What is Payroll Accounting?
The payroll accounting is an accounting function within the organization that looks into the management, recording, determination, and analysis of the compensation of the employees. They work towards the calculation of taxes and benefits along with the salary given to the employees.
The accounting function looks into the reconciliation of employee benefits such as superannuation schemes and gratuity. It determines the taxes payable by each employee corresponding to the salaries payable by the organization. It also determines the amount which would be deducted on the salaries payable.
These deductions are always in line with the applicable legal laws. The deductions under the US laws are federal withholdings, FICA, state withholdings, employee health insurance costs, 401K, disability taxes of state.
Examples of Payroll Accounting
Let us take an example of a business that has to pay $1,000 to the employee. The applicable federal income taxes amount to $100, State income taxes amount to $150, and FICA is payable at $50. Help the payroll executive prepare journal entries and record the transaction.
Here, $1,000 would be recorded as gross salaries under expense account of the income statement, and hence it would be shown as credit. As a balancing act, record the FICA, State income taxes, federal income taxes, and salaries payable liability account of the balance sheet as the debit.
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Note, whenever there is an increase in a liability account, it is credited, whereas whenever there is an increase in the expense account, it is debited. The following would be the journal entry, as shown below: –
Types of Payroll Accounting
There are three basic types. These comprise of accrued wages, manual payments, and initial recordings.
#1 – Initial Recordings
- The initial recordings can be termed as the primary transactions carried out in the accounting of the payroll. The payroll executive records the gross wages earned by the employee and its corresponding withholdings.
- The initial recordings also include and account for employment taxes.
- The employment taxes are generally classified as federal income taxes.
#2 – Accrued Wages
- The accrued wages are wages that the business owes to the employees corresponding to the service disbursed by them and are yet to be paid.
#3 – Manual Payments
- The manual payments are classified as the payments that are made when employees terminate their services to the business, and the payroll executives update this specific line item to record the cleared dues of the employees.
Payroll Accounting Journal Entries
Under payroll accounting, the payroll executive makes entries under expense, liabilities, and assets. The Asset and expense accounts are classified as debits when it increases and credit when it decreases. The Liabilities, equities, and revenue accounts are classified as credits when it increases and debits when there is a decline in their values. The following steps would be performed, as shown below: –
- The payroll executive records the transactions under the payroll general ledger. These would be classified as payroll expenses.
- As these are paid to the employees it would increase the expense amount. Hence in the journal, it would be shown as debit. Therefore, it could be correct to state that the wages, salaries, and applicable payroll taxes are debited.
- Since such amounts are recorded in expense account but yet to be paid in the liabilities section, this would increase the liabilities account.
- This would result in the crediting of FICA taxes and wages payable under the balance sheet of current liabilities.
- Once the payroll payments are made to the employees, the cash account, which is an asset account and liabilities account, namely the wages payable, would decrease. This would result in a credit in a cash account and debit in the liabilities account.
- A basic journal entry would be as follows: –
- Every big organization consists of a large number of employees.
- In such organizations, it plays a critical and vital role.
- This function performs administrative functions that ensure that employees get their dues on time as well as the organization complies with the legal and tax laws.
- By ensuring proper and transparent financial management, this function ensures that the employees get their correct dues on time.
- This function monitors the expenditure of payroll and ensures that the organization does not waste too much of its financial resources.
- All organizations are required to pay taxes to the Internal revenue service on the salaries paid. Hence, this function performs necessary actions to compute the correct tax and report the same to the Internal revenue service.
- Payroll accounting saves a lot of time for an organization.
- It provides a framework on the computations of correct dues for the employees.
- The in-house payroll system ensures better control and compliance of the data of employees.
- The functions ensure that the financial resources are utilized effectively, and the organization has cash on hand once all legal requirements are fulfilled.
- It ensures that the organizations meet their tax filing deadlines.
- Managing payroll work could turn out to be uphill tasks if being done using manual systems and without software.
- An inhouse payroll department could itself can transform into an added cost function for the business.
- There is always a scope of human errors and fraud, which in turn may affect the employees of the business.
- For example, the payroll department may end showing an overstated or understated ending balance of provident fund balance of all the employees due to minor accounting errors.
- Similarly, the payroll department may end up withholding more payments of the employee as compared to what it should have withheld.
- At times salaries disbursement may be delayed due to system maintenance of the payroll departments.
Payroll accounting is an essential function for growth as well as large businesses. They help and manage the salaries, wages, bonuses, and commissions payable to the employees of the business. The department works and determines the number of deductions that are to be withheld from the salary payable as per the applicable legal and labor laws.
The department has three basic types of payroll accounting entries, which are classified as the initial recordings, manual payments, and accrued wages. The departments may do weekly, biweekly, and monthly basis payments after making applicable deductions.
This has been a guide to payroll accounting and its meaning. Here we discuss examples, types, and journal entries of payroll accounting along with advantages and disadvantages. You may learn more about financing from the following articles –