Most business entities record their transactions and perform accounting by using the accrual basis of accounting. Under the accrual basis accounting, the transactions are recorded as soon as they occur; even any one aspect of the transaction is completed.
To understand the example of an accrual basis, consider a transaction of credit sale. Mr. Robert is a retailer, and Mr. George is a customer. Mr. George purchased a convection oven from Mr. Robert and promised to pay the amount in 15 days from the date of purchase.
Under the accrual basis, the transaction will be recorded on the day of purchase and not the day of payment. It shows how accrual basis accounting works.
The accrual basis of accounting gives rise to many accounts for recording two aspects of a transaction. However, when an accrual basis accounting involves payment of cash in advance or payment due, the most common accounts are accruals and prepaid or assets.
Accrual accounts record the effect of transactions giving rise to a liability for a business entity. Similarly, the prepaid give rise to an asset account for the business entity.
This article will discuss classifying, measuring, and recognizing accrued payroll under the prescribed framework of GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).
What Is Accrued Payroll?
Accrued payroll signifies the compensation and salaries of all the employees working at a business entity that has not yet been paid.
The concept of accrued payroll has derived from the accrual basis of accounting that emphasizes recording a transaction even if cash has not been paid or received.
In most small businesses, the salaries and compensation of employees are paid at the start of the following month when employees provide the services. The accrued payroll account is credited to the liabilities account of the business entity.
What Kind Of Account Is Accrued Payroll?
The payroll, compensation, and salaries, are expenses for a business. If the business entity had paid its employees, the cash would be credited.
On the other hand, if the cash is not paid but payable, the liability account of the business entity is increased.
Therefore, the accrued payroll account is created to record the effect of this transaction. In a nutshell, accrued payroll is a liability for any business entity and is recorded in the balance sheet liabilities.
Accrued Payroll Vs. Payroll Expense
Payroll expense is the net amount of the payroll. It is the amount that a company has paid to its employees or is yet to be paid. For instance, if we take an example of a company’s annual financial statement.
All the payroll from January to November has been paid to the employees. However, the payroll for December will be paid in January of next year.
Let’s say that the monthly payroll of the company is 150,000 USD. The financial statements of the company will show that payroll expense is 18,00,000 USD.
However, the cash credited is 16,50,000 USD. 150,000 USD has been credited and recorded in the accrued payroll as a liability account.
This example highlights the difference between the payroll expense and the accrued payroll account. Accrued payroll is a part of the payroll expense, and it is always a liability. On the other hand, payroll expenses can be due or paid.
What Is Included In Accrued Payroll?
The payroll account of any business entity generally has four types of accounts. The same goes for the accrued payroll. Let’s discuss each of them.
Most commonly, the bonuses earned in one financial period are paid in the next one. For instance, many business entities make announcements about the bonuses earned by employees at the end of a financial period and pay in the next year.
Therefore, the bonuses are recorded as a part of accrued payroll.
Salaries and Wages
Wages and salaries of employees are remuneration or compensation of services they have provided to a business entity.
The salaries and wages represent the compensation before the tax deductions and retirement contributions. The salaries and wages also include the fringe benefits and perquisites value provided to the accrued payroll.
Payroll taxes, contributions, deductions
It is an open secret that tax becomes due every time your employee earns compensation and a business entity pays the employee.
The taxes paid are used for employees’ retirement plans, health benefits, etc. payroll taxes are also added to accrued payroll. Some taxes are employer-paid, employee-paid, or a split between the two.
The deductions also include health insurance, 401(k) contributions, etc.
Paid Time Off
Every business entity allows a fixed vacation or sick time, and tracking it helps the businesses estimate how much employees earn as sick time or vacation. How a company offers sick time or vacation varies from business to business.
Some business entities might offer their employees 0.5 days off time per month, or others might allow three days off at each quarter-end. PTO is recorded as part of accrued payroll.
However, if a company follows the use-it-or-lose-it policy, the PTO adjustment is not carried forward next year.
How To Calculate Accrued Payroll?
The accrued payroll is calculated by adding up the balances of all the accounts. Let’s understand it by an example of a company ABC, based in Colorado, USA.
Salaries and Wages
The company follows weekly wages payments. Every employee gets the payment in the next week when services are provided. Leslie is an employee who gets paid 15 USD per hour.
He worked 35 hours in the final week of December, which will become accrued and paid next year. The accrued salary and wages for the last week of December will be 15 USD X 35 = 525 USD.
Leslie has earned an 800 USD bonus in a year for reaching the sales target. She will receive the amount in the next year starting from Jan 1. The bonus amount will be added to Leslie’s weekly wages due.
Taxes and Contributions
Let’s take the example of the same employee Leslie and her tax deductions. Let’s say all the employee-paid taxes equal 406 USD for Leslie.
The employer-paid taxes amount to 160 USD. The payable taxes amount for 90 USD whereas, the remaining amount represents health insurance premiums
After deducting the employee-paid taxes of 406 USD from Leslie’s bonus and wages, her accrued wages will become 1119 USD.
Paid Time Off
The company follows a use-it-or-lose-it policy. Therefore, no PTO will be accrued in the financial year.
All the due payroll items will add up in the accrued payroll general ledger.
Journal Entries To Record Accrued Payroll
Let’s understand the journal entries for accrued payroll by considering the same example of Leslie as we discussed above.
Let’s consider that Leslie earned an 800 USD bonus and 525 USD wages for the final week of December. The amount of taxes and contributions identified was 406 USD. The journal entry for the above example will be as follow:
|Wages And Salaries Expenses||1,525|
|Employee-paid Taxes Liabilities||406|
|(accrued payroll payable to Leslie)|
For the employer-paid taxes and deductions, the entries for insurance will be recorded separately.
|Payroll Tax Expense||90|
|Employer tax payable||90|
|(payroll tax expenses recorded and payable)|
For recording the insurance premiums, the following entry will be passed:
|Health Insurance Expense||60|
|Employer-funded insurance premiums payable||60|
|(health insurance expenses recorded and payable)|
Impact Of Accrued Payroll On Accounting Equation
Let’s analyze the impact of accrued payroll on the accounting equation of the business entity. We will go back to the example of Leslie.
Assets = Liabilities + Shareholders Equity
Let’s start with the first entry of wages and bonuses. The entry will affect the accounting equation as follow:
The upward directing arrow shows that the liabilities have increased because the wages and bonus of Leslie are a liability for the business entity.
On the other hand, the downward directing arrow of shareholder’s equity signifies decreased profit. Shareholder’s equity consists of profits and the stock value. The wages are an expense for a company and, therefore, will decrease the profit.
The second entry for the employer-paid taxes will also similarly impact the equation. The tax and health insurance are expenses for the employer.
The increase in expense will decrease the profit, which will be reflected in the shareholder’s balance sheet equity. Similarly, the business entity has not paid the taxes and deductions yet.
They are payable and liability for the business entity. This will be reflected in the liabilities account of the balance sheet.
Is Accrued Payroll a Current Liability or An Expenses?
Accrued payroll is a current liability. It represents the wages and salaries a company owes to its employees for work they have done but have yet to be paid.
At the end of an accounting period, if some payroll expenses have been incurred but not paid, they are recorded as a liability on the company’s balance sheet under the “current liabilities” section.
The income statement reports payroll expenses as an operating expense, representing the total compensation paid to employees during the accounting period.
However, any unpaid portion of these expenses is accounted for as accrued payroll and classified as a current liability until the employees receive their wages or salaries.
Once the payroll is paid, the accrued liability is reduced to zero.
Is Accrued Payroll a Financial Instrument?
No, accrued payroll is not considered a financial instrument. Financial instruments refer to contracts that give rise to a financial asset in one entity and a financial liability or equity instrument in another.
These instruments can include cash, stocks, bonds, derivatives, loans, and other contractual agreements with a monetary value.
On the other hand, accrued payroll is an accounting concept used to recognize the wages and salaries a company owes its employees for work they have done but have yet to be paid.
It represents a current liability on the company’s balance sheet and is not a separate tradable contract or financial asset.
Accrued payroll is not transferable or exchangeable as financial instruments are, and it does not have a market value that can be bought or sold.
Here are some of the key differences between accrued payroll and financial instruments:
- Accrued payroll is not a contract.
- Accrued payroll does not give one party a right to receive cash or another financial asset.
- Accrued payroll does not obligate another party to deliver cash or another financial asset.
- Accrued payroll is classified as a liability on the balance sheet.
- Financial instruments are classified as assets or liabilities on the balance sheet, depending on whether they give the company a right to receive cash or an obligation to deliver cash.
Accrued payroll is a collective account that records all the wages, salaries, bonuses, etc., to show the amount earned by employees but yet to be paid by the employer.
Understanding different taxes, deductions, and items of payroll are important for scheduling the payments. It is also important from the employee perspective to understand the complexities.
This article has explained the process of realizing and recording accrued payroll in the books of a business entity. Don’t forget to go through the impact of accrued payroll on the accounting equation too.