1. No. A discounted note payable has no stated interest rate, but provides interest by discounting the note proceeds. The discount, which is the difference between the proceeds and the face of the note, is the interest and is accounted for as such.
2. a. Employee’s federal income taxes, social security, and Medicare
b. Employees Federal Income Tax Payable, Social Security Tax Payable, and Medicare Tax Payable
3. The deductions from employees’ earnings are for amounts owed (liabilities) to others for such items as federal taxes, state and local income taxes, and contributions to pension plans.
4. 1. a2. c3. c4. b5. b
5. An advantage of using a separate payroll bank account is that reconciling the bank statementsis simplified. In addition, a payroll bank account establishes control over payroll checksand, thus, prevents their theft or misuse.
6. a. Constants are data that remain unchanged from payroll to payroll. These include employeenames, social security numbers, marital status, number of income tax withholding allowances, rates of pay, tax rates, and withholding tables.
b. Variables are data that change from payroll to payroll. These include number of hours ordays worked for each employee, accrued days of sick leave, vacation credits, total earningsto date, and total taxes withheld.
7. The vacation pay expense should be recorded during the period in which the vacation privilege is earned.
8. In a defined contribution plan, the company invests contributions on behalf of the employeeduring the employee’s working years. Normally, the employee and employer contribute to the plan. The employee’s pension depends on the total contributions and the investment returnsearned on those contributions.
9. To match revenues and expenses properly, the liability to cover product warranties should be recorded in the period during which the sale of the product is recorded.
10. When the defective product is repaired, the repair costs would be recorded by debiting Product Warranty Payable and crediting Cash, Supplies, or another appropriate account.
11. IAS 37 uses the word “provision” to make a distinction between a relatively low uncertain present obligation while leaves the term “contingent liability” to represent possible obligation or high uncertain present obligation.An entity should recognize a provision when and only when all the following three criteria are met: (1) the entity has a present obligation (legal or constructive) as a result of a past event (the obligating event); (2) an outflow of economic resources is probable (more likely than not)for the settlement of the obligation, and(3) the amount can be estimated reliably.A contingent liability is disclosed but not accrued.
12. The primary difference between a provision and a contingent liability is the likelihood of potential resource outflows and the reliability of the estimated amount for the outflows. For a provision, the likelihood of the outflows has to be probably, i.e., a likelihood of more than 50 percent, and the estimated amount of outflows has to be reliable. A provision is recognized while a contingent liability is disclosed. When the likelihood of the resourceis more than 50 percent but the estimated amount is unreliable, only contingent is disclosed and a provision is not recognized.
13. According to IAS 1 Presentation of Financial Statements , a liability is classified as current when thefollowing conditions are satisfied:(a) the reporting entity expects to settle the liability in its normal operating cycle; (b) the reporting entity holds the liability primarily for the purpose of trading;(c) the liability is due to be settled within twelve months after the reporting period; or(d) the reporting entity does not have an unconditional right to defer settlement of the liability for at least 12months after the reporting period.
14. In dealing with potential obligations, the likelihood that the event creating the liability occurring is classified as probable , reasonably possible , or remote . Under IFRS, an obligation isprobable when it is more likely than not that a present obligation exists at the date of financial position. “Reasonably possible” means that it is more likely than not at the date of financial position that a present obligation does not exist.
15. IFRS provides measurement guidance of a provision. The principle is that the amount recognized as a provision reflects the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. According to IAS 37 (para. 37), the best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the end of the reporting period orto transfer it to a third party at that time.There are a variety of approaches to reach a best estimate, for instance, the expected value of possible outcomes. This suggests that where the provision being measured involves a large population of items, the obligation can be estimated by weighting all possible outcomes by their associated probabilities. In a simplified case, where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the mid-point of the range (i.e., the expected value) is the best estimate.
The effective interest rate is higher for the discounted note because the creditor lent only $236,800 in return for $3,200 interest over 60 days. In the undiscountednote, the creditor must lend $240,000 for 60 days to earn the same $3,200 interest.
Ex. 10–14Big Howie’s Hot Dog Stand does have an internal control procedure that should detect the payroll error. Before funds are transferred from the regular bank account to the payrollaccount, the owner authorizes the total amount of the week’s payroll. The owner shouldcatch the error, since the extra 60 hours will cause the weekly payroll to be substantiallyhigher than usual. The owner should sign the paychecks, thereby restricting access tocash by employees who are responsible for record keeping.
Ex. 10–15a. Appropriate. All changes to the payroll system, including wage rate increases,
should be authorized by someone outside the Payroll Department.
b. Inappropriate. Each employee should record his or her own time out for lunch. Under the current procedures, one employee could clock in several employees who are still out to lunch. The company would be paying employees for more time than they actually worked.
c. Inappropriate. Payroll should be informed when any employee is terminated. A supervisor or other individual could continue to clock in and out for the terminated employee and collect the extra paycheck.
d. Inappropriate. Access to the check-signing machine should be restricted.
e. Appropriate. The use of a special payroll account assists in preventing fraud and makes it easier to reconcile the company’s bank accounts.
b. In a defined contribution plan, the company invests contributions on behalf of the employee during the employee’s working years. Normally, the employee
and employer contribute to the plan. The employee’s pension depends on the total contributions and the investment return on those contributions. In a defined benefit plan, the company pays the employee a fixed annual amount based on a formula. The employer is obligated to pay for (fund) the employee’s future pension benefits.
Ex. 10–17The $4,267 million unfunded pension liability is the approximate amount of the pension obligation that exceeds the value of the net assets of the pension plan.Apparently, Procter & Gamble has underfunded its plan relative to the obligationthat has accrued over time. This can occur when the company contributes lessto the plan than the annual pension cost.
The obligation grows yearly by the amount of the periodic pension cost. Thus, the$538 million periodic pension cost is a measure of the amount of pension earned byemployees during the year. The annual pension cost is determined by makingassumptions about employee life expectancies, employee turnover, expectedcompensation levels, and interest.
Parts on repaired units: $50 × 160 = $8,000Product Warranty Provision 12,800 Repair Parts 8,000 Wages Payable 4,800
(To record honoring of 160 warranty contracts)(2) 5,000 units × 5% = 250 units
250 units × $80 = $20,000 Product Warranty Expense 20,000
Product Warranty Provision 20,000(To record estimated cost of honoring 250 warrantycontracts)
The balance in Product Warranty Provision at year end is $7,200 ($20,000 –$12,800) which equals the expected cost of honoring the 90 remainingexpected warranty contracts.
b. The quick ratio decreased between the two statement of financial position dates. The major reason is a significant increase in inventory which likely drove the increase in accounts payable. Cash also declined, possibly to purchase the inventory. As a result, quick assets actually declined, while the current liabilities increased. The quick ratio for December 31, 2014, is not yet at an alarming level. However, the trend suggests that the company’s current asset (working capital) management should be watched closely.
December 31, 2014: = 1.2
December 31, 2013:
Product Warranty ProvisionNo entry is required. Disclosure of this contingent liability should be made in thenotes to the financial statements.
2. a. Social security tax paid by employer…………………………………… $19,780.80
b. Medicare tax paid by employer…………………………………………… 4,945.20
c. Earnings subject to unemployment compensation tax, $10,000 for all employees except Arnett, Harvin, and Ward.Thus, total earnings subject to SUTA and FUTA are$62,080 [(4 × $10,000) + $8,250 + $6,000 + $7,830].State unemployment compensation tax: $62,080 × 5.4%…………… 3,352.32
d. Federal unemployment compensation tax: $62,080 × 0.8%………… 496.64
e. Total payroll tax expense……………………………………………………$28,574.96
Social Security Tax Payable 4,668Medicare Tax Payable 1,167Employees Federal Income Tax Payable 15,404Employees State Income Tax Payable 3,501Bond Deductions Payable 1,700Salaries Payable 51,360
* The gross earnings are determined by multiplying the monthly earnings by thenumber of months of employment based on the date of hire.
2. a. Social security tax paid by employer……………………………………$17,163.90
b. Medicare tax paid by employer…………………………………………… 4,290.98
c. Earnings subject to unemployment compensation tax, $10,000 for all employees except Stewart and Tolbert.Thus, total earnings subject to SUTA and FUTA are$59,375 [(5 × $10,000) + $4,500 + $4,875].State unemployment compensation tax: $59,375 × 5.4%…………… 3,206.25
d. Federal unemployment compensation tax: $59,375 × 0.8%………… 475.00
e. Total payroll tax expense………………………………………………… $25,136.13
Social Security Tax Payable 1,455Medicare Tax Payable 364Employees Federal Income Tax Payable 4,317Employees State Income Tax Payable 1,091Bond Deductions Payable 1,150Salaries Payable 15,873
CP 10–1The firm has no implicit or explicit contract to pay any bonus. The bonus is discretionary, even if the firm paid a two-week bonus for 10 straight years. The firm is not behaving unethically for reducing the bonus to one week—regardless of the reason. Tonya Latirno, on the other hand, has taken things into her own hands. Sensing that she is being cheated, she tries to rectify the situation to her own advantage by working overtime that isn’t required. This behavior could be considered fraudulent, even though Tonya is actually present on the job during the overtime hours. The point is that the overtime is not required by the firm. Tonya is incorrect in thinking that her behavior is justified because she did not receive the full two-week bonus. In fact, this behavior would not be justified even if she had a legitimate claim against the company. If she had a claim or grievance against the firm, then it should be handled by other procedural or legal means.
CP 10–2Sumana’s interpretation of the pension issue is correct. The employee earns the pension during the working years. The pension is part of the employee’s compensation that is deferred until retirement. Thus, Felton should record an expense equal to the amount of pension benefit earned by the employee for the period. This gives rise to the rather complex issue of estimating the amount of the pension expense. Francie indicates that the complexity of this calculation makes determining the annual pension expense impossible. This is not so. There are a number of mathematical and statistical approaches (termed “actuarial” approaches) that can reliably estimate the amount of benefits earned by the workforce for a given year.
As a side note, Francie’s perspective can be summarized as “pay as you go.” In her interpretation, there is no expense until a pension is paid to the retiree. Failing to account for pension promises when they are earned is not considered sound accounting.
CP 10–3a. The so-called “underground economy” hides transactions from IRS scrutiny
by conducting business with cash (not check or credit card, which leaves an audit trail). The intent in many such transactions is to evade income tax illegally. However, just because a transaction is in cash does not exempt it from taxation. Tina Song also appears to perform construction services on a cash basis to evade reporting income while paying employees with cash to avoid paying social security and Medicare payroll taxes. The IRS reports that nearly 86% of the persons convicted of evading employment taxes were sentenced to an average of 17 months in prison and ordered to make restitution to the government for the taxes evaded, plus interest and penalties.
b. Marvin should respond that he would rather receive a payroll check as a normal employee does. Receiving cash as an employee, rather than a payroll check, subverts the U.S. tax system. That is, such cash payments do not include deductions for payroll taxes, as required by law. That is why, for example, cash tips must be formally reported to the IRS and subjected to payroll tax deductions by the employer. In addition, if Marvin followed Tina’s advice, Marvin not only would be avoiding payroll deductions, but would also be underreporting income. This would subject Marvin to potential fines and possible criminal prosecution for underreporting income.
CP 10–4The purpose of this activity is to familiarize students with retrieving and using IRSforms. Students should be able to find the three required forms without much difficulty. Encourage students to retrieve the forms from the IRS Web site, since this is a useful source for any IRS form or publication that they might need. IRS Web site forms come in .pdf format, which means an Adobe Acrobat Reader isnecessary to open and print the file. This software is available as a free plug-in on most Internet browser software. However, some students may need to download a free version in order to open the forms. This is also a useful exercise, since manysophisticated forms on the Web require an Acrobat Reader.
The W-2 form is the Annual Wage and Tax Statement transmitted by the employer to the IRS. The IRS uses this information to reconcile the taxpayer’s reported incomeand withholding taxes with the taxpayer’s tax return. Copies of the W-2 are providedfor the employee’s own records and for submitting with state and federal tax returns.
Form 940 is the Employer’s Annual Federal Unemployment Tax Return. The FUTA taxis reported annually, while the 941 payroll taxes are reported quarterly to the IRS.
Form 941 is the Employer’s Quarterly Federal Tax Return. This return is used to reportfederal withholding payroll taxes collected from employees and FICA taxes (bothemployee and employer portions) for the quarter.
CP 10–5This activity does not require the student to research the contingency notes for Altria Group. The contingency disclosure is extensive and complicated. Rather, the student should identify Altria Group’s main business, and from this information determine the likely cause of the contingency disclosures.
a. Altria Group is a holding company for a number of businesses including Philip Morris. Thus, Altria’s primary business is in the manufacture and distribution of tobacco products.
b. The health concerns surrounding tobacco products give rise to numerous lawsuits and legal actions against Altria. The notes to the financial statements include an extensive section describing the scope and status of these actions. As of December 31, 2011, Altria had over 109 cases pending, including 18 class actions and 1 health care recovery action (by state and federal governments). Altria’s Form 10-K provides a section describing some of these actions.
