Google showed 19,311 hits. this was the third one, smart ass:
CHAPTER 10
EXPENDITURE CYCLE: OTHER OPERATING ITEMS
1. EMPLOYEE COMPENSATION
More is involved then just salary expense (payroll) for work done in the current period. Employees working for a company earn their current salary, but must pay employee taxes. The company, as employer, must collect the employee taxes from the employee (this is done through deductions from the salary prior to payment of the salary to the employee) and then remit these withheld taxes to the proper taxing authorities. The taxes that must be withheld from an employee’s paycheck are: Federal income tax, State income tax (none in Florida), Social Security taxes (FICA).
In addition, the Employer also has to pay taxes to taxing authorities. The Employer (company) has to pay an equal share of FICA taxes, Federal unemployment taxes and State unemployment taxes.
Employees are also entitled to compensated absences. Compensated absences means a company pays employees for a certain number of days when the employees do not work. This includes vacation leave days and sick leave days. The expense should be recognized in the period in which the days are earned, not in the period in which the actual cash payment occurs.
Therefore, at the time company pays salary to employee, these are some of the journal entries that must be made:
Salary Expense 10,000
Federal Income Tax Withheld 1,000
State Income Tax Withheld 300
Fica Tax Withheld 800
Salary Payable 7,100
Payroll Expenses 1,000
FICA tax payable 800
Federal unemployment tax pay. 150
State unemployment tax pay. 50
(all expense items above are approximations).
BONUSES
Bonus plans allow employees to receive additional compensation if certain earnings objectives are met
These plans are usually restricted to top management
One possible danger is that managers will attempt to manipulate reported earnings
EMPLOYEE STOCK OPTIONS
Under employee stock option plans, managers are given the option of purchasing shares of the company’s stock in the future at a price that is specified today (option price)
EMPLOYEE STOCK OPTIONS
Two methods of accounting for employee stock options
Intrinsic value method
Is based on the assumption that the value of an option, if any, is measured on the day it is granted (market price minus the option price)
Fair value method
Is based on the assumption that the value of the option lies in the chance that the stock price will increase above the exercise price
INTRINSIC VALUE METHOD
Most companies set the option price above the market price at the date of grant so that no compensation expense is measured and recorded
For example, if the option price is set at $60 when the market price is $50, there is no compensation to employees, and thus, no expense recorded under this method
FAIR VALUE METHOD
The fair value is estimated by a formula that considers several factors including the expected volatility of the stock price and the length of the exercise period
The fair value of the options is reported as compensation expense on the income statement
FASB’S ACCOUNTING TREATEMENT
Companies are encouraged, but not required, to adopt the fair value method
The intrinsic value method is allowed, but if used, companies must disclose what net income would have been under the fair value method
Most U.S. companies use the intrinsic value method
POSTEMPLOYMENT BENEFITS
Are benefits that occur after an employee has ceased to work for an employer but before an employee retires
E.g., a severance pay package
The cost must be estimated and reported when the decision is made to downsize the labor force
PENSIONS
A pension is cash compensation received by an employee after the employee has retired
There are two types of pension plans:
Defined contribution plan
Defined benefit plan
DEFINED CONTRIBUTION PLAN
This type of plan requires the company to contribute a fixed amount of money to a pension fund each year on behalf of the employee
The amount of cash contributed to the pension fund during the year is reported as pension expense
DEFINED BENEFIT PLAN
This type of plan requires the company to pay employees a fixed monthly cash amount after they retire based on a pension formula that considers years of service and highest salary
DEFINED BENEFIT PLAN
Estimation of the pension liability
The amount that would have to be deposited in a bank today to accumulate enough interest to pay employees their pension benefits at retirement (actuarial present value)
This pension liability is called the projected benefit obligation (PBO)
The PBO is offset against the plan assets fair value when reported on the balance sheet
DEFINED BENEFIT PLAN
Three components of pension expense:
Interest cost
Service cost
Expected return on pension fund assets
DEFINED BENEFIT PLAN
Interest cost
The increase in the PBO due to the passage of time (PBO x discount rate)
The discount rate used is the settlement rate
The implicit rate of interest necessary to purchase annuity contracts settling the pension obligation
DEFINED BENEFIT PLAN
Service cost
The increase in the PBO from service provided by employees during the current period
Expected return on pension fund assets
The return that the company earns on the assets in the pension fund
This is a negative component of pension expense
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Other employee benefits provided after retirement include
Health care plans
Life insurance plans
Accounting rules require that these benefits be recognized as an expense and a liability as they are incurred
INCOME TAXES
Income tax expense and the amount paid for income tax during a period are different for two reasons:
Income taxes are not paid in the same year in which they are incurred
A firm may choose one accounting method for tax purposes and another for financial reporting purposes
INCOME TAXES
Differences in financial income and taxable income are due to timing differences
Timing differences can be
Permanent or
Temporary
TIMING DIFFERENCES
Permanent differences
Enter into accounting income, but never into taxable income
These are statutory differences between GAAP and the Internal Revenue Code
For example, interest on state and local bonds is included in financial income, but not in taxable income
TIMING DIFFERENCES
Temporary differences
Some transactions affect taxable income in a different period from financial accounting income
Depreciation methods
Rent received in advance
The affects of these differences are recorded as deferred tax assets or liabilities and shown on the balance sheet
DEFERRED TAXES
Deferred Tax Liability
Requires a payment in the future
Is the expected income tax on income earned but not yet taxed
Is not an existing legal liability
Income Taxes Payable, based on taxable income on the tax return, is an existing legal liability
DEFERRED TAXES
A typical entry for recording income taxes with a Deferred Tax Liability would be
DEFERRED TAXES
Deferred Tax Asset
Represents the expected benefit of a future tax deduction for an expense item that has already been incurred but is not yet deductible for tax purposes
It can only be recognized if it is “more likely than not” that future income will be realized against which the deduction can be offset
DEFERRED TAXES
A typical entry for recording income taxes with a Deferred Tax Asset would be
CAPITALIZE VERSUS EXPENSE
An expenditure that is expected to benefit future periods is capitalized as an asset
All other expenditures are treated as expenses
CAPITALIZE VERSUS EXPENSE
Research and development costs
Research is defined as
Those activities undertaken to discover new knowledge that will be useful in developing new products, services, or processes or that will result in significant improvement of existing products or processes
Development
Applies the research findings to develop a plan or design for new or improved products and processes
CAPITALIZE VERSUS EXPENSE
Research and development costs are expensed in the period incurred due to the uncertainty surrounding the future economic benefits of R&D activities
CAPITALIZE VERSUS EXPENSE
Software development requires special treatment
All costs incurred up to the point where technological feasibility is established are to be expensed as research and development
After technological feasibility is established, costs incurred are capitalized
Determining technological feasibility is a matter of judgement
CAPITALIZE VERSUS EXPENSE
Oil and gas exploration costs
Two methods of accounting for the cost of “dry holes”:
Full cost method
All exploratory costs are capitalized and allocated to the cost of successful wells
Successful efforts method
Exploratory costs for dry holes are expensed, and only exploratory costs for successful wells are capitalized
CAPITALIZE VERSUS EXPENSE
Advertising costs
Generally, advertising costs are expensed due to the uncertainty of their future economic benefits
In selected cases where the future benefits are more certain, advertising costs should be capitalized
CONTINGENCIES
A contingency is an uncertain circumstance involving a potential gain or loss that will not be resolved until some future event occurs
CONTINGENCIES
Three important definitions:
Probable
Likely to occur
Remote
Not likely to occur
Reasonably possible
More than remote but less than likely
CONTINGENT LOSSES
Likelihood
Probable
Reasonably possible
Remote
Accounting Action
Recognize a probable liability if the amount can be reasonably estimated.
Disclose a possible liability in a note.
No recognition or disclosure unless contingency represents a guarantee. Then, note disclosure is required.
CONTINGENT GAINS
Likelihood
Probable
Reasonably possible
Remote
Accounting Action
Recognize a probable asset if the amount can be reasonably estimated. If not estimable, disclose facts in a note.
Disclose a possible asset in a note, but be careful to avoid misleading implications. In practice, possible contingent gains are often not disclosed.
No recognition or disclosure.
ACCOUNTING FOR LAWSUITS
If the facts of the case indicate that a loss is probable and the amount of the loss can be estimated, a loss should be reported on the income statement and a liability should be reported on the balance sheet
ACCOUNTING FOR ENVIRONMENTAL LIABILITIES
Most companies do not reflect these loss contingencies as liabilities on the balance sheet because the future cost of the cleanup is very difficult to estimate
--------------------------------------------------------------------------------
For problems or questions contact Barbara Gugliotta Pierce, Ph.D..
Last updated: 05/09/2002 .
Copyright © 2002 |
