Payroll accounting

The accounting for payroll involves all aspects of paying compensation and benefits to employees. The outcome of this process is precise records regarding the expenses associated with all types of compensation, as well as timely payments to employees. Though some systems that incorporate more or less automation may not include all of these steps, the general process flow will apply to most payroll systems:

  1. Set up new employees. Have new employees fill out payroll-specific information as part of the hiring process, such as the W-4 form and medical insurance forms that may require payroll deductions. Set aside copies of this information in order to include it in the next payroll.
  2. Collect timecard information. Salaried employees require no change in wages paid for each payroll, but you must collect and summarize information about the hours worked by non-exempt employees. This may involve having employees scan a badge through a computerized time clock.
  3. Verify timecard information. Summarize the payroll information just collected and have supervisors verify that employees have correctly recorded their time.
  4. Summarize wages due. Multiply the number of hours worked by the pay rate for each employee, also factoring in any overtime or shift differentials.
  5. Enter employee changes. Employees may ask to have changes made to their paychecks, usually to the number of tax exemptions or pension withholdings. You may need to record much of this prior to calculating taxes, since it impacts the amount of wages to which taxes are applied.
  6. Calculate taxes. Use IRS tax tables to determine the amount of taxes to be withheld from employee gross wages.
  7. Calculate wage deductions. There may be a number of additional deductions to take away from employee net income, including deductions for medical insurance, life insurance, garnishments, and union dues. You must also track the goal amounts for these deductions, so that you stop deducting once the goal totals are reached.
  8. Deduct manual payments. If manual payments have already been made to employees, such as advances, then deduct these amounts from the remaining net pay.
  9. Create a payroll register. Summarize the wage and deduction information for each employee in a payroll register, which you can then summarize to also create a journal entry to record the payroll. This document is automatically created by all payroll software packages.
  10. Print paychecks. Print employee paychecks using the information in the payroll register. You normally itemize gross wages, deductions, and net pay in a remittance advice that accompanies the paycheck.
  11. Pay by direct deposit. Notify your direct deposit processor of the amount of any direct deposit payments, and issue remittance advices to employees for these payments.
  12. Issue paychecks. Have a paymaster issue paychecks to employees, requiring employee identification if there are a large number of employees.
  13. Deposit withheld taxes. Deposit all withheld payroll taxes and employer matched taxes at a bank that is authorized to handle these transactions.

Payroll Journal Entries

The primary journal entry for payroll is the summary-level entry that is compiled from the payroll register, and which is recorded in either the payroll journal or the general ledger. This entry usually includes debits for the direct labor expense, salaries, and the company's portion of payroll taxes. There will also be credits to a number of accounts, each one detailing the liability for payroll taxes that have not been paid, as well as for the amount of cash already paid to employees for their net pay. The basic entry (assuming no further breakdown of debits by individual department) is:

  Debit Credit
Direct labor expense xxx  
Salaries expense xxx  
Payroll taxes expense xxx  
     Cash   xxx
     Federal withholding taxes payable   xxx
     Social security taxes payable   xxx
     Medicare taxes payable   xxx
     Federal unemployment taxes payable   xxx
     State withholding taxes payable   xxx
     State unemployment taxes payable   xxx
     Garnishments payable   xxx


When you later pay the withheld taxes and company portion of payroll taxes to the IRS, you then use the following entry to reduce the balance in the cash account, and eliminate the balances in the liability accounts:

  Debit Credit
     Cash   xxx
Federal withholding taxes payable xxx  
Social security taxes payable xxx  
Medicare taxes payable xxx  
Federal unemployment taxes payable xxx  
State withholding taxes payable xxx  
State unemployment taxes payable xxx  
Garnishments payable xxx  

 
It is quite common to have some amount of unpaid wages at the end of an accounting period, so you should accrue this expense (if it is material). The accrual entry, as shown next, is simpler than the comprehensive payroll entry already shown, because you typically clump all payroll taxes into a single expense account and offsetting liability account. After recording this entry, you reverse it at the beginning of the following accounting period, and then record the actual payroll expense whenever it occurs.

  Debit Credit
Direct labor expense xxx  
Salaries expense xxx  
     Accrued salaries and wages   xxx
     Accrued payroll taxes   xxx