What is Payroll Accounting?

Explanation

The accounting functionAccounting FunctionAccounting functions are financial systems that help in the bookkeeping of financial information in an organization, financial analysis, summary creation, reporting of transactions and act as the backbone for almost any business. Accounting as a system tries to identify, assess and record the transactions of financial nature in a very systematic approach.read more looks into reconcilingReconcilingReconciliation is the process of comparing account balances to identify any financial inconsistencies, discrepancies, omissions, or even fraud. At the end of any accounting period, reconciliation involves matching balances and ensuring that debits (credits) from one account for one transaction is same as the credit (debits) to another account for the same transaction.read more employee benefits such as superannuation schemes and gratuity. It determines the taxes payable by each employee corresponding to the salaries payableSalaries PayableSalary payable refers to the liability of the company towards its employees against the amount of salary of a period that became due but has not been paid yet to them by the company and it is shown in the balance of the company under the head liability.read more 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.

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Examples of Payroll Accounting

Let us take an example of a business that has to pay $1,000 to an employee. The applicable federal income taxesFederal Income TaxesFederal income tax is the tax system in the United States and is levied and governed by Internal Revenue Services (IRS). It helps determine the tax charged on the income earned by individuals, corporations, and various other legal entities.read more amount to $100, State income taxes amount to $150, and FICA is payable at $50. Help the payrollPayrollPayroll refers to the overall compensation payable by any organization to its employees on a certain date for a specific period of services they have provided in the entity. This total net pay comprises salary, wages, bonus, commission, deduction, perquisites, and other benefits.read more executive prepare journal entries and record the transaction.

Answer

Here, $1,000 would be recorded as gross salaries under expense accountExpense AccountExpense accounting is the accounting of business costs incurred to generate revenue. Accounting is done against the vouchers created at the time the expenses are incurred.read more 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 sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more as the debit.

Note that an increase in a liability accountLiability AccountLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company.read more is credited, whereas it is debited whenever there is an increase in the expense account. The following would be the journal entry, as shown below: –

Types of Payroll Accounting

There are three basic types. These comprise accrued wages, manual payments, and initial recordings.

#1 – Initial Recordings

  • The initial recordings can be termed the primary transactions carried out in the payroll accounting. The payroll executive records the gross wagesGross WagesGross wages are the amount of remuneration paid to employees before any deductions like taxes, including social security and Medicare, life insurance, pension contributions, bonuses.read more 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.

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 debitsDebitsDebit represents either an increase in a company’s expenses or a decline in its revenue. read more when it increases and credit when it decreases. The Liabilities, equities, and revenue accountsRevenue AccountsRevenue accounts are those that report the business’s income and thus have credit balances. Revenue from sales, revenue from rental income, revenue from interest income, are it’s common examples.read more are classified as credits when it increases and debits when there is a decline in their values. The following steps will be performed, as shown below: –

  • The payroll executive records the transactions under the general payroll ledgerLedgerA general ledger is an accounting record that compiles every financial transaction of a firm to provide accurate entries for financial statements. The double-entry bookkeeping requires the balance sheet to ensure that the sum of its debit side is equal to the credit side total. A general ledger helps to achieve this goal by compiling journal entries and allowing accounting calculations.
  • read more. 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 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 liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more.Once the payroll payments are made to the employees, the cash account, an asset accountAn Asset AccountAsset Accounts are one of the categories in the General Ledger Accounts holding all the credit & debit details of a Company’s assets. The examples include Short-Term Investments, Prepaid Expenses, Supplies, Land, equipment, furniture & fixtures etc. read more, 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: –

Importance

  • 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.This function ensures that the employees get their correct dues on time by ensuring proper and transparent financial management.This function monitors payroll expenditure 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.

Advantages

  • 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.

Disadvantages

  • 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 of 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 errorsAccounting ErrorsAccounting errors refer to the typical mistakes made unintentionally while recording and posting accounting entries. These mistakes should not be considered fraudulent behaviour first-hand as this can happen with anyone and by anyone.read more.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.

Conclusion

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 department has three basic types of payroll accounting entriesAccounting EntriesAccounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. read more 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.

This has been a guide to payroll accounting and its meaning. Here we discuss examples, types, and journal entries of payroll accounting and its advantages and disadvantages. You may learn more about financing from the following articles –

  • Payroll RecordsPayroll TaxIncome Tax vs Payroll TaxPayroll FormulaSeverance Pay