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Hiring your first employee is an exciting step in growing your business; however, there are new challenges that you will need to overcome. Implementing the necessary procedures to maintain records and promote accuracy within your payroll function relies on creating an effective payroll accounting system.
Understanding the basics of payroll accounting, the importance and general processes, and how to include automation are vital areas to maximize growth potential and minimize the risk of costly errors.
What is Payroll Accounting?
Payroll accounting calculates, distributes, and tracks employees’ compensation. This involves managing the components of individual compensation and the employer’s liability. Payroll accounting doesn’t just handle salaries and wages. It dives into each segment associated with paying your employees, including:
- Calculating accurate gross pay
- Withholding the proper federal, state, and local taxes
- Remitting employer taxes
- Filing required payroll reports
- Analyzing employee benefits
- Retaining records
- Leveraging Insights for growth
- Making strategic hiring decisions
Federal, state, and local regulations influence payroll calculations. These regulatory agencies control the amount of taxes withheld, how benefits and garnishments are paid and record retention requirements. Payroll accounting encompasses every required law and regulation to promote compliance.
How do accounting methods impact payroll accounting?
Payroll accounting follows the matching principle under accrual accounting. This regulation requires that expenses be recorded in the same period as corresponding revenue. For example, if you record the sale of a machine, you must also record any labor associated with building the machine in the same period. To follow the matching principles, businesses record payroll expenses to the accrual account until those items are paid out of the checking account.
Cash basis taxpayers don’t follow generally accepted accounting principles. As a result, expenses are only recorded once cash leaves the checking account. This eliminates the need for a double payroll entry, and instead, only one entry is entered to record payroll from the business bank account.
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Why is Payroll Accounting Important?
Payroll accounting is a vital component of your accounting system. First, it helps you carefully track expenses associated with payroll, including gross wages, employer taxes, and benefits offered. This gives your business the best chance to comply with governing agencies.
In addition, payroll accounting ensures that you are paying workers properly. There are significant differences between an independent contractor and an employee. Independent contractors aren’t subject to withholding taxes on the employee or employer side. When you mistake an employee for an independent contractor, the IRS may assess back taxes with fines and penalties. Payroll accounting increases your chances of proper classification.
Payroll deductions can become complex, with some being pre-tax and a few remaining post-tax. Pre-tax deductions must be subtracted from gross pay before any taxes are calculated, while post-tax deductions are taken from the after-tax income. Miscalculating these items can lead to overstating or understating benefit payments, with the cost of errors falling on the employer.
Another hidden benefit of payroll accounting is more informed business decisions. By effectively tracking payroll expenses, you can see the cost of each employee about the value they provide your business. Maybe you uncover that adding an employee can increase productivity by 20% and generate more revenue. This is crucial information when looking to scale your business.
What types of expenses fall under payroll accounting?
The expenses you incur in your payroll accounting are unique to your business. This is because you can choose which benefits you offer employees. Common expense categories you might see include:
- Compensation – Salaries, commissions, tips, reimbursements
- Payroll Taxes – Federal, state, and local taxes
- FICA Taxes – Social Security and Medicare taxes for both the employee and employer
- Employee Benefits – Health insurance, retirement matches, health savings account
- Other Benefits – Tuition reimbursements, childcare, parking, cafeteria plans
You must pay your employees Social Security, Medicare, and unemployment taxes as an employer. However, the burden falls on you to remit the proper amounts for federal and state taxes on your employees’ behalf. Choosing the benefits you want to offer employees is a critical decision as it not only impacts the marketability of job openings at your business, but certain options can also be costly.
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How is payroll accounting done?
Understanding payroll accounting remained only half the battle with processing and remitting payroll on the other end. Whether you are processing your first payroll or trying to clean up your existing processes, consider following these five steps.
Step #1: Create Your Chart of Accounts
The chart of accounts is where your payroll will be recorded. You will need to create expense accounts and a liability account. Set up an account for each payroll line item. This would include wages, commissions, reimbursements, taxes, and benefits. The liability account represents what you need to pay out. This account will be found under current liabilities on the balance sheet. Even if you don’t plan on offering extensive benefits immediately, setting everything up at once can be helpful.
Keep in mind that each class of employees should have its category for reporting purposes, such as direct labor and office staff. This is useful when you are analyzing profitability and growth potential. Additionally, payroll taxes should be broken out as well. You may need to adjust your chart of accounts after you process a few payrolls to tailor the output on the financials to your business’s needs.
Step #2: Gather Payroll Information
Once the chart of accounts is set up, you are ready to gather payroll information. How are you paying employees? For hourly employees, you will need a timecard to base earnings on, but for salary employees, the amounts do not change each pay period. Investing in time-tracking software for your hourly employees can help you pay employees accurately.
After you process your payroll, you will want to gather reports for that pay period. This includes the payroll register, insurance payments, tax reports, and other benefit reports. If you are using a software program to process payroll, a payroll report function should house the most needed information.
Step #3: Record Journal Entries
Once you have all your reports, you must record the payroll journal entry. You may need to complete multiple journal entries depending on your accounting method.
Journal Entry to Record Payroll on Cash Basis of Accounting
Debit: Wages $5,000
Debit: Payroll Taxes $2,000
Debit: Health Insurance $1,000
Credit: Cash $8,000
Journal Entry to Record Payroll on an Accrual Basis of Accounting
Debit: Wages $5,000
Debit: Payroll Taxes $2,000
Debit: Health Insurance $1,000
Credit: Accrued Payroll $8,000
Journal Entry Once the Payroll is Paid
Debit: Accrued Payroll $8,000
Credit: Cash $8,000
Journal Entry to Record Accrued Time Off
Debit: Wages $4,000
Credit: Accrued Vacation $4,000
Calculating the accrued payroll is based on the close date of your financials. For example, if your books close on the last day of the month, you will need to determine how many days were worked during that month but paid in the next month. Let’s say you pay employees every two weeks. If one full week of the payroll occurred before month-end, you would accrue 50% of the payroll.
Step #4: Post Payroll
After entering the journal entries, you must post them to the general ledger. Some accounting systems automatically post the entries, but for others, you must submit the transaction manually. You want to ensure accuracy in the entries before you post them since some software programs don’t allow you to reverse them.
Double-check each journal entry line item against the different payroll reports you have pulled. Do the total gross wages in your entry tie out to what’s on the report? How about the net cash pulled from your bank account? An easy check is to make sure your debits equal your credits.
If you have more than one employee in your accounting or payroll department, having a second reviewer can be a great idea. This not only deters fraud and asset misappropriation but can also help you catch errors and mistakes in a timely manner.
Step #5: Reconcile Payroll
The final stage of payroll accounting is to complete the payroll reconciliation. This step ensures that your payroll accounts tie to the general ledger. Furthermore, payroll reconciliations also help you stay on track with a budget. Most companies take advantage of a monthly payroll reconciliation. Working this step into your monthly reconciliations allows you to make necessary adjustments before the books are closed.
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What is a Payroll Accounting Example?
Let’s try a simple example to reinforce the previous concepts discussed. Alpha LLC’s payroll reports show that they paid $15,000 in gross wages, had $2,500 in employer taxes, $500 in reimbursements, and $1,000 in insurance premiums. What would the payroll journal entry be, assuming Alpha LLC reports on an accrual basis?
The correct answer is as follows:
Debit: Gross Wages $15,000
Debit: Employer Taxes $2,500
Debit: Reimbursements $500
Debit: Insurance Premiums $1,000
Credit: Accrued Payroll $19,000
How to Automate Payroll Accounting?
There are ways to improve efficiency in your payroll accounting function. Automating mundane tasks provides more accuracy and leads to less time spent recording payroll. The first way to automate payroll accounting is to connect your payroll system with your accounting software if they are separate. Some accounting software programs have built-in payroll processing features that eliminate the need for this step.
Seamless integration allows data to automatically import between programs, eliminating the need for time-intensive data entry. In addition, choosing software that can post payroll to the general ledger can save you significant time. Instead of matching up different payroll reports, you can rely on the software to make the entries. Although you will still need to review the transactions, this saves time and reduces errors. This automation feature is especially important for businesses that don’t have multiple employees working in the payroll function.
Payroll accounting automation can also be achieved using cloud-based software programs that allow real-time data access. Instead of waiting and manually importing transactions, you can view reports immediately after payroll is submitted, providing clarity in the decision-making process.
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How to implement payroll accounting automation?
Now that we know the importance of payroll accounting automation, let’s see how you can implement it immediately. We are listing four simple steps to shift to an automated payroll process.
- Find a payroll automation platform.
- Automate information extraction and sync databases
- Add proper rules to comply with your policies.
- Train employees on how to submit their expenses and documents
Find a payroll automation platform.
There are a lot of payroll automation platforms out there, but find the one which suits you the best. In the next section, we will cover the best way to find a payroll accounting automation solution in detail, but for now, here are some major things you should watch out for:
- Does the software integrate with your existing systems? [Most important]
- Can it automate manual tasks like data entry to save employees time?
- Is it flexible enough to allow modifications in workflows?
- Can the payroll accounting automation solution grow with the business?
Automate information extraction and sync databases
What’s the use of having an automated payroll solution if you need to enter the data manually? Find a solution to automate data extraction from employee documents and sync the HRMS database in real time.
Automate data extraction from employee documents like contracts, expense reports, reimbursement forms, receipts, tax returns, and more. This will reduce errors in the payroll reports and pay slips.
Add proper rules to comply with your policies.
Most accounting automation software comes with workflow automation as a feature. You can use them to set up proper rules to ensure your tax calculations, PTO calculations, bonus, etc comply with your company policies.
Train employees on how to submit their expenses and documents
Train your employees on how to use the system, how to submit their expenses and their documents to ensure error-free payroll processing. You can ask employees to use OCR software, receipt scanner apps, or OCR extension to extract data from their documents on the go.
How to choose a payroll accounting system?
Different software caters to different use cases. You must clearly understand your requirements to select the best payroll accounting software for your business. Nevertheless, here are some features that must be considered while choosing your payroll accounting automation software:
- OCR – To extract information from employee documents
- Workflows – To automate, you need rule-based workflows
- Integrations – Out-of-the-box integrations save a lot of time
- Data management – Your solution should be able to manage your employee information properly
- Other add-ons – Tax Filing, Attendance tracking, PTO tracking, and employee dashboards
Apart from this, keep a tab on other things like
- Do they provide 24/7 support?
- How is their customer service?
- Does it fit your budget constraints?
- Can the software grow with your requirements?
- How easy is it to use it?
- Will it work with your current HR software?
Once you’ve answered the above questions, you should know which software is right for you.
Nanonets for Payroll Accounting
Nanonets is an AI-based intelligent document processing platform with in-built OCR software. Nanonets can automate all aspects of payroll processing with end-to-end document workflows, a powerful OCR engine, and seamless integrations.
Here’s why you should consider Nanonets:
- Automate data entry – Nanonets can extract data from your documents and automatically upload the data into the required software
- Do away with manual checks – You can use rule-based workflows to automate manual checks like date format, currency, tax calculations, and more.
- Get approvals on the go – Do away with manual approval processes. Add your stakeholders and their review stages in Nanonets approval workflows and automate your approval processes.
- Make it easy for employees to submit reimbursements – Ask your employees to send the receipts in the email. Nanonets will automatically extract the information and populate your expense reports, reimbursement forms, and accounting entries.
- Be audit ready – Maintain a log of all your actions with Nanonets.
- Customer focussed team – You’ll get 24×7 support, a talented training team, and a dedicated customer success manager.
Automate your payroll processes with Nanonets and save time, effort, and costs. Book a call with our team today to see how you can reduce employee efforts and make your accounting processes seamless.
Payroll accounting is designed to help businesses keep track of their most important resource: employees. By implementing the right controls and understanding the basics, you can see the benefits of payroll accounting on growth, retention, and future hiring decisions.
Nanonets accounting automation software can automate manual processes like reimbursements, data entry, general ledger coding, payment reconciliation, and more. Find out how Nanonets’ use cases can apply to your product.
Payroll Accounting FAQs
What is a payroll journal entry?
The payroll journal entry records the payroll in your accounting system. There will be a line item for each separate expense account with an offsetting credit to the payroll bank account or wages payable account.
Is payroll an asset or liability?
Wages payable are considered a short-term liability on the balance sheet. The payroll liability account will include every expense associated with the payroll, including employer taxes and garnishments.
Is payroll bookkeeping or accounting?
Payroll is considered bookkeeping. Bookkeeping, accounting, and payroll are intertwined in the job duties. Accounting is completed sporadically, while bookkeeping occurs more frequently, resulting in payroll being associated with bookkeeping.
What is double entry for payroll?
There are two entries needed to record payroll. The first entry records the items to the expense account with an offsetting credit to the payroll accrual account. When the payroll is actually paid, there will be another entry to zero out the accrual account and reduce cash.
Is payroll debit or credit entry?
The payroll liability account is considered a credit on the balance sheet. The wages, employer taxes, and benefits are considered debits on the income statement. When payroll is paid and the checking account balance decreases, a credit will be recorded.
What type of accounting is payroll accounting?
Payroll falls under general accounting. This commonly involves both financial and managerial accounting principles. The recording of payroll is financial accounting, while managing employees and making hiring decisions is considered managerial accounting.
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