Introduction:
TechCo, a company that manufactures electronic gadgets, paid its employee, John Doe, who is directly involved in the production process. John Doe's services are essential for converting raw materials into finished goods. As part of the salary payment, TechCo also accounted for the tax deduction at source (TDS) on John Doe's salary.
The Situation:
John Doe, an employee at TechCo, was paid a salary of $1,000 on August 25, 2024 for services provided during the monthly period ending August 23, 2024. John Doe's role involves directly converting raw materials into finished goods inventory. The salary payment was net of $150 tax deduction at source (TDS), which was deducted from his gross salary. The total gross salary was $1,150.
Case Facts:
Gross Salary for John Doe: $1,150
TDS: $150
Net Salary Paid to John Doe: $1,000
Date of Payment: August 25, 2024
Salary Period: Monthly period ending August 23, 2024
IFRS Journal Entries
Now, let’s think about how TechCo would record this transaction in their accounting books according to IFRS (International Financial Reporting Standards). Since John Doe's services were directly used to convert raw materials into finished goods, the salary cost should be capitalized into the inventory account, instead of expense.
When John Doe's salary is paid:
Debit: Inventory - Finished Goods for the gross salary amount (since his work was directly related to producing inventory).
Credit: Cash/Bank for the net salary paid to John Doe.
Credit: Tax Payable - TDS - Salaries, Wages & Fees - Direct for the TDS amount.
Can You Figure Out the Journal Entries?
Based on the information provided:
When TechCo pays John Doe's salary:
Debit: Inventory - Finished Goods for $1,150 (the gross salary, as this cost is directly related to production)
Credit: Cash/Bank for $1,000 (net salary paid to John Doe)
Credit: Tax Payable - TDS - Salaries, Wages & Fees - Direct for $150 (tax deducted at source or TDS from John Doe's salary)
Explanation:
Inventory - Finished Goods (Debit): Reflects the value of John Doe’s labor that was directly involved in creating the finished goods. This is an asset since it adds value to the inventory.
Cash/Bank (Credit): Decreases by the amount actually paid to John Doe after the TDS deduction.
Tax Payable - TDS - Salaries, Wages & Fees - Direct (Credit): Represents the tax liability that TechCo must remit to the government for the TDS deducted from John Doe’s salary.
This case study demonstrates how TechCo capitalizes labor costs directly related to production into inventory, and how it accounts for net salary payments and tax deductions. The journal entries ensure that all aspects of the transaction are accurately recorded in TechCo’s financial records.
Disclaimer: This case study is designed to enhance digital financial literacy and business management skills among students, to help them apply these concepts in real-world scenarios to boost their earnings, employability and entrepreneurial potential. The case was edited by Razi Amin, a Harvard MBA with 30+ years of leadership and advisory experiences at major international banks in New York, London, Hong Kong and Washington, DC. Razi is also a member of Harvard Alumni for Global Women's Empowerment. While AI technology was used for prompt-engineering to generate case content, every case has been rigorously reviewed and edited to ensure accuracy, clarity, and educational effectiveness. Reproduction of this case material is prohibited without permission from ASPEN Capital Solutions LLC.
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