How Do You Book a Payroll Journal Entry?

Payroll is probably one of the most common journal entries – and one of the most common for pitfalls and errors. 

This blog is about going back to the basics in accounting, and the objective of the post is to walk you through the correct way to book a payroll journal entry.

Payroll 101

But first, let’s talk a bit about payroll. This is one of the biggest expenses on the income statement, and one of the most complex. Depending on your company’s operations, compensation paid to employees may consist of hourly wages, monthly salaries, commissions, bonuses, tips, or some combination of all of those. If you’re new to payroll, get the full scoop from IRS Publication 15, Employer’s Tax Guide.

What makes payroll accounting so complex is not so much the composition of what makes up gross wages, but all the taxes and other deductions that come out of it first, before the employee receives any cash. 

First, there are federal taxes on compensation:

• Federal Insurance Contributions Act (FICA) Taxes: These are social security and Medicare taxes and are paid jointly by employees and employers. Employers and employees both pay 6.2% for social security and 1.45% for Medicare. Social security tax is only paid on compensation up to a wage base limit, which increases each year. For 2020, this limit is $137,700.
• Federal Unemployment (FUTA) Tax : This is paid by employers only. The federal rate is 6%, but generally employers get a credit for state unemployment taxes paid. 
• Federal Income Taxes: Income tax is withheld from employees’ compensation to cover the taxes they owe when they file their 1040. 

Depending on where your business is located, and where your remote employees live and work, you may also need to withhold state and local income taxes. 

Payroll is also the vehicle for administering many common employee fringe benefits, so your payroll journal entries may also include amounts for health insurance, retirement plan contributions, dependent care benefits, vacation, and sick leave, as well as expense reimbursements. 

Some benefits, such as health insurance, are exempt from all federal taxes, while others are subject to some or all employment taxes. Check out IRS Pub 15-B, Employer’s Guide to Fringe Benefit for full details. Figuring out which benefits are subject to which taxes quickly gets complex, so outsourcing this to a payroll provider can be a very wise choice. 

There are a few different ways to “group” these payroll journal entries. Some companies will post entries for individual employees, while others do it by department. If the former is the case, it’s important to store this information in a private folder so that it is not accessible to everyone in the accounting team. How you choose to group these entries really depends on which format your payroll provider uses to report on the information, or if your business has strict requirements around it.

The level of detail in your journal entries and your chart of accounts is another choice. The examples we show here have only a few payroll expense accounts, but depending on the format that your payroll provider reports the information to you and how detailed you want your bookkeeping to be, you can add many more accounts. 

For example, instead of the generic “payroll tax expense” and “payroll accrual/clearing” we have, you could break that down into the individual tax expenses and separate liability accounts. For example, you could have an expense account for FUTA Tax and a balance sheet account for FUTA Tax Payable. Using a payroll journal entry template can help you make sure you don’t miss anything. Putting that template in Excel can help you make sure your debits equal your credits. 

Like all payroll-related liabilities, these additional liability accounts are all current liabilities. Any balances that don’t get cleared out within a couple pay periods should be investigated. 

The details:

Journal:  Payroll

Frequency: Each pay period, or each reporting period (i.e. monthly or biweekly)

FloQast folder location (LEARN MORE ABOUT FLOQAST FOLDERS): ‘Payroll Liabilities’ if payroll provider produces reports by department or, in a new FloQast instance specific to payroll if the underlying reporting is by individual and therefore too sensitive to share with the whole Accounting team.

Let’s work through an example with a biweekly pay period and two departments. The pay period runs Monday through the next Sunday, and payday is on the following Friday. Let’s look at the pay period October 12 - 25, 2020, with payday on October 30. 

The dr.’s and cr.’s

DateAccount NameDRCR10/25/20Gross wage expense - Dept A$500,000Gross wage expense - Dept B$150,000Bonus expense - Dept B$33,000Commission expense - Dept A$12,000Payroll tax expense (employer portion) - Dept A$46,000Payroll tax expense (employer portion) - Dept B$16,470Benefit contra expense - employee contributions$2,050FSA clearing - employee withholdings$5,000Payroll accrual/clearing$750,420

Memo: To record the payroll journal entry for the pay period ending October 25, 2020

Next, we need to fund payroll. A best practice is to use a separate bank account and a separate cash account in your general ledger just for payroll. Exactly when that payroll account needs to be funded depends on your payroll provider and your bank. For this example, let’s say that the payroll company requires funding on the day before payday. 

DateAccount NameDRCR10/29/20Payroll accrual/clearing$745,420Operating cash$745,420

Memo: To record cash paid for net pay, employee tax withholdings, and employer taxes

The last kind of journal entry you may need to make is to accrue payroll when the end of a pay period and the end of an accounting period don’t coincide. This ensures that the financial statements reflect all the expenses incurred during that period. For this organization, the next biweekly pay period would be from October 26 through November 8, 2020. For the October month-end close, the following journal entry would accrue six days of payroll:  

DateAccount NameDRCR10/31/20Gross wage expense - Dept A$214,285Gross wage expense - Dept B$64,285Bonus expense - Dept B$10,000Commission expense - Dept A$6,000Payroll tax expense (employer portion) - Dept A$16,852Payroll tax expense (employer portion) - Dept B$5,683Benefit contra expense - employee contributions$879FSA clearing - employee withholdings$2,143Accrued wages$314,083

Memo: To accrue payroll for October

On November 1, this entry needs to be reversed so that the accrued wages don’t overstate the actual wages for November. 

What if my account is now out of balance?

• Make sure there aren’t additional earnings codes this period, like “additional earnings,” or “correct / adjustment pays”
• Make sure there aren’t new withholdings like 401k or Flex spending that need to be added to the payroll journal entry template

Reconciliation (CLICK HERE FOR 3 BEST PRACTICE EXCEL RECONCILIATION TEMPLATES)

• Reconcile your cash balance
• Reconcile your payroll clearing – tax adjustments or pay dates that cross into the next period might be proper reconciling items. Look at next month’s bank account transactions!
• Reconcile your benefit clearing accounts

Common pitfalls

• You might think to debit wage expense and employer tax expense for the cash that goes out. Be careful!  This understates wages and overstates employer tax expense

How auditors audit

• Auditors will probably perform analytics on your income statement. “Why did wage expense go down one quarter for a specific department?”  “Why were commissions so high this month?”  If your payroll journal is designed properly, you’ll have no problem answering these questions!  (“Reduction in headcount.”  “Sales increased.”)