Accounting Procedures for Calculating Bonuses

Bonus plans reward employees for achieving specific objectives. Some businesses pay bonuses on an “all-or-nothing” basis, while others use a sliding scale and pay according to how close an employee comes to fully achieving the objective. Bonus and commission plans are not the same. A bonus is a fixed amount, while a commission is most often a percentage based on a level of sales. Accounting procedures for calculating bonuses depend on how an employee qualifies to receive a bonus and how a bonus will be paid.

A first step in calculating a bonus is to decide whether an employee must meet the target objective in full or if the bonus will be paid according to how close an employee comes to meeting the target objective. Business rules can say, for example, that department managers will receive a quarterly bonus of $900 if service levels average 98 percent for the quarter. Business rules can also say that department managers can receive up to $900 quarterly, or $300 per month for each month that service levels average 98 percent.

Record an all-or-nothing journal entry for a bonus payment at the end of an accounting period by debiting the bonus expense account and crediting cash and payroll taxes payable accounts. Bonus payments are subject to the same payroll taxes as regular wages. The Internal Revenue Service lets the business decide whether to calculate federal income tax as normal or use a flat 25 percent withholding rate. States that have a tax withholding requirement vary as to whether the business can use a flat percentage rate. Calculate and record all other employee and employer payroll taxes, garnishments or other court-ordered payments the same as regular payroll. Business rules determine whether bonus pay is subject to voluntary deductions such as a retirement plan or charitable donation.

For bonus payments that accrue over time, start by determining whether a bonus will be paid for the interim period. Make no journal entry if the employee doesn’t qualify, but if a bonus will be paid for the period, debit a bonus expense account for the qualifying amount and credit an accrued bonus liability account. When paying the bonus at the end of the accounting period, debit the accrued bonus liability account for the full amount of the bonus and credit cash and payroll taxes payable.

Whether a bonus is a single payment or accrues over time, bonus earnings must be recognized in the tax year in which the expense is incurred. If the reporting period for a one-time bonus payment ends on Dec. 31 but the bonus isn’t actually paid until Jan. 15, year-end financial statements must show the total bonus due as a current liability. When payment is made in January, debit the liability account and credit cash and payroll taxes payable.