It is amazing just how much difficulty business owners and bookkeepers have in understanding how to post payroll entries. A common misconception is that somehow a business’ gross wage expense is altered by decisions that the employees make as to how to spend their salaries. Part of the cause is the way in which businesses must assume responsibility for some of these decisions, such as turning over 401k contributions, Section 125 cafeteria plan deferrals and the like. Another part of the cause is that accounting software makes bad bookkeepers out of good business owners.
But here is the accounting, legal and tax reality of employee wages: the salaries recorded on your books must always be the amount which your employee has earned for the period in question. This must always be the “gross” amount, not reduced by ANY deferrals made by the employee. What the employee decides to do cannot impact the expense that you as an employer incur when you pay your employees the wages they have earned.
The next challenge is trying to create a journal entry from the payroll reports you receive from the payroll service bureau. I follow the practice of using a “payroll clearing account” which is an account in your general ledger meant to always end up having a zero balance at month end. Using a clearing account makes it easier to post payroll entries, especially if you use direct deposit for your employees’ paychecks. Here is an example of how this works.
A direct deposit comes out of your business checking account to pay your employees, usually accompanied by a report called a “check register” which should be familiar sounding. The check register shows each direct deposit amount, with a total amount debited from your business account usually a day or two before payday. Let’s say this amount is $25,000. Remember, this is your employee’s net pay. Then, your bank account gets hit for another sum, which includes employer payroll taxes and employee withholdings. We’ll say this amount is $10,000. And, you also need to turn over employee retirement plan contributions and Section 125 plan contributions to a 3rd party administrator, in the amounts of $3,000 and $1,000 respectively. You will also receive reports that indicate how these amounts have been determined. Usually, the payroll journal and the cash requirements report are the most helpful in generating the format for the journal entry.
Using a payroll clearing account allows you to post the bank debits in lump sums without needing to know at the time how these amounts are to be spread and “grossed up” to employees’ wages and employer payroll taxes. Here’s how this looks, using “T-accounts”:
Clearing account Cash
Dr | Cr Dr | Cr
As you can see, we’ve just dumped the entries into the clearing account, but now we can reconcile cash easily at month end because the totals entered will match the bank statement.
At month end or before, we need to “clear” the clearing account with a journal entry. We can look at the payroll journal and find the amounts for gross wages for the month, and total employer payroll taxes. Here’s what the entry looks like:
Dr Cr Type of account
Gross wages $34,000 expense
Employer taxes 5,000 expense
Payroll clearing $35,000 clearing
Retirement plan payable 3,000 liability
Section 125 plan payable 1,000 liability
I realize this seems too easy, but there’s really nothing more complicated to it. When the checks were written to pay the retirement plan and 125 funds to 3rd party administrators, you posted those to the same liability accounts noted above. At the end of the month, those account balances would be zero, since no further funds are owed. The clearing account is now zero. And, gross wages are really, really gross.