Accounting for Performance Bonus
Performance bonus is the additional payment from the employer to the employee regarding the company’s performance. Employers provide extra pay to the staff as a reward for their hard work in the prior year. It will motivate staff to work harder and achieve higher profit in the future.
Bonus is the extra expense of the company when profit has to reach a certain level. The company usually prepares a budget at the beginning of the year. It includes the bonus package when actual profit equal to or higher than target profit. The amount of bonus will depend on the company policy and board approval.
The bonus package will be allocated to all staff base on the board and management decisions. Some company designs the bonus package base on the total salary expense so they simply allocate to all staff base on the percentage. So everyone will receive the bonus at a certain percentage of their salary. Some company will allocate the package to each department. Head of department has the right to allocate bonuses base on individual performance.
Bonus Journal Entries
Bonus is the expense of the company in the current financial year. It will reduce the profit of the company.
Performance Bonus Example
Company ABC has prepared the budget at the beginning of the year. They will provide a bonus of one million if the company profit is more than $ 10 million.
At the end of the year, company makes a profit of $ 15 million, so it is more than the target and employees will be entitled to receive the performance bonus.
At the end of the year, company should record the following entries:
When the company make payment to the staff
Accrual Performance Bonus
Bonus is the expense that should be recorded in the current financial year. However, it usually paid in the next accounting period after the year-end closing. We need to wait for the current year report which depends on how fast the report is prepared. So it will be too late to record the bonus expense. In order to comply with the matching principle, the company should make a proper accrual bonus at the end of the financial year.
The current year’s income statement needs to reflect the bonus expense even it is not yet paid. The bonus is the current year’s expense so we could not record it as the next year’s expense even it is paid in next period. Besides the expense, company also records the bonus payable as the liability to employees.
The company only accrue the bonus when there is a high possibility that the profit will reach a certain level. The management expects that the company can achieve the financial goal. Otherwise, it will overstate the expense in the current year which will impact the profit as the expense will not happen.
The accrued bonus can be different from the actual expense due to under or over accrue. The difference will impact the next accounting record. If the company accrue less than the actual payment, they need to record extra expenses in the next report. If the company accrue more than the actual expense, they need to reverse the difference to expense. The treatment here is the same as normal accrual.
Accrued Bonus Journal Entries
|Accrued Bonus Expense||000|
|Accrued Bonus Payable||000|
When the company makes payment to employee:
|Accrued Bonus Payable||000|
|Salary Tax Payable||000|
|Other Tax Payable||000|
The Impact of Tax on Bonus
The whole bonus package will not be paid to the staff, it needs to deduct some portion as the tax. The tax includes salary tax, withholding tax on social security, federal withholding tax, withholding tax on medical and other tax. A large part of the bonus package will be paid to the government instead.