Current Liabilities and Contingencies
13
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of Liabilities
Result from past transactions or events.
Arise from present obligations to other entities.
Probable future sacrifices of economic benefits.
What is a Current Liability?
LIABILITIES
Long-term Liabilities
Expected to be satisfied with current assets or by the creation of other current liabilities.
Current Liabilities
Obligations payable within one year or one operating cycle, whichever is longer.
Current Liabilities
Current Liabilities
Short-term notes payable
Accrued expenses
Cash dividends payable
Taxes payable
Accounts payable
Unearned revenues
Open Accounts and Notes
Accounts Payable
Obligations to suppliers for goods purchased on open account.
Trade Notes Payable
Similar to accounts payable, but recognized by a written promissory note.
Short-term Notes Payable
Cash borrowed from the bank and recognized by a promissory note.
Credit lines
Prearranged agreements with a bank that allow a company to borrow cash without following normal loan procedures and paperwork.
Interest
Interest on notes is calculated as follows:
Amount borrowed
Interest rate is always stated as an annual rate.
Interest owed is adjusted for the portion of the year that the face amount is outstanding.
Interest-bearing Notes
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 6 months and has a stated interest rate of 9%. Record the journal entry.
September 1:
Cash .................................................... 80,000
Notes payable ....................... 80,000
To record short-term note payable to Cooke Bank.
How much interest is owed to Cooke Bank at year-end, on December 31?
$80,000 × 9% × 4/12 = $2,400
Interest-bearing Notes
Assume Eagle Boats’ year-end is December 31. Record the necessary adjustment at year-end.
December 31:
Interest expense ................................... 2,400 Interest payable ....................... 2,400
To accrue interest on note due to Cooke Bank.
Record the journal entry for the loan repayment when the note matures on February 28.
February 28:
Interest payable ................................... 2,400
Interest expense ................................... 1,200
Note payable ……………………………. 80,000
Cash …………………………… 83,600
To pay off note and interest.
Noninterest-bearing Notes
Notes without a stated interest rate carry an implicit, or effective rate.
The face of the note includes the amount borrowed and the interest.
Noninterest-bearing Notes
On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,600 in exchange for equipment valued at $10,000.
How much interest will Batter-Up pay on the note?
Interest = Face Amount - Amount Borrowed
= $10,600 - $10,000
= $600
Noninterest-bearing Notes
On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,600 in exchange for equipment valued at $10,000.
What is the effective interest rate on the note?
Commercial Paper
Commercial paper is a term used for unsecured notes issued in minimum denominations of $25,000 with maturities ranging from 30 days to 270 days.
Issued directly to the lender and is backed by a line of credit with a bank.
Recorded in the same manner as notes payable.
Salaries, Commissions, and Bonuses
Compensation expenses such as salaries, commissions, and bonuses are liabilities at the balance sheet date if earned but unpaid.
These accrued expenses/accrued liabilities are recorded with an adjusting entry prior to preparing financial statements.
Vacations, Sick Days, and Other
Paid Future Absences
Sick pay quite often meets the conditions for accrual, but accrual is not mandatory because future absence depends on
future illness, which usually is not a certainty.
An employer should accrue an expense and the related liability for employees’ compensation for future absences (such as vacation pay) if the obligation meets all four of these conditions:
The obligation is for services already performed.
The paid absence can be taken in a later year—the benefit vests or the benefit can be accumulated over time.
Payment is probable.
The amount can be reasonably estimated.
Liabilities from Advance Collections
Refundable deposits
Advances from customers
Gift cards
Collections for third parties
Gift Cards
During their December 2010 Christmas promotion, MegloMart sold 20,000 gift cards at $25 each. All gift card sales were for cash. On December 31, 2010, only 1,000 gift cards had been redeemed. Unused gift cards expire on December 31, 2011, if not used to purchase MegloMart merchandise.
December 31, 2010:
Cash (20,000 × $25) ................................... 500,000 Unearned revenue …....................... 500,000
To record cash received from gift card sales.
Prepare the journal entries on December 31, 2010 to record the December 2010 sale and redemption of gift cards.
December 31, 2010:
Unearned revenue (1,000 × $25) ............... 25,000
Sales revenue …............................. 25,000
To record revenue from gift card redemptions.
Gift Cards
By December 31, 2011, 18,500 additional gift cards had been redeemed. Prepare the journal entry on December 31 to record the 2011 redemptions.
On December 31, 2011, the 500 remaining cards had not been redeemed. Prepare the journal entry on December 31 to record the gift card expirations.
December 31, 2011:
Unearned revenue (18,500 × $25) …................. 462,500 Sales revenue (18,500 × $25) …......... 462,500
To record revenue from gift card redemptions.
December 31, 2011:
Unearned revenue (500 × $25) …..................... 12,500 Gift card breakage revenue ………..….. 12,500
To record revenue from gift card expirations.
A Closer Look at the Current and
Noncurrent Classification
Debt that is callable by the lender in the coming year (or operating cycle, if longer) should be classified as a current liability, even if the debt is not expected to be called.
Current maturities of long-term obligations usually are reclassified and reported as current liabilities if they are payable within the upcoming year (or operating cycle, if longer than a year).
The ability to refinance on a long-term basis can be demonstrated by an:
existing refinancing agreement, or
actual financing prior to issuance of the financial statements.
Short-Term Obligations
Expected to be Refinanced
A company may reclassify a short-term liability as long-term if two conditions are met:
It has the intent to refinance on a long-term basis.
It has demonstrated the ability to refinance.
and
. GAAP vs. IFRS
Liabilities payable within the coming year are classified as long‐term liabilities if refinancing is completed before date of issuance of the financial statements.
Liabilities payable within the coming year are classified as long‐term liabilities if refinancing is completed before the balance sheet date.
Classification of Liabilities to be Refinanced
Loss Contingencies
A loss contingency is an existing uncertain situation involving potential loss depending on whether some future event occurs.
Two factors affect whether a loss contingency must be accrued and reported as a liability:
the likelihood that the confirming event will occur.
whether the loss amount can be reasonably estimated.
Likelihood of occurrence:
Probable
A confirming event is likely to occur.
Reasonably Possible
The chance the confirming event will occur is more than remote, but less than likely.
Remote
The chance the confirming event will occur is slight.
Loss Contingencies
Loss Contingencies
A loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.
Product Warranties and Guarantees
Product warranties inevitably entail costs.
The amount of those costs can be reasonably estimated using commonly available estimation techniques.
The estimate requires the following entry:
Warranty expense ......................................... $,$$$
Estimated warranty liability .............. $,$$$
To accrue warranty expense.
Extended Warranty Contracts
Extended warranties are sold separately from the product.
The related revenue is not earned until:
Claims are made against the extended warranty, or
The extended warranty period expires.
Premiums
Premiums included with the product are expensed in the period of sale.
Premiums that are contingent on action by the customer require accounting similar to warranties.
Litigation Claims
The majority of medium and large-size corporations annually report loss contingencies due to litigation.
The most common disclosure is a note to the financial statements.
Subsequent Events
Events occurring between the fiscal year-end date and report date can affect the appearance of disclosures on the financial statements.
Fiscal Year Ends
Financial Statements
Clarification
Cause of Loss Contingency
Subsequent Events
Events occurring after the year-end date and report date can also affect the appearance of disclosures on the financial statements.
Fiscal Year Ends
Financial Statements
Clarification
Cause of Loss Contingency
Unasserted Claims and Assessments
Is a claim or assessment probable?
No
Yes
No disclosure needed
Unasserted claim
Evaluate (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated. An estimated loss and contingent liability would be accrued if an unfavorable outcome is probable and the amount can be reasonably estimated.
. GAAP vs. IFRS
Defines probable as more likely than not, a lower threshold than . GAAP.
Refers to accrued liabilities as provisions and non-accrued as contingent liabilities.
Requires use of midpoint of a range of equally likely outcomes.
Requires reporting present values when material.
Defines probable as an event is likely to occur.
Refers to both accrued and non-accrued obligations as contingent liabilities.
Requires use of low end of a range of equally likely outcomes.
Allows using present value under some circumstances.
Contingencies
Gain Contingencies
As a general rule, we never record GAIN contingencies.
Note that the prior rules have supported the recording of LOSS contingencies.
Appendix 13
Payroll-Related Liabilities
Employers incur several expenses and liabilities from having employees.
FICA Taxes
Medicare Taxes
Federal Income Tax
State and Local Income Taxes
Voluntary Deductions
Gross Pay
Net Pay
Payroll-Related Liabilities
Amounts withheld depend on the employee’s earnings, tax rates, and number of withholding allowances.
Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency.
Federal Income Tax
State and Local Income Taxes
Employees’ Withholding Taxes
FICA Taxes
Medicare Taxes
% of the first $106,800 earned in the year.
% of all wages earned in the year.
Employers must pay withheld taxes to the Internal Revenue Service (IRS).
Employees’ Withholding Taxes
Federal Insurance Contributions Act (FICA)
Amounts withheld depend on the employee’s request.
Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency.
Examples include union dues, savings accounts, pension contributions, insurance premiums, charities.
Voluntary Deductions
FICA Taxes
Medicare Taxes
Federal and State Unemployment Taxes
Employers’ Payroll Taxes
% on the first $7,000 of wages paid to each employee (A credit up to % is given for SUTA paid.)
Federal Unemployment Tax Act (FUTA)
Basic rate of % on the first $7,000 of wages paid to each employee (Merit ratings may lower SUTA rates.)
State Unemployment Tax Act (SUTA)
Federal and State
Unemployment Taxes
Fringe Benefits
In addition to salaries and wages, withholding taxes, and payroll taxes, most companies provide a variety of fringe benefits.
Health insurance premiums
Life insurance premiums
Retirement plan contributions
Employers must pay the amounts promised to fund employee fringe benefits to the designated agency.
End of Chapter 13
Chapter 13: Current Liabilities and Contingencies.
Chapter 13 deals with short-term liabilities. In Part A of the chapter, the focus is on liabilities that are classified appropriately as current. In Part B of the chapter, we turn our attention to situations in which there is uncertainty as to whether an obligation really exists. These are designated as loss contingencies.
Most liabilities obligate the debtor to pay cash at specified times and result from legally enforceable agreements. Liabilities have three essential characteristics. Liabilities:
Are probable, future sacrifices of economic benefits.
Arise from present obligations to transfer goods or provide services to other entities.
Result from past transactions or events.
In a classified balance sheet, we categorize liabilities as either current liabilities or long-term liabilities. The general definition of a current liability is an obligation payable within one year or within the company’s operating cycle, whichever is longer. Another more discriminating definition identifies a current liability as an obligation expected to be satisfied with current assets or by the creation of other current liabilities. Liabilities should be recorded at their present values, but the relatively short-term maturity of current liabilities makes the time value component immaterial.
Examples of obligations reported as current liabilities are:
Accounts payable.
Taxes payable.
Unearned revenues.
Cash dividends payable.
Accrued expenses.
Short-term notes payable.
Accounts payable are obligations to suppliers for goods purchased on open account.
Trade notes payable are similar to accounts payable but are recognized by a written promissory note.
Short-term notes payable are cash borrowings from a bank that are recognized by promissory notes.
Credit lines are prearranged agreements with a bank that allow a company to borrow cash without following normal loan procedures and paperwork.
When a company borrows money, it pays the lender interest for the term of the loan. The interest on short-term loans is calculated by multiplying the amount borrowed times the annual interest rate times the fraction of the year the loan is outstanding.
Part I
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in six months and has a stated interest rate of nine percent. Record the borrowing on September 1. Record the journal entry.
Part II
We record the borrowing on books of Eagle Boats with a debit to cash and a credit to notes payable for $80,000. The borrowing increased the asset cash and also increased the liability notes payable. Now let’s compute the interest.
Part III.
How much interest is owed to the bank at the end of the year?
Part IV.
To answer this question we will use the interest computation formula, multiplying the amount borrowed times the annual interest rate times the fraction of the year that the loan is outstanding. The amount borrowed is $80,000. The annual interest rate is nine percent. The loan has been outstanding for four months, or four-twelfths of a year. Eighty thousand dollars times nine percent times four-twelfths equals $2,400.
Part I.
Next let’s record the adjusting entry on December 31 to recognize the interest obligation to the bank.
Part II.
We debit interest expense and credit the liability interest payable for $2,400.
Part III.
The loan matures six months from the date of borrowing on February 28 of the next year. Let’s record the loan repayment. Don’t forget that we need to recognize additional interest for the two months since the last entry on December 31.
Part IV.
The total amount of interest for the six months from September 1 until February 28 is $3,600 — $2,400 for the four months from September 1 until December 31, and $1,200 for the two months from December 31 until February 28.
The $2,400 interest obligation for the first four months was recorded as an interest payable in the adjusting entry made on December 31. Since we are now repaying the bank, we remove this liability with a debit to interest payable for $2,400. In addition, we debit interest expense for the $1,200 of interest for the two months from December 31 until February 28. Also, we debit note payable to remove the $80,000 for the original amount borrowed.
The total amount owed to the bank is the $80,000 originally borrowed plus the $3,600 of interest. We credit cash for $83,600 to record this payment.
On occasion, a bank might make a loan with a noninterest-bearing note. Even though the note is called a noninterest-bearing note, the note actually does bear interest. The face amount of the note includes both the amount borrowed and the interest.
Let’s look at an example to see how we might determine the amount of interest on a noninterest-bearing note.
Part I.
On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,600 in exchange for equipment valued at $10,000.
How much interest will Batter-Up pay on the note?
Part II.
The actual amount borrowed is $10,000, the value of the equipment. The amount that Batter-Up will repay is $10,600, the face amount of the note. To compute the amount of interest on the note, we subtract the amount borrowed from the face amount to get $600 of interest.
Part I.
The information is the same.
On May 1, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,600 in exchange for equipment valued at $10,000.
What is the effective interest rate on the note?
Part II.
We divide the amount of interest, $600, by the $10,000 borrowed to get a six percent effective interest rate.
Some large corporations obtain temporary financing by issuing commercial paper, often purchased by other companies as a short-term investment. Commercial paper is a term used for unsecured notes issued in minimum denominations of $25,000 with maturities ranging from 30 days to 270 days. Normally commercial paper is issued directly to the lender and is backed by a line of credit with a bank.
Interest often is discounted at the issuance of the note. Commercial paper has become an increasingly popular way for large companies to raise funds, the total amount having expanded over fivefold in the last decade. In fact, large companies have become so dependent on obtaining financing through the commercial paper market that a freeze-up of that market contributed to a global economic crisis in 2008. Commercial paper is recorded in the same manner as notes payable.
Compensation for employee services can be in the form of hourly wages, salary, commissions, bonuses, stock compensation plans, or pensions. Accrued liabilities arise in connection with compensation expense when employee services have been performed as of a financial statement date, but employees have yet to be paid. These accrued expenses/accrued liabilities are recorded by adjusting entries at the end of the reporting period, prior to preparing financial statements.
An employer should accrue an expense and the related liability for employees’ compensation for future absences (such as vacation pay) if the obligation meets all four of these conditions:
The obligation is attributable to employees’ services already performed.
The paid absence can be taken in a later year—the benefit vests (will be compensated even if employment is terminated) or the benefit can be accumulated over time.
Payment is probable.
The amount can be reasonably estimated.
The liability is accrued at the current wage rate.
A liability for sick leave is normally not accrued because future absence depends on future illness, which usually is not a certainty. However, if employees are paid for unused sick days (such as at retirement) it’s appropriate to record a liability for the unused sick pay.
Liabilities are created when amounts are received that will be returned or remitted to others. Examples are:
Refundable deposits
Advances from customers (called unearned revenue or deferred revenue)
Gift cards (also unearned revenue)
Collections for third parties
Part I.
During their December 2010 Christmas promotion, MegloMart sold 20,000 gift cards at $25 each. All gift card sales were for cash. On December 31, 2010, only 1,000 gift cards had been redeemed. Unused gift cards expire on December 31, 2011, if not used to purchase MegloMart merchandise.
Part II.
In the first entry, we record the receipt of cash from gift card sales. The cash received is recorded as unearned revenue, a liability. Although payment has been received, revenue will not be earned until gift card recipients exchange gift cards for merchandise or until the gift cards expire (gift card breakage).
In the second entry, we record the revenue earned from gift card redemptions. When gift cards are redeemed for merchandise, revenue is earned. The liability unearned revenue is reduced and revenue is recognized.
Part I.
By December 31, 2011, 18,500 additional gift cards had been redeemed. Prepare the journal entry on January 31 to record the 2011 redemptions.
Part II.
Again, if gift cards are redeemed for merchandise, revenue is earned. The liability unearned revenue is reduced and revenue is recognized.
Part III.
On December 31, 2011, the 500 remaining cards had not been redeemed. Prepare the journal entry on December 31 to record the gift card expirations.
Part IV.
Revenue is also recognized when gift cards expire. Whether redeemed or expired, the liability unearned revenue is reduced and revenue is recognized. The revenue from expired gift cards (breakage) is not reported separately, but is included in sales revenue.
Long-term obligations (bonds, notes, lease liabilities, deferred tax liabilities) usually are reclassified and reported as current liabilities when they become payable within the upcoming year (or operating cycle, if longer than a year). For example, a 20-year bond issue is reported as a long-term liability for 19 years but normally is reported as a current liability on the balance sheet prepared during the 20th year of its term to maturity.
The requirement to classify currently maturing debt as a current liability includes debt that is callable (in other words, due on demand) by the creditor in the upcoming year (or operating cycle, if longer), even if the debt is not expected to be called.
A company may reclassify a short-term liability as long-term only if two conditions are met:
It has the intent to refinance on a long-term basis.
It has demonstrated the ability to refinance.
The ability to refinance on a long-term basis can be demonstrated by:
An existing refinancing agreement, or
By actual financing prior to issuance of the financial statements.
Under . GAAP, liabilities payable within the coming year are classified as long‐term liabilities if refinancing is completed before date of issuance of the financial statements. Under IFRS, refinancing must be completed before the balance sheet date for liabilities payable within the coming year to be classified as long‐term liabilities.
A loss contingency is an existing uncertain situation involving potential loss depending on whether some future event occurs.
Two factors affect whether a loss contingency must be accrued and reported as a liability:
The likelihood that the confirming event will occur.
Whether the loss amount can be reasonably estimated.
Accounting standards require that the likelihood that the future event(s) will confirm the incurrence of a liability be categorized as:
probable, meaning that the confirming event is likely to occur.
reasonably possible, meaning that the chance the confirming event will occur is more than remote, but less than likely.
remote, meaning that the chance the confirming event will occur is slight.
The table on this screen summarizes the accounting and reporting for loss contingencies. The information presented here should provide you with a quick reference and a very useful study guide for loss contingencies.
In summary, a loss contingency is accrued only if a loss is probable and the amount can reasonably be estimated.
Product warranties inevitably entail costs. Since the amounts of those future costs can be reasonably estimated, usually based on past experience, we should accrue a liability for the estimated cost of the warranty obligation. To accrue the warranty liability, we debit warranty expense and credit estimated warranty liability.
Extended warranties are sold separately from the product.
Even though cash is received at the time the warranty contract is sold, revenue is not recognized until it is earned. At the time of the sale, an entry is made to record a liability for the deferred revenue. Revenue is earned when claims are made against the extended warranty, or when the extended warranty period expires. In most cases, the deferred revenue (liability) is recognized as revenue on a straight-line basis over the life of the extended warranty.
Premiums are promotional items provided with a product to enhance the sale of the product. Premiums included with the product are expensed in the period of sale. Premiums that are contingent on action by the customer require accounting similar to warranties. Mail-in, cash rebate offers are an example of the second type of premium. The cost of the cash rebates, based on estimated redemptions, using past redemption history, is recognized as an expense in the period of sale, and as an estimated liability. While it is difficult to predict whether a particular buyer will redeem a premium, it is much easier to predict the total number of premiums that will be redeemed based on how previous customers have tended to react.
The majority of medium and large-size corporations annually report loss contingencies due to litigation. The most common disclosure is a note to the financial statements. Accrual of a loss due to pending or actual litigation is extremely rare.
Most companies realize that the outcome of litigation is highly uncertain, making likelihood predictions difficult. Companies may accrue estimated lawyer fees and other legal costs, but usually do not record a loss until after the ultimate settlement has been reached or negotiations for settlement are substantially completed. Instead, disclosure notes typically describe the specifics of the litigation along with whether management feels an adverse outcome would materially affect the financial position of the company.
Events occurring between a company’s fiscal year-end date and the financial statement issue date are called subsequent events. These subsequent events can be used to determine how contingencies, existing before the fiscal year end are reported.
If a contingency occurs after the fiscal year-end date, a liability cannot be accrued because it didn’t exist at the end of the year. However, if failure to disclose any possible loss would result in misleading financial statements, the situation should be described in a disclosure note, including the effect of any possible loss on key accounting numbers.
In fact, any event occurring after the fiscal year-end but before the financial statements are issued that has a material effect on the company’s financial position must be disclosed in
a subsequent events disclosure note. Examples are an issuance of debt or equity securities, a
business combination, and discontinued operations.
An unfiled lawsuit or an unasserted claim or assessment need not be disclosed unless it is probable that the claim or assessment will occur. If it is probable, then the likelihood of an unfavorable outcome and the feasibility of estimating a dollar amount should be considered in deciding whether and how to report the probable loss.
A two-step process is involved in deciding how and unasserted claim it should be reported:
1. Is a claim or assessment probable? (If the answer to this question is no, no disclosure is needed; skip step 2.)
2. Only if a claim or assessment is probable should we evaluate (a) the likelihood of an unfavorable outcome and (b) whether the dollar amount can be estimated. If the conclusion of step 1 is that the claim or assessment is not probable, no further action is required. If the conclusion of step 1 is that the claim or assessment is probable, the decision as to whether or not a liability is accrued or disclosed is precisely the same as when the claim or assessment already has been asserted.
Accounting for contingent losses is quite similar between IFRS and . GAAP. A loss contingency is accrued under . GAAP if it’s both probable and can be reasonably estimated. IFRS is similar, but defines “probable” as “more likely than not,” which is a lower threshold than typically associated with “probable” in . GAAP. Also, IFRS refers to these accrued liabilities as “provisions,” and refers to possible obligations that are not accrued as “contingent liabilities,” while the term “contingent liabilities” is used for all of these obligations in . GAAP.
If there is a range of equally likely outcomes associated with a contingency, IFRS requires using the midpoint of the range, while . GAAP requires use of the low end of the range.
Another difference in accounting relates to whether to report a long‐term contingency at its expected future value or its present value. IFRS requires reporting, present values of estimated cash flows when the effect of time value of money is material. . GAAP allows using present values under some circumstances when the timing of cash flows is fixed or reliably determinable.
A gain contingency is an uncertain situation that might result in a gain. Although loss contingencies are accrued when certain conditions are met, gain contingencies are not accrued. The practice of conservatism accounts for the difference in treatment of loss contingencies and gain contingencies.
Even though gain contingencies are not accrued, those that are material may be disclosed in notes to the financial statements. When disclosing gain contingencies, the wording should not be so optimistic as to give misleading implications as to the likelihood of realization.
Appendix 13: Payroll-Related Liabilities
Most of you have probably worked at some time in your life. You know that amounts are withheld from your paycheck and you may have wondered how this money is handled by your employer. In addition to remitting amounts withheld from your paycheck, your employer also pays payroll tax expenses in connection with having you on the payroll. These are not amounts withheld from your paycheck but are costs to your employer.
Gross pay is the amount you actually earn during a pay period. Out of your gross pay, amounts are withheld for social security (FICA) taxes, Medicare taxes, and federal income taxes. If you live in a state or locality that has an income tax, additional amounts will be withheld. In addition to these mandatory withholdings, you may elect to have amounts withheld from your gross pay. For example, if you are eligible to participate in a contributory retirement plan or a medical savings plan, your employer may withhold amounts from your pay to contribute to these plans for you.
Your gross pay less all withholdings, mandatory and voluntary, results in the net pay that you receive.
Employers are required by law to withhold federal (and sometimes state) income taxes and Social Security taxes from employees’ paychecks and remit these to the Internal Revenue Service.
The amount of income taxes withheld from your gross pay usually depends on how much you earn during the pay period and the number of withholding allowances you claimed on the W4 form you completed when you first went to work. Your employer must pay the taxes withheld from employees’ gross pay to the appropriate government agency.
The rate of withholding for FICA taxes and Medicare taxes increase periodically. Currently, the FICA rate is percent on the first $106,800 of gross pay. In addition, the Medicare rate of percent is applied to total gross pay with no limit on the amount of gross pay.
Your employer is required to match the amounts withheld for FICA and Medicare on a dollar for dollar basis. For example, for every ten dollars withheld from your paycheck, your employer must pay ten dollars on your behalf to the Internal Revenue Service.
The amount withheld from gross pay for voluntary deductions depends upon which plans you participate in at your place of employment. Your employer makes payments to the proper designated agencies for amounts withheld as voluntary deductions.
Your employer must match your contributions for FICA and Medicare taxes. In addition to matching your contributions for FICA and Medicare, your employer must pay all federal and state unemployment taxes. Let’s look a little closer at the unemployment taxes on the next slide.
The federal and state unemployment tax rates are subject to change. Currently, the federal rate is a maximum of percent on the first $7,000 of earnings for each employee. The federal tax can be reduced by as much as percent for contributions to state unemployment programs. Most states reduce this rate for employers with excellent employment records.
In addition to salaries and wages, withholding taxes, and payroll taxes, most companies provide a variety of fringe benefits such as health insurance, life insurance, and retirement programs. Employers must pay the amounts promised to fund employee fringe benefits to the designated agency.
End of chapter 13.
