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Ch. 10: Current Liabilities 1

Chapter 10Current Liabilities

In this chapter you will learn how current liabilities affect businesses, how they are controlled, accounted for, and reported in financial statements.

What Are Current Liabilities?

As you remember from previous chapters, one way in which companies obtain resources is to borrow them. The resources are called assets and the sources of the resources are called liabilities. If the dollar amount of the borrowed resources must be paid within one year to the company or person from whom the resources were obtained, the liabilities are considered to be current liabilities. If, on the other hand, the resources do not have to be paid for within a year, the liabilities are considered long-term liabilities. For example, if a company borrows $100,000 from a bank on January 15, the result could be an increase in resources (cash) and an increase in liabilities (notes payable). If the cash must be repaid to the bank by July 15, six months after it was borrowed, the notes payable would be considered current liabilities. If the cash must be repaid to the bank by July 15, 18 months after it was borrowed, the notes payable would be considered long-term liabilities.

In terms of the accounting equation, current liabilities are obviously liabilities, as shown below. The numbers in parentheses refer to the chapters in which the items are discussed.

AssetsCurrent Assets

Cash and Cash Equivalents (6)

Accts. Receivable (7)Allow. for Uncoll.

Accounts (7)Merchandise

Inventory (8)Property, Plant, & Equipment

Land (9)Buildings (9)Accum. Depr., Buildings

(9)Equipment (9)Accum. Depr., Equipment

(9)Autos & Trucks (9)Accum. Depr., Autos &

Trucks (9)

= LiabilitiesCurrent Liabilities (10)

+ Stockholders' EquityRevenues

Sales (7)Sales Returns &

Allowances (7)Cost of Goods Sold (8)Operating Expenses

Uncollectible Accts. Expense (7)

Depreciation Exp. (9)Bank Service Exp. (6)

Other Revenues & Expenses

Interest Revenue (6)Interest Expense (6)Gain or Loss on Disposal

of Prop., Plt., & Eq. (9)

2 Ch. 10: Current Liabilities

The dollar amount of current liabilities differs from company to company. Exhibit 10-1 presents current liabilities for three merchandising companies and compares them to the companies' total assets. As Exhibit 10-1 shows, there are many differences among the companies. For example, on January, 31, 2007, Wal-Mart's current liabilities were approximately $52 billion while Federated Department Stores’ were approximately $6 billion. The data show current liabilities are sources of approximately 30% of the resources (assets) of the three companies. Since 30% of the assets of the companies were obtained through current liabilities, the other 70% must have come from long-term liabilities, owners' investments, or management operations (net income). These other sources of resources will be examined in following chapters.

Exhibit 10-1Current Liabilities and Total Assets ($ millions)

January 31, 2007

CompanyCurrent

LiabilitiesTotalAssets Percent

Federated Department Stores $6,359 $29,559 21.5Target $11,117 $37,349 29.8Wal-Mart $51,754 $151,193 34.2

The Nature of Current Liabilities

There are many different current liabilities, all of which have the common characteristic that they must be paid for within twelve months. Exhibit 10-2 lists the major current liabilities for three merchandising companies. Once again, there are many differences among the companies. For example, Wal-Mart's accounts payable were approximately $28 billion while Federated Department Stores’ were approximately $2 billion.

Exhibit 10-2Current Liabilities ($ millions)

January 31, 2007

Current Liability

FederatedDepartment

Stores Target Wal-MartNotes Payable $641 $0 $2,570Accounts Payable $2,454 $6,575 $28,090Taxes Payable $962 $872 $706Current Portion of Long-term Debt $9 $1,362 $5,428Other $2,293 $2,308 $14,960Totals $6,359 $11,117 $51,754

Because there are many different types of current liabilities, it would be difficult to examine them all in one textbook, let alone one chapter. The following sections of this chapter examine some of the more important current liabilities. As you proceed through this material you should already be familiar with some of it because specific current liabilities were discussed in previous


chapters when resources were examined. For example, in the following discussion of accounts payable, you will recognize much material from the Chapter 8 merchandise inventory coverage.

Notes Payable

Notes payable are written promises to pay known dollar amounts, on specific dates, to the owners of the notes. The dollar amounts to be paid include the amount borrowed (called principal) and interest. For example, if on January 23, Lowell Merchandising Corporation signed a $78,000, 6%, 90-day note payable to Medford Company, Lowell Merchandising Corporation would have to pay Medford Company $79,153.97 on April 22. The $79,153.97 is the $78,000 principal borrowed plus interest of $1,153.97 ($78,000 x .06 x 90/365). The 90/365 fraction represents the number of days the money was borrowed (90) divided by the number of days in a year (365). The use of this fraction is necessary because it is common to state interest rates, such as the 6%, on an annual or 365-day basis. It is important to note that on January 23, as soon as the companies agree on the terms of the $78,000 note, both companies know the Lowell Merchandising Corporation must pay $79,153.97 to the Medford Company on April 22. Thus, once a note payable is issued, the companies know the dollar amount borrowed ($78,000), the dollar amount that must be paid ($79,153.97), and the date on which the amount must be paid (April 22).

Notes payable usually arise when companies buy merchandise or property, plant, and equipment. Continuing the Lowell Merchandising Corporation example, if the company acquired $78,000 of merchandise inventory from Medford Company by signing a note payable, the effects on the accounting equation would be as follows.

Total Resources

=Sources of Borrowed Resources

+Sources of

Owner Invested Resources

+Sources of

Management Generated Resources

Assets = Liabilities + Stockholders' Equity+ $78,000 = + $78,000

Lowell Merchandising Corporation's resources (assets) increase by $78,000 because they now have $78,000 more merchandise inventory. Lowell Merchandising Corporation's sources of resources (liabilities) increase because they owe $78,000 to Medford Company. In terms of a journal entry, remembering assets increase with debits and debits must equal credits, the following entry would result.

Date DescriptionPosting

Ref. Debits CreditsJan. 23 Merchandise Inventory 131 78,000

Notes Payable 211 78,000Merch. inventory purchase

As time passes and Lowell Merchandising Corporation uses the merchandise inventory obtained from Medford Company, the dollar amount Lowell Merchandising Corporation owes to Medford Company increases. This increase is for interest. For example, if Lowell Merchandising Corporation acquired the $78,000 merchandise inventory from Medford Company on January 23, and paid for it on the same day, January 23, Lowell Merchandising Corporation would pay only


$78,000. If, however, Lowell Merchandising Corporation waits until April 22, Lowell Merchandising Corporation would have to pay Medford Company $1,153.97 interest on the $78,000. Remember, interest is calculated as follows: principal x rate x time = $78,000 x .06 x 90/365 = $1,153.97. Over 90 days, until Lowell Merchandising Corporation pays Medford Company, the cost of borrowing affects Lowell Merchandising Corporation's accounting equation as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $1,153.97 + - $1,153.97

Lowell Merchandising Corporation's assets do not change because the company has not acquired additional resources from Medford Company, other than the $78,000 of merchandise inventory, nor has it paid out any resources. Lowell Merchandising Corporation's liabilities (interest payable) increase by $1,153.97 because on April 22, they now owe an additional $1,153.97 to Medford Company. Lowell Merchandising Corporation's stockholders' equity decreases by the $1,153.97 cost of borrowing (interest expense). In terms of a journal entry, remembering liabilities increase with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsApril 22 Interest Expense 522 1,153.97

Interest Payable 217 1,153.97Interest on Notes Payable

The interest expense resulting from notes payable is reported as part of other revenues and expenses on the income statement. Interest payable is reported on the balance sheet as a current liability if it must be paid within 12 months.

Since you are familiar with the accounting process, the $1,153.97 in the above journal entry may be a bit troublesome to you. In fact, although the total interest expense for 90 days is $1,153.97, it would not all be recorded in April. The adjusting process discussed in Chapter 4 suggests Lowell Merchandising Corporation would record interest expense in each month it uses the $78,000 of resources obtained from Medford Company but not repaid to them. Lowell Merchandising Corporation would record the following amounts of interest expense for each month.

Month Interest Expense January (9 days: 23rd thru 31st) $115.40 ($78,000 x .06 x 9/365)February (28 days) 359.01 ($78,000 x .06 x 28/365)March (31 days) 397.48 ($78,000 x .06 x 31/365)April (22 days: 1st thru 22nd) 282.08 ($78,000 x .06 x 22/365)Total (90 days) $1,153.97 ($78,000 x .06 x 90/365)


Each interest expense amount would be recorded through a journal entry like the one shown above. Once the $282.08 expense is recorded on April 22, the total interest expense and total interest payable recorded from January 23 through April 22 will be $1,153.97.

When Lowell Merchandising Corporation pays back the amount borrowed from Medford Company through notes payable ($78,000) and pays the related interest ($1,153.97), the effect is to reduce Lowell Merchandising Corporation's resources and sources of resources, as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $79,153.97 = - $78,000.00

- $1,153.97

Lowell Merchandising Corporation's assets decrease because its cash has been reduced. Lowell Merchandising Corporation's liabilities decrease because it no longer owes $79,153.97 to Medford Company. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsApril 22 Notes Payable 211 78,000.00

Interest Payable 217 1,153.97Cash 111 79,153.97

Notes payable payment

A careful review of the above example shows Lowell Merchandising Corporation acquired $78,000 of merchandise inventory from Medford Company by paying $79,153.97. In total, resources decreased by $1,153.97 (merchandise inventory increased by $78,000 and cash decreased by $79,153.97) and stockholders' equity decreased as a result of the $1,153.97 interest expense. The important question to consider is why would Lowell Merchandising Corporation pay $79,153.97 for $78,000 of merchandise inventory? The answer, of course, is Lowell Merchandising Corporation expects to be able to sell the merchandise inventory to its customers at prices resulting in more than $79,153.97. In effect, by borrowing merchandise inventory from Medford Company and selling it to customers at higher prices, Lowell Merchandising Corporation expects to increase its resources. For example, if Lowell Merchandising Corporation can sell the merchandise inventory to customers for $90,000, Lowell Merchandising Corporation's resources would increase by $10,846.03 ($90,000 - $79,153.97). The fact that companies like Lowell Merchandising Corporation can increase resources through the above process is why such companies are willing to borrow even though it costs them interest.

In addition to buying merchandise and property, plant, and equipment by issuing notes payable to suppliers, some large companies borrow cash by issuing notes payable to individuals and other companies who buy them as investments. Such notes payable having initial maturities of less than 270 days and minimum denominations of $25,000 are known as commercial paper. For


example, for the two-year period ended January 31, 2007, Federated Department Stores reported as a current liability commercial paper averaging approximately $600 million.

Individuals and companies buy commercial paper, such as Federated Department Stores’, for the interest they can earn by owning it. Banks are major purchasers of commercial paper. From the standpoint of the issuing company, such as Federated Department Stores, commercial paper is very similar to notes payable. When a company issues commercial paper, it receives cash. At some point in the future, the cash must be repaid along with interest. Certain common practices relating to the sale of commercial paper have resulted in a few relatively minor differences between the accounting for notes payable and commercial paper. For the purposes of this text, however, you should be aware of the following major points with regard to commercial paper. First, commercial paper is a source of cash resources for many large corporations, such as Federated Department Stores. When cash is received, resources (assets) and sources of resources (liabilities) increase. Over time, the loan must be repaid along with interest. The interest expense is recognized in the periods during which the cash is used. As you noticed, the major points related to commercial paper are the same as those for notes payable. This would be expected because commercial paper is just a special type of notes payable.

** You now have the background to do exercises 10.1, 10.2, and 10.3.

Accounts Payable

Accounts payable are dollar amounts owed to suppliers for products or services purchased from them. For merchandising companies, the vast majority of accounts payable arises through the purchase of merchandise inventory, as discussed in Chapter 8. Accounts payable and notes payable have many similarities. They are both current liabilities if they must be paid within one year. The date by which they must be paid and the dollar amount required to be paid are known at the time they are created. Remember the previous discussion of the Lowell Merchandising Corporation's January 23, signing of a $78,000, 6%, 90-day note payable to Medford Company. On January 23, as soon as the companies agreed on the terms of the note, both companies knew the Lowell Merchandising Corporation must pay $79,153.97 ($78,000 principal + $1,153.97 interest) to the Medford Company on April 22. Similarly, when companies purchase merchandise or services on account, they immediately know the dollar amount that must be paid and the date by which the payment must be made.

The major difference between accounts payable and notes payable relates to interest. If notes payable are paid on time, interest is part of the required payment. Again, remember the Lowell Merchandising Corporation example. If the Lowell Merchandising Corporation pays on time, April 22, it will pay $78,000 principal plus $1,153.97 interest. On the other hand, if accounts payable are paid on time, interest payments are not required. One reason accounts payable do not require interest payments if paid on time is because accounts payable are usually for very short time periods, often 30 days. On the other hand, if accounts payable are not paid on time, suppliers often charge interest for the number of days payments are late.

When companies purchase merchandise on account, their resources and sources of resources increase. For example, if the Lowell Merchandising Corporation purchases $12,000 of merchandise inventory on account, the effects on the company's accounting equation would be as follows. Remember, you can always review Chapter 8 if you are unclear about this material.


Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $12,000 = + $12,000

Lowell Merchandising Corporation's resources (assets) increase by $12,000 because they now have $12,000 more merchandise inventory. Lowell Merchandising Corporation's sources of resources (liabilities) increase because they owe $12,000 to suppliers. In terms of a journal entry, remembering assets increase with debits and debits must equal credits, the following entry would result.


Ref. Debits CreditsJan. 5 Merchandise Inventory 131 12,000

Accounts Payable 212 12,000Merch. inventory purchase

Purchases on account have payment terms associated with them. For example, it is possible the Lowell Merchandising Corporation's $12,000 purchase was made with terms of 2/10, n/30. The first part of the purchase terms, 2/10, means the Lowell Merchandising Corporation can take a 2 percent discount from the $12,000 if payment is made within 10 days of the purchase. Thus, if the Lowell Merchandising Corporation pays for the merchandise by January 14, it will be allowed to deduct $240 ($12,000 x .02) from the $12,000 invoice price. As a result, if it pays for the merchandise by January 14, the Lowell Merchandising Corporation will pay its supplier only $11,760 ($12,000 - $240). The second part of the purchase terms, n/30, means if the Lowell Merchandising Corporation does not pay for the merchandise within 10 days, it must pay the full amount, $12,000, within 30 days of the purchase, which is February 3.

Continuing the Lowell Merchandising Corporation example, if the purchase terms were 2/10, n/30 and the company took advantage of the 2 percent discount by paying for the purchase on January 14, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $11,760 = - $12,000

- $240

The easier effect to see is the $12,000 decrease in the Lowell Merchandising Corporation's sources of resources (liabilities). Lowell Merchandising Corporation's liabilities decrease simply because once they pay their supplier, they no longer owe $12,000. On the other hand, resources decrease for two reasons. First, the company's cash is reduced by the $11,760 cash payment. Second, the company's merchandise inventory is reduced by $240. This $240 reduction of merchandise inventory is necessary because it was originally recorded as $12,000 when the merchandise was purchased on January 5. Since only $11,760 was actually paid for the


merchandise, it should be reported at $11,760 not $12,000. Thus, the $12,000 merchandise inventory must be reduced by $240 to bring it to $11,760. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsJan. 14 Accounts Payable 212 12,000

Cash 111 11,760Merchandise Inventory 131 240

Accounts payable payment

If the Lowell Merchandising Corporation does not pay for the merchandise by January 14, but instead waits until February 3 to pay, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of



Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $12,000 cash payment. The company's sources of resources (liabilities) decrease because once they pay their supplier, they no longer owe $12,000. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsFeb. 3 Accounts Payable 212 12,000

Cash 111 12,000Accounts payable payment

When payment for purchases is made after the discount period, an adjustment to merchandise inventory is not required because the cost of the merchandise originally recorded when the merchandise was purchased is correct. Remember, on January 4, the Lowell Merchandising Corporation recorded the cost of the merchandise purchased as $12,000. Since the company actually paid $12,000 for the merchandise on February 3, the $12,000 merchandise originally recorded is correct and does not need to be adjusted.

In a manner quite similar to merchandise inventory purchases on account, companies also often purchase services on account. For example, it is very common for telephone services and electricity services to be paid for in the month following the use of the services. When companies purchase services on account and use them up in the same month, their resources remain unchanged and their sources of resources both increase and decrease. For example, consider the Lowell Merchandising Corporation's January 29, receipt of a $258 invoice from the Merrimack Power


Company for electric power used in January. The effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $258 + - $258

Lowell Merchandising Corporation's resources remain unchanged because the electric power purchased was used up by the company. Lowell Merchandising Corporation's sources of resources (liabilities) increase because they owe $258 to the Merrimack Power Company. Similarly, the company's sources of resources (stockholders' equity) decrease to recognize the expense related to using the electric power (utilities expense). As suggested in earlier chapters, it may be easier to understand this event in two parts. First, the Lowell Merchandising Corporation acquires a resource (electric power) on account. As a result, resources (assets) increase and sources of resources (liabilities) increase. As the electricity is used up, resources decrease and stockholders' equity decreases. By combining these two effects, resources remain unchanged, they increased and decreased by the same amount. Sources of resources changed as liabilities increased and stockholders' equity decreased by the same amount. In terms of a journal entry, remembering liabilities increase with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsJan. 29 Utilities Expense 513 258

Accounts Payable 212 258January electricity

When the Lowell Merchandising Corporation pays for the electricity, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $258 = - $258

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $258 cash payment. The company's sources of resources (liabilities) decrease because once they pay Merrimack Power Company, they no longer owe them $258. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsFeb. 7 Accounts Payable 212 258


Cash 111 258Accounts payable payment

** You now have the background to do exercises 10.4 and 10.5.

Taxes Payable

Taxes payable are dollar amounts owed to governments, primarily for services provided by them. For example, corporations pay income taxes to the U.S. federal government for military protection and many other services. Corporations operating in many locations throughout the world usually must be concerned with many different taxes. In this chapter, liabilities for three specific taxes will be examined: sales taxes, income taxes, and payroll taxes.

Sales taxes payable Sales taxes payable are dollar amounts owed to state governments for certain products and services sold to customers. Almost all U.S. states have sales taxes. When products and services are sold, customers are charged for the price of the products and services plus the sales taxes. Thus, in effect, companies act as sales taxes collectors for state governments.

Assume the Lowell Merchandising Corporation operates in a state having a 6% sales tax. If, on March 18, the Lowell Merchandising Corporation sells for cash products having a sales price of $2,000, the company would charge its customers $2,120. The $2,000 is the sales price of the products and the $120 ($2,000 x .06) is the sales tax. Selling $2,000 of products for cash in a state with a 6% sales tax affects Lowell Merchandising Corporation's accounting equation as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $2,120 = + $120 + + $2,000

Lowell Merchandising Corporation's assets increase because the company has received $2,120 cash. Liabilities (sales taxes payable) increase by $120 because once the sale is made, the company now owes $120 to the state government. Stockholders' equity increases by the $2,000 sales revenue. In terms of a journal entry, remembering assets increase with debits and debits must equal credits, the following entry would result.


Ref. Debits CreditsMar. 18 Cash 111 2,120

Sales Taxes Payable 214 120Sales 415 2,000

Cash sales

In actual business practice, sales taxes can be quite complicated. Although most states have sales taxes, they do not all tax the same things. Some states tax certain products and services while other states tax different products and services. Additionally, states do not charge sales taxes on


products sold to companies that, in turn, are going to sell the products to consumers. States charge sales taxes only on those products sold to consumers. For example, when the Lowell Merchandising Corporation buys merchandise from the Medford Company, there is no sales tax involved. The sales tax is charged at the time the Lowell Merchandising Corporation sells the products to its customers, as shown above.

States establish specific schedules for companies to follow for paying sales taxes. For example, continuing the Lowell Merchandising Corporation example, assume the state in which the company operates requires sales taxes to be paid by the 10th day of the month after which a sale is made. If the Lowell Merchandising Corporation had recorded total sales taxes payable of $3,100 during March, this amount would have to be paid to the state by April 10. When the company pays the sales taxes to the state, the payment affects Lowell Merchandising Corporation's accounting equation as follows.

Total Resources


+Sources of


+Sources of



Lowell Merchandising Corporation's assets decrease because the company has paid out $3,100 cash. Liabilities (sales taxes payable) decrease by $3,100 because once the payment is made, the company no longer owes $3,100 to the state government. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsApr. 10 Sales Taxes Payable 214 3,100

Cash 111 3,100Sales taxes payment

You should note in the above entry Lowell Merchandising Corporation does not record any sales taxes expense. Sales taxes are collected from customers and paid by the company to the state government. Thus, in effect, the sales taxes are a cost to the customer, not to Lowell Merchandising Corporation.


Income taxes payable Income taxes payable are dollar amounts owed to governments for services provided by them. Some of the services are easy to see, such as the daily work of senators or the activities of the armed forces stationed around the world. Other services are more difficult to see, such as the work of the Central Intelligence Agency. Corporate income taxes are major sources of funds for governments. In the U.S., corporations pay federal income taxes, state income taxes in most states, and local income taxes in some cities and towns. Similar to individuals, corporations pay income taxes if they generate income. Income taxes are not paid by corporations that do not generate income, that is, if their expenses are greater than their revenues. Companies that are not


incorporated, such as sole proprietorships and partnerships, do not pay income taxes. The income taxes of such companies are paid by owners.

Although detailed tax regulations may vary from state to state and from locality to locality, there are many similarities between such taxes and federal income taxes. All income taxes are based on taxable income. In 2008, for those corporations with taxable income of $18,333,333 or more, the U.S. federal income tax rate was 35%. For corporations with taxable income less than $18,333,333, the tax rate varied, depending upon the amount of taxable income. Each year, the federal government provides companies with several publications that help identify revenues and expenses included in the calculation of taxable income and show the appropriate tax rates.

The actual calculation of a corporation's income taxes can be very complicated. The tax code, which is the detailed set of rules to be followed by taxpayers, is administered in the U.S. by the Internal Revenue Service (IRS). Occasionally, the tax code is modified to make changes specified by the government. As a result of the complicated nature of income taxes, most corporations employ their own tax accountants and tax lawyers. Other corporations make use of outside tax experts.

In its simplest form, assuming the Lowell Merchandising Corporation's taxable income for 2008 was $30,000,000, its income taxes expense would be $10,500,000 ($30,000,000 x .35). Corporations pay their taxes to the federal government according to time schedules specified by the IRS. In general, however, tax payments are not required to be made on the same day as the income is earned. As a result of corporations not having to pay income taxes immediately, the effect of income taxes on the Lowell Merchandising Corporation's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $10,500,000 + - $10,500,000

Lowell Merchandising Corporation's resources do not change because the company has not paid the taxes. Sources of resources (liabilities) increase because the company owes the federal government $10,500,000. Similarly, the company's sources of resources (stockholders' equity) decrease to recognize the expense related to using the government's services (income taxes expense). Once again, it may be easier to understand this event in two parts. First, the Lowell Merchandising Corporation acquires a resource (governmental protection, for example) on account. As a result, resources (assets) increase and sources of resources (liabilities) increase. As the protection is used up, resources decrease and stockholders' equity decreases. By combining these two effects, resources remain unchanged, they increased and decreased by the same amount, sources of resources changed as liabilities (income taxes payable) increased and stockholders' equity decreased by the same amount (by increasing income taxes expense). In terms of a journal entry, remembering liabilities increase with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsDec. 31 Income Taxes Expense 551 10,500,000

Income Taxes Payable 219 10,500,000


Federal income taxes

When the Lowell Merchandising Corporation pays its income taxes, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $10,500,000 = - $10,500,000

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $10,500,000 cash payment. The company's sources of resources (liabilities) decrease because once they pay the taxes, they no longer owe $10,500,000 to the government. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsJan. 15 Income Taxes Payable 219 10,500,000

Cash 111 10,500,000Income taxes payment

One of the complicating features involved in income tax calculations is that it is legal and very common for corporations to follow one set of rules for tax purposes and another set of rules in preparing financial statements. For example, remember the depreciation discussion in Chapter 9? It is possible for companies to depreciate their property, plant, and equipment on an accelerated basis for tax purposes while using straight-line depreciation for their financial statements. Similarly, as you remember from Chapter 8, it is possible for companies to use different inventory methods for tax and accounting purposes. When companies use accounting methods for tax purposes that differ from the methods they use for their financial statements, the result usually is the income taxes expense reported on the company's income statement differs from the income taxes reported on the company's tax return. Since each company makes actual cash payments for income taxes based on tax returns, the result is the company’s income taxes expense will differ from its income taxes payable.

Continuing the discussion of the Lowell Merchandising Corporation's $30,000,000 taxable income reported on its income statement, consider what could happen if by using accelerated depreciation for federal tax purposes and straight-line depreciation for its financial statements, the company reports $2,000,000 of higher depreciation expense on its tax return than in its financial statements. With $2,000,000 higher depreciation expense, the company’s taxable income will be $2,000,000 lower on its tax return than it will be in its income statement. Using the 35% federal tax rate, the company would calculate its federal income taxes as follows.

IncomeStatement

FederalTax Return

Taxable income $30,000,000 $28,000,000


Income taxes expense (35%) $10,500,000 $9,800,000

The above federal tax return calculations show the Lowell Merchandising Corporation owes only $9,800,000 to the federal government for income taxes, not the $10,500,000 reported on its income statement. By following tax rules the company will be able to postpone, or defer, $700,000 of taxes payments. However, the company knows, as the property, plant, and equipment get older, straight-line depreciation expense in later years will be greater than accelerated depreciation expense. (Remember, you can review this idea in Chapter 9.) When this happens, the income taxes expense reported on the company's income statement will be less than the income taxes reported on its tax return. In other words, the Lowell Merchandising Corporation knows eventually it will have to pay the federal government the full amount of income taxes reported on its income statement. However, it could take several years for this to happen.

Because it is common for income taxes expense in companies' income statements to differ from income taxes reported in their tax returns, companies use the following system:

Income taxes expense = income taxes expense reported on incomestatement

Income taxes payable = income taxes reported on tax return

Deferred taxes = difference between income taxes expense andincome taxes payable

Deferred taxes are postponed taxes payments. They are liabilities because they will eventually have to be paid. They are considered current liabilities if they will be paid in the next twelve months. Usually, however, they are considered long-term liabilities because it may be many years before they will be paid.

Continuing the Lowell Merchandising Corporation example, the effect of income taxes on the accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $9,800,000 + - $10,500,000

+ $700,000

Lowell Merchandising Corporation's assets do not change because the company did not pay the taxes. Sources of resources (liabilities) increase because the company owes the federal government $10,500,000. However, because only $9,800,000 of taxes must be paid in the near future, $9,800,000 would be a current liability and $700,000 would be considered a long-term liability. The company's sources of resources (stockholders' equity) decrease to recognize the expense related to using the government's services (income taxes expense). In terms of a journal entry, remembering liabilities increase with credits and debits must equal credits, the following entry would result.



Ref. Debits CreditsDec. 31 Income Taxes Expense 551 10,500,000

Income Taxes Payable 219 9,800,000Deferred Income Taxes Payable 229 700,000

Federal income taxes

When the Lowell Merchandising Corporation pays the current portion of its income taxes, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $9,800,000 = - $9,800,000

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $9,800,000 cash payment. The company's sources of resources (liabilities) decrease because once they pay the taxes, they no longer owe $9,800,000 to the government. The $700,000 liability for deferred taxes remains unchanged because this amount has not been paid to the government and is still owed by the company. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.

Date Description Ref. Debits CreditsJan. 15 Income Taxes Payable 219 9,800,000

Cash 111 9,800,000Income taxes payment

** You now have the background to do exercises 10.8, 10.9, and 10.10.

Payroll taxes payable Payroll taxes payable are dollar amounts owed to federal and state governments for services related to employees. Such services include general governmental services provided to all citizens and retirement and medical benefits provided to many citizens. Payroll taxes payable arise for two reasons. First, to ease the process of governments collecting taxes from citizens and also to make it easier for citizens to pay their taxes, employers act as governmental collection agents for certain taxes. This means employers withhold dollar amounts for taxes from employees' earnings and pay these amounts to governments. For example, consider an employee who earns $100 and is taxed $10. The employer would withhold $10 from the employee's earnings. The employee would receive $90 and the employer would pay the $10 to the appropriate governments. Until the employer pays the governments, the $10 would be reported as part of the liability, payroll taxes payable. The second reason for payroll taxes payable is employers are taxed by federal and state governments to help fund specific governmental programs relating to employees. These taxes may be viewed by companies as another cost of doing business in the U.S., similar to the cost of goods sold, advertising expense, and utilities expense. To understand payroll


taxes payable, the following paragraphs briefly examine payroll systems in which the dollar amounts of payroll taxes are calculated.

Payroll systems Payroll refers to the dollar amounts earned by employees for services they provide to the companies where they work. For service companies, such as medical, legal, accounting, and consulting firms, payroll is often the largest cost of operating. For merchandising companies, such as grocery stores and clothing stores, payroll costs are often the second largest cost, with only the cost of goods sold being larger. Payroll systems vary from the relatively simple to the very complex. For example, a company with only one or two employees can probably use a very simple payroll system. On the other hand, with 1.9 million employees on January 31, 2007, a company like Wal-Mart would use a very complicated payroll system. Regardless of the complexity of payroll systems, the following paragraphs examine four basic concepts important to understanding payroll: earnings, deductions, net pay, and employer payroll taxes.

Employee earnings The total dollar amount earned by an employee during a given time period is called the employee's earnings or gross pay. Some employees earn a salary, that is, they earn the same dollar amount each period. For these employees, gross pay is quite easy to determine: their gross pay equals their salary. For example, if Lynn Catton earns a weekly salary of $900 from the Lowell Merchandising Corporation, her weekly gross pay would simply be $900. Many other employees do not earn salaries but earn wages. Such employees' earnings are based on the number of hours they work and their wage rates per hour. For example, if the Lowell Merchandising Corporation's Jorge Munez works 40 hours in a given week and his wage rate is $9 per hour, his gross pay for the week would be $360 (40 hours x $9 per hour).

Further complicating an employee's gross pay is the fact companies often pay employees a higher rate if they work more than the normal number of hours expected. This additional pay is called overtime. For example, assume the Lowell Merchandising Corporation's policy is to pay hourly employees time and a half (or 150%) for all hours worked in excess of 40 hours per week. If Jorge Munez worked 46 hours in a given week, his gross pay would be calculated as follows.

Hours Rate Gross PayFirst 40 hours (called straight-time) $9 $3606 hours over 40 (called overtime) $13.50 ($9 x 1.5) $81

Gross pay $441

In addition to salaries and wages, there are several other ways employees are compensated. For example, it is common for salespersons to receive a base salary of a small amount and then receive a commission of a percentage of the sales revenue they generate for the company. For example, assume the Lowell Merchandising Corporation pays Mark Gearin a weekly salary $500 plus a commission of 1 percent of the sales he generates. If he generates sales of $8,000, his gross pay for the week would be $580. Gearin's gross pay would be his $500 weekly salary plus his sales commission of $80 ($8,000 x .01).

It is also common for companies to pay bonuses to employees, especially to top executives. A bonus is an amount paid in addition to regular salaries and wages, and is usually given as a reward for good performance. For example, for the year ended January 31, 2007, in addition to his $1.3 million salary, the president and chief executive officer of Wal-Mart received incentive


payments of approximately $4.3 million. The gross pay of employees receiving bonuses is equal to their salary or wages plus their commissions, if any, plus their bonuses.

** You now have the background to do exercise 10.11.

Deductions Payroll deductions are dollar amounts withheld (or deducted) from employees' gross pay. Dollar amounts deducted from gross pay are not paid to employees, but are eventually paid to other entities, such as governments, insurance companies, investment funds, and unions.

Employee federal income taxes For most employees, the largest deduction from their gross pay is federal income taxes. In the U.S., federal income taxes are required to be withheld from most employees' earnings. The actual dollar amount of federal income taxes withheld from each employee is based on information provided to employers by the Internal Revenue Service. For example, in order to encourage families, it has been part of U.S. tax policy to tax large families less than small families. This is just one example of how U.S. tax policies are used to support programs considered desirable by the federal government. The dollar amount of federal income taxes withheld from employees' gross pay is paid to the government by the employer. Although the total dollar amount withheld influences when payments are made, employers must pay the taxes at least every three months (quarterly).

Employee state income taxes Similar to federal income taxes, many states also have income taxes which must be withheld from employees' gross pay. The amount withheld from each employee is determined according to information provided by the states. Such amounts are paid to the states according to states’ payment schedules.

Employee FICA taxes Beginning in 1937, employees have had amounts withheld from their gross pay to help fund the federal government's social security program. The tax is commonly referred to as FICA because it was created through the Federal Insurance Contributions Act (FICA). One part of the FICA social security program, referred to as OASDI, provides old age, survivors, and disability insurance benefits to qualified individuals. In its first year, 1937, the FICA tax was 1 percent of the first $3,000 of gross pay earned by each employee. For example, an employee who earned $7,000 in 1937 would have had $30 ($3,000 x .01) withheld from her gross pay. Note the amount of the employee's earnings in excess of $3,000 was not taxed for FICA purposes. Since 1937, both the FICA tax rate and the amount of gross pay on which the tax is based have increased. For example, in 2008, the OASDI portion of the FICA tax was 6.2 percent of the first $102,000 earned by each employee. Thus, an employee who earned $7,000 in 2008 would have $434 ($7,000 x .062) withheld from her gross pay. Note that since the employee's earnings of $7,000 were well below the $102,000 limit, all $7,000 of the gross pay was subject to the OASDI FICA tax. Viewed another way, in 1937, the most an employee could have withheld from her pay was $30 ($3,000 x .01), while in 2008, the maximum amount for OASDI had grown to $6,324 ($102,000 x .062).

A second part of the FICA social security program provides health care insurance to qualified individuals. This program, which began in 1966, is commonly referred to as the Medicare program. Similar to the OASDI FICA tax, the Medicare FICA tax has increased over the years. In 2008, the Medicare tax was 1.45 percent of each employee's gross pay. Thus, the Medicare tax is levied on all employee earnings. For example, an employee whose gross pay is $8,000 would have $101.50 ($8,000 x .0145) withheld from his pay, while an employee whose gross pay is $150,000


would have $2,175 ($150,000 x .0145) withheld. Like federal income taxes withheld, although the total dollar amount of FICA taxes (OASDI and Medicare) withheld influences when payments are made, employers must pay the taxes at least every three months (quarterly).

As an example of how changes in FICA taxes can affect individuals, consider what happened to Michael Eisner, chairman and chief executive officer of The Walt Disney Company. Prior to 1994, only the first $135,000 of each employee's earnings were subject to Medicare taxes. In 1994, however, this limit was removed making all earnings subject to Medicare taxes. As a result of this change, the amount of Medicare taxes on Mr. Eisner's $11 million earnings increased by approximately $160,000!


Other deductions In addition to income taxes and FICA taxes, employees can have many other deductions from their gross pay. For example, it is common for employees to have union dues, insurance premiums, contributions, and savings plan payments withheld from their gross pay. Such dollar amounts are withheld from employees' gross pay and recorded as current liabilities by the employer.

Net pay Employees' net pay is the dollar amount of earnings the employees actually receive from their employers. Net pay, also referred to as take-home pay, is calculated by subtracting the employees' deductions from the employees' gross pay. As examples of net pay, consider the payroll for the week ended October 31, 2008 for two employees of the Lowell Merchandising Corporation. One employee, Lisa Gurecki, earns a weekly salary of $2,000, and a second employee, Jaime Simes earns wages of $12 per hour. For the 43 weeks ended October 24, Lisa Gurecki earned $101,000 (including earnings for special projects) and Jaime Simes, who joined the company in July, earned $6,720. For the week ended October 31, the net pay for each employee could be calculated as follows.

Gross pay: L. Gurecki's gross pay is simply her $2,000 weekly salary.J. Simes' gross pay is the number of hours he worked multiplied by his wage rate per hour. If he worked 40 hours during the week, his gross pay would be $480 (40 hours x $12 per hour).

Federal income tax: Federal income taxes are determined through the use of information provided by the IRS. For this example, assume that L. Gurecki's federal income taxes withheld are $390, while J. Simes' are $63.

State income tax: State income taxes are determined through the use of information provided by the state. For this example, assume that L. Gurecki's state income taxes withheld are $100, while J. Simes' are $24.00.

FICA OASDI tax: For 2008, the OASDI portion of the FICA tax is 6.2% of the first $102,000 earned by each employee. Since prior to October 31, L. Gurecki had earned $101,000, only $1,000 ($102,000 - $101,000) of her current week's gross pay is subject to the OASDI tax. Thus, for the week ended October 31, the OASDI tax withheld from L. Gurecki's gross pay is $62 ($1,000 x .062).


Remember, only the first $102,000 of an employee's 2008 yearly earnings are subject to the OASDI tax. The $101,000 of L. Gurecki's previous earnings had been taxed earlier in 2008, when she earned that part of her salary. For J. Simes, the OASDI tax withheld is $29.76 ($480 x .062). Note since J. Simes had earned only $6,720 prior to October 31, his gross pay is not close to the OASDI limit of $102,000. Thus, the full amount of his $480 weekly pay is subject to the OASDI tax.

FICA Medicare tax: For 2008, the Medicare portion of the FICA tax is 1.45% of gross pay earned by each employee. L. Gurecki's Medicare tax withheld would be $29 ($2,000 x .0145) and J. Simes' would be $6.96 ($480 x .0145).

Other deductions: Each week, L. Gurecki has $6 for union dues, $3 for a contribution to the American charities, and $20 for additional health and life insurance withheld from her gross pay. Similarly, J. Simes has union dues of $2 and $4 for insurance withheld from his weekly pay.

Net pay: Employees' net pay is determined by subtracting their deductions from gross pay, as summarized below. As shown, L. Gurecki had gross pay of $2,000, deductions of $610, resulting in net pay of $1,390 for the week. Similarly, J. Simes had gross pay of $480, deductions of $129.72, resulting in net pay of $350.28 for the week.

ItemLisa

GureckiJaimeSimes Totals

Gross pay $2,000.00 $480.00 $2,480.00Deductions:

Federal income tax $390.00 $63.00 $453.00State income tax 100.00 24.00 124.00FICA tax:

OASDI 62.00 29.76 91.76Medicare 29.00 6.96 35.96

Union dues 6.00 2.00 8.00American charities 3.00 0.00 3.00Insurance 20.00 4.00 24.00

Total deductions 610.00 129.72 739.72Net pay $1,390.00 $350.28 $1,740.28

Continuing the Lowell Merchandising Corporation example, assuming L. Gurecki and J. Simes are the company's only two employees, the October 31, 2008 weekly payroll would affect the company's accounting equation as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $2,480 + - $2,480


The company's sources of resources (liabilities) increase because the company owes its employees for the work they did for the company during the week. In fact, as you know from the previous paragraphs, the company only owes its employees their net pay ($1,740.28). All the other dollar amounts withheld from employees' gross pay ($739.72) are owed to other entities. For example, the federal income taxes withheld ($453) are owed to the federal government, while union dues withheld ($8.00) are owed to the employees' union. Similarly, the company's sources of resources (stockholders' equity) decrease to recognize the $2,480 expense related to using the employees' services.

The journal entry to record payroll depends primarily upon two considerations. First, what services did the employees provide? For example, if L. Gurecki is an administrator and J. Simes is a salesperson, Gurecki's gross pay would be considered an administrative expense while Simes' would be a selling expense. If, on the other hand, both employees were salespersons, both gross pays would be selling expenses. The second consideration for recording payroll is the number of individual liability accounts used. Most corporations do not simply record all deductions in the same payroll taxes account, but prefer to use many separate accounts. Again, assuming L. Gurecki is an administrator, J. Simes is a salesperson, and the Lowell Merchandising Corporation uses separate liability accounts, the following journal entry would result.


Ref. Debits CreditsOct. 31 Administrative Salaries Expense 514 2,000.00

Sales Wages Expense 516 480.00Employees' Federal Inc. Tax. Payable 231 453.00Employees' State Inc. Tax. Payable 232 124.00FICA Taxes Payable 233 127.72Employees' Union Dues Payable 234 8.00Employees' Amer. Charities Payable 235 3.00Employees' Insurance Payable 236 24.00Salaries and Wages Payable 214 1,740.28

Oct. 25-31 payroll

Although the above journal entry may look intimidating, the major points you should note are as follows. The company's expense for salaries and wages is equal to employees' gross pay. It is the gross payroll that the company must eventually pay out in cash. Because employers act as collection agents, however, the gross pay is not the dollar amount employees receive. Employees will receive their net pay, which is recorded in the above entry as a $1,740.28 credit to the liability, salaries and wages payable. The liabilities in the above journal entry, other than salaries and wages payable, represent dollar amounts deducted from employees' gross pay. The liabilities reflect the amounts owed to varies entities, such as the federal government and state government. Several of the liabilities include the word "employees" in their account names in order to clearly indicate such amounts were deducted from employees' gross pay. Finally, FICA Taxes Payable includes both OASDI and Medicare taxes. The account name does not include the word "employees" because the account is also used to record FICA taxes on the employer, as discussed later in this chapter.


As the above example illustrates, the calculations and journal entry involved in employee payroll can be quite detailed. This is one reason payroll systems were some of the first business applications for computers. Today, virtually all large companies in the U.S. use computers in their payroll systems. Not only can computers do the calculations faster than humans, but with good programs they can also do it more accurately.

Employers usually pay their employees after their work is done. It is common for employees to be paid one or two weeks after they work. When the Lowell Merchandising Corporation pays its employees for the work they did during the week ended October 31, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $1,740.28 = - $1,740.28

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $1,740.28 cash payment. The company's sources of resources (liabilities) decrease because once they pay the employees, they no longer owe them $1,740.28. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsNov. 7 Salaries and Wages Payable 213 1,740.28

Cash 111 1,740.28Oct. 31 payroll payment

When a company pays the amounts withheld (deducted) from employees' gross pay, the effects on the company's accounting equation and the journal entry to record them are similar to the paying of employees' net pay. For example, when the Lowell Merchandising Corporation pays the state income taxes withheld, the effects on the company's accounting equation would be as follows.


Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $124 = - $124

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $124 cash payment. The company's sources of resources (liabilities) decrease because once they pay the state income taxes, they no longer owe the state $124. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsNov. 14 Employees' State Income Tax. Payable 232 124

Cash 111 124Employees' SIT payable pmt.


Employer payroll taxes In addition to paying employees their net pay and paying the amounts withheld from employees' gross pay to federal and state governments, unions, charities, etc., companies are also required to pay employer payroll taxes. In effect, employer payroll taxes are dollar amounts charged to employers for the right to employ workers. These dollar amounts are used by governments to help fund two employee-related programs: the FICA program and federal and state unemployment programs.

Employer FICA tax To help fund the federal government's social security program, employers must pay the same two FICA taxes employees have withheld from their gross pay, as discussed earlier in this chapter. Employers must pay OASDI tax (old age, survivors, and disability insurance) and Medicare tax. For 2008, the employer's OASDI portion of FICA taxes was 6.2% of the first $102,000 earned by each employee. You should note this is the same as the OASDI tax withheld from each employee. For 2008, the employer's Medicare portion of FICA taxes was 1.45% of each employee's total earnings. Again, this is the same as the Medicare tax withheld from each employee.

Continuing the Lowell Merchandising Corporation example, the company's portion of OASDI tax for the week ended October 31, 2008 payroll would be $91.76 ($62 for L. Gurecki + $29.76 for J. Simes = $91.76). The company's Medicare tax would be $35.96 ($29 for L. Gurecki + $6.96 for J. Simes = $35.96). You can verify these numbers by reviewing the detailed calculations presented in the previous section. The company's total FICA taxes for the October 31 payroll would be $127.72 ($91.76 OASDI + $35.96 Medicare). The payroll taxes affect the company's accounting equation as follows.


Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $127.72 + - $127.72

Lowell Merchandising Corporation's sources of resources (liabilities) increase because the company owes the federal government $127.72 for payroll taxes. The company's sources of resources (stockholders' equity) decrease to recognize the $127.72 payroll taxes expense related to using the employees' services. In terms of a journal entry, remembering liabilities increase with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsOct. 31 Payroll Taxes Expense 518 127.72

FICA Taxes Payable 233 127.72Employers' FICA tax

When the Lowell Merchandising Corporation pays the FICA taxes amount to the federal government, the effects on the company's accounting equation and the journal entry to record them are identical to the paying of the FICA taxes withheld from employees' gross pay. For example, when the Lowell Merchandising Corporation pays the $127.72 FICA taxes, the effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $127.72 = - $127.72

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $127.72 cash payment. The company's sources of resources (liabilities) decrease because once they pay the FICA taxes, they no longer owe the federal government $127.72. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsNov. 10 FICA Taxes Payable 233 127.72

Cash 111 127.72FICA tax payable payment

In actual practice, the journal entry to record the payment of FICA taxes payable is slightly different from the above. Complying with IRS rules, companies do not pay FICA taxes separately, but combine such payments with the amounts withheld from employees gross pay for FICA and


federal income taxes. Since all these dollar amounts go to the same place (the federal government), companies combine them all in one cash payment.

As a result of charging employees and employers for FICA taxes, the federal government helps fund FICA programs. For example, since the government collected $127.72 by having it withheld from employees' earnings and collected another $127.72 by taxing the employer (Lowell Merchandising Corporation), the government obtained a total of $255.44 ($127.72 + $127.72 = $255.44) for use in its FICA programs.

Employer unemployment taxes The second type of payroll taxes charged to employers helps fund federal and state unemployment programs. The purpose of these programs is to provide benefits to qualified unemployed individuals, for a limited time, to help them financially while they attempt to find new jobs. Unlike FICA taxes that are levied on both employees and employers, however, most unemployment taxes are charged to employers only, although there are a few states that charge employees, too. In 2008, employers were charged a federal unemployment tax of .8% of the first $7,000 earned by each employee. The actual federal unemployment tax rate is 6.2%, but employers who properly pay their state unemployment tax have the federal rate reduced to .8%. State unemployment tax rates vary from state to state and employer to employer. States usually examine each employer annually and adjust the employer’s state unemployment tax rate based on the employer's employment record. For example, employers who do not lay off many employees will receive lower state unemployment tax rates than employers who frequently lay off employees. Although unemployment taxes are collected by federal and state governments, the federal government does not pay unemployment benefits directly to employees. The federal government takes the unemployment taxes received from employers and distributes them to the states. The states, in turn, pay the benefits to the unemployed.

Continuing the Lowell Merchandising Corporation example for payroll for the week ended October 31, 2008, the company would only pay payroll taxes on J. Simes' earnings. Remember, in 2008, payroll taxes were based on the first $7,000 of each employee's earnings. Since L. Gurecki had earned $96,500 prior to the October 31 week, her payroll greatly exceeds the $7,000 limit. Thus, there would not be any payroll taxes on her October 31 earnings of $2,000. Since J. Simes earned $6,720 prior to the October 31 week, the maximum earnings on which he could be further taxed is $280 ($7,000 - $6,720 = $280). In fact, the company's payroll taxes would be based on only $280 of J. Simes' $480 of earnings during the October 31 week. Once the $280 is taxed, the company would have reached the maximum $7,000 yearly limit on J. Simes' earnings. Assuming the federal unemployment tax rate is .8% of the first $7,000 and the state unemployment tax rate is 5.4% of the first $7,000, the company's unemployment taxes would be as follows.

Federal unemployment tax $2.24 ($280 x .008)State unemployment tax $15.12 ($280 x .054)Total unemployment taxes $17.36

The effects of unemployment taxes on the company's accounting equation are as follows.


Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity+ $17.36 + - $17.36

Lowell Merchandising Corporation's sources of resources (liabilities) increase because the company owes the federal and state governments $17.36 for payroll unemployment taxes. The company's sources of resources (stockholders' equity) decrease to recognize the $17.36 payroll taxes expense related to using the employees' services. In terms of a journal entry, remembering liabilities increase with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsOct. 31 Payroll Taxes Expense 518 17.36

Federal Unemployment Tax. Payable 216 2.24State Unemployment Tax. Payable 218 15.12

Unemployment taxes

When the Lowell Merchandising Corporation pays the unemployment taxes to the federal and state governments, the effects on the company's accounting equation and the journal entry to record them are similar to the paying of FICA taxes. The effects on the company's accounting equation would be as follows.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity- $17.36 = - $17.36

Lowell Merchandising Corporation's resources (assets) decrease because the company's cash is reduced by the $17.36 cash payments. The company's sources of resources (liabilities) decrease because once they pay the unemployment taxes, they no longer owe the federal and state governments $17.36. In terms of a journal entry, remembering assets decrease with credits and debits must equal credits, the following entry would result.


Ref. Debits CreditsNov. 10 Federal Unemployment Tax. Payable 216 2.24

State Unemployment Tax. Payable 218 15.12Cash 111 17.36

Unemployment tax payment


Payroll and payroll taxes summarized When companies hire employees, the companies become responsible for (1) paying employees' earnings and (2) paying governments for payroll taxes charged to the employers. Thus, an employer's total payroll-related expenses are the sum of its gross payroll and its payroll taxes. In the case of the Lowell Merchandising Corporation's October 31 payroll, the company's total payroll-related expenses are as follows.

Employees' gross pay $2,480.00

(L. Gurecki's $2,000 + J. Simes' $480)

Employer's payroll taxes $145.08 (FICA = $127.72 + unemployment $17.36)

Total payroll-related expenses

$2,625.08

It is important to note payroll expenses include more than just the earnings of employees. Payroll expenses include taxes charged to employers for the right to employ workers. In the case of the Lowell Merchandising Corporation, even though employees earned $2,480 during the week of October 31, the company's payroll taxes increased the company's expenses to $2,625.08.

Finally, because of governmental regulations and a willingness to help employees, companies do not pay employees their gross pay. Dollars are withheld from employees' earnings and paid to governments, unions, charities, etc. These dollar amounts withheld appear as liabilities in the accounting records of employers until they are paid to the various institutions.

** You now have the background to do exercise 10.15 and problems 10.1 and 10.2.

Current Portion of Long-term Liabilities

Chapter 11 examines long-term liabilities, which are liabilities that must be paid some time in the future, but not in the next twelve months. Some liabilities are primarily long-term liabilities but also have a current liability portion. For example, you are probably aware of the mortgages you, your parents, relatives, or friends have on their houses. Companies also have mortgages and other long-term liabilities similar to mortgages. Mortgages are mostly long-term liabilities, but they usually have amounts that must be paid off each month. The amount of a mortgage or other long-term liability that must be paid off in the next twelve months would be considered a current liability while the amount that would be paid off later would be a long-term liability. For example, on January 31, 2007 Wal-Mart had long-term debt of $32 billion. $5 billion of this debt must be paid before January 31, 2008 and, thus, was reported on Wal-Mart's January 31, 2007 balance sheet as the current liability, current portion of long-term debt. Since Wal-Mart was not required to pay the other $27 billion ($33 billion - $5 billion = $27 billion) by January 31, 2007, it was not reported as a current liability but, instead, was properly reported as a long-term liability.

Reporting the current portion of long-term liabilities as a current liability does not affect a company’s accounting equation. As discussed in detail in Chapter 11, when a long-term liability is created, the most likely effects are an increase in resources (cash) and an increase in long-term liabilities (bonds payable). Reporting part of this bonds payable liability as the current portion of long-term debt does not change either total resources or sources of resources. It simply reports some of the liability as a current liability and some as a long-term liability. In fact, in most instances no journal entries are required in the reporting of the current portion of long-term debt. The accounting


records continue to show the total debt in the bonds payable (long-term liability) account. When the financial statements are prepared, the portion of the bonds payable due to be paid within the next twelve months will be reported as a current liability and the rest will be reported as a long-term liability.

Financial Statement Reporting of Current Liabilities

Current liabilities are reported as liabilities on the balance sheet as shown below.


Cash $18,330Accounts Receivable $75,000Less: Allowance for Uncollectible Accounts $1,500 $73,500Merchandise Inventory $210,000

Total Current Assets $301,880Property, Plant, and Equipment

Land $30,000Buildings $120,000Less: Accumulated Depreciation $40,000 $80,000Machinery & Equipment $150,000Less: Accumulated Depreciation $50,000 $100,000Autos & Trucks $95,000Less: Accumulated Depreciation $55,000 $40,000

Total Property, Plant, & Equipment $250,000Total Assets $551,880

Liabilities and Stockholders’ EquityLiabilities

Current LiabilitiesNotes Payable $34,500Accounts Payable $84,490Taxes Payable $11,900Current Portion of Long-term Debt $28,000

Total Current Liabilities $158,890

The various activities that gave rise to current liabilities would appear elsewhere on the financial statements. For example, cash borrowed through the use of notes payable could still be in the cash account reported as an asset on the balance sheet. Merchandise purchased on account, which resulted in accounts payable, would be reported on the balance sheet as the asset merchandise inventory if still on hand or on the income statement as the cost of goods sold if the merchandise were sold to customers. Salaries and wages, which resulted in payroll taxes reported as part of the taxes payable liability, would be reported as part of operating expenses on the income statement. Income taxes, which resulted in income taxes payable reported as part of the taxes payable liability, would be reported as income taxes expense on the income statement.


Sales $400,000

Cost of Goods Sold $160,000

Gross Profit $240,000

Operating ExpensesSalaries and Wages Expense $103,00

0Depreciation Expense $10,000Supplies Expense $3,000Utilities Expense $9,000Rent and Insurance Expense $14,000Uncollectible Accounts Expense $1,000

Total Operating Expenses $140,000

Income from Operations $100,000

Other Revenues and (Expenses) ($1,000)Income Before Taxes $99,000Income Taxes Expense $34,650Net Income $64,350


Chapter 10 Critical Points

• One important source of resources is borrowing.• If borrowed resources must be paid for within twelve months, the source of the

resources is considered to be a current liability.• Notes payable that must be repaid in the next twelve months are current liabilities.• Notes payable require payment of principal and interest at specific dates in the future.• Accounts payable are current liabilities usually resulting from purchases of

merchandise or services.• Sales taxes payable are created when products or services are provided to customers

in states that levy sales taxes.• Income taxes payable arise when companies generate taxable income.• Deferred taxes will result when a company’s taxable income in its income statement

differs from its taxable income in its tax return.• Payroll taxes payable result from (1) withholdings from employees’ gross pay and (2)

employers being charged for government services related to employees.• Employee gross pay does not equal net pay because of payroll deductions.• Current liabilities are reported in a separate section on the balance sheet.• The following major topics have been examined so far.



Cash and Cash Equivalents (6)

Accts. Receivable (7)Allow. for Uncoll.

Accounts (7)Merchandise

Inventory (8)Property, Plant, & Equipment

Land (9)Buildings (9)Accum. Depr., Buildings

(9)Equipment (9)Accum. Depr., Equipment

(9)Autos & Trucks (9)Accum. Depr., Autos &

Trucks (9)

= LiabilitiesCurrent Liabilities

Notes Payable (10)Accounts Payable (10)Taxes Payable (10)Current Portion of Long-

term Debt (10)

+ Stockholders' EquityRevenues

Sales (7)Sales Returns &

Allowances (7)Cost of Goods Sold (8)Operating Expenses

Uncollectible Accts. Expense (7)

Depreciation Exp. (9)Salaries & Wages

Expense (10)Payroll Taxes

Expense (10)Bank Service Exp. (6)

Other Revenues & Expenses

Interest Revenue (6)Interest Expense (6)Gain or Loss on Disposal

of Prop., Plt., & Eq. (9)Income Taxes

Expense (10)

Chapter Ten Questions

1. Define the term current liabilities.

2. Give three examples of current liabilities.

3. What are notes payable?

4. When notes payable are paid off, what two dollar amounts must be paid?

5. State the formula for calculating interest on a note payable.


6. If part of the formula used to calculate interest on a note payable contained the fraction 60/365, what would the 365 represent and why is it needed?

7. On which financial statement and in which section of the statement is interest expense reported?

8. What are accounts payable?

9. What is the primary cause of accounts payable for merchandising companies?

10. What is the major difference between notes payable and accounts payable?

11. What is a purchases discount?

12. What are sales taxes payable?

13. When a company charges its customers sales taxes and later pays the sales taxes to the state, why doesn’t the company record a sales taxes expense?

14. What are income taxes payable?

15. Give three examples of services provided by the federal government.

16. What are deferred taxes and why do they exist?

17. What are the two reasons for payroll taxes?

18. Identify the two largest costs of merchandising companies.

19. Define the term gross pay.

20. What is the difference between salaries and wages?


21. What are payroll deductions?

22. Give three examples of payroll deductions.

23. Identify the two parts of the FICA social security program.

24. Define the term net pay.

25. Identify four payroll taxes levied on employers.

26. Identify a difference between FICA taxes and unemployment taxes.

27. On which financial statement are current liabilities reported?

Chapter Ten Exercises

Exercise 10.1: Notes Payable Interest

The Pappalardo Corporation is considering buying merchandise through the use of notes payable. For each of the three notes payable below, calculate the total interest the Pappalardo Corporation would pay.

1. $50,000, 8%, 60-day note payable.

2. $60,000, 9%, 90-day note payable.

3. $80,000, 10%, 120-day note payable.


Exercise 10.2: Notes Payable Journal Entries

The Hartshorn Corporation engaged in several transactions related to notes payable. Prepare journal entries to record the company's following transactions. Before you prepare each journal entry, determine the transaction's effects on the company's resources and sources of resources.

March 17 The company purchased $30,000 of merchandise by issuing a 7%, 120-day note.

Total Resources


+Sources of


+Sources of


Assets = Liabilities + Stockholders' Equity


Ref. Debits CreditsMarch 17

March 31 The company recorded the March interest expense related to the $30,000 note payable.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsMarch 31


April 30 The company recorded the April interest expense related to the $30,000 note payable.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsApril 30

May 31 The company recorded the May interest expense related to the $30,000 note payable.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsMay 31

June 30 The company recorded the June interest expense related to the $30,000 note payable.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsJune 30


July 14 The company recorded the July interest expense related to the $30,000 note payable.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsJuly 14

July 14 The company paid the note payable and interest.

Total Resources


+Sources of


+Sources of





Exercise 10.3: Using Notes Payable to Purchase Merchandise

The Tucker Corporation received $74,000 from customers for merchandise it sold to them. The merchandise was purchased by the Tucker Corporation when it issued a $40,000, 8%, 90-day note payable. The company paid the $40,000 note and interest at the end of 90 days. Determine the dollar amount by which the Tucker Corporation’s resources increased by using notes payable to acquire merchandise and then selling the merchandise to customers.


Exercise 10.4: Purchases Discounts

The Clark Corporation purchases most of its merchandise inventory on account. For each of the following purchases, determine the amount of the purchases discount the Clark Corporation can take if its pays within the discount period.

1. $20,000 merchandise purchased with terms of 2/10, n/30.

2. $10,000 merchandise purchased with terms of 1/15, n/30.

3. $25,000 merchandise purchased with terms of n/15.

Exercise 10.5: Accounts Payable Journal Entries

The Mursjid Corporation engaged in several transactions related to accounts payable. Prepare journal entries to record the company's following transactions. Before you prepare each journal entry, determine the transaction's effects on the company's resources and sources of resources.

May 10 The company purchased $20,000 of merchandise on account from the Antonelli Company. Purchase terms were 2/10, n/30.

Total Resources


+Sources of


+Sources of






May 13 The company purchased $16,000 of merchandise on account from the Laurenza Company. Purchase terms were 1/10, n/30.

Total Resources


+Sources of


+Sources of





May 18 The company paid for merchandise purchased on May 10 from the Antonelli Company.

Total Resources


+Sources of


+Sources of






May 25 The company purchased $14,000 of merchandise on account from the Brown Company. Purchase terms were n/30.

Total Resources


+Sources of


+Sources of





June 10 The company paid for merchandise purchased on May 13 from the Laurenza Company.

Total Resources


+Sources of


+Sources of





June 14 The company purchased $10,000 of merchandise for cash from the Antonelli Company.

Total Resources


+Sources of


+Sources of






June 22 The company paid for merchandise purchased on May 25 from the Brown Company.

Total Resources


+Sources of


+Sources of





Exercise 10.6: Sales Taxes Payable Journal Entries

The DeVelis Corporation operates in a state having a 7% sales tax. Prepare journal entries to record the company's following transactions. Before you prepare each journal entry, determine the transaction's effects on the company's resources and sources of resources.

July 1-31 The company had credit sales of $35,000 during July.

Total Resources


+Sources of


+Sources of






July 1-31 The company had cash sales of $49,000 during July.

Total Resources


+Sources of


+Sources of





Aug. 9 The company paid sales taxes due for July sales.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsAug. 9

Exercise 10.7: Sales Taxes Payable

The Bithoney Corporation sells its products for cash. The company operates in a state having a 6% sales tax. During February, the company recorded sales taxes payable of $48,000.

1. Calculate the dollar amount of cash sales recorded by the Bithoney Corporation in February.

2. Calculate the dollar amount of cash collected from customers by the Bithoney Corporation in February.


Exercise 10.8: Income Taxes Expense

The 2008 U.S. federal income tax rate schedule for corporations is shown below.

Taxable Income Income Taxes Payable

From ToOf taxable

income over$0 $50,000 $0 + 15% $0

50,001 75,000 $7,500 + 25% 50,00075,001 100,000 $13,750 + 34% 75,000

100,001 335,000 $22,250 + 39% 100,000335,001 10,000,000 $113,900 + 34% 335,000

10,000,001 15,000,000 $3,400,000 + 35% 10,000,00015,000,001 18,333,333 $5,150,000 + 38% 15,000,00018,333,334 35% 0

Calculate the Cavaretta Corporation’s 2008 income taxes payable under each of the following independent conditions.

1. Cavaretta Corporation’s taxable income is $30,000.

2. Cavaretta Corporation’s taxable income is $400,000.

3. Cavaretta Corporation’s taxable income is $12,000,000.

4. Cavaretta Corporation’s taxable income is $30,000,000.

5. Cavaretta Corporation’s taxable income is $3,500,000,000.


Exercise 10.9: Income Taxes Expense and Income Taxes Payable

For the year ended December 31, the Campbell Corporation reported taxable income of $780,000. The company used the same accounting methods for tax purposes and for its financial statements.

1. Calculate the dollar amount of the company’s income taxes expense and income taxes payable. For simplification, assume the income taxes rate is 35%.

2. Prepare the journal entry to record the corporation’s income taxes, assuming the taxes are not paid until the following year. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsDec. 31

3. Prepare the journal entry to record the corporation’s income taxes cash payment made in the following year. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of




Ref. Debits CreditsJan. 12


Exercise 10.10: Deferred Income Taxes

There are several differences between the accounting methods the DAmico Corporation uses in the preparation of its financial statements and in the preparation of its federal income taxes return. For the year ended December 31, the company’s taxable income on its income statement was $175,000, while it was $160,000 for income taxes purposes. For simplification, assume the income taxes rate is 35%.

1. Calculate the income taxes expense the company would report on its income statement.

2. Calculate the income taxes payable the company would report on its income taxes return.

3. Prepare the journal entry to record the corporation’s income taxes for the year ended December 31, assuming taxes are not paid until the following year. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of





Exercise 10.11: Gross Pay

The Sanghani Corporation has four employees. David Lambert and Susan LaMarca are salaried employees, while Marc Ahdab and Pamela Budd are hourly employees. Lambert’s salary is $2,000 per week. LaMarca's salary is $1,500 per week. Ahdab and Budd each earn $8 per hour plus .5% of their weekly sales. During the week ended September 25, Ahdab worked 40 hours and generated sales of $8,000, while Budd worked 40 hours and generated sales of $7,000. For her excellent performance, LaMarca earned a $250 bonus.


Calculate the gross pay of each of the Sanghani Corporation’s four employees for the week ended September 25.

Exercise 10.12: FICA Taxes

For 2008, the OASDI FICA tax rate is 6.2% of the first $102,000 of employee earnings and the Medicare FICA tax is 1.45% of all earnings. Prior to November 8, the Daoulas Corporation’s three employees had the following gross pay: Stephen Collins $100,800, Reno Defilippis $24,000, and Joseph Meuse $6,700. During the week ended November 14, Collins earned $2,500, Defilippis $900, and Meuse $500.

Calculate the dollar amount of OASDI and Medicare taxes withheld from the pay of each of the Daoulas Corporation’s three employees for the week ended November 14.

Exercise 10.13: Net Pay

For 2008, the OASDI FICA tax rate is 6.2% of the first $102,000 of employee earnings and the Medicare FICA tax is 1.45% of all earnings. Prior to October 12, Kevin Peters had earned gross pay of $100,300. During the week ended October 18, Peters earned $3,000. During the week, in addition to FICA taxes, Peters had federal income taxes of $800, state income taxes of $150, and union dues of $20 withheld from his pay.

Calculate the dollar amount of Peters’ net pay for the week ended October 18.


Exercise 10.14: Payroll Journal Entries

For the week ended June 11, the Laquidara Corporation’s payroll was as follows.Gross pay $265,000.00Deductions

Federal Income Taxes $78,500.00State Income Taxes $13,400.00OASDI FICA Taxes $14,200.00Medicare FICA Taxes $3,842.50Union Dues $950.00Insurance $2,400.50

Prepare the journal entry to record the corporation’s payroll for the week ended June 11. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of





Exercise 10.15: Employer Payroll Taxes

Prior to December 14, the Smetana Corporation’s three employees had the following gross pay: Kevin Shaw $101,400, Melissa Machado $28,000, and Linda Forte $6,800. During the week ended December 20, Shaw earned $2,900, Machado $1,100, and Forte $800. For 2008, the OASDI FICA tax rate is 6.2% of the first $102,000 of employee earnings and the Medicare FICA tax is 1.45% of all employee earnings. The corporation’s federal unemployment tax rate is .8% of the first $7,000 earned by each employee and its state unemployment tax rate is 5.4% of the first $7,000 earned by each employee.


1. Calculate the dollar amount of each of the following payroll taxes for the Smetana Corporation for the week ended December 20.

A. OASDI FICA tax.

B. Medicare FICA tax.

C. Federal unemployment tax.

D. State unemployment tax.

2. Prepare the journal entry to record the corporation’s payroll taxes for the week ended December 20, assuming taxes are not paid until the following year. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of






Exercise 10.16: Reporting Current Liabilities

The following account balances were reported by the Sotirakos Corporation on March 31. Prepare the current liabilities section of the company’s March 31 balance sheet.

Accounts Payable $18,000Accounts Receivable $46,000Accumulated Depreciation, Buildings $35,000Accumulated Depreciation, Equipment $85,000Allowance for Uncollectible Accounts $7,500Buildings $240,000Cash $9,300Common Stock $150,000Current Portion of Long-term Debt $16,500Equipment $459,000Land $45,000Long-term Debt $395,000Merchandise Inventory $57,500Notes Payable $180,000Retained Earnings $120,300Taxes Payable $11,500


Chapter Ten Problems

Problem 10.1: Payroll

Holly Matson's business, Matson Consulting Incorporated, has 5 employees who are paid each week. As of November 8, each employee's gross earnings were as follows.

Archambault $18,000Cavaretta $6,900Hsu $101,300Norton $3,000Santos $105,000

For this year, the OASDI FICA tax rate is 6.2% of the first $102,000. The Medicare FICA tax rate is 1.45% of gross pay. Federal unemployment tax is .8% of the first $7,000 per employee. State unemployment tax is 4% of the first $7,000 per employee.

1. Complete the Matson Consulting Incorporated payroll register for the week ended November 15.

Employee Gross FIT SIT OASDI Medicare Union NetArchambault $800.00 $140.00 $42.00 $______

_$______

_$7.00 $549.80

Cavaretta $500.00 $80.00 $26.00 $_______

$7.25 $7.00 $________

Hsu $1,600.00 $350.00 $84.00 $_______

$_______

$7.00 $________

Norton $200.00 $30.00 $11.00 $12.40 $_______

$7.00 $________

Santos $2,700.00 $600.00 $142.00 $_______

$_______

$7.00 $________

Totals $5,800.00 $_______ $_______

$136.40 $_______

$_______

$4,039.50

2. Prepare the journal entry to record the payroll for the week ended November 15. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of




Date Description Debits CreditsNov. 15 Salaries and Wages Expense $5,800.00

____________________ $____________________________ $________FICA Taxes Payable $ 220.50____________________ $____________________________ $________

______________________________________

3. Prepare the journal entry to record the payroll taxes for the week ended November 15. Before

you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of



Date Description Debits CreditsNov. 15 Payroll Taxes Expense $234.90

____________________ $____________________________ $________State Unemployment Tax Payable $ 12.00

_____________________________________


Problem 10.2: Payroll

Robert Donaruma's business, Donaruma Investments Incorporated, has 5 employees who are paid each week. As of September 8, each employee's gross earnings were as follows.

Almeida $140,000Curotto 100,800Forte 28,000LaMarca 6,800Pidgeon 2,000

For this year, the OASDI FICA tax rate is 6.2% of the first $102,000. The Medicare FICA tax rate is 1.45% of gross pay. Federal unemployment tax is .8% of the first $7,000 per employee. State unemployment tax is 4% of the first $7,000 per employee.

1. Complete the Donaruma Investments Incorporated payroll register for the week ended September 15.

Employee Gross FIT SIT OASDI Medicare Union NetAlmeida $3,500.00 $700.00 $175.00 $______ $______ $3.00 $2,571.25Curotto $1,500.00 $270.00 $75.00 $______ $21.75 $3.00 $________Forte $700.00 $110.00 $35.00 $______ $______ $3.00 $________LaMarca $400.00 $50.00 $20.00 $24.80 $______ $3.00 $________Pidgeon $300.00 $30.00 $15.00 $______ $______ $3.00 $________ Totals $6,400.00 $______ $______ $161.20 $______ $______ $4,651.00

2. Prepare the journal entry to record the payroll for the week ended September 15. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of




Date Description Debits CreditsSept. 15 Salaries and Wages Expense $6,400.00

____________________ $____________________________ $________FICA Taxes Payable $ 254.00____________________ $____________________________ $________

___________________________________

3. Prepare the journal entry to record the payroll taxes for the week ended September 15. Before you prepare the entry, determine the transaction's effects on the company's resources and sources of resources.

Total Resources


+Sources of


+Sources of



Date Description Debits CreditsSept. 15 Payroll Taxes Expense $278.00

____________________ $____________________________ $________State Unemployment Tax Payable $ 20.00_________________________________

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