Non-Profit And Payroll Accounting: February 2015

Introduction to Nonprofit Accounting

From churches to youth organizations to the local chambers of commerce, nonprofit organizations make our communities more livable places. Unlike for-profit businesses that exist to generate profits for their owners, nonprofit organizations exist to pursue missions that address the needs of society. Nonprofit organizations serve in a variety of sectors, such as religious, education, health, social services, commerce, amateur sports clubs, and the arts.

Nonprofits do not have commercial owners and must rely on funds from contributions, membership dues, program revenues, fundraising events, public and private grants, and investment income.

Our intent is to present some of the basic concepts that are unique to nonprofit accounting and reporting, including the financial statements required by the Financial Accounting Standards Board (FASB).

Financial Statements of Nonprofits

The following table compares the main financial statements of a nonprofit organization with those of a for-profitcorporation.

Statement of Financial Position

Financial Statements of Nonprofits

The following table compares the main financial statements of a nonprofit organization with those of a for-profitcorporation.

Illustration of the Statement of Financial Position and the Statement of Activities

We are now ready to present examples of the statement of financial position and the statement of activities. To do that, we'll follow the activities of a nonprofit organization called Home4U, a daytime shelter for adults.

Let's assume that Home4U was incorporated in January 2013 and its accounting years will end on each December 31. The following transactions occurred during a three-month period.

Transaction 1. On January 31, a donor contributes $10,000, without restriction, for the operation of Home4U. This transaction affects the general ledger accounts as follows:

Assuming this is the only transaction in January, the general ledger account balances will result in the following financial statements:

Illustration of the Statement of Financial Position and the Statement of Activities

Let's assume that Home4U was incorporated in January 2013 and its accounting years will end on each December 31. The following transactions occurred during a three-month period.

Transaction 1. On January 31, a donor contributes $10,000, without restriction, for the operation of Home4U. This transaction affects the general ledger accounts as follows:

Assuming this is the only transaction in January, the general ledger account balances will result in the following financial statements:

Statement of Functional Expenses

The statement of functional expenses is described as a matrix since it reports expenses by their function (programs, management and general, fundraising) and by the nature or type of expense (salaries, rent). For instructional purposes we highlighted the column headings to indicate the expenses by function. We also highlighted the words in the first column as they indicate the nature or type of expenses.

The FASB does not require the statement of functional expenses for every nonprofit, however it is encouraged.

Introduction to Payroll Accounting

It's a fact of business—if a company has employees, it has to account for payroll and fringe benefits.

In this explanation of payroll accounting we'll introduce payroll, fringe benefits, and the payroll-related accounts that a typical company will report on its income statement and balance sheet. Payroll and benefits include items such as:

Many of these items are subject to state and federal laws; some involve labor contracts or company policies.

Note: AccountingCoach.com focuses on financial statement reporting and not on income tax returnreporting. You should consult with a tax professional or review the Internal Revenue Service publications to learn how employers and employees are required to report salaries, wages, and fringe benefits for income tax purposes.

For the years 2011 and 2012 only, the employee's tax rate for Social Security was 4.2% instead of the usual 6.2%. (The employer's rate remained at 6.2% and the employee and employer Medicare tax rates remained at 1.45%.)

Salaries, Wages, & Overtime Pay

In this section of payroll accounting we focus on the gross amounts earned by the employees of a company.

Salaries

Salaries are usually associated with "white-collar" workers such as office employees, managers, professionals, and executives. Salaried employees are often paid semi-monthly (e.g., on the 15th and last day of the month) or bi-weekly (e.g., every other Friday) and their salaries are often stated as a gross annual amount, such as "$48,000 per year." The "gross" amount refers to the pay an employee would receive before withholdings are made for such things as taxes, contributions to United Way, and savings plans.

Since salaried employees earn a specified annual amount, it is likely that their gross pay for each pay period is the same recurring amount. For example, if a manager's salary is $48,000 per year and salaries are paid semi-monthly, the manager's gross pay will be $2,000 for each of the 24 pay periods. (If the manager is paid bi-weekly, the gross pay would be $1,846.15 for each of the 26 pay periods.) A salaried employee's work period usually ends on payday; for example, a paycheck on January 31 usually covers the work period of January 16-31. This is convenient for accounting purposes if the company prepares financial statements on a calendar month basis.

Wages

Payroll Withholdings: Taxes & Benefits Paid by Employees

This section of payroll accounting focuses on the amounts withheld from employees' gross pay. (In Part 4 of payroll accounting we will discuss the payroll taxes that are not withheld from employees' gross pay.)

The U. S. income tax system—as well as most state income tax systems—requires employers to withhold payroll taxes from their employees' gross salaries and wages. The withholding of taxes and other deductions from employees' paychecks affects the employer in several ways: (1) it reduces the cash amount paid to employees, (2) it creates a current liability for the employer, and (3) it requires the employer to remit the withheld taxes to the federal and state government by specific deadlines. Failure to remit payroll taxes in a timely manner results in interest and penalties levied on the employer; flagrant violations trigger more severe consequences.

Payroll withholdings include:

Employee portion of Social Security tax
Employee portion of Medicare tax
Federal income tax
State income tax
Court-ordered withholdings
Other withholdings

Payroll Withholdings: Taxes & Benefits Paid by Employees

Payroll Taxes, Costs & Benefits Paid by Employers

In addition to salaries and wages, the employer will incur some or all of the following payroll-related expenses:

Employer portion of Social Security tax
Employer portion of Medicare tax
State unemployment tax
Federal unemployment tax
Worker compensation insurance
Employer portion of insurance (health, dental, vision, life, disability)
Employer paid holidays, vacations, and sick days
Employer contributions toward 401(k), savings plans, & profit-sharing plans
Employer contributions to pension plans
Post-retirement health insurance

1. Employer portion of Social Security tax

Payroll Taxes, Costs & Benefits Paid by Employers

In addition to salaries and wages, the employer will incur some or all of the following payroll-related expenses:

Employer portion of Social Security tax
Employer portion of Medicare tax
State unemployment tax
Federal unemployment tax
Worker compensation insurance
Employer portion of insurance (health, dental, vision, life, disability)
Employer paid holidays, vacations, and sick days
Employer contributions toward 401(k), savings plans, & profit-sharing plans
Employer contributions to pension plans
Post-retirement health insurance

1. Employer portion of Social Security tax

Examples of Payroll Journal Entries For Wages

NOTE: In the following examples we assume that the employee's tax rate for Social Security is 6.2% and that the employer's tax rate is 6.2%. (During the years 2011 and 2012 only, the employee's rate was reduced to 4.2%.)

In this section of payroll accounting we will provide examples of the journal entries for recording the gross amount of wages, payroll withholdings, and employer costs related to payroll.

Let's assume that a distributor has hourly-paid employees working in two departments: delivery and warehouse. The company's workweek is Sunday through Saturday and paychecks are dated and distributed on the Thursday following the workweek.

For the workweek of December 18-24, the gross wages are $1,000 for hourly employees in the delivery department and $1,300 for employees in the warehouse. Tax withholdings are determined by consulting government payroll guidelines; other withholdings are based on agreements with employees and court orders. Paychecks are dated and distributed on December 29.

The journal entry to record the hourly payroll's wages and withholdings for the work period of December 18-24 is illustrated in Hourly Payroll Entry #1. In accordance with accrual accounting and the matching principle, the date used to record the hourly payroll is the last day of the work period.

Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the workweek of December 18-24 that will be paid on December 29.

In addition to the wages and withholdings in the above entry, the employer has incurred additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2, which is also dated the last day of the work period. The items included are the employer's share of FICA, the employer's estimated cost for unemployment tax, worker compensation insurance, compensated absences, and company contributions for the company's 401(k) plan. The company is recognizing these additional expenses and the related liability in the period in which the employees are working and earning them. Later, when the company pays for them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company does not provide post-retirement benefits—like pensions or health insurance—to its employees.)

Hourly Payroll Entry #2: To record the company's additional payroll-related expense for hourly-paid employees for the workweek of December 18-24.

On payday, December 29, the checks will be distributed to the hourly-paid employees. The following entry will record the issuance of those payroll checks.

Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll checks on Dec. 29. (These checks reflect the net pay for the wages earned during the workweek of Dec. 18-24).

Some withholdings and the employer's portion of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following Hourly Payroll Entry #4 were remitted on payday.

Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the hourly-paid workweek of Dec. 18-24.

End of Month and End of Year

Let's continue with our example of the payroll for the hourly-paid employees. We'll assume that this distributor's accounting month and accounting year both end on Saturday, December 31. The matching principle requires the company to report all of its December expenses (not simply its cash payments) on its December financial statements. This means the company must report on its income statement the hourly wages and other payroll expenses that the company incurred (and the employees earned) through December 31.

Recall that the paychecks issued on December 29 covered the work done by hourly employees through December 24. The company must now record the cost of work done during the week of December 25-31 (a week that includes a Christmas holiday plus a number of employees taking vacation days).

Let's assume that during the workweek of December 25-31, delivery department employees took $300 worth of their holiday and vacation days. Since a portion of the employer's estimated cost of holiday and vacation days was recorded as an expense and liability via each week's Hourly Payroll Entry #2, the $300 associated with the days actually taken this week will not be recorded as an expense—rather, the $300 associated with the days taken this week will reduce the liability that is recorded with each week's Hourly Payroll Entry #2. In other words, only $700 of the delivery department's employee gross wages of $1,000 is for the work performed this week. The warehouse department had a similar situation. Of the warehouse department's $1,300 of weekly wages, only $1,050 is the expense for the work performed this week. The wages associated with the "days off with pay" reduces the company's liability that was provided for each week in Hourly Payroll Entry #2. Except for the holiday and vacation days, the workweek payroll for December 25-31 is similar to the previous week.

Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the workweek of December 25-31 that will be paid on January 5.

In addition to the wages and withholdings in Hourly Payroll Entry #1, the employer has incurred additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2, which is also dated the last day of the work period. The items included are the employer's share of FICA, the employer's estimated cost for unemployment tax, worker compensation insurance, compensated absences, and company contributions for the company's 401(k) plan. The company is recognizing these additional expenses and the related liability in the period in which the employees are working and earning them. Later, when the company pays for them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company does not provide post-retirement benefits-like pensions or health insurance-to its employees.)

Hourly Payroll Entry #2: To record the company's additional payroll-related expense for hourly-paid employees for the workweek of December 25-31.

On payday, January 5, the checks will be distributed to the hourly-paid employees. The following entry will record the issuance of those payroll checks.

Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll checks on Jan 5. (These checks reflect the hourly-paid employees' take home pay from their wages earned during the workweek of Dec. 25-31).

Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the hourly-paid workweek of Dec. 25-31.

Additional Accrual of Wages

In our example above, the workweek ended on the same day as the calendar month and year: December 31. In other months and in some years, the last full workweek might end on the 28th of the month. In that case, the employer will need to estimate the payroll and payroll-related expenses for the 29th, 30th, and 31st days of the month. Those estimates will be used to record an accrual-type adjusting entry on the 31st. This is required so that all of the expenses actually occurring during the month are matched with the revenues of the month. Recording wages expense in the proper period is critical for accurate financial statements and therefore a very important part of payroll accounting.

Examples of Payroll Journal Entries For Wages

In this section of payroll accounting we will provide examples of the journal entries for recording the gross amount of wages, payroll withholdings, and employer costs related to payroll.

Examples of Payroll Journal Entries For Salaries

Note: In the following examples we assume that the employee's tax rate for Social Security is 6.2% and that the employer's tax rate is 6.2%. (During 2011 and 2012 only, the employee's rate was reduced to 4.2%.)

Let's assume our company also has salaried employees who are paid semimonthly on the 15th and the last day of each month. The pay period for these employees is the half-month that ends on payday. There is one salaried employee in the warehouse department with a gross salary of $48,000 per year, or $2,000 per pay period. There are four salaried employees in the Selling & Administrative Department with combined salaries of $9,000 per pay period.

Because the salaried employees are paid on the last day of the month and their pay period ends right on payday, there is no need to accrue for salaries at the end of December (or any other calendar month). The salaried payroll entry for the work period of December 16-31 will be dated December 31 and will look like this:

Salaried Payroll Entry #1: To record the salaries and withholdings for the work period of December 16-31 that will be paid on December 31.

In addition to the salaries recorded above, the company has incurred additional expenses pertaining to the salaried payroll for this semi-monthly period of December 16-31. These expenses must be included in the December financial statements, as shown in the next journal entry:

Salaried Payroll Entry #2: To record additional payroll-related expense for salaried employees for the work period of December 16-31.

On payday, December 31, the checks will be distributed to the salaried employees. The following entry will record the issuance of those payroll checks.

Salaried Payroll Entry #3: To record the distribution of the salaried employees' payroll checks on Dec. 31. (These checks reflect the take-home pay for the salaries earned during the work period of Dec. 16-31).

Some withholdings and the employer portion of FICA were remitted on payday; others are not due until a later date. Some withholdings, such as health insurance, were recorded as reductions of the company's expenses in Salaried Payroll Entry #1. We will assume the amounts in the following Payroll Entry #4 were remitted on payday.

Salaried Payroll Entry #4: To record the remittance of some of the payroll withholdings and company matching pertaining to the salaried employees during the work period of Dec. 15-31.

Additional Information and Resources

Because the material covered here is considered an introduction to this topic, many complexities have been omitted. You should always consult with an accounting professional for assistance with your own specific circumstances.

Sample Transactions #4 - #6

Sample Transaction #4

The fourth transaction occurs on December 3, when a customer gives Direct Delivery a check for $10 to deliver two parcels on that day. Because of double entry, we know there must be a minimum of two accounts involved—one of the accounts must be debited, and one of the accounts must be credited.

Because Direct Delivery received $10, it must debit the account Cash. It must also credit a second account for $10. The second account will be Service Revenues, an income statement account. The reason Service Revenues is credited is because Direct Delivery must report that it earned $10 (not because it received $10). Recording revenues when they are earned results from a basic accounting principle known as the revenue recognition principle. The following tip reflects that principle.

Here's a Tip

Revenues accounts are credited when the company earns a fee (or sells merchandise) regardless of whether cash is received at the time.

Here are the two parts of the transaction as they would look in the general journal format:

Sample Transaction #5

Let's assume that on December 3 the company gets its second customer-a local company that needs to have 50 parcels delivered immediately. Joe's price of $250 is very appealing, so Joe's company is hired to deliver the parcels. The customer tells Joe to submit an invoice for the $250, and they will pay it within seven days.

Joe delivers the 50 parcels on December 3 as agreed, meaning that on December 3 Direct Delivery has earned$250. Hence the $250 is reported as revenues on December 3, even though the company did not receive any cash on that day. The effort needed to complete the job was done on December 3. (Depositing the check for $250 in the bank when it arrives seven days later is not considered to take any effort.)

Let's identify the two accounts involved and determine which needs a debit and which needs a credit.

Because Direct Delivery has earned the fees, one account will be a revenues account, such as Service Revenues. (If you refer back to the last TIP, you will read that revenue accounts—such as Service Revenues—are usually credited, meaning the second account will need to be debited.)

In the general journal format, here's what we have identified so far:

We know that the unnamed account cannot be Cash because the company did not receive money on December 3. However, the company has earned the right to receive the money in seven days. The account title for the money that Direct Delivery has a right to receive for having provided the service is Accounts Receivable (an asset account).

Again, reporting revenues when they are earned results from the basic accounting principle known as the revenue recognition principle.

Sample Transaction #6

For simplicity, let's assume that the only expense incurred by Direct Delivery so far was a fee to a temporary help agency for a person to help Joe deliver parcels on December 3. The temp agency fee is $80 and is due by December 12.

If a company does not pay cash immediately, you cannot credit Cash. But because the company owes someone the money for its purchase, we say it has an obligation or liability to pay. Most accounts involved with obligations have the word "payable" in their name, and one of the most frequently used accounts is Accounts Payable. Also keep in mind that expenses are almost always debited.

The accounts and amounts for the temporary help are:

Here's a Tip

Expenses are (almost) always debited.

Here's a Tip

If a company does not pay cash right away for an expense or for an asset, you cannot credit Cash. Because the company owes someone the money for its purchase, we say it has an obligation or liability to pay. The most likely liability account involved in business obligations is Accounts Payable.

Revenues and expenses appear on the income statement as shown below:

After the entries through December 3 have been recorded, the balance sheet will look like this:

Notice that the year-to-date net income (bottom line of the income statement) increased Stockholders' Equity by the same amount, $180. This connection between the income statement and balance sheet is important. For one, it keeps the balance sheet and the accounting equation in balance. Secondly, it demonstrates that revenues will cause the stockholders' equity to increase and expenses will cause stockholders' equity to decrease. After the end of the year financial statements are prepared, you will see that the income statement accounts (revenue accounts and expense accounts) will be closed or zeroed out and their balances will be transferred into the Retained Earnings account. This will mean the revenue and expense accounts will start the new year with zero balances—allowing the company "to keep score" for the new year.

Marilyn suggested that perhaps this introduction was enough material for their first meeting. She wrote out the following notes, summarizing for Joe the important points of their discussion:

When a company pays cash for something, the company will credit Cash and will have to debit a second account. Assuming that a company prepares monthly financial statements—
- If the amount is used up or will expire in the current month, the account to be debited will be an expense account. (Advertising Expense, Rent Expense, Wages Expense are three examples.)
- If the amount is not used up or does not expire in the current month, the account to be debited will be an asset account. (Examples are Prepaid Insurance, Supplies, Prepaid Rent, Prepaid Advertising, Prepaid Association Dues, Land, Buildings, and Equipment.)
- If the amount reduces a company's obligations, the account to be debited will be a liability account. (Examples include Accounts Payable, Notes Payable, Wages Payable, and Interest Payable.)
When a company receives cash, the company will debit Cash and will have to credit another account. Assuming that a company will prepare monthly financial statements—
- If the amount received is from a cash sale, or for a service that has just been performed but has not yet been recorded, the account to be credited is a revenue account such as Service Revenues or Fees Earned.
- If the amount received is an advance payment for a service that has not yet been performed or earned, the account to be credited is Unearned Revenue.
- If the amount received is a payment from a customer for a sale or service delivered earlier and has already been recorded as revenue, the account to be credited is Accounts Receivable.
- If the amount received is the proceeds from the company signing a promissory note, the account to be credited is Notes Payable.
- If the amount received is an investment of additional money by the owner of the corporation, a stockholders' equity account such as Common Stock is credited.
Note: To learn more about debits and credits, go to Explanation of Debits and Credits and Quiz for Debits and Credits.
Revenues are recorded as Service Revenues or Sales when the service or sale has been performed, notwhen the cash is received. This reflects the basic accounting principle known as the revenue recognition principle.
Expenses are matched with revenues or with the period of time shown in the heading of the income statement, not in the period when the expenses were paid. This reflects the basic accounting principle known as the matching principle.
The financial statements also reflect the basic accounting principle known as the cost principle. This means assets are shown on the balance sheet at their original cost or less and not at their current value. The income statement expenses also reflect the cost principle. For example, the depreciation expense is based on the original cost of the asset being depreciated and not on the current replacement cost.