Employee benefits are a large component of both small and large business costs; accounting for these costs incorrectly can greatly distort the financial picture of your business. Accounting for these costs, with a few exceptions, follows the basics rules of expense recognition, so by remembering to match the period the company incurs the cost with the period that the company receives the benefits you'll be over halfway there.
Determining Cost and Classification
Accounting for fringe benefits first requires the accountant to determine the cost of benefits. In many cases, this is as simple as examining the invoiced cost of insurance or other benefits and then correctly booking this cost as a general and administrative expense or sales expense, dependent on the classification of the employee as either administrative or sales staff. For some other benefits, such as share-based payment arrangements, where employees have stock options, or contingent consideration agreements, where a company's acquisition price changes based upon post-business combination conditions, the accounting becomes more complex and a certified public accountant should be involved.
Period of Benefit
In order to book a known expense amount, the period that the benefit is granted must be determined. In most cases, the expense for the fringe benefit is booked into the period matched with the period the employee worked to earn the benefit. For example, if an employee earns 7 hours of vacation time each pay period to accrue for annual leave, the company should record the expense each pay period of 7 hours of vacation and not wait until the employee uses the vacation.
Termination benefits, including severance payments, job placement and counseling costs are accounted for based upon the date that the company has an obligation to pay the benefit. This is determined based upon the date that the communication has been made to employees regarding their termination and whether employees must work a requisite service period to be eligible for the payout or benefits. If an employee is entitled to termination benefits whether the employee works until the employer's retention date or not, then an expense is incurred when the benefits are communicated to the employee. If the employee would forfeit the benefits by not working until a specified date, then the cost of the benefits should be recognized ratably over the period that the employee must work.
Pensions and 401k Plans
Accounting for post-employment benefits generally implies two types of plans. Defined benefit plans, commonly known as pension plans, provide a known payout based upon a number of years of service. These plans are waning in popularity. This is partially due to the complexity in the rules regarding pension accounting. Defined contribution plans, such as 401(k) plans, provide an unknown benefit amount at retirement based upon a series of contributions by employees and employers during the workers career. Employers account for the expenses related to defined contribution plans, including matching payments, by recognizing expense in step with the benefit that the company enjoys from the worker.