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How to Record Accrued Payroll and Taxes

It’s the nature of the beast that most companies will have accrued payroll and related payroll taxes. In other words, a company owes these taxes but has not yet paid them. This topic is easy to understand if you think about the way you’ve been paid by an employer in the past.

Most companies have a built-in lag time between when employees earn their wages and when the paychecks are cut. For example, Green Inc. pays its employees on the 1st and 15th of every month, with 15 days of wages in arrears. This means that when the employees get their paycheck on July 15, it’s for work they did from June 16 through June 30.

So to match expenses to revenue when preparing financial statements for the one-month period ending June 30, the gross wages earned but not yet paid as of June 30 have to be added to the balance sheet as a current liability.

In addition, you have to add any payroll taxes or benefits that will be deducted from the employee’s paycheck when the check is finally cut.

The following are examples of employee payroll–related accruals:

  • Federal Insurance Contributions Act (FICA): The Social Security portion of this tax provides old age, survivor, and disability benefits.

    For decades, the FICA rate was 6.2 percent on wages up to a certain wage base dollar amount. The Medicare portion had no base wage limit with a tax rate of 1.45 percent. Together, the rate is 7.65 percent for employees and a 7.65 percent match for the employer’s portion.

    However, legislation subsequent to publication can always affect any type of payroll tax rates. Your intermediate accounting professor will have the current info should your contemporaneous rates not be the same as above.

  • Federal withholding tax: The company calculates this tax using Circular E, based on the marital status and exemptions the employee lists on form W-4.

  • State and local withholding tax: The business also deducts any tax for state or local jurisdictions that mandate tax collection.

  • Healthcare or other insurance premiums: An employer may pay only a portion or all of the health insurance premium for employees and their family. The additional amount for health and other insurance, such as life insurance, is a deduction as well if the employee authorizes it.

  • 401(k) and other retirement deductions: Many employers have plans that allow employees to make benefit deductions on pretax dollars. Pretax means the deduction is made before the employee is assessed federal withholding tax, or FICA. So if your gross wage is $500 and you have $100 in pretax deductions, you pay tax on $400.

The employer business also has payroll tax expense based on the employees’ gross wages. These items are recorded as short-term liabilities as well:

  • FICA: The employer is obligated to match each employee’s contribution dollar for dollar.

  • State Unemployment Tax Act (SUTA): This tax percentage varies based on employers’ unemployment claim experience, as well as each state’s rates. There is a statutory taxable wage limit that varies by state.

  • Federal Unemployment Tax Act (FUTA): The employer pays FUTA tax at 6.2 percent of the first $7,000 of wages each year. (A credit up to 5.4 percent is given to companies subject to and current on their SUTA payments). In times of catastrophic unemployment, FUTA kicks in to pay unemployment claims after SUTA is exhausted.

  • Employer benefits: Additionally, the employer has an expense for the company portion of healthcare, 401(k) match, and any other benefit programs the company provides.

So that you can better understand this class of current liabilities, here’s a typical payroll and payroll tax accrual question. It’s quite similar to the questions in your financial accounting textbook:

Green Inc. owes its employees gross wages of $75,000. Employee FICA tax on this amount is $5,737.50, and employees have opted to have income tax withholdings of $3,680.

They also have health insurance for $3,000 and retirement contributions for $4,500 withheld from their paychecks. Total deductions are $16,917.50. Net payroll is the difference between the gross of $75,000 and the deductions of $16,917.50, which equals $58,082.50.

After a company runs payroll, how does it record gross wages, tax, and other deductions made from the employees’ checks as short-term liabilities? Additionally, how does it record the related payroll tax expense?

Given in this example is the fact that federal unemployment tax totals $100 and state unemployment tax totals $465. The employer has no employer benefit expense.

Wondering how to answer this question via journal entries?

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