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4.3. The Journal Entry for Payroll

I.M. Fictitious' pay would be recorded as follows:

7-31-xx

Salaries Expense

3,000

Federal Income Tax Payable

349

State Income Tax Payable

117

Social Security Payable

180

Medicare/Medicaid Payable

45

Insurance Payable

175

Retirement Contribution Payable

200

Charitable Contribution Payable

25

Health/Child Flex Payable

75

Cash

1,834

To record payroll of Fictitious

Although not illustrated, as the company remits the withheld amounts to the appropriate entities (i.e., turns the taxes over to the government, retirement contributions to an investment trust, etc.), it would debit the related payable and credit cash.

4.4. Employer Payroll Taxes and Contributions

Recall from above, that social security and medicare/medicaid tax amounts must be matched by employers.

In addition, the employer must pay federal and state unemployment taxes. These taxes are levied to provide funds that are paid to workers who are temporarily unable to find employment. The bulk of unemployment tax is usually levied at the state level since most states choose to administer their own unemployment programs (which is encouraged by the federal government via a system of credits to the federal tax rate). The specific rates will depend on the particular state of employment, and each individual employer's history. Employers who rarely release employees get a favorable rate (since they don't contribute to unemployment problems), but those who do not maintain a stable labor pool will find their rates going higher. Like social security, the unemployment tax stops each year once a certain maximum income level is reached. In this text, I will assume the federal rate is one-half of one percent (0.5%), and the state rate is three percent (3%), on a maximum income of $10,000. Thus, I assume the federal unemployment tax (FUTA) is capped at $50 per employee and the state unemployment tax (SUTA) is capped at $300.

Many employers will carry workers' compensation insurance. The rules about this type of insurance vary from state to state. Generally, this type of insurance provides for payments to workers who sustain on-the-job injuries, and shields the employer from additional claims. But, for companies that do not carry such insurance, the employer has an unlimited exposure to claims related to work place injuries. Nevertheless, the cost of this insurance can be very high (for risky work, like construction), and some employers don't carry such policies. Please be advised that these are very general statements; if you have specific questions about the rules in your state, you should consult appropriate counsel and not rely on this generalization.

Many employers will provide health care insurance and retirement plan contributions. These amounts can often be substantial, perhaps even exceeding the amounts contributed by employees on their own behalf.

As you can see, the employer's cost of an employee goes well beyond the amount reported on the pay check. For many companies, the total cost of an employee can be 125% to 150% of the gross earnings. Of course, these added costs also need to be entered in the accounting records. Below is the entry for I. M. Fictitious:

7-31-xx

Payroll Tax Expense

225

Employee Benefits Expense

675

Social Security Payable

180

Medicare/Medicaid Payable

45

FUTA Payable

0

SUTA Payable

0

Insurance Payable

475

Retirement Contribution Payable

200

To record employer portion of payroll taxes and benefits

In preparing this entry it was assumed that (a) FUTA and SUTA bases had already been exceeded earlier in 20XX (hence the related amounts are zero), (b) the employer exactly matched employee contributions to insurance and retirement programs, and (c) the employer incurred workers' compensation insurance of $300 (bringing total insurance to $475 ($175 + $300)). Note that additional accounts could be used to separate employee benefits expense into more specific sub components (like insurance expense, retirement plan expense, etc.).

4.5. Annual Reports

Each employee and the Internal Revenue Service is to receive an annual statement regarding compensation. Shortly after the conclusion of a calendar year, an employer must review their employee records and prepare a summary wage and tax statement (commonly called a W-2). This information helps employees accurately prepare their own annual federal and state income tax returns, and allows the government to verify amounts reported by those individual taxpayers.

4.6. Accurate Payroll Systems

As you can tell, accuracy is vital in payroll accounting. Oftentimes, a business may hire an outside firm that specializes in payroll management and accounting. The business then need only provide the outside firm with information about time worked by each employee (and of course the money to cover the gross payroll). The outside firm manages the rest - providing individual paychecks/deposits, payroll recordkeeping, government compliance reporting, timely processing of tax deposits, and the like. For many businesses, being relieved of the burden of payroll processing is a great relief and allows them to focus on their product and customer.

But, when a business manages its own payroll, very accurate data must be maintained. Most firms will set up a separate payroll journal or data base that tracks information about each employee, as well as in the aggregate. In addition, it is quite common to open a separate payroll bank account into which the gross pay is transferred and from which paychecks and tax payments are disbursed. This system provides an added control to make sure that employee funds are properly maintained, processed, and reconciled.

 
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