Current liabilities and payroll

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					Chapter 11 - Current liabilities and payroll
Beginning with Chapter 7, you have learned about internal control - procedures designed to safeguard assets. These procedures were applied to cash in Chapter 7. Thereafter, additional assets were introduced: receivables (Chapter 8), inventory (Chapter 9), and non-current assets (Chapter 10). In this chapter we continue to focus on the statement of financial position, but switch to the other side of the accounting equation and examine liabilities, specifically current liabilities and payroll. Noncurrent liabilities are examined in Chapter 16. The learning objectives for this chapter are to: 1. 2. 3. 4. 5. 6. Account for current liabilities of known amount. Account for current liabilities that must be estimated. Calculate payroll amounts. Record basic payroll transactions. Use a payroll system. Report current liabilities on the statement of financial position.

Liabilities are obligations to transfer assets (for example, to make cash payments for purchases on account) or to provide services in the future (for example, to earn unearned revenue). Current liabilities are due within one year or within the company’s operating cycle if it is longer than one year. Non-current liabilities are those not classified as current.

Objective 1 - Account for current liabilities of known amount.
Current liabilities include liabilities of a known amount and liabilities that are estimated. Current liabilities of a known amount are:   accounts payable: amounts owed to suppliers for goods or services purchased on account short-term bills payable: bills due within one year. Companies issue bills payable to borrow cash, to purchase inventory, or to purchase non-current assets. Interest expense and interest payable must be accrued at the end of the accounting period.

Suppose a company acquires inventory and issues a bill payable. The entry is: Inventory Bills Payable (Short-Term) XX XX

Interest expense and interest payable are recorded at the end of the accounting period with this entry: Interest Expense Interest Payable XX XX

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When the bill is paid off at maturity, the entry is: Bill Payable Interest Payable Interest Expense Cash XX XX XX XX

Bills payable are often issued at a discount. This means that the borrower repays the interest and receives cash in an amount equal to the face value of the bill less the discount. The entry is: Cash Bills Payable (Short-Term) XX XX

At the end of the financial period an adjusting entry is needed to accrued interest that is calculated on the face value of the bill: Interest Expense Bills Payable XX XX

Crediting Bills Payable increases the balance of the Bills Payable. When the bill is paid off, two entries are required. First, the balance (from the beginning of the current financial period to the present) of interest expense is recorded: Interest Expense Bill Payable XX XX

The balance in Bills Payable is now the face value so…. Second, the payment is recorded: Bills Payable Cash XX XX

Other current liabilities are accrued expenses, unearned revenues, payroll liabilities, the current portion of long-term debt, and contingent liabilities of a known amount (such as contingent liabilities arising from bills discounted and guaranteed bills). The GST is added to most retail sales. GST is usually collected in addition to the price of an item. Retailers are actually collecting the tax for the government, and therefore GST Clearing (when in credit) is a current liability. In previous chapters it was explained that businesses also receive back the GST they have paid. The GST Clearing account contains the net GST to be paid or refunded. Some non-current liabilities, such as bills, bonds, or mortgages are paid in instalments. The current portion of long-term debt is the amount of that debt that is payable within one year. It is reported in the current liabilities section of the statement of financial position. The remainder is reported in the non-current section of the statement of financial position. Accrued expenses such as interest payable and payroll items are current liabilities. Unearned revenues occur when a company receives cash from customers before earning the revenue. As goods are delivered or services are rendered, revenue is recorded. Unearned revenue is recorded as:


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Cash Unearned Revenue


As the unearned revenue is earned, it is recorded as: Unearned Revenue Revenue XX XX

Objective 2 - Account for current liabilities that must be estimated.
Current liabilities that are estimated include warranties payable, holiday pay liability, and income tax payable (for a company). Recall that the matching principle requires that expenses be matched with revenues. A company can reasonably estimate, often as a percentage of sales, the amount of warranty expense that will be incurred as a result of defective products. Estimated Warranty Payable is a current liability, recorded as: Warranty Expense Estimated Warranty Payable XX XX

It is important to remember that when a repair or replacement occurs within the warranty period, the Estimated Warranty Payable (rather than Warranty Expense) is debited. Most companies provide paid holidays to their employees. The matching principle dictates that the amount of holiday pay employees have earned be recorded in the period when it was earned and not in a subsequent period when the employee actually takes the time off with pay. Therefore, the company needs to accrue the estimated holiday liability each period, as follows: Holiday Pay Expense Estimated Holiday Pay Liability XX XX

When an employee takes time off with pay, the liability account is debited as follows: Estimated Holiday Pay Liabilities Cash XX XX

Like sole proprietorships and partnerships, companies must pay taxes on their income. On a regular basis throughout the year, companies send in payments to the Australian Taxation Office, recorded as follows: Income Tax Expense Cash XX XX

At the end of the year, the corporation must accrue the taxes owed, but not yet paid, as follows: Income Tax Expense Income Tax Payable XX XX

The liability will be removed when the company remits a payment to the ATO.

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A contingent liability is a potential liability that depends on a future event that may occur as the result of a past transaction. Contingent liabilities may be difficult to estimate, as in lawsuits, where the amounts are determined by the courts. The disclosure principle requires companies to keep outsiders informed of relevant information about the company. Accounting for both current liabilities and contingent liabilities can pose ethical challenges for the business. Because some current liabilities must be estimated (which means the related expense is also estimated), someone may attempt to manipulate the amount of the estimate in an attempt to manipulate the amount of reported profit. In addition, someone may choose to overlook, or underestimate, the amount of a contingent liability. External auditors are particularly concerned with unreported liabilities and want to ensure that the financial statements are accurate. Review the Decision Guidelines following contingent liabilities in your text on page 459.

Objective 3 - Calculate payroll amounts.
Gross pay is the total amount an employee earns before taxes and other deductions. Net pay is the amount of money the employee receives (take home pay). Some payroll deductions from gross pay are required, such as ‘Pay-as-You-Go’ income taxes (and Medicare levy), and in some cases superannuation. Others are optional, such as union dues and health insurance premiums. The amount of income tax withheld is determined by the amount earned, and the number of rebates claimed by the employee (this information is supplied to the business when the employee completes a tax file number declaration - see Exhibit 11-4 in your text). The amounts withheld from gross pay are liabilities the employer (boss) has to outside parties. Often the employer and the employee contribute to superannuation. The employer may also provide a car and a number of other ‘fringe benefits’. The cost of all the benefits, including gross pay, provided to the employee are added together and called the ‘salary package’. In addition to taxes withheld from employees’ earnings, the employer is responsible for payment of the compulsory ‘superannuation guarantee levy’, workers compensation insurance and payroll tax which is levied by the State governments. These amounts are expenses to the employer, not payroll deductions, and are costs in addition to gross pay of employing people. Exhibit 11-5 shows a typical disbursement of payroll costs by an employer.

Objective 4 - Record basic payroll transactions.
The following example shows how payroll entries are made. Suppose that when you graduate, you get a job that pays $4,000 per month, and you are paid monthly. Assume also that your employer pays $170 per month for your health insurance and $360 per month for your superannuation, and is required to pay payroll tax of $240. Your pay slip reports the following: Gross pay Superannuation* Income Tax (and Medicare) Deducted Net Pay * Employee’s superannuation contribution $4,000 260 1,040 $2,700


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Your employer’s entry to record salary expense is: Salary Expense Employee Income Tax Payable Superannuation Payable Salary Payable to Employee Your employer would record payroll expense as: Payroll Tax Expense Payroll Tax Payable 240 240 4,000 1,040 260 2,700

Finally, your employer would record fringe benefits expense: Health Insurance Expense Superannuation Expense Employee Benefit Payable 170 360 530

Objective 5 - Use a payroll system.
A payroll system includes these components: 1. 2. 3. 4. a payroll record (or register) a payroll bank account payroll cheques an earnings record for each employee.

1. The payroll record lists individual earnings and deductions for employees as well as totals. Computerised systems may also calculate employer payroll tax expense and compulsory ‘superannuation guarantee’ levy. The payroll register is the source document for recording the payroll. (See Exhibit 11-7.) 2. The company deposits money in the payroll bank account exactly to cover net pay. 3. Most companies pay employees by ‘direct deposit’ or electronic funds transfer and issue a ‘pay slip’ which lists gross pay, deductions, and net pay. A payroll cheque that has the details of the pay slip may be used by some. Using the example in the previous section, the entry your employer makes when your pay is distributed to you is: Salary Payable Cash (Payroll account) 2,700 2,700

Assume you are the only employee of your company. Then taxes are remitted to the government and other authorities are paid. The entry is: Employee Income Tax Payable Superannuation Payable ($260 + $360) Payroll Tax Payable Health Insurance Payable Cash (Regular account) 1,040 620 240 170 2,070

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Note that the Superannuation Payable amount ($620) includes both the amount withheld from your pay ($260) and the amount recorded by your employer as an employee benefits expense ($360). 4. Employers maintain earnings records (see Exhibit 11-9) and prepare PAYG Payment Summary (still often referred to as a ‘group certificates’) (see Exhibit 11-10 ) for their own records, the Australian Taxation Office and the employees. Internal Control over Payroll Special controls for payroll accounting are necessary because of the large number of transactions and the number of different parties involved. These controls are designed to maintain an efficient system while, at the same time, safeguarding payroll payments. Efficiency is achieved when separate bank accounts are maintained for payroll payments, while payroll disbursements are safeguarded through the separation of duties related to personnel (hiring and firing) and payroll (cheques distribution or EFT, time cards, employee identification cards, etc.)

Objective 6 - Report current liabilities on the statement of financial position.
At the end of the financial year, liabilities are reported on the statement of financial position. The year-end payroll liability is the amount of payroll expense still unpaid. Study Exhibit 11-11 in your text to review how current liabilities are reported on the statement of financial position and the categories of current liabilities.

All the self-testing materials in this chapter focus on information and procedures that your instructor is likely to test in quizzes and examinations.

I. Matching Match each numbered term with its lettered definition.
_____ 1. _____ 2. _____ 3. _____ 4. _____ 5. _____ 6. _____ 7. _____ 8. PAYG payment summary superannuation Medicare levy conservatism gross pay net pay employment declaration contingent liabilities _____ 9. discounting a bill payable _____ 10. current asset; bill payable _____ 11. payroll tax _____ 12. tax instalment deductions _____ 13. commission _____ 14. overtime _____ 15. fringe benefits _____ 16. internal control

A. a liability which may arise in the future B. a borrowing arrangement in which the bank subtracts the interest amount from the bill’s face value and the borrower receives the net amount C. benefits which an employee will receive after retirement D. the form given to both the employee and the ATO setting out gross wages and tax deducted during the financial year E. a form submitted by each employee indicating the employee’s rebates and assistance claimed F. employee compensation calculated as a percentage of the sales that the employee has made


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G. employee compensation, like health and personal use of a motor vehicle, which the employee does not receive immediately in cash H. a guiding principle which suggests accountants and auditors should not understate the liabilities I. income taxes that are deducted from employees’ gross pay and remitted to the government J. the amount of employee compensation that the employee actually takes home K. bill payable due within one year, a common form of financing L. excess hours worked for which a premium is earned M. a tax paid by employers to the state government, based on gross salaries N. an amount in addition to tax withheld from an employee’s gross salary equal to 1.5% of gross salary used by the federal government for health care O. the total amount of salary, wages, commissions, or any other employee compensation before taxes and other deductions are taken out P. procedures used to improve efficiency and safeguard payroll payments

II. Multiple Choice

Circle the best answer.

1. Which of the following is not a current liability? A. Warranties B. Superannuation Expense C. Unearned Revenue D. Holiday Pay Liability

2. Interest on a discounted bill payable is recorded: A. at maturity B. at the end of the accounting period C. in monthly payments D. when the bill is discounted

3. Which of the following is probably a contingent liability? A. Interest Payable B. Bills Payable C. Lawsuit Claims D. Income Tax Payable

4. The major expense of most service organisations is: A. Payroll B. Interest Expense C. Cost of Goods Sold D. Rent Expense

5. A contingent liability becomes a real liability when: A. a loss is probable but cannot be estimated B. a loss is possible C. a loss is probable and can reasonably be estimated D. a loss can be reasonably estimated

6. Which of the following is a tax added to the selling price? A. income tax B. Medicare tax C. state payroll tax D. goods and services tax

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7. Which of the following is not a component of a payroll? A. payroll cheque B. payroll record C. payroll petty cash fund D. earnings records

8. Which of the following is not a control for safeguarding cash in a payroll system? A. B. C. D. separating hiring duties from the pay disbursement duties requiring employees to wear identification badges maintaining two payroll bank accounts having employees punch a time clock

9. Which of the following is not required to calculate tax instalment deductions for an employee? A. occupation B. HECS debt C. claiming tax-free threshold D. amount of gross pay

10. Which of the following is not an estimated liability? A. Warranties B. Company Income Tax Payable C. Holiday Pay D. Bills Payable

III. Completion

Complete each of the following statements.

1. Estimating the warranty expense is an example of the _________________________ principle. 2. Discount on Bills Payable is a(n) ______________________________________ account. 3. Listing a contingent liability is an example of the _____________________________ principle. 4. To calculate the amount to tax instalment deductions for income taxes, the following information (among others) is required from the tax file number declaration: ________________________________________, ___________________________________, and _____________________________________________________________________________. 5. The two main figures shown on a group certificate are _______________________________ and ___________________________________________________. 6. The ‘Employment Declaration’ is completed by both the ______________________________ and the ______________________________. 7. Most employees are now paid by having their pay placed directly into their bank accounts (direct credit). From the employer’s perspective this system has at least two advantages: it provides good ______________________________ and is _______________________________. 8. ATO is an acronym for the _____________________________________________________.


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9. The account title Payroll Tax Expense reflects which level of government tax? ______________. 10. For a contingent liability to be recorded, SAC 4 requires that the liability be both ________________ and _____________________.

IV. Daily Exercises
1. Indicate whether each of the following is paid by the employee (deducted from his or her gross pay), and which is paid by the employer, or both. Paid by employee Donations to charity Medicare levy Payroll tax Income tax Superannuation Union dues Fringe benefits tax Paid by employer

2. Indicate whether each of the following liabilities is a known amount (K) or an estimated amount (E). _____ _____ _____ _____ _____ _____ A. B. C. D. E. F. Accounts Payable Bills Payable Property (Land) Taxes Payable Warranty Payable Salaries Expense Income Taxes Payable _____ _____ _____ _____ _____ G. H. I. J. K. GST Payable Liability for Holiday Pay Superannuation Benefits Interest Payable Long Service Leave Payable

3. Record the following transactions: a. On June 1, a used truck is purchased for $12,000, and a six-month, 12% bill payable is issued.

b. Adjust for interest as of June 30, the close of the financial year.

c. The payment of the bill on December 1.

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4. Review the facts in Daily Exercise #3 above but assume the company signed a bill for $12,720 with the interest included in the face value of the bill. Record the June 1, June 30, and December 1 entries. (This method of recording bills payable is not used in the textbook but some of your lecturers may wish you to see an alternative way to record this type of transaction.)

5. If a company has net sales of $4,200,000, and past experience indicates estimated warranty expense to be 2.5% of net sales, record the adjusting entry for the warranty payable. Assuming a customer returns an item covered by the warranty the following month, and the company uses $75 in parts and $115 in labour to repair the item, present a journal entry to record the repair.

V. Exercises
Make journal entries for each of the following independent transactions or groups of transactions. 1. A company borrows $12,000 on February 1, giving a 9%, a one-year bill payable. GENERAL JOURNAL Date Accounts Debit Credit

Record an adjusting entry on June 30 for the above bill. GENERAL JOURNAL Date Accounts Debit Credit


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2. A company discounts a $40,000, 120-day bills payable to the bank at 12% on 2/10/05. GENERAL JOURNAL Date Accounts Debit Credit

3. A company receives $13,580 when it discounts a four-month bill payable at 9%. Record the receipt of the money and the repayment of the bill four months later. GENERAL JOURNAL Date Accounts Debit Credit

4. The entry to record sales revenue and 10% goods and services tax on sales of $99,000 (including GST) made during the month of August (hint: divide by 11). GENERAL JOURNAL Date Accounts Debit Credit

5. Sue Simmons earns $20.00 per hour with time and a half for more than forty hours per week. During the second week of the new year, she worked forty-eight hours. Sue’s payroll deductions include income tax of $273, Medicare at 1.5%, and a contribution to the Accountants’ Retirement Superannuation Fund of $78.00 per week. GENERAL JOURNAL Date Accounts Debit Credit

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VI. Beyond the Numbers
Review the information in Exercises 1 and 2 above and for each bill record all the transactions as they would appear on the books of the bank (the one lending the money) for the life of each bill. GENERAL JOURNAL Date Accounts Debit Credit

VII. Demonstration Problems
Demonstration Problem #1 Green Stems is a small flower shop that employs three people. Glenda Green is the store’s salesperson, and Rose Pinard and Janice Flowers are part-time employees. For the month of June 2006, Glenda’s gross salary was $5,800. Rose worked 55 hours, 40 of them at her regular wage of $10.00 per hour, and the remaining 15 hours at time and a half for overtime. Janice worked 35 hours, all at her regular rate of $10.00 per hour.


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Assume the following additional facts: From tables provided by the ATO we have calculated the amount of withheld income tax and Medicare levy to deduct from each salary:

Glenda Rose Janice Optional monthly deductions: Glenda Green Rose Pinard

$2,320 $11 Zero

Superannuation $250 Amnesty International $20

Superannuation Guarantee: The company is required to contribute to a superannuation fund an amount equal to 9% of gross salary.

Payroll Tax The company is required to pay the state government 7% of gross pay as payroll tax (states exempt small businesses - defined as gross salaries below a set level, from payroll tax, unless they are part of a ‘group’ of companies, which must be the case here).

Required: 1. Calculate the gross and net pay of each employee for the month of June. 2. Record the following payroll entries that Green Stems would make for: a. b. c. d. e. f. expense for employee salary, including overtime pay employer’s payroll taxes expense for superannuation guarantee payment of cash to employees payment of all taxes payment of optional deductions.

3. What was the total payroll expense incurred by Green Stems for the month of June? How much cash did the business actually spend on its payroll including all costs incurred beyond the cost of the gross payroll?

Requirement 1 Gross Pay Glenda Green Rose Pinard Janice Flowers Total Gross Pay

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Net pay Explanation Green Pinard Flowers

Requirement 2 Date

GENERAL JOURNAL Accounts Debit Credit


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Requirement 3 Total June Payroll

Total Cash Spent in June

Demonstration Problem #2 The following events occurred in December at Vega Del Toro Company: 1. On June 1, borrowed $15,000 from the bank, signing a six-month bill at 9% interest. 2. On June 15, purchased equipment and signed a one-year, non-interest-bearing bill payable for $10,000. The cash price of the equipment was $9,100. 3. During June a competitor filed a lawsuit against the company alleging violation of a patent. If the company loses the suit, it is estimated damages will exceed $1 million. 4. The June payroll totalled $45,000, which will be paid on July 10. Employees accrue holidays benefits at the rate of 2% of monthly payroll. (Ignore payroll deductions and the employer’s payroll tax expense.) 5. Sales for the month amounted to 700 units at $200 each, subject to a GST of 10%. Each unit carries a ninety-day warranty requiring the company to repair or replace the unit if it becomes defective during the warranty period. The estimated cost to the company to honour the warranty is $45, and past experience has shown that approximately 3% of the units will be returned during the warranty period.

Required: 1. Record the external transactions and, where appropriate, the required adjusting entry at June 30. 2. Based on your entries in Requirement 1, present the current liability section of the statement of financial position.

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Requirement 1 (Journal entries) Date Accounts Debit Credit

Requirement 2 (Current liability section of statement of financial position)


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SOLUTIONS I. Matching
1. 2. 3. 4. D C N H 5. 6. 7. 8. O J E A 9. B 10. K 11. M 12. I 13. 14. 15. 16. F L G P

II. Multiple Choice
1. B Of the items listed, all are liabilities that are due within one year except for superannuation which is an expense. The bill payable is discounted (interest is taken out) when the loan is made. The bank subtracts the interest from the bill’s face and we record the interest both at the end of the financial period (if it occurs during the life of the bill) and at maturity. A contingent liability is not an actual liability. It is a potential liability that depends on a future event arising out of a past transaction. Of the items listed, all except ‘lawsuit claims’ are real liabilities. Recall that Cost of Goods Sold is the largest expense for a retailing business. The efforts of employees are a significant part of doing business in service companies and, accordingly, Payroll is often the major expense. Record an actual liability when 1) it is probable that the business has suffered a loss, and 2) its amount can be reasonably estimated. Goods and services tax is 10% added to most goods and services. Of the items listed, all are components of a payroll except for the ‘payroll petty cash fund’ which is a non-existent item. Of the items listed, only B is not a control for safeguarding cash in a payroll system. Income taxes are based on gross pay, not your occupation (see the Employment Declaration on page 462 of the textbook). Bills payable are a known liability; all the others are estimated.


A & B C






6. 7.


8. 9.




III. Completion
1. matching (Matching means to identify and measure all expenses incurred during the period and to ‘match’ them against the revenue earned during that period.) 2. contra liability (It has a debit balance.)

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3. disclosure (providing relevant information to outsiders) 4. basis of payment (item 7), residency status (item 8), claiming the tax free threshold (item 9), family assistance and tax offset (item 10 and 11), HECS (item 12) and offset superannuation (item 13) 5. yearly gross wages, tax deducted 6. employee, employer 7. internal control, efficient (or less expensive than cash or cheque payments) 8. Australian Taxation Office 9. State 10. Probable, reasonably estimated

IV. Daily Exercises
1. Paid by employee Paid by employer Donations to charity x Medicare levy x Payroll tax x Income tax x Superannuation x x Union dues x Fringe benefits tax x (The fringe benefits tax is paid by the employer but is usually added in to calculate the employees ‘salary package’.)

2. K K E or K E K E or K A. B. C. D. E. F. Accounts Payable Bill Payable Property (Land) Taxes Payable Warranty Payable Salaries Expense Income Taxes Payable K E or K E K E G. H. I. J. K. GST Payable Liability for Holiday Pay Superannuation Benefits Interest Payable Long Service Leave Payable (this would have required some research)

3. Equipment (Truck) Bills Payable Interest Expense Interest Payable ($12,000  12%  1/12) Bills Payable Interest Payable Interest Expense Cash 12,000 12,000 120 120

12,000 120 600 12,720


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4. Truck Discount on Bills Payable Bills Payable Interest Expense Discount on Bills Payable Bills Payable Interest Expense Discount on Bills Payable Cash 12,000 720 12,720 120 120 12,720 600 600 12,720

5. Warranty Expense Estimated Warranty Payable ($4,200,000  2.5%) Estimated Warranty Payable Parts Inventory Wage Expense 105,000 105,000

190 75 115

Study Tip: Note the cost of the employee’s time to repair the item is included in the total debit to the estimated warranty payable account. The amount for wages originally recorded as an expense is netted off to the payable - it is not an expense of the period in which the repair is recorded.

V. Exercises 1. GENERAL JOURNAL Date 1/2 Accounts Cash Bill Payable Debit 12,000 Credit 12,000

Adjusting entry on June 30: GENERAL JOURNAL Date 30/6 Accounts Interest Expense Interest Payable Debit 450 Credit 450

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2. GENERAL JOURNAL Date 2/10 Accounts Cash Bill Payable Discount = 40,000  .12  120/360 = $1,600 Debit 38,400 Credit 38,400

3. GENERAL JOURNAL Date Cash Bills Payable Discount = Bills Payable  0.09  4 months Working back Cash + Discount = Bills Payable 13,580 + (Bills Payable  0.09  4/12) = Bills Payable 13,580 / 0.97 = 14,000 Bill Payable Interest Expense Cash 13,580 420 14,000 Accounts Debit 13,580 Credit 13,580

4. GENERAL JOURNAL Date Cash GST Clearing Sales Revenue 33,000 / 11 = GST Accounts Debit 99,000 Credit 9,000 90,000

5. GENERAL JOURNAL Date Accounts Wage Expense Income Tax Payable Medicare Tax Payable Accountants Superannuation Payable Wage Payable Wage Expense = (40 hrs  $20) + (8 hrs  $20  1.5) Debit 1,040 Credit 373.00 15.60 78.00 573.40


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VI. Beyond the Numbers
1. Date 1/2 Accounts Bill Receivable Cash Interest Receivable Interest Revenue Cash Bill Receivable Interest Receivable Interest Revenue Debit 12,000 Credit 12,000 450 450 13,080 12,000 450 630



2. 2/10

Bill Receivable Cash Cash Bill Receivable Interest Revenue

38,400 38,400 40,000 38,400 1,600


Study Tip: If it is a Bill Payable to the maker, then it must be a Bill Receivable to the payee.

VII. Demonstration Problems
Demonstration Problem #1 Solved and Explained Requirement 1 Gross Pay $5,800 625 350 $6,775

Glenda Green Rose Pinard Janice Flowers Total Gross Pay

(Salary) (40 hrs  $10 + 15 overtime hrs  $15) (35 hrs  $10 per hr)

Gross pay represents an employee’s total earnings before any amounts (for taxes and optional deductions) are subtracted. Net pay Explanation Gross pay Less: Income tax and Medicare levy Optional deductions: Superannuation Amnesty International Net pay Green 5,800 2,320 250 3,230 20 594 350 Pinard 625 11 Flowers 350 0

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Requirement 2 GENERAL JOURNAL Date a. Accounts Sales Salary Expense Office Salary Expense Income Tax Payable (2,320 + 11) Superannuation Payable Amnesty International Payable Salary Payable to Employees PR Debit 5,800 975 Credit

2,331 250 20 4,174


Payroll Tax Expense Payroll Tax Payable (7% of $6,775)

474.25 474.25

The cost of payroll to an employer will often exceed the actual compensation earned by employees by a substantial amount. In addition to payroll tax and workers compensation insurance, numerous additional costs can greatly increase the cost of payroll. Note the company does not incur an expense for a tax and optional deductions. The company merely acts as a collector for the ATO and superannuation fund (or as a collector for another third party). The only taxes and other collections or payments that ultimately result in an expense to the business are those paid by the business, such as payroll tax and workers compensation insurance.

Date c.

Accounts Superannuation Guarantee Expense (6,775  0.09) Superannuation Guarantee Payable Salary Payable (to Employees) Cash Income Tax Payable Payroll Tax Payable Superannuation Guarantee Payable Cash Superannuation Payable Amnesty International Payable Cash


Debit 609.75

Credit 609.50


4,174.00 4,174.00 2,331.00 475.25 609.50 3,415.75 250.00 20.00 270.00




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Requirement 3 The total cost of the payroll includes gross salaries and wages plus all additional costs to the employer in the form of either fringe benefits or payroll related taxes paid by the employer. Summarised in entries (a) to (c) above, total December payroll for Green Stems, Inc. totalled $7,531.73, calculated as follows: Total December Payroll Gross wages: Sales salary Office salary Payroll tax expense (entry b) Superannuation Guarantee (entry c)

$5,800.00 975.00 475.25 609.50 7,859.75

Total cash spent by the business is also $7,859.75 as summarised by entries (d) to (f).

Demonstration Problem #2 Solved and Explained Requirement 1 1. 1/6 Cash Bill Payable Interest Expense Interest Payable 15,000 15,000 112.50 112.50


The company needs to accrue interest expense for June, calculated as follows: $15,000 × 0.09 × 1/12 = $112.50

2. 15/6

Equipment 9,100 Bill Payable 9,100 Since the cash price of the equipment on the purchase date is $9,100, there will be $900 in interest to pay over the life of the bill. Interest Expense 37.50 Bills Payable 37.50 Since the $900 in interest applies to the life of the bill (one year), a portion needs to be transferred to interest expense for June, calculated as follows: $900 × 15/360 = $37.50 (same as 900  1/24 i.e. half a month - for reasons of simplicity in calculations we often use 360 days rather than 365) 30/6

3. No entry required. However, the footnotes to the statement of financial position should contain information about this lawsuit. This is an example of a contingent liability.

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4. 30/6

Salary Expense Salary Payable

45,000 45,000

Holiday Pay Expense 900 Estimated Holiday Pay Liability


The matching principle requires that the additional expense of holiday pay be included with June’s other expenses. The calculation is $45,000 × .02 = $900. As employees claim their holiday pay, the entry is: Estimated Holiday Pay Liability XX Cash XX (Of course, holiday pay is subject to taxes just as salaries are.)


Accounts Receivable Sales GST Clearing

147,000 133,636 13,364 (rounded)

(GST is $147,000 / 11 = $13,363.60 - you can check by taking $133,636 and adding 10% = $147,000)

12/31 Warranty Expense Estimated Warranty Payable

945 945

The warranty expense is based on the cost to the company of repairing or replacing each unit. Therefore, the estimate is calculated as follows: Unit sales × estimate × cost to repair/replace 700 × 0.03 × $45 = $945 Study Tip: Estimating warranty expense is another example of the matching principle.

Requirement 2 (Current liability section of statement of financial position) Bills Payable ($15,000 + $9,100 + $37.50) Interest Payable Salaries Payable Holiday Pay Liability GST Clearing Warranty Payable Total Current Liabilities $24,138 112 45,000 900 13,364 945

Materiality means cents are not normally shown in the statement of financial positions.


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Description: 1. Account for current liabilities of known amount. 2. Account for current liabilities that must be estimated. 3. Calculate payroll amounts. 4. Record basic payroll transactions. 5. Use a payroll system. 6. Report current liabilities on the statement of financial position.