CHAPTER 11
Current Liabilities and Payroll
Chapter Outline
Objective 3: Compute payroll amounts
A. Payroll costs are so important that many businesses have a special system to account for their labor costs.
1. Businesses pay their employees for a set number of hours called straight time.
2. Employees earn a higher rate (called overtime) for hours worked in excess of straight time.
B. Gross pay is the total amount of salary, wages, commissions, and other compensation before taxes and other deductions are taken out.
C. Net pay is the gross pay minus all deductions. Exhibit 11-3 is an illustration of gross pay and net pay.
D. Payroll deductions may either be required or optional.
1. Employee income taxes and social security tax are examples of required deductions.
a. The law requires that income tax be withheld from employees’ salaries and wages.
1) The amount withheld depends on the number of withholding allowances claimed by the employee. An employee can claim a personal allowance and an additional allowance for each dependent.
2) The employee files a Form W-4 (Exhibit 11-4) with the employer to indicate the number of allowances claimed.
b. Social Security (FICA) tax is also deducted from an employee’s gross pay. FICA taxes are used by the government to provide old age, survivors’, and disability insurance (called OASDI benefits), as well as health insurance (called Medicare).
1) The amount of FICA tax deducted depends on the earnings of the employee.
2) The OASDI portion of the tax is calculated as a certain percentage of base income. In 2000, the tax was 6.2% of the first $76,200 of an employee’s earnings. The taxable amount of earnings is adjusted annually based on the rate of inflation.
3) The Medicare tax applies to all employee earnings. In 2000, the tax rate was 1.45%.
2. Some businesses make optional payroll deductions for such items as union dues, insurance premiums, payroll savings plans, and charitable gifts. Employers often make certain deductions available to employees as a part of a cafeteria plan.
E. The employer must also pay certain payroll taxes.
1. The employer must match the employee’s contribution to Social Security.
2. Only the employer is responsible for paying unemployment taxes. The unemployment tax is divided between the state and the federal government. Recently, the tax was 6.2% on the first $7,000 of an employee’s earnings.
a. The state unemployment tax is 5.4% of the first $7,000 (but may be different in certain states) of an employee’s earnings.
b. The federal unemployment tax is 0.8% of the first $7,000 of an employee’s earnings. Exhibit 11-5 shows the payroll costs for one employee.
Objective 4: Record basic payroll transactions
A. The entry to record the employer’s salary expense is:
Salary Expense (gross pay) XX
Employee Income Tax Payable XX
FICA Tax Payable XX
Optional Deductions Payable XX
Salary Payable (take-home pay) XX
B. The entry to record the employer’s payroll tax expense is:.
Payroll Tax Expense XX
FICA Tax Payable XX
State Unemployment Tax Payable XX
Federal Unemployment Tax Payable XX
C. The entry to record employee fringe benefits, such as insurance and retirement, is:
Employee Benefits Expense XX
Employee Benefits Payable XX
D. Exhibit 11-6 illustrates these basic payroll entries.
Objective 5: Use a payroll system
A. The payroll record or payroll journal (Exhibit 11-7) lists each employee and the gross deductions, and the net pay for each. This information is used to record all payroll amounts for the period.
B. The payroll bank account is a separate bank account used only for payroll checks. After the checks have cleared, the account should have a zero balance.
C. Payroll checks usually have a perforated attachment listing gross pay, deductions, and net pay that employees can retain for their records. Many companies deposit payroll checks directly into the employee’s account by electronic funds transfer. Exhibit 11-8 is an example of a typical payroll check.
D. The employer records payroll cash disbursements with credits to Cash and debits to Salary Payable to Employees, the liabilities for payroll taxes and payroll deductions, and the liabilities for employee benefits.
E. Employers must file payroll tax returns with both state and federal governments.
1. Form 941 (Exhibit 11-9) reports the employees’ taxes withheld, employees’ FICA taxes withheld, the employer’s FICA taxes, and the amount of these taxes paid during the quarter.
2. An earnings record is usually maintained for each employee as an accounting tool to facilitate preparation of tax reports, such as Form W-2. The earnings record reports the earnings and deductions for each pay period as well as the year-to-date totals. Exhibit 11-10 is an example of an employee earnings record.
F. Form W-2 is sent to each employee after the year-end and must accompany the employee’s income tax return. Exhibit 11-11 illustrates Form W-2.
G. Many employers provide postretirement benefits to their employees after retirement. These benefits include pensions and medical insurance. The FASB requires that companies accrue these expenses during the years that the employee works rather than when the payments are made after retirement.
H. Internal control over payrolls include controls for efficiency and controls for safeguarding payroll disbursements.
1. Controls for efficiency include:
a. Use of a separate payroll account(s) and
b. Use of computers to process the payroll.
2. Controls for safeguarding payroll disbursements include:
a. Separating the duty of hiring and firing from the duty of distributing paychecks,
b. Requiring identification badges to ensure only actual employees receive pay, and
c. Having employees punch time cards.
Objective 6: Report current liabilities on the balance sheet
A. The balance sheet should report all payroll liabilities such as those to employees, state and federal governments, unions, etc. These are usually current liabilities.
B. Exhibit 11-12 shows the current liabilities of the IBM.
C. Decision guidelines provide answers to important payroll questions.