How do I record payroll expenses and liabilities in my business’s books?

As a company grows, so does the need for accurate bookkeeping. Clean financial records give you an up-to-the-second picture of cash flow and profit, and you’ll have to provide them to any bank considering a business loan or investor thinking about a deal. Once you add payroll to those records, simply talking about it includes taking on a whole new language of acronyms and obscure terms.

FICA, gross wages, FUTA, general ledger. What language is that? The sheer amount of accounting terms around payroll makes it seem like rocket science, but as an owner doing the books you mostly just need to memorize a few terms and write stuff down when you write your employees a check. This walkthrough spells out exactly what you need to know.

Payroll accounting is a process of entering all the wages and other compensation paid to a company’s staff into the general ledger. Imagine printing out a pay stub for an employee and following it down the page with a pen. First, you write down gross wages, then subtract out withholding taxes and benefit deductions to get net pay. Those tax and benefit costs flow into a few liability and expense accounts in the books. These costs can include employee wages or benefits, payments to the government for FICA and FUTA.

Taking care of payroll records makes you well-organized. It lets you forecast cash flow with confidence, analyze profit and costs, and finish annual tax returns faster. Take a break and be proud of yourself.

Payroll Expenses

No one ever simplified this language for busy owners, which is why phrases like “payroll expenses” can sound intimidating. It’s really just the wages you pay your employees, plus the other payroll-related expenses that the law mandates you pay as an employer, including your share of Social Security and Medicare taxes.

Resist the temptation to make a single payroll entry each time you hand out paychecks. Instead, break it into several journal entries to match different benefits and costs, each roughly following the sections on your pay stub.

The wages you pay employees themselves are usually the single largest payroll expense. Some account for wages in a single account, while others keep them separated into several accounts, often split by type of payment like hourly or salary and by department. Don’t be too neat - choose categories that fit your business and how you run things.

Customizing wage accounts can tell you which wage costs are fixed, like salary, and which can shift, such as hourly wages. But adding extra detail in recording wages makes the general ledger more complex and takes more time to put in order.

Write down any payroll payments outside of wages - your side of FICA taxes (Social Security and Medicare), federal and state unemployment taxes (FUTA/SUTA), any 401(k) match you provide, bonuses, reimbursements and daily allowances known as per diems. Like wages, each one of these should go to its own general ledger account.

Payroll Liabilities

Think of a liability as an “IOU” - an IOU that you write to the vendor you bought something from. What makes a liability a liability is that you haven’t yet written the check to close the deal. Let’s say that you bought a $10 stapler on a credit card. That stapler’s still $10, but you haven’t paid out yet. In the meantime, you owe the money on the credit card you used to pay for it.

Unpaid payroll expenses similarly belong to someone else until the check is signed over. When you hand out each paycheck you subtract a slice for income tax and other withholding taxes. Your business doesn’t get to keep those dollars; instead they sit as payroll liabilities until you send them to the tax agency. The same goes for any deductions that staff asked you to take out of their check, such as for health insurance or 401(k) contributions. To make reconciling your books easier, put each liability in its own account.

Record This on the Books

Time for debits and credits. These two words stick out like a sore thumb in the wild language of accounting, but they’re essential for any business. Increases in expense accounts (such as for wages) happen in the debits column; increases to liability accounts go in the credits column. Decreases run the other way. The size of the debits must exactly match the credits or else you made an error somewhere in the math.

Say a company pays one person a salary of $5,000 per month.

The rates below are simplified to make the arithmetic easier. Say, for example, the business takes 20% out for federal income tax withholding and 10% for state income tax, both deducted from the employee’s check. Employee FICA costs here are 5% (again, not the real rate.) Assume this employee takes no health insurance deductions and puts nothing into their 401(k).

The employer carries some costs on top of the wages, like FUTA (assumed at 5% here), their full share of the monthly health insurance premium ($400), and their matching share of FICA taxes.

To record this on the books, you’ll end up juggling all these entries on one journal page with their proper labels. Gross wages - the employee’s pre-tax wages - will total $5,000 as a single debit to Wage Expense.

Add it up and the company has spent $5,900 total, $5,000 in salary plus an extra $900 for FICA, FUTA and health insurance. Out of that, the employee keeps $3,250 in net pay. The rest is owed to the insurer, to the federal tax agencies and to the state tax agencies until those bills are paid.

This stuff matters. Payroll isn’t really one line item - dig into it and you see what it really costs you and what you owe people.

Handling payroll by hand is tedious and takes hours. Luckily, there are affordable outsourced payroll services that handle calculating payroll and sending in payments to the IRS. There are some providers out there that will deal with the IRS and repay any fines if they underpaid your tax bill. Make sure the provider stands behind its numbers with a guarantee.