Employee Compensation

Lecture 7
Completing the Operating Cycle
Reading: Chapter 8
(Albrecht, Stice, Stice, Skousen, Accounting Concepts and Applications, 10th edition, 2008 Southwestern)
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Payroll
Recognize the expense. FICA taxes and Federal income withholdings.
Withholding these taxes for the government. They should not be recognized as an expense of the company.

Employer payroll taxes

Employers portion of FICA taxes. Federal and state unemployment taxes. Added to taxes payable to the government.
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Payroll Journal Entries

Salaries Expense. . . . . . . . . . . . . . . . . . . . . . FICA Taxes Payable, Employee. . . . . . . Federal Withholding Taxes Payable . . . State Withholding Taxes Payable . . . . . Salaries Payable . . . . . . . . . . . . . . . . . . . To record employees salary. 2,700 180 486 243 1723

Other Employee Compensation

Bonuses
Recorded just like payroll. Many times they are earnings based.
Good incentive for management improvement but can also provide incentives to manipulate earnings.

Payroll Tax Expense. . . . . . . . . . . . . . . . . . . 278 FICA Taxes Payable, Employer . . . . . . . 180 Federal Unemployment Taxes Payable. 30 State Unemployment Taxes Payable. . . 68 To record liabilities associated with employees salary.

Compensated absences
Recognized as the employee earns the right to these absences.
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Other Employee Compensation

Stock options
Fair value of the options are recognized over the period the options are earned.

Other Compensation Journal Entries

Salaries Expense . . . . . . . . . . . . . . . . . . . . . . Sick Days Payable. . . . . . . . . . . . . . . . . . . To recognize accrued sick pay. 125 125

Postemployment benefits
Severance or other benefits. Estimated and accrued in the period the employees are terminated.

Sick Days Payable . . . . . . . . . . . . . . . . . . . . . 125 Various Taxes Payables. . . . . . . . . . . . . . 35 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 To record payment of sick day net of FICA, federal, and state taxes. Salaries Expense . . . . . . . . . . . . . . . . . . . . . . 150,000 Various Taxes Payables. . . . . . . . . . . . . . 60,000 Bonus Payable . . . . . . . . . . . . . . . . . . . . . 90,000 To record bonus earned by employees.
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Pensions
Defined contribution plan
Employer contributes specific amount every year to be paid to employee after retirement. Employee receives what was contributed plus the earnings. The employee bears the risk of poor returns.

Pensions
Pension fund
Money set aside to fulfill pension obligation.

Pension benefit obligation

Estimated liability of retirement payments.

Pension-related interest cost

The increase in the pension obligation resulting from interest on the unpaid obligation.

Defined benefit plan

Employee receives amount defined in the plan. Usually based on the number of years worked. Company sets aside money to cover the obligation, but the risk of poor returns remains with the company.
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Service Cost
The increase in the pension obligation resulting from an employee working another year.

Return on pension fund assets

The return the company earns on its pension fund.
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Pensions
Pension Benefit Obligation Pension Fund Assets = Net Pension Liability Interest Cost + Service Cost Expected Return on Fund Assets = Pension Expense
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Sales Taxes
Paid by customer, but collected by the company for the government.
Example: Bondss Barbeque sold a 100 sandwiches for $340. What is the journal entry assuming the state charges a 5 percent sales tax? Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales Revenue. . . . . . . . . . . . . . . . . . Sales Tax Payable. . . . . . . . . . . . . . . 357 340 17
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From sale of sandwiches, including 5% sales tax.

Property Taxes
Assessed by county. Usually paid for a year in advance.
Example: The City of Riverton assesses property taxes on land and buildings. Bonds Barbeque pays its property taxes on a calendar-year basis and paid Riverton $6,200 last year for the current year. Make Bonds appropriate journal entry. 12/31 Property Tax Expense . . . . . . . . . 6,200 Prepaid Property Taxes. . . . . . 6,200 To record property tax expense by using up prepaid property taxes.

Income Taxes
Based off income. May be different from actual taxes paid.
Example: Bonds Barbeques pretax income is $385,000. Its income tax rate for the year for both federal and state is 30 percent. Prepare an adjusting entry at year-end showing the companys tax expense. 12/31 Income Tax Expense . . . . . . . . 115,500 Income Tax Payable. . . . . . . 115,500 To record income tax expense and tax liability on $385,000 pretax income for year using a 30 percent effective tax rate.

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Deferred Taxes
Occur because of timing differences in revenue and expense recognition according to GAAP rules versus IRS rules.
Example: Bonds Barbeques owes $80,000 in taxes on its income. It also has gains on a mutual fund that will not be taxed until the mutual fund is sold. These taxes will be $40,000. Prepare an entry showing the companys tax expense.

Contingencies
Contingent Liabilities
Depend on some future event to determine if a liability actually exists.

Environmental Liabilities
Liability definitely exists, but measurement is difficult. Minimum liability established. Extensive note disclosure.
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Income Tax Expense. . . . . . . . . Income Tax Payable. . . . . . . Deferred Tax Liability. . . . . .

120,000 80,000 40,000

To record income tax expense and deferred tax liability due to unrealized gains on mutual funds.

Accounting for Contingent Liabilities

Term
Probable

Capitalize vs. Expense

Research and Development
Expenditures should be expensed when incurred. Uncertainty of future benefits.

Definition
The future event is likely to occur.

Accounting
Estimate the amount of the contingency and make the appropriate journal entry; provide detailed disclosure in notes. Provide detailed disclosure of the possible liability in the notes. No disclosure required.
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Advertising
Expenditures should be expensed when incurred. Uncertainty of future benefits. Exception for targeted marketing to previous customers.
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Possible

The chance of the future event occurring is more than remote but less than likely. The chance of the future event occurring is slight.

Remote

Income Statement Revisited

Gross Margin
Net Sales minus Cost of Goods Sold.

Review the Income Statement Format

Revenues Cost of goods sold = Gross margin Selling expenses General and administrative expenses = Operating income +/ Other revenues and expenses = Income before taxes Income tax = Income after taxes +/ Extraordinary items = Net income

Other Revenues and Expenses

Items earned or incurred outside of, or peripheral to, the normal operations of a firm. (i.e. dividends received from investments)

Extraordinary Items
Nonoperating gains and losses
Unusual in nature. Infrequent in occurrence. Material in amount.

Reported net of taxes. (i.e. losses from floods, fires, earthquakes, etc.)

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Earnings Per Share

Net income divided by shares outstanding. Basic Earnings Per Share
Based on historical information.

Diluted Earnings Per Share

Considers the effect on net income and shares outstanding of stock transactions that might occur in the future.
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