12.5: Payroll Accounting Defined

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If you haven’t already, at some point you will most likely receive a paycheck. The first time you do, you will be disappointed. You will want to know who took all your money! But not to worry, this section and the next will explain where it all goes.

What is included in an employee’s paycheck?

Gross Pay: This is the amount of money you are promised either hourly, weekly or annually.
Federal Income Tax Withheld (also referred to as FIT): You will fill out a document called a W-4 when you are hired. This document allows you to claim allowances and a federal filing status for tax purposes. These options along with your gross pay are used to calculate your federal tax withheld. This will reduce your gross pay.
State Income Tax Withheld (also referred to as SIT): A different form than the W-4 but the same concept except it applies to the state. Not all states have a state income tax. This will reduce your gross pay.
FICA Social Security Tax (also referred to as OASDI): This tax helps fund social security and is calculated as gross pay x 6.2% unless you make OVER $118,500 in 2015 then you are only responsible to pay 6.2% of $118,500 and nothing more. This will reduce your gross pay.
FICA Medicare Tax (also referred to as HI): This tax helps fund medicare and is calculated as gross pay x 1.45%. Everyone must pay the 1.45% of gross pay without limit. This will reduce your gross pay.
Voluntary Deductions: Any deductions you authorize will also reduce your gross pay. This includes things like medical premiums, 401K and savings accounts, charity donations, etc.
Net Pay: Finally! This is the amount you will receive after all taxes and voluntary deductions have been taken out.

Wait — this section is on current liabilities so how do they fit in? Your employer will take money out of your paycheck for the items listed above and combine them with other employee amounts to send one big check to the government or business (for voluntary deductions). When you are paid, the company records liabilities for the amounts taken out of your paycheck.

Don’t think employers are getting off easy! There is a cost (more than gross pay) for having employees. The employer must pay the following on every dollar an employee earns:

FICA Social Security Tax: This tax helps fund social security and is calculated as gross pay x 6.2% unless an employee makes OVER $118,500 in 2015 then you are only responsible to pay 6.2% of $118,500 and nothing more for that employee.
FICA Medicare Tax: This tax helps fund medicare and is calculated as gross pay x 1.45%. Everyone must pay the 1.45% of gross pay without limit.
Federal Unemployment Tax (FUTA): This tax is for unemployment claims and is typically calculated as 0.8% of the first $7,000 of an employee’s earnings. Once the employee has earned more than $7,000 in gross pay for the year, the company no longer has to pay FUTA tax.
State Unemployment Tax (SUTA): This tax is for the state unemployment and does not have a consistent rate. The rate is provided by the state annually and can change each year by business.
Voluntary Deductions Matching: Any matching funds the company provides for insurance or retirement plans.

In the next section we will look at the entries required for payroll with both the employee and employer side of the transactions.

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