Current Liabilities and Payroll Accounting: Questions

Chapter 11
Current Liabilities and Payroll

Accounting
QUESTIONS
1. The three questions are: (1) Who must be paid? (2) When is payment due? (3) How
much is to be paid?
2. A current liability is expected to be paid within one year or the company’s operating
cycle, whichever is longer. Any liability that is not current is considered to be long
term.
3. An estimated liability is an obligation to make a future payment, the exact amount of
which is uncertain, but it is capable of being reasonably estimated.
4. The amount of the sale for the item only is $950 ($988/1.04).
5. The combined Social Security tax rate (assuming the maximum wage amount is not
yet reached) is 12.4% (6.2% + 6.2%). The maximum level of earnings [wage base on
which taxes are due] for 2008 is $102,000.
6. The Medicare tax rate is 1.45%. This rate is applied to all wages earned by an
employee—no maximum limit exists.
7. An employee’s gross earnings along with the number of withholding allowances that
an employee claims, as well as whether they are married or single, determine the
amount deducted for federal income taxes.
8. The employee is responsible for federal income taxes, state income taxes, local
income taxes (if any), and the employee portion of the FICA taxes. The employer is
responsible for both federal and state unemployment taxes and the employer
portion of the FICA taxes.
9. An unemployment merit rating is based on an evaluation of an employer’s
experience in creating or avoiding unemployment with its employees. The merit
rating affects the state unemployment taxes that the employer must pay. Merit
ratings cause more of the cost of unemployment benefits to be paid by those who
create more unemployment.
10. The obligation to correct or replace defective products (or services) is created when
the products are sold with the warranties. Even though the seller does not know
with certainty when the obligation will be paid, to whom it will be paid, or the amount
to be paid, past experience shows that some amount will probably be paid. If the
©McGraw-Hill Companies, 2009

Solutions Manual, Chapter 11 605
seller can reasonably estimate that amount, the warranty liability must be reported
on the balance sheet.

606 Fundamental Accounting Principles, 19th Edition
11. There are no conditions in which a probable loss tied to a future event can create a
liability, regardless of its probability. A liability is an obligation created by a past
event, not by a future event. If a disaster occurs, the company must report the loss
in the period when it occurs.
12.A A wage bracket withholding table shows for a pay period of a given length (weekly,
biweekly, semimonthly, monthly), the amounts of federal income taxes to be
withheld from the pay of an employee, at varying amounts of gross pay and varying
numbers of withholding allowances.
13.A Single employee earning $725 with two allowances has $76 taxes withheld.
Single employee earning $625 with no allowances has $81 taxes withheld.
14. At March 3, 2007, Best Buy reports “Accrued compensation and related expenses”
in the amount of $332,000,000.
15. Circuit City has two income-tax-related assets on its balance sheet, and one income-
tax-related liability. One account is a current Deferred income taxes asset account
and another is a noncurrent Deferred income taxes asset account. Deferred tax
assets are accounts that represent income taxes that the company has paid before
the taxes have been reported on the income statement as income tax expenses. The
income-tax-related liability is Accrued income taxes. This represents taxes that
must be paid to the government in the short term.
16. At December 31, 2006, RadioShack reports Accounts payable of $254,500,000.
17. At September 30 2006, Apple reports two current liabilities: Accounts payable, and
Accrued expenses.

QUICK STUDIES
Quick Study 11-1 (5 minutes)
Items 3, 4, 5 and 6 are current liabilities for this company.
Oct. 31 Cash...........................................................................
7,500,000
Unearned Ticket Revenue................................. 7,500,000
To record sales in advance of concerts.
Nov. 5 Unearned Ticket Revenue.......................................

1,500,000
Earned Ticket Revenue...................................... 1,500,000
To record concert revenues earned.
($7,500,000 / 5 dates = $1,500,000)
Sept. 30 Cash...........................................................................
12,720
Sales.................................................................... 12,000
Sales Taxes Payable.......................................... 720
To record cash sales and 6% sales tax.
Sept. 30 Cost of Goods Sold..................................................7,800

Merchandise Inventory...................................... 7,800
To record cost of Sept. 30th sales.
Oct. 15 Sales Taxes Payable................................................ 720

Cash..................................................................... 720
To record remittance of sales taxes to govt.

1. Computation of interest payable at December 31, 2009:

Days from November 7 to December 31..................... 54 days
Accrued interest (8% x $80,000 x 54/360)................... $960
2. 2009
Dec.31 Interest Expense....................................................... 960
Interest Payable................................................. 960
To record accrued interest (8% x $80,000 x 54/360).
3. 2010
Feb. 5 Interest Expense*..................................................... 640
Interest Payable........................................................ 960
Notes Payable........................................................... 80,000
Cash.................................................................... 81,600
To record payment of note plus interest
*(8% x $80,000 x 36/360).
[Note: Two months (January and February) of earnings have

already been recorded for each of the 5 employees.]
Mar. 31 Payroll Taxes Expense............................................1,457.50

FICA—Social Security Taxes Payable1............. 930.00
FICA—Medicare Taxes Payable2....................... 217.50
State Unemployment Taxes Payable3............... 270.00
Federal Unemployment Taxes Payable4........... 40.00
To record employer payroll taxes.
1
$15,000 x 6.2% = $930.00
2
$15,000 x 1.45% = $217.50
3
[5 x ($7,000 - ($3,000 x 2))] x 5.4% = $270.00
4
[5 x ($7,000 - ($3,000 x 2))] x 0.8% = $40.00
Vacation Benefits Expense*.................................... 250

Vacation Benefits Payable............................... 250
To record vacation benefits accrued.
* ($3,250 - $3,000)

Dec. 31 Employee Bonus Expense...................................... 15,000

Bonus Payable.................................................. 15,000
To record expected bonus costs.
2009
July 24 Estimated Warranty Liability................................... 55
Repair Parts Inventory...................................... 55
To record cost of warranty repairs.
1. (b); reason—is reasonably estimated but not a probable loss.

2. (b); reason—probable loss but cannot be reasonably estimated.
3. (a); reason—can be reasonably estimated and loss is probable.

$1,044,000
Times interest earned = $145,000 = 7.2 times
Interpretation: This company’s times interest earned ratio of 7.2 exceeds

(is superior to) its competitors’ average ratio of 4.0. Moreover, a times
interest earned of 7.2 suggests sufficient income to cover interest
obligations.
Quick Study 11-11B (10 minutes)
Dec. 31 Income Taxes Expense............................................ 40,000

Income Taxes Payable...................................... 34,000
Deferred Income Tax Liability.......................... 6,000
To record tax expense and deferred tax liability.

EXERCISES
Exercise 11-1 (10 minutes)
1. C 3. L 5. C 7. C 9. C
2. C 4. N 6. L 8. C 10. C
[Note: All entries dated December 31, 2009.]
1. Warranty Expense.................................................... 3,444

Estimated Warranty Liability............................. 3,444
To record warranty expense [4,100 units x 6% x $14].
2. No adjusting entry can be made since the loss cannot be reasonably

estimated. Disclosure of the suit as a contingent liability should be made
in the notes to the financial statements.
3. Vacation Benefits Expense..................................... 2,940

Vacation Benefits Payable................................. 2,940
To record vacation benefits expense
[28 employees x 1 day x $105].
4. No adjusting entry is required since it is not probable that the supplier will
default on the debt. The guarantor, Madison Company, should describe the
guarantee in its financial statement notes as a contingent liability.
5. Cash..................................................................................
556,400
Sales........................................................................... 520,000
Sales Taxes Payable................................................. 36,400
To record sales and sales taxes.
Cost of Goods Sold.........................................................

260,000
Merchandise Inventory............................................. 260,000
To record cost of sales.
6. Unearned Services Revenue..........................................

104,000
Earned Services Revenue........................................ 104,000
To record product revenue earned.

1. B = 0.04 ($1,300,000 – B)
B = $52,000 – 0.04B
1.04B = $52,000
B = $50,000
2.
2009
Dec. 31 Employee Bonus Expense................................. 50,000
Bonus Payable............................................ 50,000
To record expected bonus costs.
3.
2010
Jan. 19 Bonus Payable.................................................... 50,000
Cash............................................................. 50,000
To record payment of bonus.
1. Maturity date = May 15 + 180 days = November 11, 2009
2a.
May 15 Cash...........................................................................137,000
Notes Payable..................................................... 137,000
Borrowed cash by issuing an interest-bearing note.
2b.
Nov 11 Interest Expense*..................................................... 6,165

Notes Payable...........................................................137,000
Cash..................................................................... 143,165
Repaid note plus interest.
* Principal...............................
$137,000
x Interest rate......................... 9%
x Fraction of year...................180/360
Total interest..........................
$ 6,165

1. Maturity date = November 1 + 180 days = April 30, 2010.
2. Principal.......................................................................... $240,000
x Interest rate.................................................................. 10%
x Fraction of year (Nov. 1 – Dec. 31)............................ 60/360
Total interest in 2009..................................................... $ 4,000
3. Principal.......................................................................... $240,000
x Interest rate.................................................................. 10%
x Fraction of year (Jan. 1 – Apr. 30)............................. 120/360
Total interest in 2010..................................................... $ 8,000
4a.
2009
Nov. 1 Cash...........................................................................240,000
Notes Payable..................................................... 240,000
Borrowed cash by issuing an interest-bearing note.
4b.
2009
Dec. 31 Interest Expense....................................................... 4,000
Interest Payable.................................................. 4,000
Accrued interest on note payable.
4c.
2010
Apr. 30 Interest Expense....................................................... 8,000
Interest Payable........................................................ 4,000
Notes Payable...........................................................240,000
Cash..................................................................... 252,000

Subject
to Tax Rate Tax Explanation
a.
FICA--Social Security........ $2,100 6.20% $130.20 Full amount is subject to tax.
FICA—Medicare............... 2,100 1.45 30.45 Full amount is subject to tax.
FUTA............................... 1,100 0.80 8.80 $1,000 is over the maximum.
SUTA............................... 1,100 2.90 31.90 $1,000 is over the maximum.
b.
FICA--Social Security........ $2,500 6.20% $155.00 Full amount is subject to tax.
FUTA............................... 0 0.80 0.00 Full amount is over maximum.
SUTA............................... 0 2.90 0.00 Full amount is over maximum.
c.
FICA--Social Security........ $6,300 6.20% $390.60 $1,100 is over the maximum.
FUTA............................... 0 0.80 0.00 Full amount is over maximum.
SUTA............................... 0 2.90 0.00 Full amount is over maximum.

(1)
Sept. 30 Salaries Expense......................................................2,100.00
FICA—Social Security Taxes Payable.............. 130.20
FICA—Medicare Taxes Payable........................ 30.45
Employee Federal Income Taxes Payable......... 250.00
Salaries Payable................................................. 1,689.35
To record payroll for pay period ended September 30.
(2)
Sept. 30 Payroll Taxes Expense............................................ 201.35
Federal Unemployment Taxes Payable............ 8.80
State Unemployment Taxes Payable................ 31.90

1. Warranty Expense = 3% of dollar sales = 3% x $9,400 = $282
2. The December 31, 2009, balance of the liability equals the expense
because no repairs are provided in 2009. Therefore, the ending balance
of the Estimated Warranty Liability account is $282.
3. The company should report no additional warranty expense in 2010 for

this copier.
4. The December 31, 2010, balance of the Estimated Warranty Liability

account equals the 2010 beginning balance minus the costs incurred in
2010 to repair the copier:
Ending 2009 balance........................................................... $ 282
Less parts cost.................................................................... (125)
Ending 2010 balance........................................................... $ 157
5. Journal entries
2009 (a)
Aug. 16 Cash........................................................................... 9,400
Sales.................................................................... 9,400
To record cash sale of copier.
Aug. 16 Cost of Goods Sold.................................................. 6,500

To record cost of August 16 sale.
(b)
Dec. 31 Warranty Expense.................................................... 282
Estimated Warranty Liability............................. 282
To record warranty expense for copier sold in 2009.
2010 (c)
Nov. 22 Estimated Warranty Liability................................... 125
Repair Parts Inventory....................................... 125
To record cost of warranty repairs.

(a) (b) (c) (d) (e) (f)

Numerator
Income before
interest & taxes.....$189,100 $170,236 $192,654 $178,364 $118,950 $40,309
Denominator
Interest expense......$ 36,600 $ 11,660 $ 7,506 $ 31,110 $ 9,516 $74,469
Ratio....................... 5.17 14.60 25.67 5.73 12.50 0.54
Analysis: Company (c) has the strongest ability to pay interest expense as
it comes due as evidenced by the company’s times interest earned
(coverage) ratio of 25.67 times.
Exercise 11-10A (15 minutes)
Gross Pay............................................................................. $735.00

Social Security tax deduction (6.2%)................................ $ 45.57
Medicare tax deduction (1.45%)........................................ 10.66
Income tax deduction (from Exhibit 11A.6)...................... 93.00
Total deductions................................................................. 149.23
Net Pay................................................................................. $585.77
Note: Ken LeShon is not subject to state income tax because his cumulative earnings
from the previous pay period exceed the $9,000 maximum.
Exercise 11-11A (15 minutes)

Regular pay (47 hours @ $12)........................................... $564.00
Overtime premium pay (7 hours @ $6.00)........................ 42.00
Gross pay.......................................................................... 606.00
FICA—Social Security tax deduction (6.2%).................... $ 37.57
FICA—Medicare tax deduction (1.45%)............................ 8.79
Income tax deduction (from Exhibit 11A.6)...................... 58.00
Total deductions............................................................... 104.36
Net pay................................................................................. $501.64

Exercise 11-12B (25 minutes)
1. Income Taxes Payable (target balance)...............................................

$46,693
Total accrued [($45,200 + $29,400 + $50,000) x .34]............................
42,364
Adjustment (additional expense)..........................................................
$ 4,329
2.
2009 (a)
Dec. 31 Income Tax Expense................................................ 4,329
Income Taxes Payable....................................... 4,329
To adjust tax expense and liability.
2010 (b)
Jan. 20 Income Taxes Payable............................................. 46,693
Cash..................................................................... 46,693
To make the final quarterly payment
of income taxes for 2009.

PROBLEM SET A
Problem 11-1A (45 minutes)
Locust Natl. Bank Fargo

1. Maturity dates
Date of the note..............................May 19 July 8 Nov. 28
Term of the note (in days)............. 120 120 60
Maturity date...................................Sept. 16 Nov. 5 Jan. 27
2. Interest due at maturity

Principal of the note.......................
$ 39,000 $120,000 $60,000
Annual interest rate....................... 9% 8.5% 8%
Fraction of year..............................120/360 120/360 60/360
Interest expense.............................
$ 1,170 $ 3,400 $ 800
3. Accrued interest on Fargo note at the end of 2008

Total interest for note.................................................... $ 800
Fraction of term in 2008................................................. 33/60
Accrued interest expense............................................. $ 440
.........................................................................................
4. Interest on Fargo note in 2009

Total interest for note.................................................... $ 800
Fraction of term in 2009................................................. 27/60
Interest expense in 2009................................................ $ 360

Problem 11-1A (Concluded)
5.
2008
Apr. 20 Merchandise Inventory............................................ 48,250
Accounts Payable—Locust............................... 48,250
Purchased merchandise on credit.
May 19 Accounts Payable—Locust..................................... 48,250

Cash..................................................................... 9,250
Notes Payable—Locust..................................... 39,000
Paid $9,250 cash and gave a 120-day,
9% note to extend due date on account.
July 8 Cash...........................................................................120,000
Notes Payable—National................................... 120,000
Borrowed cash with a 120-day, 8.5% note.
Sept. 16 Interest Expense....................................................... 1,170

Notes Payable—Locust........................................... 39,000
Cash..................................................................... 40,170
Paid note with interest.
Nov. 5 Interest Expense....................................................... 3,400

Notes Payable—National.........................................120,000
Cash..................................................................... 123,400
28 Cash........................................................................... 60,000
Notes Payable—Fargo Bank............................. 60,000
Borrowed cash with 60-day, 8% note.
Dec. 31 Interest Expense....................................................... 440

Interest Payable.................................................. 440
2009
Jan. 27 Interest Expense....................................................... 360
Notes Payable—Fargo Bank................................... 60,000
Interest Payable ....................................................... 440
Cash..................................................................... 60,800

1.
2008
Nov. 11 Cash........................................................................... 4,500
Sales.................................................................... 4,500
Sold razors to customers.
11 Cost of Goods Sold.................................................. 1,200

To record cost of November 11 sale (75 x $16).
30 Warranty Expense.................................................... 315

To record razor warranty expense
and liability at 7% of selling price.
Dec. 9 Estimated Warranty Liability................................... 240

Merchandise Inventory...................................... 240
To record cost of razor warranty
replacements (15 x $16).
16 Cash........................................................................... 12,600
Sales.................................................................... 12,600

To record cost of December 16 sale (210 x $16).
29 Estimated Warranty Liability................................... 480



2009
Jan. 5 Cash........................................................................... 7,800
Sales.................................................................... 7,800

To record cost of January 5 sale (130 x $16).


2. Warranty expense for November 2008 and December 2008

Sales Percent Warranty Expense
November.................. $ 4,500 7% $ 315
December.................. 12,600 7 882
Total........................... $17,100 $1,197
3. Warranty expense for January 2009

Sales in January............................... $ 7,800
Warranty percent............................. 7%
Warranty expense............................ $ 546
4. Balance of the estimated liability as of December 31, 2008

Warranty expense for November.................................... $ 315 credit
Warranty expense for December.................................... 882 credit
Cost of replacing items in December (45 x $16)............ (720) debit
Estimated Warranty Liability balance............................. $ 477 credit
1,050
5. Balance of the estimated liability as of January 31, 2009
Beginning balance.......................................................... $ 477 credit
Warranty expense for January....................................... 546 credit
Cost of replacing items in January (35 x $16).............. (560) debit
Estimated Warranty Liability balance........................... $ 463 credit

1. Milo Company
Income before interest & taxes $290,000
Interest expense = $60,000 = 4.83
2. Warner Company
Interest expense = $350,000 = 1.66
3. Sales increase by 40% (multiply prior sales by 1.4)

Milo Co. Warner Co.
Sales............................................. $2,030,000 $2,030,000
Variable expenses....................... 1,624,000 1,218,000
Income before interest................ 406,000 812,000
Interest expense (fixed).............. 60,000 350,000
Net income................................... $ 346,000 $ 462,000
Net income increases by............ 50% 101%

Milo Co. Warner Co.
Sales............................................. $2,175,000 $2,175,000
Income before interest................ 435,000 870,000
Net income................................... $ 375,000 $ 520,000
Net income increases by*.......... 63% 126%
* Computed as the increase in net income divided by prior net income.

Milo Co. Warner Co.
Sales............................................. $2,610,000 $2,610,000
Income before interest................ 522,000 1,044,000
Net income................................... $ 462,000 $ 694,000
Net income increases by............ 101% 202%

6. Sales decrease by 20% (multiply prior sales by 0.8)

Milo Co. Warner Co.
Sales........................................ $1,160,000 $1,160,000
Variable expenses.................. 928,000 696,000
Income before interest........... 232,000 464,000
Interest expense (fixed)......... 60,000 350,000
Net income.............................. $ 172,000 $ 114,000
Net income decreases by...... -25% -50%

Milo Co. Warner Co.
Sales........................................ $1,015,000 $1,015,000
Net income.............................. $ 143,000 $ 56,000

Milo Co. Warner Co.
Sales........................................ $ 870,000 $ 870,000
Net income.............................. $ 114,000 $ (2,000)
9. The higher fixed-cost strategy (having more fixed interest expense) of

Warner Co. accentuates the effects of increases and decreases in sales.
That is, increases in sales produce greater increases in net income and
decreases in sales produce greater decreases in net income. The
higher fixed-cost strategy of Warner Co. is indicated by a lower value of
the times interest earned ratio.
The higher fixed-cost strategy works fine if the sales level increases.
Warner Co. enjoys greater percent increases in its net income because
it has made this choice (see parts 3, 4, and 5).
The lower fixed-cost strategy protects the company if the sales level
decreases. Milo Co. experiences smaller percent decreases in its net
income because it has made this choice (see parts 6, 7, and 8).

1. Each employee’s FICA withholdings for Social Security
Dahlia Trey Kiesha Chee Total

Maximum base.............. $102,000 $102,000 $102,000 $102,000
Earned through 8/18..... 100,500 31,850 6,260 1,000
Would-be subject to tax. . $ 1,500 $ 70,150 $ 95,740 $101,000
Earned this week.......... $ 3,600 $ 1,275 $ 1,440 $ 400
Pay subject to tax......... 1,500 1,275 1,440 400

Tax rate.......................... 6.20% 6.20% 6.20% 6.20%
Social Security tax....... $ 93.00 $ 79.05 $ 89.28 $ 24.80 $286.13
2. Each employee’s FICA withholdings for Medicare (no limits)

Earned this week.......... $ 3,600 $ 1,275 $ 1,440 $ 400
Tax rate.......................... 1.45% 1.45% 1.45% 1.45%
Medicare tax.................. $ 52.20 $ 18.49 $ 20.88 $ 5.80 $ 97.37
3. Employer’s FICA taxes for Social Security

Amount from part 1...... $ 93.00 $ 79.05 $ 89.28 $ 24.80 $286.13
4. Employer’s FICA taxes for Medicare

Amount from part 2....... $ 52.20 $ 18.49 $ 20.88 $ 5.80 $ 97.37

5. Employer’s FUTA taxes

Maximum base............... $ 7,000 $ 7,000 $ 7,000 $ 7,000
Earned through 8/18...... 100,500 31,850 6,260 1,000
Would-be subject to tax. . . 0 0 740 6,000
Earned this week.......... $ 3,600 $ 1,275 $ 1,440 $ 400

Pay subject to tax........ 0 0 740 400
Tax rate......................... 0.8% 0.8% 0.8% 0.8%
FUTA tax....................... $ 0.00 $ 0.00 $ 5.92 $ 3.20 $ 9.12
6. Employer’s SUTA taxes

Subject to tax (from 5). $ 0 $ 0 $ 740 $ 400
Tax rate......................... 2.15% 2.15% 2.15% 2.15%
SUTA tax....................... $ 0.00 $ 0.00 $ 15.91 $ 8.60 $ 24.51
10.75
7. Each employee’s net (take-home) pay

Gross earnings............ $3,600.00 $1,440.00 $400.00 $6,715.00
$1,275.00
Less
FICA Social Sec. tax.... (93.00) (79.05) (89.28) (24.80) (286.13)
FICA Medicare taxes. . . (52.20) (18.49) (20.88) (5.80) (97.37)
Withholding taxes........ (450.00) (140.00) (173.00) (36.00) (799.00)
Health insurance......... (11.00) (11.00) (11.00) (11.00) (44.00)
Take-home pay............ $2,993.80 $1,026.46 $1,145.84 $322.40 $5,488.50
8. Employer’s total payroll-related expense for each employee

Gross earnings............. $3,600.00 $1,275.00 $1,440.00 $400.00 $6,715.00
Plus
FICA Social Sec. tax...... 93.00 79.05 89.28 24.80 286.13
FICA Medicare taxes..... 52.20 18.49 20.88 5.80 97.37
FUTA tax........................ 0.00 0.00 5.92 3.20 9.12
SUTA tax....................... 0.00 0.00 15.91 8.60 24.51
Health insurance........... 11.00 11.00 11.00 11.00 44.00
Pension contrib. (8%). . . 288.00 102.00 115.20 32.00 537.20
Total payroll expense. . . $4,044.20 $1,485.54 $1,698.19 $485.40 $7,713.33

Part 1
Jan. 8 Office Salaries Expense...........................................27,760
Sales Salaries Expense...........................................70,240
FICA—Social Sec. Taxes Payable*................... 6,076
FICA—Medicare Taxes Payable**..................... 1,421
Employee Fed. Inc. Taxes Payable................... 13,360
Employee Medical Insurance Payable............. 1,350
Employee Union Dues Payable......................... 840
Salaries Payable................................................. 74,953
To record payroll for period.
* $98,000 x 6.2%
**$98,000 x 1.45%
Part 2
Jan. 8 Payroll Taxes Expense............................................13,181
FICA—Social Sec. Taxes Payable.................... 6,076
FICA—Medicare Taxes Payable........................ 1,421
State Unemployment Taxes Payable*.............. 4,900
Federal Unemployment Taxes Payable**........... 784
* $98,000 x .05 = $4,900
**$98,000 x .008 = $784

Problem 11-6AA (50 minutes)
Mar. 15 FICASocial Security Taxes Payable....................7,440

FICAMedicare Taxes Payable..............................1,740
Employee Fed. Income Taxes Payable..................5,250
Cash..................................................................... 14,430
To record payment of FICA and federal
income taxes.
31 Office Salaries Expense...........................................24,000

Shop Wages Expense.............................................. 36,000
FICASocial Sec. Taxes Payable.................... 3,720
FICAMedicare Taxes Payable........................ 870
Employee Fed. Income Taxes Payable............ 5,250
31 Salaries Payable....................................................... 50,160

Cash..................................................................... 50,160
To record payment of payroll.*
*The check numbers may be entered in the Payroll Register.
31 Payroll Taxes Expense*............................................5,550

FICASocial Sec. Taxes Payable.................... 3,720
State Unemployment Taxes Payable................ 800
Federal Unemployment Taxes Payable............ 160
*
Amount earned through 2/28 = 2 x $3,000 = $6,000
Subject to SUTA/FUTA in March = $7,000 - $6,000 = $1,000
SUTA = $1,000 x 20 employees x 4.0% = $800
FUTA = $1,000 x 20 employees x 0.8% = $160
FICASocial Security Taxes = $3,720 (same as employees)
FICAMedicare Taxes = $870 (same as employees)

Problem 11-6AA (Concluded)
Apr. 15 FICASocial Security Taxes Payable....................7,440

FICAMedicare Taxes Payable..............................1,740
Employee Fed. Income Taxes Payable..................5,250
Cash..................................................................... 14,430
To record payment of FICA and
federal income taxes.
15 State Unemployment Taxes Payable......................5,600

Cash..................................................................... 5,600
To record payment of SUTA taxes [$4,800 + $800].
30 Federal Unemployment Taxes Payable..................1,120

Cash..................................................................... 1,120
To record payment of FUTA taxes [$960 + $160].
30 No entry required upon mailing Form 941.

PROBLEM SET B
Problem 11-1B (45 minutes)
Wolf Autumn City

Products Bank Bank
1. Maturity dates
Date of the note................................

May 23 July 15 Dec. 6
Term of the note (in days)............... 60 90 90
Maturity date.....................................
July 22 Oct. 13 Mar. 6
2. Interest due at maturity
Principal of the note.........................$5,400 $8,500 $9,600

Annual interest rate.......................... 8% 8% 6%
Fraction of year................................60/360 90/360 90/360
Interest expense...............................$ 72 $ 170 $ 144
3. Accrued interest on City Bank note at the end of 2008
Total interest for note................................................................. $ 144

Fraction of term in 2008............................................................. 25/90
Accrued interest expense.......................................................... $ 40
4. Interest in 2009
Total interest for note................................................................. $ 144
Fraction of term in 2009............................................................. 65/90
Interest expense in 2009............................................................ $ 104

Problem 11-1B (Concluded)
5.
2008
Apr. 22 Merchandise Inventory............................................ 6,000
Accounts PayableWolf Products. . 6,000
Purchased merchandise on credit.
May 23 Accounts PayableWolf Products........................ 6,000

Cash..................................................................... 600
Notes PayableWolf Products......................... 5,400
Paid $600 cash and gave a 60-day,
8% note to extend due date on account.
July 15 Cash........................................................................... 8,500

Notes PayableAutumn Bank.......................... 8,500
Borrowed cash with a 90-day, 8% note.
22 Interest Expense....................................................... 72
Notes PayableWolf Products............................... 5,400
Cash..................................................................... 5,472
Oct. 13 Interest Expense....................................................... 170

Notes PayableAutumn Bank................................ 8,500
Cash..................................................................... 8,670
Dec. 6 Cash........................................................................... 9,600

Notes PayableCity Bank................................. 9,600
Borrowed cash with a 90-day, 6% note.
31 Interest Expense....................................................... 40
2009
Mar. 6 Interest Expense....................................................... 104
Notes PayableCity Bank....................................... 9,600
Cash..................................................................... 9,744

1.
2009
Nov. 16 Cash........................................................................... 4,250
Sales.................................................................... 4,250
Sold coffee grinders to customers.
16 Cost of Goods Sold.................................................. 750

To record cost of November 16 sale (50 x $15).

To record coffee grinder warranty expense
Dec. 12 Estimated Warranty Liability................................... 165

To record cost of coffee grinder
warranty replacements (11 x $15).
18 Cash........................................................................... 13,600
Sales.................................................................... 13,600

To record cost of December 18 sale (160 x $15).

31 Warranty Expense.................................................... 1,088

Estimated Warranty Liability............................. 1,088

2010
Jan. 7 Cash........................................................................... 8,075
Sales.................................................................... 8,075

To record cost of January 7 sale (95 x $15).


2. Warranty expense for November 2009 and December 2009

Sales Percent Warranty Expense
November......................... $ 4,250 8% $ 340
December......................... 13,600 8 1,088
Total.................................. $17,850 $1,428
3. Warranty expense for January 2010

Sales in January............................. $8,075
Warranty percent............................ 8%
Warranty expense........................... $ 646
4. Balance of the estimated liability as of December 31, 2009

Warranty expense for November.................................... $ 340 credit
Warranty expense for December.................................... 1,088 credit
Cost of replacing items in December (33 x $15)............ (495) debit
5. Balance of the estimated liability as of January 31, 2010

Beginning balance............................................................ $ 933 credit
Warranty expense for January........................................ 646 credit
Cost of replacing items in January (45 x $15)............... (675) debit

1. Ellis Company
Interest expense = = 1.67
$75,000
2. Seidel Company
Interest expense = = 5.0
$12,500

Ellis Co. Seidel Co.
Sales........................................ $350,000 $350,000
Net income.............................. $100,000 $ 75,000
Net income increases by....... 100% 50%

Sales........................................ $375,000 $375,000
Net income.............................. $112,500 $ 81,250
Net income increases by....... 125% 62.5%

Sales........................................ $450,000 $450,000
Net income.............................. $150,000 $100,000
Net income increases by....... 200% 100%


Sales........................................ $200,000 $200,000
Net income.............................. $ 25,000 $ 37,500

Sales........................................ $175,000 $175,000
Net income.............................. $ 12,500 $ 31,250
Net income decreases by...... -75% -37.5%

Sales........................................ $150,000 $150,000
Net income.............................. $ 0 $ 25,000
9. The higher fixed-cost strategy (having more fixed interest expense) of

Ellis Co. accentuates the effects of increases and decreases in sales.
That is, increases in sales produce greater increases in net income and
decreases in sales produce greater decreases in net income. The
higher fixed-cost strategy of Ellis Co. is indicated by a lower value of the
times interest earned ratio.
The higher fixed-cost strategy works fine if the sales level increases.
Ellis Co. enjoys substantially greater increases in its net income
because it has made this choice (see parts 3, 4, and 5).
The lower fixed-cost strategy protects the company if the sales level
decreases. Seidel Co. experiences much smaller decreases in its net
income because it has made this choice (see parts 6, 7, and 8).

1. Each employee’s FICA withholdings for Social Security

Ahmed Carlos Jun Marie Total
Maximum base............. $102,000 $102,000 $102,000 $102,000
Earned through 9/23.... 99,500 31,850 6,380 1,021
Would-be subject to tax. $ 2,500 $ 70,150 $ 95,620 $100,979
Earned this week.......... $ 4,900 $ 1,280 $ 920 $ 400
Pay subject to tax........ $ 2,500 $ 1,280 $ 920 $ 400

Tax rate......................... 6.2% 6.20% 6.20% 6.20%
Social Security tax....... $ 155.00 $ 79.36 $ 57.04 $ 24.80 $ 316.20
2. Each employee’s FICA withholdings for Medicare (no limits)

Earned this week.......... $ 4,900 $ 1,280 $ 920 $ 400
Tax rate......................... 1.45% 1.45% 1.45% 1.45%
Medicare tax................. $ 71.05 $ 18.56 $ 13.34 $ 5.80 $ 108.75
3. Employer’s FICA taxes for Social Security

Amount from part 1...... $155.00 $ 79.36 $ 57.04 $ 24.80 $ 316.20
4. Employer’s FICA taxes for Medicare

Amount from part 2...... $ 71.05 $ 18.56 $ 13.34 $ 5.80 $ 108.75

Problem 11-4B(Concluded)
5. Employer’s FUTA taxes

Maximum base............ $ 7,000 $ 7,000 $ 7,000 $ 7,000
Earned through 9/23... 99,500 31,850 6,380 1,021
Would-be subject to tax. $ 0 $ 0 $ 620 $ 5,979
Earned this week........ $ 4,900 $ 1,280 $ 920 $ 400
Pay subject to tax....... $ 0 $ 0 $ 620 $ 400
Tax rate........................ 0.8% 0.8% 0.8% 0.8%
FUTA tax...................... $ 0.00 $ 0.00 $ 4.96 $ 3.20 $ 8.16
6. Employer’s SUTA taxes

Subject to tax (from 5). $ 0 $ 0 $ 620 $ 400
Tax rate........................ 1.75% 1.75% 1.75% 1.75%
SUTA tax..................... $ 0.00 $ 0.00 $ 10.85 $ 7.00 $ 17.85
7. Each employee’s net (take-home pay)

Gross earnings............ $4,900.00 $1,280.00 $920.00 $400.00 $7,500.00
Less
FICA Social Sec. tax.... (155.00) (79.36) (57.04) (24.80) (316.20)
FICA Medicare taxes. . . (71.05) (18.56) (13.34) (5.80) (108.75)
Withholding taxes........ (613.00) (140.00) (110.00) (37.00) (900.00)
Health insurance......... (10.00) (10.00) (10.00) (10.00) (40.00)
Net pay......................... $4,050.95 $1,032.08 $729.62 $322.40 $6,135.05
8. Employer’s total payroll-related expense for each employee

Gross earnings............ $4,900.00 $1,280.00 $ 920.00 $400.00 $7,500.00
Plus
FICA Social Sec. tax.... 155.00 79.36 57.04 24.80 316.20
FICA Medicare taxes. . . 71.05 18.56 13.34 5.80 108.75
FUTA tax...................... 0.00 0.00 4.96 3.20 8.16
SUTA tax...................... 0.00 0.00 10.85 7.00 17.85
Health insurance......... 10.00 10.00 10.00 10.00 40.00
Pension contrib. (8%). . 392.00 102.40 73.60 32.00 600.00
Total payroll................. $5,528.05 $1,490.32 $1,089.79 $482.80 $8,590.96

Part 1
Jan. 8 Sales Salaries Expense...........................................20,160

Office Salaries Expense...........................................70,840
Delivery Wages Expense......................................... 3,000
FICA—Social Security Taxes Payable*............ 5,828
FICA—Medicare Taxes Payable**..................... 1,363
Employee Med. Insurance Payable.................. 1,350
Employee Union Dues Payable......................... 820
* $94,000 x 6.2% = $5,828
** $94,000 x 1.45% = $1,363
Part 2
Jan. 8 Payroll Taxes Expense............................................ 9,823

FICA—Social Security Taxes Payable.............. 5,828
FICA—Medicare Taxes Payable........................ 1,363
State Unemployment Taxes Payable*.............. 1,880
Federal Unemployment Taxes Payable**........... 752
* $94,000 x .02 = $1,880
**$94,000 x .008 = $752

Problem 11-6BA (50 minutes)
Mar. 15 FICA—Social Security Taxes Payable....................... 4,464

FICA—Medicare Taxes Payable.............................. 1,044
Employee Fed. Income Taxes Payable..................... 4,050
Cash..................................................................... 9,558
31 Office Salaries Expense...........................................21,000

Shop Wages Expense..............................................15,000
FICA—Social Security Taxes Payable.............. 2,232
FICA—Medicare Taxes Payable........................ 522
To record payroll period.
31 Salaries Payable.......................................................29,196
Cash..................................................................... 29,196
To record payment of payroll.*
*Check numbers may be entered in the Payroll Register.
31 Payroll Taxes Expense*............................................ 3,450

FICASocial Security Taxes Payable.............. 2,232
State Unemployment Taxes Payable................ 600
Federal Unemployment Taxes Payable............ 96
*
Amount earned through 2/28 = 2 x $3,000 = $6,000
Subject to SUTA/FUTA in March = $1,000
SUTA = $1,000 x 12 x 0.05 = $600
FUTA = $1,000 x 12 x 0.008 = $96
FICASocial Security Taxes = $2,232 (same as employees)
FICAMedicare Taxes = $522 (same as employees)

Problem 11-6BA (Concluded)
Apr. 15 FICASocial Security Taxes Payable.................... 4,464

FICAMedicare Taxes Payable.............................. 1,044
Employee Fed. Income Taxes Payable.................. 4,050
Cash..................................................................... 9,558
15 State Unemployment Taxes Payable...................... 4,200

Cash..................................................................... 4,200
To record payment of SUTA taxes.
($3,600 + $600)
30 Federal Unemployment Taxes Payable.................. 672

Cash..................................................................... 672
To record payment of FUTA taxes.
($576 + $96)
30 No entry required upon mailing Form 941.

Serial Problem — SP 11
Serial Problem — SP 11, Success Systems (30 minutes)

1.
Gross pay (8 days x $125 per day)...................................... $1,000.00
FICA Social Security tax deduction (6.2%)*..................... $ 62.00
FICA Medicare tax deduction (1.45%)............................... 14.50
Income tax deduction......................................................... 159.00
Total deductions................................................................. 235.50
Net Pay................................................................................. $ 764.50
*Employee has not reached the maximum limit.
2. 2010
Feb. 26 Wages Expense........................................................ 1,000.00
Employee Federal Income Taxes Payable....... 159.00
Cash..................................................................... 764.50
To record payroll period.
3. 2010
Feb. 26 Payroll Taxes Expense............................................124.50
FICA—Social Sec. Taxes Payable.................... 62.00
State Unemployment Taxes Payable*.............. 40.00
Federal Unemployment Taxes Payable**........... 8.00
* $1,000 x .04 = $40.00
**$1,000 x .008 = $8.00
4. 2010
Mar. 25 Accounts Receivable – Wildcat Services.............. 2,912
Sales.................................................................... 2,800
Sales Taxes Payable.......................................... 112
Sold merchandise on credit and collected
sales tax of 4%.
Mar. 25 Cost of Goods Sold.................................................. 2,002

To record cost of March 25 sale.

Comprehensive Problem
Bug-Off Exterminators (100 minutes)
Part 1
a. Correct ending balance of cash and the amount of the omitted check
Balance per bank..................................$15,100

Plus deposit in transit.......................... 2,450
Less outstanding checks..................... (1,800)
Reconciled balance..............................$15,750
Balance per books................................$17,000

Plus interest earned.............................. 52
Less service charges............................ (15)
Balance before omitted check............. 17,037
Reconciled balance (from above)............ (15,750)
Omitted check.......................................$ 1,287
b. Allowance for doubtful accounts
Unadjusted balance.............................. $ 828 credit

Anticipated write-off............................. (679) debit
Revised unadjusted balance................ 149 credit
Desired ending balance........................ 700 credit
Necessary adjustment.......................... $ 551 credit
c. Depreciation expense on the truck
Cost......................................................................
$32,000
Less salvage value............................................. (8,000)
Depreciable cost.................................................
$24,000
Useful life (years)................................................
4
Annual depreciation for 2009............................
$ 6,000
d. Depreciation expense on the equipment

Sprayer Injector
Cost........................................................ $27,000 $18,000
Less salvage value............................... (3,000) (2,500)
Depreciable cost................................... $24,000 $15,500
Useful life (years).................................. 8 5
Depreciation for 2009........................... $ 3,000 $ 3,100

Comprehensive Problem (Continued)
e. Adjusted revenue and unearned revenue balances
Total advance received......................................... $ 3,840

Months in contract................................................  12
Revenue per month............................................... $ 320
Months of services provided................................ 5
Total earned ($320 x 5 months)............................ (1,600)
Overstatement of revenue ($3,840 – $1,600)...... $ 2,240
Extermination Services Revenue account

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

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

Unadjusted balance............................................. $ 1,400 credit
Warranty expense................................................ 1,444 credit
Ending adjusted balance..................................... $ 2,844 credit
g. Note payable and interest accrual
The note originated on December 31, 2009. The first time interest
will be payable is December 31, 2010. The annual interest expense
on the note is $1,200 ($15,000 x .08).
Thus, the adjusted balance for both Interest Payable and Interest
Expense at December 31, 2009, is zero.

Part 2
BUG-OFF EXTERMINATORS
December 31, 2009
Unadjusted Adjusted
Trial Balance Adjustments . Trial Balance
$
Cash ..................................... (a) $1,250 $ 15,750
17,000
Accounts receivable.............. 4,000 (b1) 679 3,321
Allowance for
doubtful accounts............... $ 828 (b1) $ 679 (b2) 551 $ 700
Merchandise inventory..........11,700 11,700
Trucks...................................32,000 32,000
Accum. deprec.–Trucks......... 0 (c) 6,000 6,000
Equipment.............................45,000 45,000
Accum. deprec.–Equip.......... 12,200 (d) 6,100 18,300
Accounts payable.................. 5,000 (a) 1,287 3,713
Estim. warranty liability.......... 1,400 (f) 1,444 2,844
Unearned services rev........... 0 (e) 2,240 2,240
Interest payable.................... 0 0
Long-term notes 15,000 15,000
payable.................................
D. Buggs, Capital................... 59,700 59,700
D. Buggs, Withdrawals..........10,000 10,000
Extermination
services revenue................. 60,000 (e) 2,240 57,760
Interest revenue..................... 872 (a) 52 924
Sales..................................... 71,026 71,026
Cost of goods sold................46,300 46,300
Deprec. expense–Trucks....... 0 (c) 6,000 6,000
Deprec. expense–Equip......... 0 (d) 6,100 6,100
Wages expense.....................35,000 35,000
Interest expense.................... 0 0
Rent expense........................ 9,000 9,000
Bad debts expense................ 0 (b2) 551 551
Miscellaneous expense......... 1,226 (a) 15 1,241
Repairs expense.................... 8,000 8,000
Utilities expense.................... 6,800 6,800
Warranty expense.................. _______ (f) 1,444 ______ 1,444 _______
0

Totals....................................
$226,026 $226,026 $18,316 $18,316 $238,207 $238,207

Part 3
2009
(a) Miscellaneous Expenses............................................ 15
Accounts Payable........................................................ 1,287
Interest Revenue.................................................... 52
Cash........................................................................ 1,250
Adjust cash account. (Separate entries are acceptable.)
(b1) Allowance for Doubtful Accounts............................... 679

Accounts Receivable.............................................. 679
Wrote off uncollectible accounts.
(b2) Bad Debts Expense...................................................... 551

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

Accumulated Depreciation—Trucks..................... 6,000
Depreciation on truck.
(d) Depreciation Expense—Equipment............................ 6,100

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

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

Estimated Warranty Liability................................. 1,444
Estimate warranty expense.
(g) No interest accrual required for 2009

Part 4
Income Statement
For Year Ended December 31, 2009
Revenues
Extermination services revenue............... $57,760
Sales............................................................ 71,026
Interest revenue.......................................... 924
Total revenues............................................ $129,710
Expenses
Cost of goods sold..................................... 46,300
Depreciation expense—Trucks................. 6,000
Depreciation expense—Equipment.......... 6,100
Wages expense........................................... 35,000
Interest expense......................................... 0
Rent expense.............................................. 9,000
Bad debts expense..................................... 551
Miscellaneous expenses............................ 1,241
Repairs expense......................................... 8,000
Utilities expense......................................... 6,800
Warranty expense....................................... 1,444
Total expenses............................................ 120,436
Net income.................................................... $ 9,274
Statement of Owner’s Equity
For Year Ended December 31, 2009
D. Buggs, Capital, December 31, 2008......................... $ 59,700
Add: Investments by owner........................................ 0
Net income........................................................... 9,274
68,974
Less: Withdrawals by owner........................................ (10,000)
D. Buggs, Capital, December 31, 2009......................... $ 58,974

Comprehensive Problem
Part 4 (concluded)
Balance Sheet
December 31, 2009
Assets
Current assets
Cash................................................................ $15,750
Accounts receivable......................................$ 3,321
Allowance for doubtful accounts................. (700) 2,621
Merchandise inventory.................................. 11,700
Total current assets....................................... 30,071
Plant assets
Trucks............................................................. 32,000
Accumulated depreciation—Trucks............. (6,000) 26,000
Equipment....................................................... 45,000
Accumulated depreciation—Equipment...... (18,300) 26,700
Total plant assets........................................... 52,700
Total assets....................................................... $82,771
Liabilities
Current liabilities
Accounts payable..........................................$ 3,713
Estimated warranty liability........................... 2,844
Unearned services revenue.......................... 2,240
Total current liabilities................................... $ 8,797
Long-term liabilities
Long-term notes payable.............................. 15,000
Total liabilities.................................................. 23,797
Equity
D. Buggs, Capital.............................................. 58,974
Total liabilities and equity............................... $82,771

Reporting in Action — BTN 11-1
1. Times interest earned
($ millions) 2007 2006 2005

Fiscal Fiscal Fiscal
Year Year Year
Net income.................................................. $1,377 $1,140 $ 984
Add income taxes...................................... 752 581 509
Income before taxes.................................. 2,129 1,721 1,493
Add interest expense (from note 7).......... 31 30 44
Income before interest and taxes............. $2,160 $1,751 $1,537
Times interest earned ratio................... 69.7 58.4 34.9
Analysis comment: For each of these fiscal years, it appears that Best
Buy’s risk of not being able to cover its interest expense is low. In
addition, Best Buy’s times interest earned ratio is higher than the
industry average of 28.1 for all three years.
2. Gift card liabilities arise when a customer purchases a gift card. It is

unearned revenue until the gift card recipient buys merchandise with
the card.
3. Yes. Best Buy has both commitments and contingencies (see its Note
No.12). Its contingencies arise from a lawsuit alleging discrimination in
employment, as well as various other legal proceedings arising in the
normal course of business. Their commitments include: a contractual
obligation with Accenture LLP to assist in improving their information
systems; letters of credit for purchase obligations; and a commitment
to purchase, construct, and lease facilities.
4. The solution depends on the financial statement information accessed.

Comparative Analysis — BTN 11-2
1. Best Buy—Times interest earned

Current One Year Two Years
($ millions) Year Prior Prior
Net income.................................................. $1,377 $1,140 $ 984
Add income taxes...................................... 752 581 509
Add interest expense................................. 31 30 44
Income before taxes and interest............. $2,160 $1,751 $1,537
Times interest earned ratio................... 69.7a 58.4b 34.9c

a
$2,160/$31 = 69.7
b
$1,751/$30 = 58.4
c
$1,537/$44 = 34.9
Circuit City—Times interest earned

Net income.................................................. $ (8) $ 140 $ 62

Add income taxes...................................... 31 86 36
Income before taxes and interest............. $ 25 $ 229 $ 102
Times interest earned ratio....................... 12.5a 76.3b 25.5c

a
$25/$2 = 12.5
b
$229/$3= 76.3
c
$102/$4 = 25.5
RadioShack—Times interest earned

Net income.................................................. $ 73 $ 267 $ 337
Add income taxes...................................... 38 52 205
Income before taxes and interest............. $ 155 $ 364 $ 572
Times interest earned ratio................... 3.5a 8.1b 19.1c

a
$155/$44 = 3.5
b
$364/$45 = 8.1
c
$572/$30 = 19.1

Comparative Analysis (concluded)
Note to instructor: Some more advanced students might note that all three
companies have either discontinued operations, cumulative effects of changes in
accounting principles or both. These items are presented net of tax effects. Thus,
income taxes can be adjusted for these separate treatments of taxes. This analysis is
not shown here.
2. Except for one year prior, Best Buy appears considerably stronger in its
ability to make interest payments should income decline. For all three
years, Best Buy’s times interest earned exceeded the industry average
of 28.1. For one out of the three years, Circuit City’s times interest
earned ratio exceeded the industry average of 28.1, and in the one year
prior also exceeded Best Buy’s times interest earned. For all three
years, RadioShack had the lowest times interest earned and was below
the industry average of 28.1.
Ethics Challenge — BTN 11-3
1. It is in Bly’s self-interest to maximize the amount of revenues less

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

warranty expenses via the warranty expense accrual in the short run,
over several years the amounts should even out. The dealership
should probably adjust the warranty expense accrual to match the
usual (average) experience over time. Given the variable nature of
warranty expenses, at times it might warrant being adjusted upward
(lowering Bly’s bonus) or downward (increasing Bly’s bonus). The
accountant and others should offer input into this decision. Since the
experience with warranties has varied, a percent should perhaps be
based on a long-run average, with some additional weight given to
recent experience.

Communicating in Practice — BTN 11-4
MEMORANDUM
To: Madeline Pretti, General Manager

From: Dustin Clemens, ManagerAccounting and Finance
Date:
Subject: Reporting warranties in financial statements
This memorandum is in response to your comment on my proposal for the

treatment of a contingency in our financial statements. You specifically
object to the proposed recognition of an expense and liability for
warranties. The purpose of this memorandum is to respond to your
objection.
Both the conservatism and matching principles apply to accounting for

warranties. Conservatism requires us to include an expense in this year’s
financial statements for costs that we may or may not pay in the future.
Another point in favor of reporting the expense and liability now is that we
offered the warranty in order to achieve the reported sales. Therefore, our
income measure would be incomplete if it did not match the cost of
fulfilling the warranty against revenues generated by offering the warranty.
This treatment would be in compliance with the matching principle.
Your comment also raised the objection that we don’t know what costs
will be. If they are not reasonably estimable, generally accepted
accounting principles will allow us to leave them out of the financial
statements. But we must describe the contingency in the notes. I will be
checking with the product design engineers to get their opinion on the
estimableness of repair costs. If the product is different from others, we
may have a basis for going with only a note disclosure. However, financial
statement recognition is a more effective way to get the information into
users’ hands. As a result, it is usually preferred, even if we are uncertain
about the amount.

Taking It to the Net — BTN 11-5
1. McDonald’s 2006 current liabilities include the following

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

millions) is
$17.7 / ($17.7 + $8,416.5) = 0.21%
3. Times interest earned for McDonald’s as of 12/31/2006
($ millions) 12/31/2006
Net Income................................................................ $ 3,544.2
Plus income taxes.................................................... 1,293.4
Plus interest expense.............................................. 402.0
Income before interest and taxes........................... $ 5,239.6
Times interest earned.............................................. 13.0 times
Comment: The 13.0 times interest earned ratio seems more than
sufficient for McDonald’s to cover its interest obligations, and it is
higher than the industry average of 7.9.

Teamwork in Action — BTN 11-6
1. Option A: Interest Expense = $6,000 x 10% x 90/360 = $150
Option B: Interest Expense = $6,000 x 8% x 120/360 = $160
The interest expense in option B does exceed option A. If interest cost

is the only consideration, then Option A is the preferred loan. However,
if a mere $10 more is paid in interest expense the business can use the
loan money for an additional 30 days. The decision on which loan is
preferred will ultimately depend on whether interest cost savings is
valued more than the additional time to use the loaned money.
2. Entries:
2a. Issue date, Option A
June 1 Cash........................................................................... 6,000
Notes Payable..................................................... 6,000
Borrowed cash by issuing an
interest-bearing note.
2b. Issue date, Option B

June 1 Cash........................................................................... 6,000
Notes Payable..................................................... 6,000
Borrowed cash by issuing an
interest-bearing note.
2c. Maturity date, Option A

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

Sep. 29 Notes Payable........................................................... 6,000
Interest Expense....................................................... 160
Cash..................................................................... 6,160

Teamwork in Action (Concluded)
4. Entries:
4a. Adjusting entry, Option A (Dec. 31)

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

Accrue interest on note payable
[$6,000 x 8% x 30/360].
4c. Maturity date entry, Option A
March 1 Interest Expense....................................................... 100

Notes Payable........................................................... 6,000
Cash..................................................................... 6,150
4d. Maturity date entry, Option B
March 31 Interest Expense....................................................... 120

Notes Payable........................................................... 6,000
Cash..................................................................... 6,160

Entrepreneurial Decision — BTN 11-7
1.
Feed Granola Company
Income Statement (Prospective)
Current European Total
Operations
Sales............................................. $1,000,000 $ 250,000 $1,250,000
Cost of goods sold (30%)........... 300,000 75,000 375,000
Gross profit.................................. 700,000 175,000 875,000
Operating expenses (25%)......... 250,000 62,500 312,500
Income before interest................ 450,000 112,500 562,500
Interest expense.......................... 0 21,000 21,000
Net income................................... $ 450,000 $ 91,500 $ 541,500
2. Times interest earned = $562,500 / $21,000 = 26.8 times
3.
Operations
Sales............................................. $1,000,000 $ 400,000 $1,400,000
Gross profit.................................. 700,000 280,000 980,000
Net income................................... $ 450,000 $ 159,000 $ 609,000
Times interest earned = $630,000 / $21,000 = 30.0 times

Entrepreneurial Decision (concluded)
4.
Operations
Sales............................................. $1,000,000 $ 100,000 $1,100,000
Gross profit.................................. 700,000 70,000 770,000
Net income................................... $ 450,000 $ 24,000 $ 474,000
Times interest earned = $495,000 / $21,000 = 23.6 times
5. In each of these cases, Feed Granola Company’s times interest earned

is at least 23.6, so it appears that if it takes out the loan and can
generate at least $100,000 in sales in Europe, then Feed Granola
Company will have little trouble paying its interest expense.
Hitting the Road — BTN 11-8
There is no formal solution to this problem. A discussion of the

importance of safeguarding social security information would be
appropriate especially with respect to the Administration’s decision to no
longer transfer benefit information online.

Global Decision — BTN 11-9
1. DSG — Times interest earned

(₤ millions) Current Year One Year Prior
Net income.................................................. ₤207 ₤222

Add income taxes...................................... 89 89
Income before income taxes..................... 296 311
Add interest expense................................. 73 65
Income before taxes and interest............. ₤369 ₤376
Times interest earned ratio....................... 5.1a 5.8b

a
₤369/ ₤73 = 5.1
b
₤376/ ₤65 = 5.8
2. Of these four companies, Best Buy has the best coverage of interest
expense for the current year. Specifically, Best Buy’s times interest
earned of 69.7 for the current year is superior to Circuit City’s value of
12.5, and DSG’s 5.1, and RadioShack’s 3.5. In the prior year, Circuit
City’s times interest earned was the highest at 76.3, followed by Best
Buy’s at 58.4, RadioShack’s at 8.1, and DSG’s at 5.8.


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Chapter 11

Current Liabilities and Payroll

©McGraw-Hill Companies, 2009

©McGraw-Hill Companies, 2009

©McGraw-Hill Companies, 2009

Quick Study 11-1 (5 minutes)

Items 3, 4, 5 and 6 are current liabilities for this company.

Quick Study 11-2 (10 minutes)

Nov. 5 Unearned Ticket Revenue.......................................

Quick Study 11-3 (10 minutes)

Sept. 30 Cost of Goods Sold..................................................7,800

Oct. 15 Sales Taxes Payable................................................ 720

©McGraw-Hill Companies, 2009

1. Computation of interest payable at December 31, 2009:

Quick Study 11-5 (15 minutes)

[Note: Two months (January and February) of earnings have

Mar. 31 Payroll Taxes Expense............................................1,457.50

Quick Study 11-6 (5 minutes)

Vacation Benefits Expense*.................................... 250

©McGraw-Hill Companies, 2009

Dec. 31 Employee Bonus Expense...................................... 15,000

Quick Study 11-8 (10 minutes)

Quick Study 11-9 (10 minutes)

1. (b); reason—is reasonably estimated but not a probable loss.

Quick Study 11-10 (10 minutes)

Interpretation: This company’s times interest earned ratio of 7.2 exceeds

Quick Study 11-11B (10 minutes)

Dec. 31 Income Taxes Expense............................................ 40,000

©McGraw-Hill Companies, 2009

Exercise 11-1 (10 minutes)

Exercise 11-2 (15 minutes)

[Note: All entries dated December 31, 2009.]

1. Warranty Expense.................................................... 3,444

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

3. Vacation Benefits Expense..................................... 2,940

Cost of Goods Sold.........................................................

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

©McGraw-Hill Companies, 2009

Exercise 11-4 (30 minutes)

1. Maturity date = May 15 + 180 days = November 11, 2009

Nov 11 Interest Expense*..................................................... 6,165

©McGraw-Hill Companies, 2009

1. Maturity date = November 1 + 180 days = April 30, 2010.

©McGraw-Hill Companies, 2009

Exercise 11-7 (20 minutes)

©McGraw-Hill Companies, 2009

1. Warranty Expense = 3% of dollar sales = 3% x $9,400 = $282

3. The company should report no additional warranty expense in 2010 for

4. The December 31, 2010, balance of the Estimated Warranty Liability

Aug. 16 Cost of Goods Sold.................................................. 6,500

©McGraw-Hill Companies, 2009

(a) (b) (c) (d) (e) (f)

Ratio....................... 5.17 14.60 25.67 5.73 12.50 0.54

Exercise 11-10A (15 minutes)

Gross Pay............................................................................. $735.00

Exercise 11-11A (15 minutes)

©McGraw-Hill Companies, 2009