Payroll Accounting: Recording Employee Compensation
Payroll is often a company’s largest expense. Recording it correctly matters not just for accuracy but because payroll has legal, tax, and regulatory implications — errors attract penalties from tax authorities and erode employee trust.
Components of Gross Pay
- Basic Salary — The fixed monthly component.
- Allowances — HRA (House Rent Allowance), transport allowance, special allowance.
- Overtime — Additional pay for hours worked beyond the standard working week.
- Bonuses / Commissions — Variable pay tied to performance.
Statutory Deductions (the US)
- Income Tax (TDS) — Tax Deducted at Source from salary based on projected annual income.
- Provident Fund (PF) — 12% of basic salary deducted from employee; employer contributes another 12%.
- Employee State Insurance (ESI) — For employees earning under $21,000/month; 0.75% deducted from employee, 3.25% paid by employer.
- Professional Tax — State-level tax, typically $200/month.
The Payroll Journal Entry
Employee gross salary: $50,000
Less: TDS $5,000 | PF (employee) $1,800 | Prof. Tax $200
Net Pay: $43,000Journal Entry:
Dr. Salaries Expense $50,000
Cr. TDS Payable $5,000
Cr. PF Payable (Employee) $1,800
Cr. Professional Tax Payable $200
Cr. Cash / Bank $43,000
Employer’s Contribution
Employer PF contribution (12% of basic $30,000 = $3,600):
Dr. Employer PF Contribution Expense $3,600
Cr. PF Payable (Employer) $3,600
Remitting Deductions
TDS must be deposited with the government by the 7th of the following month. PF must be deposited by the 15th. Failure to remit on time attracts interest and penalties. Accurate payroll records are essential for Form 16 (employee TDS certificate) and quarterly TDS returns.
Leave and Accrued Liabilities
If employees have unused leave that they are entitled to carry forward or receive as payout, this represents an accrued liability that should be recognised on the balance sheet.
Lesson Summary
- Gross pay minus statutory deductions (TDS, PF, ESI, Prof Tax) = net pay.
- Employer contributions (PF, ESI) are additional expenses beyond gross salary.
- Payroll deductions must be remitted to the government by statutory deadlines.
The Complete Payroll Process
Payroll accounting has two distinct stages: (1) recording the payroll expense (what employees earned and what was deducted), and (2) recording the employer’s payroll taxes (FICA match, FUTA, SUTA).
Stage 1: Employee Payroll Journal Entry
Scenario: Biweekly payroll for 3 employees: Gross wages $15,000
| Account | Debit | Credit |
|---|---|---|
| Wages Expense | $15,000 | |
| Federal Income Tax Payable (20%) | $3,000 | |
| FICA Payable — SS (6.2%) | $930 | |
| FICA Payable — Medicare (1.45%) | $217.50 | |
| Health Insurance Payable | $600 | |
| 401(k) Contributions Payable | $750 | |
| Cash (net pay to employees) | $9,502.50 |
Stage 2: Employer Payroll Tax Entry
| Account | Debit | Credit |
|---|---|---|
| Payroll Tax Expense | $1,147.50 | |
| FICA Payable — SS (employer match 6.2%) | $930 | |
| FICA Payable — Medicare (employer match 1.45%) | $217.50 |
Total employer cost: $15,000 gross wages + $1,147.50 employer taxes = $16,147.50 per pay period.
Payroll Compliance Deadlines
| Tax | Deposit Deadline | Filed With |
|---|---|---|
| Federal Income Tax + FICA | Semi-weekly or monthly (depends on payroll size) | IRS Form 941 (quarterly) |
| FUTA (Federal Unemployment) | Quarterly if liability > $500 | IRS Form 940 (annually) |
| SUTA (State Unemployment) | Quarterly | State unemployment agency |
| W-2 Forms | January 31 (to employees and SSA) | Social Security Administration |
The federal and state income taxes withheld from employees are called ‘trust fund taxes’ because you’re holding them in trust for the government. Failing to remit them can result in a 100% Trust Fund Recovery Penalty assessed personally against officers — one of the most serious tax penalties in the US tax code.
Payroll Accounting Practice Worksheet — Download, print, and complete to reinforce this lesson.