Lecture: Current Liabilities and Payroll
Lecture script · about 15–20 minutes spoken · Week 12
Opening
Think about the first paycheck you ever got. Maybe it came from a café, a warehouse, or a campus job. You did the math in your head, hours times the rate, and then the check was smaller. Lines on the stub had taken some away. That small shock is where this lecture starts.
Our bicycle shop's mechanic has had that week. The mechanic worked 45 hours at $24 an hour and earned $1,140. The paycheck says $957.79. Where did the rest go? And here's the twist: the week cost the shop more than $1,140, not less.
Let me remind you where we are. In Week 2 you learned that a liability is an obligation to transfer resources to others. In Week 4 you recorded wages the shop owed but hadn't paid yet. In Week 5 you split the balance sheet into current and long-term items. And in Week 10 you computed simple interest on a note the shop held.
Here's the plan. I'll walk you through the common current liabilities, then three of them in detail: a note payable, sales tax, and the part of a long loan that's due soon. Then we'll spend most of our time on payroll, from gross pay to the paycheck and on to the taxes the shop owes on its own account. We'll finish with possible losses that aren't certain yet. Next week, in Long-Term Liabilities, you'll move to debts that last for years.
1. The debts due soon
Picture a household at the end of a month. There's a credit card bill, a phone bill, and a short loan from a relative that has to be repaid by summer. Every one of those is a promise to pay soon. None of them is something the household used up.
A business keeps the same kind of list, and it has a name. Current liabilities are obligations expected to be paid within one year or the operating cycle. The common ones are accounts payable, short-term notes payable, sales taxes payable, unearned revenue, payroll liabilities, and the current portion of long-term debt.
You've met some already. The shop's Month 1 balance sheet showed Accounts Payable of $300, Wages Payable of $400, and Unearned Revenue of $900. Together that's $1,600 of current liabilities. Unearned Revenue is the odd one out, because the shop settles it with work, the cycling club's tune-ups, not with cash.
Here's the wrong turn I want you to avoid. A liability is not an expense. An expense is something used up to earn revenue. A liability is a debt still owed. When the shop pays a supplier, it lowers Accounts Payable and Cash, and it records no expense at all.
Pause and try this. The shop pays the $300 it owes a supplier. Does that payment record an expense?
Think about what was used up, and when.
Here's the answer. No. The payment lowers Accounts Payable and Cash by $300. Any expense was recorded when the supplies were used, not when the bill was paid.
2. A note from the borrower's side
In Week 10 a youth cycling program signed a $6,000, 6 percent, 3-month note to the shop. On the shop's books it was a receivable. Now flip the paper over. On the program's books, the very same note is a debt.
A note payable is a liability created when a business signs a written promise to repay a sum, usually with interest, by a stated date. The interest is the price of using the lender's money for a while, and it goes to Interest Expense.
You already know the arithmetic. Interest is the face, times the yearly rate, times the fraction of a year. That's $6,000 times 6 percent times three twelfths, which comes to $90. So at maturity the program pays $6,090. It debits Notes Payable for $6,000 and Interest Expense for $90, and it credits Cash for $6,090. Both sides come to $6,090.
The classic slip is to charge a full year of interest. A full year at 6 percent would be $360. But this note runs three months, so it owes a quarter of that.
Pause and try this. Which part of the program's $6,090 payment is an expense?
Split the payment into what ends the debt and what it cost.
Here's the answer. The $90 of interest. The $6,000 repays the amount borrowed, so it lowers Notes Payable, and only the interest is the cost of borrowing.
3. Collecting tax for someone else
Now picture a campus bookstore's register on a busy afternoon. A student buys a hoodie, and the screen adds a line for tax. The store collects that money, but it was never the store's.
Sales taxes payable is a current liability for the sales tax a seller has collected from customers and owes to the state or city until it sends the money in.
Here's an illustrative day. The bookstore sells $2,000 of sweatshirts at an illustrative 8 percent rate. Real rates are set by each state and city, and this one describes no real place. The tax is $160, so customers pay $2,160. The store debits Cash for $2,160, credits Sales Revenue for $2,000, and credits Sales Taxes Payable for $160. Later, when it sends the tax to the state, it debits Sales Taxes Payable and credits Cash for $160.
It's tempting to call all $2,160 revenue, because it all landed in the drawer. But the store did no work for the $160 and can't keep it.
Pause and try this. Of the $2,160 the bookstore collected, how much did it earn?
Ask which part the store gets to keep.
Here's the answer. $2,000. The other $160 passed through the register on its way to the government, so it's a liability, never revenue.
4. The part of a long loan that's due soon
Think about a car loan with five years of payments. If a friend asked what you owe in the coming year, you'd count only this year's share. A balance sheet asks the same question.
The current portion of long-term debt is the part of a long-term loan that's due within the next year. It's reported as a current liability, while the rest stays long-term.
Here's an illustrative landscaping company. It owes $50,000 on a five-year note and repays $10,000 a year. The $10,000 due next year is a current liability. The other $40,000 stays in long-term liabilities. Notice what didn't happen: no journal entry changed the debt. The company still owes $50,000. Only the classification moved.
Pause and try this. Where does the landscaping company report the $10,000 it must repay next year?
Think about what's due within a year.
Here's the answer. In current liabilities, as the current portion of long-term debt. Classification follows the due date, so a lender can see what must be paid soon.
5. Gross pay and the overtime rule
Now to payroll, the biggest current liability for many small businesses. Every pay stub starts with hours.
Gross pay is the total an employee earns for a pay period, regular pay plus any overtime pay, before anything is withheld.
Overtime has a rule, and it comes from its source: the Fair Labor Standards Act, the FLSA. In the Department of Labor's words: "Unless exempt, employees covered by the Act must receive overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their regular rates of pay." Time and one-half means the regular rate times 1.5.
So let's pay the mechanic. The 40 regular hours at $24 come to $960. The overtime rate is $24 times 1.5, or $36 an hour. The mechanic worked 45 hours, so 5 of them are overtime, and 5 times $36 is $180. Gross pay is $960 plus $180, or $1,140.
Pause and try this. If someone paid those 5 overtime hours at the regular $24, what would they pay?
Multiply the hours by the rate you'd use.
Here's the answer. $120, because 5 times $24 is $120. The rule requires $180, so paying the regular rate shorts the mechanic, and the 1.5 multiplier belongs on every hour over 40.
6. What gets held back
Here's where the paycheck starts to shrink. The employer keeps part of gross pay and sends it to others on the employee's behalf. Those amounts are withholdings.
Two federal taxes come first, and their rates come from the issuing bodies. For wages paid in 2026, the Social Security Administration and IRS Publication 15 state them. Social Security tax is 6.2 percent each for employees and employers, charged only on wages up to that year's wage base. The wage base for 2026 is $184,500. Medicare tax is 1.45 percent each, on all wages, with no wage base.
The mechanic is far below the wage base, so the whole $1,140 is taxed. Social Security is $1,140 times 0.062, which is $70.68. Medicare is $1,140 times 0.0145, which is $16.53. Payroll runs to the cent.
Income tax is withheld too. But real income tax withholding comes from the IRS's own tables and the employee's withholding form, and this course doesn't compute it. The shop's $95.00 is an illustrative amount, there so the rest of the arithmetic can be shown. There's also an Additional Medicare Tax of 0.9 percent on wages above $200,000. You'll know it by name, and it doesn't touch this paycheck.
Pause and try this. Why can you compute the mechanic's Social Security from a rate, but not the income tax?
Think about where each number comes from.
Here's the answer. Social Security has one pinned rate, 6.2 percent, below the wage base. Income tax withholding depends on the IRS's tables and the employee's form, so the course labels the $95.00 illustrative.
7. The paycheck, and the entry
What's left after the withholdings is net pay, the take-home amount: gross pay minus all withholdings. The three withholdings total $182.21, and $1,140 minus $182.21 is $957.79. Check it the other way: $70.68, $16.53, $95.00, and $957.79 add back to $1,140.00.
Now record it, the way you'd walk any transaction. What happened? The mechanic earned a week's wages. Wages Expense goes up by the whole $1,140.00, because that's what the work cost. Three liabilities go up: Social Security Tax Payable by $70.68, Medicare Tax Payable by $16.53, and Federal Income Tax Payable by $95.00. And Wages Payable goes up by $957.79, the check the shop still owes the mechanic. One debit of $1,140.00, four credits that add to $1,140.00.
Here's the wrong turn. It's tempting to debit Wages Expense for $957.79, because that's the check. But the withholdings are still part of what the mechanic earned. The shop only sends them somewhere else.
Pause and try this. In the payroll entry, which account gets the $957.79?
Ask who is still waiting to be paid that amount.
Here's the answer. Wages Payable. The shop owes the mechanic the net pay until the check is handed over, and Wages Expense carries the full $1,140.00.
8. The employer's own taxes
The withholdings are the mechanic's taxes. The shop owes taxes of its own on the same wages. It matches the Social Security and Medicare: $70.68 plus $16.53, or $87.21. It debits Payroll Tax Expense for $87.21 and credits the two tax payables. Payroll Tax Expense is the expense account for the employer's own payroll taxes, a cost on top of gross pay. The shop also owes federal and state unemployment taxes. You'll name them in words; their rates aren't part of this course's figures.
Then everyone gets paid. The shop pays the mechanic $957.79 and clears Wages Payable. It sends the government $269.42: Social Security of $141.36, which is both shares, Medicare of $33.06, both shares again, and the $95.00 of income tax.
So what did the week cost? Gross pay of $1,140.00 plus the match of $87.21 is $1,227.21. And the cash that left, $957.79 to the mechanic and $269.42 to the government, is also $1,227.21. Everything ties.
Pause and try this. Does the shop's $87.21 match appear anywhere on the mechanic's pay stub?
Picture the stub from gross pay down to net pay.
Here's the answer. No. The match is the shop's own cost, recorded as Payroll Tax Expense. It never comes out of the mechanic's pay, even though it equals the mechanic's withholding to the cent.
9. The ceiling on Social Security
Social Security has a ceiling, and Medicare doesn't. That matters only near the top, but there a careless payroll overcharges people.
Take a second employee whose wages this year already total $184,000. The wage base is $184,500, so only $500 of this $1,140 paycheck is still below the ceiling. Social Security is $500 times 0.062, or $31.00. Medicare has no ceiling, so it's still $16.53 on the full $1,140. The employee's wages now reach $185,140, which is below $200,000, so no Additional Medicare Tax.
Pause and try this. On the second employee's next paycheck, how much Social Security will be withheld?
Remember where the year's wages now stand.
Here's the answer. None. The employee has passed the $184,500 wage base, so Social Security stops for the rest of the year, while Medicare keeps going on every dollar.
10. Losses that may or may not happen
Last idea. Imagine a customer says a repaired bicycle failed on a hill and files a claim against the shop. The shop might lose, or it might not. It might know how much, or it might not.
A loss contingency is a possible loss that depends on a future event. Here's how it sorts. It's recorded when the loss is probable and the amount can be reasonably estimated. It's disclosed in the notes when the loss is reasonably possible, or probable but not reasonably estimable. And a remote loss needs neither. This course teaches it in words only, because real cases call for judgment by managers, lawyers, and auditors.
Pause and try this. The shop's lawyer says a loss is reasonably possible but not likely. What does the shop do?
Run the three cases in order.
Here's the answer. It describes the claim in the notes and records nothing. A reasonably possible loss is disclosed, not recorded.
Closing
Let me pull it together in the order we built it. Current liabilities are debts due within a year, and a liability is never an expense. A note payable's interest is the face times the rate times the fraction of a year. Sales tax collected is owed to the government, never revenue. The part of a long loan due next year is a current liability. Gross pay includes overtime at time and one-half for hours over 40. For 2026, Social Security is 6.2 percent up to $184,500, and Medicare is 1.45 percent on everything. Net pay is gross pay minus every withholding, and the shop's match is a second cost on top. The mechanic earned $1,140, took home $957.79, and the week cost the shop $1,227.21. And a possible loss is recorded only when it's probable and can be estimated.
Next in this module, read the Readings & Resources page, then work the lecture tutorial and the practice set before the quiz, the discussion, and the assignment. Next week, in Long-Term Liabilities, you'll price bonds and spread a discount or a premium across their life.
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