According to Connecteam, a New York-based software firm that helps you manage your business, 2 in every 5 small companies face an average of $845 in annual IRS payroll tax penalties. Perfecting your payroll journal entries can help you avoid this fate. Here's everything you need to know about maintaining proper payroll accounting and creating accurate payroll journal entries.
What is payroll accounting?
Payroll accounting is the process of tracking all the money you spend on wages and payroll taxes. It's integral to ensure your employees are paid in full and on time, and it also keeps you out of hot water with the IRS. Proper payroll accounting also keeps your general ledger balanced, so you can be more confident in your financial statements' accuracy.
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What are payroll journal entries?
Payroll journal entries are the numbers you record in your small business's general ledger to track employees' wages. Each payroll journal entry is paired with another entry of an equivalent and opposite amount, as payroll journals heed the double-entry accounting method. In this method, when your company earns money in one account (credit), it loses money in another (debit).
The double-entry accounting method underlying payroll journal entries can be represented with this mathematical equation:
Assets = Liabilities + Equity
A longer version of this equation might be:
Assets + Gains + Revenues = Liabilities + Equities + Expenses + Losses
Let's look at a simplified example to understand how this equation factors in with journal entries. When paying employees, for instance, you would debit your expense accounts because you lose cash. However, you would also credit your liability accounts (a liability is any economic burden). That's because your as expenses increase, your cash amount decreases.
Types of payroll journal entries
These are the three main types of payroll journal entries:
1. Initially recording payroll entry
Initial recordings are the most detailed type of payroll entry. Initial recordings display debits for your wages, direct labor expenses and payroll taxes. The equal – and opposite – transactions for the first two of these three categories are liability general ledger account credits.
Wages and direct labor are the same thing in many cases, but they may differ in some industries. In construction, for example, direct labor often comprises wages paid for open jobs, whereas wages comprise other employees' pay overhead.
If you withhold other payroll deductions, such as benefits plan premiums or wage garnishments, you'll also need to record these values in your initial recording payroll entry. You should then record each individual benefit amount in its own row as a credit.
Your initial recording payroll entry should look like this table:
|9/10/2021||Payroll taxes expense||$70,000||N/A|
|9/10/2021||Employee FICA tax payable||N/A||$15,000|
|9/10/2021||Federal income tax payable||N/A||$24,000|
|9/10/2021||State income tax payable||N/A|
|9/10/2021||Wage garnishments payable||N/A||$1,000|
|9/10/2021||Employer FICA tax payable||N/A||$15,000|
|9/10/2021||FUTA tax payable||N/A||$1,000|
|9/10/2021||SUTA tax payable||N/A||$6,000|
Note that payroll taxes are unique in payroll journaling because you withhold them earlier than you actually pay them. When you pay each tax, you'll need to debit the individual tax and credit your payroll account with the corresponding amount. After this, the relevant sections of your payroll journal entry will appear similar to this table.
|9/10/2021||Employee FICA tax payable||$15,000||N/A|
|9/10/2021||Federal income tax payable||$24,000||N/A|
|9/10/2021||State income tax payable||$8,000||N/A|
|9/10/2021||Wage garnishments payable||$1,000||N/A|
|9/10/2021||Employer FICA tax payable||$15,000||N/A|
|9/10/2021||FUTA tax payable||$1,000||N/A|
|9/10/2021||SUTA tax payable||$6,000||N/A|
2. Accrued payroll entry
Your initial payroll entry may not cover all your wages, despite how comprehensive it appears. That's because – in some cases – you'll still have wages to pay after an accounting period closes. Therefore, you'll need to create an accrued payroll entry.
When creating accrued payroll journal entries, group all your wages in one row and your payroll taxes in another. This type of payroll journaling is simpler than initial recording. However, you'll need to reverse your accrued entries when your next accounting period begins.
An accrued payroll entry may look like this:
|9/10/2021||Accrued payroll taxes||N/A||$50,000|
3. Manual payroll entry
If you pay wages by check outside of your company's typical paydays, you'll need to create manual payroll entries to account for them. However, you might not do so in your payroll account. Often, these atypically timed payments come from your accounts payable. You can still use the same line items as described earlier in your accounts payable.
How to record payroll entries
While the best online payroll software streamlines payroll accounting, you should still know how to complete this task yourself.
For starters, understanding the payroll journaling process can help you find discrepancies in your software's calculations that indicate numbers incorrectly entered into your system. More importantly, knowing how the process works will give you more control over your employee payment processes. Follow these steps to create payroll entries.
1. Log your wage payments in the appropriate accounts.
Let's say that, for the period in question, you pay $200,000 total in wages. You'll need to record this amount as a debit in your wages account and a credit in your wages payable account. The distinction between these two similarly named accounts is that the latter is a liability, and the former is an expense. Since these accounts are both on the right-hand side of the assets equation, it's mathematically correct to credit one and debit the other in equal amounts.
Your payroll journal entry will look similar to this chart:
If your company distinguishes between direct labor and wages, you'll need to break your $200,000 debit into these corresponding rows:
2. Write down your employee payroll deductions.
You also deduct FICA taxes, income taxes, the employees' portion of benefit premiums, and wage garnishments from your workers' paychecks. You must record these deductions as transactions in your general ledger.
To create payroll journal entries for these deductions, create a row for each type of tax titled "[tax name] payable." Record each tax amount as a credit. Then, record the sum of these credits as a payroll tax debit.
Your payroll journal entry for these deductions should appear similar to this table:
|9/10/2021||Employee FICA tax payable||N/A||$60,000|
|9/10/2021||Federal income tax payable||N/A||$96,000|
|9/10/2021||State income tax payable||N/A||$32,000|
|9/10/2021||Wage garnishments payable||N/A||$4,000|
|9/10/2021||Employee health insurance premiums payable||N/A||$8,000|
3. Record your employer payroll deductions.
Employee payroll deductions are only part of the story. You must also pay employer payroll taxes for your small business. These taxes include FUTA, SUTA and the employer's share of FICA taxes. One way to double-check your math is to confirm that your employee and employer FICA tax amounts are equal.
You'll record these taxes as credits in your payroll journal under a debit you'll title as "payroll expenses." You'll also record credits for the total premiums you pay for each of your benefits plans, including your mandatory workers' compensation insurance. Add the dollar value to the leave that your employees take as credits.
The corresponding payroll journal entry will look like this chart:
|9/10/2021||Employer FICA tax payable||N/A||$60,000|
|9/10/2021||FUTA tax payable||N/A||$4,000|
|9/10/2021||SUTA tax payable||N/A||$24,000|
|9/10/2021||Employer health insurance premiums payable||N/A||$20,000|
|9/10/2021||Employer worker's comp insurance premiums payable||N/A||$12,000|
|9/10/2021||Employer pay for employee leave payable||N/A||$4,000|
4. Add cash to your payroll account.
Add cash to your payroll account to ensure you cover all the necessary payroll costs. When you transfer money from your operating cash account to your payroll cash account, you must record a debit in your payroll account and a credit in your operating cash account.
To determine the amount of cash to add, first add the wages debit in step one, the separate wages debit in step two, and the payroll expenses debit in step three. Then, subtract the leave credit from step three because you don't pay cash for leave. The resulting number is how much cash you must add to your payroll account. In this example, you would use this formula:
$200,000 + $200,000 + $124,000 - $4,000 = $520,000
Your payroll journal entry will appear similar to this table:
5. Pay your employees and record the payments.
When you pay your staff, you must create another payroll journal entry. Since you debited your payroll account to afford your employee payouts, you'll credit it once you send the payments. To balance this credit, you'll debit your wages payable account. Your journal entry for the payment looks like this chart:
6. Pay all your deductions and record the payments.
The final step is to pay all the deductions that you recorded – except employee leave. All these deductions receive debits equal to their credits, and then your payroll account gets a credit equal to the sum of all these debits. The payroll journal entry looks like this chart:
|9/10/2021||Employee FICA tax payable||$60,000||N/A|
|9/10/2021||Federal income tax payable||$96,000||N/A|
|9/10/2021||State income tax payable||$32,000||N/A|
|9/10/2021||Wage garnishments payable||$4,000||N/A|
|9/10/2021||Employee health insurance premiums payable||$8,000||N/A|
|9/10/2021||Employer FICA tax payable||$60,000||N/A|
|9/10/2021||FUTA tax payable||$4,000||N/A|
|9/10/2021||SUTA tax payable||$24,000||N/A|
|9/10/2021||Employer health insurance premiums payable||$20,000||N/A|
|9/10/2021||Employer workers' comp insurance premiums payable||$12,000||N/A|
Creating these tables is tedious and time-consuming. Payroll software can automate the process by giving you a complete ledger or payroll journal in just moments.
Payroll software for journal entries
Any process involving a large number of manual calculations is susceptible to human error. Payroll software solves this problem with automated calculations, which free you up to address other pressing matters for your small business.
Some payroll services, such as ADP, are engineered to handle complex payrolls. You can learn about the benefits and disadvantages of this software in our full review of ADP. Other programs are geared toward new or very small businesses. For an example, see our review of OnPay. Rest assured, a software program exists to meet your payroll needs.