COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Employee Compensation - Payroll, Pensions, and other Issues Chapter 17 S t I c e | S t I c e | S k o u s e n Intermediate Accounting 16E Prepared by: Sarita Sheth | Santa Monica College

Learning Objectives 1.Account for payroll and payroll taxes, and understand the criteria for recognizing a liability associated with compensated absences. 2.Compute performance bonuses, and recognize the issues associated with postemployment benefits. 3.Understand the nature and characteristics of employer pension plans, including a detailed discussion of defined benefit plans.

Learning Objectives 4.Use the components of prepaid/accrued pension costs and changes in the components to compute the periodic expense associated with pensions. 5.Prepare required disclosures associated with pensions, and understand the accounting treatment for pension settlements and curtailments. 6.Describe the few remaining differences between U.S. pension accounting standards and the provisions of IAS Explain the differences in accounting for pensions and postretirement benefits other than pensions.

Payroll and Payroll Taxes 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) Social security and income tax legislation impose five taxes based on payrolls: 4.State unemployment insurance (tax to employer only) 5.Individual income tax (tax to employee only but withheld and paid by employer)

FICA Federal Insurance Contributions Act (FICA) – both the employers and employees are required to provide funds. Employer is required to withhold FICA taxes from each employee’s wages. In 2005, annual wages up to $90,000 were subject to 6.20% of FICA tax.

FICA FICA also includes Medicare tax for federal hospital insurance. This tax is separate from the previously discussed slide. The tax is applied to all wages earned and there is no upper limit. For 2005, the rate was 1.45% for both employer and employee.

FUTA Federal Social Security Act and the Federal Unemployment Tax Act (FUTA) established unemployment insurance plans. Employers are taxed quarterly; no tax levied on employees. Tax rate since on the first $7,000 of wages earned is 6.2%. Employer can apply for a credit limited to 5.4% for taxes paid on state unemployment tax.

State Unemployment Insurance State unemployment tax laws (SUTA) differ across states. Most states only tax employers, but some both. As a result of the credit applied for federal taxes the amount of tax taking state rates into account does not exceed 0.8%.

Accounting for Payroll Taxes 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.

Accounting for Payroll Taxes Salaries Expense16,000 FICA Taxes Payable 1,224 Employees Income Taxes Payable 1,600 Cash13,176 Assume salaries for Jan are $16,000. SUTA is 5.4%. Withholdings are $1,600 and FICA is 7.65%. The employer records for payroll and payroll taxes: To record payment of payroll and related employee withholdings.

Accounting for Payroll Taxes Payroll taxes are: An expense to the employer. A liability to the employer until they are paid. Payroll taxes are: An expense to the employer. A liability to the employer until they are paid.

Accounting for Payroll Taxes Payroll Tax Expense 2,216 FICA Taxes Payable 1,224 State Unemployment Taxes Payable 864 FUTA Payable 128 Assume salaries for Jan are $16,000. SUTA is 5.4%. Withholdings are $1,600 and FICA is 7.65%. Employer’s make this entry to record THEIR portion of FICA and other payroll taxes: To record payroll tax liability to the employer x $16, x $16, x $16,000

Compensated Absences Compensated absences are payments by employers for: Vacations, Holidays, Sick days Other personal days Compensated absences are payments by employers for: Vacations, Holidays, Sick days Other personal days

Compensated Absences At the end of the period, the firm has a liability for the earned by unused compensated absences. They must match the estimated amount of liability to current revenue. The tricky part comes when estimating how much should be accrued. FASB 43 provides guidance on this issue.

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 3.Are estimable and probable

Compensated Absences S&N Corporation has 20 employees who are paid an average of $700 per week. During 2007, a total of 40 vacation weeks was earned by all employees, but only 30 weeks of vacation were taken. They took the remaining 10 weeks of vacation in 2008 when the average rate of pay was $800 per week.

Compensated Absences Wages Expense 7,000 Vacation Wages Payable7,000 To record accrued vacation wages ($700 x10 weeks). Wages Expense 1,000 Vacation Wages Payable 7,000 Cash8,000 To record payment at current rates of previously earned vacation time ($800 x 10 weeks). Journal entry for 2007 Journal entry for 2008

Stock-Based Compensation 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. Bonus calculation: B = 0.10($100,000 – B) B = $10,000 – 0.10B B B = $10, B = $10,000 B = $9,091 (rounded)

Postemployment Benefits 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: –Severance –Benefits, –Disability related benefits, –Job training and counseling

Accounting for Pensions There are three main categories for pensions: 1.Government plans, primarily Social Security 2.Individual plans, such as individual retirement accounts (IRAs) 3.Employer plans

Nature and Characteristics of Employer Pension Plans Noncontributory - funded entirely by the employer Contributory - employee also contributes to the cost of the plan Defined Contribution -employer pays a periodic contribution which is administered by an independent third party. Defined Benefit- employee is guaranteed a specified retirement income. Vested Benefits- occurs when an employee has met certain requirements and is eligible to receive pension benefits at retirement.

Defined Benefit Plans Employer Current Employees Services Wages and Salaries Pension Fund Contributions Retired Employees Defined Benefits

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.

Corridor Amortization Corridor amount- the accumulated unrecognized pension gain/loss from prior years that is more than an amount defined by the FASB. Amortization is required only on a portion of the 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.

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.

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. 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 =

Deferred Pension Cost An employer may be required to record an additional pension liability if they are 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.

Deferred Pension Cost Accumulated benefit obligation$1,250,000 Fair value of the pension fund1,140,000 Accrued pension cost16,000 Unrecognized prior service cost80,000 Clapton Corporation computes the following balances as of December 31, 2008: 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 Liability94,000 To recognize additional pension liability. Deferred Pension Cost 80,000 Excess of Additional Pension Liability over Unrecognized Prior Service Cost 14,000 Additional Pension Liability94,000 To recognize additional pension liability.

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

Disclosure of Pension Plans 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 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

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 description of the investment strategy 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.Certain information about postretirement benefits

Settlements and Curtailments Settlement occurs when an employer takes an irrevocable action that relieves the employer of primary responsibility for all or part of the obligation. Curtailment 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

International Pension Accounting Standards 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.

Postretirement Benefits other than Pensions For some firms, other postretirement benefits like healthcare for retirees represent a bigger economic obligation than pension obligations. Accounting is similar to the accounting for a defined benefit pension plan. Some differences include: 1.Often not a function of salary level. 2.They may not be funded. 3.There is no minimum liability provision.