Financial Reporting of Employee Bonus - Essay Example

Case 1: You work in the financial reporting group at Joyner, Inc., a corporation that is in its first year as a publicly traded company.  Your group is preparing the company’s first-quarter financial statements.  Your supervisor has asked you to make sure the expenses are correctly presented in the quarterly report.  Joyner has a long-standing policy of paying generous year-end bonuses to its employees, typically 5% of the company’s net income before bonuses.  As you work on your section of the quarterly report, you wonder if the bonuses should be reflected in first-quarter expenses.  The projected net income before bonuses for the year is $17.2 million.  The preliminary net income before bonuses for the first quarter is $3.7 million.

According to (FASB 11) inaccurate recognition of bonuses results into inaccuracies within financial statements and hence it is important to make appropriate recording of bonuses as well as well as taxes associated with the same. Treatment of accounting transactions often requires careful consideration of the implications of the same both technically and at ethical levels. Reliable sources often emphasize the importance of accruing bonuses whenever it is expected that the company’s financial/operational performance will at least be equivalent to the set performance levels to warrant issuance of bonuses (Kimball 12). The accrual decision requires considerable judgment of the performance of the entire period which encompasses many future months during which one thing or another may impede achievement of the bonus plan objectives. A number of alternatives have been proposed for accrual of bonuses. These include:

Debit

Credit

Bonus expense

185,000

     Accrued bonus liability

185,000

Where payment for the accrued bonus is made later, the journal entry eliminates accrued bonus liability whilst recognizing any arising payroll tax liabilities which are associated with the accrued bonus. A entry for this could be as follows,

Debit

Credit

Accrued bonus liability

185,000

     Cash

xxx

     Taxes

xxx

As a matter of fact, when a percentage bonus is issued at the end of every quarter, it is important to recognize a portion of the bonus at the end of each month’s closing financial statements. For instance, the 5% bonus at each quarter’s end, an accrual of 5% of total salary expense is recorded at the end of every month’s cycle closure (FASB 54). A debit is posted to employee bonuses account for total accrual amount and credit is made to bonus accrual account. In the case discussed in the report, the bonus payment is pegged to the projected net income before bonuses of $17.2 million. However, going by the earnings for the current quarter, there is no high likelihood of attaining the projected income before payment of bonuses and hence its non-accrual is recommended until such time that the probability of attaining the projected income before bonus is achieved.

In general, the best way to treat the bonus expense is to handle it as an accrued expense or rather an expense incurred but not yet paid. This is consideration of the fact that whilst the bonus is anticipated, changes in the financial results of the company can prevent the company from incurring this expense at the end of the financial period. Incurrence of this expense is pegged on a condition which must be achieved for it to be affected. It is therefore important this expense is incurred where it is highly probable that the set condition is achieved. This account concept draws from the two principles which underlay accrual accounting. These include the following:

1. The first principle demands that expenses are only recorded upon being incurred and that the expenses are offset against corresponding revenues. In this case, the bonus expense will only be incurred at the end of the year when the set turnover has been achieved.
2. The second matching principle is on revenue recognition and demands that revenues are recognized wen realized and earned. In this context, revenues are “realized" when a cash claim is received, and revenues are "earned" upon transfer of the same.