1. 17-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University Employee Compensation— Payroll, Pensions, and Other Compensation Issues

2. 17-2 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: (continues)

3. 17-3 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)

4. 17-4 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.

5. 17-5 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. Federal Hospital Insurance

6. 17-6 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)

7. 17-7 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.

8. 17-8 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.

9. 17-9 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)

10. 17-10 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.

11. 17-11 Salaries Expense16,000 FICA Taxes Payable 1,224 Employees Income Taxes Payable 1,600 Cash13,176 To record payment of payroll and related employee withholdings. 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: Accounting for Payroll Taxes (continues)

12. 17-12 Accounting for Payroll Taxes Payroll Tax Expense2,216 FICA Taxes Payable 1,224 State Unemployment Taxes Payable 864 Federal Unemployment Taxes Payable128 To record payment of payroll and related employee withholdings. The employer’s payroll tax entry is as follows: $16,000 ×.0765 $16,000 × 0.054.008 (0.062 – 0.054) × $16,000

13. 17-13 Accounting for Payroll Taxes Payroll Tax Expense583 FICA Taxes Payable459 State Unemployment Taxes Payable 108 FUTA Payable 16 To accrue the payroll tax liability of the employer. 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: 0.0765 × $6,000 0.054 × $2,000 0.008 × $2,000

14. 17-14 Compensated Absences Vacations Holidays Illnesses Other personal activities Compensated absences include payments by employers for: (continues)

15. 17-15 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)

16. 17-16 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. Compensated Absences

17. 17-17 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. Compensated Absences (continues)

18. 17-18 Wages Expense 7,000 Vacation Wages Payable7,000 To record accrued vacation wages ($700 × 10 weeks ). Wages Expense 1,000 Vacation Wages Payable 7,000 Cash8,000 To record payment at current rates of previously earned vacation time ($800 × 10 weeks). Journal Entry for December 31, 2010 Journal Entry for December 31, 2011 Compensated Absences

19. 17-19 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)

20. 17-20 B = 0.10($100,000 – B) B = $10,000 – 0.10B B + 0.10B = $10,000 1.10B = $10,000 B = $9,091 (rounded) Stock-Based Compensation and Bonuses 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

21. 17-21 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

22. 17-22 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)

23. 17-23 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

24. 17-24 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.

25. 17-25 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.

26. 17-26 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.

27. 17-27 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.

28. 17-28 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

29. 17-29 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)

30. 17-30 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)

31. 17-31 Step 1: Estimate Pension Obligation (2% × 10 years) × $40,000 = $8,000 (continues) The annual amount that Bach should receive on her retirement Estimation of Pension Obligation

32. 17-32 Accumulated Benefit Obligation (ABO) X X X X X $8,000 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 (continues) Estimation of Pension Obligation

33. 17-33 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, I = 5% The PBO is $12,176, which is the PV of the 10 future annual payments of $34,575. Estimation of Pension Obligation (continues)

34. 17-34 Pension-Related Liability PBO, January 1, 2011$12,176 Pension fund at fair value, January 1, 2011 (10,000) Pension-related liability, January 1, 2011$ 2,176 In Statement No. 87, the FASB stipulates that these two items be offset against one another and a single amount be shown. Estimation of Pension Obligation (continues)

35. 17-35 PBO, Beginning ofDiscountInterest Period×Rate=Cost $12,176×0.10=$1,218 Computation of Pension Expense for 2011: Interest Cost (rounded) (continues) Estimation of Pension Obligation

36. 17-36 (continues) 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. Computation of Pension Expense for 2011: Service Cost Estimation of Pension Obligation

37. 17-37 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) Estimation of Pension Obligation

38. 17-38 Projected Benefit Obligation, End of Year Service cost and interest cost PBO, beginning of year +– Retirement benefits paid ± Change in actuarial assumptions (continues) Estimation of Pension Obligation

39. 17-39 Fair Value of Pension Fund, End of Year Employer contribu- tions Fair value of pension fund, 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) Estimation of Pension Obligation

40. 17-40 Pension-Related Asset/Liability1,500 Cash1,500 To record 2011 contribution to pension plan. Thakkar would make the following journal entries for 2011: Prepaid Expense1,357 Pension-Related Asset/Liability1,357 To record 2011 pension expense. Service cost ($1,339) + Interest cost ($1,218) – Expected return ($1,200) New contributions to pension fund Estimation of Pension Obligation

41. 17-41 Thornton Electronics—2011 Thornton’s pension-related balances as of January 1, 2011, are as follows:

42. 17-42 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.

43. 17-43 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 Income75,000 Projected Benefit Obligation75,000 To record January 1, 2011, prior service cost arising from plan amendment.

44. 17-44 The Basic Spreadsheet Financial Statement Accounts Detailed Accounts Cash PBO 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 Prior Service Cost Pension Related Asset/ (Liability) Net Pension Expense Accumulated Other Comprehen. Income Fair Value of Pension Fund Periodic Pension Expense Items The work sheet is divided into two sections : The work sheet is divided into two sections: the Financial Statement Accounts section The work sheet is divided into two sections: the Financial Statement Accounts section and the Detailed Accounts section.

45. 17-45 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 rate11.0% Long-term expected rate of return10.0% (continues)

46. 17-46 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)

47. 17-47 (continues)

48. 17-48 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)

49. 17-49 (continues)

50. 17-50 Actual Return on the Pension Fund Fair value of pension fund, 12/31/11 $1,513,500 Fair value of pension fund, 1/1/11 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 (continues) The actual return of $138,500 is shown in entry (c) as in Slide 17-51.

51. 17-51 (continues)

52. 17-52 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)

53. 17-53

54. 17-54 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)

55. 17-55 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) 2 × 15 = 825 15 employees for 10 years 150 825 × $75,000 Amortization of Prior Service Cost = $13,636 (amortization for 2011) (continues)

56. 17-56

57. 17-57 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 17- 58. (continues)

58. 17-58

59. 17-59 Summary Journal Entries Pension Expense115,136 Pension-Related Asset/Liability101,500 Accumulated Other Comprehensive Income13,636 (continues) Summary journal entry to recognize pension expense for 2011.

60. 17-60 Summary Journal Entries Pension-Related Asset/Liability115,000 Cash115,000 Summary journal entry to record pension fund contribution.

61. 17-61 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 rate11.0% Long-term expected rate of return on pension fund 10.0% (continues)

62. 17-62 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 rate11.0% Long-term expected rate of return10.0% Accumulated benefit obligation, December 31, 2013$1,795,150 (continues)

63. 17-63 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.

64. 17-64 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.

65. 17-65 Disclosure of Pension Plans 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 FASB Statement No. 132 requires the following major disclosure requirements for most publicly traded companies: (continues)

66. 17-66 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) Disclosure of Pension Plans

67. 17-67 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) Disclosure of Pension Plans

68. 17-68 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 Disclosure of Pension Plans 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

69. 17-69 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)

70. 17-70 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.

71. 17-71 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.