17-1 intermediate accounting james d. stice earl k. stice © 2012 cengage learning powerpoint...

17-1

Intermediate Accounting

James D. Stice Earl K. Stice

© 2012 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Employee Compensation—Payroll, Pensions, and Other Compensation Issues

Chapter 17Chapter 17

18th Edition

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)

4. State unemployment insurance tax (tax to employer only)

Social security and income tax legislation impose five taxes based on payrolls:

(continued)

17-3

5. Individual income tax (tax to employee only but withheld and paid by employer)

Payroll and Payroll Taxes

17-4

Federal Old-Age, Survivors’, and Disability Tax

• 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 2010, annual wages up to $106,800 were subject to 6.20% for FICA tax.

17-5

• The Federal Insurance Contribution Act (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; there is no upper limit.

• The tax rate for 2010 was 1.45% for both employer and employee.

Federal Hospital Insurance

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.

(continued)

17-7

• 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.

• Payment to the federal government is required quarterly.

Federal Unemployment Insurance

17-8

State Unemployment Insurance

• State unemployment compensation laws (SUTA) are not the same in all states. In most states, laws call for tax only on employers, but a few states tax both employer and employee.

• Although the normal rate on employers may be 5.4%, states have merit rating or experience plans providing for lower rates based on employer’s individual employment experiences.

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.

• Most states and many local governments also impose income taxes on the earnings of employees that the employer must withhold and remit.

(continues)

17-10

• 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, the states, the territories, and their agencies, instrumentalities, and political subdivisions.

Income Tax

17-11

Salaries Expense 16,000 FICA Taxes Payable

1,224Employees Income Taxes Payable 1,600

Cash13,176

To record payment of payroll andrelated 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

(continued)

17-12

Payroll Tax Expense 2,216 FICA Taxes Payable 1,224 State Unemployment Taxes Payable 864 Federal Unemployment Taxes Payable 128

To record payment of payroll and relatedemployee withholdings.

The employer’s payroll tax entry is as follows:

$16,000 × .0765$16,000 × 0.054

.008 (0.062 – 0.054) × $16,000


(continued)

17-13

Payroll Tax Expense 583FICA Taxes Payable 459State Unemployment Taxes Payable 108FUTA Payable 16 To accrue the payroll tax liability of the employer.

The salaries and wages accrued 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 0.0765 ×× $6,000$6,000

0.0765 0.0765 ×× $6,000$6,0000.054 0.054 ×× $2,000$2,000

0.054 0.054 ×× $2,000$2,0000.008 0.008 ×× $2,000$2,000

0.008 0.008 ×× $2,000$2,000


17-14

Compensated Absences

Vacations Holidays Illnesses Other personal activities

• Compensated absences include payments by employers for:

(continued)

• The longer an employee works for a company, the longer the vacation allowed or the more liberal the time allowed for illnesses.

17-15

• 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.

(continued)


17-16

The FASB, in ASC paragraphs 710-10-25-1 through 3, 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.


17-17

Stock-Based Compensation and Bonuses

• In addition to stock options, employees often earn bonuses based on a company’s performance over a given period of time.

• This additional compensation should be recognized in the period in which it is earned.

(continued)

17-18


• 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.

(continued)

17-19

B = 0.10($100,000 – B)

B = $10,000 – 0.10B

B + 0.10B = $10,000

1.10B = $10,000

B = $9,091 (rounded)

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

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


17-20

Postemployment Benefits

• Because of downsizing, an employee cannot count on remaining with one employer for his or her entire career.

• Some employees change jobs to facilitate career advancement and to enhance their family’s quality of life.

• It is common for an employee to be terminated.

• Compensation issues following employment but preceding retirement have increased in magnitude.

(continued)

17-21


• Examples of the types of benefits granted to terminated employees include: Supplemental unemployment benefits Severance benefits Disability-related benefits Job training and counseling

• And, continuation of benefits such as: Health care benefits Life insurance coverage

17-22

Accounting for Pensions

Financing retirement years is accomplished by establishing some type of pension plan that sets aside funds during an employee’s working years so that at retirement the funds and earnings from investment of the funds may be returned to the employee in lieu of earned wages.

(continued)

17-23


In the United States, three major categories of pension plans have emerged:1. Government plans, primarily Social

Security2. Individual plans, such as individual

retirement accounts (IRAs)3. Employer plans

(continued)

17-24

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


17-25

Funding of Employer Pension Plans

• ERISA requires companies to fund their pension plans in an orderly manner so that the employee is protected at retirement.

• 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.

(continued)

17-26

Funding of Employer Pension Plans

There are two basic classifications of pension plans:1) defined contribution plan

2) defined benefit plan

17-27

• Defined contribution pension plans are relatively simple in their construction and raise very few accounting issues for employers.

• The employer pays a periodic contribution amount into a separate trust fund, which is administered by an independent third-party trustee.

Defined Contribution Pension Plans

(continued)

17-28

• When an employee retires, the accumulated value in the fund is used to determine the pension payout to the employee.

• The employee’s retirement income therefore depends on how the fund has been managed. In effect, the investment risk is borne by the employee.

Defined Contribution Pension Plans

17-29

• Defined benefit pension plans are much more complex than defined contribution plans.

• Under defined benefit 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.

• Because the benefits are defined, the funding must vary as conditions change.

Defined Benefit Pension Plans

(continued)

17-30

Defined Benefit Pension Plans

A pension fund may be viewed essentially as funds set aside to meet the employer’s future pension obligation just as funds may be set aside for other purposes.

17-31

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.

17-32

Funding of Defined Benefit Plans

• The periodic amounts to be contributed to a defined benefit plan by the employer are directly related to the future benefits expected to be paid to current employees.

• All funding methods are based on present values. The additional future benefits earned by employees each year must be discounted to their present value, referred to as the actuarial present value, using the assumed rate of return on pension plan investments.

17-33

Issues in Accounting for Defined Benefit Plans

A list of issues relating to accounting and reporting by employers 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

17-34

Simple Illustration of Pension Accounting

• Lorien Bach is 35 years old.

• She has worked for Thakkar for 10 years.

• Her salary for 2012 was $40,000.

• Pension payments begin after the employee turns 65; payments made at the end of the year.

• 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.

(continued)

17-35

• In valuing pension fund liabilities, Thakkar uses a discount rate of 10%.

• As of January 1, 2013, Thakkar had a pension fund containing $10,000.

• During 2013, 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)

Simple Illustration of Pension Accounting

17-36

Estimate Pension ObligationEstimate Pension Obligation

(2% × 10 years) × $40,000 = $8,000

(continued)

The annual amount that Bach should receive on her retirement at age 65.

Estimation of Pension Obligation

17-37

Accumulated Benefit Obligation (ABO)Accumulated Benefit Obligation (ABO)Accumulated Benefit Obligation (ABO)Accumulated Benefit Obligation (ABO)

X X X X X X X X X X

$8,0

00

$8,0

00

$8,0

00

$8,0

00

$8,0

00

$8,0

00$8

,000

$8,0

00

$8,0

00

$8,0

00

Accumulated benefit obligation (ABO)

PV of an annuity of $8,000 per year for ten

years deferred for 30 years is

$2,817

30 years30 years

(continued)


17-38


• The accumulated benefit obligation (ABO) is the actuarial present value of expected future pension payments, using the current salary as the basis for forecasting the amount of the pension benefit payments.

• The alternative measure of the pension obligation that does not consider the impact of future salary increases is called the projected benefit obligation (PBO).

(continued)

17-39

Projected Benefit Obligation (PBO)Projected Benefit Obligation (PBO)Projected Benefit Obligation (PBO)Projected Benefit Obligation (PBO)

Thakkar Company expects Bach’s 2012 salary of $40,000 to increase 5% every year until retirement. Bach’s salary is expected to increase to $172,877 by the year 2043. The pension benefit payment based on this salary is as follows:

(2% × 10 years) × $172,877 = $34,575 (rounded)

PV = $40,000, N = 30, I = 5%

(continued)


17-40


• The PBO at January 1, 2013, is $12,176. This is the present value of the 10 future annual payments of $34,575 that Bach is expected to received.

(continued)

17-41

Pension-Related LiabilityPension-Related LiabilityPension-Related LiabilityPension-Related Liability

PBO, January 1, 2013 $12,176Pension fund at fair value, January 1, 2013 (10,000) Pension-related liability, January 1, 2013 $ 2,176

FASB ASC paragraph 715 stipulates that these two items be offset against one another and a single amount be shown.


If the fair value of the pension fund If the fair value of the pension fund had exceeded the projected benefit had exceeded the projected benefit obligation, the resulting net asset obligation, the resulting net asset

would have been labeled would have been labeled Pension-Related Asset.Pension-Related Asset.

If the fair value of the pension fund If the fair value of the pension fund had exceeded the projected benefit had exceeded the projected benefit obligation, the resulting net asset obligation, the resulting net asset

would have been labeled would have been labeled Pension-Related Asset.Pension-Related Asset.

17-42

PBO,Beginning of Discount Interest

Period × Rate = Cost$12,176 × 0.10 = $1,218

Interest CostInterest CostInterest CostInterest Cost

(rounded)

(continued)

Computation of Pension Expense for 2013

obligation discount rate

17-43(continued)

Bach’s work for Thakkar Company during the year results in an increase in forecasted annual pension benefit payments from Thakkar to Bach. The impact of this extra year of service is to increase the December 31, 2013, 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.

Service CostService CostService CostService Cost


17-44

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 2013. Thakkar’s net pension expense is reduce by $1,200 ($10,000 x 0.12).

(continued)

Return on the Pension FundReturn on the Pension FundReturn on the Pension FundReturn on the Pension Fund


17-45


In addition to these changes in the PBO and the pension fund, two additional events are common when dealing with pension plans:1. Contributions to the plan

2. Benefits paid from the plan

(continued)

17-46

Projected Benefit Obligation, End of YearProjected Benefit Obligation, End of YearProjected Benefit Obligation, End of YearProjected Benefit Obligation, End of Year

Service cost and interest

cost

PBO, beginning

of year+ –

Retirement benefits

paid±

Change in actuarial

assumptions

(continued)


17-47


The fair value of the pension fund is based on its market value at a given measurement date.

Fair Value of Pension Fund, End of YearFair Value of Pension Fund, End of YearFair Value of Pension Fund, End of YearFair 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

(continued)

17-48

Pension-Related Asset/Liability 1,500Cash 1,500 To record 2013 contribution to pension

plan.

Thakkar would make the following journal entries for 2013:

Prepaid Expense 1,357Pension-Related Asset/Liability 1,357

To record 2013 pension expense.

Service cost ($1,339) + Interest cost ($1,218) – Expected return ($1,200)

New contributions to pension fund

Basic Pension Journal Entries

17-49

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.

(continued)

17-50

Prior Service Cost

• The amount of prior service cost is determined by actuaries and represents the increase in the PBO arising from the adoption or amendment of the plan.

• The accounting profession has been in general agreement that prior service cost should not be recognized as part of expense at the plan’s adoption or amendment date but should be amortized over future periods.

17-51

IAS 19

According to paragraph 96 of IAS 19, past service cost (equivalent to prior service cost) is recognized as an expense over the period when the retroactive benefits vest.

If the retroactive benefits vest immediately, then under IAS 19 the entire amount of past service cost is expensed immediately.

17-52

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

PriorService

Cost

Pension Related Asset/

(Liability)

Net Pension

Expense

Accumulated Other

Comprehen. Income

Fair Value ofPension

Fund

Periodic Pension Expense

Items

The work sheet is divided into two sections: the Financial Statement Accounts section and the Detailed Accounts section.

17-53

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.

• The FASB states that prior service cost should be amortized by “assigning an equal amount to each future period of service of each employee active at the date of the amendment who is expected to receive benefits under the plan.” The future period of service is referred to as the expected service period.

17-54

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.

17-55

Deferral of Gains and Losses

• Because pension costs include many assumptions and estimates, frequent adjustments must be made for variations between the actual results and the estimates or projections that were used in determining net periodic pension expense for the previous period.

• Such differences between expected results and actual experience give rise to a deferred pension gain or loss.

17-56

Deferral of Current-Year Difference between Actual and Expected Return on Pension Fund

• In estimating the return on the pension fund, the expected long-term rate of return on assets should be used rather than a more volatile short-term rate.

• In the short run, the actual return on the pension fund usually will differ from the expected return.

17-57

Differences in Actuarial Estimates of PBO

• The actuarial computation of the projected benefit obligation involves many estimates: Future interest rates Life expectancy rates Future salary rates

• The deferred loss arising from the adjustment to the PBO becomes part of the deferred net pension gain or loss for possible future amortization.

17-58

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.

(continued)

17-59

The FASB indicated that any systematic method of amortizing the deferred net gain or loss that equaled or exceeded the straight –line amortization over the remaining expected service years of the employees would be acceptable as long as the procedure is applied consistently to both gains and losses.

Amortization of Deferred Net Pension Gain or Loss from Prior Years

17-60

Revolutionary IASB Exposure Draft

Key elements of the exposure draft are as follows:• Balance sheet reporting of the net pension

liability/asset with adjustments.

• Use of actual return on the pension fund rather than expected return.

• No accumulated other comprehensive income

• Decomposition of the pension expense components.

17-61

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

The major disclosure requirements in FASB ASC Topic 715 for most publicly traded companies are as follows:

(continued)

17-62

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

(continued)


17-63

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

(continued)


17-64

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. 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


17-65

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.

• A curtailment of a pension plan arises from an event that significantly reduces the benefits that will be provided for present employees’ future services. Curtailments include: Termination of an employee earlier than expected Termination or suspension of a pension plan

17-66

FASB ASC paragraph 715-30-35-39 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.

Settlements

17-67

Informal Rather than Formal Plans

• Many company postretirement benefit plans are not written into formal contracts.

• Companies often begin paying for postretirement health care benefits as a continuation of health care coverage for active employees.

17-68

Pay-as-You-Go Accounting Rather than Accrual Accounting

• Because postretirement benefit plans are usually not funded, almost all companies previously charges these costs against revenue in the period the benefit costs were incurred rather than when the employee service was rendered.

• This policy results in uneven charges against revenue and does not recognize a liability for unfunded postretirement benefits.

17-69

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.

17-70

Chapter 17Chapter 17

The EndThe EndThe EndThe End

$

₵

17-1 intermediate accounting james d. stice earl k. stice © 2012 cengage learning powerpoint...

Documents

federal tax

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individual income tax

disability tax

tax rate

federal hospital insurance

medicare tax

state unemployment tax