Employee Compensation Payroll Pensions and Other Compensation Issues

Employee Compensation: Payroll, Pensions, and Other Compensation Issues

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

Learning Objectives Use the components of prepaid/accrued pension costs and changes in the components to compute the periodic expense associated with pensions. Prepare required disclosures associated with pensions, and understand the accounting treatment for pension settlements and curtailments.

Learning Objectives Describe the few remaining differences between U. S. pension accounting standards and the provisions of IAS 19. EXPANDED MATERIAL Explain the differences in accounting for pensions and postretirement benefits other than pensions, and be able to account for postretirement benefits other than pensions. 4

Employee Compensation Event Line Payroll Compensated Absences Ti Stock Options and Bonuses m e Postemployment Benefits Pensions and Postretirement Benefits Other Than Pensions 5

Payroll and Payroll Taxes Social security and income tax legislation impose four taxes based on payrolls: Federal old-age, survivors’, disability, and hospital insurance (tax to both the employee and employer). Federal unemployment insurance (tax to employer only). State unemployment insurance (tax to employer only). Individual income tax (tax to employee only). 6

Salary Expenses and Liabilities Æ The employee’s gross earnings are an expense to the employer. Æ Withholdings are an expense to the employee, not to the employer. Æ Withholdings become a liability to the employer only because the employer keeps money earned by employees and pays obligations on their behalf. 7

Accounting for a Payroll Employers make this entry to record expense for salaries paid to employees: Salaries Expense 2, 000 FICA Taxes Payable 133 Employees Income Taxes Payable 540 Cash 1, 327 To record payment of payroll and related employee withholdings.

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

Accounting for a Payroll Employers make this entry to record their portion of FICA and other payroll taxes: Payroll Tax Expense 204 FICA Taxes Payable State Unemployment Taxes Payable Federal Unemployment Taxes Payable To record the payroll tax liability of the employer. 133 50 21

Compensated Absences Compensated absences include payments by employers for vacation, holiday, illness, or other personal activities. 11

Compensated Absences S&N Corporation has 20 employees who are paid an average of $350 per week. During 2001, a total of 40 vacation weeks was earned by all employees, but only 30 weeks of vacation were taken.

Compensated Absences The entry to record the accrued vacation on December 31, 2001, would be: Wages Expense 3, 500 Vacation Wages Payable To record accrued vacation wages ($350 x 10 weeks). 3, 500

Compensated Absences In 2002, when the additional vacation weeks are taken, the average rate has increased to $400 per week. Wages Expense 500 Vacation Wages Payable 3, 500 Cash 4, 000 To record payment at current rates of previously earned vacation time ($400 x 10 weeks).

Major Categories of Pension Plans £ Government plans, primarily social security £ Individual plans, such as individual retirement accounts (IRAs) £ Employer plans

Pension Fund Characteristics • • • Noncontributory Contributory Defined Contribution Defined Benefit Vested Benefits 16

Potential Measures of Pension Liability Benefits for vested and nonvested employees at future salaries Benefits for vested and nonvested employees at current salaries Accumulated Benefits for Benefit Vested vested Obligation Benefit employees Obligation at current salaries PV of Expected Cash Flows Projected Benefit Obligation (GAAP) 17

Defined Benefit Pension Plans Services Wages and Salaries Current Employees Defined Benefits Retired Employees Contributions Employer Pension Fund 18

Defined Benefit Pension Plans It says that vesting occurs when an employee has met certain specified requirements. . .

Defined Benefit Pension Plans …and is eligible to receive pension benefits at retirement even if the employee stops working for the employer.

Calculating Pension Costs A Spreadsheet Approach 2 21 1

The Basic Spreadsheet Formal Accounts Beginning Balances (a) Service Cost (b) Interest Cost (c) Actual Return on Assets (d) Benefits Paid (e) PSC Amortization (f) Transition Amortization (g) Deferred Gain (h) Amort. of Deferred Loss Summary Journal Entries (1) Annual Pension Cost Acc. (2) Annual Pension Contri. (3) Min. Liab. Adjustment Annual Pension Expense Cash Prepaid/ Accrued Pension Cost 22 Memorandum Accounts Periodic Pension Cost Items PBO Unamortized Unrecognized Fair Value Deferred Transition Prior Service of Plan Gain/Loss Cost Assets

Memorandum Accounts Projected Benefit Obligation Fair Value of Plan Assets Deferred Gain/Loss Unamortized Transition Gain/Loss 23 Unrecognized Prior Service Cost

Memorandum Accounts Projected Benefit Obligation Fair Value of Plan Assets Deferred Gain/Loss Unamortized Transition Gain/Loss 24 Unrecognized Prior Service Cost • Actuarial present value of pension benefits. • Uses the benefits per year of service approach. • Assumes future compensation levels. Retirement Change in PBO Service Interest = + + - Benefits ± Actuarial Cost Eo. Y Bo. Y Cost Paid Assumptions

Memorandum Accounts Projected Benefit Obligation Fair Value of Plan Assets Deferred Gain/Loss Unamortized Transition Gain/Loss 25 Unrecognized Prior Service Cost • Amount that could be received from the sale of plan assets in a current sale between a willing buyer and seller. • Increased by employer/employee contributions. • Decreased by benefits paid. Actual Benefits FVPA = Return + Contributions ± Paid Bo. Y Eo. Y on Assets

Memorandum Accounts Projected Benefit Obligation Fair Value of Plan Assets Deferred Gain/Loss Unamortized Transition Gain/Loss 26 Unrecognized Prior Service Cost • The difference between the actual and expected return. • The FASB decided to minimize the volatility of net periodic pension expense by allowing deferral of some gains and losses and amortization over future periods rather than requiring immediate recognition.

Memorandum Accounts Projected Benefit Obligation Fair Value of Plan Assets Deferred Gain/Loss Unamortized Transition Gain/Loss 27 Unrecognized Prior Service Cost • The difference between the PBO and the FVPA at the time FASB Statement No. 87 was adopted by a company. • If the PBO was the larger of the two values at the transition date, the difference was a loss.

Memorandum Accounts Projected Benefit Obligation Fair Value of Plan Assets Deferred Gain/Loss Unamortized Transition Gain/Loss 28 Unrecognized 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.

Corridor Amortization • Amortization is required only on portion of 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. 29

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.

Periodic Memorandum Entries ëService cost ëInterest cost ëActual return on plan assets ëBenefits paid ëPrior service cost amortization ëTransition amortization ëDeferred gain/loss ëAmortization of deferred gain/loss 31

Periodic Memorandum Entries Service Cost Periodic Pension Cost XXX Projected Benefit Obligation (XXX) Present value of additional benefits earned by employees during the year • Increases periodic pension cost (debit). • Increases PBO (credit). 32

Periodic Memorandum Entries Interest Cost Periodic Pension Cost Projected Benefit Obligation XXX (XXX) Calculated as settlement interest rate multiplied by beginning of year PBO-represents increase in PBO due to interest. • Increases periodic pension cost (debit). • Increases PBO (credit). 33

Periodic Memorandum Entries Periodic Pension Cost Fair Value of Plan Assets Actual Return on (XXX) XXX Plan Assets Measures actual earnings on pension assets. • Decreases periodic pension cost (credit). • Increases fair value of plan assets (debit). 34

Periodic Memorandum Entries Projected Benefit Obligation 35 Fair Value of Plan Assets (XXX) XXX Benefits Paid Records payments to pension beneficiaries. • Decreases PBO (debit). • Decreases fair value of plan assets (credit).

Periodic Memorandum Entries Periodic Pension Cost XXX Unrecognized Prior Service Costs (XXX) Prior Service Cost Amortization Records amortization of prior service costs. • Increases periodic pension cost (debit). • Decreases unrecognized prior service cost (credit). 36

Periodic Memorandum Entries Transition Amortization Periodic Pension Cost Unamortized Transition (Gain)/Loss (XXX) XXX (XXX) Records amortization of unrecognized transition gain or loss. • Impacts periodic pension cost and unamortized transition gain/loss. • Nature of debits and credits varies by gain or loss status. 37

Periodic Memorandum Entries Deferred Gain/ Loss Periodic Pension Cost Unrecognized Net Pension (Gain)/Loss XXX (XXX) Records deferral of net pension gain or loss. • Impacts periodic pension cost and unrecognized net pension gain/loss. • Nature of debits and credits varies by gain or loss status. 38

Periodic Memorandum Entries Periodic Pension Cost Amortization XXX of Deferred (XXX) (Gain)/Loss Records corridor amortization. Unrecognized Net Pension (Gain)/Loss (XXX) XXX 39

Formal Accounts Net Pension Expense Cash Prepaid/ Accrued Pension Cost Periodic Pension Cost Items • Records total pension costs accrued. • Debited for the sum of all periodic pension cost items. 40

Formal Accounts Net Pension Expense Cash Prepaid/ Accrued Pension Cost Periodic Pension Cost Items • Records cash expended for contributions to plan assets. • Debited for actual amount of cash contributed to pension fund. 41

Formal Accounts Net Pension Expense Cash Prepaid/ Accrued Pension Cost Periodic Pension Cost Items • Reflects changes in net pension asset or liability. • Debited for cash contributions to pension plan assets. • Credited for net pension cost. 42

Formal Accounts Net Pension Expense Cash Prepaid/ Accrued Pension Cost Periodic Pension Cost Items • Records noncurrent asset arising from recognition of additional pension liability for unfunded pension plans. • Account balance should not exceed the sum of unrecognized transition loss plus prior service costs. 43

Summary Journal Entries ! Annual Pension Cost Accrual ! Annual Pension Contribution ! Minimum Liability Adjustment 44

Summary Journal Entries Pension Cost Prepaid/ Accrued Pension Cost 45 Annual Pension XXX (XXX) Cost Accrual • Records sum of periodic pension cost items. • Increases pension cost (debit). • Increases pension liability (credit to Prepaid/Accrued Pension Cost).

Summary Journal Entries Cash Prepaid/ Accrued Pension Cost Annual Pension (XXX) XXX Contribution • Records contributions to plan assets. • Decreases pension liability (debit to Prepaid/Accrued Pension Cost). • Decreases Cash (credit). 46

Summary Journal Entries Minimum Liability Adjustment Prepaid/ Accrued Pension Cost (XXX) XXX • Records minimum pension liability. • Increases pension liability (credit to Prepaid/Accrued Pension Cost). • Increases Pension Cost (credit). 47

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. Minimum Pension ABO - FV Plan = Liability Assets 48

The End