Payroll Accounting Process

What is Payroll Accounting?

Payroll Accounting is the method of accounting for payroll. Payroll is the aggregate expenditure on wages and salaries incurred by a business in an accounting period. It can also refer to a listing of employees giving details of their pay.

Payroll includes the gross pay due to the employee and employer taxes. The gross pay is divided into net pay actually received by the employee and deductions made from the gross pay for employee taxes and other deductions such as pension contributions, healthcare contributions, and union subscriptions.

In payroll accounting it is important to distinguish between employee taxes which are deducted from the employees gross pay and are therefore paid by the employee, and employer taxes which are in addition to the gross pay and paid by the employers.

Both payroll taxes are usually collected by the employer and paid over to the relevant tax authority.
The analysis of payroll is shown below:

payroll accounting

Payroll Accounting and the Recording of Payroll

Different Countries have their own employer and employee tax situations and the taxes and deductions may have different names, but the basic payroll accounting procedures are the same.

As an example of payroll accounting, if gross pay is 2,000, employee tax is 500, and other deductions are 100, then the net pay due do the employee is 1,400. The payroll accounting journal entries would be as follows:

Payroll – Gross pay
Account Debit Credit
Gross Wages 2,000
Employee tax control 500
Other deductions control 100
Net pay control 1,400
Total 2,000 2,000

The gross wage is the expense charged to the income statement. The control accounts are all balance sheet accounts representing liabilities for the amounts deducted from the payroll. The employee tax control represents the amount due to the tax authority, the net pay control represents the amount due to the employee, and finally, the other deductions control is the amount due to whichever body the deduction was made on behalf of, for example, the pension scheme, healthcare scheme or union.

Employers Tax Journal

In addition the employer payroll tax liability needs to be recorded with the following payroll journal entry:

Payroll Accounting – Employer tax
Account Debit Credit
Employer tax 300
Employer tax control 300
Total 300 300

The first entry is the expense charged to the income statement, and the second entry is the liability to the tax authorities recorded in the balance sheet control account.

Pay the Employee the Net Pay

Net pay is the gross pay which a person earns less taxes and other deductions such as pension contributions. It is the amount of pay which a person gets to keep.

The net-pay formula can be stated as follows:

Net pay = Gross pay – Taxes – Deductions

When you pay the employees using cash, the entry is to the net pay control account

Payroll Accounting – Gross pay
Account Debit Credit
Net pay control 1,400
Cash 1,400
Total 1,400 1,400

Any difference on this account should be reconciled by the payroll accounting team, as it means an employee has either been underpaid or overpaid.

Pay the Tax to the Tax Authorities

Next the tax authority is paid and the tax control accounts are cleared using the following payroll tax accounting journal.

Payroll – Payment to tax authority
Account Debit Credit
Employee tax control 500
Employer tax control 300
Cash 800
Total 800 800

Again the control accounts should net to zero after the payments have been made, and any difference needs to be investigated before completing that periods payroll process.

Pay Over the Deductions

Finally, the other deductions are paid to the appropriate body such as for example a pension scheme, healthcare scheme, or union, and the control accounts are cleared using the following payroll deductions accounting journal.

Payroll Accounting – Payment of other deductions
Account Debit Credit
Other deductions control 100
Cash 100
Total 100 100

In the example above, the other deductions can refer to many types of deduction such as pension contributions, healthcare schemes, union subscriptions. If there is more than one type of deduction, it is best to maintain a control account for each one so that the liability to a particular organization is clearly identified in the balance sheet of the business.

Other Payroll Accounting Terms

Other payroll terms include the following.

Fringe Benefits

Fringe benefits are payments in kind by a business to an employee in addition to their normal remuneration wages or salary for their work. For example, a business provides an employee with a fringe benefit when they allow the employee to use a business vehicle to commute to and from work.

Examples of employee benefits include holiday pay, subsidized meals, car fringe benefits, pension schemes, business health insurance, childcare assistance, life insurance benefits, and employee discounts.

The advantage of an employer paying fringe benefits is that some employee benefits are exempt from taxation, and so for the same cost to the business, the employee receives a greater benefit than had the amount been paid to them as taxable wages or salary. Not all benefits are exempt from taxation, others may be subject to fringe benefits tax.

Fringe benefits are sometimes referred to as employee benefits or benefits in kind.

Payroll Garnishment

A garnishment is a legal process in which one person (the garnishee) is ordered to withhold money due to another person and to pay the money held over to a third party. So for example, if A owes money to B, then C can be instructed to hold money due to A, and to pay the money withheld over to B.

A typical example is when an employer is asked to garnish wages sometimes referred to as a payroll garnishment, in this case a garnishment notice is served on the employer who in accordance with the garnishment order, is instructed to withhold money due to the employee for wages, and to pay that money to a third party, usually the courts, for unpaid taxes or child support.

For a business, a garnishment payable represents monies deducted from the employee and owed to the courts or the tax authorities, and is shown as a current liability in the balance sheet of the business.

Time and a Half

Time and a half is a term used in relation to the payment of employees by a business.

An employee has a normal hourly pay rate, if for a particular period of time the employee is on time and a half pay, then for the hours worked during that period, the normal rate is multiplied by one and a half.

Time and a half pay is normally paid for working above and beyond normal hours, for example, overtime, bank holiday, weekends etc.

How to Calculate Time and a Half for Overtime

If for example, an employee has a normal hourly rate of 10.00, and worked for 40 hours of which 5 hours were time and a half overtime, then the calculation would be as follows.

Normal rate of pay 10.00 per hour
Time and half rate of pay = 1.5 x 10.00 = 15.00 per hour
Time and half overtime pay = Overtime hours  x 15.00 per hour
Time and half overtime pay = 5 x 15.00 = 75.00

This overtime pay would then be added to the normal pay of 35 x 10.00 = 350.00, to give total pay of 425.00.

Last modified January 14th, 2020 by Michael Brown

About the Author

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.

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