With a large tub of ice cream in my lap, I watched The Avengers a few nights ago (I’m rewatching all of the Marvel Cinematic Universe movies in release date order.) I nearly dropped my spoon in excitement when I heard Black Widow mention an accounting concept, the one we’re talking about today.
She said, “I’ve got red in my ledger.” Though she might be talking about having blood on her hands from being a double agent, she’s referring to accrued expenses. In accounting, when you owe someone money — including your employees — you record it in your books.
Overview: What is the accruing payroll methodology?
The accruing payroll methodology tells you to record compensation in the accounting period — a month or year — it’s earned, even when it’s not paid until the next period.
Say your business announces annual bonuses in December 2020 but pays them with the first payroll in January 2021. Since employees earned bonuses in 2020, you accrue a payroll expense for the bonus amount before the ball drops at midnight on Jan. 1. The bonuses count as a wage expense on your 2020 income statement.
Accrued payroll is a debt owed to employees. All accrued expenses are liabilities on your balance sheet until they’re paid.
Only businesses that follow the accrual method of accounting need to accrue payroll on their books. Under the cash method of accounting, you record transactions when cash enters or leaves your business. The more precise accrual accounting method has you record transactions when you earn revenue and incur expenses, not necessarily when cash flows.
4 examples of payroll accruals
Record all types of compensation — salaries, hourly wages, and bonuses — in the period your employees earned them. Don’t forget about taxes and paid time off (PTO) either.
1. Salary and hourly wages
Gross wages are an employee’s total compensation before payroll deductions, such as taxes and retirement contributions. A payroll accrual starts with recording the total amount an employee earned during the period.
Don’t forget to include taxable fringe benefits, such as commuter benefits, in the gross wages accrual.
Similarly, cash bonuses earned in one period and paid in the next warrant a payroll accrual. Many businesses tell employees how much they earned in annual bonuses in December but don’t pay until January. If that’s the case for your business, you need to record the bonus payments in December because that’s the year in which your employees earned bonuses.
3. Payroll taxes, deductions, and contributions
Every time you pay employees, you and your employee both owe Uncle Sam. Your business and its employees might also contribute to employee health and retirement plans. Include all of these payments in the payroll accrual.
Let’s start with payroll taxes. They’re either 100% employer-paid, 100% employee-paid, or split between employers and employees.
You deduct the following taxes from employee pay:
- one-half of Federal Insurance Contributions Act (FICA) taxes
- federal income tax withholding
- state income tax withholding (if applicable)
- state Unemployment Tax Act (SUTA) taxes (only in Alaska, Pennsylvania, and New Jersey)
- other state and local taxes
Employers are responsible for:
- one-half of FICA Taxes
- SUTA taxes
- federal Unemployment Tax Act (FUTA) taxes
- other state and local taxes
Employees contribute to health insurance and retirement by taking a pretax payroll deduction. Businesses often match employee 401(k) contributions or subsidize health insurance premiums. Put these contributions on the books before the month or year ends.
4. Paid time off (PTO)
Businesses that offer employees defined vacation and sick time need to track how much they’d walk away with if they left the company. With every payroll accrual, update how much your employee earned in vacation and sick time.
Businesses award time off differently. Employees at one company might earn 0.5 vacation days every pay period, while another company might grant three days to employees at the end of each quarter. All that’s to say your time-off accrual might look different than my payroll accrual examples.
Unless your company lets employees roll PTO days into the new year, you need to reverse the accrual at the end of the year with an adjusting entry. Businesses with a use-it-or-lose-it policy start every January with a clean slate because they’re no longer responsible for paying out PTO.
You can avoid accruing vacation and sick time — and paying departing employees for unused time off — by adopting an unlimited PTO policy.
How to calculate accrued payroll
Let’s calculate accrued payroll using my fictitious candy factory, RL Good Candy, based in the District of Columbia.
1. Salary and hourly wages
My employee Susie is paid $15 per hour and receives a paycheck every Monday for the previous week’s work.
Let’s suppose she works 40 hours in the final week in December, which ends on a Friday. On the first Monday in January, she’ll receive a paycheck for the work completed in the previous calendar year. I use the accrual basis of accounting, so I must accrue payroll equal to her wages for the last week in December.
On Dec. 31, I accrue $600 in gross wages ($15 per hour ✕ 40 hours).
If Susie receives a $1,000 bonus in 2021 for reaching her sales targets in 2020, I’d accrue $1,000 in bonus compensation by Dec. 31, 2020.
Bonuses may be taxed the same as regular wages when paid with a regularly scheduled payroll run. Susie’s gross wages to be paid on the first Monday in January is $1,600 ($600 hourly wages + $1,000 bonus).
3. Payroll taxes, contributions, and deductions
Here’s where the accrual calculation gets slightly hairy (I can confirm the candy isn’t affected.) Let’s calculate payroll taxes, contributions, and deductions for Susie.
To calculate taxes and contributions, you can look at a similar payroll period or run the numbers through an online payroll calculator.
First is the employee-paid taxes, which come out of your employee’s paycheck.
Susie’s net pay, or paycheck amount, is $1,093.40 ($1,600 gross wages – $506.60 payroll deductions).
Next, record employer-paid payroll taxes.
You’ll notice I’m not accruing anything for FUTA and SUTA, two employer-paid payroll taxes. That’s because both taxes usually fizzle out early in the year for full-time employees. FUTA only applies to the first $7,000 of an employee’s wages, resetting every January.
4. Paid time off (PTO)
At my company, full-time employees earn four hours — one half-day — in PTO with every weekly paycheck. Yes, that’s 26 vacation days per year. No, I’m not accepting applications.
At RL Good Candy, I’d accrue 10% of an employee’s wages for PTO (8 hours PTO earned / 80 hours worked in two weeks). For an employee paid $2,000 every two weeks, the PTO accrual is $200 ($2,000 bi-weekly paycheck ✕ 10%).
How to record accrued payroll and taxes
So you know how much to accrue for payroll. Now, put it together by recording it in your accounting software.
Payroll software integrates with accounting software to record your payroll accrual with one massive journal entry. For demonstration purposes, let’s break it down.
1. Record employee wages and deductions
Report your employee’s wages and deductions first. Remember: debits must equal credits in every journal entry. Here’s Susie’s accrued wages payroll journal entry:
The Wages Payable account is your employee’s net pay, or the amount written on her payroll check.
2. Record employer payroll taxes and contributions
Record employer-paid payroll taxes, such as the employer’s portion of FICA, FUTA, and SUTA. As I mentioned, I don’t owe FUTA and SUTA on Susie’s wages since I’m accruing payroll at the end of the year, after she’s earned more than $7,000 for the year.
Then, record your employer contributions to health insurance and retirement plans.
3. Record PTO accrual
Finally, record the amount put aside for the paid leave your employee accrued during the pay period.
Don’t forget to reverse payroll accruals
Black Widow’s full quote is this: “I’ve got red in my ledger. Now I need to wipe it out.” Do as Black Widow says.
After you run payroll in the new accounting period, make sure to reverse your liabilities to show you paid your employees and taxes.
View more information: https://www.fool.com/the-blueprint/payroll/accruing-payroll/