INTRODUCTION TO PAYROLLS
Payrolls represent the entire amount paid to all employees over a given accounting period. Because employees are very sensitive to payroll errors or any irregularities, payroll systems should assure accurate and timely payments. Accurate records are also required by federal and state government agencies. Payroll expenditures typically have a significant impact on the income statement of a firm. Manual labor, whether skilled or unskilled usually receives renumeration in the form of wages. Wages are usually stated in terms of an hourly rate, weekly rate, or on a piecework basis.
Salaries are paid to those individuals that hold administrative, executive, managerial or sales positions. Their pay is usually stated on a monthy or annual basis. Payment for work can take the form of property, shelter, food, services, securities, or promissory notes. Salaries and wages are often supplemented by commissions, bonuses, cost-of-living adjustments, profit sharing and/or pension plans. Employers and employees typically meet and agree on a fair salary or wage rate.
Bonuses are usually based upon the productivity of an individual. Today's companies are relying less on salary and more on bonuses to attract and reward executives. Bonuses can be computed in several different ways, each yielding a different amount. The bonus percentage can be based on income
1)- before deducting the bonus and income taxes,
2)- after deducting the bonus, but before deducting income taxes,
3)- before deducting the bonus, but after deducting income taxes,
4)- after deducting the bonus and income taxes.
Gross pay is total earnings of an employee before any deductions. Net pay is the ammount an employee receives after all deductions. Deductions are commonly made for federal, state, and local income taxes. While state and local income taxes vary from state to state, all employers must withhold federal income and FICA taxes. Deductions can be made for voluntary items such as health insurance, charitable contributions, pension fund contributions and union dues.
Employers can be subject to both federal and state taxes based on the amount of compensation paid to their employees. FICA taxes by the employer are equal to the payments made by an employee. Federal Unemployment Compensation Tax is levied on employers only, and the funds collected are used to provide a temporary relief to individuals unemployed as a result of economic forces beyond their control. State Unemployment Compensation Taxes are paid by employers only.
The three major components of a payroll system are:
1)- payroll register: it is used to assemble and summarize data for each payroll period,
2)- employee's earnings record: it provides detailed information for each employee, and
3)- payroll checks, direct ATM deposits or cash, usually accompanied by a statement showing all the deductions.
The payroll register consists of constant and variable elements. Wage rate are typical constant element. Hours worked vary. Information obtained from the payroll register is used for general ledger entries, to issue payroll checks and statements, and to update employees' earnings records. Data from the employees' earnings records are used to prepare wage and tax statements and payroll tax returns. Entries recorded in the general ledger are used to prepare the income statement and balance sheet.
Internal controls for payroll systems are similar to those for cash disbursements. A voucher system is recommended. When names are to be deleted or added to the payroll register, they should be supported by a written statement from personnel. Attendance records are taken by personnel to ensure accurate determination of pay, vacation benefits and sick leave benefits. As an extra measure of safety, employee identification cards are often issued and must be presented by employees when receiving paychecks.
When employers agree to pay part or all of the costs of fringe benefits, they incur an expense and a liability. Fringe benefits commonly offered by employers are vacations, health insurance, pension plans, life insurance and disability insurance. The cost of the fringe benefits should be properly matched to the period an employee has worked. If the employee has not received the fringe benefit, a liability remains. Depending on when the liability is expected to be paid, it may be classified as either short-term or long-term on the balance sheet.
Mr Jones works as a janitor at XYZ company. He is entitled
to take two weeks paid vacation per year after working one
full year. On May 5, Mr Jones completes his twelth month of work,
and XYZ company records its vacation pay liability in the following
entry
May 5 Vacation pay expense 2,000
Vacation pay payable 2,000
To accrue vacation pay for
week ending May 5 for Mr Jones
Mr Jones takes his vacation the first two weeks of August.
XYZ payroll department enters Mr Jones's salary liability
for the first week in the following entry:
Aug 12 Vacation pay payable 1,000
Salaries payable 800
Income taxes payable and
other payroll liabilities 200
To record vacation taken by Mr
Jones.
Observe that vacation pay liability can only be recorded in this manner if the company uses the accrual method of accounting. |
Employee pension plans are one of the most important fringe benefits and operating expense, as well as costly and complex. There are many different types of pension plans. If the employee contributes to his/her pension plan, it is called contributory; if he/she does not, it is called noncontributory. In a defined contribution pension plan, the amount contributed by the employer is determined when the pension expense is calcutate based on current employee's salary, employee's age and years of employment; the employer has no further liability. Pension plans that are fully funded, are usually managed by banks or pensions funds. In a defined benefit pension plan, the pension expense is estimate based not just on current salary but also expected employee years of service, life expectancy, employee turnover, as well as expected investment fund future income. Actuaries are used to calculate such benefits. The employer must incur an additional contribution liability in a defined benefit pension plan if the amount in the fund is insufficient to make the promised retirement payments; the unfunded pension liability can be quite large. Conversely, in a defined contribution pension plan, the employee bears the investment risk in the pension fund. In the United States, pension plans must comply with the requirements of the Employment Retirement Income Security Act (or ERISA), and employer must make disclosures in the Annual Report.
Individual pension plans are increasingly common because the employee sets up, funds and controls one's own pension plan, rather than leaving the moneys under the control of the employer or a bank.
Promissory notes are commonly issued for goods purchased on account or when a bank extends a short-term loan. Notes issued by banks can be interest-bearing or non-interest bearing. Non-interest bearing notes deduct the interest from the face value (or maturity value) of the note from the amount loaned to the borrower. An interest bearing note requires payment of both the principal and interest accrued at maturity. An adjusting entry is necessary whenever interest is paid a day other than the end of the financial periods.
ABC company bougth ten tonnes of steel from XYZ company on credit
on May 1 for $10,000 with term 2/10 Net30. On May 30, ABC issues
and sends a 90 day 10% promissory note to XYZ company. On August
31, ABC pays the $10,000 note and an interest of $250
(10,000 x 10% x 90/360).
The entries at ABC company are
May 1 Raw materials inventory 10,000
Accounts payable 10,000
May 30 Accounts payable 10,000
Notes payable 10,000
Aug 31 Notes payable 10,000
Interest expense 250
Cash 10,250
The entries at XYZ company are
May 1 Accounts receivable 10,000
Sales 10,000
Cost of goods sold 7,000
Goods inventory 7,000
May 30 Notes receivable 10,000
Accounts receivable 10,000
Aug 31 Cash 10,250
Notes receivable 10,000
Interest revenue 250
Note that ABC could have issues a non-interest bearing 90 day promissory note of $10,250 on May 30 for its liability of $10,000. The implied interest in such non-interest bearing note is known as discount rate. |
To record a product warranty liability, Debit Product Warranty Expense and credit Product Warranty Payable (AT THE TIME OF SALE). When a product is replaced, debit Product Warranty Payable and credit Inventory. The amount recorded for product warranty liabilities is estimated, and adjustments may be necessary if more or less goods are actually replaced or repaired.