I'm Larry Walther, this is principlesofaccounting.com, Chapter 12.
And in this module, we will look at the basic accounting for payroll.
So, first of all,
recognize that many services are provided to a business by other than employees.
Payroll and tax record keeping requirements differ, whether someone
providing service to a company is an independent contractor, or an employee.
An independent contractor performs a designated task, or service for a company.
The company has the right to control or
direct only the result of the work done by an independent contractor.
Conversely, an employee works for a specific business and
performs activities as directed by that business.
The business controls what will be done, and how it will be done.
These subtle definitional differences between an independent contractor and
an employee are very important,
as they define the relationship between the company and
the worker, and who's responsible for various payroll tax obligations.
Amounts paid to an independent contractor generally does not involve
tax withholdings by the payer, instead,
the payer will report the amount of earnings on a Form 1099.
That 1099 is provided to both the Internal Revenue Service, as well as the worker.
And the independent contractor then becomes responsible for
paying payroll taxes, as are associated with their earnings.
Amounts paid to employees, however, are usually reduced by variety of taxes and
other reductions.
Employers may also pay costs related to these deductions.
So, we'll look closer at this, but first some terminology.
Gross Pay is the total earnings of an employee.
Hourly employees would determine their gross pay by
looking at the number of hours worked times the hourly rate.
Salaried employees may be subject to a flat amount for a period of time.
In any event, overtime rules may cause an increase in the pay for
either category of employee.
Net pay is the gross pay less applicable deductions.
So, let's look at a paycheck, here on the top, we've got a paycheck to I.M.
Fictitious for $1834, even though their gross earnings was $3000.
We have 1834 paid to the employee or the net pay.
This is offset by a variety of deductions related to Federal Income Tax,
State Income Tax Social Security, Medicare, insurance, retirement plans,
charitable contributions, healthcare, child care plans, and so forth.
So, you can see there's quite a difference potentially between gross pay and net pay.
Let's consider some of these deductions more closely.
Income taxes, these are taxes on income that are required to be
withheld by federal, and sometimes state, and even city governments.
Withheld amounts must be remitted periodically to the government
by the employer.
In essence, that money that was withheld by the employer from the employee's pay,
the employer becomes an agent for the government, and is responsible for
collecting that amount,
carrying that amount on their liability until it's remitted to the government.
The level of withholdings are based upon the employees level of income,
the frequency of the pay period, the marital status of the employee, and
the number of other withholding allowances that the employee may be entitled to.
The employee will claim their withholding allowances by
filling out a form W4 at the time they're hired by the employer.
Employers who fail to make timely remittances are subject to
harsh penalties.
This is simply nothing to mess around with.
It's not the employers money, it's due to the government.
So, the employer needs to make timely remittance to these amounts.
The government makes it very easy for
the employer to remit the amounts withheld from employee.
Most commercial banks are approved to accept the amounts.
And there's even online systems that allow very easy transfer of funds for
the amounts withheld from employees.
The frequency of the required remittance is based upon the size of the employer,
and the total amount of the payroll.
Social Security and Medicare Taxes are another category of tax,
also known as FICA, or Federal Insurance Contributions Act.
Tax transfers money to retirees, and
certain persons not able to provide for themselves.
So, the beneficiaries of these payments are retirees and so forth.
Social security provides a modest income stream to beneficiaries.
Medicare provides for the healthcare costs of the beneficiary.
The social security tax is usually calculated as a percentage of income up to
a certain maximum level.
If an employees income exceeds the annual limit, the tax ceases to be withheld for
that year.
It'll start up in the next calendar year.
Medicare and Medicaid is subject to a lower percentage tax rate, but
it has no annual maximum income limit.
It continues up to the full amount earned by the employee.
The employee's amount for these taxes, the amount withheld from the employee,
the employer has to pay an equal amount to match that, so
the full cost of the employee is much higher than simply the gross pay.
There are other employee deductions that can relate to healthcare insurance
premiums, contributions to retirement programs, charitable contributions, and
certain tax-advantaged health and child care savings programs.
Employer that collects these amounts from the employees has also a duty, of course,
to remit the appropriate entities, such as an insurance company.
Okay, here's a payroll journal entry.
Here, we've got a gross pay of $3,000 with debiting salary expense, but
we're only crediting cash, 1834, the amount remitted to the employee.
All of the other items reflect the differences,
the various payable federal income tax, payable state income tax,
payable social security payable and self-worth.
Let's turn to the employer payroll taxes.
The social security and Medicare taxes, I've already mentioned, must be matched.
Employers are also subject to unemployment taxes,
that are levied that the employee never sees.
If there's a Federal Unemployment Tax, that's usually a fair nominal rate.
The federal government has fairly well delegated this to the states.
The State Unemployment Tax can be a higher rate.
These taxes provide benefits to unemployed workers who are temporarily
unable to find employment.
The rates vary by state, and they also are employers specific.
An employer that has a very good history of not laying off employees
will find themselves over time with a much lower rate than someone who has a history
of having workers who they have to let go.
So, employers who rarely release employees generally get more favorable rates.
The tax stops each year once a maximum amount of income level
is reached by employee.
Employers may also carry workers compensation insurance,
which provides payments to workers who sustain on-the-job injuries, and
shields the employer from additional claims.
Employers may provide health insurance and bear the cost of that health insurance,
as well as make retirement plan contributions.
Obviously, the employer's cost of an employee goes well beyond
the amount reported on the paycheck.
Here's a journal entry now not for the gross pay, but for
the additional cost related to the payroll tax.
So, I've got payroll tax expense, and
other employee benefits expenses being debited.
So, if we look at the credits, we're crediting social security payable,
Medicare payable, and in this case, I'm assuming that the federal and
state unemployment tax bases have already been exceeded.
We've got our insurance payable, worker's compensation payable, retirement payables.
All of these amounts would in turn be remitted to the appropriate body.
Additional reports, shortly after the conclusion of the calendar year,
an employer must review its employee records and prepare an annual wage and
tax statement, commonly known as a W-2.
This information is furnished to the employee and the government,
this helps the employee accurately file their own income tax return, and allows
the government to verify the amounts that are reported and paid to individuals.
An accurate payroll system is important, a business may
hire an outside firm that specializes in payroll management and accounting.
The outside firm actually manages the payroll, the record keeping, and
the actual disbursement of the paycheck.
Most firms will set up a separate payroll database that tracks their information
about each employee, as well as aggregate information.
And indeed, some companies may establish a separate bank account for
depositing the gross pay into the account, and then dispersing that
out the net pay to the employee, and the other amounts to the various bodies,
such as the taxing agency and so forth, so that at the end of the month,
you should be able to reconcile that account to essentially a zero balance,
showing that the gross pay was disbursed into the account,
and then appropriately redisbursed to the appropriate persons.