Payroll Accruals: Wages, Taxes and More! Presented by: Daniel Dycus, CPP / Daniel.Dycus@intelsat.com / 703.559.7692 1 DEFINITIONS Accrual – A revenue or expense that has occurred but has not yet been recorded in the accounting records. Adjusting Entries – Journal entries typically made at the end of the month to be sure costs and revenue are matched and recorded in the proper period. Assets – Items owned by the business (Cash). Balance Sheet – The financial report that lists a company’s assets, liabilities, and owner’s equity. It provides a snapshot of the company’s financial position. Credit – The right side of an account. For an asset, it represents a decrease; for a liability, increase. Debit – The left side of an account. For an asset, it represents an increase; for a liability, a decrease. Expenses – The cost of doing business. Fiscal Year – The business year for accounting purposes. A period used for calculating annual financial statements in a business. General Journal / Journal – The book of original entry for transactions, including most adjusting entries. This is the first place a transaction is recorded. General Ledger – A company’s complete set of accounts, which shows increases and decreases in each individual account and their balances. Liability – The money owed by a business. Reconcile – To check that account totals agree with supporting data or calculations. Trial Balance – The first figuring of balance sheet and income statement accounts to see if debits and credits are the same. 1 2 CASH BASIS VS. ACCRUAL BASIS The company must determine at the outset whether to use a cash basis or accrual basis for recording transactions and filing taxes. From a financial position, the accrual basis is more informative because it matches revenues and expenses. The IRS requires most established businesses with revenues over a certain amount to use the accrual method. For small and start‐up businesses, there are advantages to the cash basis. They only pay taxes on income received, they can control taxable income by delaying cash deposits and bookkeeping on a cash basis is simpler and less time‐consuming. Some small businesses maintain their records on a cash basis and their financial statements in an accrual basis to get a better picture of the year. 3 WHAT ARE GENERALLY ACCRUED? 
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Wages Employer Taxes Vacation/Paid Time Off Employer Contributions to a 401(k) or deferred plan Bonuses Commissions Severance Retention Payments Relocation 4 HOW DO ACCRUALS WORK AND HOW ARE THEY BOOKED? In each of the sections below there will be sample journal entries. Some will show department, some will show just a basic journal. The specifics of the journal are company dependent. There are some companies that book everything to a cost center, home department, etc. and others that book to a central cost center for purposes of accruals. Both are accurate; just be sure to understand your organization's choice when booking accruals and making the payments. There are multiple ways to achieve the same end result. 4.1 WAGES The accrual of wages is to cover the number of days from your last pay period end date until the end of the month. Generally, this will be less than the number of days in your pay period, however, there will be times that the accrual is more than the number of pay period days. Determining what to accrue is up to each company. When preparing a payroll accrual, you generally want to only accrue items that happen regularly and consistently. For example, you would not accrue a referral bonus on a regular monthly payroll accrual. 2 When accruing wages, companies do this in a variety of ways that are demonstrated over the next several examples. All examples are working with a biweekly payroll for simplicity, but remember to use the pay frequency back at your office. Scenario 1 The calendar shows the pay period end dates in orange and the pay dates in green. When accruing, use the pay register from the last payroll that was processed. In this case, the last pay date was 1/17/XX. 3 Depending on the company, the accrual will either be at the individual department level or at a centralized department. If at a centralized cost center, it will book at the actual cost center when the actual wages are posted to the general ledger. To calculate the accrual, take the wages to be accrued and divide by the total number of days included in the payroll and then multiply by the number of days to accrue. 4 Once the entry reverses in February, the actual payroll will post to the general ledger in February. Depending on how many days you accrue, it may take two payrolls for the pay to all be posted into the general ledger. Scenario 2 This scenario is another way to process a payroll accrual. In this scenario, the amount to accrue is based on a daily rate that was paid during the last 12 months of pay. This is known as a rolling 12 months. Again, the wages that are included are dependent on the company. The scenario shows the salaries broken out by department and the journal entry would be posted the same as in scenario 1. Like in scenario 1, the entry will reverse in the following month and the actual payroll will book to the general ledger. 5 Scenario 3 There are times when an accrual may need to be longer than one entire pay period. This only occurs a few times a year. In the example below, the company’s pay period end for the last payday of the year is on December 15. Paying biweekly one week in arrears requires an accrual for December 16‐31, which is 12 days for a company that accrues 5 days per week. 4.2 EMPLOYER TAXES The accrual of employer taxes are on the same dollars that you are accruing for wages. Like wages, this accrual is to cover the number of days from your last pay period end date until the end of the month. Generally, this will be less than the number of days in your pay period, however, there will be times that the accrual is more than the number of pay period days. Determining what to accrue is up to each company. Most of the time companies would accrue social security and Medicare. Some companies also accrue FUTA and SUTA. When accruing employer taxes, companies do this in a variety of ways that are demonstrated over the next several examples. All examples are working with a biweekly payroll for simplicity, but remember to use the pay frequency back at your office. 6 Scenario 1 The calculation of employer taxes will be built using the same pay period and wages as in Scenario 1 under 4.1 Wages. 7 Scenario 2 This scenario is another way to process a tax accrual. In this scenario, the amount to accrue is based on a daily rate that was paid during the last 12 months. This is known as a rolling 12 months. 8 4.3 VACATION / PAID TIME OFF Vacation and Paid Time Off Accruals can be accrued a variety of ways. Scenario 1 – In this example, the vacation is accrued on the first day of the year and taken during the year. The amount can be deducted and leave the salaries intact or it can be deducted and reduce salaries and wages. There would be a journal entry each month when an employee took leave to reduce the amount of the liability. How the balance at year‐end would be handled would depend on company policy. If the balance is use it or lose it, then the balance would be reduced to zero and a new accrual would start at the beginning of the next year. If there is a carry‐over period, then a journal entry would need to be done to bring the balance down to the maximum allowed for carry‐over. 9 Scenario 2 – With this example, salaries remains whole for the year. 10 4.4 EMPLOYER CONTRIBUTIONS TO A 401(K) OR DEFERRED PLAN Employer contributions to a 401(k) Plan depend on the actual plan. One important item to remember is that you may have more than one plan and they may operate differently. The following list are examples of types of 401(k) Employer Contributions that may need to be accrued: Pay Period Match – This is the match that is done each pay period Company Contribution – Many times this is done annually and you have to be employed at year‐end to receive this. With this type of match, the company would accrue a monthly amount each period. When working with this accrual, it may increase for an entire year. You must understand the plan document to know what to accrue. You need to know if it is only on eligible wages, if there is a waiting period to participate and if terminated employees receive the benefit. Discretionary Contributions – This type of contribution generally is based on company performance and would be contributed on an annual basis. Like the company contribution, the employee would generally need to be employed at year‐end to receive. Annual True Up Contribution – Depending on how the plan is written, there may be a true up to contribute all of the match to the employee if they front load their contributions. Depending on the type of contribution being made, these liabilities may remain on the books for the entire year before they clear. Many times, you will find that the discretionary contribution is held until after the books are closed for the year they are accrued to ensure that the targets are met. Scenario 1 – Per Pay Period Match – This is done very much like the monthly payroll and tax accrual. It can be done on either a department level or a centralized department level. This example shows the accrual being booked to one department. This accrual would reverse in the next month and the actual payroll would then record the actual 401(k) match expense. 11 Scenario 2 – Company Contribution – This is generally done at a company level in a centralized department on the month wages. Make sure that the accrual is only built on eligible wages. The format of this entry can be done in a variety of ways, but the main concern is to build the accrual on eligible wages. 12 Scenario 3 – Discretionary Contributions – When a company offers a discretionary contribution (for example 0‐4% depending on performance of the company) they generally pick a target to start the accrual off with. Then during the year, the accrual may be adjusted up or down depending on company performance. 13 Continuing with this scenario. Assume that in month 9, the company won an extremely large contract and the company was now exceeding its original goals and the projections were that the company was going to exceed all goals for the year and wanted to assume that in the accrual at this point. Scenario 4 – Annual True‐up Contribution – This is the hardest to build an accrual on. Many companies base this accrual on the amount that was trued up in the previous year. 14 4.5 BONUSES A bonus is something given or paid that is usual or expected. For most companies these bonuses that are accrued are paid either quarterly or annually. These are the one‐off type bonuses, such as a spot award, length of service award or safety award. When preparing an accrual for this type of payment, there has to be a set way to gather the required data. Many times, this accrual is compiled based on the expected payout that was provided to the Financial Planning Department when the annual budget was prepared. There are also times when the accounting department receives the information on a monthly basis where they attempt to calculate the accrual number based on actual numbers using the actual current headcount and percentages due to each employee. Employer taxes should be accrued on this as well. If the accrual is based on the budget, then the company will have to look at a way of estimating how much of the bonus will be subject to social security, Medicare and additional Medicare. Many times, this is determined by when the bonus is paid. If it is paid early in the year, then the accrual of 7.65% and no additional Medicare may be sufficient realizing that some may hit the social security limit, thus being over‐accrued and some may hid the additional Medicare tax, thus being under‐accrued. When accruing for bonuses, you may also need to consider the 401(k). If your bonus plan allows for 401(k) deferrals, you may need to consider an additional accrual for the 401(k) match. The example below shows the accrual based on the budget. When a company calculates monthly based on current headcount, the process of accruing is the same, once you get the number. Like many other accruals, the company will determine if this is booked at a department/cost center level or at a centralized cost center. 15 16 4.6 COMMISSIONS Commission is a fee or percentage allowed to a sales representative or an agent for services rendered. Depending on the company, commissions may also be referred to as bonuses and not commissions. Either way, for the purpose of an accrual, they are the same. When preparing an accrual for this type of payment, there has to be a set way to gather the required data. Many times, this accrual is compiled based on the expected payout that was provided to the Financial Planning Department when the annual budget was prepared. There are also times when the accounting department receives the information on a monthly basis where they attempt to calculate the accrual number based on actual numbers received and expected numbers for what is not known. Either way, the accrual is a best guess estimate for the payout. The examples below will show the entries based on booking to budget and adjustments as needed for payments made in excess of the budget. When booking to calculations based on known numbers and projected numbers, the journal entries would be the same, except the numbers provided would be used instead of the budget. 17 18 4.7 SEVERANCE Severance packages are most typically offered for employees who are laid off or retire. Severance pay was instituted to help protect the newly unemployed. Sometimes, it may be offered for people who resign, regardless of the circumstances, or are fired. Policies for severance packages are often found in a company's employee handbook, and in many countries are subject to strict government regulation. Severance contracts often stipulate that the employee will not sue the employer for wrongful dismissal or attempt to collect on unemployment benefits, and that if the employee does so, then they must return the severance money. Generally severance payments would be accrued in the month that the employee is notified. The payment will occur once all documents are signed and received back and the waiting period has lapsed. When a payment is made, it can be journalized to severance payable or severance expense. If the journal is to severance expense, then a reversing entry will need to be made to release the accrual for the severance. 19 4.8 RETENTION Retention bonuses are a form of financial incentive. The bonus is usually issued to key employees as a strategy to motivate the individual to remain an employee of the company. A retention bonus is usually extended when circumstances indicate the employee may be considering resignation, an action that will result in an undesirable loss to the business. The retention bonus is an incentive that is offered above and beyond any other salary, wage, or other benefits currently extended to the employee. Generally, it is considered a one‐time transaction, but may be paid out in multiple payments over time. It is hoped that the employee will reconsider any other employment options that may have come about and stay with the employer. It is not unusual for a retention bonus to be issued to key employees when a business is going through some type of major change, such as a merger or acquisition situation. The idea is to entice the employee to remain in their position at least until the current set of circumstances has been resolved. Accruals for retention payments start the month the employee is notified. The way the employee is to receive the payment will determine the way the accrual will occur. Example 1 will show how an employee will receive a lump sum payment after a certain period of time. The amount of time is determined by the company and put in the agreement. Generally, payment will be processed in the first pay period after the completion of the time required in the agreement. Example 2 will show how an employee will receive several payments over a period of time. When this occurs, the accrual has to be broken out based on each individual payment made. 20 21 22 23 If you have booked the payment to Retention Expense, the entry that would need to be completed is one similar to the one in Retention Example 1, Scenario #2. 4.9 RELOCATION Many times a company will relocate an employee or new hire from one location to a new location. These moves can be either domestic or international. Depending on the expense, some may be tax free, some may be taxable, some may have to be reported on the Form W‐2 and some may even be grossed up. No matter how it is taxed or reported, the accrual remains the same. Relocations can be processed either in house or by using a third‐party relocation company to complete the relocation. Either way, the accrual should be placed on the books when the employee initiates their move. To find out the accrual 24 amount, there needs to be a cost estimate completed and sent to accounting for recording. As the payments are made, they need to release this accrual. Relocations generally have a time limit on completing the move. At the end of this time, any unused accrual needs to be released from the books. Also, there may be adjustments made to the accrual anytime if the company finds that the employee is not going to use some of the relocation items. 25