Chapter 17
18th
Edition
Employee
Compensation—Payroll,
Pensions, and Other
Compensation Issues
Intermediate
Accounting
James D. Stice
Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2012 Cengage Learning
17-1
Payroll and Payroll Taxes
Social security and income tax legislation impose
five taxes based on payrolls:
1. Federal old-age, survivors’, and disability (tax to
both the employee and employer)
2. Federal hospital insurance (tax to both
employer and employee)
3. Federal unemployment insurance (tax to
employer only)
4. State unemployment insurance tax (tax to
employer only)
(continued)
17-2
Payroll and Payroll Taxes
5. Individual income tax (tax to employee only but
withheld and paid by employer)
17-3
Federal Old-Age, Survivors’,
and Disability Tax
•
•
•
The Federal Insurance Contributions Act
(FICA) provides for FICA taxes from both
employers and employees to provide funds
for federal old-age, survivors’, and disability
benefits for certain individuals and members
of their families.
The employer is required to withhold FICA
taxes from each employee’s wages.
In 2010, annual wages up to $106,800 were
subject to 6.20% for FICA tax.
17-4
Federal Hospital Insurance
•
•
•
The Federal Insurance Contribution Act
(FICA) also includes a provision for
Medicare tax.
This tax differs from the tax previously
discussed in that the tax is applied to all
wages earned; there is no upper limit.
The tax rate for 2010 was 1.45% for both
employer and employee.
17-5
Federal Unemployment Insurance
•
•
The Federal Social Security Act and the
Federal Unemployment Tax Act (FUTA)
provide for the establishment of
unemployment insurance plans.
Employers with insured workers employed
in each of 20 weeks during a calendar
year or who pay $1,500 or more in wages
during a calendar quarter are affected.
(continued)
17-6
Federal Unemployment Insurance
•
•
•
•
Tax rate on the first $7,000 of wages earned
has been 6.2% since 1985.
Employer can apply for a credit limited to
5.4% for taxes paid on state unemployment
tax, effectively reducing the federal tax to
0.8% (6.2% – 5.4%).
No tax is levied on the employee.
Payment to the federal government is
required quarterly.
17-7
State Unemployment Insurance
•
•
State unemployment compensation laws
(SUTA) are not the same in all states. In
most states, laws call for tax only on
employers, but a few states tax both
employer and employee.
Although the normal rate on employers may
be 5.4%, states have merit rating or
experience plans providing for lower rates
based on employer’s individual employment
experiences.
17-8
Income Tax
•
Federal income taxes on the wages of
individuals are collected in the period in
which the wages are paid.
•
The “pay-as-you-go” plan requires
employers to withhold income tax from
wages paid to their employees.
•
Most states and many local governments
also impose income taxes on the earnings
of employees that the employer must
withhold and remit.
(continues)
17-9
Income Tax
• Withholding is required not only of
employers engaged in a trade or business
but also of religious and charitable
organizations, educational institutions,
social organizations, and governments of
the United States, the states, the territories,
and their agencies, instrumentalities, and
political subdivisions.
17-10
Accounting for Payroll Taxes
Salaries for the month of January for a retail
store are $16,000. The SUTA tax rate is 5.4%.
Withholdings are $1,600 and FICA tax rate is
7.65%. The employer records the payroll as
follows:
Salaries Expense
FICA Taxes Payable
Employees Income Taxes Payable
Cash
16,000
1,224
1,600
13,176
To record payment of payroll and
related employee withholdings.
(continued)
17-11
Accounting for Payroll Taxes
The employer’s payroll tax entry is as follows:
Payroll Tax Expense
FICA Taxes Payable
State Unemployment Taxes Payable
Federal Unemployment Taxes
Payable
2,216
1,224
864
128
To record payment of payroll and related
employee withholdings.
$16,000 ×
.008 (0.062$16,000
– .0765 ×
0.054) × $16,000 0.054
(continued)
17-12
Accounting for Payroll Taxes
The salaries and wages accrued at December 31
were $9,500. Of this amount, $2,000 was subject
to unemployment taxes and $6,000 to FICA tax.
The adjusting entry for the employer’s payroll
taxes would be as follows:
Payroll Tax Expense
0.0765 ×
FICA Taxes Payable
0.054
×
$6,000
State Unemployment Taxes Payable
0.008 ×
$2,000
FUTA Payable
To accrue the payroll tax liability of$2,000
the
employer.
583
459
108
16
17-13
Compensated Absences
•
•
Compensated absences include payments
by employers for:
 Vacations
 Holidays
 Illnesses
 Other personal activities
The longer an employee works for a
company, the longer the vacation allowed or
the more liberal the time allowed for
illnesses.
(continued)
17-14
Compensated Absences
•
•
•
At the end of any given period, the firm has a
liability for the earned but unused
compensated absences.
The estimated amounts earned must be
charged against current revenue and a
liability established for that amount.
The difficult part comes when estimating how
much should be accrued.
(continued)
17-15
Compensated Absences
The FASB, in ASC paragraphs 710-10-25-1
through 3, requires a liability to be recognized
for compensated absences that:
1. have been earned through services already
rendered
2. vest or can be carried forward to
subsequent years, and
3. are estimable and probable.
17-16
Stock-Based Compensation
and Bonuses
• In addition to stock options, employees
often earn bonuses based on a
company’s performance over a given
period of time.
• This additional compensation should be
recognized in the period in which it is
earned.
(continued)
17-17
Stock-Based Compensation
and Bonuses
• Photo Graphics, Inc. gives its store
managers a 10% bonus based on
individual store earnings.
• The bonus is to be based on income
after deducting the bonus, but before
deducting income taxes. Income for a
particular store is $100,000 before
charging any bonus or income taxes.
(continued)
17-18
Stock-Based Compensation
and Bonuses
B = 0.10($100,000 – B)
B = $10,000 – 0.10B
B + 0.10B = $10,000
1.10B = $10,000
B = $9,091 (rounded)
PROOF: B = 0.10($100,000 – B)
B = 0.10($100,000 – $9,091)
B = 0.10($90,909)
B = $9,090.90 or $9,091
17-19
Postemployment Benefits
•
•
•
•
Because of downsizing, an employee cannot
count on remaining with one employer for his
or her entire career.
Some employees change jobs to facilitate
career advancement and to enhance their
family’s quality of life.
It is common for an employee to be
terminated.
Compensation issues following employment
but preceding retirement have increased in
magnitude.
(continued)
17-20
Stock-Based Compensation
and Bonuses
•
•
Examples of the types of benefits granted
to terminated employees include:




Supplemental unemployment benefits
Severance benefits
Disability-related benefits
Job training and counseling
And, continuation of benefits such as:
 Health care benefits
 Life insurance coverage
17-21
Accounting for Pensions
Financing retirement years is accomplished
by establishing some type of pension plan
that sets aside funds during an employee’s
working years so that at retirement the funds
and earnings from investment of the funds
may be returned to the employee in lieu of
earned wages.
(continued)
17-22
Accounting for Pensions
In the United States, three major categories of
pension plans have emerged:
1. Government plans, primarily Social
Security
2. Individual plans, such as individual
retirement accounts (IRAs)
3. Employer plans
(continued)
17-23
Accounting for Pensions
Postretirement benefits other than pensions
extend benefits beyond the active years of
employment and include such items as:
• Health care
• Life insurance
• Legal services
• Special discounts on items produced or
sold by the employer
• Tuition assistance
17-24
Funding of Employer Pension Plans
•
•
•
ERISA requires companies to fund their
pension plans in an orderly manner so that
the employee is protected at retirement.
Noncontributory pension plans are
funded entirely by the employer.
Plans where the employee also contributes
to the cost of the plan are referred to as
contributory pension plans.
(continued)
17-25
Funding of Employer Pension Plans
There are two basic classifications of pension
plans:
1) defined contribution plan
2) defined benefit plan
17-26
Defined Contribution Pension Plans
•
•
Defined contribution pension plans are
relatively simple in their construction and
raise very few accounting issues for
employers.
The employer pays a periodic contribution
amount into a separate trust fund, which is
administered by an independent third-party
trustee.
(continued)
17-27
Defined Contribution Pension Plans
•
•
When an employee retires, the
accumulated value in the fund is used to
determine the pension payout to the
employee.
The employee’s retirement income
therefore depends on how the fund has
been managed. In effect, the investment
risk is borne by the employee.
17-28
Defined Benefit Pension Plans
•
•
•
Defined benefit pension plans are much
more complex than defined contribution
plans.
Under defined benefit plans, the employee
is guaranteed a specified retirement income
often related to his or her number of years
of employment and average salary over a
certain number of years.
Because the benefits are defined, the
funding must vary as conditions change.
(continued)
17-29
Defined Benefit Pension Plans
A pension fund may be viewed essentially
as funds set aside to meet the employer’s
future pension obligation just as funds may
be set aside for other purposes.
17-30
Vesting of Pension Benefits
Vesting occurs when an employee has
met certain specified requirements and is
eligible to receive pension benefits at
retirement regardless of whether or not the
employee continues working for the
employer.
17-31
Funding of Defined
Benefit Plans
•
The periodic amounts to be contributed to a
defined benefit plan by the employer are
directly related to the future benefits
expected to be paid to current employees.
•
All funding methods are based on present
values. The additional future benefits earned
by employees each year must be discounted
to their present value, referred to as the
actuarial present value, using the assumed
rate of return on pension plan investments.
17-32
Issues in Accounting for
Defined Benefit Plans
A list of issues relating to accounting and
reporting by employers follows:
1. The amount of net periodic pension expense
to be recognized on the income statement
2. The amount of pension liability or asset to be
reported on the balance sheet
3. Accounting for pension settlements,
curtailments, and terminations
4. Disclosures needed to supplement the
amounts reported in the financial statements
17-33
Simple Illustration of
Pension Accounting
•
•
•
•
•
•
Lorien Bach is 35 years old.
She has worked for Thakkar for 10 years.
Her salary for 2012 was $40,000.
Pension payments begin after the employee
turns 65; payments made at the end of the year.
The annual payment is equal to 2% of the
highest salary times the number of years with the
company.
Thakkar knows for certain that Bach will live
exactly 75 years. Her benefits are fully vested.
(continued)
17-34
Simple Illustration of
Pension Accounting
• In valuing pension fund liabilities, Thakkar uses a
•
•
•
•
discount rate of 10%.
As of January 1, 2013, Thakkar had a pension
fund containing $10,000.
During 2013, Thakkar made additional
contributions of $1,500.
The fund earned a return of $1,200 during the
year.
Thakkar expects to earn an average return of 12%
on pension fund assets.
(continues)
17-35
Estimation of Pension
Obligation
Estimate Pension Obligation
(2% × 10 years) × $40,000 = $8,000
The annual amount that
Bach should receive on
her retirement at age 65.
(continued)
17-36
Estimation of Pension
Obligation
Accumulated Benefit Obligation (ABO)
PV of an
annuity of
$8,000 per
year for ten
years deferred
for 30 years is
$2,817
X
X
X X X X X X X X
30 years
Accumulated benefit
obligation (ABO)
(continued)
17-37
Estimation of Pension
Obligation
•
The accumulated benefit obligation (ABO)
is the actuarial present value of expected
future pension payments, using the current
salary as the basis for forecasting the amount
of the pension benefit payments.
•
The alternative measure of the pension
obligation that does not consider the impact of
future salary increases is called the projected
benefit obligation (PBO).
(continued)
17-38
Estimation of Pension
Obligation
Projected Benefit Obligation (PBO)
Thakkar Company expects Bach’s 2012 salary
of $40,000 to increase 5% every year until
retirement. Bach’s salary is expected to increase
to $172,877 by the year 2043. The pension
benefit payment based on this salary is as
follows:
(2% × 10 years) × $172,877 = $34,575 (rounded)
PV = $40,000, N = 30, I = 5%
(continued)
17-39
Estimation of Pension
Obligation
•
The PBO at January 1, 2013, is $12,176.
This is the present value of the 10 future
annual payments of $34,575 that Bach is
expected to received.
(continued)
17-40
Estimation of Pension
Obligation
Pension-Related Liability
PBO, January 1, 2013
Pension fund at fair value, January 1, 2013
Pension-related liability, January 1, 2013
$12,176
(10,000)
$ 2,176
FASB ASC paragraph 715 stipulates that these
two items be offset against one another and a
If the fairbe
value
of the pension fund
single amount
shown.
had exceeded the projected benefit
obligation, the resulting net asset
would have been labeled
Pension-Related Asset.
17-41
Computation of Pension
Expense for 2013
Interest Cost
PBO,
Beginning of
Period
$12,176
×
×
Discount
Rate
0.10
=
=
Interest
Cost
$1,218
(rounded)
obligation discount rate
(continued)
17-42
Computation of Pension
Expense for 2013
Service Cost
Bach’s work for Thakkar Company during the
year results in an increase in forecasted annual
pension benefit payments from Thakkar to Bach.
The impact of this extra year of service is to
increase the December 31, 2013, PBO by $1,339
over what it would have been if Bach had just
vacationed for the entire year. Therefore, the
service cost element of pension expense for the
year is $1,339.
(continued)
17-43
Computation of Pension
Expense for 2013
Return on the Pension Fund
Pension expense is reduced by the return on
the pension fund for the year. Because
Thakkar expects a 12% rate of return, the
original $10,000 will have a return of $1,200
in 2013. Thakkar’s net pension expense is
reduce by $1,200 ($10,000 x 0.12).
(continued)
17-44
Computation of Pension
Expense for 2013
In addition to these changes in the PBO and
the pension fund, two additional events are
common when dealing with pension plans:
1. Contributions to the plan
2. Benefits paid from the plan
(continued)
17-45
Computation of Pension
Expense for 2013
Projected Benefit Obligation, End of Year
PBO,
beginning +
of year
Service
Retirement
cost and
benefits
interest –
paid
cost
±
Change in
actuarial
assumptions
(continued)
17-46
Computation of Pension
Expense for 2013
The fair value of the pension fund is based
on its market value at a given measurement
date.
Fair Value of Pension Fund, End of Year
Fair value
Employer
of pension
fund,
+ contributions
beginning
of year
Retirement
benefits ±
–
paid
Actual return
on pension
fund
(continued)
17-47
Basic Pension Journal Entries
Thakkar would make the following journal
entries for 2013:
Prepaid Expense
Pension-Related Asset/Liability
1,357
1,357
To record 2013 pension expense.
Pension-Related Asset/Liability
1,500
Service cost ($1,339)
+ Interest cost
Cash
($1,218) – Expected return1,500
($1,200)
To record 2013 contribution to pension
plan.
New contributions to
pension fund
17-48
Prior Service Cost
When a pension plan is initially adopted or
amended to provide increased benefits,
employees are granted additional benefits
for services performed in years prior to the
plan’s adoption or amendment. The cost of
these additional benefits is called prior
service cost.
(continued)
17-49
Prior Service Cost
•
The amount of prior service cost is
determined by actuaries and represents
the increase in the PBO arising from the
adoption or amendment of the plan.
•
The accounting profession has been in
general agreement that prior service cost
should not be recognized as part of
expense at the plan’s adoption or
amendment date but should be amortized
over future periods.
17-50
IAS 19
According to paragraph 96 of IAS 19, past
service cost (equivalent to prior service cost)
is recognized as an expense over the period
when the retroactive benefits vest.
If the retroactive benefits vest immediately,
then under IAS 19 the entire amount of past
service cost is expensed immediately.
17-51
The Basic Spreadsheet
Financial Statement Accounts
Net
Pension
Expense
Cash
Pension Accumulated
Related
Other
Asset/ Comprehen.
(Liability)
Income
Detailed Accounts
Periodic
Pension
Expense
Items
Fair
Value of Prior
Pension Service
PBO Fund
Cost
Beginning Balances
(a) Service Cost
(b) Interest Cost
(c) Actual Return
(d) Benefits Paid
(e) PSC Amortization
(g) Deferred Loss
(h) Amort. of Deferred Loss
Summary Journal Entries
(1) Accrual Pension
Expense Accrual
(2) Annual Pension
Contribution
The work sheet is divided into two
sections: the Financial Statement
Accounts section and the Detailed
Accounts section.
(3) Minimum Liability
Adjustment
17-52
Amortization of Prior
Service Cost
•
Prior service cost (PSC) is the cost of
benefits granted to employees for past service
when a pension plan is adopted or amended.
•
The FASB states that prior service cost should
be amortized by “assigning an equal amount
to each future period of service of each
employee active at the date of the
amendment who is expected to receive
benefits under the plan.” The future period of
service is referred to as the expected service
period.
17-53
Plan Contributions
•
Under the Pension Protection Act of 2006,
companies are required to contribute an
amount equal to their service cost and interest
cost each year plus an additional contribution
designed to eliminate any remaining shortfall
within seven years.
17-54
Deferral of Gains and Losses
•
Because pension costs include many
assumptions and estimates, frequent
adjustments must be made for variations
between the actual results and the estimates
or projections that were used in determining
net periodic pension expense for the previous
period.
•
Such differences between expected results
and actual experience give rise to a deferred
pension gain or loss.
17-55
Deferral of Current-Year Difference between
Actual and Expected Return on Pension Fund
•
In estimating the return on the pension
fund, the expected long-term rate of return
on assets should be used rather than a
more volatile short-term rate.
•
In the short run, the actual return on the
pension fund usually will differ from the
expected return.
17-56
Differences in Actuarial
Estimates of PBO
•
•
The actuarial computation of the projected
benefit obligation involves many estimates:
 Future interest rates
 Life expectancy rates
 Future salary rates
The deferred loss arising from the
adjustment to the PBO becomes part of the
deferred net pension gain or loss for
possible future amortization.
17-57
Amortization of Deferred Net Pension
Gain or Loss from Prior Years
•
•
The deferred pension gain or loss from prior
years is amortized over future years if it
accumulates to more than an amount defined
by the FASB as a corridor amount.
Amortization is required only on that portion of
the unrecognized net gain or loss that exceeds
10% of the greater of:
 PBO or
 the market-related value of plan assets at
the beginning of the year.
(continued)
17-58
Amortization of Deferred Net Pension
Gain or Loss from Prior Years
The FASB indicated that any systematic
method of amortizing the deferred net gain or
loss that equaled or exceeded the straight –
line amortization over the remaining expected
service years of the employees would be
acceptable as long as the procedure is
applied consistently to both gains and losses.
17-59
Revolutionary IASB
Exposure Draft
Key elements of the exposure draft are as
follows:
• Balance sheet reporting of the net pension
liability/asset with adjustments.
•
Use of actual return on the pension fund rather
than expected return.
•
•
No accumulated other comprehensive income
Decomposition of the pension expense
components.
17-60
Disclosure of Pension Plans
The major disclosure requirements in FASB
ASC Topic 715 for most publicly traded
companies are as follows:
1. A reconciliation between the beginning and
ending balances for the projected benefit
obligation
2. A reconciliation between the beginning and
ending balances in the fair value of the
pension fund
(continued)
17-61
Disclosure of Pension Plans
3. A disclosure of the accumulated benefit
obligation
4. The funded status of the plans and the amounts
recognized in the balance sheet
5. The components of pension expense for the
period
6. Any effects on the other comprehensive income
for the period and the details of the existing
balances in accumulated other comprehensive
income
(continued)
17-62
Disclosure of Pension Plans
7. The assumptions used relating to (a)
discount rate, (b) rate of compensation
increase, and (c) expected long-term rate of
return on the pension fund
8. Disclosure of the percentage of the different
types of investments held in the pension fund
along with a narrative description of the
investment strategy
(continued)
17-63
Disclosure of Pension Plans
9. For each of the next 5 years, disclose an
estimate of the amount of cash to be paid in
benefits and the amount of cash to be
contributed by the company to the pension
fund
10. For postretirement benefits: assumed
heath care cost trend rates and their
effect on service and interest costs and the
ABO if the assumed health care cost trend
rates were one percentage point higher
17-64
Pension Settlements and
Curtailments
• Settlement of a pension plan occurs when an
employer takes an irrevocable action that
relieves the employer of primary responsibility for
all or part of the obligation.
• A curtailment of a pension plan arises from an
event that significantly reduces the benefits that
will be provided for present employees’ future
services. Curtailments include:
 Termination of an employee earlier than expected
 Termination or suspension of a pension plan
17-65
Settlements
FASB ASC paragraph 715-30-35-39 requires
that a settlement be recognized in the current
period if it:
1. was an irrevocable action,
2. relieved the employer of primary
responsibility for the pension benefit
obligation, and
3. eliminated significant risks related to the
obligation and the assets used to effect the
settlement.
17-66
Informal Rather than
Formal Plans
•
•
Many company postretirement benefit plans
are not written into formal contracts.
Companies often begin paying for
postretirement health care benefits as a
continuation of health care coverage for
active employees.
17-67
Pay-as-You-Go Accounting Rather
than Accrual Accounting
• Because postretirement benefit plans are
usually not funded, almost all companies
previously charges these costs against
revenue in the period the benefit costs
were incurred rather than when the
employee service was rendered.
•
This policy results in uneven charges
against revenue and does not recognize a
liability for unfunded postretirement
benefits.
17-68
Nonpay-Related Rather than
Pay-Related Benefits
•
The date when employees become eligible
for postretirement benefits is known as the
full eligibility date.
•
After that date is reached, the employee is
eligible to receive 100% of the
postretirement benefits regardless of any
future service or pay level reached.
17-69
Chapter 17
₵
The End
$
17-70
17-71