Doing a monthly payroll reconciliation helps small businesses ensure their payroll transactions are flowing smoothly through their accounting records. Payroll reconciliation is important because it can help catch errors or outstanding items that need attention before too much time passes. A payroll reconciliation is essentially a report that’s put together using the different payroll transactions that move through your balance sheet accounts. To complete, you’ll list all transactions that don’t clear to $0 and research the issues that need to be rectified so that all payroll-related funds go where they should be.
Usually, small business owners will have their bookkeepers do payroll reconciliations, but whoever you make responsible for it will benefit if you have payroll software like Gusto. You can print payroll and transaction reports within minutes, making the research process faster for you or your accountant. Since Gusto pays your employees and tax agencies, you can be assured that the data in your payroll software matches what actually happened, giving you a solid source to check your general ledger transactions against. Try it free today.
Note: What we’re about to cover is a partial balance sheet reconciliation—it’s only looking at payroll-related accounts, primarily liabilities (those that show money you’ve expensed or collected but are waiting to pay out). It’s easy to confuse a payroll balance sheet reconciliation with a payroll audit. If you just need to audit the payroll expenses you paid out, check our article on how to conduct a payroll audit.
1. List Your Payroll Balance Sheet Accounts
Before we dive into the reconciliation process, let’s first make a list of the balance sheet accounts you need to reconcile each month.
A balance sheet is one of the major financial statements businesses produce that show the balance of their assets, liability, and equity accounts at a single point in time—for instance, Dec. 31, 2021 vs a period of time like, Jan. 1, 2021 through Dec. 31, 2021.
Here’s a list of the payroll-related balance sheet accounts you may need to reconcile:
- Accrued payroll: Houses net payroll amount that has been earned but not paid out.
- Federal Income Tax Withholdings Payable: Federal tax you’ve withheld from employee paychecks but haven’t paid to the IRS.
- State Income Tax Withholdings Payable: State tax you’ve withheld from employee paychecks but haven’t paid to applicable tax agencies.
- FICA Tax Payable: This includes both the employee and employer portion of Social Security and Medicare tax that hasn’t been paid; half is withheld from employee paychecks, and the other half is expensed from the business.
- 401(k) Payable: This holds the contributions employees make to their 401(k) accounts (you can create different accounts if you have multiple retirement account options); you can also put any contribution matches your business is making into this account, and hold the money there until it’s paid.
- Health Insurance Payable: This liability account should only have employee-paid insurance premiums plus contributions you have booked as a business expense but have not paid.
Pro Tip: If your accounting system allows, consider labeling the transactions that consist of both employee and employer funds (use the codes EE and ER). This will help you during the reconciliation process, especially when you’re trying to research discrepancies.
Keep in mind that most likely, all of the accounts you’ll be reconciling will be liability accounts. This means the money should stay in the account until you pay it out. The point of reconciling your payroll accounts is to ensure nothing is lingering around too long; when you do find items that don’t clear from your payroll balance sheet accounts each month or quarter, it’s likely you may have forgotten to pay a bill, or a transaction wasn’t recorded correctly.
If you’re feeling a little unsure about this step, the general ledger accounts, or related journal entries, take a quick look at our guide on how to do payroll accounting.
2. Set up Monthly Payroll Reconciliation Sheets
Download our payroll reconciliation spreadsheet to give yourself a head start. You’ll need to make copies for each payroll account on the balance sheet, and be sure to make a new copy at the end of each month. Label the spreadsheet with the account name. You should have a beginning and ending balance for each that ties to the general ledger balance records. Leave space in between for reconciling items.
Reconciling items are transactions that aren’t reflected correctly or at all in the general ledger. You’ll find it causes your general ledger to be out of balance, which means it won’t be clear how the account’s beginning balance transitioned to the ending balance.
3. Gather Reports From Your Payroll Software & General Ledger
You’ll need a monthly transaction report from your general ledger for each payroll related balance sheet account, preferably one that shows the beginning and ending balances for the month. Reports you may need to gather from your payroll software are a payroll register, or list of monthly payroll transactions, payroll tax report, payroll deduction report, etc. For more complex issues, you may have to dig into your payroll cash reports or itemized invoices from your benefit providers.
4. Review Payroll Transactions & Reconcile Differences
Now you’re ready to start reconciling your payroll accounts. If you can download the transactions from your accounting software into excel, the process may be easier, or you can copy and paste them into your spreadsheet.
If your account had transactions for the month but has a $0 balance at month-end, you should show this on your reconciliation sheet and verify it’s clear; I would still paste the transaction list in another tab just to have it in your records in the event that you need to take another look at the account later.
If there is a balance at month-end, you’ll need to sift through each debit and credit to find those that did not clear out completely. When dealing with numerous transactions, I always found it helpful to delete the debits and credits that net to $0, so it’s easy to see what’s remaining. If your business is really small, and you have a handful of transactions, this process will be a breeze, and you may not need to do that. Either way, I still recommend maintaining a separate tab that shows all of the transactions, whether they cleared or not.
Let’s look at a payroll reconciliation example:
In the example above, we see that employee health insurance premiums were collected during the Nov. 15 and Nov. 30 payroll runs and booked to the liability account. We also see where the business paid the insurance company and classified $20,000 as coming from employee premiums. The issue is that the $20,000 debit did not clear the account to $0. Instead, there’s a $500 credit left in the account, which means $500 of employee premiums were not used to pay November’s health insurance bill.
To resolve the issue and clear the account, you’ll need to research the reason behind it before coming up with a solution.
5. Fix Payroll Reconciling Items
All reconciling items can be vastly different in what they require to resolve. In our health insurance premium example above, the first step would be to take a look at the health insurance invoice. Is it itemized by employee? Also, look at your payroll deduction report for the month. Take a look at the employee paychecks you withheld $500 from for the month, or $250 from each pay period. Are the employees still with the company? Are they showing on the invoice?
Depending on the answers to these questions, you may need to reverse the $500 transaction and refund an employee their money, work with the insurance company to determine if the invoice needs to be corrected, or hold the money to pay on next month’s bill.
Other common reconciliation items you may run into are:
- A check was voided in the payroll system but not the GL (having payroll software that’s integrated with your GL can eliminate this issue, because it automates the process).
- A bill from your benefits provider was different from expectations; maybe an employee left, and you withheld their premium for the next month. If you didn’t notify the company, the charge will still show on the invoice. This can lead to an additional, unnecessary expense if you allow it.
- Employees left before 401(k) contributions qualified for vesting; the funds would be set aside and still show in the liability account if not yet paid but will need to be reversed to reconcile.
- You expensed charges that should have been covered by employee deductions.
When doing payroll reconciliations, don’t be afraid to dive deep when necessary. Call vendors, verify payroll details with employers, check your bank and tax records, etc. Also, pay attention to payroll compliance rules; if you’re only paying taxes quarterly or annually, some of your tax liability accounts have a balance more often than not. Stay abreast of the deadlines, and be sure the charges clear when they should.
Tips to Make Payroll Reconciliations Easier
To wrap things up, let’s review a few tips you can follow to make your payroll reconciliations simpler.
- Reconcile the payroll balance sheet accounts regularly—monthly, at least.
- Add special codes or labels to transactions to help you identify them quicker, i.e., like those that include funds from employees vs employers, or those that have a variety of transactions coming in like if the health insurance payable account includes dental, vision, and medical premiums.
- Set your payroll reconciliation sheets up so they’re easy to follow—including account names and numbers, dates, and transaction descriptions.
- Input records of all year-to-date transactions in a separate tab within your reconciliation.
- Add a column for notes, so you can document helpful information, like when a certain charge should clear.
- Add separate tabs for supporting detail like invoices, emails, and other documentation that can help explain any outstanding items.
- When doing payroll, keep payroll transactions as easy-to-follow as possible.
As a small business owner, it won’t hurt to learn how to reconcile payroll. Even if you hire a bookkeeper to do the reconciliation for you, you need to know what to expect, so you know when something is off. All money and payments should flow smoothly through your payroll balance sheet accounts, and even if expectations and actual payments don’t always match exactly, the differences should be cleared in a timely manner.