Payroll Accounting

Payroll accounting is an accounting function within the organization that looks into the management, recording, determination, and analysis of the compensation of the employees. In addition, they work towards calculating taxes and benefits along with the salary given to the employees.

The department has three basic types of payroll accounting entries which are classified as the initial recordings, manual payments, and accrued wages. After making applicable deductions, the departments may do weekly, biweekly, and monthly basis payments.

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 business employees. In addition, the department works and determines the number of deductions be withheld from the salary payable as per the applicable legal and labor laws.

The accounting function looks into reconciling 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 from the salaries payable.

These deductions are always in line with the applicable legal laws. For example, the deductions under the US laws are federal withholdings, FICA, state withholdings, employee health insurance costs, 401K, and disability taxes of state.

There are three basic types of it, exploring which will make payroll accounting meaning clearer. These comprise accrued wages, manual payments, and initial recordings. With the rise of digital currencies, businesses are also exploring crypto payroll solutions, allowing employees to receive salaries in Bitcoin, Ethereum, or stablecoins.

#1 - Initial Recordings

• The initial recordings can be termed the primary transactions carried out in payroll accounting. The payroll executive records the gross wages earned by the employee and their 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 and are yet to be paid.

#3 - Manual Payments

• Manual payments are classified as the payments made when employees terminate their services to the business. The payroll executives update this specific line item to record the cleared dues of the employees.

Let us take an example of a business that has to pay $1,000 to an 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.

Answer

Here, $1,000 would be recorded as gross salaries under expense account of the income statement, and hence it would be shown as credit. Then, 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.

Note that an increase in a liability account is credited, whereas it is debited whenever there is an increase in the expense account. The following shows how payroll accounting entries are made:

Under payroll accounting services, 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 show how to do payroll accounting:

• The payroll executive records the transactions under the general payroll ledger. These would be classified as payroll expenses.
• As these are paid to the employees, it would increase the expense. Hence in the journal, it would be shown as a debit. Therefore, it could be correct to state that the wages, salaries, and applicable payroll taxes are debited.
• Since such amounts are recorded in the expense account but yet to be paid in the liabilities section, the liabilities account would increase.
• This would result in crediting FICA taxes and wages payable under the balance sheet of current liabilities.
• Once the payroll payments are made to the employees, the cash account, an asset account, and the liabilities account, namely the wages payable, would decrease. This would result in a credit in a cash account and a debit in the liabilities account.
• A basic journal entry would be as follows: –

The reasons that make payroll accounting a must for any organization are:

• 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 legal and tax laws.
• This function ensures that the employees get their correct dues on time by ensuring proper and transparent financial management.
• This function monitors payroll expenditures and ensures that the organization does not waste too much of its financial resources.
• All organizations must 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.

The benefits of having this department include:

• Payroll accounting saves a lot of time for an organization.
• It provides a framework for 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.

Payroll accounting services also have drawbacks. Let us have a look at a few of them:

• Managing payroll work could be an uphill task if done using manual systems and without software.
• An in-house payroll department could itself transform into an added cost function for the business.
• There is always a scope for human errors and fraud, which may affect the employees of the business.
• For example, the payroll department may show an overstated or understated ending balance of provident fund balance of all the employees due to minor accounting errors.
• Similarly, the payroll department may withhold more payments from the employee than what it should have withheld.
• At times salary disbursement may be delayed due to system maintenance of the payroll departments.

This has been a guide to what is Payroll Accounting. We explain it with journal entries, importance, types, advantages, disadvantages, and an example. You may learn more about financing from the following articles –

• Payroll Records
• Payroll Tax
• Income Tax vs Payroll Tax
• Payroll Formula
• Severance Pay