Payroll Accounting

What Is Payroll Accounting?

Payroll accounting is the management and bookkeeping of an employee’s compensation. This information is aggregated into financial journal entries that detail the date of compensation, its numerical values, and where it is delivered. 

Payroll is recorded in journal entries, which, when consolidated, will build into the general ledger. This general ledger is the list of broader corporate transactions that are essential for financial reporting. 

Accounting software may make payroll easier, assist organizations in expanding and avoiding overextension, and provide a better understanding of employee costs, which is critical for sensible growth.

Regardless of sector or vertical, accounting aids in understanding how payroll affects the bottom line. Without comprehensive payroll accounting records, determining employee costs gets increasingly difficult as the business scales.

Whether someone manages payroll in-house or outsourced to a payroll agency, be sure someone’s payroll and accounting software are tightly integrated. 

Smart businesses monitor cash entering and leaving their accounts closely, especially when it comes from the most expensive expenditure, employees.

Common Line Items in Payroll Accounting

The following are common line items in payroll accounting:

1. Gross wage reparations (expense): Salaries, wages, paid time off (PTO), or any taxable income reported on their W-2 at the end of the year.
2. Paycheck deduction for benefits (expense): Health, dental, vision, other governed-mandated deductions, garnishments for children or spousal support, and other supplemental insurance. 401k or other retirement employer-provided retirement plans.
3. Federal, state, and/or local tax (liability): The amount withheld from employee paychecks for taxes.
4. Federal Insurance Contributions Act (FICA) taxes (liability): Medicare and Social Security taxes
5. Workers‘ compensation (liability): Amount paid to workers who have been impaired due to their occupation.

Why is Payroll Accounting Important?

Payroll accounting lets you maintain a record of employee costs. It’s significant for primarily three reasons:

• Scrutinizing company expense
• Identifying and computing the cost of each employee
• Guaranteeing tax conformity

Accurate payroll accounting helps you see the cost associated with employees, so it can be used to access company-wide profitability.

Employee compensation, payroll taxes, employer parts of federal withholdings, employee benefit payments, and other deductions are all included. 

Payroll accounting software ensures that anyone not only keeps track of their payroll bills but also follows all local, state, and federal employment requirements and doesn’t break any tax laws. 

Professionals who focus on payroll accounting are essential for organizations aiming for efficient business and office administration and compliance with tax legislation. It’s critical not just from a financial management standpoint, but also from a legal and technological standpoint. 

Management has to ensure they are paying the employees fair market and aren’t allocating funds in the wrong areas. 

From a legal standpoint, someone will normally be required to record what they are paying to their employees to the Treasury so they can appropriately monitor tax and payroll deductions and match them up with tax returns for the firm and the persons being paid.

Payroll Accounting Entries

The process involves determining primary items, gathering payroll-related documents, and recording them on a payroll journal entry to the general ledger.

1. Identify and set up payroll-related accounts

Management in corporate has to decide how to compensate employees and to what degree of magnitude.

This could include, but is not limited to:

• Employee compensation
• Employer taxes and insurance
• Benefits
• Payroll taxes payable
• Employee deferrals payable

Benefits might encompass health, dental, life, vision, sick leave, pension plans, child care benefits, paid leave, and others. 

Attractive benefits drive more motivation for employees and an aptitude to produce better quality work products and processes. Some benefits are optional and some are mandated by law in either the federal, state, or local level.

Not all jobs are the same, so project-based roles are driven by salaries, and hourly-based roles are driven by wages. Payroll schedules affect the intermediate liquidity in cash for companies within every fiscal quarter, so payroll schedules are important. 

Compensation is usually cashed out weekly, biweekly, semimonthly, and monthly. There are exceptions for daily cashed-outs, typically for waged employees or an end-of-the-year bonus seen in salaried jobs.

2. Obtain paperwork from new employees 

Essential paperwork is required for onboarding. Common forms employees need to fill out include:

• W-4 form: Employees complete this form to designate how much they wish to have withheld from their pay for taxes.
• I-9 form: Check the citizenship of people within the United States. All employers in the U.S. are required to have employees complete this form before being officially hired.
• State withholding forms (if applicable)
• Direct deposit authorization form: Authorizes employers to deliver payroll to an employee’s bank account.

3. Determining payroll for employees' side

Calculate taxes and other deductions based on compensation into the payroll journal entries.

Pick the methodology to determine payroll delivery payments:

For this example, we will opt for initial recording since it’s by far the most common method utilized by both, accountants and software.

The payroll employment to this specific employee is $1,650 after accounting for withholdings. 

Additional withholdings can be accounted for in addition to government-mandated ones. Gross wages encompass all taxable income.

This process has to be repeated for all hourly or salaried employees on the employer’s payroll. This isn’t done by hand as accounting software commonly performs this arithmetic. 

4. Determining payroll expenses for the employer side

Step 3 was the employee side of the take-home payroll. Step 4 is the expenses and liabilities items for the employer side. 

There are still benefits labor receives that aren’t withheld from the employees but are still an expense for the employers. These are called payroll expenses & liabilities which are usually recorded in a journal entry by month.

Set up an expense and liability account with many of the common line items including but not limited to:

• Dental Insurance expense
• Vision Insurance expense
• Health insurance expense
• 401k match expense
• Paid time off expenses
• Sick leave expense and liability
• Parental leave expense
• Disability insurance expense
• Tuition reimbursement expense
• Stock options or equity expense
• Performance bonuses expense
• Employee discount expense
• Federal and state tax liability
• Federal Insurance Contribution Act tax liability
• Workers compensation liability

A good example would be health insurance expense, which is common in most American workplaces. After reaching a deductible, every dollar additionally spent is an expense to the employer but not the employee. 

On the employee side, nothing gets withheld so the net take-home pay is the same, but for the employer side, expenses would increase.

5. Tax payments

After determining the payroll costs for both the employer and the payroll income for the employes, taxes are the final step. 

Aggregate all the taxes the employees pay through withholdings each pay period as well as what the business owes. 

For example, employees do not pay unemployment tax, but it gets aggregated anyway to the total tax payments for the company. 

Taxes are usually paid out every quarter or fiscal year. Most companies keep all of their tax records on file in preparation for any surprise tax audit to avoid hefty penalties.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accounting Equation
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• Bond Payables
• Capitalized Cost