Accounting: The Language of Business (Part 70)

Liabilities are just assets in hiding.

Mark Victor Hansen

 Current Liabilities (Part E)

by

Charles Lamson

Employees Earnings Record

The amount of each employee's earnings to date must be available at the end of each payroll period. This cumulative amount is required to compute each employee's social security and Medicare tax withholding and the employer's payroll taxes. It is essential, therefore, that a detailed payroll record be maintained for each employee. This record is called an employee's earnings record.

Exhibit 6, shows a portion of the employee's earnings record for John T. McGrath. The relationship between this record and the payroll register can be seen by tracing the amounts entered on McGrath's earnings record for December 27 back to its source---the fourth line of the payroll register in Exhibit 5 (from part 69).

EXHIBIT 6 Employee's Earnings Record

EXHIBIT 6 (concluded)

In addition to spaces for recording data for each payroll period and the cumulative total of earnings, the employee's earnings record has spaces for quarterly totals and the yearly total. These totals are used in various reports for tax, insurance, and other purposes. One such report is the wage and tax statement, commonly called a Form W-2. You may recall receiving a W-2 form for use in preparing your individual tax return. This form must be provided annually to each employee as well as to the Social Security Administration. The amounts reported in the Form W-2 shown below were taken from McGrath's employees earnings record.

Payroll Checks

At the end of each pay period, payroll checks are prepared. Each check includes a detachable statement showing the details of how the net pay was computed. Exhibit 7 is a payroll check for John T. McGrath.

EXHIBIT 7 Payroll Check

The amount paid to employees is normally recorded as a single amount, regardless of the number of employees. There is no need to record each payroll check separately in the journal, since all of the details are available in the payroll register.

For paying their payroll, most employers use payroll checks drawn on a special bank account. After the data for the payroll period have been recorded and summarized in the payroll register, a single check for the total amount to be paid is written on the firm's regular bank account. This check is then deposited in the special payroll bank account. Individual payroll checks are written from the payroll account, and the numbers of the payroll checks are inserted in the payroll register.

    

An advantage of using a separate payroll bank account is that the task of reconciling the bank statements is simplified. In addition, a payroll bank account establishes control over payroll checks by preventing the theft or misuse of uncashed payroll checks.

Currency may be used to pay payroll. However, many employees have their net pay deposited directly in a bank. In these cases, funds are transferred electronically.

Payroll System Diagram

You may find Exhibit 8 useful in following the flow of data within the payroll segment of an accounting system. The diagram indicates the relationships among the primary components of the payroll system we described in this post.

Our focus in the preceding discussion has been on the outputs of a payroll system: the payroll register, payroll checks, the employee's earnings records, and tax and other reports. As shown in the diagram in Exhibit 8, the inputs into a payroll system may be classified as either constants or variables.

Constants are data that remain unchanged from payroll to payroll and thus do not need to be entered into the system each pay period. Examples of constants include such data as each employee's name and social security number, marital status, number of income tax withholding allowances, rate of pay, payroll category (office, sales, etc.), and department where employed. The FICA tax rates and various tax tables are also constants that apply to all employees. In a computerized accounting system, constants are stored within a payroll file.

Variables are data that change from payroll to payroll and thus must be entered into the system each pay period. Examples of variables include such data as the number of hours or days worked for each employee during the payroll period, days of sick leave with pay, vacation credits, and cumulative earnings and taxes withheld. If salespersons are paid commissions, the amount of their sales would also vary from period to period.

Internal Controls for Payroll Systems

Payroll processing, as we discussed above, requires the input of a large amount of data, along with numerous and sometimes complex computations. These factors, combined with the large dollar amounts involved, require controls to ensure that payroll payments are timely and accurate. In addition, the system must also provide adequate safeguards against theft or other misuse of funds.

It is normally desirable to use a system that includes procedures for proper authorization and approval of payroll. When a check-signing machine is used it is important that blank payroll checks and access to the machine be carefully controlled to prevent the theft or misuse of payroll funds.

It is especially important to authorize and approve in writing employee additions and deletions in changes in pay rates. For example, numerous payroll frauds have involved a supervisor adding fictitious employees to the payroll. The supervisor then cashes the fictitious employees' checks. Similar frauds have occurred where employees have been fired but the payroll department is not notified. As a result, payroll checks to the fired employees are prepared and cashed by a supervisor.

To prevent or detect frauds such as those we described above, employees' attendance records should be controlled. For example you may have used an "In & Out" card on which your time of arrival to and departure from work was recorded when you inserted the card into a time clock. A payroll department employee may be stationed near the time clock during normal arrival and departure times in order to verify that employees "clock-in" only once and only for themselves. Employee identification cards or badges may also be used to verify that only authorized employees are clocking in and are permitted to enter work areas. When payroll checks are distributed, employee identification cards may be used to deter one employee from picking up another check.

Other controls include verifying and approving all payroll rate changes. In addition, in a computerized system, all program changes should be properly approved and tested by employees who are independent of the payroll system. The use of a special payroll bank account, as we discussed earlier in this post, also enhances control over payroll. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 448-452*

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