Accounting for Current Liabilities

  • Account for deferred and accrued current liabilities

 

You’ve seen, in the section on inventory, how to record accounts payable. What follows are a few examples of how we would account for other current liabilities, both deferred and accrued.

Accrue sales tax

Assume a company sells merchandise in a state with a 6% sales tax. If it sells goods with a sales price of $1,000 on credit, the company makes this entry:

Journal
Date Description Post. Ref. Debit Credit
Accounts Receivable  (1,000 + 60) 1,060
      Sales 1,000
      Sales Tax Payable (1,000 x 6%) 60
To record sales and sales tax payable.

Now assume there are no other sales for the entire period. The following entry shows the payment to the state:

Journal
Date Description Post. Ref. Debit Credit
Sales Tax Payable 60
      Checking Account 60

Record deferred revenues

Let’s say we work for a hardware store that sells 67 gift cards to our customers in a big promotion on March 1. Each gift card has a face value of $100 and we are in a state with no sales tax. The journal entry would look like this:

JournalPage 86
Date Description Post. Ref. Debit Credit
20–
March 1 Checking account 6,700.00
March 1         Deferred revenue 6,700.00
March 1 To record sale of gift cards

 

We increased the checking account by the amount of cash received and we increased a liability that represents the amount of revenue collected that hasn’t actually been earned because we haven’t sold any stock in trade.

Posting this to the general ledger results in the following:

Checking
Debit Credit
6,700.00
Double line Double line 6,700.00
Deferred Revenue
Debit Credit
6,700.00
Double line 6,700.00 Double line
Sales Revenue
Debit Credit
Double line 0.00 Double line

A customer comes in on March 15th and buys a $55 saw using a gift card. The entry would be:

JournalPage 86
Date Description Post. Ref. Debit Credit
20–
March 15 Deferred revenue 55.00
March 15     Sales revenue 55.00
March 15 To record sale using gift card
Checking
Debit Credit
6,700.00
Double line Double line
Deferred Revenue
Debit Credit
6,700.00
55.0
Double line Double line 6,645.00
Sales Revenue
Debit Credit
55.0
Double line Double line

The unearned (deferred) revenue has been earned and that economic event is now recorded in our books.

Accrue income tax expense

According to The Home Depot footnote disclosures (page 53), income tax expense on $15 billion of earnings for the fiscal year ended February 2, 2020, was $3.282 billion. The balance sheet shows income taxes payable at $55 million. We could conclude therefore that during the year, the company made estimated tax payments (much like the withholding deducted from your paycheck) to the IRS of $3.227 billion.

Here is the rationale, working backward from what we see on the balance sheet and in the notes:

Assume the company was making quarterly estimated tax payments to the IRS that totaled $3.227 billion and posted those payments to a current asset account called prepaid taxes.

in millions
Two T accounts side by side. On the left is a checking account. There is a credit entry of 800 dollars labeled as 'est pmt 1'. There is a credit entry of 800 dollars labeled as 'est pmt 2'. There is a credit entry of 800 dollars labeled as 'est pmt 3'. There is a credit entry of 827 dollars labeled as 'est pmt 4'. On the right is a prepaid taxes chart. There is a debit entry of 800 dollars labeled as 'est pmt 1'. There is a debit entry of 800 dollars labeled as 'est pmt 2'. There is a debit entry of 800 dollars labeled as 'est pmt 3'. There is a debit entry of 827 dollars labeled as 'est pmt 4'. There is a debit total of 3,227 dollars.

After the year end accounting, at the very end of the cycle, the tax accountants determine the exact amount of tax that is due based on the financial accounting records adjusted to comport to the Internal Revenue Code. This is usually the very last adjusting journal entry.

The current taxes come out to be $3.282 billion, and the company has paid in $3.227 billion according to the general ledger. This would be verified against information provided by the IRS. Therefore, the company owes another $55 million to balance out last year’s taxes, meaning this expense has been incurred but not yet recorded. Therefore, the additional expense will be accrued (added to) the books for the fiscal year ended February 2, 2020, and reported as part of the overall expenses for that year.

The final adjusting journal entry then looks like this, except it would have the exact numbers with six more digits:

JournalPage 101
Date Description Post. Ref. Debit Credit
2020
Feb 2 Provision for income taxes 3,282
Feb 2       Prepaid income tax 3,227
Feb 2       Income taxes payable 55
Feb 2 To accrue income tax liability.

And it would then result in this after posting to the general ledger:

in millions
Two T accounts side by side. On the left is a checking account. There is a credit entry of 800 dollars labeled as 'est pmt 1'. There is a credit entry of 800 dollars labeled as 'est pmt 2'. There is a credit entry of 800 dollars labeled as 'est pmt 3'. There is a credit entry of 827 dollars labeled as 'est pmt 4'. On the right is a prepaid taxes chart. There is a debit entry of 800 dollars labeled as 'est pmt 1'. There is a debit entry of 800 dollars labeled as 'est pmt 2'. There is a debit entry of 800 dollars labeled as 'est pmt 3'. There is a debit entry of 827 dollars labeled as 'est pmt 4'. There is a debit total of 3,227 dollars. On the credit side, there is an adjusting journal entry of 3,227 dollars. This is highlighted in green. There is a new debit total of 0 dollars.

Two T accounts side by side. On the left is an income taxes payable chart. On the credit side, there is an adjusting journal entry of 55 dollars. This value is highlighted in green. There is a credit total of 55 dollars. On the right is a provision for income taxes chart. On the debit side, there is an adjusting journal entry of 3,282 dollars. This value is highlighted in green. There is a debit total of 3,282 dollars.

Actual expense on the face of the income statement for The Home Depot is 3.473 billion, due to the other entries to a noncurrent liability account called deferred income taxes that reconciles taxes based on book income to the actual tax liability. Deferred income taxes will be covered in the section on noncurrent liabilities, but as you can see, much of the calculations involved in these numbers are best addressed in more advanced courses. A company like The Home Depot has an entire department of tax accountants that do nothing but manage the complexities of tax planning and reporting.