Payroll
Content
It's a fact of business–if a company has employees, it has to account for payroll and fringe benefits. In this explanation of payroll accounting we'll introduce payroll, fringe benefits, and the payroll-related accounts that a typical company will report on its income statement and balance sheet. Payroll and benefits include items such as: salaries wages bonuses & commissions to employees overtime pay payroll taxes and costs o Social Security o Medicare o federal income tax o state income tax o state unemployment tax o federal unemployment tax o worker compensation insurance employer paid benefits o holidays o vacations o sick days o insurance (health, dental, vision, life, disability) o retirement plans o profit-sharing plans
Many of these items are subject to state and federal laws; some involve labor contracts or company policies. NOTE: AccountingCoach.com focuses on financial statement reporting and not on income tax return reporting. You should consult with a tax professional or review the Internal Revenue Service publications to learn how employers and employees are required to report salaries, wages, and fringe benefits for income tax purposes. For the years 2011 and 2012, the U.S. government reduced the employee's tax rate for Social Security from 6.2% to 4.2%. (The employer's rate remains at 6.2% and the employee and employer Medicare tax rates remain at 1.45%.) The tax rate for Social Security and the amount subject to the tax can be found at http://www.irs.gov/pub/irs-pdf/p15.pdf
Matching Principle
As we proceed with our explanation of payroll accounting, it will be helpful to recall the matching principle of accounting. This principle will guide us to better understand how payroll and fringe benefits are reported on financial statements. (We're assuming that a company follows the accrual method of accounting.) The matching principle requires a company to match expenses to the accounting period in which the related revenues are reported. If a direct connection between revenues and an expense does not exist, then the expense should appear on the income statement for the accounting period in which it was
incurred. Keep in mind that expenses are often incurred (or occur) in a different accounting period than when they are paid. Let's use three payroll examples to illustrate this point: 1. A company employs a student to work a total of five days—from December 26 through December 30, 2011. On December 30 the student submits her time card. The company issues her payroll check on the next scheduled payday, January 5, 2012.
Even though the check is dated January 5, 2012, the matching principle requires that the company report the expense and the liability in December 2011 when the work was performed (and the company incurred the liability). Because the student was only employed for the last five days of December, the company would not have any wage or fringe benefits expense for her during January. The paycheck issued on January 5 merely reduces the company's liabilities and cash. 2. Let's assume that a company gives its sales manager an annual bonus of 1% of sales, to be paid on January 15, 2012. The bonus amount is calculated by multiplying the sales from January 1 through December 31, 2011 times 1%.
The matching principle requires that the company report 1% of sales as a Bonus Expense on its income statement (and a liability for the total amount owed must be reported on its balance sheet) in every accounting period in which sales occurred in 2011. If the company violates the matching principle by ignoring the bonus expense throughout the year 2011 (when sales actually occurred) and reports the entire bonus amount as an expense for just one day (January 15, 2012), every income statement pertinent to 2011 will report too much net income and the income statement that includes January 15, 2012 will report too little net income. The matching principle requires that the bonus expense pertinent to the 2011 sales be matched with the 2011 sales on the 2011 income statement.
If the entries are recorded properly, the balance sheet dated December 31, 2011 will report a current liability for the total bonus amount owed to the sales manager. On January 15, 2012 (when the company pays the bonus) the company will not have an expense; rather, the payment will reduce the company's cash and reduce the current liability that was established when the bonus was recorded as an expense in 2011.
3. A company has a vacation plan that will provide two weeks of vacation in the year 2012 if the employee worked the entire year of 2011. In the year 2011 (when the employee is working) the company reports the vacation expense on its 2011 income statement. The company's December 31, 2011 balance sheet will report a current liability for the two weeks of vacation pay that was earned by each employee but not yet taken. In 2012 (when employees take the vacations that were earned and expensed in 2011), the company will reduce its cash and its vacation liability.
As you learn about accounting for payroll and fringe benefits, keep the matching principle in mind. As the above examples show, the date on which a company pays wages or fringe benefits is not necessarily the date on which the company reports the expense on its financial statements.
Salaries, Wages, & Overtime Pay
In this section of payroll accounting we focus on the gross amounts earned by the employees of a company.
Salaries
Salaries are usually associated with "white-collar" workers such as office employees, managers, professionals, and executives. Salaried employees are often paid semi-monthly (e.g., on the 15th and last day of the month) or bi-weekly (e.g., every other Friday) and their salaries are often stated as a gross annual amount, such as "$48,000 per year." The "gross" amount refers to the pay an employee would receive before withholdings are made for such things as taxes, contributions to United Way, and savings plans. Since salaried employees earn a specified annual amount, it is likely that their gross pay for each pay period is the same recurring amount. For example, if a manager's salary is $48,000 per year and salaries are paid semi-monthly, the manager's gross pay will be $2,000 for each of the 24 pay periods. (If the manager is paid bi-weekly, the gross pay would be $1,846.15 for each of the 26 pay periods.) A salaried employee's work period usually ends on payday; for example, a paycheck on January 31 usually covers the work period of January 16–31. This is convenient for accounting purposes if the company prepares financial statements on a calendar month basis.
Wages
Wages are often associated with production employees (sometimes referred to as "blue-collar" workers), non-managers, and other employees whose pay is dependent on hours worked. The pay for these employees is generally stated as a gross, hourly rate, such as "$13.52 per hour." Again, the "gross" amount refers to the pay an employee would receive before withholdings are made for such things as taxes, contributions, and savings plans. Employees receiving wages are often paid weekly or biweekly. To determine the gross wages earned during a work period, the employer multiplies each employee's hourly rate times the number of work hours recorded for the employee during the work period. Due to the extra time needed to make calculations for each employee, hourly-paid employees typically receive their paychecks approximately five days after the work period has ended. When the hourly-paid employees have work periods that are weekly or biweekly, but the company's financial statements cover calendar months, the company will likely have to prepare an accrual-type adjusting entry at the end of the month. If hourly wages are a significant portion of a company's expenses, it is critical that the company report the correct amount of wages expense that pertains to the 30 or 31 days in the month, not the 28 days in a four-week work period.
Bonuses & Commissions Paid to Employees
Throughout our explanation, bonuses paid to employees and sales commissions paid to employees will be considered to be part of salaries.
Overtime Pay
Overtime refers to time worked in excess of 40 hours per week. Whether or not employees are paid for overtime depends on each employee's job responsibilities and rate of pay—some employees are exempt from overtime pay and some are not. For example, executives are considered to be "exempt"; their employers are not required to pay them for their overtime hours because (1) their compensation is high, and (2) they can control their work hours. Executives do not need state or federal wage and hour laws to protect them from company abuse. On the other hand, a design technician earning an annual salary of $18,000 per year is probably not in control of her work hours. If she works for an executive who decides to work 60 hours per week, the design technician needs to be protected from having to work 60 hours per week for no more pay than she would receive for 40 hours of work. This employee is considered a "nonexempt" employee—she is not exempt from being paid overtime compensation. Some unethical companies have been known to classify "hourly wage" employees as "salaried" in hopes of making them exempt from overtime pay—federal and state laws exist to prevent such unfair treatment of employees. When processing payroll, don't assume that it's only the hourly paid employees who receive overtime pay—state and federal laws require overtime payments to lower-paid salaried employees. It is also possible that some generous employers will give overtime pay to employees who are not required by law to receive it.
Overtime Premium
An overtime premium refers to the "half" portion of "time-and-a-half" or "time-and-one-half" overtime pay. For example, assume an employee in the production department is expected to work 40 hours per week at $10 per hour. If the employer requires the employee to work 42 hours in a given week, the extra two hours are paid at time-and-a-half and the employee earns a total of $430 for the week (40 hours × $10 per hour, plus 2 overtime hours × $15 per hour). It can also be computed as 42 hours at the straighttime rate of $10 per hour plus 2 hours times the overtime premium of $5 per hour.
Payroll Withholdings: Taxes & Benefits Paid by Employees
This section of payroll accounting focuses on the amounts withheld from employees' gross pay. (In Part 4 of payroll accounting we will discuss the payroll taxes that are not withheld from employees' gross pay.) The U. S. income tax system—as well as most state income tax systems—requires employers to withhold payroll taxes from their employees' gross salaries and wages. The withholding of taxes and other deductions from employees' paychecks affects the employer in several ways: (1) it reduces the cash amount paid to employees, (2) it creates a current liability for the employer, and (3) it requires the employer to remit the withheld taxes to the federal and state government by specific deadlines. Failure to remit payroll taxes in a timely manner results in interest and penalties levied on the employer; flagrant violations trigger more severe consequences. Payroll withholdings include: 1. Employee portion of Social Security tax
2. 3. 4. 5. 6.
Employee portion of Medicare tax Federal income tax State income tax Court-ordered withholdings Other withholdings
1. Employee portion of Social Security tax
A key component of payroll accounting is the Social Security tax. (The Social Security tax along with the Medicare tax make up what is referred to as FICA.) Social Security tax is withheld from an employee's salary or wages and the employer is also required to pay a Social Security tax. In other words, the employer is responsible for remitting to the federal government both the employee and the employer portions of the Social Security tax. As a result, Social Security tax is both an employee withholding and an employer expense. (The official title for the system financed by the Social Security tax is Old Age, Survivors and Disability Insurance, or OASDI. As the name indicates, this system pays retirement, disability, family, and survivors' benefits.) In 2012, the amount of Social Security tax that an employer must withhold from an employee is 4.2% of the first $110,100 of the employee's annual wages and salary; any amount above $110,100 is not subject to Social Security tax withholdings. For example: If an employee earns $40,000 in wages in 2012, the entire $40,000 is subject to withholdings at 4.2%, for a total annual withholding of $1,680. If an executive earns $300,000 in salary in 2012, only the first $110,100 of the salary is subject to the Social Security tax of 4.2%, for a total annual withholding of $4,624.20. (The remaining $189,900 of salary is not subject to Social Security tax withholdings, although it will be subject to the Medicare tax discussed in the next section.) The amount withheld—and the employer's portion—are reported as a current liability until the amounts are remitted to the government by the employer. NOTE: The employee's tax rate for Social Security and the amount subject to the tax can be found at http://www.irs.gov/pub/irs-pdf/p15.pdf.
2. Employee portion of Medicare tax
Medicare tax is also withheld from an employee's salary or wages and is matched by a contribution from the employer. In other words, the employer is responsible for remitting to the federal government two times the amount of Medicare tax withheld from each employee. As a result, Medicare tax is both an employee withholding and an employer expense. (The Medicare program helps pay for hospital care, nursing care, and doctor's fees for people age 65 and older as well as for some individuals receiving Social Security disability benefits.) The combination of the Social Security tax and the Medicare tax is referred to as FICA (an acronym for Federal Insurance Contribution Act). An employer must withhold 1.45% of each employee's annual wages and salary for Medicare tax. Unlike the Social Security tax, this percentage is applied on every employee's total salary no matter how large the salary might be—an executive's salary of $300,000 has Medicare tax withholdings of $4,350 (the entire $300,000 times 1.45%). The amount withheld—and the employer's matching amount—are reported as a current liability until the amounts are remitted to the government by the employer.
3. Federal income tax
Another part of payroll accounting involves the employees' federal income tax. An employer is required to withhold the federal income tax that an employee is expected to owe based on salaries or wages. The amount withheld, however, is rarely the exact amount of income tax that the employee will owe to the government. The employee's year-end income tax return will dictate the exact amount owed for the year, meaning the employee will either pay in a little more in taxes, or will receive a tax refund. The amount withheld for federal income tax is based on the employee's salary or wages as well as personal information that the employee is required to provide the employer on federal form W–4 (including marital status and the number of dependents claimed as exemptions). In cases where an employee is paid low wages and/or has a large number of personal exemptions, it may not be necessary for the employer to withhold any federal income tax. Unlike FICA, there is no employer contribution for federal income tax. Amounts withheld from employees for federal income taxes are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the federal government, the current liability is reduced.
4. State income tax
In most states payroll accounting will involve a state income tax. In those states an employer is required to withhold the state income tax that an employee is expected to owe based on salaries or wages. Like its federal counterpart, the amount withheld is rarely the exact amount of income tax that the employee will owe to the state government. (It should be noted here that some states do not levy a personal income tax.) The amount withheld for state income tax is based on the employee's salary or wages as well as personal information that the employee is required to provide the employer on a state version of federal form W–4 (including marital status and the number of dependents claimed as exemptions). In cases where an employee is paid low wages and/or has a large number of personal exemptions, it may not be necessary for the employer to withhold any state income tax. Like the federal income tax (and unlike the FICA tax), there is no employer contribution for state income tax. Amounts withheld from employees for state income taxes are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the state government, the current liability is reduced.
5. Court-ordered withholdings
Payroll accounting also involves withholdings for items other than payroll taxes. For example, courts of law may order employers to garnish (withhold money from) an employee's salary or wages for purposes such as paying child support or repaying debts. The amounts withheld from employees for court-ordered withholdings are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the designated parties, the liability is reduced. Some court orders may include a small fee to be withheld from the employee in order to reimburse the employer for administrative expenses. For example, the court order might direct the employer to withhold $101 from the employee and to remit $100 to a designated agency. The $1 difference will be a credit to the company's administrative expenses or to a miscellaneous revenue account.
6. Other withholdings
In addition to the mandatory withholdings that an employer makes for taxes and court orders, payroll accounting often includes amounts that employers may be willing to withhold at the direction of its employees. These voluntary withholdings can include such things as:
union dues charitable contributions insurance premiums 401(k) and 403(b) contributions U.S. savings bonds purchases payments owed to the company for the purchase of company merchandise
If the voluntary withholdings are to be remitted to places outside of the company (a local charity, for example), the amounts withheld are reported on the employer's balance sheet as a current liability. When the employer remits the withholdings, the current liability will be reduced. If the withholdings are for amounts that are due the company (such as employees' share of insurance premiums or amounts owed by employees for company merchandise), no remittance is required. Rather, the journal entry reflects a credit that reduces the company's insurance expense or reduces the company's receivables from employees. Sample journal entries are provided in Part 5 and Part 6.
Net Pay
Net pay is the amount that remains after withholdings are deducted from an employee's gross pay. Net pay is also referred to as "take home pay" or the amount that an employee "clears." From the company side of the transaction, it is the amount of cash the company will pay directly to the employees on payday.
Payroll Taxes, Costs & Benefits Paid by Employers
In addition to salaries and wages, the employer will incur some or all of the following payroll-related expenses: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Employer portion of Social Security tax Employer portion of Medicare tax State unemployment tax Federal unemployment tax Worker compensation insurance Employer portion of insurance (health, dental, vision, life, disability) Employer paid holidays, vacations, and sick days Employer contributions toward 401(k), savings plans, & profit-sharing plans Employer contributions to pension plans Post-retirement health insurance
1. Employer portion of Social Security tax
Understanding the Social Security tax and the Medicare tax is critical for payroll accounting. In this section we discuss the employers' portion of the Social Security tax. In addition to the amount withheld from its employees for Social Security taxes, the employer must contribute/remit an additional amount, which is an expense for the employer. In the year 2012, the employer's portion of the Social Security tax is 6.2% of the first $110,100 of an employee's annual wages and salary. For example, if an employee earns $40,000 of wages, the entire $40,000 is subject to the Social Security tax. This means that in addition to the withholding of $1,680, the employer must also pay $2,480. The combined amount to be remitted to the federal government for this one employee is $4,160 ($1,680 of withholding plus the employer's portion of $2,480).
For an executive with an annual salary of $300,000 in the year 2012, only the first $110,100 is subject to the Social Security tax. This means that in addition to the withholding of $4,624.20, the employer must also pay $6,826.20. The combined amount to be remitted to the federal government for this one employee is $11,450.40 ($4,624.20 + $6,826.20). The employer's share of Social Security taxes is recorded as an expense and as an additional current liability until the amounts are remitted.
2. Employer portion of Medicare tax
Every employer must contribute/remit to the federal government an amount identical to the Medicare tax withheld from each employee's pay. This match is considered to be an expense for the employer. For the year 2012, the employer's portion of the Medicare tax is the same rate as the employee's withholding— 1.45% of every dollar of each employee's annual wages and salary. Unlike the Social Security tax, there is no cap (ceiling or limit); if a top executive earns a salary of $300,000, the employer must pay a Medicare tax of $4,350 in addition to the $4,350 that was withheld from the executive. The combined amount to be remitted to the federal government for this one employee is $8,700. The employer's share of Medicare taxes (the ―match‖) is recorded as an expense and as an additional current liability until the amounts are remitted.
3. State unemployment tax
State governments administer unemployment services and determine the state unemployment tax rate for each employer. (Some not-for-profit organizations—such as churches without schools—may not be required to pay state unemployment taxes. You should check with your state unemployment office to learn the specifics for your organization.) Generally, states require that the employers pay the entire unemployment tax. Often, employers that have built up a large reserve in the state's unemployment fund will have lower unemployment tax rates; conversely, employers with a small reserve (or no reserve at all) will have higher unemployment tax rates. The unemployment tax rate is often applied only to the first $7,000 of each employee's annual salary and wages (this amount will differ from state to state). If we assume that an employer's unemployment tax rate is 4% and that this is applied to the first $7,000 of annual salaries and wages, then the employer's state unemployment tax cost will be a maximum of $280 per year for each employee ($7,000 × 4%). To illustrate, let's assume that a company has three employees. In 2012, Employee #1 earned $19,000, Employee #2 earned $40,000, and Employee #3 (who only recently joined the company) earned $4,000. If the 2012 state unemployment tax rate is 4%, the employer will pay a tax of $720 to the state government: Employee #1 Employee #2 Employee #3 Total for 2012 $7,000 × 4% = $280 $7,000 × 4% = $280 $4,000 × 4% = $160 $720
Even though the state unemployment tax is based on employee salaries and wages, the entire tax is paid by the employer. There is no withholding from an employee's salary or wages for the state unemployment tax.
4. Federal unemployment tax
The federal government oversees the state unemployment programs and requires employers to pay a federal unemployment tax of 0.8% on each employee's first $7,000 of annual salaries and wages. Using the example of three employees with annual 2012 earnings of $19,000, $40,000, and $4,000; with a federal unemployment tax rate of 0.8%, the employer will pay a tax of $144 to the federal government: Employee #1 Employee #2 Employee #3 Total for 2012 $7,000 × 0.8% = $56 $7,000 × 0.8% = $56 $4,000 × 0.8% = $32 $144
Even though the federal unemployment tax is based on employee salaries and wages, the entire tax is paid by the employer. There is no withholding from an employee's salary or wages for the federal unemployment tax.
5. Worker compensation insurance
Worker compensation insurance provides coverage for employees who are injured on the job. State law usually requires that employers carry this insurance. Worker compensation insurance rates are a function of at least three variables: (1) the type of business or industry, (2) the type of job being performed, and (3) the employer's history of claims. For example, statistics show that a production worker in a meat packing plant has a greater-than-average chance of suffering job-related cuts or back injuries. Because of this, worker compensation insurance rates for these employees can be as high as 15% of wages. On the other hand, the office staff of the meat packing plant—provided that they do not venture out into the production area—may have a rate that is less than 1% of salaries and wages. The worker compensation insurance rates are then applied to the wages and salaries of the employees to arrive at the worker compensation insurance premiums or costs. Although the insurance premiums are based on employee salaries and wages, the entire premium cost is likely to be paid by the employer and is considered an expense for the employer. (Contact your state's worker compensation office for the specifics in your state.) If the employer pays the premium in advance, a current asset such as Prepaid Insurance is used. The account balance will be reduced and Worker Compensation Insurance Expense will increase as the employees work. If the employer does not pay the premiums in advance, the company must accrue the expense with an adjusting entry that increases Worker Compensation Insurance Expense along with increases in a current liability such as Worker Compensation Insurance Liability. In this situation the current liability will be reduced when the employer pays the worker compensation insurance premiums. Worker compensation insurance is a significant expense for the employer and therefore we consider it an important part of payroll accounting.
6. Employer portion of insurance (health, dental, vision, life, disability)
In the past, many companies included group health, dental, vision, disability, and life insurance in the benefit package provided to employees. Over the past few decades, however, the cost of these group policies has risen significantly—in 2012, it was not uncommon to see an insurance premium for family coverage at $12,000 per year per employee. As a result of these escalating costs, most companies now require employees to pay a portion of the premium cost; this amount is usually collected by means of employee-directed payroll withholding. The employers' net cost (or expense) is simply the total amount of premiums paid to the insurance company minus the portion of the cost the employer collects from its employees.
7. Employer paid holidays, vacations, and sick days
Many companies pay their permanent employees for holidays such as New Year's Day, Memorial Day, July 4th, Labor Day, Thanksgiving, and Christmas. It is not unusual for employees to be paid for 10 holidays per year. It is also common for employees to earn one week of vacation after one year of service. Many employers give their employees two weeks of vacation after three years of service, with more weeks given after 10 years of service. Paid sick days are also a common benefit given to employees. If an employee is absent from work due to such things as illness or surgery, the company will pay the employee for the time missed. Employers generally set policies as to how sick days are to be used, and as to whether or not an employee is permitted to carry over unused sick days into subsequent years. The matching principle requires that the cost of compensated (or paid) absences (holidays, vacations, and sick days) be recognized as an expense during the time the employee is present and working. In other words, the cost is expensed when the benefit is being earned by the employee, not when the benefit is being used by the employee. (However, the Financial Accounting Standards Board generally allows for sick days and holidays not to be accrued.) To illustrate, assume that an employee works full-time for the entire year 2011 and as a result earns one week of vacation to be taken any time during the year 2012. During the year 2011 (when the employee is working), the employer records the vacation expense and the vacation liability. In 2012, when the employee takes the vacation earned in the previous year, the employer records the cash payment by crediting Cash and reduces the company liability by debiting Vacation Payable.
8. Employer contributions toward 401(k), savings plans, and profit-sharing plans
If an employer is required to contribute company money into an employee's savings program or profitsharing plan, the contribution should appear as an expense in the period when the employee earned the company contribution. It is also likely that the company will have the expense and the liability before the company actually pays the amount. This situation requires the company to record an adjusting entry in order to match the expense to the proper accounting period.
9. Employer contributions to pension plans
Some companies provide pensions for their employees. This means their employees will receive ongoing monthly payments after they retire from the company. The matching principle requires that the cost of the benefit should be recognized during the years that the employees are working (earning the benefit), and not when the employee is retired. Note: In effect, pensions (and other benefits) are part of the compensation package given to employees working at a company. While some parts of the compensation package are paid out during the time the employee is working, other benefits are deferred until the employee is retired. The cost of the entire compensation package, however, must be expensed or assigned to products manufactured when the employee is working, so that the cost of the employee's work is matched with the revenue resulting from the employee's work.
The concept is that in the years that the employee works, the company will charge Pension Expense and will credit either Pension Payable or Cash. For more specifics on pensions, you are referred to an Intermediate Accounting text or to the Financial Accounting Standards Board's website www.fasb.org.
10. Post-retirement health insurance
Some companies continue to provide health insurance coverage to employees after they have retired. This retiree benefit is considered to be part of the compensation package earned by employees while they are working. Again, accrual accounting and the matching principle require that the cost of this future insurance coverage be expensed (or assigned to manufactured products) during the years the employees are working by debiting an expense and crediting a liability. During the employees' retirement years, the company's payment for insurance will reduce the company's liability and will reduce its cash. To learn more on the accounting for post-retirement benefits, such as health insurance coverage, you are referred to an Intermediate Accounting text and/or to the Financial Accounting Standards Board's website www.fasb.org.
Examples of Payroll Journal Entries For Wages
NOTE: In the following examples we assume that the employee's tax rate for Social Security is 4.2% and that the employer's tax rate is 6.2%. In this section of payroll accounting we will provide examples of the journal entries for recording the gross amount of wages, payroll withholdings, and employer costs related to payroll. Let's assume that a distributor has hourly-paid employees working in two departments: delivery and warehouse. The company's workweek is Sunday through Saturday and paychecks are dated and distributed on the Thursday following the workweek. For the workweek of December 18–24, the gross wages are $1,000 for hourly employees in the delivery department and $1,300 for employees in the warehouse. Tax withholdings are determined by consulting government payroll guidelines; other withholdings are based on agreements with employees and court orders. Paychecks are dated and distributed on December 29. The journal entry to record the hourly payroll's wages and withholdings for the work period of December 18–24 is illustrated in Hourly Payroll Entry #1. In accordance with accrual accounting and the matching principle, the date used to record the hourly payroll is the last day of the work period. Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the workweek of December 18-24 that will be paid on December 29. Date Account Name Debit Credit Dec. 24 Wages Expense: Delivery Dept Wages Expense: Warehouse Dept FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Health Ins. Expense: Delivery Health Ins. Expense: Warehouse United Way Payable 1,000.00 1,300.00 129.95 300.00 110.00 70.00 90.00 80.00 30.00
Garnishment Payable Net Payroll Payable
50.00 1,440.05
* $2,300 x 5.65%
In addition to the wages and withholdings in the above entry, the employer has incurred additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2, which is also dated the last day of the work period. The items included are the employer's share of FICA, the employer's estimated cost for unemployment tax, worker compensation insurance, compensated absences, and company contributions for the company's 401(k) plan. The company is recognizing these additional expenses and the related liability in the period in which the employees are working and earning them. Later, when the company pays for them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company does not provide post-retirement benefits—like pensions or health insurance—to its employees.)
Hourly Payroll Entry #2: To record the company's additional payroll-related expense for hourlypaid employees for the workweek of December 18-24. Date Dec. 24 Account Name FICA Expense: Delivery * FICA Expense: Warehouse Unemployment Tax Expense: Warehouse Worker Compensation Insurance Expense Holiday, Vac., Sick Days Expense: Delivery Holiday, Vac., Sick Days Expense: Warehouse 401(k) Expense: Delivery 401(k) Expense: Warehouse FICA Tax Payable Unemployment Tax Payable Worker Comp Insurance Payable Holiday, Vacation, Sick Days Payable 401(k) Payable Debit 76.50 99.45 4.00 46.00 100.00 130.00 10.00 25.00 175.95 4.00 46.00 230.00 35.00 Credit
* $1,000 x 7.65%
On payday, December 29, the checks will be distributed to the hourly-paid employees. The following entry will record the issuance of those payroll checks. Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll checks on Dec. 29. (These checks reflect the net pay for the wages earned during the workweek of Dec. 18-24). Date Dec. 29 Account Name Net Payroll Payable Cash Debit 1,440.05 1,440.05 Credit
Some withholdings and the employer matching of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following Hourly Payroll Entry #4 were remitted on payday. Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the hourly-paid workweek of Dec. 18-24. Date Dec. 29 Account Name FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Cash Debit 305.90 300.00 110.00 105.00 820.90 Credit
* $129.95 from Entry #1 + $175.95 from Entry #2 End of Month and End of Year
Let's continue with our example of the payroll for the hourly-paid employees. We'll assume that this distributor's accounting month and accounting year both end on Saturday, December 31. The matching principle requires the company to report all of its December expenses (not simply its cash payments) on its December financial statements. This means the company must report on its income statement the hourly wages and other payroll expenses that the company incurred (and the employees earned) through December 31. Recall that the paychecks issued on December 29 covered the work done by hourly employees through December 24. The company must now record the cost of work done during the week of December 25–31 (a week that includes a Christmas holiday plus a number of employees taking vacation days). Let's assume that during the workweek of December 25–31, delivery department employees took $300 worth of their holiday and vacation days. Since a portion of the employer's estimated cost of holiday and vacation days was recorded as an expense and liability via each week's Hourly Payroll Entry #2, the $300 associated with the days actually taken this week will not be recorded as an expense—rather, the $300 associated with the days taken this week will reduce the liability that is recorded with each week's Hourly Payroll Entry #2. In other words, only $700 of the delivery department's employee gross wages of $1,000 is for the work performed this week. The warehouse department had a similar situation. Of the warehouse department's $1,300 of weekly wages, only $1,050 is the expense for the work performed this week. The wages associated with the ―days off with pay‖ reduces the company's liability that was provided for each week in Hourly Payroll Entry #2. Except for the holiday and vacation days, the workweek payroll for December 25-31 is similar to the previous week. Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the workweek of December 25-31 that will be paid on January 5. Date Dec. 31 Account Name Wages Expense: Delivery Dept Debit 700.00 Credit
Holiday, Vacation, Sick Days Payable Wages Expense: Warehouse Dept Holiday, Vacation, Sick Days Payable FICA Tax Payable Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Health Ins. Expense: Delivery Health Ins. Expense: Warehouse United Way Payable Garnishment Payable Net Payroll Payable
300.00 1,050.00 250.00 129.95 300.00 110.00 70.00 90.00 80.00 30.00 50.00 1,440.05
In addition to the wages and withholdings in Hourly Payroll Entry #1, the employer has incurred additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2, which is also dated the last day of the work period. The items included are the employer's share of FICA, the employer's estimated cost for unemployment tax, worker compensation insurance, compensated absences, and company contributions for the company's 401(k) plan. The company is recognizing these additional expenses and the related liability in the period in which the employees are working and earning them. Later, when the company pays for them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company does not provide post-retirement benefits—like pensions or health insurance—to its employees.) Hourly Payroll Entry #2: To record the company's additional payroll-related expense for hourlypaid employees for the workweek of December 25-31. Date Dec. 31 Account Name FICA Expense: Delivery FICA Expense: Warehouse Unemployment Tax Expense: Warehouse Worker Compensation Insurance Expense Holiday, Vac., Sick Days Expense: Delivery Holiday, Vac., Sick Days Expense: Warehouse 401(k) Expense: Delivery 401(k) Expense: Warehouse FICA Tax Payable Unemployment Tax Payable Worker Comp Insurance Payable Holiday, Vacation, Sick Days Payable 401(k) Payable Debit 76.50 99.45 4.00 46.00 100.00 130.00 10.00 25.00 175.95 4.00 46.00 230.00 35.00 Credit
On payday, January 5, the checks will be distributed to the hourly-paid employees. The following entry will record the issuance of those payroll checks. Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll checks on Jan 5. (These checks reflect the hourly-paid employees' take home pay from their wages earned during the workweek of Dec. 25-31). Date Jan. 5 Account Name Net Payroll Payable Cash Debit 1,440.05 1,440.05 Credit
Some withholdings and the employer matching of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following Payroll Entry #4 were remitted on payday. Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the hourly-paid workweek of Dec. 25-31. Date Jan. 5 Account Name FICA Tax Payable Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Worker Comp Insurance Payable Cash Debit 305.90 300.00 110.00 105.00 600.00 1,420.90 Credit
Additional Accrual of Wages
In our example above, the workweek ended on the same day as the calendar month and year: December 31. In other months and in some years, the last full workweek might end on the 28th of the month. In that case, the employer will need to estimate the payroll and payroll-related expenses for the 29th, 30th, and 31st days of the month. Those estimates will be used to record an accrual-type adjusting entry on the 31st. This is required so that all of the expenses actually occurring during the month are matched with the revenues of the month. Recording wages expense in the proper period is critical for accurate financial statements and therefore a very important part of payroll accounting. NOTE: In the following examples we assume that the employee's tax rate for Social Security is 4.2% and that the employer's tax rate is 6.2%. Let's assume our company also has salaried employees who are paid semimonthly on the 15th and the last day of each month. The pay period for these employees is the half-month that ends on payday. There is one salaried employee in the warehouse department with a gross salary of $48,000 per year, or $2,000 per pay period. There are four salaried employees in the Selling & Administrative Department with combined salaries of $9,000 per pay period. Because the salaried employees are paid on the last day of the month and their pay period ends right on payday, there is no need to accrue for salaries at the end of December (or any other calendar month).
The salaried payroll entry for the work period of December 16–31 will be dated December 31 and will look like this: Salaried Payroll Entry #1: To record the salaries and withholdings for the work period of December 16-31 that will be paid on December 31. Date Dec. 31 Account Name Salaries Expense: Delivery Dept Salaries Expense: Selling & Admin Dept FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Health Ins Expense: Delivery Health Ins. Expense: Selling & Admin United Way Payable Net Payroll Payable Debit 2,000.00 9,000.00 621.50 1,800.00 400.00 200.00 40.00 200.00 100.00 7,638.50 Credit
* $11,000 x 5.65%
In addition to the salaries recorded above, the company has incurred additional expenses pertaining to the salaried payroll for this semi-monthly period of December 16–31. These expenses must be included in the December financial statements, as shown in the next journal entry: Salaried Payroll Entry #2: To record additional payroll-related expense for salaried employees for the work period of December 16-31. Date Dec. 31 Account Name FICA Expense: Delivery FICA Expense: Selling & Admin 401(k) Expense: Delivery 401(k) Expense: Selling & Admin FICA Tax Payable * 401(k) Payable Debit 153.00 688.50 20.00 80.00 841.50 100.00 Credit
* $11,000 x 7.65%
On payday, December 31, the checks will be distributed to the salaried employees. The following entry will record the issuance of those payroll checks. Salaried Payroll Entry #3: To record the distribution of the salaried employees' payroll checks on Dec. 31. (These checks reflect the take-home pay for the salaries earned during the work period of Dec. 16-31). Date Account Name Debit Credit
Dec. 31
Net Payroll Payable Cash
7,638.50 7,638.50
Some withholdings and the employer portion of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Salaried Payroll Entry #1. We will assume the amounts in the following Payroll Entry #4 were remitted on payday. Salaried Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the salaried employees during the work period of Dec. 15-31. Date Dec. 31 Account Name FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable United Way Payable Cash Debit 1,463.00 1,800.00 400.00 300.00 100.00 4,063.00 Credit
* $621.50 from Entry #1 + $841.50 from Entry #2
Many of these items are subject to state and federal laws; some involve labor contracts or company policies. NOTE: AccountingCoach.com focuses on financial statement reporting and not on income tax return reporting. You should consult with a tax professional or review the Internal Revenue Service publications to learn how employers and employees are required to report salaries, wages, and fringe benefits for income tax purposes. For the years 2011 and 2012, the U.S. government reduced the employee's tax rate for Social Security from 6.2% to 4.2%. (The employer's rate remains at 6.2% and the employee and employer Medicare tax rates remain at 1.45%.) The tax rate for Social Security and the amount subject to the tax can be found at http://www.irs.gov/pub/irs-pdf/p15.pdf
Matching Principle
As we proceed with our explanation of payroll accounting, it will be helpful to recall the matching principle of accounting. This principle will guide us to better understand how payroll and fringe benefits are reported on financial statements. (We're assuming that a company follows the accrual method of accounting.) The matching principle requires a company to match expenses to the accounting period in which the related revenues are reported. If a direct connection between revenues and an expense does not exist, then the expense should appear on the income statement for the accounting period in which it was
incurred. Keep in mind that expenses are often incurred (or occur) in a different accounting period than when they are paid. Let's use three payroll examples to illustrate this point: 1. A company employs a student to work a total of five days—from December 26 through December 30, 2011. On December 30 the student submits her time card. The company issues her payroll check on the next scheduled payday, January 5, 2012.
Even though the check is dated January 5, 2012, the matching principle requires that the company report the expense and the liability in December 2011 when the work was performed (and the company incurred the liability). Because the student was only employed for the last five days of December, the company would not have any wage or fringe benefits expense for her during January. The paycheck issued on January 5 merely reduces the company's liabilities and cash. 2. Let's assume that a company gives its sales manager an annual bonus of 1% of sales, to be paid on January 15, 2012. The bonus amount is calculated by multiplying the sales from January 1 through December 31, 2011 times 1%.
The matching principle requires that the company report 1% of sales as a Bonus Expense on its income statement (and a liability for the total amount owed must be reported on its balance sheet) in every accounting period in which sales occurred in 2011. If the company violates the matching principle by ignoring the bonus expense throughout the year 2011 (when sales actually occurred) and reports the entire bonus amount as an expense for just one day (January 15, 2012), every income statement pertinent to 2011 will report too much net income and the income statement that includes January 15, 2012 will report too little net income. The matching principle requires that the bonus expense pertinent to the 2011 sales be matched with the 2011 sales on the 2011 income statement.
If the entries are recorded properly, the balance sheet dated December 31, 2011 will report a current liability for the total bonus amount owed to the sales manager. On January 15, 2012 (when the company pays the bonus) the company will not have an expense; rather, the payment will reduce the company's cash and reduce the current liability that was established when the bonus was recorded as an expense in 2011.
3. A company has a vacation plan that will provide two weeks of vacation in the year 2012 if the employee worked the entire year of 2011. In the year 2011 (when the employee is working) the company reports the vacation expense on its 2011 income statement. The company's December 31, 2011 balance sheet will report a current liability for the two weeks of vacation pay that was earned by each employee but not yet taken. In 2012 (when employees take the vacations that were earned and expensed in 2011), the company will reduce its cash and its vacation liability.
As you learn about accounting for payroll and fringe benefits, keep the matching principle in mind. As the above examples show, the date on which a company pays wages or fringe benefits is not necessarily the date on which the company reports the expense on its financial statements.
Salaries, Wages, & Overtime Pay
In this section of payroll accounting we focus on the gross amounts earned by the employees of a company.
Salaries
Salaries are usually associated with "white-collar" workers such as office employees, managers, professionals, and executives. Salaried employees are often paid semi-monthly (e.g., on the 15th and last day of the month) or bi-weekly (e.g., every other Friday) and their salaries are often stated as a gross annual amount, such as "$48,000 per year." The "gross" amount refers to the pay an employee would receive before withholdings are made for such things as taxes, contributions to United Way, and savings plans. Since salaried employees earn a specified annual amount, it is likely that their gross pay for each pay period is the same recurring amount. For example, if a manager's salary is $48,000 per year and salaries are paid semi-monthly, the manager's gross pay will be $2,000 for each of the 24 pay periods. (If the manager is paid bi-weekly, the gross pay would be $1,846.15 for each of the 26 pay periods.) A salaried employee's work period usually ends on payday; for example, a paycheck on January 31 usually covers the work period of January 16–31. This is convenient for accounting purposes if the company prepares financial statements on a calendar month basis.
Wages
Wages are often associated with production employees (sometimes referred to as "blue-collar" workers), non-managers, and other employees whose pay is dependent on hours worked. The pay for these employees is generally stated as a gross, hourly rate, such as "$13.52 per hour." Again, the "gross" amount refers to the pay an employee would receive before withholdings are made for such things as taxes, contributions, and savings plans. Employees receiving wages are often paid weekly or biweekly. To determine the gross wages earned during a work period, the employer multiplies each employee's hourly rate times the number of work hours recorded for the employee during the work period. Due to the extra time needed to make calculations for each employee, hourly-paid employees typically receive their paychecks approximately five days after the work period has ended. When the hourly-paid employees have work periods that are weekly or biweekly, but the company's financial statements cover calendar months, the company will likely have to prepare an accrual-type adjusting entry at the end of the month. If hourly wages are a significant portion of a company's expenses, it is critical that the company report the correct amount of wages expense that pertains to the 30 or 31 days in the month, not the 28 days in a four-week work period.
Bonuses & Commissions Paid to Employees
Throughout our explanation, bonuses paid to employees and sales commissions paid to employees will be considered to be part of salaries.
Overtime Pay
Overtime refers to time worked in excess of 40 hours per week. Whether or not employees are paid for overtime depends on each employee's job responsibilities and rate of pay—some employees are exempt from overtime pay and some are not. For example, executives are considered to be "exempt"; their employers are not required to pay them for their overtime hours because (1) their compensation is high, and (2) they can control their work hours. Executives do not need state or federal wage and hour laws to protect them from company abuse. On the other hand, a design technician earning an annual salary of $18,000 per year is probably not in control of her work hours. If she works for an executive who decides to work 60 hours per week, the design technician needs to be protected from having to work 60 hours per week for no more pay than she would receive for 40 hours of work. This employee is considered a "nonexempt" employee—she is not exempt from being paid overtime compensation. Some unethical companies have been known to classify "hourly wage" employees as "salaried" in hopes of making them exempt from overtime pay—federal and state laws exist to prevent such unfair treatment of employees. When processing payroll, don't assume that it's only the hourly paid employees who receive overtime pay—state and federal laws require overtime payments to lower-paid salaried employees. It is also possible that some generous employers will give overtime pay to employees who are not required by law to receive it.
Overtime Premium
An overtime premium refers to the "half" portion of "time-and-a-half" or "time-and-one-half" overtime pay. For example, assume an employee in the production department is expected to work 40 hours per week at $10 per hour. If the employer requires the employee to work 42 hours in a given week, the extra two hours are paid at time-and-a-half and the employee earns a total of $430 for the week (40 hours × $10 per hour, plus 2 overtime hours × $15 per hour). It can also be computed as 42 hours at the straighttime rate of $10 per hour plus 2 hours times the overtime premium of $5 per hour.
Payroll Withholdings: Taxes & Benefits Paid by Employees
This section of payroll accounting focuses on the amounts withheld from employees' gross pay. (In Part 4 of payroll accounting we will discuss the payroll taxes that are not withheld from employees' gross pay.) The U. S. income tax system—as well as most state income tax systems—requires employers to withhold payroll taxes from their employees' gross salaries and wages. The withholding of taxes and other deductions from employees' paychecks affects the employer in several ways: (1) it reduces the cash amount paid to employees, (2) it creates a current liability for the employer, and (3) it requires the employer to remit the withheld taxes to the federal and state government by specific deadlines. Failure to remit payroll taxes in a timely manner results in interest and penalties levied on the employer; flagrant violations trigger more severe consequences. Payroll withholdings include: 1. Employee portion of Social Security tax
2. 3. 4. 5. 6.
Employee portion of Medicare tax Federal income tax State income tax Court-ordered withholdings Other withholdings
1. Employee portion of Social Security tax
A key component of payroll accounting is the Social Security tax. (The Social Security tax along with the Medicare tax make up what is referred to as FICA.) Social Security tax is withheld from an employee's salary or wages and the employer is also required to pay a Social Security tax. In other words, the employer is responsible for remitting to the federal government both the employee and the employer portions of the Social Security tax. As a result, Social Security tax is both an employee withholding and an employer expense. (The official title for the system financed by the Social Security tax is Old Age, Survivors and Disability Insurance, or OASDI. As the name indicates, this system pays retirement, disability, family, and survivors' benefits.) In 2012, the amount of Social Security tax that an employer must withhold from an employee is 4.2% of the first $110,100 of the employee's annual wages and salary; any amount above $110,100 is not subject to Social Security tax withholdings. For example: If an employee earns $40,000 in wages in 2012, the entire $40,000 is subject to withholdings at 4.2%, for a total annual withholding of $1,680. If an executive earns $300,000 in salary in 2012, only the first $110,100 of the salary is subject to the Social Security tax of 4.2%, for a total annual withholding of $4,624.20. (The remaining $189,900 of salary is not subject to Social Security tax withholdings, although it will be subject to the Medicare tax discussed in the next section.) The amount withheld—and the employer's portion—are reported as a current liability until the amounts are remitted to the government by the employer. NOTE: The employee's tax rate for Social Security and the amount subject to the tax can be found at http://www.irs.gov/pub/irs-pdf/p15.pdf.
2. Employee portion of Medicare tax
Medicare tax is also withheld from an employee's salary or wages and is matched by a contribution from the employer. In other words, the employer is responsible for remitting to the federal government two times the amount of Medicare tax withheld from each employee. As a result, Medicare tax is both an employee withholding and an employer expense. (The Medicare program helps pay for hospital care, nursing care, and doctor's fees for people age 65 and older as well as for some individuals receiving Social Security disability benefits.) The combination of the Social Security tax and the Medicare tax is referred to as FICA (an acronym for Federal Insurance Contribution Act). An employer must withhold 1.45% of each employee's annual wages and salary for Medicare tax. Unlike the Social Security tax, this percentage is applied on every employee's total salary no matter how large the salary might be—an executive's salary of $300,000 has Medicare tax withholdings of $4,350 (the entire $300,000 times 1.45%). The amount withheld—and the employer's matching amount—are reported as a current liability until the amounts are remitted to the government by the employer.
3. Federal income tax
Another part of payroll accounting involves the employees' federal income tax. An employer is required to withhold the federal income tax that an employee is expected to owe based on salaries or wages. The amount withheld, however, is rarely the exact amount of income tax that the employee will owe to the government. The employee's year-end income tax return will dictate the exact amount owed for the year, meaning the employee will either pay in a little more in taxes, or will receive a tax refund. The amount withheld for federal income tax is based on the employee's salary or wages as well as personal information that the employee is required to provide the employer on federal form W–4 (including marital status and the number of dependents claimed as exemptions). In cases where an employee is paid low wages and/or has a large number of personal exemptions, it may not be necessary for the employer to withhold any federal income tax. Unlike FICA, there is no employer contribution for federal income tax. Amounts withheld from employees for federal income taxes are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the federal government, the current liability is reduced.
4. State income tax
In most states payroll accounting will involve a state income tax. In those states an employer is required to withhold the state income tax that an employee is expected to owe based on salaries or wages. Like its federal counterpart, the amount withheld is rarely the exact amount of income tax that the employee will owe to the state government. (It should be noted here that some states do not levy a personal income tax.) The amount withheld for state income tax is based on the employee's salary or wages as well as personal information that the employee is required to provide the employer on a state version of federal form W–4 (including marital status and the number of dependents claimed as exemptions). In cases where an employee is paid low wages and/or has a large number of personal exemptions, it may not be necessary for the employer to withhold any state income tax. Like the federal income tax (and unlike the FICA tax), there is no employer contribution for state income tax. Amounts withheld from employees for state income taxes are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the state government, the current liability is reduced.
5. Court-ordered withholdings
Payroll accounting also involves withholdings for items other than payroll taxes. For example, courts of law may order employers to garnish (withhold money from) an employee's salary or wages for purposes such as paying child support or repaying debts. The amounts withheld from employees for court-ordered withholdings are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the designated parties, the liability is reduced. Some court orders may include a small fee to be withheld from the employee in order to reimburse the employer for administrative expenses. For example, the court order might direct the employer to withhold $101 from the employee and to remit $100 to a designated agency. The $1 difference will be a credit to the company's administrative expenses or to a miscellaneous revenue account.
6. Other withholdings
In addition to the mandatory withholdings that an employer makes for taxes and court orders, payroll accounting often includes amounts that employers may be willing to withhold at the direction of its employees. These voluntary withholdings can include such things as:
union dues charitable contributions insurance premiums 401(k) and 403(b) contributions U.S. savings bonds purchases payments owed to the company for the purchase of company merchandise
If the voluntary withholdings are to be remitted to places outside of the company (a local charity, for example), the amounts withheld are reported on the employer's balance sheet as a current liability. When the employer remits the withholdings, the current liability will be reduced. If the withholdings are for amounts that are due the company (such as employees' share of insurance premiums or amounts owed by employees for company merchandise), no remittance is required. Rather, the journal entry reflects a credit that reduces the company's insurance expense or reduces the company's receivables from employees. Sample journal entries are provided in Part 5 and Part 6.
Net Pay
Net pay is the amount that remains after withholdings are deducted from an employee's gross pay. Net pay is also referred to as "take home pay" or the amount that an employee "clears." From the company side of the transaction, it is the amount of cash the company will pay directly to the employees on payday.
Payroll Taxes, Costs & Benefits Paid by Employers
In addition to salaries and wages, the employer will incur some or all of the following payroll-related expenses: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Employer portion of Social Security tax Employer portion of Medicare tax State unemployment tax Federal unemployment tax Worker compensation insurance Employer portion of insurance (health, dental, vision, life, disability) Employer paid holidays, vacations, and sick days Employer contributions toward 401(k), savings plans, & profit-sharing plans Employer contributions to pension plans Post-retirement health insurance
1. Employer portion of Social Security tax
Understanding the Social Security tax and the Medicare tax is critical for payroll accounting. In this section we discuss the employers' portion of the Social Security tax. In addition to the amount withheld from its employees for Social Security taxes, the employer must contribute/remit an additional amount, which is an expense for the employer. In the year 2012, the employer's portion of the Social Security tax is 6.2% of the first $110,100 of an employee's annual wages and salary. For example, if an employee earns $40,000 of wages, the entire $40,000 is subject to the Social Security tax. This means that in addition to the withholding of $1,680, the employer must also pay $2,480. The combined amount to be remitted to the federal government for this one employee is $4,160 ($1,680 of withholding plus the employer's portion of $2,480).
For an executive with an annual salary of $300,000 in the year 2012, only the first $110,100 is subject to the Social Security tax. This means that in addition to the withholding of $4,624.20, the employer must also pay $6,826.20. The combined amount to be remitted to the federal government for this one employee is $11,450.40 ($4,624.20 + $6,826.20). The employer's share of Social Security taxes is recorded as an expense and as an additional current liability until the amounts are remitted.
2. Employer portion of Medicare tax
Every employer must contribute/remit to the federal government an amount identical to the Medicare tax withheld from each employee's pay. This match is considered to be an expense for the employer. For the year 2012, the employer's portion of the Medicare tax is the same rate as the employee's withholding— 1.45% of every dollar of each employee's annual wages and salary. Unlike the Social Security tax, there is no cap (ceiling or limit); if a top executive earns a salary of $300,000, the employer must pay a Medicare tax of $4,350 in addition to the $4,350 that was withheld from the executive. The combined amount to be remitted to the federal government for this one employee is $8,700. The employer's share of Medicare taxes (the ―match‖) is recorded as an expense and as an additional current liability until the amounts are remitted.
3. State unemployment tax
State governments administer unemployment services and determine the state unemployment tax rate for each employer. (Some not-for-profit organizations—such as churches without schools—may not be required to pay state unemployment taxes. You should check with your state unemployment office to learn the specifics for your organization.) Generally, states require that the employers pay the entire unemployment tax. Often, employers that have built up a large reserve in the state's unemployment fund will have lower unemployment tax rates; conversely, employers with a small reserve (or no reserve at all) will have higher unemployment tax rates. The unemployment tax rate is often applied only to the first $7,000 of each employee's annual salary and wages (this amount will differ from state to state). If we assume that an employer's unemployment tax rate is 4% and that this is applied to the first $7,000 of annual salaries and wages, then the employer's state unemployment tax cost will be a maximum of $280 per year for each employee ($7,000 × 4%). To illustrate, let's assume that a company has three employees. In 2012, Employee #1 earned $19,000, Employee #2 earned $40,000, and Employee #3 (who only recently joined the company) earned $4,000. If the 2012 state unemployment tax rate is 4%, the employer will pay a tax of $720 to the state government: Employee #1 Employee #2 Employee #3 Total for 2012 $7,000 × 4% = $280 $7,000 × 4% = $280 $4,000 × 4% = $160 $720
Even though the state unemployment tax is based on employee salaries and wages, the entire tax is paid by the employer. There is no withholding from an employee's salary or wages for the state unemployment tax.
4. Federal unemployment tax
The federal government oversees the state unemployment programs and requires employers to pay a federal unemployment tax of 0.8% on each employee's first $7,000 of annual salaries and wages. Using the example of three employees with annual 2012 earnings of $19,000, $40,000, and $4,000; with a federal unemployment tax rate of 0.8%, the employer will pay a tax of $144 to the federal government: Employee #1 Employee #2 Employee #3 Total for 2012 $7,000 × 0.8% = $56 $7,000 × 0.8% = $56 $4,000 × 0.8% = $32 $144
Even though the federal unemployment tax is based on employee salaries and wages, the entire tax is paid by the employer. There is no withholding from an employee's salary or wages for the federal unemployment tax.
5. Worker compensation insurance
Worker compensation insurance provides coverage for employees who are injured on the job. State law usually requires that employers carry this insurance. Worker compensation insurance rates are a function of at least three variables: (1) the type of business or industry, (2) the type of job being performed, and (3) the employer's history of claims. For example, statistics show that a production worker in a meat packing plant has a greater-than-average chance of suffering job-related cuts or back injuries. Because of this, worker compensation insurance rates for these employees can be as high as 15% of wages. On the other hand, the office staff of the meat packing plant—provided that they do not venture out into the production area—may have a rate that is less than 1% of salaries and wages. The worker compensation insurance rates are then applied to the wages and salaries of the employees to arrive at the worker compensation insurance premiums or costs. Although the insurance premiums are based on employee salaries and wages, the entire premium cost is likely to be paid by the employer and is considered an expense for the employer. (Contact your state's worker compensation office for the specifics in your state.) If the employer pays the premium in advance, a current asset such as Prepaid Insurance is used. The account balance will be reduced and Worker Compensation Insurance Expense will increase as the employees work. If the employer does not pay the premiums in advance, the company must accrue the expense with an adjusting entry that increases Worker Compensation Insurance Expense along with increases in a current liability such as Worker Compensation Insurance Liability. In this situation the current liability will be reduced when the employer pays the worker compensation insurance premiums. Worker compensation insurance is a significant expense for the employer and therefore we consider it an important part of payroll accounting.
6. Employer portion of insurance (health, dental, vision, life, disability)
In the past, many companies included group health, dental, vision, disability, and life insurance in the benefit package provided to employees. Over the past few decades, however, the cost of these group policies has risen significantly—in 2012, it was not uncommon to see an insurance premium for family coverage at $12,000 per year per employee. As a result of these escalating costs, most companies now require employees to pay a portion of the premium cost; this amount is usually collected by means of employee-directed payroll withholding. The employers' net cost (or expense) is simply the total amount of premiums paid to the insurance company minus the portion of the cost the employer collects from its employees.
7. Employer paid holidays, vacations, and sick days
Many companies pay their permanent employees for holidays such as New Year's Day, Memorial Day, July 4th, Labor Day, Thanksgiving, and Christmas. It is not unusual for employees to be paid for 10 holidays per year. It is also common for employees to earn one week of vacation after one year of service. Many employers give their employees two weeks of vacation after three years of service, with more weeks given after 10 years of service. Paid sick days are also a common benefit given to employees. If an employee is absent from work due to such things as illness or surgery, the company will pay the employee for the time missed. Employers generally set policies as to how sick days are to be used, and as to whether or not an employee is permitted to carry over unused sick days into subsequent years. The matching principle requires that the cost of compensated (or paid) absences (holidays, vacations, and sick days) be recognized as an expense during the time the employee is present and working. In other words, the cost is expensed when the benefit is being earned by the employee, not when the benefit is being used by the employee. (However, the Financial Accounting Standards Board generally allows for sick days and holidays not to be accrued.) To illustrate, assume that an employee works full-time for the entire year 2011 and as a result earns one week of vacation to be taken any time during the year 2012. During the year 2011 (when the employee is working), the employer records the vacation expense and the vacation liability. In 2012, when the employee takes the vacation earned in the previous year, the employer records the cash payment by crediting Cash and reduces the company liability by debiting Vacation Payable.
8. Employer contributions toward 401(k), savings plans, and profit-sharing plans
If an employer is required to contribute company money into an employee's savings program or profitsharing plan, the contribution should appear as an expense in the period when the employee earned the company contribution. It is also likely that the company will have the expense and the liability before the company actually pays the amount. This situation requires the company to record an adjusting entry in order to match the expense to the proper accounting period.
9. Employer contributions to pension plans
Some companies provide pensions for their employees. This means their employees will receive ongoing monthly payments after they retire from the company. The matching principle requires that the cost of the benefit should be recognized during the years that the employees are working (earning the benefit), and not when the employee is retired. Note: In effect, pensions (and other benefits) are part of the compensation package given to employees working at a company. While some parts of the compensation package are paid out during the time the employee is working, other benefits are deferred until the employee is retired. The cost of the entire compensation package, however, must be expensed or assigned to products manufactured when the employee is working, so that the cost of the employee's work is matched with the revenue resulting from the employee's work.
The concept is that in the years that the employee works, the company will charge Pension Expense and will credit either Pension Payable or Cash. For more specifics on pensions, you are referred to an Intermediate Accounting text or to the Financial Accounting Standards Board's website www.fasb.org.
10. Post-retirement health insurance
Some companies continue to provide health insurance coverage to employees after they have retired. This retiree benefit is considered to be part of the compensation package earned by employees while they are working. Again, accrual accounting and the matching principle require that the cost of this future insurance coverage be expensed (or assigned to manufactured products) during the years the employees are working by debiting an expense and crediting a liability. During the employees' retirement years, the company's payment for insurance will reduce the company's liability and will reduce its cash. To learn more on the accounting for post-retirement benefits, such as health insurance coverage, you are referred to an Intermediate Accounting text and/or to the Financial Accounting Standards Board's website www.fasb.org.
Examples of Payroll Journal Entries For Wages
NOTE: In the following examples we assume that the employee's tax rate for Social Security is 4.2% and that the employer's tax rate is 6.2%. In this section of payroll accounting we will provide examples of the journal entries for recording the gross amount of wages, payroll withholdings, and employer costs related to payroll. Let's assume that a distributor has hourly-paid employees working in two departments: delivery and warehouse. The company's workweek is Sunday through Saturday and paychecks are dated and distributed on the Thursday following the workweek. For the workweek of December 18–24, the gross wages are $1,000 for hourly employees in the delivery department and $1,300 for employees in the warehouse. Tax withholdings are determined by consulting government payroll guidelines; other withholdings are based on agreements with employees and court orders. Paychecks are dated and distributed on December 29. The journal entry to record the hourly payroll's wages and withholdings for the work period of December 18–24 is illustrated in Hourly Payroll Entry #1. In accordance with accrual accounting and the matching principle, the date used to record the hourly payroll is the last day of the work period. Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the workweek of December 18-24 that will be paid on December 29. Date Account Name Debit Credit Dec. 24 Wages Expense: Delivery Dept Wages Expense: Warehouse Dept FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Health Ins. Expense: Delivery Health Ins. Expense: Warehouse United Way Payable 1,000.00 1,300.00 129.95 300.00 110.00 70.00 90.00 80.00 30.00
Garnishment Payable Net Payroll Payable
50.00 1,440.05
* $2,300 x 5.65%
In addition to the wages and withholdings in the above entry, the employer has incurred additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2, which is also dated the last day of the work period. The items included are the employer's share of FICA, the employer's estimated cost for unemployment tax, worker compensation insurance, compensated absences, and company contributions for the company's 401(k) plan. The company is recognizing these additional expenses and the related liability in the period in which the employees are working and earning them. Later, when the company pays for them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company does not provide post-retirement benefits—like pensions or health insurance—to its employees.)
Hourly Payroll Entry #2: To record the company's additional payroll-related expense for hourlypaid employees for the workweek of December 18-24. Date Dec. 24 Account Name FICA Expense: Delivery * FICA Expense: Warehouse Unemployment Tax Expense: Warehouse Worker Compensation Insurance Expense Holiday, Vac., Sick Days Expense: Delivery Holiday, Vac., Sick Days Expense: Warehouse 401(k) Expense: Delivery 401(k) Expense: Warehouse FICA Tax Payable Unemployment Tax Payable Worker Comp Insurance Payable Holiday, Vacation, Sick Days Payable 401(k) Payable Debit 76.50 99.45 4.00 46.00 100.00 130.00 10.00 25.00 175.95 4.00 46.00 230.00 35.00 Credit
* $1,000 x 7.65%
On payday, December 29, the checks will be distributed to the hourly-paid employees. The following entry will record the issuance of those payroll checks. Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll checks on Dec. 29. (These checks reflect the net pay for the wages earned during the workweek of Dec. 18-24). Date Dec. 29 Account Name Net Payroll Payable Cash Debit 1,440.05 1,440.05 Credit
Some withholdings and the employer matching of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following Hourly Payroll Entry #4 were remitted on payday. Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the hourly-paid workweek of Dec. 18-24. Date Dec. 29 Account Name FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Cash Debit 305.90 300.00 110.00 105.00 820.90 Credit
* $129.95 from Entry #1 + $175.95 from Entry #2 End of Month and End of Year
Let's continue with our example of the payroll for the hourly-paid employees. We'll assume that this distributor's accounting month and accounting year both end on Saturday, December 31. The matching principle requires the company to report all of its December expenses (not simply its cash payments) on its December financial statements. This means the company must report on its income statement the hourly wages and other payroll expenses that the company incurred (and the employees earned) through December 31. Recall that the paychecks issued on December 29 covered the work done by hourly employees through December 24. The company must now record the cost of work done during the week of December 25–31 (a week that includes a Christmas holiday plus a number of employees taking vacation days). Let's assume that during the workweek of December 25–31, delivery department employees took $300 worth of their holiday and vacation days. Since a portion of the employer's estimated cost of holiday and vacation days was recorded as an expense and liability via each week's Hourly Payroll Entry #2, the $300 associated with the days actually taken this week will not be recorded as an expense—rather, the $300 associated with the days taken this week will reduce the liability that is recorded with each week's Hourly Payroll Entry #2. In other words, only $700 of the delivery department's employee gross wages of $1,000 is for the work performed this week. The warehouse department had a similar situation. Of the warehouse department's $1,300 of weekly wages, only $1,050 is the expense for the work performed this week. The wages associated with the ―days off with pay‖ reduces the company's liability that was provided for each week in Hourly Payroll Entry #2. Except for the holiday and vacation days, the workweek payroll for December 25-31 is similar to the previous week. Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the workweek of December 25-31 that will be paid on January 5. Date Dec. 31 Account Name Wages Expense: Delivery Dept Debit 700.00 Credit
Holiday, Vacation, Sick Days Payable Wages Expense: Warehouse Dept Holiday, Vacation, Sick Days Payable FICA Tax Payable Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Health Ins. Expense: Delivery Health Ins. Expense: Warehouse United Way Payable Garnishment Payable Net Payroll Payable
300.00 1,050.00 250.00 129.95 300.00 110.00 70.00 90.00 80.00 30.00 50.00 1,440.05
In addition to the wages and withholdings in Hourly Payroll Entry #1, the employer has incurred additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2, which is also dated the last day of the work period. The items included are the employer's share of FICA, the employer's estimated cost for unemployment tax, worker compensation insurance, compensated absences, and company contributions for the company's 401(k) plan. The company is recognizing these additional expenses and the related liability in the period in which the employees are working and earning them. Later, when the company pays for them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company does not provide post-retirement benefits—like pensions or health insurance—to its employees.) Hourly Payroll Entry #2: To record the company's additional payroll-related expense for hourlypaid employees for the workweek of December 25-31. Date Dec. 31 Account Name FICA Expense: Delivery FICA Expense: Warehouse Unemployment Tax Expense: Warehouse Worker Compensation Insurance Expense Holiday, Vac., Sick Days Expense: Delivery Holiday, Vac., Sick Days Expense: Warehouse 401(k) Expense: Delivery 401(k) Expense: Warehouse FICA Tax Payable Unemployment Tax Payable Worker Comp Insurance Payable Holiday, Vacation, Sick Days Payable 401(k) Payable Debit 76.50 99.45 4.00 46.00 100.00 130.00 10.00 25.00 175.95 4.00 46.00 230.00 35.00 Credit
On payday, January 5, the checks will be distributed to the hourly-paid employees. The following entry will record the issuance of those payroll checks. Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll checks on Jan 5. (These checks reflect the hourly-paid employees' take home pay from their wages earned during the workweek of Dec. 25-31). Date Jan. 5 Account Name Net Payroll Payable Cash Debit 1,440.05 1,440.05 Credit
Some withholdings and the employer matching of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following Payroll Entry #4 were remitted on payday. Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the hourly-paid workweek of Dec. 25-31. Date Jan. 5 Account Name FICA Tax Payable Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Worker Comp Insurance Payable Cash Debit 305.90 300.00 110.00 105.00 600.00 1,420.90 Credit
Additional Accrual of Wages
In our example above, the workweek ended on the same day as the calendar month and year: December 31. In other months and in some years, the last full workweek might end on the 28th of the month. In that case, the employer will need to estimate the payroll and payroll-related expenses for the 29th, 30th, and 31st days of the month. Those estimates will be used to record an accrual-type adjusting entry on the 31st. This is required so that all of the expenses actually occurring during the month are matched with the revenues of the month. Recording wages expense in the proper period is critical for accurate financial statements and therefore a very important part of payroll accounting. NOTE: In the following examples we assume that the employee's tax rate for Social Security is 4.2% and that the employer's tax rate is 6.2%. Let's assume our company also has salaried employees who are paid semimonthly on the 15th and the last day of each month. The pay period for these employees is the half-month that ends on payday. There is one salaried employee in the warehouse department with a gross salary of $48,000 per year, or $2,000 per pay period. There are four salaried employees in the Selling & Administrative Department with combined salaries of $9,000 per pay period. Because the salaried employees are paid on the last day of the month and their pay period ends right on payday, there is no need to accrue for salaries at the end of December (or any other calendar month).
The salaried payroll entry for the work period of December 16–31 will be dated December 31 and will look like this: Salaried Payroll Entry #1: To record the salaries and withholdings for the work period of December 16-31 that will be paid on December 31. Date Dec. 31 Account Name Salaries Expense: Delivery Dept Salaries Expense: Selling & Admin Dept FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable Health Ins Expense: Delivery Health Ins. Expense: Selling & Admin United Way Payable Net Payroll Payable Debit 2,000.00 9,000.00 621.50 1,800.00 400.00 200.00 40.00 200.00 100.00 7,638.50 Credit
* $11,000 x 5.65%
In addition to the salaries recorded above, the company has incurred additional expenses pertaining to the salaried payroll for this semi-monthly period of December 16–31. These expenses must be included in the December financial statements, as shown in the next journal entry: Salaried Payroll Entry #2: To record additional payroll-related expense for salaried employees for the work period of December 16-31. Date Dec. 31 Account Name FICA Expense: Delivery FICA Expense: Selling & Admin 401(k) Expense: Delivery 401(k) Expense: Selling & Admin FICA Tax Payable * 401(k) Payable Debit 153.00 688.50 20.00 80.00 841.50 100.00 Credit
* $11,000 x 7.65%
On payday, December 31, the checks will be distributed to the salaried employees. The following entry will record the issuance of those payroll checks. Salaried Payroll Entry #3: To record the distribution of the salaried employees' payroll checks on Dec. 31. (These checks reflect the take-home pay for the salaries earned during the work period of Dec. 16-31). Date Account Name Debit Credit
Dec. 31
Net Payroll Payable Cash
7,638.50 7,638.50
Some withholdings and the employer portion of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Salaried Payroll Entry #1. We will assume the amounts in the following Payroll Entry #4 were remitted on payday. Salaried Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the salaried employees during the work period of Dec. 15-31. Date Dec. 31 Account Name FICA Tax Payable * Federal Inc Tax Withholdings Payable State Inc Tax Withholdings Payable 401(k) Payable United Way Payable Cash Debit 1,463.00 1,800.00 400.00 300.00 100.00 4,063.00 Credit
* $621.50 from Entry #1 + $841.50 from Entry #2
