Guide to Payroll Accounting

While employees are a business's greatest assets, it's critical to clearly understand what it costs to keep staff on board. That's where an accounting system for payroll comes into play since it can help keep track of employee-related expenses such as wages, benefits, and taxes. So, what exactly is payroll accounting, why is it important, and which expenses does it track?

What Is Payroll Accounting?

Payroll accounting is a system that records and keeps track of payroll-related expenses, such as employees' wages, benefit costs, and payroll taxes. It doesn't include rent, utilities, equipment, inventory, or any other business expenses unrelated to employee compensation or benefits. Besides payroll taxes and FICA, payroll accounting doesn't track business taxes such as sales, excise, or company income taxes.

The information input into a payroll accounting system is stored in payroll journal entries. These provide records of payroll expenses and details about each transaction (e.g., date of compensation and payroll amounts). A general ledger will record each journal entry for financial reporting and business-related purposes.

Expenses That May Fall Under Payroll Accounting

As mentioned earlier, a payroll accounting system only keeps records of expenses related to paying employees. The chart below explains 5 types of accounting payroll expenses:

The Importance of Payroll Accounting

It's imperative to business cash flow to keep accurate and up-to-date records of payroll expenses. For many businesses, paying employees is one of the largest items in the budget. Payroll accounting offers a holistic view of an organization's financial health and the cost of each employee, factors that can influence hiring and compensation decisions later. Payroll accounting also plays an integral role in adhering to payroll tax obligations. Should your business ever be audited, maintaining comprehensive records through a payroll accounting system can help streamline the process, providing transparency and traceability that can prove invaluable during financial assessments.

What Are the Basic Types of Payroll Accounting?

For payroll accounts, you can choose between three types of journal entries to help ensure payroll is correctly recorded in the system:

• Initial recording or originating entry: This is the standard method to enter payroll data. These entries include your employees' gross earnings, taxes, and withholdings.
• Accrued wages: Use this entry at the end of an accounting period, such as quarter-end or year-end. It will also include wages that you still owe your employees. Once you pay these wages, you make reversed entries in your ledger to account for this payment.
• Manual payment: While used infrequently, you would use this entry type to adjust an employee's pay. For example, if you've terminated an employee and mailed them their last paycheck, you would record it as a manual payment.

How To Do Payroll Accounting With the Help of Payroll Software

Payroll accounting starts with setting up a system that works for your business. With the right accounting software, you can set up automatic payments, process individual payments, or integrate with a payroll service. Follow these steps to help maximize your business's payroll accounting system.

Set Up Your Accounting Software

While you can certainly process payments yourself, it can quickly become time-consuming and vulnerable to errors. Consider automating the process using a third-party payroll provider that integrates with payroll to help save time and resources.

Create Accounts for Each Expense Type

Set up an account for each payroll expense (find more details in the chart above), such as wages, payroll taxes, and 401(k) matches.

Set Up Recurring Payments

You can set up your payroll accounting software to automate issuing regular employee payments. You may also even be able to tag payments and categorize them based on expense type.

Reconcile Payments

Even if you automate processes, routinely checking payments for accuracy is still a good idea.

Create Detailed Accounting Reports

You can compile payment records for a single pay run or over a certain period. You can also better understand employee costs by tagging expenses and running reports, and breaking down expenses by category.

Start, Stop, or Change Payments

You can add, remove, or change payment amounts as employees join or leave the business, as compensation changes, if employees move and the taxes applied to their paychecks change, or if tax rates change.

Proper Payroll Accounting Is Critical for Businesses

Adept business owners closely monitor cash flow, especially payroll costs. Whether you do payroll on your own or use a payroll service, your payroll accounting system can play an important role in helping you plan for future growth and make sound hiring decisions.