Employee Compensation: Payroll, Pensions, and Other Compensation Issues

1. Employee Compensation: Payroll, Pensions, and Other Compensation Issues

2. 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.

3. 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.

4. 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.

5. Employee CompensationEvent Line Time Payroll Compensated Absences Stock Options and Bonuses Postemployment Benefits Pensions and Postretirement Benefits Other Than Pensions

6. 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).

7. Salary Expenses and Liabilities • 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.

8. 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.

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

10. 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 133 State Unemployment Taxes Payable 50 Federal Unemployment Taxes Payable 21 To record the payroll tax liability of the employer.

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

12. 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.

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

14. 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).

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

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

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

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

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

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

21. 21 Calculating Pension Costs A Spreadsheet Approach

22. The Basic Spreadsheet Formal Accounts Memorandum Accounts Prepaid/ Periodic Unamortized Transition Gain/Loss Unrecognized Prior Service Cost Annual Accrued Pension Fair Value Deferred Gain/Loss Pension Pension Cost of Plan Expense Cash Cost Items PBO Assets 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

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

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

25. Memorandum Accounts Actual Return on Assets Benefits Paid FVPA BoY FVPA EoY = + Contributions - ± Projected Benefit Obligation Fair Value of Plan Assets Unamortized Transition Gain/Loss Unrecognized Prior Service Cost Deferred Gain/Loss • 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.

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

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

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

29. 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.

30. 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.

31. Periodic Memorandum Entries • Service cost • Interest cost • Actual return on plan assets • Benefits paid • Prior service cost amortization • Transition amortization • Deferred gain/loss • Amortization of deferred gain/loss

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

33. Periodic Memorandum Entries Periodic Pension Cost Projected Benefit Obligation Interest Cost 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).

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

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

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

37. Periodic Memorandum Entries Periodic Pension Cost Unamortized Transition (Gain)/Loss Transition Amortization (XXX) 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.

38. Periodic Memorandum Entries Periodic Pension Cost Unrecognized Net Pension (Gain)/Loss Deferred Gain/ Loss (XXX) XXX 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.

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

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

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

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

43. Formal Accounts Prepaid/ Accrued Pension Cost Periodic Pension Cost Items Net Pension Expense Cash • 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.

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

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

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

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

48. Minimum Pension Liability Minimum Pension ABO - FV Plan Liability Assets = • Net amount of pension liability that must be reported for underfunded plans. • Measured as difference between ABO and Fair Value of Plan Assets.

49. The End