Payroll calculation and accounting entry explanation

Chapter VIII: Payroll Accounting
12. Payroll Accounting Functionality and Explanation
ACCOUNTING EXPLANATION & HOW TO USE MS DYNAMICS AX 2012 R3 P a g e | 265
PAYROLL CALCULATION EXPLANATION
There are three main steps in which the system supports accounting by generating
automatic accounting entries after worker’s pay statement is calculated.
• When submitting pay statements, system will generate payroll disbursement
journals to recognize the “Net Pay” to workers.
• When posting pay statements, system will generate pay statement journals
to recognize payroll expenses.
• When generating vendor invoices, system will generate vendor invoice
journals to recognize debts payable into account payable module, e.g. taxes
payable, benefits payable.
In the step of generating pay statement, worker earnings, benefits and taxes will be
calculated. Payroll taxes including tax items and tax rates imposed by federal
government and states will be calculated automatically thanks to payroll tax
calculation engine generated in payroll module.
Payroll taxes include items such as social security tax, medicare tax, federal income
tax, state income tax and so on.
The calculation of social security and medicare tax is rather simple. Therefore, in this
part, we will focus more on federal income tax and state income tax.
There are three ways of calculating federal income tax:
• Percentage method
• Wage bracket method
• Supplemental method
The percentage method is widely used and integrated into software as a key method
of calculation.
Although this method involves many complicated calculations, it is more flexible
than the wage bracket method because it can be applied to payroll periods, such as
weekly, biweekly, semimonthly, monthly, quarterly, semiannually, and annually, and
to wage amounts that exceed those in the wage bracket tables.
The percentage method tables can be found in “IRS Publication 15, Circular E;
Employer's Tax Guide”. The Internal Revenue Service website is: https://www.irs.gov

RARE EXAMPLE 3: PAYROLL CALCULATION AND ACCOUNTING ENTRY EXPLANATION
In this example we will see in detail how Payroll module calculates salaries and
wages, tax and fringe benefits for workers and how automatic accounting entries are
booked.
Notes:
In this example, we assume that tax and tax rates of 2014 include the followings:
• Social Security tax of 6.2% is imposed on wages paid to employees. The tax is
imposed on both the employers and the employees.
• Medicare Tax of 1.45% of wages is imposed on employers and employees,
with no limitation.
• Federal Income Tax is calculated by using the percentage method and based
on the guidelines in “Publication 15, Cat. No. 10000W, (Circular E), Employer's
Tax Guide For use in 2014”.
• State Income Tax is calculated by using the formula published by Virginia
State on the website.: http://www.tax.virginia.gov/withholding-calculator
This withholding formula is effective 01/01/2008. The Virginia withholding
tax calculation formula is:
Keys:
G = Gross Pay for Pay Period P = Pay periods per year
A = Annualized gross pay E1 = Personal and Dependent Exemptions
T = Annualized taxable income E2 = Age 65 and Over & Blind Exemptions
WH = Tax to be withheld for pay
period W = Annualized tax to be withheld
Calculation steps
1. G x P - [$3000+ (E1 x 930) + (E2 x 800)] = T
2. Calculate W as follows:
If T is: W is:
Not over $3,000 2% of T
Over But Not Over Then
$3,000 $5,000 $60 + (3% of excess over $3,000)
$5,000 $17,000 $120 + (5% of excess over $5,000)
$17,000 $720 + (5.75% of excess over $17,000)
3. W / P = WH

In the September-pay period, Employee #3 is paid a monthly salary of $3,000 gross
and car allowance of $150. Car allowance is exempt from personal income tax. In
addition, the marital status of this employee is "single".
This employee participated in Aon Premier Care benefit and Roth 401 (k) saving plan.
Employee’s deduction from wages for Aon Premier Care is $10 per month and
contribution from employer is $15. Deduction from wages for Roth 401 (k) is 5% on
gross salaries and employer contribution is 50% of the amount deducted from the
employee's salary. It means that if the employee deduction for Roth 401 (k) = $3,000
x 5% = $150, the employer contribution for Roth 401 (k) = $150 x 50% = $75.
At the end of September, accountants will use Microsoft Dynamics AX to calculate
income for employees, fringe benefits and tax. Employee #3's pay statement is
calculated by the system as follows:
Pay statement totals:
• Gross pay: $3,150
• Employee deductions: $910.23
• Net pay: $2,239.77
• Employer contributions: $319.50
This includes the followings:
1. Earnings
FIGURE 12.66 PAY STATEMENT FORM – EARNINGS PAGE
Gross pay $3,150 include:
• Gross base salary: $3,000
• Car allowance: $150

2. Benefit calculations
FIGURE 12.67 PAY STATEMENT FORM – BENEFIT CALCULATIONS PAGE
Benefit calculations include:
• Aon Premier Care
o Employee deduction: $10
o Employer contribution: $15
• Roth 401(k)
o Employee deduction: $150
o Employer contribution: $75

3. Tax calculations
FIGURE 12.68 PAY STATEMENT FORM – TAX CALCULATIONS PAGE
Tax calculations include:
• Social Security tax – FICA (Federal Insurance Contributions Act tax)
o Employee deduction equal employer contribution:
$3,000 x 6.2 % = $186
• Medicare Tax
o Employee deduction equal employer contribution:
$3,000 x 1.45 % = $43.5
• Federal Income Tax
o Employee withholding: $384.06
This number should be round-off, which equals $384
• Virginia State Income Tax
o Employee withholding: $136.67

Federal Income Tax – Explanation
For 2014, Employee#3's withholding is $384, and is figured as follows:
Step 1: Looking at the monthly percentage method withholding table for single
person, the appropriate wage bracket is over $944 but not over $3,263.
FIGURE 12.69 PERCENTAGE METHOD TABLES FOR INCOME TAX WITHHOLDING (FOR
WAGES PAID IN 2014)
Step 2: The tax is $75.60
Step 3: Employee#3's excess wages are $2,056 = $3,000 - $944
Step 4: Multiply $2,056 by 15%, which equals $308.40
Step 5: Add $75.60 and $308.40, which equals $384
Federal Income Tax to be withheld per pay period is $384

State Income Tax – Explanation
TABLE 12.5 THE VIRGINIA WITHHOLDING TAX CALCULATION FORMULA TABLE
Keys:
G = Gross Pay for Pay Period P = Pay periods per year
A = Annualized gross pay E1 = Personal and Dependent Exemptions
T = Annualized taxable income E2 = Age 65 and Over & Blind Exemptions
WH = Tax to be withheld for pay period W = Annualized tax to be withheld
Calculation steps
1. G x P - [$3000+ (E1 x 930) + (E2 x 800)] = T
2. Calculate W as follows:
If T is: W is:
Not over $3,000 2% of T
Over But Not Over Then
$3,000 $5,000 $60 + (3% of excess over $3,000)
$5,000 $17,000 $120 + (5% of excess over $5,000)
$17,000 $720 + (5.75% of excess over $17,000)
3. W / P = WH
Step 1: Employee #3 is single person, with no spouse and children are blind. He
claims a total of zero exemptions.
• E1 = 0 (zero)
• E2 = 0 (zero)
Step 2: Employee #3 is paid on a monthly basis, and his gross wages for this pay
period were $3,000
• G = $3,000
Step 3: Calculations
1. G × P − [$3000 + (E1 × 930) + (E2 × 800)] = T
$3,000 × 12 − [$3,000 + (0 × 930) + (0 × 800)] = T
$36,000 − [$3000 + 0 + 0] = T
$33,000 = T
2. W is $720 + 5.75% of amount over $17,000 ($33,000 − $17,000 = $16,000)
5.75% of $16,000 = $920
$720 + $920 = $1,640
3. W / P = WH
$1,640 ÷ 12 = $136.67
State Income Tax to be withheld per pay period is $136.67

PAYROLL ACCOUNTING ENTRY EXPLANATION
Journal Entry #1
Journal Entry #1 is used to recognize the net salary (take home pay) payable to the
employees.
This is the first accounting entry in the payroll accounting process. When the
employee’s earning statement is reviewed and if everything was calculated correctly,
it will be submitted. This means that the employer is ready to pay the employee.
When earning statement is submitted, the system will generate accounting entry
automatically to record the net salary payable to the employee and post it into the
account payable module.
FIGURE 12.70 PAYROLL JOURNAL ENTRIES #1
Entry #1 Sub ledger
journal
Posting type Ledger account
Account name
Curr. Debit Credit
Payroll
payable
G_18000131 Vendor balance
00003, Clearing
account - Payroll USD 0.00 2,239.77
G_18000131
Purchase
expenditure for
expense
00003, Clearing
account - Payroll USD 2,239.77 0.00
Ledger account is used in this accounting entry is “Payroll clearing account” which is
set up in Payroll parameters.
Sub ledger account is used in this accounting entry is “Vendor account for worker
payments” which is set up in Payroll parameters.

Journal Entry #2
Journal Entry #2 is used to record the remittance of the payroll payment.
This is the second accounting entry in payroll accounting process. The payment
method to the employee can be check, electronic payment or cash. Regardless of the
payment method, after paying, the accountants have to book the payment.
Payroll payment journal will be generated automatically by the system at the same
time when the earning statement is submitted.
Entry # 2 Journal
number
Account name
Curr. Debit Credit
Payroll
Net Pay
Gene_1
6000123
Vendor
balance
00003, Clearing
account - Payroll USD 2,239.77 0.00
Gene_1
6000123 Bank 17100, Cash USD 0.00 2,239.77
In this accounting entry, the system will continue to use ledger account “Payroll
clearing account” as debit account. It means that “Vendor balance” in Entry #1 and
Entry #2 are settled. Account entry type “Purchase expenditure for expense” in Entry
# 1 will be settled in the next accounting entry: Entry # 3.
The credit account is “cash”; the reduced amount is for the corresponding net salary
of the employee.
Ledger account, sub ledger account and journal name in this entry are automatically
generated depending on the method of payment and payment journal name which
are setup in Payroll parameters.

Journal Entry #3
Journal Entry #3 is used to record the payroll expense and payroll-related expense
for employee’s salaries in the pay period.
This is the third accounting entry in the payroll accounting process. It is also
generated automatically when pay statement is posted. All expenses will be sorted
and aggregated for this entry, including the cost of salaries, fringe benefits and taxes.
All the liabilities will be aggregated. However, they will be sorted in details in the
next accounting entry: Entry #4.
Entry #3 Sub ledger
journal
Posting
type
Ledger account
Account name
Curr. Debit Credit
Payroll
post
costs
G_18000132 Payroll
51300, General and
Administrative USD
3,229.5
0 0.00
G_18000132 Payroll
35100, Current Tax &
Duty Liabilities USD 0.00 979.73
G_18000132 Payroll
52100, Employee
Benefits USD 240.00 0.00
G_18000132 Payroll
00003, Clearing
account - Payroll USD 0.00 3,150.00
G_18000132 Payroll
00003, Clearing
account - Payroll USD 910.23 0.00
G_18000132 Payroll
36100, Other
Liabilities USD 0.00 250.00
The “Payroll clearing account” in this accounting entry will be settled with account
entry type “Purchase expenditure for expense” left in Entry #1. It is split into 2
accounts: gross pay and employee deductions. Gross pay is treated as expense and is
the total of net pay and employee deduction. Its balance is credited while the
balance of “purchase expenditure for expense” left in Entry #1 is debited. At this
point of time, “Payroll clearing account” has completed its role.

The recognition of expenses and accounts payable are aggregated and categorized
depending on ledger account setup in parts of Earning Codes, Benefit Plans and Tax
codes.
Journal Entry #4
Journal Entry #4 is used to recognize payables to benefit provider and tax
authorities.
This is the fourth entry in the payroll accounting process. This accounting entry is
also automatically generated when Generate vendor invoices function is performed.
Total liabilities at this step will be split according to each vendor and posted into the
Account payable module.
The liabilities are aggregated and sorted accounting to the vendors, depending on
Accounting – Vendor setup in parts of benefit plans and tax codes.

Entry #4 Sub
ledger
journal
Account name
Curr. Debit Credit
Aon
heath
care
G_180001
33 Vendor balance 36100, Other Liabilities USD 0.00 25.00
G_180001
33
Purchase expenditure
for expense 36100, Other Liabilities USD 25.00 0.00
Roth
401(k)
G_180001
34 Vendor balance 36100, Other Liabilities USD 0.00 225.00
G_180001
34
for expense 36100, Other Liabilities USD 225.00 0.00
Social
security
tax
G_180001
35 Vendor balance
G_180001
35
for expense
Medicare
tax
G_180001
36 Vendor balance
G_180001
36
for expense
Social
security
tax
G_180001
37 Vendor balance
G_180001
37
for expense
Federal
income
tax
G_180001
38 Vendor balance
G_180001
38
for expense
Medicare
tax
G_180001
39 Vendor balance
G_180001
39
for expense
State
income
tax
G_180001
40 Vendor balance
G_180001
40
for expense
Although in Entry #3, the liabilities have been recorded. But those are only
recognized in the Ledger account. The entry of posting type “Vendor balance” in
Entry #4 is actually connected with sub ledger account - vendors.
The entry of posting type “Purchase expenditure for expense” in this entry is used to
settle the payables in the Entry # 3.
For example, liability of $250 in Entry #3 is defined as total liabilities of Aon Heath
Care and Roth 401 (k). It will be settled with entries of posting type "Purchase
expenditure for expense" in Entry # 4.

TABLE 12.6 LIABILITIES IN PAYROLL ENTRY #3 SETTLE TO “PURCHASE EXPENDITURE
FOR EXPENSE” IN PAYROLL ENTRY #4
Entry #3 Sub ledger
journal Posting type
Ledger account
Account name Curr. Debit Credit
Liabilities
G_18000132 Payroll
36100, Other
Liabilities USD 0.00
250.0
0
Liabilities in Entry #3 settle to “Purchase expenditure for expense” in Entry #4.
Entry #4
Sub ledger
journal Posting type
Ledger account
Account name Curr. Debit Credit
Aon heath
care
36100, Other
G_18000133
Purchase
expenditure for
expense
36100, Other
Roth
401(k)
36100, Other
Liabilities USD 0.00
225.0
0
G_18000134
Purchase
expenditure for
expense
36100, Other
Liabilities USD
225.0
0 0.00
At this time, accountants have to continue to make payments to the vendors for the
debts are recorded in details in Entry #4. However, payroll accounting processes is
now considered to be completed.
The book “Financial and Managerial Accounting in ERP System Microsoft Dynamics
AX 2012 R3”
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Payroll calculation and accounting entry explanation

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