Accrual Method for the Corporation, Cash Method for the Employees
The short answer is that the corporation’s financial statements are prepared using the accrual method of accounting (generally accepted accounting principles), while the employee payroll records for the Internal Revenue Service (IRS) requires the cash method of accounting.
Example of the Corporation’s Wages Expense (Based on Work Dates)
To illustrate, let’s assume that a new retailer (that uses the accrual method of accounting) begins operations on December 27. The employees working from December 27 through December 31 will receive their first paychecks on January 4. If the employees earn a total of $5,000 of wages during the five days ending on December 31, the retailer’s general ledger and financial statements for the period ending December 31 must report wages expense of $5,000 and a liability of $5,000 as of December 31. In accounting jargon, the retailer must accrue the expense and liability through an adjusting entry dated December 31.
Example of the Employees’ Earnings Reported to IRS (Based on Pay Dates)
The retailer’s payroll department must report to the IRS the wages paid. Therefore, the amount reported to the IRS is based on the pay dates. Since January 4 is the first time the employees will be paid, the employees’ wages earned during December 27-31 will be reported to the IRS as January wages.
