1. Created by Cheryl Albers, CPP Milwaukee, WI
Payroll Accounting
Created by Cheryl Albers, CPP
Milwaukee, WI

2. Accounting may not be the payroll departments’ major responsibility but it is important and payroll must be comfortable with basic accounting principles and understand how payroll data affects the company’s financial accounts. The payroll data must be accurate and timely so that the finance department can prepare financial statements.
There are several areas in a company that make use of the information supplied by payroll. This would include general accounting for the preparation of financial statements, cost accounting for the determining of the cost of items produced (i.e. labor) and possible cost savings and budgeting in order to project costs and revenues.

3. Payroll Accounting also includes the responsibility for safeguarding the records and assets being accounted for; internal and external controls that maintain the integrity of the payroll process.

4. Accounting
By definition accounting is the art or system of keeping and analyzing financial records.
In general, accounting is a way of keeping track of an organization’s financial transactions by identifying and classifying those transactions. This information is used to prepare the company’s financial statements which are used by management, auditors, etc. to gauge the company’s financial health and prospects for the future.
Accounting standards are set by private organizations not by law. Before 1974 GAAP (Generally Accepted Accounting Principles) was used. Since 1974, the Financial Accounting Standards Board (FASB) has set the standards for recording financial transactions.

5. Account Classifications
All of a company’s transactions are recorded and classified into various accounts using a “double-entry” system that is based on two equations:
Assets - Liabilities = Equity (Net worth)
This is the equation that provides the basis for the financial statement called a Balance Sheet.

6. The second equation is actually made up of two:
Revenue - Expenses = Net Income
Net Income – Income Distributed + Contributed Capital = Equity(net worth)
This equation is the basis for two financial statements, the Income Statement and the Statement of Retained Earnings.

7. In order for each equation to remain in balance (the amounts on one side equal amounts on the other side) a ‘double entry’ for each transaction is required. One account is increased while another is decreased.
There are generally five types of accounts used to classify transactions: assets, liabilities, expenses, revenue and equity. The asset, liabilities and expense accounts are usually the only account types affected by entries from the payroll department.

8. Account Balances
Even though the majority of accounting systems are computerized and interface with the payroll system, payroll practitioners must be familiar with the manual method of recording transactions. Knowing the basics makes it easier to trace a transaction even in a computerized system.
The simplest account structure is shaped like the letter T. The account title and account number appear above the T. Debits (abbreviated Dr.) always go on the left side of the T, and credits (abbreviated Cr.) always go on the right. For accounting purposes, think of debit and credit simply in terms of the left-hand and the right-hand side of a T account. Using the left and right side format makes the determination of the account’s balance much easier.

9. T-account

10. Accountants record increases in assets, expenses and income distributed on the debit (left) side and record increases in liabilities, revenues, and owner’s capital accounts on the credit (right) side. Asset, expense and owner’s equity accounts normally have debit balances. Liability, revenue and owner’s capital accounts normally have credit balances. To determine the correct entry, identify the accounts affected by a transaction, which category each account falls into and whether the transaction increase or decreases the account’s balance.
Tracking business activity with T accounts would be cumbersome because most businesses have a large number of transactions every day.

11. Normal Account Balances
Type of Account Normal Account Balance Asset Debit Liability Credit Equity Credit Revenue Credit Expense Debit Income Distributed Debit Contributed Capital Credit

12. In an asset or expense account, which has a normal debit balance, any entry increasing these accounts appears of the debit side while an entry decreasing these accounts appear on the credit side.
Liability or revenue accounts are the opposite. Liabilities have a normal credit balance and any entry increasing these accounts appears of the credit side while an entry decreasing these accounts appear on the debit side.

13. The first step in the account process is to analyze each transaction and identify what effect it has on the accounts. After making this determination, an accountant enters the transaction into a journal, a process which is called journalizing the transactions. All businesses use a general journal and many companies use specialized journals for certain transactions.

14. After journalizing transactions, the next step in the accounting process is to post the transactions to the accounts in the general ledger. Although T accounts provide a conceptual framework for understanding accounts, most businesses use a more informative and structured spreadsheet layout. A typical account includes date, explanation, and reference columns to the left of the debit column and a balance column to the right of the credit column. The reference column identifies the journal page containing the transaction. The balance column shows the account’s balance after every transaction. When an account does not have a normal balance, brackets enclose the balance. Assets normally have debit balances, for example, so brackets enclose a checking account’s balance only when the account is overdrawn.

15. With the computerization of most companies’ accounting systems, journals are frequently replaced by subsidiary ledgers, from which summarized entries are posted directly to the general ledger. Entries documenting payroll expenses may be contained in a subsidiary ledger known as the Payroll Register.
After posting all transactions from an accounting period, accountants prepare a trail balance to verify that the total of all accounts with debit balances equal the total of all accounts with credit balances. The trial balance lists every open general ledger account by account number and provides separate debit and credit columns for entering account balances. Trial balances usually include accounts that had activity during the accounting period but have a zero balance at the end of the period.

16. The trial balance is a useful tool, but every transaction must be analyzed, journalized, and posted to ensure the reliability and usefulness of accounting records. Some errors do not cause a trial balance’s column totals to disagree. For example, the columns in a trial balance agree when transactions are not journalized or when journal entries are not posted to the general ledger. Similarly, recording transactions in the wrong accounts does not lead to unequal trial balances. Another common error a trial balance does not catch happens when a single transaction is posted twice.

17. The balance sheet provides a look at the company’s financial condition at a specific point in time by listing its assets, liabilities and net worth. The income (or profit and loss) statement shows the company’s net income or loss for an accounting period, which is the difference between revenue and expense for the periods. The statement of retained earnings shows the amount of income remaining and available for investment after any distribution to stock holders or other owners. The statement of cash flow shows the sources and uses of cash during the accounting period. Rather than listing each account individually and providing voluminous detail, the financial statements combine general ledger accounts into logical classifications that can be more easily understood and compared. For example, the liability section of the balance sheet may include a line for Accounts Payable, which includes all amounts owed to company suppliers of goods and services.

18. Payroll journal entries can impact operating expenses and non operating revenue on the income statement and current assets and current liabilities on the balance sheet.

19. Chart of accounts
In most companies, a chart of accounts lists each account by name and number, with a number being used to identify each account. Generally the numbering scheme will contain logic providing for easy identification of the broad type of account involved as well as its more specific character. In larger organizations, the account number can contain 15 – 20 digits, with specific digits designating company divisions, departments, and locations as well as the type of account.

20. Accounting as it Pertains to Payroll
Payroll transactions are generally recorded initially in the payroll register.
Payroll transactions includes, but are not limited to, gross payroll, fica taxes withheld from the employees checks, federal income tax withheld from the employees checks, state, local and city income taxes withheld from the employees checks and net pay.

21. In its simplest form, the entry for a $25,000
In its simplest form, the entry for a $25, gross payroll would be a debit to wage expense of $25, and credits to employee withholding liabilities of $10, and cash (net pay) of $15, The description could then be: to record the payment of salaries and record withheld liabilities.
Most companies record a great deal of detail for this entry. The gross pay is usually split up into different accounts that represent various departments or cost centers but no matter what they’re called these accounts show the total gross earnings that the employer incurs as an expense of doing business.

22. The taxes must be withheld as required by law
The taxes must be withheld as required by law. Since the employer withheld these taxes from the pay of the employees, these amounts represent a liability to the company. Each type of taxes often has its own account and some companies departmentalize these taxes as well. The normal balance of a liability account is a credit. This would be the first credit entry mentioned of $10,
Net pay is the amount paid to employees each pay day. This is usually drawn from a payroll checking account. Asset accounts, like cash, carry a debit balance and therefore would be the second credit entry of $15, which would reduce the payroll checking account.

23. Recording the Payroll Taxes
An employer incurs payroll taxes with each payroll. This is a cost of doing business. These taxes include FICA, Federal Unemployment and State Unemployment. These taxes are an expense of the employer as well as a liability because these taxes are owed to the government.
In its simplest form, the entry for $5, of these payroll taxes would be a debit of $5, to payroll tax expense and a $5, credit to payroll tax liability. The description could then be: to record the expense and liability of the taxes to the employer.

24. Many companies choose to record all of these entries in summary by type of tax. The employer portion of FICA/FUTA/SUTA are expense accounts and carry a debit balance. The FICA, FUTA and SUTA payable accounts are liabilities and carry a credit balance. (The FICA account is often split in Social Security and Medicare parts.)

25. Transactions for Other Payroll Deductions
Most companies have other deductions that must be taken into consideration when payroll is prepared. Examples are health insurance, dental insurance, union dues, garnishments, child support, to name a few. Most deductions are a result of company policies, court orders, collective bargaining agreements or retirement benefits.
When an employer garnishes an employees check and/or deducts dues, etc., the money collected becomes a liability to the company. Therefore you will find accounts such as union dues payable or child support payable in a payroll journal entry.

26. Accounting Periods
Each organization sets its own accounting year. Some companies close their accounting year at the end of the calendar year while other companies choose to end their accounting year on another day when business is slower. Any 12-month accounting period that ends on a day other than December 31 is called a fiscal year.
Since payroll taxes are always reported on a calendar year basis, the payroll department may have two year end reconciliation processes. One at the end of the fiscal year and one at the end of the calendar year.

27. Accruals/Reversals
Accrual of the payroll is required when the payroll period and the accounting period ending dates are not the same. For this reason companies must accrue or account for payroll expenses through the end of each accounting period. This is done to comply with the match principle under which any revenue, expenses and liabilities must be matched to the accounting period in which they were earned or accrued.
Because accruals are generally estimates of payroll expenses and liabilities, they must be reversed during the next accounting period when the actual expenses and liabilities are recorded. Otherwise you can end up overstating expenses and liabilities.

28. Balancing and Reconciling Payroll Accounts
The double entry method of accounting provides an easy way to check that the debits and credits balance. Balancing should be done periodically as well as before and after journal entries are posted to the general ledger.
When a payroll account doesn’t balance check the account against the payroll register totals for the month. Research any difference and make correcting entries.

29. Reconciliation and Periodic Balancing
Make sure that the payroll register is accurate each payroll period. Check that gross wages less deductions equals the net checks, check that the total of withheld Social Security and Medicare taxes equals the current rate for each multiplied by the total taxable wages for the pay period and that there are no missing paychecks.
Verification procedures should be carried out to check the accuracy of payroll records at each major stage of the payroll process which would be paying wages, depositing taxes, and reporting wages and withheld taxes.

30. Verify that Social Security and Medicare taxes equal the current rate for each multiplied by taxable wages for each, that the tax deposits equals the liabilities on the 941’s, that the 940 balances to the quarterly 941’s and that the total amounts of withheld taxes and Social Security and Medicare wages reported on the quarterly 941’s equals the total of the W-2’s.

31. Reconciling the Payroll Bank Account
The following steps are used to reconcile the payroll bank account when it has a balance that is not zero:
Add any deposits/interest and subtract any charges that are on the bank statement but not on the general ledger.
Check off each check and deposit on the ledger that is listed on the bank statement.
Total all uncleared checks.

32. Subtract the uncleared checks from the ending balance of the bank statement.
Compare the ending balance of the ledger to the revised ending balance on the bank statement.
If the account is out of balance – check that all cleared checks have been recorded, that no encoding errors have been made by the bank and all deposits, interest and charges have been accounted for.

33. Internal Controls The basic mechanisms of internals controls are:
Segregation of job duties.
Rotation of job duties.
Controlling payroll distribution.
Physical payouts to check for phantom employees.
Verifying negative pay deductions (this increases net pay).

34. Reconciliation of payroll bank account by non-payroll personnel.
Securing blank check stock away from the method of affixing signatures.
Review time cards/sheets for accuracy and signatures; time could be an automated process, check for approvals.
Make sure computer system edits and alerts are in place.
Use of an internal auditor.

35. SOX – Sarbanes-Oxley Act – Public Company Accounting Reform and Investor Protection Act - sets up the framework for the establishment of the Public Company Accounting Oversight Board.
In general, SOX requires public companies to have a framework for identifying, documenting and evaluating their internal controls over financial reporting and provides for a logical way to analyze a company’s control system. It also requires audit partners to rotate every 5 years, the certification of financial reports, complaint procedures must be established, to name a few.
Among other prohibitions, Sox prohibits loans to officers or directors.

36. Controlling Check Fraud
Check fraud has become more prevalent in recent years as technology advances have made it easier to reproduce or overcome most security features. 
Some security features are manufactured right into the paper and are difficult and expensive to reproduce.
Another security feature is printed onto the paper as a design or ink to overcome some types of duplicating. Using both ink and design can significantly hinder the fraudulent copying of a check.

37. A third security feature and the most effective security feature is called Positive Pay which is bank sponsored electronic data checking. It requires the actual one to one comparison of the check information with company and bank records and the verification of check number and check value before the check is processed.
A well trained teller at the financial institution can also be a good deterrent to check fraud.

38. Problems and Questions

39. Classify each of the following as an asset, liability or owner’s equity
Cash ______________
Loan payable to a credit union ____________________
Company owned vehicle________________
Owner’s financial interest______________
SUTA taxes payable_______________________

40. Some of the ledger accounts of Alber’s Pet Sitting are listed below
Some of the ledger accounts of Alber’s Pet Sitting are listed below. Classify each account as an account shown on the Income Statement or the Balance Sheet.
Accounts payable____________________________
Accounts receivable___________________________
Cash__________________________________
Office Furniture__________________________
Miscellaneous expense_____________________
Copy machine_____________________________

41. What is the normal balance of the following accounts – credit or debit?
Accounts receivable________________________
Sales___________________________
Shipping expense_______________________
Health insurance premiums payable________________________
Payroll taxes expense____________________________

42. Problem and Question Answer Key
1st slide – asset; liability; asset; owner’s equity, liability
2nd slide – balance sheet; balance sheet; balance sheet; balance sheet; income statement; balance sheet
3rd slide – debit; credit; debit; credit; debit

43. Definitions
Account: The representation of assets, expenses, liabilities and revenue in the general ledger, to which debit and credit entries are posted to record changes in the value of an account.
Accounting period: Used when preparing financial report. It may be a month, quarter, a half year or a year, also known as the business cycle
Accrual: The recognition of assets, expenses, liabilities, or revenues after the cash value has been determined but before it is transferred

44. Assets: Anything of value that is owned by the company – there are three types: Current; Property, Plant and Equipment and Deferred
Balance: noun - The value of an account, as determined by calculating the deference between the debits and credits in the account
Balance: verb – To balance. To determine that an account balance is correct or what the correct balance should be and make it correct. Also, to prove that the debit and credits equal, i.e. that they are in balance
Balance Sheet: A financial statement that represents a business’s financial position as of a certain date

45. Calendar year: Regardless of the firm’s fiscal year, payroll is based on the calendar year
Chart of Account: List of accounts by name and number
Contributed Capital: The amount the company’s owners have contributed to the company
Credit: An accounting entry that increases liabilities and revenues and decreases assets and expenses
Debit: An accounting entry that increases assets and expenses and decreases liabilities and revenues

46. Double entry accounting: The recording of equal debits and credits for every financial transaction
Equity: Represents the owner’s investment in the company
Expenses: The cost of goods or services used in the process of obtaining revenue for the company – there are two types: Current and Long-Term
FASB: Financial Accounting Standards Board
Financial Statements: Balance Sheet, Income statement, Profit and Loss Statement

47. GAAP: Generally accepted accounting principles
Financial Accounting Standard Board (FASB): Group that sets the standards for sound financial management
Fiscal year: Any 12 month accounting period adopted by a business. Some companies select a slow time of their business or tie it into when they want their annual financial reports finalized
GAAP: Generally accepted accounting principles
General Ledger: A record of business transactions by account

48. Generally accepted accounting principles (GAAP): A set of rules and procedures set forth by the Financial Accounting Standards Board that outline accepted accounting practices broadly and in detail
Income Statement: A financial statement showing a company’s results of operations for an accounting period or fiscal year
Internal Audit: An audit of a business’s policies, procedures, operations, and records carried out by employee of the business

49. Internal Control: Measures used by a company to safeguard company assets by preventing errors, waste, embezzlement and fraud
Journal: Chronological record of the daily transactions of a business. It shows the debits and credits entered to a specific ledger account and a description of the account
Journal Entry: a list of debits and credits for a specific entry
Liabilities: Debts of a business that have yet to be paid. They represent a claim against the company’s assets

50. Matching principle: Matching revenue earned during an accounting period with the expenses incurred in generating the revenue
Owner’s equity: the assets of a company minus its liabilities
Payroll journal: The original source journal with all of the data for the current payroll
Payroll register: A report listing and summarizing the compensation paid and deductions taken from each employee’s wages for the payroll period

51. Post: The act of transferring amounts from journal entries to the general ledger
Retained Earnings: The amount by which revenue has exceeded expenses, reduced by any amount returned to the owners
Revenue: Amounts received for good sold and services rendered during the accounting period (cash, the expectation of receiving cash, or services) (usually not affected by payroll)
Segregation of duties: A basic principle of internal control that prevents individuals from having responsibilities for all phases of a job process