Chapter 7
Calculating Pay and Recording Payroll Taxes: The Beginning of
the Payroll Process
Chapter Overview
This chapter examines the process of calculating employee pay and payroll taxes. The employees’ pay
depends on their status as hourly or salary. Hourly employees need to have their pay computed at their
hourly rate plus additional pay for overtime (if applicable), while for salaried employees it is usually a
set pay per period. Each employee actually receives net pay or the amount after withholdings for federal
income tax, state income tax, and social security tax have been subtracted from their gross earnings. The
federal income withholding depends on several factors, most importantly the number of allowances the
Learning Objectives
After studying Chapter 7, your students should gain proficiency in the following:
2. Prepare a Payroll Register and Maintain an Employee Earnings Record.
4. Journalize the Payroll Register, Employer Tax Liability, and Workers’ Compensation Insurance.
Chapter 7 Assignment Grid
Estimated Level
Learning Time in of
Assignment Topic(s) Objective(s) Minutes Difficulty
Discussion Questions and Critical Thinking/Ethical Case
1 Fair Labor Standards Act 1 5 Easy
2 Overtime Pay 1 5 Easy
3 W-4 Form 1 5 Easy
13 OASDI and Medicare Taxes 1 5 Medium
14 FUTA 3 5 Medium
15 SUTA 3 5 Medium
Concept Checks
1 Calculating Gross Earnings 1 10 Easy
2 FIT and FICA 1 15 Easy
3 Net Pay 1 15 Medium
Exercises (Set A)
7A-1 Gross Wages 1 15 Easy
7A-2 Net Pay 1 20 Medium
7A-3 Employer Tax 3 20 Medium
7A-4 Employer Tax 3 15 Easy
Exercises (Set B)
7B-1 Gross Wages 1 15 Easy
7B-2 Net Pay 1 20 Medium
7B-3 Employer Tax 3 20 Medium
Estimated Level
Learning Time in of
Assignment Topic(s) Objective(s) Minutes Difficulty
Problems (Set A)
7A-1 Gross Earnings 1 20 Easy
7A-2 Net Pay 1 30 Medium
Problems (Set B)
7B-1 Gross Earnings 1 20 Easy
7B-2 Net Pay 1 30 Medium
Financial Report Problem
Learning Unit 7-1: Gross Pay, Employee Payroll Tax Deductions
for Federal Income Tax Withholding, State Income Tax
Withholding, FICA (OASDI, Medicare), and Net Pay
Summary: Businesses need the ability to pay their employees and pay the associated payroll taxes. The
accounting process used in payroll is the same for all businesses regardless of size. The accountant that
calculates and records each payroll for the company and the following are especially important:
• Accountants must be accurate in everything. Any mistake made in working with the payroll may
affect both the employee and the company.
To begin the payroll process, employees are classified as “hourly” or “salaried”. If an employee is an
hourly employee, that employee only will be paid for the hours he or she worked. Employees classified
as salaried employees receive a fixed dollar amount for the time period worked. Pay periods are defined
involved in interstate commerce, which is doing business in more than one state. A workweek,
according to the law, is a 7-day (or 168-hour) period.
Federal Income Tax Withholdings are taxes that are also called payroll taxes and must be paid by the
employees. Employees pay these amounts by having them taken out, or withheld, from their paychecks.
W-4, Employee’s Withholding Allowance Certificate. It is completed by every employee and provides
information that will be used to determine the amount of federal income tax (FIT) withholdings.
Most states also charge their residents an income tax based on the amount of money they earn from their
employers. In those states a state income tax (SIT) withholding is necessary. FICA (Federal
Insurance Contribution Act) requires employers to withhold tax amounts from employees’ pay and
Key Concepts: Fair Labor Standards Act (Federal Wage and Hour Law), interstate commerce, pay or
payroll period, gross earnings (gross pay), workweek, Form W-4 (Employee’s Withholding Allowance
Certificate), allowances (also called exemptions), federal income tax (FIT) withholding, wage bracket
table, Circular E, state income tax (SIT) withholding, FICA (Federal Insurance Contributions Act),
taxable earnings, calendar year, medical insurance, net pay
Lecture Outline:
1. Gross Earnings:
a. Employee classification:
i. “hourly” where employees are paid based on the number of hours worked;
ii. “salary” where employees are paid a fixed dollar amount for the time period.
2. Pay periods: lengths of time by an employer to calculate the amount of an employee’s earnings.
a. daily,
b. weekly,
c. biweekly (every two weeks),
d. semimonthly (twice a month),
3. Gross earnings:
a. The total amount earned by an employee BEFORE any deductions are applied to reduce the
amount that employee finally receives.
4. Fair Labor Standards Act (FLSA): When the company is involved in interstate commerce, then the
FLSA is the Federal Wage and Hour Law that
a. contains rules stating the minimum hourly rate of pay,
b. is the law of overtime (maximum number of hours a worker will work before being paid
time and a half),
c. Has other rules and regulations employers must follow for payroll purposes.
d. The amount of pay for an hourly employee can be computed:
i. Regular pay + overtime pay, where
1. Regular pay = regular rate X regular hours
2. Overtime pay = regular rate X 1.5 X regular hours;
e. Or an alternative computation:
5. Employee payroll taxes and deductions:
a. Federal income tax withholding (FIT):
i. amount of income tax the employer withholds from the employee’s gross pay.
b. Circular E is an IRS tax publication of tax tables and is used to determine the amount of FIT
to withhold. Employers refer to the wage bracket table (See Fig. 7.2).
6. State income tax withholdings (SIT):
7. Other withholdings can be for:
a. county taxes,
8. FICA (Federal Insurance Contributions Act of 1935):
a. Social Security – OASDI (Old Age, Survivors, and Disability Insurance)
9. Net Pay:
a. Employee’s net pay is the gross pay less the total of FIT, SIT, FICA, and other withholdings.
Teaching Tips/Strategy:
Indicate to students that the earning limit and percentages may change on an annual basis. Assist
Use the “Ten-Minute Quiz” questions #1, #2, #3, #4 #5, #7 and #8 to reinforce the Learning Unit #1
concept.
Learning Unit 7-2: Preparing a Payroll Register and Maintaining
an Employee Earnings Record
Summary: The register includes each employee’s gross earnings, employee withholdings, net pay,
taxable earnings, cumulative earnings, and the accounts charged for the salary and wage expense
for that pay period. (See Figure 7.3)
After preparing the payroll register for the period, and in order to comply with all applicable
Key Concepts: Payroll register, individual employee earnings record
Lecture Outline:
1. The payroll register includes:
a. employee names,
b. pay period (daily, weekly, biweekly, semimonthly, monthly, quarterly, annually),
c. each employee’s gross earnings,
d. employee withholding taxes,
e. net pay,
2. Individual employee earnings record:
a. Prepared after the payroll register is completed and is required by law,
b. Summarizes the total amount of wages paid,
c. Summarizes the deductions per employee for the calendar year,
Teaching Tips/Strategy: Review the basic elements of the payroll register and the individual earnings
record. Use the Success Coach LU 7-2 to clarify the payroll register and employee earnings record
concepts.
Learning Unit 7-3: Employer Taxes for FICA (OASDI, Medicare),
FUTA, SUTA, and Workers’ Compensation Insurance
Summary: Employers pay exactly the same amount of Social Security taxes (OASDI and Medicare) for
each employee as the employee pays. The employee’s and employer’s OASDI rate is 6.2% each.
Employers also pay unemployment taxes (SUTA and FUTA) that are used to provide unemployed
workers with benefits while they are looking for work. Unemployment taxes are paid by employers
based on wages paid to employees. Federal Unemployment Tax Act (FUTA) taxes pay the costs of
Key Concepts: Federal Unemployment Tax Act (FUTA), State Unemployment Tax Act (SUTA),
workers’ compensation insurance, experience or merit rating
Lecture Outline:
1. Employers taxes:
a. FICA (Federal Insurance Contributions Act of 1937):
i. Social Security – OASDI (Old Age. Survivors, and Disability Insurance) and FICA –
Medicare .
ii. Employers’ amount is the same amount as the employees.
iii. Deposited every payroll or quarterly.
b. FUTA – Federal Unemployment Tax Act (1935):
i. Law that requires employer payments for the unemployment insurance portion.
ii. FUTA tax rate is 6.0% on gross wages up to a wage base limit of $7,000.
c. SUTA – State Unemployment Tax:
i. A tax levied by every state to provide income for unemployed workers.
ii. Wage base limits vary from state to state but have at least a base rate of $7,000.
iii. The wage rate may vary from state to state.
iv. Payment frequency depends on the state.
d. Workers’ Compensation Insurance:
i. Insurance required by the employers to protect their employees against losses due to
injury or death incurred while on the job.
ii. This insurance is completely paid by the employer (in most states).
iii. The rate varies from state to state and business to business based on the type of work
Teaching Tips/Strategy: The employer tax responsibilities are a complex subject and difficult for the
students to understand. Try using Concept Check #5 and Exercise 7A-3 to explain the employer’s tax
liabilities. Encourage the student to share their experiences and opinion on this topic. Explore the
Use the Success Coach LU 7-3 and the “Ten-Minute Quiz” questions #6 and #9 to review these
concepts.
Learning Unit 7-4: The Payroll Register, Employer Tax Liability,
and Workers’ Compensation Insurance
Summary: At this point in the payroll process, the accountant has calculated gross earnings, deductions
for employee withholdings, and net pay for each of the organization’s employees. The accountant enters
these amounts into two accounting records called the payroll register and the employee earnings record.
The accountant also computes the amount of payroll taxes that the employer must pay. The accountant
Workers’ compensation insurance is the insurance paid in advance by an employer to protect its
Key Concepts: Payroll tax expense
Lecture Outline:
Recording the Payroll – The first journal entry will record the employees’ payroll liability. It uses the
payroll register to determine:
1. The gross pay for each payroll expense category (hourly, salary, departmental, etc.)
2. The amounts of deductions owed for payroll taxes:
a. FIT Payable
b. SIT Payable
c. FICA OASDI Payable
d. FICA Medicare Payable
e. Other various liabilities
f. And Wages and Salaries Payable
The Journal Entry to record the payroll expense (employee’s payroll or paycheck details) is:
Dr. Specfic Deparmental Expense XXX
Cr. FIT Payable XXX
3. The payroll taxes are liabilities from the time the employee earns the salaries and the time the taxes
are paid to the taxing authority. These items are the employer’s responsibility and in most states,
ONLY the employer pays for those expenses.
4. Recording Payroll Tax Expense: Payroll Tax Expense is the general ledger account that records the
total of the employer’s FICA–OASDI, FICA-Medicare, FUTA, and SUTA taxes.
a. The employer’s payroll taxes are an added expense for the company and are not part of
the payroll expense that records the employee payroll and the employee withholding.
b. Tax liabilities are placed in separate liability accounts; because, for the most part, they
are paid to different taxing authorities on separate checks.
The journal entry to record the payroll (employer’s ONLY) is:
Dr. Payroll Tax Expense XXX
Cr. FICA OASDI Payable XXX
Teaching Tips/Strategy: Students need to realize that these amounts are liabilities at this point in time.
The salaries payable is a liability from the time the employee earns the salary and the time when they are
paid the salary. The student also needs to understand that FIT, SIT, and the employee’s portion of FICA
are not expenses to the company.
Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its!
Name Date Section
CHAPTER 7
TEN-MINUTE QUIZ
Circle the letter of the best response.
1. Tim earns $16 per hour. He worked 47 hours this pay period and receives time-and-a-half for
any hours worked over 40 hours per week. His gross pay is:
a. $640
b. $752
c. $808
d. $1,128
2. Employers determine the amount of federal income tax withholdings based on the number of
allowances an employee has indicated on form:
a. W-2
b. W-3
c. W-4
d. Circular E
3. Employers determine the amount of withholdings based on the employee’s designation of
allowances, the number of pay periods, the amount of pay per this pay period, and:
a. W-2
b. W-3
c. Form 941
d. Circular E
4 Generally, employers are required to withhold a portion of an employee’s wages for all except:
a. Federal unemployment tax
b. FICA
c. Federal income tax
d. State income tax
5 Employers may withhold all of the following except:
a. Union dues
b. FICA
c. FUTA
d. SIT
6. Employers pay which of the following tax(es)?
a. FUTA (employer and employee portions)
b. SUTA (employer and employee portions)
c. Medical insurance tax
d. FICA (employer portion)
7. Which of the following payroll taxes does not have maximum wage base?
a. FICA – OASDI
b. FICA – Medicare
c. FUTA
d. SUTA
8. Hallie’s earnings for the pay period are $5,200. Prior to this, she has earned a total of $125,400.
If the FICA-OASDI rate is 6.2% for the first $127,200 and the FICA-Medicare rate is 1.45%,
how much FICA tax should be withheld for this pay period?
a. $187.00
b. $397.80
c. $137.70
d. $286.20
9. Ken’s earnings for the pay period are $5,200. Prior to this, he has earned a total of $3,000. If the
state unemployment tax is 5.4% of the first $7,000 and the federal unemployment tax is 0.6%,
how much is the employer’s liability for federal unemployment tax?
a. $0
b. $24
c. $32
d. $248
10. Employers record each employee’s gross earnings, employee withholding taxes, net pay, and
taxable earnings in:
a. The payroll register
b. The payroll tax return
c. The social security return
d. The federal income tax return
Answer Key to Chapter 7 Quiz
1. c