K1 Financial Accounting

C2. Payroll

Payroll accounting records what an entity owes its employees and the authorities. Gross pay is the total earned before deductions. From gross pay the employer deducts income tax and the employee's social security contributions (and other deductions such as pension contributions) and pays them to the authorities. The employee receives net pay. The employer also pays its own social security contributions, which are an extra cost of employing the person.

The staff cost in profit or loss is gross pay plus the employer's social security contributions. The employee's deductions are not an extra cost to the employer, because they come out of the gross pay. The amounts deducted and the employer's contributions are liabilities until they are paid to the tax and social security authorities.

The journal at the payroll date is: debit payroll (staff costs) expense with gross pay plus the employer's contributions, credit net wages payable (or bank) with the net pay, credit the tax payable account with the income tax deducted, and credit the social security payable account with both the employee's and the employer's contributions. When the net pay is paid, debit net wages payable and credit bank, and when the authorities are paid, debit the payables accounts and credit bank.

Worked figures

Gross pay is $400,000, employee social security $30,000, employee income tax $50,000 and employer social security $40,000. Net pay = 400,000 - 30,000 - 50,000 = $320,000. Staff cost = 400,000 + 40,000 = $440,000. The amount owed to the authorities is 50,000 + 30,000 + 40,000 = $120,000.

Key terms

• Gross pay: Total pay earned before any deductions.
• Net pay: Pay received by the employee after deductions.
• Employer's social security contribution: A cost to the employer on top of gross pay.

Study tip: Remember that only the employer's contribution adds to the cost of staff. Everything deducted from the employee is already inside the gross figure.

Practice questions for section C2

H. Partnerships

A partnership is a business owned by two or more people who share its profits. The partnership agreement sets out how the partners will share profits and losses, and it usually covers the capital each partner contributes, interest on capital and drawings, partners' salaries, the profit-sharing ratio, what happens when a partner joins or leaves, and how disputes are settled. If there is no agreement, partners generally share profits equally.

The profit for the year is divided in an appropriation account. First any partners' salaries are deducted, then interest on capital is added for each partner, interest charged on drawings is deducted from the partner, and what remains is shared in the profit-sharing ratio. If there is a loss it is shared in the same way.

Each partner has a capital account and a current account. The capital account holds the amount of capital contributed, which stays fixed unless the partners agree to change it. The current account holds the partner's share of profit, salary and interest, less drawings and interest on drawings, so it changes each year. A debit balance on a current account means the partner has drawn more than has been earned.

The financial statements of a partnership are like those of a sole trader, with an appropriation account and a note or section showing the capital and current accounts of each partner. When a new partner is admitted, the old partners are entitled to the goodwill that has built up in the business. If goodwill is not kept in the books, it is created by crediting the old partners in their old profit-sharing ratio and then written off by debiting all the partners, including the new partner, in the new ratio. ACCA's note says no calculation of the value of goodwill is required, so the amount will be given.

Worked figures

Profit is $90,000. Partner A has a salary of $10,000. Interest on capital at 5 percent is $5,000 for A (capital $100,000) and $3,000 for B (capital $60,000). The residual is 90,000 - 10,000 - 5,000 - 3,000 = $72,000, shared 3:2, which gives A $43,200 and B $28,800. Partner A's total share is 10,000 + 5,000 + 43,200 = $58,200 and partner B's is 3,000 + 28,800 = $31,800.

New partner: A and B share 3:2. C joins and the new ratio is 2:2:1. Goodwill is given as $50,000. Creating it credits A $30,000 and B $20,000. Writing it off debits A $20,000, B $20,000 and C $10,000. The net effect is A +$10,000, B nil and C -$10,000.

Key terms

• Appropriation account: The account that shows how the profit is divided between the partners.
• Capital account: The account that holds each partner's fixed capital contribution.
• Current account: The account that records each partner's share of profit and drawings.

Study tip: Set out the appropriation as a table with a column for each partner. It makes errors easy to spot.

Practice questions for section H