Payroll accounting refers to the accounting of salaries, wages and benefits payable to employees as a result of their employment.
Most businesses usually have employees working for them. If there are employees, the entity has to account for the salaries, wages and benefits paid to them.
You must have noticed that sometimes salaries are paid with delay and sometimes salaries are taken by employees in advance. Should we alter the recognition of payroll expense based on the payment of salaries and benefits? Not at all! We know that as per accrual based accounting, payment of expenses is not the decisive factor in determining the timing of recognition of expense.
Payroll expense must be recorded when it is incurred. In other words, payroll expense is recorded when the employees earn their salaries and benefits regardless of the payment status.
Payroll components
Let’s see some typical payroll items used by various companies.
- Salaries – Fixed periodical amounts agreed between the employer and the employee (for e.g., monthly salaries) which are typically paid to the employee at the end of each such period (for e.g., monthly salaries paid at the end of each month).
- Wages – Amounts paid to workers for the time worked by them as per agreed hourly rates. Wages are typically paid by the end of the working day or are paid by the end of each week.
- Allowances – For regular employees, some extra payments in addition to the salaries are typically agreed between the employer and the employee to compensate the employee for their specific expenses. For instance, accommodation allowance, travelling allowance, medical allowance etc. are some common examples of allowances paid by employers.
- Fringe benefits – Any benefits given by the employer to the employee in kind rather than cash. For instance, company maintained car, free medical treatment, free accommodation etc. are some common examples of fringe benefits.
Accounting of payroll expense
Usually, the payrolls are processed periodically, for instance at the end of each month and include different types of benefits payable to employees. Then there are certain deductions such as income tax deductible at source, any adjustment of advance previously given to any employee etc. A net figure is calculated for each employee which is then paid by the employer.
It must be noted that payroll expense is always recorded at the gross amounts of salaries, wages, and benefits. The deductions part is related to the second effect of the payroll expense double-entry. At an accounting period end, any portion of the payroll expense that is incurred but not yet paid to the employees will be included as current liabilities on the balance sheet.
Typically, following journal entries will be used to record the payroll expense and subsequent payment to employees.
Payroll accounting – Journal entry to record payroll expense
Following entry is made to record payroll expense:
Dr. Salaries, wages, and benefits expense
Dr. Company’s portion of payroll tax expense
Cr. Company’s portion of payroll tax payable
Cr. Withholding tax payable
Cr. Social security tax payable
Cr. Any other taxes or contributions from salary (for e.g., provident fund contribution)
Cr. Advance salary adjustment (if an employee had obtained any loan)
Cr. Payable to employees
Payroll accounting – Journal entry to record payments
Following entry is made to record payment to employees:
Dr. Payable to employees
Cr. Cash or bank
Following entry is recorded on subsequent payment of deducted tax, company’s portion of payroll taxes, and other liabilities related to social security of employees etc.
Dr. Company’s portion of payroll tax payable
Dr. Withholding tax payable
Dr. Social security tax payable
Dr. Any other taxes or contributions from salary (for e.g., provident fund contribution)
Cr. Cash or bank
Difference between employee and independent consultant
Companies use employees as well as independent consultants for various tasks. For example, a company may have an employee working as an accountant and doing certain accounting tasks, whereas some accounting tasks may be outsourced to an independent accountant working as a consultant or independent contractor. Differentiating between employees and independent consultants and contractors is important, as income tax laws regarding tax deduction at source are different for employees and other parties. Payments to employees are processed through standard payroll, whereas payments to consultants and contractors are processed through the company’s accounts payable system.
Some factors are mentioned below that can be considered to identify the employment relationship.
- Presence of an employment contract.
- Employer has control over the tasks to be assigned to the person.
- Employer has control over the way the tasks are performed.
- The person working is not in a position to decline a work assigned to him by the employer.