Payroll and Payroll Taxes: Videos & Practice Problems

Understanding payroll expenses is crucial for managing a business's finances, as these expenses represent one of the largest costs associated with employee compensation. Payroll encompasses salaries and wage expenses, which include the gross pay earned by employees. The term "gross" refers to the total amount earned before any deductions, while "net" pay is the amount employees actually receive after withholdings, such as taxes.

When recording payroll in accounting, the salary expense is debited for the total gross amount, but the actual cash paid to employees is less due to tax withholdings. These withholdings create payroll liabilities for the employer, as they are responsible for remitting these amounts to the government on behalf of the employees. Both employees and employers contribute to payroll taxes, making it essential to understand the different types of taxes involved.

Key payroll taxes include:

• Income Taxes: Employees are liable for federal and state income taxes, which are withheld from their paychecks. The employer remits these taxes to the government.
• FICA Tax: This tax, which stands for the Federal Insurance Contributions Act, includes Social Security and Medicare taxes. Both employees and employers pay 7.65% of the employee's gross pay towards FICA.
• Unemployment Taxes: Employers are responsible for federal and state unemployment taxes. The federal unemployment tax rate is 6.2% on the first $7,000 earned by each employee.

Additionally, employee benefits such as health insurance and retirement plans are also part of salary and wage expenses. These benefits may involve further withholdings from employee paychecks or direct payments made by the employer, contributing to the overall payroll expense.

In summary, payroll expenses consist of three main components: the actual cash compensation paid to employees, the taxes withheld and remitted to the government, and the costs associated with employee benefits. Understanding these elements is vital for accurate financial reporting and effective business management.

In April, the employees of Stern Company earned a total of $120,000 in wages. However, this amount is not fully paid out in cash due to various withholdings and employer liabilities. The withholdings include $7,000 for Social Security (FICA), $13,000 for federal income taxes, and $4,000 for state income taxes. Additionally, the company incurs costs for federal and state unemployment taxes totaling $180 and $300, respectively. The employer also contributes $2,500 towards an employee-sponsored health insurance program. Since all amounts are to be paid in May, the journal entries will reflect accrued liabilities rather than cash transactions.

The first step involves recording the employee compensation. The total salary expense is debited for $120,000, representing the gross pay earned by employees. The withholdings are recorded as liabilities: FICA payable for $7,000, federal taxes payable for $13,000, and state taxes payable for $4,000. The net pay, which is the amount employees will receive, is calculated as follows:

Net Pay = Gross Pay - (FICA + Federal Taxes + State Taxes) = $120,000 - ($7,000 + $13,000 + $4,000) = $96,000.

This net pay is recorded as salaries payable. The journal entry for employee compensation is summarized as:

Debit: Salary Expense $120,000Credit: FICA Payable $7,000Credit: Federal Taxes Payable $13,000Credit: State Taxes Payable $4,000Credit: Salaries Payable $96,000

Next, the employer's liabilities are recorded. The employer is responsible for matching the FICA contributions, which amounts to another $7,000. Additionally, the employer must account for the unemployment taxes: FUTA payable for $180 and SUTA payable for $300. The total employer liabilities are calculated as:

Total Employer Taxes = FICA + FUTA + SUTA = $7,000 + $180 + $300 = $7,480.

This total is debited to salary expense, reflecting the employer's share of payroll costs. The journal entry for employer liabilities is:

Debit: Salary Expense $7,480Credit: FUTA Payable $180Credit: SUTA Payable $300Credit: FICA Payable $7,000

Finally, the entry for employee benefits is recorded. The health insurance premium of $2,500 is debited to salary expense, and since it will be paid in May, it is credited to insurance payable. The journal entry for employee benefits is:

Debit: Salary Expense $2,500Credit: Insurance Payable $2,500

To summarize the total salary expense for April, we add all components together:

Total Salary Expense = Employee Wages + Employer Taxes + Employee BenefitsTotal Salary Expense = $120,000 + $7,480 + $2,500 = $129,980.

Understanding these entries is crucial, particularly the distinction between employee and employer liabilities. The FICA tax is shared between both parties, while income taxes are solely the employee's responsibility, and unemployment taxes are borne by the employer. This comprehensive approach to payroll accounting ensures accurate financial reporting and compliance with tax obligations.