Bonus Accrual

Top

Newsletter Sign Up

Home >> Payroll Accounting Topics

Overview of the Bonus Accrual

Create a bonus accrual journal entry whenever the expected financial or operational performance of the company matches or exceeds the levels required in the bonus plans for various employees. For example, the management team may be given a year-end bonus if profits exceed ten percent of revenues, or the sales staff may receive an override commission if the entire group’s sales exceed $10 million. A sample of this transaction is shown below:

	Debit	Credit
Bonus expense [by department]	xxx
Accrued bonus liability		xxx

When the bonus is eventually paid, the resulting journal entry will clear out the accrued bonus liability, while also recording any payroll tax liabilities associated with the bonus payment, as shown below:

	Debit	Credit
Accrued bonus liability	xxx
Cash		xxx
Federal withholding taxes payable		xxx
Social security withholding taxes payable		xxx
Medicare withholding taxes payable		xxx
Federal unemployment taxes payable		xxx
State withholding taxes payable		xxx
State unemployment taxes payable		xxx

The decision to make the bonus accrual entry is extremely judgmental, since the eventual awarding of the bonus may be subject to results in future months that you can only guess at early in the bonus measurement period. Consequently, it is common to either only make the entry after several months of performance have been completed, or to enter smaller amounts early in the measurement period and larger ones later on, after the likelihood of success has become more clear.

The source information for the bonus accrual should be stored in the human resources department, which should have control over the underlying bonus plans for all employees. The payroll staff should convert these sometimes complex documents into a brief summary document that clearly outlines the potential amounts of any bonuses, as well as the goals that must be achieved in order to be awarded them.

The Two and a Half Month Rule

If a company accrues a bonus expense at the end of one tax year and does not pay out the bonus within two and a half months of the year end, these payments are not deductible unless the employee receiving the bonus has reported the bonus payment in his taxable income. Alternatively, if the company does pay the employee within two and a half months of the year end, it can deduct the expense in the tax year in which the employee earned the bonus.