chapter 17
Employee
Compensation—Payroll,
Pensions, and Other
Compensation Issues
1
Learning Objectives
1.
2.
3.
4.
5.
6.
7.
Account for payroll and payroll taxes, and understand the
criteria for recognizing a liability associated with
compensated absences.
Compute performance bonuses and recognize the issues
associated with postemployment benefits.
Understand the nature and characteristics of employer
pension plans, including a detailed discussion of defined
benefit plans.
Use the components of prepaid/accrued pension costs and
changes in the components to compute the periodic expense
associated with pensions.
Prepare required disclosures associated with pensions, and
understand the accounting treatment for pension settlements
and curtailments
Describe the few remaining differences between U.S.
pension accounting standards and the provisions of IAS 19.
Explain the differences in accounting for pensions and
postretirement benefits other than pensions.
2
Employee Compensation
Event Line
Payroll
Compensated
Absences
Stock Options
and Bonuses
Postemployment
Benefits
Pensions and
Postretirement
Benefits Other Than
Pensions
3
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 to employer
only)
5. Individual income tax (tax to employee only but
withheld and paid by employer)
4
Payroll and Payroll Taxes
FICA
a.k.a. Social
Security
The FICA tax rate and the maximum amount
taxable continue to change. As of 2002 …the
rate is 6.20% on annual wages up to $84,900.
This affect both employer and employee.
Federal Hospital Insurance
a.k.a.
Medicare Tax
There is no upper limit on this tax.
The 2002 rate is1.45% for both
employer and employee.
5
Payroll and Payroll Taxes
Federal Unemployment Insurance
Work
for
Food
The employer pays 6.2% on the first
$7,000 earned by each employee. A
credit of 5.4% may be applied based on
state unemployment tax (see below),
therefore making it 0.8%
State Unemployment Insurance
The employer usually pays 5.4% to
the state on the first $7,000 earned
by each employee.
6
Payroll and Payroll Taxes
Income Tax
Employers are required to withhold income tax from
wages paid to their employees. Withholding tables
provide information about how much to withhold
from each employee. These deductions are affected
by the number of exemptions claimed.
7
8
Salary Expenses and Liabilities
 The employee’s gross earnings are an
expense to the employer.
 Withholdings are an expense to the
employee, not to the employer.
 Withholdings become a liability to the
employer only because the employer keeps
money earned by employees and pays
obligations on their behalf.
9
Accounting for a Payroll
Eg. Total salary for 15 employees = $16,000. State
unemployment tax = 5.4%. Income tax with-holding =
$1,600. Combined FICA = 7.65%. This employer would
make the following entry to record salary expense:
Salaries Expense
16,000
FICA Taxes Payable
1,224
Employees Income Taxes Payable
1,600
Cash
13,176
To record payment of payroll and
related employee withholdings.
Continued
10
Accounting for a Payroll
Employers make this entry to record their portion of
FICA and other payroll taxes e.g. SUT & FUT:
Payroll Tax Expense
2,216
FICA Taxes Payable
1,224
State Unemployment Taxes Payable
864
Federal Unemployment Taxes Payable
128
0.0765 x $16,000
To record the payroll tax liability
of the employer.
0.054 x $16,000
Payroll taxes are:
•An expense to the employer.
•A liability to the employer until they are paid.
0.008 x
$16,000
Compensated Absences
Compensated absences include payments by
employers for vacation, holiday, illness, or other
personal activities.
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
(3) Are estimable and probable
11
Compensated Absences
12
S&N Corporation has 20 employees who are paid an
average of $700 per week. During 2004, a total of 40
vacation weeks was earned by all employees, but only 30
weeks of vacation were taken.
The entry to record the accrued vacation on
December 31, 2004, would be:
Wages Expense
Vacation Wages Payable
To record accrued
vacation wages ($700 x
10 weeks).
7,000
7,000
Continued
Compensated Absences
In 2005, when the additional vacation weeks
are taken, the average rate has increased to
$800 per week.
Wages Expense
Vacation Wages Payable
Cash
1,000
7,000
8,000
To record payment at current rates of previously
earned vacation time ($800 x 10 weeks).
Compensated absences are not tax deductible until
payment is made, while they are deductible under GAAP,
once accrued. This gives right to deferred tax!
13
Stock-Based Compensation
(recall ACC301 - Chapter 11) and Bonuses
Photo Graphics, Inc. gives it store managers a 10% bonus
based on individual store earnings. The bonus is to based on
income after deducting the bonus, but before deduction for
income taxes. Store X has income for the year of $100,000.
B = 0.10($100,000 – B)
B = $10,000 – 0.10B
B + 0.10B = $10,000
1.10B = $10,000
B = $9,091 (rounded)
Continued
14
Major Categories of
Pension Plans
15
1. Government plans, primarily social security
2. Individual plans, such as individual retirement accounts (IRAs)
3. Employer plans:
•Noncontributory – only the employer pays
•Contributory – the employee also pays
•Defined Contribution – benefits vary
•Defined Benefit – contributions vary
•Vested Benefits - Vesting occurs when an employee has met certain
specified requirements and is eligible to receive pension benefits at
retirement even if the employee stops working for the employer
Defined Benefit Pension Plans
Services
Employer
Contributions
Wages and Salaries
Current
Employees
Pension
Fund
Defined Benefits
Retired
Employees
16
Issues in Accounting for
Defined Benefit Plans
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
Simple Illustration
Lorien Bach is 35 years old and has worked for Thakkar
for 10 years. Her salary for 2004 was $40,000. Pension
payments begin after the employee turns 65. The annual
year-end payment is equal to 2% of the highest salary
times the number of years with the company.
Thakkar knows for certainty that Bach will live until she
is 75. Thakkar uses a discount rate of 10%. As of
January 1, 2005, Thakkar had a pension fund of
$10,000. During 2005 an additional $1,500 was
contributed. The fund earned $350 and the average
return is 12%.
Continued
18
Simple Illustration
19
Estimation of Pension Obligation
(2% x 10 years) x $40,000 = $8,000
The annual amount that
Bach should received on her
retirement
Continued
Simple Illustration
Accumulated Benefit Obligation (ABO)
PV of a an
annuity of
X
$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
Accumulated benefit
obligation (ABO)
Continued
20
Simple Illustration
Projected Benefit Obligation (PBO)
Assume Thakkar Company expects
Bach’s 2004 salary of $40,000 to increase
5% every year until retirement.
(2% x 10 years) x $172,877 = $34,575 (rounded)
PV = $40,000, N = 30, I = 5%
Continued
21
Simple Illustration
Accrued Pension Liability
PBO, January 1, 2005
Pension fund at fair value,
January 1, 2005
Accrued pension liability*
$12,176
(10,000)
$ 2,176
FASB Statement No. 87 stipulates that
these two items be offset against one
another and a single amount be shown.
* - The reverse direction would give rise to Prepaid pension cost
22
Simple Illustration – Other Issues
1. Interest Cost
PBO, Beginning
Discount
Interest
of Period
x
Rate
= Cost
$12,176
x
0.10
= $1,218
a.k.a. settlement interest rate
2. Service Cost
Bach’s work for Thakkar during the
year 2005 results in an increase in
forecasted annual benefits to Bach
because the payments are calculated
on 11 years of service.
The impact of this one extra year of
service is to increase the December 31,
2005 PBO balance by $1,339.
Therefore, the service cost element of
pension expense for the year is $1,339.
23
Simple Illustration – Other Issues
3. 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 2005.
Continued
24
Simple Illustration
PBO, End of Year – The Liability side
Service
Retirement
PBO,
Change in
cost and
– benefits
±
beginning +
actuarial
interest
paid
of year
assumptions
cost
Continued
25
Simple Illustration
26
Fair Value of Pension Fund (FVPF)– The Asset side
Fair value
Employer
of pension
Retirement
Actual return
+ contribu- – benefits ± on pension
fund,
tions
beginning
paid
fund
of year
Continued
Simple Illustration
Accrued Pension Liability
As of December 31, 2005, the PBO for Thakkar is
$14,733 and the total FVPF is $12,700 ($10,000 +
$1,200 return + $1,500 new contributions).
PBO, December 31, 2005
Pension fund at fair value,
December 31, 2005
Accrued pension liability
Continued
$14,733
(12,700)
$ 2,033
27
28
Simple Illustration
Thakkar would make the following entries for 2005:
Pension Expense
Prepaid/Accrued Pension Cost
1,357
Prepaid/Accrued Pension Cost
Cash
1,500
1,357
1,500
Service cost ($1,339) + Interest cost
($1,218) – Expected return ($1,200)
Note - A compound entry
could have been made
New contributions
to pension fund
Comprehensive Pension Illustration - The
Basic Spreadsheet Approach – see page 1060
Formal Accounts
Net
Pension
Expense
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
Cash
Prepaid/
Accrued
Pension
Cost
29
Memorandum Accounts
Periodic
Pension
Cost/Expense
Items
PBO
Fair Value
of Plan
Assets (FVPF)
Unrecognized
Prior Service
Cost
Formal Accounts
Net
Pension
Expense
Cash
Prepaid/
Accrued
Pension
Cost
Left Side of Work Sheet
30
Formal Accounts
Net
Pension
Expense
Cash
Prepaid/
Accrued
Pension
Cost
• Records total pension costs accrued.
• Debited for the sum of all periodic
pension cost items.
31
Formal Accounts
Net
Pension
Expense
Cash
Prepaid/
Accrued
Pension
Cost
• Records cash expended for contributions
to plan assets.
• Debited for actual amount of cash
contributed to pension fund.
32
Formal Accounts
Net
Pension
Expense
Cash
Prepaid/
Accrued
Pension
Cost
• Reflects changes in net pension asset
or liability.
• Debited for cash contributions to
pension plan assets.
• Credited for net pension cost.
33
Formal Accounts
Periodic
Pension
Cost Items
Projected
Benefit
Obligation
Fair Value
of Pension
Fund
Right Side of Work Sheet
Unrecognized
Prior Service
Cost
34
Memorandum Accounts
Periodic
Pension
Cost Items
Projected
Benefit
Obligation
Fair Value
of Pension
Fund
Unrecognized
Prior Service
Cost
• Records noncurrent asset arising from
recognition of additional pension
liability for unfunded pension plans.
• Account balance should not exceed the
sum of unrecognized transition loss
plus prior service costs.
35
Memorandum Accounts
Periodic
Pension
Cost Items
Projected
Benefit
Obligation
Fair Value
of Pension
Fund
36
Unrecognized
Prior Service
Cost
Actuarial present value of pension benefits.
Uses the benefits per year of service approach.
Assumes future compensation levels.
Retirement
Change in
PBO PBO Service Interest
=
+
+
– Benefits ± Actuarial
Cost
EoY BoY Cost
Paid
Assumptions
Memorandum Accounts
Periodic
Pension
Cost Items
Projected
Benefit
Obligation
Fair Value
of Pension
Fund
Unrecognized
Prior Service
Cost
• Amount that could be received from the sale of
plan assets in a current sale between a willing
buyer and seller.
• Increased by employer/employee contributions.
• Decreased by benefits paid.
Actual
Benefits
FVPF FVPF
=
+ Contributions –
± Return
Paid
BoY
EoY
on Assets
37
Memorandum Accounts
Periodic
Pension
Cost Items
Projected
Benefit
Obligation
Fair Value
of Pension
Fund
Unrecognized
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.
38
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Net
Pension
Expense
Cash
Balance, 1/1/05
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
Left Side of Work Sheet
Continued
39
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
Projected
Benefit
Obligation
$(1,500,000)
Fair Value
of Pension
Fund
$1,385,000
Right Side of Work Sheet
Continued
40
Unrecognized
Prior Service
Cost
$75,000
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Net
Pension
Expense
Cash
Balance, 1/1/05
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
(a) Service Cost
Left Side of Work Sheet
Continued
41
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
(a)
Projected
Benefit
Obligation
$(1,500,000)
$ 75,000
(75,000)
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,385,000
Right Side of Work Sheet
Continued
42
$75,000
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Net
Pension
Expense
Cash
Balance, 1/1/05
(a) Service Cost
(b) Interest Cost
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
Left Side of Work Sheet
Continued
43
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
(a)
(b)
Projected
Benefit
Obligation
$(1,500,000)
$ 75,000
(75,000)
165,000
(165,000)
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,385,000
Right Side of Work Sheet
Continued
44
$75,000
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Actual Return on the
Pension Fund
Fair value of pension fund, 12/31/05 $1,513,500
Fair value of pension fund, 1/1/05
1,385,000
Increase in fair value
$ 128,500
Add benefits paid
125,000
Deduct contributions made
(115,000)
Actual return on the pension fund $ 138,500
45
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Net
Pension
Expense
Cash
Balance, 1/1/05
(a) Service Cost
(b) Interest Cost
(c) Actual Return
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
Left Side of Work Sheet
Continued
46
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
(a)
(b)
(c)
Projected
Benefit
Obligation
$(1,500,000)
$ 75,000
(75,000)
165,000
(165,000)
(138,500)
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,385,000
138,500
Right Side of Work Sheet
Continued
47
$75,000
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Net
Pension
Expense
Cash
Balance, 1/1/05
(a) Service Cost
(b) Interest Cost
(c) Actual Return
(d) Benefits Paid
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
Left Side of Work Sheet
Continued
48
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
(a)
(b)
(c)
(d)
Projected
Benefit
Obligation
$(1,500,000)
$ 75,000
(75,000)
165,000
(165,000)
(138,500)
125,000
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,385,000
138,500
(125,000)
Right Side of Work Sheet
Continued
49
$75,000
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Amortization of Unrecognized Prior Service Cost
Ten percent (15 employees) are expected to
retire or quit with vesting privileges.
N(N + 1) x D = Total future years of service
2
10(10 + 1)
x 15 = 825
2
150
825
x $75,000 = $13,636
Continued
50
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Net
Pension
Expense
Cash
Balance, 1/1/05
(a) Service Cost
(b) Interest Cost
(c) Actual Return
(d) Benefits Paid
(e) PSC Amortization
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
Left Side of Work Sheet
Continued
51
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
(a)
(b)
(c)
(d)
(e)
Projected
Benefit
Obligation
$(1,500,000)
$ 75,000
(75,000)
165,000
(165,000)
(138,500)
125,000
13,636
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,385,000
$75,000
138,500
(125,000)
Right Side of Work Sheet
Continued
52
(13,636)
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Left Side of
Work Sheet
Net
Pension
Expense
Balance, 1/1/05
(a) Service Cost
(b) Interest Cost
(c) Actual Return
(d) Benefits Paid
(e) PSC Amortization
1) Annual Pension
Expense Accrual $115,136
Cash
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
(115,136 )
Continued
53
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Left Side of
Work Sheet
Net
Pension
Expense
Balance, 1/1/05
(a) Service Cost
(b) Interest Cost
(c) Actual Return
(d) Benefits Paid
(e) PSC Amortization
1) Annual Pension
Expense Accrual $115,136
(2) Annual Pension
Contribution
Cash
Prepaid/
Accrued
Pension
Cost
$ (40,000 )
(115,136 )
(115,000)
115,000
Continued
54
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
Balance
(a)
(b)
(c)
(d)
(e)
(1)
(2)
Projected
Benefit
Obligation
$(1,500,000)
$ 75,000
(75,000)
165,000
(165,000)
(138,500)
125,000
13,636
Right Side of Work Sheet
55
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,385,000
$75,000
138,500
(125,000)
(13,636)
115,000
Continued
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Left Side of
Work Sheet
Net
Pension
Expense
Cash
Balance, 12/31/05
Prepaid/
Accrued
Pension
Cost
$ (40,136 )
Only column added
on the left side of the
work sheet
Continued
56
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Periodic
Pension
Expense
Items
12/31/05
Projected
Benefit
Obligation
$(1,615,000)
Fair Value Unrecognized
of Pension Prior Service
Fund
Cost
$1,513,500
Right Side of Work Sheet
Continued
57
$61,364
Thornton Electronics, Inc.—Pension
Work Sheet for 2005
Pension Expense
Prepaid/Accrued Pension Cost
115,136
115,136
To record accrual of net pension expense for 2005
Prepaid/Accrued Pension Cost
115,000
Cash
To record 2005 contribution to
the pension plan.
115,000
58
Corridor Amortization of Unrecognised
Net Pension Gain/ Loss
59
a. Differences between actual & expected return
• If actual return of pension fund > estimated return, then the
difference = Gain to be deferred
–The financial statement effect =
•
Increase Pension Expense & Decrease Net Pension Liability
–The Memorandum entries =
•
Debit Pension expense & Credit Unrecognized Net Pension Gain/Loss
• If actual return of pension fund < estimated return, then the
difference = Loss to be deferred
–The financial statement effect =
•
Decrease Pension Expense & Increase Net Pension Liability
–The Memorandum entries =
•
Credit Pension expense & Debit Unrecognized Net Pension Gain/Loss
Corridor Amortization of Unrecognised
Net Pension Gain/ Loss
b. Differences in Actuarial estimates of BPO
• If PBO should increase
•The financial statement effect = nil
•The Memorandum entries =
Credit PBO & Debit Unrecognized Net Pension Gain/Loss
60
Corridor Amortization of Unrecognised
Net Pension Gain/ Loss
61
• Amortization is required only on portion of
unrecognized net gain or loss that exceeds 10% of the
greater of:
– PBO, or
– market-related value of plan assets at the
beginning of the year.
• May use any amortization method that equals or exceeds
straight-line amortization over remaining expected service
years of covered employees, and is consistently applied.
See Thornton Electronics 2006 & 2007 pages 1063-1067
Minimum Pension Liability
• Net amount of pension liability that
must be reported for underfunded plans.
• Measured as difference between ABO
and Fair Value of Plan Assets.
Minimum Pension ABO – FV Plan
=
Liability
Assets
See pages 1067 – 1068: Quite Interesting!
62
Deferred Pension Cost
If an employer is required to record an additional
pension liability as a result of applying the minimum
liability provisions, FASB Statement No. 87 indicates
that the offsetting charge should be to the Deferred
Pension Cost account, which is an intangible asset.
Clapton Corporation computes the following balances
as of December 31, 2005:
Accumulated benefit obligation
Fair value of the pension fund
Accrued pension cost
Unrecognized prior service cost
$1,250,000
1,140,000
16,000
80,000
63
Deferred Pension Cost
64
The minimum pension liability is $110,000
($1,250,000 – $1,140,000). An additional
pension liability of $94,000 ($110,000 –
$16,000) would be recorded.
Deferred Pension Cost
80,000
Excess of Additional Pension Liability
over Unrecognized Prior Service Cost* 14,000
Additional Pension Liability
94,000
To recognize additional pension
liability.
* This is a contra equity account reported as part of
“Accumulated other comprehensive income”
Disclosure of Pension Plans
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
3. A disclosure of the accumulated benefit obligation
when the ABO exceeds the fair value of the
pension fund
4. The funded status of the plans, the amounts not
recognized in the balance sheet, and the amount
recognized in the balance sheet
Continued
65
Disclosure of Pension Plans
5. The components of pension expense for the
period
6. Any effects on the other comprehensive
income section as a result of changes in the
additional pension liability
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. Certain information about postretirement
benefits
66
Disclosure of Pension Plans
Statement No. 132 added that an employer must
disclose the amount of pension expense
recognized for defined contribution plans
separately form the amount of expense
recognized for defined benefit plans.
In addition, the nature and effect of any
significant changes during the period should be
disclosed.
67
Pension Settlements and
Curtailments
68
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. E.g. the purchase of an annuity or a lump-sum cash
payment to the employee
Curtailment of a pension plan arises from an
event that significantly reduces the benefits
that will be provided for present employees’
future services. E.g. discontinuation of a
segment or the suspension of a plan
• Termination of an employee earlier than expected
• Termination or suspension of a pension plan
International Pension
Accounting Standards
69
IFRS 19 was revised to require that a company’s pension
obligation be measured using the same approach as is used
under U.S. GAAP.
IFRS 19 does not include any provision for the recognition
of an additional minimum liability.
IFRS 19 does not allow the recognition of a net pension asset
unless the amount is less than the discounted present value of
any employee refunds to the company plus any anticipated
reductions in future pension contributions.
UK’s FRS 17 – Pension gains and losses are
recognized immediately
chapter 17
The End
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