Chapter 8: Payroll Accounting: Employee Earnings and Deductions Lecture Notes I. Employees and Independent Contractors A. Distinction 1. Employees a) Works under the control and direction of an employer. b) Employers must deduct certain taxes, maintain payroll records, and file numerous reports for all employees. 2. Independent contractors a) Perform services for a fee. b) Do not work under the control and direction of the company paying for the service. c) Only one form (Form 1099) must be filed for independent contractors. d) Also note, no payroll deductions are taken out for independent contractors. Those taxes remain the sold responsibility of the independent contractor. II. Employee Earnings and Deductions A. Three steps in determining an employee s pay: 1. Calculate total earnings. 2. Determine the amounts of deductions. 3. Subtract deductions from total earnings to compute net B. Salaries and Wages 1. Salaries a) Is compensation for managerial or administrative services. b) Normally is paid in biweekly, monthly, or annual terms. There are 52 weeks in each year but not 4 weeks in each month. That is why salaries must be annualized before determining the hourly rate. 2. Wages a) Is compensation for skilled or unskilled labor. b) Paid in terms of hours, weeks, or units produced. 3. Fair Labor Standards Act (FLSA) a) Established the 40-hour work week. b) Requires employers to pay overtime at 1½ times the regular rate to any hourly employee who works over 40 hours in a week. c) Some companies pay a higher rate for hours worked on Saturday or Sunday, but this is not required by the FLSA. d) Discuss holiday pay and how some companies distribute holiday e) Some salaried employees are exempt from the FLSA rules and are not paid overtime. These rules are typical in public accounting. C. Computing Total Earnings 1. Usually is based upon the time worked in a payroll period, sales, or units of output during the period. 2. Time cards are kept to compute employee wages. 3. Computation of total earnings for an hourly worker: a) Multiply the hourly rate by hours worked up to 40. Page 1 of 5
b) Over 40 hours, multiply the hourly rate by 1.5 by hours worked over 40. c) If the employer pays double time, multiply the qualifying hours by twice the hourly rate. d) Add the results from the different rates to obtain gross 4. Salaries are usually the same from one payment period to another. a) If overtime is paid, the hourly rate must be determined. (1) Find the total annual salary. (2) Divide the annual salary by 52 weeks. (3) Divide the answer in step 2 by 40 hours. (4) Multiply the answer in step 3 by 1.5 the result is the overtime rate. D. Deductions from Total Earnings 1. An employee s total earnings are called gross 2. Various deductions are made from gross pay to yield take-home or net a) Federal (and possibly state and city, and/or other local government) income tax withholding b) Employee FICA tax withholding c) Voluntary deductions 3. Income Tax Withholding a) Four factors determine the amount withheld. (1) Total earnings (2) Marital status (3) Number of withholding allowances claimed (a) Form W-4 declares the marital status and number of allowances claimed. (4) Length of the pay period b) A withholding allowance exempts a specific dollar amount of an employee s gross pay from federal income tax withholding. c) Employers generally use the wage-bracket method to determine the amount of tax to be withheld from an employee s d) Wage-bracket tables are provided by the IRS in Circular E Employer s Tax Guide. (1) Find the row where wages fall between at least and less than. (2) Find the column where the number of allowances is stated. (3) Where the row and column cross is the amount to be withheld. e) For state or city income taxes, withholding generally is handled in one of two ways: (1) Form and tables similar to those provided by the IRS are used. (2) An amount equal to a percentage of the federal withholding amount is withheld. 4. Employee FICA Tax Withholding a) Social Security taxes provide pension and disability benefits. (1) The current rate is 6.2% on maximum earnings of $94,200. b) Medicare taxes provide health insurance. c) (1) The current rate is 1.45% on all earnings; there is no maximum. Page 2 of 5
III. IV. 5. Voluntary deductions can be withheld from the employee s pay at the discretion of the employee. a) U.S. savings bond purchases b) Health insurance premiums c) Credit union deposits d) Pension plan payments e) Charitable contributions f) Union dues E. Computing Net Pay 1. To compute an employee s net pay for the period, subtract all tax withholdings and voluntary deductions from the gross Payroll Records A. Payroll records should provide the following information for each employee: 1. Name, address, occupation, social security number, marital status, and number of withholding allowances 2. Gross amount of earnings, date of payment, and period covered by each payroll 3. Gross amount of earnings accumulated for the year 4. Amount of taxes and other items withheld B. Payroll Records 1. The payroll register 2. The payroll check with earning statement attached 3. The employee earnings record C. Payroll Register 1. Is a form used to compute the data required at the end of each payroll period. 2. Detailed information on earnings, cumulative or year-to-date total earnings, taxable earnings, deductions, and net pay is provided for each employee. 3. Column headings for deductions may vary, depending on which deductions are commonly used by a particular business. 4. Information is taken from time cards and pay rates. 5. After the data for each employee have been entered, the amount columns in the payroll register should be totaled and the totals verified. D. Payroll Check 1. Methods of payment a) Cash b) Check, sometimes with a detachable earnings statement (pay stub) c) Direct deposit 2. Payment by check or direct deposit provides better internal accounting control than payment by cash. E. Employee Earnings Record 1. Separate records are kept for each employee. 2. Information is obtained from the payroll register. Accounting for Employee Earnings and Deductions A. Journalizing Payroll Transactions 1. Totals from the payroll register provide the data for journalizing the employee s payroll information. 2. Wages and Salaries Expense is debited for the gross Page 3 of 5
3. Deductions from wages (which are liabilities) are credited along with cash (which is net pay). 4. A separate account is kept for each earnings deduction. B. Wages and Salaries Expense 1. This account is debited for the gross pay of all employees for each pay period. 2. Separate expense accounts may be kept for the employees of different departments. C. Employee Income Tax Payable 1. This account is credited for the total federal income tax withheld from employees earnings. 2. The account is debited for amounts paid to the IRS. 3. A state or city income tax payable account is used in a similar manner. You may notice that Federal Income Tax from the payroll register becomes Employee Income Tax Payable in the journal entry. This account title is needed to distinguish this income tax from the federal income tax imposed on a business as a corporation. D. Social Security and Medicare Taxes Payable 1. These accounts are credited for the Social Security and Medicare taxes withheld from employees earnings and the Social Security and Medicare taxes imposed on the employer. 2. The accounts are debited for amounts paid to the IRS. E. Other Deductions 1. Voluntary deductions are credited when deducted from the employee s 2. When amounts are paid, accounts are debited. 3. Health Insurance Premiums Payable and United Way Contributions Payable are two common deductions. V. Payroll Record-Keeping Methods A. Manual System 1. All records are prepared by hand. 2. Information is recorded in several places. a) Payroll register b) Paycheck and stub c) Employees earnings record 3. If an employer has many employees, this system can be inefficient and costly. B. Payroll processing center 1. Is a business that sells payroll record-keeping services, leaving payroll in the hands of an outside vendor. 2. The employer provides the center with all basic employee data and each period s report of hours worked. 3. The processing center maintains all payroll records and prepares each period s payroll checks. 4. Fees can be cost efficient. Processing center fees tend to be much less than the cost to an employer of handling payroll internally. C. Electronic system 1. Is a computer system based on a software package that performs all payroll record keeping and prepares payroll checks. Page 4 of 5
2. Only the employee number and hours worked need to be entered into the computer each pay period. 3. The computer uses the employee number and hours worked to determine the gross pay, deductions, and net 4. Outputs a) Payroll register b) Checks c) Employees earnings record Page 5 of 5