A Guide to Small Business Payroll Accounting

When you manage or own your own small business there are plenty of financials that needed to be accounted for. Payroll is perhaps one of the most important, largely because if employees aren’t paid in full or on time, you likely won’t have anyone who will stick around to keep your business running. Additionally, spotty payroll practices put your company at risk for high-turnover, losing money to retrain for those positions, as well as legal repercussions. So for those looking to start a company, or for those who want to improve their accounting habits, here’s the guide to small business payroll accounting you’ll want to keep bookmarked.

What Is Payroll Accounting?

Let’s start with the basics. Payroll accounting is a general function of a business’ financial recording which is focused on employee compensation. It includes everything from gross wages and salaries to bonuses, commissions and any other earning types accrued by its employees. When you hire a new employee, they are given a W-4 form. This is the beginning of your small business payroll accounting process. Form W-4 is intended to tell you how much of your employee’s income should be withheld from their paycheck and remitted to the IRS. Completing this form correctly is the sole responsibility of the employee. Your responsibility is to withhold the correct amount and send the funds to the appropriate agency. Keep in mind, as a small business owner, you have a legal responsibility to the federal government to report your employees earnings and must provide the exact amounts paid to employees to the IRS during tax time. Personal income tax returns submitted to the government by your employees are checked against what you, as the employer, have also reported.

How to Do Payroll Accounting

Alright, so how do you actually complete payroll accounting. Here are the basic steps. 

Step 1. Set Up Your Company to Hire Employees

First and foremost you’ll need to make a couple decisions about what you’ll offer your employees not only in terms of wage and/or salary type, but if you’ll provide benefits or any additional kinds of compensation. The primary items you’ll need to set up to start hiring employees are:
  • Federal Employer Identification Number (EIN). While free to obtain, this is the number the IRS uses to track all payments made by a business.
  • Wage & Salary Types. You’ll need to decide on the salary structure you plan to use for your employees (hourly, annual, etc). This may also depend on the position or job type. For example, you may decide to pay your admin roles on an hourly basis while higher level roles may be salaried.
  • Pay Period Type. This is how often you will pay your employees. Most commonly, pay period are either weekly/biweekly or semimonthly/monthly. Keep in mind, you can also have more than one pay period. For example, your hourly employees may be paid on a weekly basis and salaried employees on a biweekly basis.
  • Benefit Types. What you decide to offer your employees in terms of benefits are a key component for payroll. For example, if you offer a 401(k) plan or contribute towards your employee’s health insurance plans, it’s up to you to decide how much you will contribute.
  • Purchase Workers’ Comp Insurance. Workers’ compensation is insurance a company purchases to help provide extra protection for employees who become injured or sick while working. Except for Texas, workers’ compensation is mandated by each state

Step 2. Gather Your Legal Paperwork

After hiring your employees, you’ll need to set them up in your payroll system. For each employee, you will typically need an I-9 form, W-4 form, and direct deposit authorization form, if applicable. Below you will find a downloadable template and a brief description of each of these forms. The payroll forms you will need employees to complete are:
  • I-9 Form
  • W-4 Form
  • Direct Deposit Authorization Form
Employees must also submit a voided check along with the completed form. This will allow you to verify that they have given you the correct bank routing and account number.  

Step 3. Calculate Paychecks

Across the board, paying employees via direct deposit will save money because you don’t have to buy paper checks or deal with mailing cost. However, it’s much easier to correct payroll mistakes manually than it is to deal with making retroactive corrections to electronic payments. While it’s possible to calculate paychecks manually, it’s much better to use a payroll software which will automatically calculate payroll checks, payroll taxes due, and send reminders to submit payroll tax. Most payroll software also allows you to submit those tax forms and payments through the platform itself.

Step 4. Record Payroll

Lastly, you must record your payroll. This requires you to set up a payroll account on your charts of accounts list which is a list of accounts used to appropriately categorize all your business transactions.

Payroll Accounting Example

There are three types of payroll accounting entries, each of which are handled differently. These include:
  • Initial recordings: Primary entries for payroll accounting, which record the gross wages your employees earn and include employment taxes you owe to the government.
  • Accrued wages: Recorded at the end of each accounting period which show the amount of wages you owe to employees that have not yet been paid. Later, these entries will be reversed.
  • Manual payments: Used when a check is cut manually for pay adjustments or when an employee if fired or let go.
Let’s take a look at how payroll might work in a specific scenario: Example 1: A company employs Hector to work a total of five days—from December 15 through December 20, 2018. The company cuts Hector’s payroll check on the next scheduled payday, January 2, 2019. Even though the check is dated January 2, 2019, the matching principle requires that the company report the expense on the December 2018 financial statements to agree with when the work was performed and the liability actually occurred. Because Hector was only employed for the last five days of December, the company does not carry any wage benefits or expense for Hector during the month of January. Typically, when it comes to payroll you have two options: either do it yourself, using the software of your choice or outsource to a professional. Of course, it’s cheaper to do payroll accounting yourself and as mentioned above, using a payroll accounting software is a great way to create ease and efficiency when managing payroll yourself. However, there are also numerous accounting services out there that can make the process of recording, filing, and paying employees’ wages and taxes even more efficient — after all, it’s what they do for a living! Payroll outsourcing options typically have the capability to track hourly employees while also calculating wages and taxes. These systems work to remove the human error associated with manually completing payroll and give you more time and space to do what you do best!