Payroll Accounting Basics for Small Businesses

Payroll accounting is the process of recording payroll expenses and liabilities in the general ledger, which is a central repository for the company’s financial accounts.

These expenses and liabilities include:

• Regular gross salary/wages plus other types of employee compensation, such as tips, bonuses, commissions, and overtime pay
• Taxes withheld from employees’ wages, such as federal income tax, Social Security tax, Medicare tax, and applicable state and local taxes
• Other deductions from wages, such as for payroll taxes, wage garnishment, and voluntary benefits like health insurance, 401k, and life insurance
• Employer share of payroll taxes, including Social Security tax, Medicare tax, and federal and state unemployment taxes
• Employer share of employee benefits, such as workers’ compensation, paid vacation and sick leave, paid holidays, health insurance, retirement plan, and life insurance

What are payroll expenses?

Payroll expenses are amounts that have been paid, such as salaries/wages processed for the current payroll period. Conversely, payroll liabilities are amounts owed but not yet paid — such as taxes withheld from employees’ wages and the employer’s portion of payroll taxes. In most cases, payroll liabilities must be remitted to a third party, such as the IRS and the state revenue agency.

To record payroll expenses and liabilities in the general ledger, you must make payroll journal entries.

Note that in small businesses, payroll journal entries typically can be posted directly to the general ledger, since the transactions are relatively limited. Large businesses, however, tend to have voluminous payrolls, which may clutter the general ledger. For this reason, large businesses often make detailed payroll journal entries in a payroll journal and then transfer the summary totals to the general ledger.

Why is payroll accounting necessary?

Payroll accounting is critical for 4 primary reasons:

1. Payroll compliance. If you have even one employee, you’re legally required to pay that employee through your payroll system plus account for mandatory deductions and applicable fringe benefits. Payroll accounting allows you to verify that your employee payments and deductions are done according to the law and company policies. Moreover, payroll accounting lets you track payroll reporting compliance, such as federal and state employment-tax filings.
2. Payroll expense management. Payroll accounting gives you a tangible guidepost for managing your payroll expenses and staying within budget. It shows where your payroll costs are going, and where you can cut back or increase spending.
3. Audit trail. If your business is ever audited — such as by the IRS or the Department of Labor — your payroll accounting records can substantiate your payroll transactions.
4. Financial statements. Payroll transactions appear on the company’s financial statements, including the income statement and the cash flow statement. So, if the payroll transactions are incorrect they will throw off the financial statements. Payroll accounting helps ensure accurate payroll and financial records.

Payroll accounting allows you to verify that your employee payments and deductions are done according to the law and company policies.

Small-business payroll accounting: the basics

When making payroll journal entries in the general ledger:

• Identify whether the transaction is an expense or a liability
• Post each expense as a debit, under the correct account name
• Post each liability as a credit, under the correct account name

In the end, the debits and credits must balance each other out.

Example of the payroll journal entry for employees’ salaries/wages and deductions

Biweekly pay period ending December 15 

Also, record additional expenses and liabilities you (the employer) incurred for the payroll period.

Example of payroll journal entry for employers’ additional expenses and liabilities

Biweekly pay period ending December 15

The total credits/liabilities should equal the total debit.

When you actually pay your employees on payday, decrease your cash account by the net salaries/wages payable.

Example of payroll journal entry for net salaries/wages paid

Pay date: December 15

Then, as you remit employee and employer payments to the respective third parties, record the payables as debits and then credit your cash account.

Example of payroll journal entry for remittances

Pay date: December 15

Follow this process as you make other remittances, such as for workers’ compensation, health insurance, and 401(k). The total debits should always equal the total credits.

Keep in mind that the above examples are for standard payroll processing. You may need to make other types of payroll journal entries — such as for manual checks issued outside of the normal payroll run.

Don’t overlook integrated software

Payroll accounting isn’t just about posting payroll transactions to the general ledger. It’s also about reconciling timekeeping, payroll, and accounting data to ensure accuracy across the board. But if done manually or through separate technologies, payroll reconciliation and accounting can take up a huge chunk of your time while elevating the chance of errors.

An integrated timekeeping, payroll, and accounting system not only simplifies payroll processing, reconciliation, and accounting but also decreases manual labor and the probability of errors. For example, the integrated system automatically:

• Transports employees’ time directly into the payroll system
• Calculates wages and deductions
• Posts payroll journal entries to the general ledger
• Organizes and stores timekeeping, payroll, and accounting records

The integrated system streamlines your timekeeping, payroll, and accounting processes while making overall compliance easier to reach.