Stice | Stice | Skousen
Intermediate Accounting,17E
Employee Compensation—
Payroll, Pensions, and Other
Compensation Issues
PowerPoint presented by: Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2010 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)
(continues)
17-2
Payroll and Payroll Taxes
4. State unemployment insurance (tax to
employer only)
5. Individual income tax (tax to employee
only but withheld and paid by employer)
17-3
Federal Insurance
Contributions Act (FICA)
• 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 2007, annual wages up to $97,200 were
subject to 6.20% of FICA tax.
17-4
Federal Hospital Insurance
• 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.
• For 2007, the rate 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.
(continues)
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.
17-7
State Unemployment Insurance
• State unemployment compensation
laws (SUTA) differ across states. Most
states only tax employers, but a few
tax both.
• Savings under state merit systems are
also allowed as credits in the
calculation of the federal contribution.
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.
(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.
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.
(continues)
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
17-12
Accounting for Payroll Taxes
Assume accrued salaries 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
$2,000
To accrue the payroll tax liability of the
employer.
583
459
108
16
17-13
Compensated Absences
Compensated absences include
payments by employers for:
• Vacations
• Holidays
• Illnesses
• Other personal activities
(continues)
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.
(continues)
17-15
Compensated Absences
FASB Statement No. 43 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
Compensated Absences
S&N Corporation has 20 employees
who are paid an average of $700 per
week. During 2010, all employees
earned a total of 40 vacation weeks
but took only 30 weeks of vacation
that year. They took the remaining
10 weeks of vacation in 2011 when
the average rate of pay was $800 per
week.
(continues)
17-17
Compensated Absences
Journal Entry for December 31, 2010
Wages Expense
Vacation Wages Payable
7,000
7,000
To record accrued vacation wages
($700 × 10 weeks).
Journal Entry for December 31, 2011
Wages Expense
Vacation Wages Payable
Cash
To record payment at current rates of
previously earned vacation time ($800 ×
10 weeks).
1,000
7,000
8,000
17-18
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.
(continues)
17-19
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
17-20
Postemployment Benefits
• In Statement No 112, FASB extends
recognition requirements to benefits
that accrue to former or inactive
employees after employment but
before retirement.
• Examples of the types of benefits:




Supplemental unemployment benefits
Severance benefits
Disability-related benefits
Job training and counseling
17-21
Accounting for Pensions
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
(continues)
17-22
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
17-23
Nature and Characteristics of
Employer Pension Plans
• 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.
• Under defined contribution pension
plans, the employer pays a periodic
contribution which is administered by an
independent third party.
17-24
Nature and Characteristics of
Employer Pension Plans
• Under defined benefit pension 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.
• A pension fund may be viewed
essentially as a fund set aside to meet
the employer’s future pension obligation.
17-25
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.
17-26
Funding of Defined
Benefit Plans
• Most defined benefit plans require
periodic contributions that
accumulate to the balance needed
to pay the promised retirement
benefits to employees.
• All funding methods are based on
present values.
17-27
Issues in Accounting for
Defined Benefit Plans
A list of issues 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
17-28
Simple Illustration of
Pension Accounting
•
•
•
•
Lorien Bach is 35 years old.
She has worked for Thakkar for 10 years.
Her salary for 2010 was $40,000.
Pension payments begin after the employee
turns 65.
• 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.
(continues)
17-29
Simple Illustration of
Pension Accounting
• Thakkar uses a discount rate of 10%.
• As of January 1, 2011, Thakkar had a
pension fund containing $10,000.
• During 2011, 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)
17-30
Estimation of Pension
Obligation
Step 1: Estimate Pension Obligation
(2% × 10 years) × $40,000 = $8,000
The annual amount that
Bach should receive on
her retirement
(continues)
17-31
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
30 years
X
X
X X X X X X X X
Accumulated benefit
obligation (ABO)
(continues)
17-32
Estimation of Pension
Obligation
Projected Benefit Obligation (PBO)
Assume Thakkar Company expects Bach’s
2011 salary of $40,000 to increase 5%
every year until retirement.
(2% × 10 years) × $172,877 = $34,575 (rounded)
PV = $40,000,
N=
30,is
I =$12,176,
5%
The
PBO
which
is the PV of the 10 future
annual payments of
$34,575.
(continues)
17-33
Estimation of Pension
Obligation
Pension-Related Liability
PBO, January 1, 2011
Pension fund at fair value, January 1, 2011
Pension-related liability, January 1, 2011
$12,176
(10,000)
$ 2,176
In Statement No. 87, the FASB stipulates
that these two items be offset against one
another and a single amount be shown.
(continues)
17-34
Estimation of Pension
Obligation
Computation of Pension
Expense for 2011: Interest Cost
PBO,
Beginning of
Period
$12,176
×
×
Discount
Rate
0.10
=
=
Interest
Cost
$1,218
(rounded)
(continues)
17-35
Estimation of Pension
Obligation
Computation of Pension
Expense for 2011: Service Cost
The impact of this extra year of service is
to increase the December 31, 2011, 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.
(continues)
17-36
Estimation of Pension
Obligation
Computation of Pension Expense for 2011:
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 2011.
(continues)
17-37
Estimation of Pension
Obligation
Projected Benefit Obligation, End of Year
PBO,
beginning +
of year
Service
Retirement
cost and
benefits
interest –
paid
cost
±
Change in
actuarial
assumptions
(continues)
17-38
Estimation of Pension
Obligation
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
The fair value of the pension fund is based
on its market value at a given measurement
date.
(continues)
17-39
Estimation of Pension
Obligation
Thakkar would make the following journal entries
for 2011:
Prepaid Expense
Pension-Related Asset/Liability
1,357
1,357
To record 2011 pension expense.
Pension-Related Asset/Liability
1,500
Service cost ($1,339)
+ Interest cost
Cash
($1,218) – Expected return1,500
($1,200)
To record 2011 contribution to pension
plan.
New contributions to
pension fund
17-40
Thornton Electronics—2011
Thornton’s pension-related balances as
of January 1, 2011, are as follows:
17-41
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.
17-42
Thornton Electronics
The cost represented by a plan
adoption or amendment is recognized
as a reduction in Other Comprehensive
Income. Thornton's prior service cost is
$75,000.
Other Comprehensive Income
Projected Benefit Obligation
75,000
75,000
To record January 1, 2011, prior service
cost arising from plan amendment.
17-43
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
(3) Minimum Liability
Adjustment
The work sheet is divided into
two sections: the Financial
Statement Accounts section
and the Detailed Accounts
section.
17-44
Thornton Electronics’ Pension
Activity for 2011
•
•
•
•
Service cost
$75,000
Contributions to pension plan
$115,000
Benefits paid to retirees
$125,000
Fair value of pension fund
at December 31, 2011
$1,513,500
• Obligation discount rate
11.0%
• Long-term expected rate of return
10.0%
(continues)
17-45
Service Cost
• Service cost is the present value of
additional benefits earned by employees
during the period.
• This cost is determined by actuaries
based on the pension plan’s benefit
formula.
• Service cost for Thornton is recorded in
the work sheet as an increase in net
periodic pension expense and an increase
to the PBO.
(continues)
17-46
(continues)
17-47
Interest Cost
• The interest cost represents the fact that
the present value of Thornton’s pension
obligation is increased by the interest on
the beginning PBO.
• The interest cost for 2011 is $1,500,000 ×
0.11, or $165,000.
• The interest cost is shown as entry (b) in
Slide 17-49.
(continues)
17-48
(continues)
17-49
Actual Return on the
Pension Fund
Fair value of pension fund, 12/31/11
Fair value of pension fund, 1/1/11
Increase in fair value
Add benefits paid
Deduct contributions made
Actual return on the pension fund
$1,513,500
1,385,000
$ 128,500
125,000
(115,000)
$ 138,500
The actual return of $138,500 is shown in
entry (c) as in Slide 17-51.
(continues)
17-50
(continues)
17-51
Actual Return on the
Pension Fund
Benefits paid from fund assets do
not reduce the account Cash; benefit
payments are shown in entry (d) on
Slide 17-53 as a decrease in both
the pension fund and the remaining
PBO.
(continues)
17-52
17-53
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.
• In Statement No. 87, FASB requires that
prior service cost be amortized by
assigning an equal amount to each future
period receiving benefit under the plan.
(continues)
17-54
Amortization of Prior
Service Cost
Ten percent (15 employees) of Thornton’s employees
are expected to retire or quit with vesting privileges.
The prior service cost is $75,000.
N(N + 1)
2
× D = Total future years of service
10(10 + 1)
× 15 = 825
2
15 employees
for 10 years
150
× $75,000
825
= $13,636 (amortization for 2011)
(continues)
17-55
17-56
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.
• Thornton made a cash contribution to the
pension fund of $115,000. This is reflected
on the worksheet as item (f) on Slide 1758.
(continues)
17-57
17-58
Summary Journal Entries
Pension Expense
115,136
Pension-Related Asset/Liability
101,500
Accumulated Other Comprehensive
Income
13,636
Summary journal entry to recognize
pension expense for 2011.
(continues)
17-59
Summary Journal Entries
Pension-Related Asset/Liability
Cash
115,000
115,000
Summary journal entry to record
pension fund contribution.
17-60
Thornton Electronics—2012
•
•
•
•
•
•
•
Service cost as reported by actuaries $87,000
Contributions to pension plan
$75,000
Benefits paid to retirees
$132,000
Actual return on pension fund
$26,350
Actuarial change increasing PBO
$80,000
Obligation discount rate
11.0%
Long-term expected rate of return
on pension fund
10.0%
(continues)
17-61
Thornton Electronics—2013
• Service cost as reported by
actuaries
$115,000
• Contributions to pension plan
$80,000
• Benefits paid to retirees
$140,000
• Actual return on pension fund
$175,500
• Obligation discount rate
11.0%
• Long-term expected rate of return
10.0%
• Accumulated benefit obligation,
December 31, 2013
$1,795,150
(continues)
17-62
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.
17-63
Corridor Amortization
May use any amortization method
that:
 equals or exceeds straight-line
amortization over remaining
expected service years of covered
employees, and
 is consistently applied.
17-64
Disclosure of Pension Plans
FASB Statement No. 132 requires the
following major disclosure
requirements for most publicly traded
companies:
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
(continues)
17-65
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
(continues)
17-66
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
(continues)
17-67
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
17-68
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.
• Curtailment of a pension plan arises from an
event that significantly reduces the benefits
that will be provided for present employees’
future services.
 Termination of an employee earlier than
expected
 Termination or suspension of a pension plan
(continues)
17-69
Pension Settlements and
Curtailments
FASB Statement No. 88 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.
17-70
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.
17-71