Payroll accounting is the recording and tracking of all payroll transactions. These transactions include paychecks distributed to employees, deductions and taxes withheld from employee paychecks, and employers’ share of benefit contributions and taxes.
To get started, you’ll need to set up a chart of accounts and gather reports from your payroll system. Having the right information will ensure your payroll journal entries are accurate and save you from having to do correcting entries later.
Here are five steps to follow to do payroll accounting manually:
1. Set Up The Chart of Accounts
Recording payroll on your books involves making sure 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 list.
Definition: The chart of accounts is a list of accounts that is used to categorize the financial transactions that your business generates.
The accounts that you need to set up to track payroll will generally be an expense account or a liability account. An expense is a cost that 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 time 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 never be booked as a business expense, because it isn’t.
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 account. There are some accounts you may not need, like health insurance if it’s not offered and others that are required, like federal income tax payable, to comply with payroll laws.
Download your free payroll chart of accounts list for future reference.
| Account Name | |
|---|---|
Gross Wage Expense | |
Health Insurance Expense | |
401(k) Match Expense | |
Federal Tax Withholding | |
FICA Tax Payable | |
FUTA Payable | |
SUTA Payable | |
State Disability Payable1 | |
Workers' Comp Payable | |
Employee Health Insurance Payable | |
401(k) Employee Contribution | |
Accrued Vacation Payable | |
Accrued Sick Payable |
The accounts you will need to set up to track payroll are:
- Gross Wage Expense: Include the amount that you pay to an employee every pay period before any deductions are made.
- Health Insurance Expense: Include the total amount of health insurance that you pay to your insurance provider (ex. Blue Cross). This can include medical, vision, and dental; if you have more than a handful of transactions though, we recommend creating subledger accounts for each insurance type, so they’re easier to track.
- 401(k) Matching Expense: If you offer a 401(k) plan to your employees, 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 the company 401(k) (ex. Fidelity).
- Federal Tax Withholding: This account should reflect the total amount of income taxes you have withheld from all employee paychecks. You will remit these funds to the IRS based on the deadlines set by them. 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.
- State Tax Withholding: It serves the same function as the federal tax withholding, except for state taxes instead of federal. If your employees are obligated to pay local taxes, you should create a separate account for it too.
- FICA Tax Payable: Deductions from employee paychecks for Social Security and Medicare taxes will accumulate in this account. You will remit these funds to the IRS based on the applicable deadlines.
- SUTA Payable: This account 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: This account should include the state disability taxes that you have withheld from employees, if applicable.
- Workers’ Compensation: In this account, you need to reflect the amount of workers’ compensation due.
- Employee Health Insurance Payable: This account 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.
- 401(k) Employee Contribution: 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).
- Accrued Vacation Pay: If you offer your employees time off with pay, then you need to keep track of 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 that you owe to the employee. If they were to quit or you fired them, then you would have to include all accrued vacation pay in their final paycheck.
2. Gather Payroll Reports
Once you’ve created your chart of accounts, you’re ready to record your payroll accounting journal entries. Of course, before you can actually post a transaction to the books, a transaction must have occurred. The regular transaction you should be posting is the payroll journal entry; you should create it after processing payroll so the record is based on an actual event that has taken place. You’ll need to gather solid source documents, like a payroll register and other payroll reports, before entering any information.
- Payroll Register: This shows detail for all payroll transactions that have occurred during a pay period (includes names, pay dates, payment amounts, etc.)
If you don’t have a payroll system, check out our guide to doing payroll in excel. We have an easy to use template that makes processing payroll manually much simpler. It’s important to keep in mind that preparing payroll in Excel can be difficult if the business has more than a handful of employees. If you’re a QuickBooks user, here’s a step-by-step guide on How to Make a Journal Entry on QuickBooks Online.
- Insurance Bills: Monthly invoice from insurance provider with breakdown of charges by employee and any administrative fees
- Payroll Tax Reports: These show a breakdown of the taxes you owe plus taxes you withheld from employee paychecks
If you use payroll software like Gusto, you can easily pull these reports from their system with just a few easy clicks. Since Gusto can help you broker health insurance plans directly through their platform, you can easily pull reports that include not only your employee payroll and tax amounts, but your health insurance expenses, as well. Sign up for a Gusto plan and get one month free when you run your first payroll. Offer will be applied to your Gusto invoice(s) while all applicable terms and conditions are met or fulfilled.
3. Record Payroll Journal Entries
A journal entry is best described as the recording of debits and credits. It generally includes an effective date, a debit amount, and a credit amount. If you use an accounting program like QuickBooks, you don’t have to enter journal entries often because QuickBooks does that for you “behind the scenes” when you create an invoice for a customer or pay a bill.
However, if you use a manual accounting system, you will need to create journal entries.
When recording payroll, you’ll generally debit Gross Wage Expense, credit all of the liability accounts, and 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.
Journal Entry to Record $10,000 in Payroll Expense
| Account Name | Debit Entry | Credit Entry |
|---|---|---|
Gross Wage Expense | $10,000 | |
Federal Tax Withholding | $1,000 | |
FICA Tax Payable | $2,000 | |
Employee Health Insurance Payable | $1,000 | |
401(k) Employee Contribution | $2,000 | |
Cash | $4,000 |
Journal Entry to Record Paying Expense Being Held as 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 (Social Security & Medicare).
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 Name | Debit Entry | Credit Entry |
|---|---|---|
FICA Tax Payable | $2,000 | |
Cash | $2,000 |
Journal Entry to Record Accrued Vacation
When recording payroll, you’ll also have to account for any accrued vacation. Let’s say an employee gets 10 vacation days each year and is paid on a biweekly pay period. You would calculate the number of vacation hours this employee would accrue each pay period as follows:
10 vacation days x 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 journal entry. Below is an example of the journal entry we would record for an employee who earns a wage of $30 per hour.
$30 x 3.08 hours = $92.40
| Account Name | Debit Entry | Credit Entry |
|---|---|---|
Gross Wage Expense | $92.40 | |
Vacation Payable | $92.40 |
Journal Entry to Record Accrued Sick Pay
Similar to accrued vacation pay, you’ll also need to keep track of 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 above accrued vacation pay example).
Let’s assume this employee has earned one hour of sick pay at a $30 per hour wage. Our journal entry would be as follows:
| Account Name | Debit Entry | Credit Entry |
|---|---|---|
Gross Wage Expenses | $30.00 | |
Sick Payable | $30.00 |
Accrued Payroll
The accrued payroll account houses any net payroll amounts (payable to employees) that have been expensed but have not yet been paid.
For Example: Assume that Ella gets paid every two weeks (10 working days), $100 a day for work performed Monday through Friday.
$100 per day x 10 days = $1,000
Her next payday is Friday, Dec. 3, 2021, which covers work she performed from Nov. 22 through Dec. 3. The issue here is that most businesses close their books at the end of each month – in this case, Nov. 30. Only a portion of Ella’s paycheck would be expensed the seven days she worked through Nov. 30.
$100 per day x 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 Dec. 3, you’ll clear the balance by debiting the account for $700.
4. Post Payroll Journal Entries to the General Ledger
Once you’ve finished entering your journal entries, you should review them for accuracy before officially posting to the general ledger – many systems 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 tie to your total payroll expense for the period? Be sure to confirm 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 in accounting or who won’t present a conflict of interest. This will ensure your journal entries have additional eyes on them before they post; it can also be helpful if you’re out on a day that payroll journal entries need to be posted.
5. Reconcile Payroll to General Ledger
One final stage in payroll accounting is to do a payroll reconciliation. A payroll reconciliation is a process you follow to ensure your payroll accounts within the general ledger accurately reflect the transactions that occurred in the payroll system. It also helps you to ensure that you are within budget throughout the year. We gave you some tips in prior steps to help check yourself along the way, but a payroll reconciliation is a more in-depth approach.
Most companies do it at least monthly and definitely at year-end. Doing monthly reconciliations on a regular basis will ensure you have time to enter a correcting journal entry before the books are closed for the month, making future payroll audits and research much easier to follow.
The Bottom Line
If you’re overwhelmed with the many aspects of learning how to do payroll accounting, you’re not alone. It’s important to choose a quality accounting program that will make documenting transactions easier. You’ll thank yourself when an audit arises or you just need to prepare an income or cash flow statement at year-end.
