sheet.
11-1
11. There are no conditions in which a probable loss tied to a future event can create a
liability, regardless of its probability. A liability is an obligation created by a past
event, not by a future event. If a disaster occurs, the company must report the loss
in the period when it occurs.
12.A A wage bracket withholding table shows for a pay period of a given length (weekly,
biweekly, semimonthly, monthly), the amounts of federal income taxes to be
withheld from the pay of an employee, at varying amounts of gross pay and varying
numbers of withholding allowances.
13.A Single employee earning $725 with two allowances has $76 taxes withheld.
Single employee earning $625 with no allowances has $81 taxes withheld.
14. At February 27, 2010, Research In Motion reports Deferred revenue in the amount
of $67,573 ($ in thousands).
15. At September 26, 2009, Apple reports Accounts payable of $5,601 million.
16. At December 31, 2009, Nokia reports six current liabilities: Current portion of longterm loans; Short-term borrowings; Other financial liabilities; Accounts payable;
Accrued expenses; and Provisions.
17. Palms current liabilities include one income-tax-related liability titled Income taxes
payable. This account reflects taxes that must be paid to the government in the
short term.
Instructor note: Palm also has one noncurrent income-tax-related account on its
balance sheet. This account is titled Non-current tax liabilities.
QUICK STUDIES
Quick Study 11-1 (5 minutes)
Items 1, 3, 5, 6 are current liabilities for this company.
Sept. 30
Cash ..........................................................................5,200
Sales ...................................................................
Sales Taxes Payable .........................................
5,000
200
To record cash sales and 4% sales tax.
Sept. 30
Cost of Goods Sold .................................................2,900

Merchandise Inventory .....................................
2,900
To record cost of Sept. 30th sales.
Oct. 15
Sales Taxes Payable ............................................... 200

Cash ....................................................................
To record remittance of sales taxes to govt.
11-2
200

Oct. 31
Cash ..........................................................................
5,500,000
Unearned Ticket Revenue .................................
5,500,000
To record sales in advance of concerts.
Nov. 8
Unearned Ticket Revenue .......................................

1,375,000
Earned Ticket Revenue .....................................
1,375,000
To record concert revenues earned.

($5,500,000 / 4 dates = $1,375,000)

1. (b); reasonis reasonably estimated but not a probable loss.
2. (b); reasonprobable loss but cannot be reasonably estimated.
3. (a); reasoncan be reasonably estimated and loss is probable.

1.
Computation of interest payable at December 31, 2011:

Days from November 7 to December 31 .................... 54 days
Accrued interest (8% x $150,000 x 54/360) ................ $1,800
2. 2011
Dec.31 Interest Expense ...................................................... 1,800
Interest Payable ................................................
1,800
To record payment of note plus interest

(8% x $150,000 x 54/360).
3. 2012
Feb. 5 Interest Expense* .................................................... 1,200
Interest Payable ....................................................... 1,800
Notes Payable ..........................................................150,000
Cash ....................................................................
To record payment of note plus interest
*(8% x $150,000 x 36/360).
11-3
153,000

Jan. 14
Sales Salaries Expense ........................................... 14,000

FICASocial Sec. Taxes Payable* ..................
FICAMedicare Taxes Payable** ....................
Employee Fed. Inc. Taxes Payable ..................
Employee Medical Insurance Payable .............
Employee Union Dues Payable ........................
Salaries Payable ................................................
868
203
2,600
309
120
9,900
To record payroll for period.

* $14,000 x 6.2%
** $14,000 x 1.45%

[Note: Two months (January and February) of earnings have
already been recorded for each of the 10 employees.]
Mar. 31
Payroll Taxes Expense ............................................ 2,770.00

FICASocial Security Taxes Payable1 ............
1,240.00
2
FICAMedicare Taxes Payable .......................
290.00
3
State Unemployment Taxes Payable ..............
1,080.00
4
Federal Unemployment Taxes Payable ..........
160.00
To record employer payroll taxes.
1
(10 x $2,000) x 6.2% = $1,240.00

(10 x $2,000) x 1.45% = $290.00
3
(10 x $2,000 [check $2,000 under max: $7,000 {$2,000 x 2}]) x 5.4% = $1,080.00
4
(10 x $2,000 [check $2,000 under max: $7,000 {$2,000 x 2}]) x 0.8% = $160.00
2

2011
July 24
Estimated Warranty Liability ..................................

Repair Parts Inventory .......................................
35
35
To record cost of warranty repairs.

Dec. 31 Employee Bonus Expense ...................................... 10,000
Bonus Payable .................................................
To record expected bonus costs.
11-4
10,000
Vacation Benefits Expense* ...................................

Vacation Benefits Payable ..............................
307.69
307.69
To record vacation benefits accrued.

* ($4,000-3,692.31)

Times interest earned =
$2,044,000
$350,000
= 5.8 times
Interpretation: This companys times interest earned ratio of 5.8 exceeds

(is superior to) its competitors average ratio of 4.0. A times interest
earned of 5.8 suggests sufficient income to cover interest obligations.
Quick Study 11-12A (15 minutes)
Gross Pay ............................................................................
Social Security tax deduction (6.2%) ..............................
Medicare tax deduction (1.45%) ......................................
Federal income tax deduction (from Exhibit 11A.6) ......
State income tax deduction (1.0%) .................................
Total deductions ...............................................................
Net Pay .................................................................................
$735.00
$45.57
10.66
93.00
7.35
156.58
$578.42
Quick Study 11-13B (10 minutes)

Dec. 31
Income Taxes Expense ........................................... 30,000

Income Taxes Payable ......................................
Deferred Income Tax Liability ..........................
22,000
8,000
To record tax expense and deferred tax liability.

a. The definitions and characteristics of current liabilities are broadly
similar for both U.S. GAAP and IFRS. Although differences exist, the
similarities vastly outweigh any differences.
b. Examples of financial liabilities under IFRS include interest-bearing
loans and borrowings, and trade (account) and other payables.
11-5
EXERCISES
Exercise 11-1 (10 minutes)
1.
3.
5.
7.
9.
2.
4.
6.
8.
10.

[Note: All entries dated December 31, 2011]
1.
Cash .......................................................................... 2,100,000

Sales ....................................................................
2,000,000
Sales Taxes Payable ..........................................
100,000
To record sales and sales taxes.
Cost of Goods Sold .................................................. 1,000,000

Merchandise Inventory ......................................
1,000,000
To record cost of sales.
2.
Unearned Services Revenue ...................................

Earned Services Revenue .................................
40,000
40,000
To record product revenue earned.

[Note: All entries dated December 31, 2011.]
1.
No adjusting entry can be made since the loss cannot be reasonably

estimated. Disclosure of the suit as a contingent liability should be made
in the notes to the financial statements.
2.
No adjusting entry is required since it is not probable that the supplier will
default on the debt. The guarantor, Moor Company, should describe the
guarantee in its financial statement notes as a contingent liability.

1.
Maturity date = May 15 + 60 days = July 14, 2011
2a.
May 15
Cash .......................................................................... 94,000

Notes Payable ....................................................
Borrowed cash by issuing an interest-bearing note.
11-6
94,000
Exercise 11-4 (Concluded)

2b.
July 14 Interest Expense* .................................................... 1,880
Notes Payable .......................................................... 94,000
Cash ....................................................................
95,880
Repaid note plus interest.

* Principal .................................$94,000
x Interest rate......................... 12%
x Fraction of year .................. 60/360
Total interest..........................$ 1,880

1.
Maturity date = November 1 + 90 days = January 30, 2012.
2.
Principal ..................................................... $150,000

x Interest rate .............................................
9%
x Fraction of year (Nov. 1 Dec. 31)........ 60/360
Total interest in 2011 .................................$ 2,250
3.
Principal ..................................................... $150,000

x Interest rate .............................................
9%
x Fraction of year (Jan. 1 Jan. 30)......... 30/360
Total interest in 2012 .................................$ 1,125
4a.
2011
Nov. 1
Cash ..........................................................................150,000
Notes Payable ....................................................
150,000
Borrowed cash by issuing an interest-bearing note.
4b.
2011
Dec. 31
Interest Expense ...................................................... 2,250

Interest Payable .................................................
2,250
Accrued interest on note payable.
4c.
2012
Jan. 30
Interest Expense ...................................................... 1,125

Interest Payable ....................................................... 2,250
Notes Payable ..........................................................150,000
Cash ....................................................................
153,375
11-7

Subject
to Tax
Rate
Tax
Explanation
a.
FICA--Social Security ........... $ 800
6.20%
FICAMedicare.....................
800
1.45
11.60 Full amount is subject to tax.
FUTA..........................................
600
0.80
4.80 $200 is over the maximum.
SUTA..........................................
600
2.90
17.40 $200 is over the maximum.
$ 49.60 Full amount is subject to tax.
b.
FICA--Social Security ........... $2,100
6.20% $130.20 Full amount is subject to tax.
FICAMedicare.....................
2,100
1.45
FUTA..........................................
0.80
0.00 Full amount is over maximum.
SUTA..........................................
2.90
c.
FICA--Social Security ........... $6,300
6.20%
FICAMedicare.....................
8,000
1.45
FUTA..........................................
0.80
SUTA..........................................
2.90
$390.60 $1,700 is over the maximum.


Sept. 30
Salaries Expense ..................................................... 800.00

FICASocial Security Taxes Payable .............
Employee Federal Income Taxes Payable .........
Accrued Payroll Payable ...................................
To record payroll for pay period ended September 30.
11-8
49.60
11.60
135.00
603.80
Exercise 11- 8 (10 minutes)

Sept. 30 Payroll Taxes Expense ............................................ 83.40
Federal Unemployment Taxes Payable ...........
State Unemployment Taxes Payable ...............
49.60
11.60
4.80
17.40

1.
B
= 0.03 ($1,000,000 B)
B
= $30,000 0.03B
1.03B = $30,000
B
= $29,126 (rounded to nearest dollar)
2.
2011
Dec. 31
Employee Bonus Expense ................................

Bonus Payable ..........................................
29,126
29,126
To record expected bonus costs.
3.
2012
Jan. 19
Bonus Payable ....................................................

Cash ...........................................................
29,126
29,126
To record payment of bonus.

[Note: All entries dated December 31, 2011.]
1.
Warranty Expense.......................................................... 3,600

3,600
To record warranty expense [3,000 units x 8% x $15].
2.
Vacation Benefits Expense ........................................... 2,400

Vacation Benefits Payable ......................................
To record vacation benefits expense
[20 employees x 1 day x $120].
11-9
2,400

1. Warranty Expense = 4% of dollar sales = 4% x $5,500 = $220
2. The December 31, 2011, balance of the liability equals the expense
because no repairs are provided in 2011. Therefore, the ending balance
of the Estimated Warranty Liability account is $220.
3. The company should report no additional warranty expense in 2012 for
this copier.
4. The December 31, 2012, balance of the Estimated Warranty Liability
account equals the 2012 beginning balance minus the costs incurred in
2012 to repair the copier:
Beginning 2011 balance .................. $220
Less parts cost ................................
(199)
Ending 2012 balance ....................... $ 21
5. Journal entries:
2011
(a)
Aug. 16 Cash ..........................................................................
Sales ...................................................................
5,500
5,500
To record cash sale of copier.
Aug. 16 Cost of Goods Sold .................................................

3,800
3,800
To record cost of August 16 sale.
(b)
Dec. 31 Warranty Expense ...................................................
Estimated Warranty Liability ............................
220
220
To record warranty expense for copier sold in 2011.
2012
(c)
Nov. 22 Estimated Warranty Liability ..................................
Repair Parts Inventory ......................................
To record cost of warranty repairs.
11-10
199
199

(a)
Numerator
Income before
interest & taxes .... $223,000
(b)
(c)
(d)
(e)
(f)
$205,000
$218,000
$407,000
$121,000 $ 8,000
$ 15,000
8,000
$ 12,000
$ 12,000 $12,000
27.25
33.92
Denominator
Interest expense ......$ 48,000
Ratio......................
4.65
13.67
10.08
0.67
Analysis: Company (d) has the strongest ability to pay interest expense as
it comes due as evidenced by the companys times interest earned
(coverage) ratio of 33.92 times.
Exercise 11-13A (15 minutes)

Regular pay (40 hours @ $12) ...........................................
Overtime premium pay (8 hours @ [$12 x 150%]) ...........
Gross pay ..........................................................................
FICASocial Security tax deduction (6.2%) .................... $ 38.69
FICAMedicare tax deduction (1.45%) ............................
9.05
Income tax deduction (from Exhibit 11A.6) ......................
61.00
Total deductions ...............................................................
Net pay .................................................................................
11-11
$480.00
144.00
624.00
108.74
$515.26
Exercise 11-14B (25 minutes)

1.
Income Taxes Payable (target balance) ...............................................

$29,100
Total accrued [($27,900 + $18,200 + $32,700) x .30] ............................
23,640
Adjustment (additional expense) ..........................................................
$ 5,460
2.
2011
(a)
Dec. 31 Income Tax Expense ................................................ 5,460
Income Taxes Payable .......................................
5,460
To adjust tax expense and liability.
2012
Jan. 20
(b)
Income Taxes Payable ............................................. 29,100
Cash .....................................................................
29,100
To make the final quarterly payment

of income taxes for 2011.

1.
Warranty Expense ...................................................

6,201
6,201
To record warranty expense and liability.
2.

Inventory.............................................................
5,220
To record cost of warranty replacements.
3.
Volvo would report warranty expense of $6,201 for 2008.
11-12
5,220

(1)
July 31 Sales Salaries Expense ...........................................
120,000
Office Salaries Expense ..........................................60,000
FICASocial Sec. Taxes Payable ....................
FICAMedicare Taxes Payable ........................
Employee Fed. Inc. Taxes Payable ...................
Employee State Inc. Taxes Payable .................
Employee Medical Insurance Payable* ............
Employee Life Insurance Payable** .................
Employee Union Dues Payable.........................
Salaries Payable .................................................
11,160
2,610
45,000
10,000
2,800
1,600
1,000
105,830

* $7,000 x 40% ** $4,000 x 40%
(2)
July 31 Salaries Payable .......................................................
105,830
Cash ....................................................................
105,830
To record payment of payroll.*

*Check numbers may be entered in the Payroll Register.
(3)
July 31 Payroll Taxes Expense ............................................23,470
State Unemployment Taxes Payable................
Employee Medical Insurance Payable* ............
Employee Life Insurance Payable** .................
11,160
2,610
2,700
400
4,200
2,400
To record employer payroll taxes and expenses.

SUTA = $50,000 x 5.4% = $2,700
FUTA = $50,000 x 0.8% = $400
FICASocial Sec. & Medicare = Same as employees
* $7,000 x 60% ** $4,000 x 60%
(4)
July 31 FICASocial Security Taxes Payable....................22,320
FICAMedicare Taxes Payable .............................. 5,220
Employee Fed. Income Taxes Payable. .................45,000
Employee State Income Taxes Payable. ................10,000
Employee Medical Insurance Payable ................... 7,000
Employee Life Insurance Payable .......................... 4,000
Employee Union Dues Payable ............................... 1,000
State Unemployment Taxes Payable ...................... 2,700
Federal Unemployment Taxes Payable.................. 400
Cash ....................................................................
To record payment of FICA, income taxes, SUTA,
FUTA, union dues, and insurance premiums.
11-13
97,640
PROBLEM SET A
Problem 11-1A (45 minutes)
Frier
1.
2.
3.
4.
Com. Bank
Maturity dates
Date of the note .............................. May 19
Term of the note (in days) .............
90
Maturity date...................................Aug. 17
July 8
120
Nov. 5
Interest due at maturity

Principal of the note ......................$30,000
Annual interest rate .......................
9%
Fraction of year .............................. 90/360
Interest expense.............................$ 675
$60,000
10%
120/360
$ 2,000
Accrued interest on UMB note at the end of 2010

Total interest for note ....................................................
Fraction of term in 2010 ................................................
Accrued interest expense .............................................
Interest on UMB note in 2011

Total interest for note ....................................................
Fraction of term in 2011 ................................................
Interest expense in 2011 ...............................................
11-14
UMB
Nov. 28
60
Jan. 27
$21,000
8%
60/360
$ 280
280
33/60
$ 154
280
27/60
$ 126
Problem 11-1A (Concluded)

5.
2010
Apr. 20 Merchandise Inventory ........................................... 38,500
Accounts PayableFrier ..................................
38,500
Purchased merchandise on credit.
May 19 Accounts PayableFrier ........................................ 38,500

Cash ....................................................................
Notes PayableFrier ........................................
8,500
30,000
Paid $8,500 cash and gave a 90-day,

9% note to extend due date on account.
July 8 Cash .......................................................................... 60,000

Notes PayableCommunity.............................
60,000
Borrowed cash with a 120-day, 10% note.
Aug. 17 Interest Expense ......................................................

675
Notes PayableFrier .............................................. 30,000
Cash ....................................................................
30,675
Paid note with interest.
Nov. 5 Interest Expense ...................................................... 2,000

Notes PayableCommunity ................................... 60,000
Cash ....................................................................
62,000
28 Cash .......................................................................... 21,000

Notes PayableUMB Bank ..............................
21,000
Borrowed cash with 60-day, 8% note.
Dec. 31 Interest Expense ......................................................

154
154
2011
Jan. 27 Interest Expense ......................................................
126
Notes PayableUMB Bank .................................... 21,000
Interest Payable ......................................................
154
Cash ....................................................................
11-15
21,280

1.
2010
Nov. 11 Cash ..........................................................................
Sales ...................................................................
6,000
6,000
Sold razors to customers.
11 Cost of Goods Sold .................................................

1,350
1,350
To record cost of November 11 sale (75 x $18).
30 Warranty Expense ...................................................

420
420
To record razor warranty expense

and liability at 7% of selling price.
Dec. 9 Estimated Warranty Liability ..................................

270
270
To record cost of razor warranty

replacements (15 x $18).
16 Cash .......................................................................... 16,800

Sales ...................................................................
16,800

3,780
3,780
To record cost of December 16 sale (210 x $18).
29 Estimated Warranty Liability ..................................

540
540


11-16
1,176
1,176

2011
Jan. 5 Cash .......................................................................... 10,400
Sales ...................................................................
10,400

2,340
2,340
To record cost of January 5 sale (130 x $18).

900
900


728
728

2.
Warranty expense for November 2010 and December 2010

Sales
Percent Warranty Expense
November .................
$ 6,000
7%
$ 420
December..................
16,800
7
1,176
Total ..........................
$22,800
$1,596
3.
Warranty expense for January 2011

Sales in January .............................. $10,400
Warranty percent .............................
7%
Warranty expense ........................... $ 728
4.
Balance of the estimated liability as of December 31, 2010

Warranty expense for November .................................... $ 420
Warranty expense for December .................................... 1,176
Cost of replacing items in December (45 x $18)* ..........
(810)
Estimated Warranty Liability balance ............................ $ 786
*Can be viewed as $270 + $540
1,050
5.
Balance of the estimated liability as of January 31, 2011

Beginning balance .......................................................... $ 786
Warranty expense for January ......................................
728
Cost of replacing items in January (50 x $18) ..............
( 900)
Estimated Warranty Liability balance ........................... $ 614
11-17
credit
credit
debit
credit
credit
credit
debit
credit

1.
Ace Co.
=
$100,000
$30,000
= 3.33
$200,000
$130,000
= 1.54
Income before interest & taxes
Interest expense
2.
Deuce Co.
Interest expense
3.
Sales increase by 30% (multiply prior sales by 1.3)

Sales.............................................
Variable expenses ......................
Income before interest ...............
Interest expense (fixed) ..............
Ace Co.
$650,000
520,000
130,000
30,000
Deuce Co.
$650,000
390,000
260,000
130,000
Net income...................................
$100,000
$130,000
Net income increases by* ..........
43%
86%
* Computed as the increase in net income divided by prior net income.
4.
5.

Sales.............................................
Net income...................................
Ace Co.
$750,000
600,000
150,000
30,000
$120,000
Deuce Co.
$750,000
450,000
300,000
130,000
$170,000
Net income increases by ............
71%
143%

Sales.............................................
Net income...................................
Ace Co.
$900,000
720,000
180,000
30,000
$150,000
Deuce Co.
$900,000
540,000
360,000
130,000
$230,000
Net income increases by ............
114%
229%
11-18

6.
Sales decrease by 10% (multiply prior sales by 0.9)

Ace Co.
Deuce Co.
Sales........................................
$450,000
$450,000
Variable expenses .................
360,000
270,000
Income before interest ..........
90,000
180,000
Interest expense (fixed) .........
30,000
130,000
Net income..............................
$ 60,000
$ 50,000
Net income decreases by ......
7.
-14%

Ace Co.
Deuce Co.
Sales........................................
$400,000
$400,000
320,000
240,000
80,000
160,000
30,000
130,000
Net income..............................
$ 50,000
$ 30,000
8.
-29%
-57%

Ace Co.
Deuce Co.
Sales........................................
$300,000
$300,000
240,000
180,000
60,000
120,000
30,000
130,000
Net income..............................
$ 30,000
$ (10,000)
9.
-29%
-57%
-114%
The higher fixed cost strategy (having more fixed interest expense) of
Deuce Co. accentuates the effects of increases and decreases in sales.
That is, increases in sales produce greater increases in net income and
decreases in sales produce greater decreases in net income. The
higher fixed cost strategy of Deuce Co. is indicated by a lower value of
the times interest earned ratio.
The higher fixed cost strategy works fine if the sales level
increases. Deuce Co. enjoys greater percent increases in its net income
because it has made this choice (see parts 3, 4, and 5).
The lower fixed cost strategy protects the company if the sales
level decreases. Ace Co. experiences smaller percent decreases in its
net income because it has made this choice (see parts 6, 7, and 8).
11-19

1. Each employees FICA withholdings for Social Security
Dale
Ted
Kate
Chas
Maximum base ............

Earned through 8/18 ...
Amount subject to tax
$106,800 $106,800
105,300
36,650
$ 1,500 $ 70,150
$106,800 $106,800
6,750
1,050
$100,050 $105,750
Earned this week .........
Subject to tax ...............

Tax rate ........................
Social Security tax ......
2,000 $
900
1,500
6.20%
$
900
6.20%
93.00 $
55.80
450 $
450
6.20%
27.90
Total
400
400
6.20%
$ 24.80 $201.50
2. Each employees FICA withholdings for Medicare (no limits)

Dale
Ted
Kate
Chas

Tax rate ........................
$ 2,000
1.45%
$ 900
1.45%
$ 450
1.45%
$ 400
1.45%
Medicare tax ................
$ 29.00
$ 13.05
$ 6.53
$ 5.80
Ted
Kate
Chas
$ 55.80
$ 27.90
$ 24.80
Kate
Chas
Total
$ 54.38
3. Employers FICA taxes for Social Security

Dale
Amount from part 1 .....
$ 93.00
Total
$201.50
4. Employers FICA taxes for Medicare

Dale
$ 29.00
Ted
$ 13.05
11-20
$ 6.53
$ 5.80
Total
$ 54.38

5. Employers FUTA taxes
Maximum base ..............
Earned through 8/18 .....
Amount subject to tax ..
Dale
$ 7,000
105,300
0
Ted
$ 7,000
36,650
0
Kate
$ 7,000
6,750
250
Chas
$ 7,000
1,050
5,950
$ 2,000

Tax rate ........................
FUTA tax ......................
0
0.8%
0.00
900
450
Total
400
0
0.8%
$ 0.00
250
0.8%
$ 2.00
400
0.8%
$ 3.20
Ted
$
0
2.15%
$ 0.00
Kate
$ 250
2.15%
$ 5.38
Chas
$ 400
2.15%
$ 8.60
10.60
5.20
6. Employers SUTA taxes

Dale
Subject to tax (from 5)
Tax rate ........................
SUTA tax ......................
0
2.15%
$ 0.00
7. Each employees net (take-home) pay

Dale
Ted
Kate
Gross earnings ............. $2,000.00
$900.00 $450.00
Less
FICA Social Sec. tax ....
(93.00)
(55.80) (27.90)
FICA Medicare taxes ....
(29.00)
(13.05)
(6.53)
Withholding taxes ........
(252.00)
(99.00) (54.00)
Health insurance ..........
(16.00)
(16.00) (16.00)
Take-home pay .............
$1,610.00 $716.15 $345.57
$ 13.98
Chas
$400.00
Total
$3,750.00
(24.80)
(5.80)
(36.00)
(16.00)
$317.40
(201.50)
(54.38)
(441.00)
(64.00)
$2,989.12
8. Employers total payroll-related expense for each employee

Dale
Ted
Kate
Chas
Gross earnings .............. $2,000.00
$ 900.00
$450.00 $400.00
Plus
FICA Social Sec. tax ......
93.00
55.80
27.90
24.80
FICA Medicare taxes .....
29.00
13.05
6.53
5.80
FUTA tax .........................
0.00
0.00
2.00
3.20
SUTA tax .........................
0.00
0.00
5.38
8.60
Health insurance ............
16.00
16.00
16.00
16.00
Pension contrib. (8%) ....
160.00
72.00
36.00
32.00
Total payroll expense .... $2,298.00 $1,056.85 $543.81 $490.40
11-21
Total
Total
$3,750.00
201.50
54.38
5.20
13.98
64.00
300.00
$4,389.06

Part 1
Jan. 8
Office Salaries Expense ..........................................

11,380.00
Sales Salaries Expense ...........................................
32,920.00
FICASocial Sec. Taxes Payable* ..................
FICAMedicare Taxes Payable** ....................
Employee Fed. Inc. Taxes Payable ..................
Employee Medical Insurance Payable .............
2,746.60
642.35
6,340.00
670.00
420.00
33,481.05

* $44,300 x 6.2%
** $44,300 x 1.45%
Part 2
Jan. 8
Payroll Taxes Expense ............................................

5,515.35
State Unemployment Taxes Payable*..............
Federal Unemployment Taxes Payable**...........
* $44,300 x .04 = $1,772.00
**$44,300 x .008 = $354.40
11-22
2,746.60
642.35
1,772.00
354.40
Problem 11-6AA (50 minutes)

Mar. 15 FICASocial Security Taxes Payable ...................3,224
FICAMedicare Taxes Payable ............................. 754
Employee Fed. Income Taxes Payable. .................3,900
Cash ....................................................................
7,878
To record payment of FICA and federal

income taxes.
31 Office Salaries Expense ..........................................

10,400
Shop Wages Expense .............................................
15,600
Employee Fed. Income Taxes Payable ............
1,612
377
3,900
20,111
31 Salaries Payable ......................................................

20,111
Cash ....................................................................
20,111

*The check numbers may be entered in the Payroll Register.
31 Payroll Taxes Expense* ...........................................2,853

*
Amount earned through 2/28 = 2 x $2,600 = $5,200
Subject to SUTA/FUTA in March = $7,000 - $5,200 = $1,800
SUTA = $1,800 x 10 employees x 4.0% = $720
FUTA = $1,800 x 10 employees x 0.8% = $144
FICASocial Security Taxes = $1,612 (same as employees)
FICAMedicare Taxes = $377 (same as employees)
11-23
1,612
377
720
144
Problem 11-6AA (Concluded)

Apr. 15 FICASocial Security Taxes Payable ...................3,224
FICAMedicare Taxes Payable ............................. 754
Employee Fed. Income Taxes Payable ..................3,900
Cash ....................................................................
7,878
To record payment of FICA and

federal income taxes.
15 State Unemployment Taxes Payable .....................2,800

Cash ....................................................................
2,800
To record payment of SUTA taxes [$2,080 + $720].
30 Federal Unemployment Taxes Payable ................. 560

Cash ....................................................................
To record payment of FUTA taxes [$416 + $144].
30 No entry required upon mailing Form 941.
11-24
560
PROBLEM SET B
Problem 11-1B (45 minutes)
Quinn
Products
1.
July 15
120
Nov. 12
Dec. 6
45
Jan. 20
$ 9,000
10%
120/360
$ 300
$16,000
9%
45/360
$ 180
Interest due at maturity

Principal of the note.........................$3,600
Annual interest rate ......................... 15%
Fraction of year ................................60/360
Interest expense ...............................$ 90
3.
City
Bank
Maturity dates
Date of the note ................................
May 23
Term of the note (in days) ...............
60
Maturity date .....................................
July 22
2.
Blackhawk
Bank
Accrued interest on City Bank note at the end of 2010

Total interest for note ................................................................ $ 180
Fraction of term in 2010............................................................. 25/45
Accrued interest expense ......................................................... $ 100
4.
Interest on City Bank note in 2011

Total interest for note ................................................................ $ 180
Fraction of term in 2011............................................................. 20/45
Interest expense in 2011............................................................ $
80
11-25
Problem 11-1B (Concluded)

5.
2010
Apr. 22
Merchandise Inventory ...........................................

Accounts PayableQuinn Products ...............
4,000
4,000
Purchased merchandise on credit.
May 23
Accounts PayableQuinn Products .....................

Cash ....................................................................
Notes PayableQuinn Products .....................
4,000
400
3,600
Paid $400 cash and gave a 60-day,

15% note to extend due date on account.
July 15
Cash ..........................................................................
Notes PayableBlackhawk Bank ....................
9,000
9,000
22
Interest Expense ......................................................

Notes PayableQuinn Products ...........................
Cash ....................................................................
90
3,600
3,690
Nov. 12

Notes PayableBlackhawk Bank ..........................
Cash ....................................................................
300
9,000
9,300
Dec. 6
Cash .......................................................................... 16,000

Notes PayableCity Bank ................................
16,000
31

100
100
2011
Jan. 20 Interest Expense ......................................................
80
Interest Payable .......................................................
100
Notes PayableCity Bank ...................................... 16,000
Cash ....................................................................
11-26
16,180

1.
2011
Nov. 16 Cash ..........................................................................
Sales ...................................................................
1,750
1,750
Sold coffee grinders to customers.

700
700
To record cost of November 16 sale (50 x $14).

175
175
To record coffee grinder warranty expense

Dec. 12 Estimated Warranty Liability ..................................

84
84
To record cost of coffee grinder

warranty replacements (6 x $14).
18 Cash ..........................................................................
Sales ...................................................................
5,250
5,250

2,100
2,100
To record cost of December 18 sale (150 x $14).

238
238


11-27
525
525

2012
Jan. 7 Cash ..........................................................................
Sales ...................................................................
2,100
2,100

840
840
To record cost of January 7 sale (60 x $14).

532
532


210
210

2.
Warranty expense for November 2011 and December 2011

Sales Percent
Warranty Expense
November ........................ $1,750
10%
$ 175
December.........................
5,250
10
525
Total .................................. $7,000
$ 700
3.
Warranty expense for January 2012

Sales in January............................................................... $2,100
Warranty percent .............................................................
10%
Warranty expense ............................................................ $ 210
4.
Balance of the estimated liability as of December 31, 2011

Warranty expense for November ................................... $ 175
Warranty expense for December ....................................
525
Cost of replacing items in December (23 x $14) ...........
(322)
credit
credit
debit
credit
Balance of the estimated liability as of January 31, 2012

Beginning balance ........................................................... $ 378
Warranty expense for January .......................................
210
Cost of replacing items in January (38 x $14) ...............
(532)
credit
credit
debit
credit
5.
11-28

1.
Virgo Co.
Interest expense
2.
Interest expense
4.
5.
$60,000
$45,000
= 1.33
$30,000
$15,000
= 2.00
Zodiac Co.
3.

Sales........................................
Net income..............................
Virgo Co.
$132,000
66,000
66,000
45,000
$ 21,000
Zodiac Co.
$132,000
99,000
33,000
15,000
$ 18,000
Net income increases by .......
40%
20%

Sales........................................
Net income..............................
Virgo Co.
$168,000
84,000
84,000
45,000
$ 39,000
Zodiac Co.
$168,000
126,000
42,000
15,000
$ 27,000
160%
80%

Sales........................................
Net income..............................
Virgo Co.
$228,000
114,000
114,000
45,000
$ 69,000
Zodiac Co.
$228,000
171,000
57,000
15,000
$ 42,000
360%
180%
11-29

6.

Virgo Co.
Zodiac Co.
Sales........................................
$ 96,000
$ 96,000
48,000
72,000
48,000
24,000
45,000
15,000
Net income..............................
$ 3,000
$ 9,000
7.
-80%

Virgo Co.
Zodiac Co.
Sales........................................
$ 60,000
$ 60,000
30,000
45,000
30,000
15,000
45,000
15,000
Net income..............................
$(15,000)
$
0
8.
-200%
-100%

Virgo Co.
Zodiac Co.
Sales........................................
$ 24,000
$24,000
12,000
18,000
12,000
6,000
45,000
15,000
Net income..............................
$(33,000)
$(9,000)
9.
-40%
-320%
-160%
The higher fixed cost strategy (having more fixed interest expense) of
Virgo Co. accentuates the effects of increases and decreases in sales.
That is, increases in sales produce greater increases in net income and
decreases in sales produce greater decreases in net income. The
higher fixed cost strategy of Virgo Co. is indicated by a lower value of
the times interest earned ratio.
The higher fixed cost strategy works fine if the sales level increases.
Virgo Co. enjoys substantially greater increases in its net income
because it has made this choice (see parts 3, 4, and 5).
The lower fixed cost strategy protects the company if the sales level
decreases. Zodiac Co. experiences much smaller decreases in its net
income because it has made this choice (see parts 6, 7, and 8).
11-30

1. Each employees FICA withholdings for Social Security
Alli
Eve
Hong
Juan
Maximum base ............
$106,800
$106,800
Earned through 9/23 ...
104,300
36,650
Amount subject to tax
$ 2,500
$ 70,150
$100,150 $ 84,600
$ 2,500
$ 1,515
475 $
600
2,500
$ 1,515
475 $
600
Tax rate ........................
6.20%
6.20%
Social Security tax ......
$ 155.00
$ 93.93
Total
$106,800 $106,800
6,650
22,200
6.20%
$
6.20%
29.45 $ 37.20 $315.58
2. Each employees FICA withholdings for Medicare (no limits)

Alli
Eve
Hong
$ 2,500
$ 1,515
Tax rate ........................
1.45%
1.45%
1.45%
Medicare tax ................
$ 36.25
$ 21.97
$ 6.89
475
Juan
$
Total
600
1.45%
8.70
$ 73.81
3. Employers FICA taxes for Social Security

Alli
Eve
Hong
Juan
Total
$ 155.00
$ 93.93
$ 29.45
$ 37.20
$315.58
Total
4. Employers FICA taxes for Medicare

Alli
Eve
Hong
Juan
$ 36.25
$ 21.97
$ 6.89
$ 8.70
11-31
$ 73.81
Problem 11-4B(Concluded)
5. Employers FUTA taxes
Alli
Maximum base ............ $ 7,000
Earned through 9/23 ... 104,300
Amount subject to tax . $
0
Eve
$ 7,000
36,650
$
0
Hong
$ 7,000
6,650
$ 350
Juan
$ 7,000
22,200
$
0
Earned this week ........ $
2,500
1,515
475
Subject to tax .............. $

Tax rate ........................
FUTA tax ...................... $
0
0.8%
0.00
0
0.8%
0.00
350
0.8%
$ 2.80
0
0.8%
$ 0.00
Hong
$ 350
1.75%
$ 6.13
Juan
$
0
1.75%
$ 0.00
Hong
$475.00
Juan
$600.00
Total
$5,090.00
(29.45)
(6.89)
(52.00)
(22.00)
$364.66
(37.20)
(315.58)
(8.70)
(73.81)
(48.00)
(480.00)
(22.00)
(88.00)
$484.10 $4,132.61
Total
600
2.80
6. Employers SUTA taxes

Alli
Subject to tax (from 5) . $
0
Tax rate ........................
1.75%
SUTA tax ..................... $
0.00
Eve
$
0
1.75%
$
0.00
7. Each employees net (take-home pay)

Alli
Eve
Gross earnings............. $2,500.00 $1,515.00
Less
FICA Social Sec. tax .... (155.00)
(93.93)
FICA Medicare taxes ...
(36.25)
(21.97)
Withholding taxes ........ (198.00)
(182.00)
(22.00)
(22.00)
Take-home pay ............. $2,088.75 $1,195.10
8. Employers total payroll-related expense for each employee

Alli
Eve
Hong
Juan
Gross earnings............. $2,500.00 $1,515.00
$475.00
$600.00
Plus
FICA Social Sec. tax ....
155.00
93.93
29.45
37.20
FICA Medicare taxes ...
36.25
21.97
6.89
8.70
FUTA tax .......................
0.00
0.00
2.80
0.00
SUTA tax .......................
0.00
0.00
6.13
0.00
22.00
22.00
22.00
22.00
Pension contrib. (5%) ..
125.00
75.75
23.75
30.00
Total payroll .................. $2,838.25 $1,728.65
$566.02
$697.90
2.49
11-32
Total
6.13
Total
$5,090.00
315.58
73.81
2.80
6.13
88.00
254.50
$5,830.82

Part 1
Jan. 8 Sales Salaries Expense ...........................................69,490
Office Salaries Expense ..........................................42,450
Delivery Wages Expense ......................................... 2,060
FICASocial Security Taxes Payable* ............
FICAMedicare Taxes Payable** .....................
Employee Med. Insurance Payable ..................
Salaries Payable .................................................
7,068
1,653
17,250
2,320
275
85,434

* $114,000 x 6.2% = $7,068
** $114,000 x 1.45% = $1,653
Part 2
Jan. 8 Payroll Taxes Expense ............................................13,509
State Unemployment Taxes Payable* ..............
Federal Unemployment Taxes Payable** ...........
* $114,000 x .034 = $3,876
**$114,000 x .008 = $912
11-33
7,068
1,653
3,876
912
Problem 11-6BA (50 minutes)

June 15 FICASocial Security Taxes Payable ...................
FICAMedicare Taxes Payable .............................
Employee Fed. Income Taxes Payable ..................
Cash ....................................................................
744
174
900
1,818

30 Office Salaries Expense .......................................... 2,000

Shop Wages Expense ............................................. 4,000
372
87
900
4,641
To record payroll period.
30 Salaries Payable ...................................................... 4,641

Cash ....................................................................
4,641

*The check numbers may be entered in the Payroll Register.
30 Payroll Taxes Expense* ...........................................

*
Amount earned through 5/31 = 5 x $1,200 = $6,000

Subject to SUTA/FUTA in June = $7,000 - $6,000 = $1,000
SUTA = $1,000 x 5 employees x 4.0% = $200
FUTA = $1,000 x 5 employees x 0.8% = $40
FICASocial Security Taxes = $372 (same as employees)
FICAMedicare Taxes = $87 (same as employees)
11-34
699
372
87
200
40
Problem 11-6BA (Concluded)

July 15 FICASocial Security Taxes Payable ...................
FICAMedicare Taxes Payable .............................
Employee Fed. Income Taxes Payable ..................
Cash ....................................................................
744
174
900
1,818

15 State Unemployment Taxes Payable .....................

Cash ....................................................................
680
680
To record payment of SUTA taxes

[$480 + $200].
31 Federal Unemployment Taxes Payable .................

Cash ....................................................................
To record payment of FUTA taxes
[$96 + $40].
31 No entry required upon mailing Form 941.
11-35
136
136
Serial Problem
SP 11
Serial Problem SP 11, Business Solutions (30 minutes)

1.
Gross pay (8 days x $125 per day) ...................................
$1,000.00
FICA Social Security tax deduction (6.2%)* ..................... $ 62.00
FICA Medicare tax deduction (1.45%) ..............................
14.50
Income tax deduction ........................................................ 159.00
Total deductions .................................................................
235.50
Net Pay ................................................................................
$ 764.50
*Employee has not reached the maximum limit.
2. 2012
Feb. 26 Wages Expense .......................................................
1,000.00
Employee Federal Income Taxes Payable ......
Cash ....................................................................
62.00
14.50
159.00
764.50
To record payroll period.
3. 2012
Feb. 26 Payroll Taxes Expense ............................................ 124.50
State Unemployment Taxes Payable*..............
Federal Unemployment Taxes Payable**...........
62.00
14.50
40.00
8.00

* $1,000 x .04 = $40.00
**$1,000 x .008 = $8.00
4. 2012
Mar. 25 Accounts Receivable Wildcat Services .............. 2,912
Sales ...................................................................
Sales Taxes Payable .........................................
2,800
112
Sold merchandise on credit and collected

sales tax of 4%.
Mar. 25 Cost of Goods Sold ................................................. 2,002

To record cost of March 25 sale.
11-36
2,002
Comprehensive Problem
Bug-Off Exterminators (100 minutes)
Part 1
a.
Correct ending balance of cash and the amount of the omitted check
Balance per bank ..................................$15,100
Plus deposit in transit .......................... 2,450
Less outstanding checks ..................... (1,800)
Reconciled balance ..............................$15,750
Balance per books ................................$17,000
Plus interest earned..............................
52
Less service charges ...........................
(15)
Balance before omitted check ............. 17,037
Reconciled balance (from above) ............ (15,750)
Omitted check ....................................... $ 1,287
b.
Allowance for doubtful accounts

Unadjusted balance .............................. $ 828 credit
Anticipated write-off .............................
(679) debit
Revised unadjusted balance ...............
149 credit
Desired ending balance .......................
700 credit
Necessary adjustment .......................... $ 551 credit
c.
Depreciation expense on the truck

Cost .....................................................................
$32,000
Less salvage value ............................................
(8,000)
Depreciable cost ................................................
$24,000
Useful life (years) ...............................................4
Annual depreciation for 2011 ...........................
$ 6,000
d.
Depreciation expense on the equipment

Sprayer
Cost ........................................................ $27,000
Less salvage value ............................... (3,000)
Depreciable cost ................................... $24,000
Injector
$18,000
(2,500)
$15,500
Useful life (years) ..................................

8
Depreciation for 2011 ........................... $ 3,000
5
$ 3,100
11-37
Comprehensive Problem (Continued)

e.
f.
g.
Adjusted revenue and unearned revenue balances

Total advance received ........................................
Months in contract ................................................
Revenue per month ..............................................
$ 3,840
12
$ 320
Months of services provided ...............................
Total earned ($320 x 5 months) ...........................

Overstatement of revenue ($3,840 $1,600) ......
(1,600)
$ 2,240
Extermination Services Revenue account

Unadjusted balance ..............................................
Overstatement .......................................................
Adjusted balance ..................................................
$60,000
(2,240)
$57,760
Unearned Services Revenue account

Unadjusted balance ..............................................
Adjustment ............................................................
Adjusted balance ..................................................
0
2,240
$ 2,240
Warranty expense
Adjusted services revenue for the year (from e) ....
Warranty percent .................................................
Warranty expense (estimated) ............................
$57,760
2.5%
$ 1,444
Estimated warranty liability

Unadjusted balance .............................................
Warranty expense ................................................
Ending adjusted balance ....................................
$ 1,400 credit
1,444 credit
$ 2,844 credit
Note payable and interest accrual

The note originated on December 31, 2011. The first time interest
will be payable is December 31, 2012. The annual interest expense
on the note is $1,200 ($15,000 x .08).
Thus, the adjusted balance for both Interest Payable and Interest
Expense at December 31, 2011, is zero.
11-38

Part 2
BUG-OFF EXTERMINATORS
December 31, 2011
Unadjusted
Trial Balance
Adjustments
Cash ...........................................
$ 17,000
(a) $1,250
(b1)
679
Accounts receivable................. 4,000

Allowance for
doubtful accounts..................
Merchandise inventory ............11,700
828 (b1)
$ 679 (b2)
Accounts payable .....................

Estim. warranty liability............
Unearned services rev .............
Interest payable ........................
Long-term notes payable ........
D. Buggs, Capital ......................
(c)
6,000
Sales............................................
700
6,000
45,000
12,200
5,000
1,400
0
0
15,000
59,700
(a)
(d)
6,100
(f)
1,444
2,240
18,300
3,713
2,844
2,240
0
15,000
59,700
1,287
(e)
D. Buggs, Withdrawals ............10,000

Extermination
services revenue ....................
Interest revenue ........................
$
11,700
32,000
Equipment..................................45,000
Accum. deprec.Equip ............
$ 15,750
3,321
551
Trucks .........................................32,000
Accum. deprec.Trucks...........
Adjusted
Trial Balance
10,000
60,000
872
71,026
(e)
2,240
Cost of goods sold ...................46,300

Deprec. expenseTrucks.........
(c) 6,000
0
Deprec. expenseEquip...........
(d) 6,100
0
Wages expense.........................35,000
Interest expense........................
0
Rent expense............................. 9,000
Bad debts expense...................
(b2)
0
551
Miscellaneous expense ........... 1,226
(a)
15
Repairs expense ....................... 8,000
Utilities expense ........................ 6,800
Warranty expense.....................
0 _______ (f) 1,444
Totals ..........................................
$226,026 $226,026
$18,316
11-39
(a)
52
46,300
6,000
6,100
35,000
0
9,000
551
1,241
8,000
6,800
______
1,444
$18,316 $238,207
57,760
924
71,026
_______
$238,207

Part 3
2011
(a)
Miscellaneous Expenses ............................................

15
Accounts Payable ........................................................ 1,287
Interest Revenue ....................................................
Cash ........................................................................
52
1,250
Adjust cash account. (Separate entries are acceptable.)
(b1)
Allowance for Doubtful Accounts ...............................

Accounts Receivable .............................................
679
679
Wrote off uncollectible accounts.
(b2)
Bad Debts Expense ......................................................

Allowance for Doubtful Accounts .........................
551
551
Recognize bad debts expense.
(c)
Depreciation ExpenseTrucks ................................... 6,000

Accumulated DepreciationTrucks .....................
6,000
Depreciation on truck.
(d)
Depreciation ExpenseEquipment ............................ 6,100

Accumulated DepreciationEquipment ..............
6,100
Depreciation on equipment.
(e)
Extermination Services Revenue ................................ 2,240

Unearned Services Revenue .................................
2,240
Adjust for unearned revenues.
(f)
Warranty Expense ........................................................ 1,444

Estimated Warranty Liability .................................
Estimate warranty expense.
(g)
No interest accrual required for 2011
11-40
1,444

Part 4
Income Statement
For Year Ended December 31, 2011
Revenues
Extermination services revenue ...............
Sales............................................................
Interest revenue .........................................
Total revenues............................................
Expenses
Cost of goods sold ....................................
Depreciation expenseTrucks ................
Depreciation expenseEquipment .........
Wages expense ..........................................
Interest expense.........................................
Rent expense..............................................
Bad debts expense ....................................
Miscellaneous expenses ...........................
Repairs expense ........................................
Utilities expense.........................................
Warranty expense ......................................
Total expenses ...........................................
Net income ...................................................
$57,760
71,026
924
$129,710
46,300
6,000
6,100
35,000
0
9,000
551
1,241
8,000
6,800
1,444
120,436
$ 9,274
Statement of Owners Equity
For Year Ended December 31, 2011
D. Buggs, Capital, December 31, 2010 ......................... $ 59,700
Add: Investments by owner ........................................
0
Net income...........................................................
9,274
68,974
Less: Withdrawals by owner ........................................ (10,000)
D. Buggs, Capital, December 31, 2011 ........................ $ 58,974
11-41
Comprehensive Problem
Part 4 (concluded)
Balance Sheet
December 31, 2011
Assets
Current assets
Cash ................................................................
Accounts receivable ...................................... $ 3,321
Allowance for doubtful accounts .................
(700)
Merchandise inventory .................................
Total current assets ......................................
Plant assets
Trucks ............................................................. 32,000
Accumulated depreciationTrucks ............ (6,000)
Equipment ...................................................... 45,000
Accumulated depreciationEquipment ..... (18,300)
Total plant assets ..........................................
Total assets ......................................................
$15,750
2,621
11,700
30,071
26,000
26,700
52,700
$82,771
Liabilities
Current liabilities
Accounts payable .......................................... $ 3,713
Estimated warranty liability .......................... 2,844
Unearned services revenue .......................... 2,240
Total current liabilities ..................................
Long-term liabilities
Long-term notes payable ..............................
Total liabilities ..................................................
Equity
D. Buggs, Capital .............................................
Total liabilities and equity ...............................
11-42
$ 8,797
15,000
23,797
58,974
$82,771
Reporting in Action
1.
BTN 11-1
Times interest earned

2010 Fiscal 2009 Fiscal 2008 Fiscal
Year
Year
Year
($ thousands)
Net income .................................................

$2,457,144 $1,892,616 $1,293,867
Add income taxes ......................................
809,366
907,747
516,653
Income before taxes ..................................

3,266,510
2,800,363
1,810,520
502
31
Add interest expense ................................
Income before interest and taxes ............

$3,266,511 $2,800,865 $1,810,551
Times interest earned ratio ..................
3,266,511.
5,579.4
58,403.9
Analysis comment: For each of these fiscal years, it is obvious that

Research In Motions risk of not being able to cover its interest
expense is low. In addition, Research In Motions times interest earned
ratio is markedly higher than the industry average of 18.1 for all three
years.
2.
Gift card liabilities arise when a customer purchases a gift card. It is

deferred (unearned) revenue until the gift card recipient buys
merchandise using (redeeming) the card.
3.
Yes. Research In Motion has both commitments and contingencies

(see its Note No.12). Its contingencies arise from (a) a credit facility, (b)
lease commitments, and (c) litigation.
4.
The solution depends on the financial statement information accessed.
11-43
Comparative Analysis
BTN 11-2
1. Research In MotionTimes interest earned

Current
Year
One Year
Prior
Two Years
Prior
Net income..................................................
$2,457.144
Add income taxes ......................................
809.366
$1,892.616
$1,293.867
907.747
516.653
Add interest expense ................................ .001

Income before taxes and interest .............
$3,266.511
.502
.031
$2,800.865
$1,810.551
Times interest earned ratio ...................

3,266,511.0a
5,579.4b
58,404.9c
($ millions)
$3,266.511/$0.001
$2,800.865/$0.502
c
$1,810.551/$0.031
b
AppleTimes interest earned

Current
Year
($ millions)
One Year
Prior
Two Years
Prior
Net income..................................................
$ 8,235
Add income taxes ...................................... 3,831
3
Income before taxes and interest .............
$12,069
$6,119
2,828
2
$8,949
$3,495
1,511
1
$5,007
4,023a
4,475b
5,007c
Times interest earned ratio ...................

a
$12,069/$3
$ 8,949/$2
c
$ 5,007/$1
b
2. Research In Motion and Apple both are in very strong positions in their
ability to make any interest payments should their income decline. For
all three years, Research In Motions times interest earned markedly
exceeded the industry average of 18.1. For each of the three years,
Apple too had times interest earned metrics that substantially exceeded
the industry average of 18.1. The difference between Research In
Motion and Apple is not worth mentioning as both are strong.
11-44
Ethics Challenge
BTN 11-3
1.
It is in Blys self-interest to maximize the amount of revenues less

warranty expenses so as to maximize his personal bonus. Since Bly
has some input into setting the warranty expense accrual percent, he
potentially faces an ethical dilemma. Specifically, the lower the
expense accrual, the lower the warranty expense, and the higher his
bonus. (The evidence indicates that Bly has tended to overestimate
warranty expense in prior years.)
2.
Although Bly might be able to affect the amount of revenues less

warranty expenses via the warranty expense accrual in the short run,
over several years the amounts should even out. The dealership
should probably adjust the warranty expense accrual to match the
usual (average) experience over time. Given the variable nature of
warranty expenses, at times it might warrant being adjusted upward
(lowering Blys bonus) or downward (increasing Blys bonus). The
accountant and others should offer input into this decision. Since the
experience with warranties has varied, a percent should perhaps be
based on a long-run average, with some additional weight given to
recent experience.
11-45
Communicating in Practice
BTN 11-4
MEMORANDUM
To:
From:
Date:
Subject:
Madeline Pretti, General Manager

Dustin Clemens, ManagerAccounting and Finance
Reporting warranties in financial statements
This memorandum is in response to your comment on my proposal for the

treatment of a contingency in our financial statements. You specifically
object to the proposed recognition of an expense and liability for
warranties. The purpose of this memorandum is to respond to your
objection.
Both the conservatism and matching principles apply to accounting for
warranties. Conservatism requires us to include an expense in this years
financial statements for costs that we may or may not pay in the future.
Another point in favor of reporting the expense and liability now is that we
offered the warranty in order to achieve the reported sales. Therefore, our
income measure would be incomplete if it did not match the cost of
fulfilling the warranty against revenues generated by offering the warranty.
This treatment would be in compliance with the matching principle.
Your comment also raised the objection that we dont know what costs
will be.
If they are not reasonably estimable, generally accepted
accounting principles will allow us to leave them out of the financial
statements. But we must describe the contingency in the notes. I will be
checking with the product design engineers to get their opinion on the
reasonableness of repair costs. If the product is different from others, we
may have a basis for going with only a note disclosure. However, financial
statement recognition is a more effective way to get the information into
users hands. As a result, it is usually preferred, even if we are uncertain
about the amount.
11-46
Taking It to the Net
BTN 11-5
1. McDonalds 2009 current liabilities include the following

Accounts payable
Income taxes
Other taxes
Accrued interest
Accrued payroll and other liabilities
Current maturities of long-term debt
2. The portion of long-term debt maturing in the next 12 months ($

millions) is
$18.1 / ($18.1 + $10,560.3) = 0.17%
3. Times interest earned for McDonalds as of 12/31/2009
($ millions)
12/31/2009
Net Income ...............................................................
$ 4,551.0
Plus income taxes ...................................................
1,936.0
Plus interest expense ..............................................
473.2
Income before interest and taxes ..........................
$ 6,960.2
Times interest earned ............................................. 14.7 times

Comment: The 14.7 times interest earned ratio seems more than
sufficient for McDonalds to cover its interest obligations, and it is
higher than the industry average of 12.0.
11-47
Teamwork in Action
BTN 11-6
1. Option A: Interest Expense = $6,000 x 10% x 90/360 = $150

Option B: Interest Expense = $6,000 x 8% x 120/360 = $160
The interest expense in option B does exceed option A. If interest cost
is the only consideration, then Option A is the preferred loan. However,
if a mere $10 more is paid in interest expense the business can use the
loan money for an additional 30 days. The decision on which loan is
preferred will ultimately depend on whether interest cost savings is
valued more than the additional time to use the loaned money.
2. Entries:
2a. Issue date, Option A
June 1 Cash .......................................................................... 6,000
Notes Payable ....................................................
6,000
Borrowed cash by issuing an

interest-bearing note.
2b. Issue date, Option B

June 1 Cash .......................................................................... 6,000
Notes Payable ....................................................
6,000
Borrowed cash by issuing an

interest-bearing note.
2c. Maturity date, Option A

Aug. 30 Notes Payable .......................................................... 6,000
150
Cash ....................................................................
6,150
2d. Maturity date, Option B

Sep. 29 Notes Payable .......................................................... 6,000
Interest Expense ...................................................... 160
Cash ....................................................................
11-48
6,160
Teamwork in Action (Concluded)

4.
Entries:
4a. Adjusting entry, Option A (Dec. 31)

50
50
Accrue interest on note

payable [$6,000 x 10% x 30/360].
4b. Adjusting entry, Option B (Dec. 31)

40
40
Accrue interest on note payable

[$6,000 x 8% x 30/360].
4c. Maturity date entry, Option A

March 1 Interest Expense ...................................................... 100
50
Notes Payable .......................................................... 6,000
Cash ....................................................................
6,150
4d. Maturity date entry, Option B

March 31 Interest Expense ...................................................... 120
40
Notes Payable .......................................................... 6,000
Cash ....................................................................
11-49
6,160
Entrepreneurial Decision
BTN 11-7
1.
SnorgTees
Income Statement (Prospective)
Current
Operations
Sales.............................................
$1,000,000
European
Total
$ 250,000 $1,250,000
Cost of goods sold (30%) ...........
300,000
75,000
375,000
Gross profit .................................
700,000
175,000
875,000
Operating expenses (25%) .........
250,000
62,500
312,500
450,000
112,500
562,500
Interest expense..........................
21,000
21,000
Net income...................................
$ 450,000
$ 91,500
$ 541,500
2. Times interest earned = $562,500 / $21,000 = 26.8 times

3.
SnorgTees
Current
Operations
Sales.............................................
$1,000,000
European
Total
$ 400,000 $1,400,000
300,000
120,000
420,000
Gross profit .................................
700,000
280,000
980,000
250,000
100,000
350,000
450,000
180,000
630,000
21,000
21,000
Net income...................................
$ 450,000
$ 159,000
$ 609,000
Times interest earned = $630,000 / $21,000 = 30.0 times
11-50
Entrepreneurial Decision (concluded)

4.
SnorgTees
Current
Operations
Sales.............................................
$1,000,000
European
Total
$ 100,000 $1,100,000
300,000
30,000
330,000
Gross profit .................................
700,000
70,000
770,000
250,000
25,000
275,000
450,000
45,000
495,000
21,000
21,000
Net income...................................
$ 450,000
$ 24,000
$ 474,000
Times interest earned = $495,000 / $21,000 = 23.6 times

5. In each of these cases, SnorgTees times interest earned is at least
23.6, so it appears that if it takes out the loan and can generate at least
$100,000 in sales in Europe, then the company will have little trouble
paying its interest expense.
Hitting the Road
BTN 11-8
There is no formal solution to this problem.

A discussion of the
importance of safeguarding social security information would be
appropriate especially with respect to the Administrations decision to no
longer transfer benefit information online.
11-51
Global Decision
BTN 11-9
1. Nokia Times interest earned

(Euro millions)
Current Year
One Year Prior
Net income .................................................
260
3,889
Add income taxes ......................................
702
1,081
Income before income taxes ....................
962
4,970
243
185
Income before taxes and interest ............
1,205
5,155
Times interest earned ratio .......................
5.0a
27.9b
1,205/ 243
5,155/ 185
2. Of these three companies, Research In Motion and Apple both have

superior coverage of interest expense for the current year and prior
year. Specifically, Research In Motions times interest earned of 3,267
for the current year is on par with that of Apples value of 4,023, and
both markedly exceed Nokias value of 5.0. The prior year shows
similar results with the exception of Nokias substantially higher times
interest earned of 27.9.
11-52

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Chapter 11 - Current Liabilities and Payroll Accounting

An estimated liability is an obligation to make a future payment, the exact amount of

An unemployment merit rating is based on an evaluation of an employers

Chapter 11 - Current Liabilities and Payroll Accounting

To record cash sales and 4% sales tax.

Cost of Goods Sold .................................................2,900

To record cost of Sept. 30th sales.

Sales Taxes Payable ............................................... 200

Chapter 11 - Current Liabilities and Payroll Accounting

Quick Study 11-3 (10 minutes)

To record sales in advance of concerts.

Unearned Ticket Revenue .......................................

To record concert revenues earned.

Quick Study 11-4 (10 minutes)

Quick Study 11-5 (15 minutes)

Computation of interest payable at December 31, 2011:

To record payment of note plus interest

Chapter 11 - Current Liabilities and Payroll Accounting

Quick Study 11-6 (15 minutes)

Sales Salaries Expense ........................................... 14,000

To record payroll for period.

Quick Study 11-7 (15 minutes)

Payroll Taxes Expense ............................................ 2,770.00

(10 x $2,000) x 6.2% = $1,240.00

Quick Study 11-8 (10 minutes)

Estimated Warranty Liability ..................................

To record cost of warranty repairs.

Quick Study 11-9 (5 minutes)

Quick Study 11-10 (5 minutes)

Chapter 11 - Current Liabilities and Payroll Accounting

Vacation Benefits Expense* ...................................

To record vacation benefits accrued.

Quick Study 11-11 (10 minutes)

Interpretation: This companys times interest earned ratio of 5.8 exceeds

Quick Study 11-13B (10 minutes)

Income Taxes Expense ........................................... 30,000

To record tax expense and deferred tax liability.

Quick Study 11-14 (10 minutes)

Chapter 11 - Current Liabilities and Payroll Accounting

Exercise 11-2 (10 minutes)

Cash .......................................................................... 2,100,000

Cost of Goods Sold .................................................. 1,000,000

Unearned Services Revenue ...................................

To record product revenue earned.

Exercise 11-3 (10 minutes)

No adjusting entry can be made since the loss cannot be reasonably

Exercise 11-4 (30 minutes)

Maturity date = May 15 + 60 days = July 14, 2011

Cash .......................................................................... 94,000

Chapter 11 - Current Liabilities and Payroll Accounting

Exercise 11-4 (Concluded)

Repaid note plus interest.

Exercise 11-5 (30 minutes)

Maturity date = November 1 + 90 days = January 30, 2012.

Principal ..................................................... $150,000

Principal ..................................................... $150,000

Interest Expense ...................................................... 2,250

Accrued interest on note payable.

Interest Expense ...................................................... 1,125

Chapter 11 - Current Liabilities and Payroll Accounting

Exercise 11-6 (20 minutes)

11.60 Full amount is subject to tax.

4.80 $200 is over the maximum.