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.

 

Forensic Accounting and Fraud Investigation: A Beginner's Guide

Miscellaneous Suspense: The Handy-Dandy GL Account

One of the great things about the discipline of accounting is that there is always a tidy solution to an accounting problem. Well, most of the time. The reason for this is because you are done only when the books are “in balance”. You can never just throw up your hands, walk away, and leave everything hanging. Each transaction must be dealt with individually and “put to bed” so to speak. But what happens when you don’t have all the information you need to complete a transaction? You may need to finish the bookkeeping by a deadline and you can’t let one piece of information stop you in your tracks.

This is where your “handy-dandy” General Ledger (GL) account called Miscellaneous Suspense is called into action. No, I didn’t type that wrong. It is not Miscellaneous Expense. The word is “suspense” like “suspended animation”. Miscellaneous Suspense is a holding account where temporary transactions are held until further information is available that will tell you where to record the transactions permanently.

To begin, we need to establish where Miscellaneous Suspense should be located on the Chart of Accounts. The Chart of Accounts is a list of all the GL accounts organized by the five sections: Assets; Liabilities; Equity; Revenue; and Expense. There is no set rule where Miscellaneous Suspense has to be located. However, it definitely does not belong in the Revenue or Expense sections. I think the easiest place to locate it is in the Asset section, under Other Assets.

Here are some examples of how to use the account:

1) Let’s assume that you are cruising along entering checks you have written into the Cash Disbursements Journal in your computer accounting software program. All of a sudden you come to a check for $86.28 that has no GL account number on it and it is written to someone that you have never heard of. The boss is out of town, or, if you are the boss, you can’t remember what that check was written for. You can simply code the check to the Miscellaneous Suspense account until you have time to figure it out. Since all checks written result in a decrease to Cash, which is recorded on the credit (right) side of the ledger, the entry of $86.28 will be recorded on the debit (left) side of the ledger.

Miscellaneous Suspense              Cash-in-Bank   

86.28    |                               | 86.28

A few days later, you discover that the check was written to a new person who comes in every two weeks to water the office plants. Using the General Journal, you write a journal entry to reclassify the Miscellaneous Suspense entry to Outside Services:

DESCRIPTION	DEBIT	CREDIT
Outside Services	86.28
Misc. Suspense		86.29
To reclassify

Miscellaneous Suspense           Outside Services

86.28     |      86.28           86.28   |

2) Sometimes when you buy machinery or equipment you buy it in stages. You may first put a down payment on the item, and then pay for installation charges when the equipment arrives. You might even buy some accessories that have to be attached to the main equipment. Sometimes you may not know whether certain attachments will fit until you try them. Instead of recording all these different payments to the Machinery & Equipment fixed assets account, you can use the Miscellaneous Suspense account to accumulate all the costs until you have a final figure. This way, when you look into the fixed asset account you can identify this one piece of equipment as costing one single amount. For example:

You bought a milling machine that costs $7,800. The down payment was $ 2,000; installation fees $500; accessories $234; $76; $123; and $42. You returned the $123 item and replaced it with a $161 item. These costs came in over a two-month period, and when the equipment was finalized you set up a Note Payable over three years for the remaining amount. The Miscellaneous Suspense account would look like this:

Miscellaneous Suspense
2,000    |
 500
  234
   76
  123
   42
  161         123
3,136         123
3,013

Using the General Journal, you would then transfer this total amount of $3,013 from Miscellaneous Suspense plus the amount of the Note Payable to the fixed asset GL account called Machinery & Equipment because that is the full cost of the milling machine.

DESCRIPTION	DEBIT	CREDIT
Mach & Equip	8,813
Notes Payable		5,800
Misc. Suspense		3,013

You are probably starting to get the idea now. If you have made a mistake and need to close the books, put the difference in Miscellaneous Suspense until you have time to make the correction. If you find a check has cleared the bank but it’s not on your register and you have no idea what the check was written for, use the Suspense account.

You should clear the Miscellaneous Suspense account by the end of each year; so make sure you write an adequate explanation as to where the numbers came from. This is an accounting technique that keeps your books tidy and easy to understand when, later on, you may be trying to remember what you did.