Basic Accounting Principles - A Beginners Guide TO GAAP and Creative Accounting

Journalizing Payroll

If you are a business owner or manager, chances are you have had to deal with payroll and all of its complexities. If you haven’t dealt with payroll yet, you may have to in the future. There are many parts to payroll. First you have to learn how to calculate withholding taxes for employees and understand all the federal and state rules associated with those taxes. If you don’t stay on top of the rules, which can change from year to year, you risk miscalculating the taxes and/or missing reporting deadlines. The price for not conforming to the rules can be severe penalties.

Faced with these hurdles, many small businesses opt for a payroll tax service. This is usually a good idea, as these services tend to be inexpensive and can lift a heavy burden from the shoulders of an owner or manager. However, the information provided by the payroll service company has to be entered into the company’s books. There is a simple way to do this, but first, you must have an understanding of what you are trying to accomplish.

It is imperative to understand the difference between “employee withholding taxes” and “employer payroll taxes”. In the U. S., it works like this:

Employee Taxes	Employer Taxes
Federal: FIT (Federal Income Tax) FICA Tax (Social Security) Medicare Tax State: SIT (State Income Tax) SDI (State Disability Insurance)	Federal: FICA Tax Medicare Tax FUTA Tax (Federal Unemployment) State: SUTA Tax (State Unemployment)

The state I use in the example is California. The state, in which you live may have different withholdings, so be sure to find out what they are, if any. Either way, you will have to follow the same accounting procedures.

Many of the larger payroll service companies provide a ton of information in the form of payroll reports. Unfortunately, the payroll information you need for your general ledger is often not easily discernable. I have had a payroll service business in Santa Barbara for 20 years, and even I have a hard time deciphering the large payroll service companies’ reports.

The larger payroll companies insist that you pay your payroll taxes “the day” of payroll. Therefore, you must set up an agreement between your bank and the payroll company so that the payroll company can automatically withdraw funds from your account to their account. They pay the taxing agencies directly. Your taxes may not be due on that exact date, so the payroll company has use of your money until the time the taxes are paid. It has been reported that they make millions on the interest alone from the float. (Well, anyway they used to).

If you use a smaller, perhaps local, payroll service company, they may simply process your payroll data and then provide you with the information you need to write your own checks to employees and the federal and state taxing authorities.

The challenge for you is to record the gross wages and withholdings in the proper accounts, and to reconcile what you actually owe for each tax against what has been paid. It’s a bit of pain, but once you get the hang of it, it’s not too difficult. Here’s how I do it:

One of your reports should be a payroll history that lists each employee, his/ her gross wages, FIT, FICA, Medicare, SIT, SDI, and net wages. For instance:

Gross Wages	FIT	FICA	Medicare	SIT	SDI	Other	Net Wages
10,000.00	2,600.00	620.00	145.00	400.00	80.00	20.00	6135.00

There should be another report that clearly shows the employer payroll taxes.

FICA	Medicare	FUTA	SUTA
620.00	145.00	80.00	350.00

This is the information you need to write your payroll journal entry. Here is an example of a journal entry for the employee side:

A.

DESCRIPTION	DEBIT	CREDIT
Gross Wages	10,000.00
FIT, FICA, Medicare		3,365.00
SIT, SDI		480.00
Employee Advance		20.00
Payroll Clearing		6,135.00
To record payroll for xx/xx/xx

Here is the example for employer payroll taxes:

B.

DESCRIPTION	DEBIT	CREDIT
Employer Payroll Tax	1,195.00
Accrued Employer P/R Tax		1,195.00
To record employer payroll taxes: FICA, Med, FUTA, SUTA

Look at what you have accomplished with these journal entries. In the first journal entry (A), you recorded your gross wages to the appropriate expense account. You set up the liability for the employee taxes payable. You recorded a credit in the employee advance account, assuming an employee was given a $20.00 advance earlier. You recorded a credit to the Payroll Clearing account for the correct amount of net checks that were paid out. This amount should clear out all the individual checks posted to the Payroll Clearing account that were paid to employees via your cash disbursements system.

For those unfamiliar with a payroll clearing account, it is a general ledger account that is normally set up in the asset section of the balance sheet. The purpose it serves is to reconcile all the net payroll checks paid to employees during an accounting period with a general journal entry that summarizes the total of all the net payroll checks. If an error occurs, the difference will remain in the payroll clearing account. This difference can then be researched to find the cause of the error.

If you write your payroll checks directly out of your cash disbursements system, along with all your other checks, then I recommend using a payroll clearing account. If you use a separate bank account just for payroll, then you probably don’t need a payroll clearing account.

In the second journal entry (B), you recorded all the employer payroll taxes to the expense account and set up the liability for those payroll taxes. When the taxes are actually paid, the amounts will be recorded as a debit to Accrued Employer Payroll Taxes, and the employee FIT, FICA, Medicare, SIT, SDI tax liability accounts, which will zero out those accounts. For instance:

DESCRIPTION	DEBIT	CREDIT
FIT, FICA, Medicare	3,365.00
SIT, SDI	480.00
Employer P/R Taxes	1,195.00
Cash		5,040.00

An advantage of using a smaller payroll service company or using your own payroll software program in your business is that you have the use of your money until the taxes become due. This can be critical if you happen to be suffering from a cash flow shortage. In addition, small payroll service companies tend to be more flexible when it comes to reversing mistakes, running a special payroll, researching tax inquiries, handling worker’s compensation audits, etc.

Whether you use an outside payroll service or buy your own payroll software, I would make sure that the reports you receive are simple to read and clearly display the critical information you need to record your payroll activity quickly and accurately. A payroll software program should post all the information automatically. However, you should be able to verify and prove that the information is correct, as mistakes do happen. This requires good reports and a solid understanding of how recording payroll works.