Key takeaways:
- Payroll accounting is the process of tracking and recording the various factors of employee compensation to ensure accurate reporting.
- The main transactions that factor into the process include wages, deductions, taxes, benefits, and liabilities.
- The process involves creating a chart of accounts, gathering the payroll reports, recording the journal entries, posting them on the general ledger, and reconciling the data.
- The easiest approach to handling this process error-free is to use accounting software with strong payroll integrations or capabilities.
What is payroll accounting?
Payroll accounting is the process of managing, recording, and reporting all aspects of payroll transactions. This includes paychecks distributed to employees, deductions and taxes withheld from employee paychecks, and the employer’s share of benefit contributions and taxes.
Accounting for payroll is fundamentally straightforward — you log all employee compensation expenses, record the liabilities for legal compliance and other benefits, and then reconcile the information in your general ledger (GL). This allows companies to reflect labor costs accurately while maintaining compliance with various tax and labor regulations.
Payroll accounting can be done manually — but this is naturally prone to error, which is exactly what you’ll want to avoid when it comes to something as sensitive and legal-heavy as payroll and accounting. We recommend using an accounting software that can automate this process.
QuickBooks, our best small business accounting software, integrates directly with payroll while offering a user-friendly interface. Learn more about it in our QuickBooks Online review.
How to do payroll accounting
The process for payroll accounting starts with setting up a chart of accounts and gathering reports from your payroll system. Having the right information will ensure your payroll journal entries (JEs) are accurate and save you from having to correct entries later. Once your JEs are posted on the GL, you’ll have to reconcile the amounts.
Here’s an in-depth look at each step to guide you.
Step 1: Set up the chart of accounts.
Recording payroll on your books involves ensuring that amounts are accurately posted to payroll accounts. Before you can record payroll, you will need to set up payroll accounts on your chart of accounts.
The accounts you need to set up to track payroll are generally expense or liability accounts.
- An expense is a cost you have incurred as a result of doing business, like for wage expense and health insurance.
- A liability is money that you owe to others. An expense can be a liability, albeit temporarily, until it’s paid.
For example, workers’ compensation is recognized as an expense once the period that the premium covers has elapsed. At that time, if the payment has not been made, the amount becomes a debt and should be recorded as a liability until it’s paid to the insurance provider.It’s important to remember that the amounts you withhold from employee paychecks to cover their responsibility toward benefits or taxes should be booked as a liability and never a business expense.
Below is a list of the accounts you will generally need to set up on your chart of accounts to track all payroll-related activities, along with a brief description of each. There are some you may not need, like health insurance if it’s not offered, and others that are required for payroll compliance, like federal income tax payable.
Name | Type | Description |
|---|---|---|
Gross Wage Expense | Expense | This should include the amount you pay an employee every pay period before any deductions are made. Read our guide on how to calculate gross pay for more information. |
Health Insurance Expense | Expense | This should include the total amount of health insurance you pay to your provider. This can include medical, vision, and dental. If you have more than a handful of transactions, we recommend creating subledger accounts for each insurance type so they’re easier to track. |
401(k) Match Expense | Expense | If you offer your employees a 401(k) plan, include the number of contributions you have made to match your employee contributions in this account. This money will be paid to the investment company that is responsible for maintaining your company's 401(k). |
401(k) Employee Contribution | Liability | All employee 401(k) contributions withheld from paychecks will accumulate in this account. This money will be paid to the investment company that is responsible for maintaining the company 401(k) (e.g., Fidelity). |
Federal Tax Withholding | Liability | This should reflect the total income taxes you have withheld from all employee paychecks. You will remit these funds to the IRS based on their deadlines. You should withhold from employee paychecks each pay period and leave the money in this account until you remit it to the IRS for payment. Learn more about payroll taxes. |
State Tax Withholding | Liability | This serves the same function as the federal tax withholding, except for state taxes instead of federal. Note that this should not be lumped together with local tax withholding. |
Local Tax Withholding | Liability | This is similar to the federal state withholding, but for those local areas that impose one. If your employees are obligated to pay local taxes, create a separate account. |
FICA Tax Payable | Liability | Deductions from employee paychecks for FICA tax (Social Security and Medicare taxes) will accumulate in this account. You will remit these funds to the IRS based on the applicable deadlines. |
Liability | Under the FUTA, employers have to pay a FUTA tax rate of 6% on the first $7,000 that each employee earns. Form 940 must be filed annually to report payments made for unemployment taxes. While you only have to file this form annually, you may be required to submit payments more often than that. | |
SUTA Payable | Liability | This should include the state unemployment taxes that you are responsible for paying. The money should stay in this account until you remit it for payment. |
State Disability Payable | Liability | This should include the state disability taxes that you have withheld from employees, if applicable. |
Workers' Comp Payable | Liability | In this account, you need to reflect the amount of workers’ compensation due. |
Employee Health Insurance Payable | Liability | This will include the amount withheld from employee paychecks for health insurance coverage. This account will reduce the amount of health insurance paid by the employer. |
Accrued Vacation Payable | Liability | If you offer your employees time off with pay, then you need to track the amount of time they have earned on the books. If an employee earns a certain number of vacation hours each pay period, you should record its value as accrued vacation because it is money you owe to the employee. If they quit or were fried, then you would have to include all accrued vacation pay in their final paycheck. |
Accrued Sick Payable | Liability | Similar to accrued vacation pay, you need to track the amount of sick pay an employee has earned on the books. You can establish how much sick pay an employee would earn per pay period. |
On benefits payables: Create a separate account for every other benefit payable excluded above. This ensures proper tracking in your books while helping you monitor where money is going and when it’s moving.
As with PTO payables, if it’s a benefit that’s accrued but not used, it stays as a liability until it’s used/paid. For benefits paid immediately, like an annual gym membership, it’s immediately classified as an expense because it’s paid immediately to the provider.
Step 2: Gather payroll reports.
The regular transaction you should be posting is the payroll JE; you should create it after processing payroll so that the record is based on an actual event. Before entering any information, you’ll need to gather solid source documents, like a payroll register and other payroll reports.
- Payroll register: This shows details for all payroll transactions that occurred during a pay period (includes names, pay dates, and payment amounts).
- Insurance bills: These are monthly invoices from the insurance provider with a breakdown of charges by the employee and any administrative fees.
- Payroll tax reports: These show a breakdown of the taxes you owe plus taxes you withheld from employee paychecks.
Step 3: Record payroll journal entries.
A JE generally includes an effective date, a debit amount, and a credit amount. When recording payroll, you’ll generally debit Gross Wage Expense, credit all liability accounts, and then credit the cash account. Gross Wages will appear on your Profit and Loss or Income Statement, and the liability and cash accounts will be included on your Balance Sheet.
JE to record $10,000 in payroll expense
JE to record paying expense being held as a liability
You’re not always going to pay an expense at the time you book it. For instance, when you expense an employee’s gross earnings, you may not be ready to remit the associated payroll tax expenses, such as FICA.
In this case, you would credit a liability account, or payable, until you’re ready to pay. In the entry above, we booked $2,000 to FICA Tax Payable.
When you’re ready to pay the tax agency, whether that be every two weeks or once a month, you’ll need to debit the FICA Tax payable account to clear the account of the amount you’re about to pay and credit Cash since money will be moving out.
Account | Debit | Credit |
|---|---|---|
FICA Tax Payable | 2,000 | |
Cash | 2,000 |
JE to record accrued vacation pay
When recording payroll, you’ll also have to account for any accrued vacation. Say an employee gets 10 vacation days each year and is paid on a biweekly pay period. You would calculate vacation accruals each pay period as follows:
10 vacation days × eight hours = 80 hours
(number of vacation hours earned each year)
80 hours ÷ 26 weeks (pay periods per year) = 3.08 hours
(number of vacation hours earned)
To accrue vacation on the books, you must use a JE. Below is an example of the JE we would record for an employee who earns a wage of $30 per hour.
$30 × 3.08 hours = $92.40
Account | Debit | Credit |
|---|---|---|
Gross Wage Expense | 92.40 | |
Accrued Vacation Payable | 92.40 |
JE to record accrued sick pay
Similar to accrued vacation pay, you’ll also need to track the amount of sick pay an employee has earned on the books. You can establish how much sick pay an employee would earn per pay period (as we did in the accrued vacation pay example above).
Let’s assume this employee has earned one hour of sick pay at a $30 per hour wage. Our JE would be as follows:
Account | Debit | Credit |
|---|---|---|
Gross Wage Expenses | 30.00 | |
Accrued Sick Payable | 30.00 |
Accrued payroll account
The accrued payroll account houses any net payroll amounts (payable to employees) that have been expensed but not yet paid.
Example: Assume that Ella gets paid every two weeks (10 working days) at a rate of $12.50 per hour ($100 per day) for work performed Monday through Friday.
$100 per day × 10 days = $1,000
Her next payday is Friday, December 3, which covers work she performed from November 22 through December 3. The issue here is that most businesses close their books at the end of each month — in this case, November 30. Only a portion of Ella’s paycheck would be expensed, which is the seven days she worked through November 30.
$100 per day × seven days = $700
When you or your bookkeeper goes to close the books for November, $700 will need to be recorded as a credit to be paid in your accrued payroll account. When you pay the full $1,000 balance on December 3, you’ll clear the balance by debiting the account for $700.
Step 4: Post payroll journal entries to the general ledger.
Once you’ve finished entering your JEs, you should review them for accuracy before officially posting to the GL, as many accounting software won’t let you reverse the entry.
- Check the numbers against the data you gathered from your payroll system. Does the total gross wage expense entry match your total payroll expense for the period?
- Ensure that your debits equal your credits (basic accounting systems should confirm this).
If you have the support, it’s a good idea to designate at least one or two other employees as secondary reviewers — someone else in the accounting or HR team or one who won’t present a conflict of interest. This will ensure your JEs have additional eyes on them before they post; it can also be helpful if you’re out on the day that payroll JEs need to be posted.
Step 5: Reconcile payroll to general ledger.
We gave you some tips in prior steps to help check yourself along the way, but doing a payroll reconciliation is a more in-depth approach. Payroll reconciliation is a process that ensures your payroll accounts within the GL accurately reflect the transactions that occurred in the payroll system. It also helps ensure that you are within budget throughout the year.
Most companies do it at least monthly and definitely at year-end. Regular reconciliations ensure you have time to enter a correcting JE before the books are closed for the month, making future payroll audits and research much easier to follow.
Software can make the reconciliation process easier. For instance, Paychex helps with payroll automation — making it easier to handle the payroll process while reducing errors. It also offers integrations to popular accounting software like QuickBooks and Xero that can simplify the reconciliation process. Learn more about the platform in our review of Paychex.
Why accounting for payroll matters
As with most accounting tasks, the main purpose of payroll accounting is to ensure compliance with the law. Beyond that, it helps you monitor your company’s cash flow, assess profitability, and prepare for regulatory audits.
Here are a few reasons why it pays to establish a proper payroll accounting process.
✅Legal compliance: It can’t be said enough — a proper process protects your company from compliance issues. A strict process ensures employees’ wages and taxes are paid correctly and on time. Also, the mere fact that you have full records is big evidence in itself that your company runs compliantly.
✅Cost management: Understanding your cash flow works better when you can actually see the figures in front of you. Payroll is one of the biggest expenses in your company, so it’s important to pay attention to budget your payroll properly.
✅Process efficiency: Having eyes on the flow of your expenses allows you to ensure that payments are actually made — and in a timely manner. This avoids debts and liabilities, which can lead to further complications if left to build.
✅Employee trust: Regular payments, proper compliance, and efficient processes all culminate in building trust in your company. Your employees will understand that their wages will always be on time and that their workplace commits to following the rule of law.
Bottom line
If you’re overwhelmed with the many aspects of learning how to do payroll accounting, you’re not alone. Choosing a quality accounting program will make documenting transactions easier is important. You’ll thank yourself when an audit arises or you just need to prepare an income or cash flow statement at year-end.
