Finance guide: payroll accounting (definition, benefits, software)

Kevin Flynn is a guest contributor. The views expressed are theirs and do not necessarily reflect the views of Rho.

A lot goes into ensuring your employees get their paychecks or direct deposits on time. That includes withholding funds for payroll taxes, deducting health insurance and retirement plan contributions, and making withheld tax deposits. This article will provide a comprehensive overview of payroll accounting. Some key takeaways are:

• The three types of payroll accounting are initial recording or originating entry, accrued wages, and manual payments.  
• Payroll accounting is an expense management process for employee compensation, taxes, and benefits programs.
• The average annual salary for a payroll manager is $66,485 ($32 per hour). Payroll consultants average $111,592.

What is payroll accounting?

Payroll accounting is a system that tracks payroll records and expenses. This process varies according to the company’s employee wages and payroll liabilities. For example, a business with dozens of W-2 employees requires different accounting entries than a company that only uses independent contractors or businesses that use a mix of both.

The accounting software employed for the three scenarios above might be similar, but the IRS tax laws differ. Please consult with a tax professional for more guidance.

Payroll accountants for W-2 employees should withhold state income taxes, federal income taxes, medicare taxes, FICA taxes, and social security taxes.

Another responsibility of a payroll accountant is to set up direct deposits, which are electronic funds transfers (EFTs) that use the Automated Clearing House (ACH) network to move money between the company bank account and the employee’s account. The accountant should know the proper steps for doing that and the NACHA rules that govern it.  

Types of payroll accounting

There are three basic types of payroll accounting. Analyzing your payroll needs will help you choose the one that best suits your company. Look at the number of withholdings you have and whether your payroll cycle will be weekly, biweekly, or monthly. The number of employees should also be assessed. Here are the three types of payroll accounting:   

• Initial recording or originating entry: Standard entries to record payroll include the employees’ gross earnings, net pay, taxes owed, and withholdings. A good payroll software platform can simplify this with automation. We’ll explain more about that below.    

• Accrued wages: Accrual is a payroll accounting process that adds up wages owed to an employee. Using an accrued wages payroll system requires doing reverse entries in the general ledger after the pay period is over. 

• Manual payment: A good example of a manual payment is issuing a final paycheck to a terminated employee. This system could also pay someone who starts work but doesn’t complete a full payroll cycle.  

What falls under payroll accounting?

Payroll accounting is an expense management process for employee compensation, taxes, and benefits programs. Here’s a breakdown of what that looks like:

• Employee compensation: Wages are employees' compensation payable when paid by the hour. Salaries are fixed amounts paid for being employed through an entire payroll cycle. Compensation could also be paid as commissions or bonuses. These forms of compensation would be entered into Box 1 of a W-2 form. 

• Taxes and unemployment: Tax withholdings include state income taxes, federal income taxes, Medicare taxes, FICA taxes, and social security taxes. Your company is also responsible for contributing to the unemployment insurance (UI) fund, a joint state-federal program employees can draw from if they’re laid off or terminated. You should consult with a tax professional for additional guidance.

• Employee benefits programs: Health insurance premiums the employer or employee owes should be tracked in a payroll accounting system. Gross pay contributions and deductions for 401(k) retirement savings, including employer matches, are also part of the payroll accounting process, as are group-term life insurance payments.

• Fringe benefits: The fair market value of fringe benefits is supposed to be reported as imputed income. One example is an employer-sponsored gym membership, which is part of an employee's compensation package. The employer is not required to withhold taxes for it but may report its value as imputed income in Box 1 of a W-2 form.  

• Wage garnishments: The payroll accountant should manage wage garnishments for legal judgments, back taxes owed, or child support. These are not “optional” deductions from an employee’s paycheck. Once the decision has been issued, neither the employee nor the employer has a choice about paying it.  

• Employer taxes: The employer is responsible for half of the federal income tax owed on an employee’s pay. They are not responsible for income taxes owed by independent contractors who do business with the company. That should be clarified in the contract outlining the work and compensation schedule.    

Why accurate payroll accounting is vital

Accurate payroll journal entries are essential for successful payroll management. Business owners will look at payroll if cash flow is a concern. Inaccurate journal entries could alter financial statements for the accounting period. The payroll accountant is responsible for having a clean ledger when upper-level management looks at the chart of accounts. 

This gets more complex when a business expands to new locations. Payroll accountants may need multi-entity accounting that requires separate ledgers and independent bookkeeping for each division. Mistakes in that scenario could affect the general ledger of the entire company. Bookkeepers put checks and balances in place to avoid this.  

Payroll process flow

A smooth process flow is essential for effective payroll management. Building a solid foundation starts with employee onboarding and accurate recording. Knowledge is also a key component. Payroll managers should constantly study tax laws and accounting rules to ensure they don’t make mistakes. Here’s a breakdown of what the payroll process looks like:   

1. Onboard new employees

The forms used in the payroll onboarding process should provide all the information a payroll manager needs to properly process an employee's payroll. That includes W-4 forms for dependent information and life or health insurance forms to identify beneficiaries.  

2. Collect hours worked for non-exempt employees

One of the primary functions of payroll accounting is recording employees' hours worked. This is necessary to calculate total gross wages. Payroll processing can’t happen until that information is in the system. 

3. Verify hours worked 

Some companies still use paper time cards, but payroll managers are more likely to see computerized time clocks or online forms. These are typically connected directly to the company’s payroll software to simplify processing. 

4. Summarize wages due

Do the math—or allow your software to do it for you. To summarize wages due, multiply the number of hours worked by the pay rate. Don’t forget to account for overtime and shift differentials. Automated payroll systems have those numbers built in.  

5. Enter employee changes

One example of an employee change is a request to do backup withholding. Another is to change the number of dependents after an employee has a child. Payroll managers can do this before calculating taxes because changes may affect the tax rate. 

6. Calculate taxes

This is another area where accounting software automation can significantly improve speed and accuracy. Payroll administrators who calculate taxes manually should use IRS tax tables to determine how much should be withheld to pay employee payroll taxes. 

7. Calculate wage deductions

Check for wage garnishments, employer-sponsored term life insurance, health insurance, and union dues to be deducted from the employee’s gross wages. Double-check retirement savings contributions that should have come out before taxes.     

8. Deduct manual payments

Avoid manual transactions whenever possible because they are messy and hard to track. An example is a cash advance that should be paid back from the employee’s next paycheck. The payroll manager is responsible for making that happen.  

9. Create a payroll register

The payroll register itemizes the wages and deductions you calculated to get to this point. The results can be summarized to create a general ledger entry for payroll. The payroll register can be used to check the work, which may require several iterations.  

10. Create (and print) paychecks

Some employees still prefer to receive a printed paycheck. Once the payroll register has been created and checked, you can create and print them. The payroll accounting system should be set up with templates for this. 

11. Pay by direct deposit or by issuing paychecks

A direct deposit is an ETF that is sent using the ACH system. Each request for a direct deposit creates an ACH credit to register the transfer of funds from the employer’s business bank account to the employee’s checking account.  

12. Deposit withheld taxes

The IRS has a failure to deposit penalty of up to 15% for employers who don’t make payroll tax deposits when they’re due. Avoid this penalty by depositing withheld taxes immediately. Use a payroll company to ensure this happens automatically.  

Payroll software benefits

Using payroll software exponentially improves this process. Payroll accounting can be complicated for companies with large workforces. Payroll software can automatically identify tax brackets, withhold taxes, and initiate direct deposits. Here are some of its other functions.    

Create accounts for each payroll expense

Payroll software is a cash flow tool. It can create accounts to allocate money for taxes, insurance, retirement savings, and other payroll expenses. 

Break down payments

Your human resources department could spend countless hours explaining how employee payments are broken down, or you can let your payroll software do that for you.  

Program automatic deposits

Setting up automatic deposits without payroll software is time-consuming and error-prone. Using the software ensures accuracy and timely fund availability.  

Reconcile payments at regular intervals

No one likes to reconcile payments, but payroll software can reconcile payments at regular intervals to ensure your payroll manager never falls behind. 

Create detailed reports 

Most payroll software today has report-generation features that create detailed reports of your payroll disbursements, expenses, tax withholdings, accrued wages, and more.  

Start, stop, or modify payroll payments with ease

How difficult is it to make changes when they’re needed? Your payroll software should be easy to use so you can make changes and train others to use the system.   

Best accounting software for payroll accounting

Payroll is used to prepare and process payroll for your employees. Accounting software keeps track of cash inflows and outflows, categorizes expenses, and provides reports you can use for tax preparation. One example is a profit and loss report (P&L) that can be used to prepare Schedule C for annual tax filings. Here are some popular accounting software options:   

1. QuickBooks 

QuickBooks directly integrates with Rho to provide account tracking, reconciliation, AR/AP management, and financial reporting. This software has several versions, including QuickBooks Online and QuickBooks SE for self-employed individuals.

2. Xero

Xero online accounting software connects with your bank, accountant, bookkeeper, and other business apps. Founded in Australia, Xero has a significant presence in the UK and the US. One of the features they offer is a multiple-currency option that’s a good option for companies doing business internationally. 

3. NetSuite

NetSuite is a good option for companies looking for enterprise-level solutions. It’s an Enterprise Resource Planning (ERP) software that can manage accounting, procurement, project management, risk management, and compliance. Netsuite can also help your firm plan, budget, predict, and report on financial results.  

Best payroll services

To help complement the accounting software you choose, here are some options for payroll services: 

1. Gusto

Gusto is cloud-based and designed for small to medium-sized businesses (SMBs). It can onboard, pay, insure, and support growing teams. Pricing starts at just $40 per month plus $6 per employee; setup is free. Gusto integrates with Rho and several other accounting and time-tracking tools. They offer a free demo if you’d like to learn more.  

2. Rippling

Rippling Global Payroll differentiates itself from other payroll accounting software by offering a multi-currency system that can be used to process payrolls in other countries. They offer a Human Capital Management (HCM) that handles traditional HR functions like recruiting, training, and performance management. Rippling can also manage independent contractors.  

3. Bamboo HR

Businesses looking for an all-in-one payroll and human resources solution should check out Bamboo HR. According to their website, over 33,000 companies use them as an employee database, reporting tool, payroll software, time tracker, and benefits administrator. Their hiring and onboarding process is designed to be cloud-based and simple to use.   

FAQs about payroll accounting 

Where do you account for payroll taxes on the income statement?

Payroll is generally logged as an “operating expense” on an income statement because it’s one of the costs of running a business, like rent, utilities, and payroll taxes.     

Are payroll withholding taxes an expense or a liability?

Payroll withholding taxes are considered a liability until the deadlines to pay them to local, state, or federal governments have been met. Until then, they are typically held in a liability account.  

Is payroll part of accounting or people operations?

Payroll is a process that requires human participation, but it’s also an accounting operation. Many of a company's payroll costs are accounting expenses.

Can accounting software do payroll?

 Yes. Some, but not all, accounting software can also prepare and process payrolls. 

Is payroll under bookkeeping or accounting?

Both. Certain payroll professionals are considered bookkeepers, but payroll is an early-stage accounting process. 

Conclusion: Make accounting and payroll seamless with Rho’s integrations

Working as a payroll manager or consultant can be lucrative, but there is much to learn before you can reach your full potential. It’s important to have the right software when preparing a payroll and to understand how the process works in case you need to do it manually. 

When it’s time to decide on the right platform to help you make your payroll and accounting seamless, consider that Rho has direct integrations with many of the most popular accounting platforms such as Quickbooks and Netsuite, and payroll providers such as Gusto and Bamboo HR. 

This helps you speed up your monthly book-closing processes, sync and reconcile transactions as they happen, and streamline your payroll, saving you time. 

Learn more about Rho’s integrations today.    

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Competitive data collected on October 1, 2024 and is subject to change.

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Note: This content is for informational purposes only. It doesn't necessarily reflect the views of Rho and should not be construed as legal, tax, benefits, financial, accounting, or other advice. If you need specific advice for your business, please consult with an expert, as rules and regulations change regularly.