What is Payroll?
Payroll means the total remuneration which a business pays to its employees for a definite period and is generally paid on a pre-specified date. The payroll system is generally handled by the accounting or the human resource department.
The payroll is usually considered as a major part of the expense which a business incurs during a given period and is therefore deductible from the gross income of the company which ultimately decreases its taxable income.
Payroll Accounting is a system of accounting that involves managing, analyzing, calculating, and recording the total compensation paid to an employee by the business. The accounting for payroll is done by payroll accountants who record financial journal entries in a summarized way and then the same is documented in a ledger.
After all the required payroll information of an employee is gathered and recorded, it is then sent to the human resource department for evaluation who finally sends it to the manager for its approval.
Inclusions made while computing compensation in Payroll Accounting:
The payroll accountants dedicatedly use their skills to ensure that appropriate and relevant information is documented in the ledger while computing employee's compensation. The major inclusions are:
i. Salaries, bonuses, and commissions: The total earnings made by an employee during the fiscal year are generally accounted for while computing the total compensation. It includes salary, overtime pay, any approved commission by the employer, etc.
ii. Withholding of taxes of employer and employee: The payroll system of accounting considers withholding of a certain amount of tax figure from the salary of an employee the amount of which is generally decided by an employee when he fills up the W-4 form at the time of employment. The taxes that are withheld include Social Security, Medicare tax, Income tax, Unemployment tax, etc.
iii. Withholding of Insurance premiums and Saving plans: The savings plan for an employee's retirement and the premiums that the employee's pay on his/her insurances are usually the amount that the employer considers withholding from the salary while computing the compensation.
iv. Fringe benefits offered by the employer: The fringe benefits given to an employee are also taken into consideration when computing the employee's compensation. The fringe benefits include paid holidays, travel allowance, medical allowance, etc.
Steps Involved in Setting up of Payroll
Payroll processing is a procedure undertaken to ensure that the employees' remuneration is properly calculated and tracked down with the appropriate amount of payroll tax calculations, deductions, and any other important steps that need to be taken care of.
Step 1: Setting up Employer Identification Number (EIN)
The EIN is a number that is used in the tracking of federal tax payments. The business must generate EIN and collect it from the Internal Revenue Service Department (IRS). It is also necessary to set up local and state tax ID.
Step 2: Tax Information
After the payroll processing gets started, the business or the company needs to make sure that their employees fill out relevant tax forms like W-4 or I-9 so that the deductions made with regards to the allowances and other payroll taxes details can properly be recorded. Once the forms are filled up the company can consider withholding an appropriate amount of taxes from the salary.
Step 3: Selection of Payroll Period
The business or the company needs to decide on an appropriate payroll schedule at their convenience. It is an important step that is immediately followed after all required tax and legal information is gathered. The payroll schedule can either be monthly, weekly, bi-weekly, or semi-monthly. After deciding the payroll period, it is important to set up a specific date on which the payment will be processed to the employees.
Step 4: Gross Pay
After the payroll schedule is set, an important step that immediately follows is the computation of gross pay. It is calculated by considering the number of hours for which an employee has worked in the payroll accounting period and multiplying it with the hourly rate.
Step 5: Determination of Deductions
The deductions that are to be made from the employee's compensation before doling out the payment can easily be determined from the different forms which an employee fills up at the time of employment. The various tax and fringe benefit deductions that are made include Income Tax, Social Security, Medicare tax, Unemployment tax, 401(k) contributions, Worker's compensation contribution, shortly, and other benefits.
Step 6: Net Pay Calculation
Once the deductions are determined, the amount is deducted from the gross pay to arrive at a net pay figure. The net pay is the amount that is disbursed to an employee on the day selected as the payroll period.
Step 7: Recording Payroll Information
After the payment is disbursed it is important to keep a record of the transactions for tax and compliance purposes. The records are necessary in case of any dispute that might arise shortly about the payment made to an employee.
Step 8: Proper Consultation with the Accountant
The business needs to keep in touch with the accountant to ensure that the payroll taxes are properly ascertained and recorded while disbursing the payment to an employee.
Advantages of Payroll Accounting
- Simple Calculations: Payroll accounting makes it easier to calculate the amount of money that is required to be disbursed to the employees after considering all the necessary deductions with the help of software. The use of the software for payroll accounting instead of manual accounting also helps in reducing errors while computing payroll taxes.
- Time-saving and cost-effective: The software used in this system of accounting helps in saving extra time and resources for the company. Since, the accounting system consists of multiple automated functions it helps in accelerating the key functions such as managing, analyzing, and recording payroll data. The use of software also replaces manual labor and the recurring cost associated with it, thereby making the payroll system of accounting cost-effective.
- Forecast: This accounting system helps in proper analysis of the financial data so that an appropriate and effective forecast can be made with regards to an increase in the salary or the workforce to increase the performance of the company.
- Proper backup: This accounting system helps in storing plenty of data and documents safely and securely with the use of the software. The use of the software in payroll accounting enables us to keep a backup of the important financial data in case the need arises in the future.
Disadvantages of Payroll Accounting
- Data Security: In payroll accounting, since most of the functions are automated and the data are stored in software, it raises a question on the security and safety of confidential data. As most of the files are password-protected, they can easily be hacked and accessed by the intruder, so the passwords must be changed regularly.
- Data Manipulation: In this system of accounting data with regards to the payroll taxes and deductions that are to be made are stored in the databases, so the human resource department or accountants need to keep a strict vigil that such sensitive data should not be manipulated by any outsider which in turn may lead to incorrect computation of compensation that is to be paid to an employee.
- Accounting Basics
- Accrued Payroll
- Payroll Services
Context and Application
This topic is significant for:
- B.com (Honors)
- Chartered Accountants (CA)
- Company Secretary (CS)
- MBA (Master of Business Administration) (Finance).
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