Payroll deals with paying your employees (including seeing that the government gets the monies they require you to withhold from the employees and the payroll taxes they require you to pay).
If you have occasional employees, or even one or two full- or part-time, you can get by recording the payroll transactions in the General Journal. The typical transaction is <date> <cash / amt– labor-expense / amt+... withholding / amt–... accrued-tax / amt–... tax-expense / amt+...> <comments>, where <comments> include who you paid and the hours they worked. Labor-expense, withholding, accrued-taxes, and tax-expense include multiple accounts as we'll get into below.
If you have more than a couple of employees it definitely pays to set up a Payroll system.
A Payroll system involves a Payroll Journal — in which payroll is accrued, i.e., held in an "owed" state (like an open vendor invoice) until paid, and a Payroll Disbursements Journal — in which the actual payments to the employees are recorded.
The typical transaction in the Payroll Journal is <date> <accrued-wage / amt– labor-expense / amt+...> <comments>, where accrued-wage is the employee's gross pay and <comments> include employee (name or number) and any other data you may wish to record, like hours-worked.
Note: Keep in mind that if you use employee numbers you will need a "key" — paper listing or computer file — associating the employee numbers with employee names, and perhaps other employee data, e.g., their pay rate, federal and state tax exemptions, address, phone, social-security number, birthdate and any other data you need or the government requires you to maintain.
The labor-expense in the above transaction might be to a single Labor account, or to many Labor accounts as shown in our earlier Chart of Accounts column, e.g., Administrative labor, Selling labor, Engineering labor, Manufacturing labor (and that could be further sub-divided into Area1 labor, Area2 labor, etc., depending on how finely we wish to track our labor costs).
Payroll Disbursements Journal
The typical transaction in the Payroll Disbursements Journal is <date> <check-nbr> <cash / amt– accrued-wage / amt+ withholding / amt–... accrued-tax / amt–... tax-expense / amt+...> <comments>, where <comments> include employee (name or number) and any other data you may wish to record. Note that the transactions in these two Journals — netted together — reduce to the cash/labor-expense/withholding/accrued-tax/tax-expense transaction we showed in the second paragraph.
If you're doing paper accounting, it's recommended you set up a separate checking account used only for Payroll. The reason for this is that your Payroll Disbursements Journal then becomes a sequential listing of your check numbers — making it immediately obvious if any have been lost or stolen.
If you're doing computer accounting, that's not as important because the computer can detect missing check numbers. (But make sure you have, get, or write software that can.)
With paper accounting, the transactions in these Journals are periodically (weekly or monthly) summarized into a Payroll Ledger, by employee (see earlier article, Paper Accounting). This lets you and others (e.g., a Labor Department or EEOC auditor) easily review the pay record and status of each employee.
Payroll Withholdings & Taxes
Now we have to get into withholdings and accrued taxes. Bear with me. This involves a lot of detail (don't blame me — blame your user-friendly government) — but there's really nothing horribly complicated about it.
The withholding portion
of the Payroll Disbursements transaction
are the monies required (by government dictum)
to be withheld from each employee's gross pay.
Withheld Federal Income Tax (WH-FIT),
Withheld Social Security (WH-FICA),
Withheld Medicare (WH-FICM), and
Withheld State Income Tax (WH-SIT).
The withholding portion of that transaction should really have been written as WH-FIT / amt–- WH-FICA / amt– WH-FICM / amt– WH-SIT / amt– .... The "..." indicates there may be more, e.g., if you have employees in other states, you'll need a separate WH-SIT account for each state... if you offer your employees "direct deposit" to their bank account, you'll have one or more WH-Bank accounts.
The accrued-tax portion
of the Payroll Disbursements transaction
are monies you are required to pay
for the "privilege" of having employees.
AT-FICA (an amount related to WH-FICA, usually equal),
AT-FICM (an amount related to WH-FICM, usually equal),
AT-FUT (Federal Unemployment Tax), and
AT-SUT (State Unemployment Tax),
The accrued-tax portion of that transaction should really have been written as AT-FICA / amt– AT-FICM / amt– AT-FUT / amt– AT-SUT / amt– ....
And the tax-expense portion
of the Payroll Disbursements transaction
are the expense part of the accrued-tax transaction, i.e.,
FICA-expense = AT-FICA,
FICM-expense = AT-FICM,
FUT-expense = AT-FUT, and
SUT-expense = AT-SUT.
The tax-expense portion of that transaction should really have been written as FICA-expense / amt+ FICM-expense / amt+ FUT-expense / amt+ SUT-expense / amt+ ....
Most of what you need to know to calculate these payroll withholdings and taxes are spelled out in Circular E (available from the Federal government and updated annually) and an equivalent booklet(s) available from the State government(s). The calculations are generally straight-forward — simple linear equations, with tables included for those processing manually.
Now, I've implied above that the accrued-tax and tax-expense amounts have to be calculated for each employee. They don't — they can be calculated on total payroll. If you're processing payroll manually, you'd typically drop these from the Payroll Disbursements transaction and record separate transactions of the form, accrued-tax / amt– tax-expense / amt+ , directly into your Purchase Journal.
However, with computer processing it's easier to calculate them by employee because they all come with upper limits — each applies only to the first $x of an employee's gross pay. (With manual processing, the person doing the processing sorta has to watch for these limits with side calculations.)
So how do all these payroll withholdings and taxes get paid to the government. The same Federal and state booklets we referred to earlier specify how and when they must be reported and paid and the Forms or deposit records to be used for reporting. A copy of these Forms or records becomes the source document for a Purchase Disbursement Journal entry recording the actual payment.
WARNING: Make these payments — and on time — even if you don't have the cash to pay anyone else. The penalties for late payments are draconian — and the government entities have Gestapo-like powers to collect far exceeding those of other debtors and penetrating into normal bankruptcy protections. Always — pay your friendly government — first!
With computer accounting, it's not necessary to keep Payroll and Payroll Disbursements transactions in separate files since recording them directly in what, in a paper system, would be considered a Payroll Ledger is more convenient.
Essential data is <employee> <date-paid> <check-nbr> <date-accrued> <transaction>, where <transaction> consists of cash / amt- accrued-wage / amt+ and all the withholdings, accrued-taxes, tax-expenses and labor-expenses we talked about earlier.
From this data, the computer can look at <date-accrued> to compile a hard-copy Payroll Journal and at <date-paid> to compile a hard-copy Payroll Disbursements Journal... or to print the payroll checks... or to printout the myriad payroll reporting forms... or to printout an Employee Pay Record for the year.
If you intend to set this up yourself, i.e., put this data into a file to be processed by your own scripts, programs, tools, etc., a suggestion. In addition to the "essential data" we showed above, consider adding another type of record (an employee-record) that contains <employee> <date-changed> <pay-rate> <federal/state-tax-exemptions>, data that you would otherwise keep in an Employee Key.
This buys you two things. First, a time-record of employee pay-rate and exemption changes. Second, it allows you to record labor-expenses in "hours" instead of "dollars" — which you need to maintain for other purposes anyway. All payroll disbursements made on or after <date-changed> are processed using the new <pay-rate> and <exemptions>. And in fact doing it this way allows you to write a script, program, macro, etc., that calculates your payroll (and writes the data into the file) automatically — you provide only employee and labor-hours (which you get from their Time Sheets or equivalent).
I use a simple 50ish-line awk script that can calculate payroll (including all the withholdings and taxes) for several hundred employees in seconds — and print out the checks and hard-copy Journals. And the only time I have to fiddle with the script is when the government's rules change (which is typically once a year).
The Payroll source documents are the employee Time Sheets (or equivalent) that record when the employee worked and generally what they did. These records are subject to audit by the Labor Department, EEOC and probably others that I haven't encountered. These should be bound into a Payroll week-paid Source Document folder.
However, there are other employee documents that need to be retained, e.g., their original employment application, employee reviews (if you do them), Federal and state W-4s (that record their federal/state tax exemption choices), employer's copy of their W-2 (reporting their annual wages and withholdings), etc.
These can be filed in separate Employee files (by employee name or number) — or simply integrated into the Payroll Source Document folders (in the week in which they occur). I very much favor the latter — especially if you're doing computer accounting — in keeping with my "always file chronological" bias.