Deferred compensation disbursements are generally not requested by the employee until after he or she retires.
Deferred compensation is an agreement between the employer and the employee to pay the employee at some point in the future, instead of when payment is normally due. The agreement to defer compensation can be informal or formal. Sometimes compensation is held in escrow to ensure the employee is paid. In deferred compensation accounting, an employee’s pay is recorded at the end of an accounting period as an adjustment to interim accounts.
Adjustments come in two forms, deferrals and accruals. Deferrals are cash payments made for assets before they are used, or payments for liabilities before income is earned. Provisions are income earned or expenses incurred but not paid or recorded before the adjustment. Therefore, although the deferred compensation accounting is labeled as deferred, it is actually a provision in accounting terms.
Accountants often use accrued expense techniques when adjusting and accounting for deferred compensation. The accountant cannot record the offset during daily expense calculations because no money was actually spent. A deferred compensation adjustment serves two purposes: it records the salary on the company’s balance sheet and it recognizes the expense as a liability for the current accounting period. Before the adjustment, the company’s expenses and liabilities are listed as lower than they actually are.
The deferred compensation accounting process typically begins when the accountant identifies the time period in which the salary expense was incurred. For example, if a company uses accounting periods of one month, the accountant determines what compensation expenses occurred in the current month. This identifies the appropriate amount of compensation for the time period. The accountant then records the full amount of the compensation under the heading of salary expenses, labeling it wages payable to distinguish the compensation from other types of salary expenses.
On the company’s balance sheet, the deferred compensation posting appears on the left -or assets- as payroll expenses, and on the right -or liabilities- as wages payable. The registration process is different if the compensation is escrowed. Instead of using accrued expense techniques, the accountant will likely only use the method the company uses for regular salary payments. The US Internal Revenue Service (IRS) requires companies to apply regular payroll tax codes when accounting for deferred compensation.