Megha Goel

Want to learn more about payroll accounting? In this post, we will look at what is payroll accounting, how it works, types, and more.

Payroll accounting

Payroll accounting is the recording of the compensation of a company’s employees. This typically includes salary, bonuses, wages, commissions, and so on that have been earned by the employees over their tenure in the company. The calculation of payroll is highly influenced by the legal system of the home country.

What is payroll?

Payroll is compensation given by a business to its employees for a set period or on a given date. It also refers to the list of employees who get paid by the company. Payroll is usually maintained by the human resources department or the accounting department. It starts with preparing a list of employees who are supposed to be paid and ends with recording these expenses.

Payroll accounting is one of the most crucial yet complicated business processes. Every business tries their best to carry out this process to the best of its abilities because any mistakes might lead to severe consequences.

Also read: Mark to market accounting | A beginner’s guide

Payroll journal entry

A payroll journal entry is the record of compensation paid to the employees. These entries are later incorporated into an entity’s financial statements through the general ledger. The key types of payroll journal entries are:

• Initial recordation: The entry records the gross wages earned by employees, pay withholdings, and taxes.

• Accrued wages: This is intended to record the amount owed to the employees but not yet paid. This entry may be avoided if the amount is immaterial.

• Manual payments: A business may occasionally issue manual paychecks to its employees because of pay adjustments or employee terminations.

Payroll ledger

Payroll ledger gives a quick view of how the employees are getting paid by a company, how much money is getting deducted from their salaries as taxes and deductions, and how often are the employees getting paid. The financial records are used to make entries in the payroll ledger. A payroll ledger is a standard practice for recordkeeping used all over the world by businesses of different sizes.

A payroll ledger may include payroll accounting details such as:

• Payment frequency
• Tax withholdings
• Business-to-business expenses (e.g. insurance premiums, payroll service charges)
• Contribution towards benefits
• Deductions
• Employee pay totals

Also read: What is materiality accounting & 5 practical examples

Salaries payable

Salaries payable is a type of entry in payroll accounting journals that describes how much a company owes its employees. Salaries payable is recorded when a company owes salary pay to their employees but haven’t made the payments yet.

As employees accrue pay by working, salaries payable keeps getting increased depending on how much money has been earned by the employees. When paychecks are distributed, salaries payable gets decreased by that amount.

Salaries payable are typically recorded by the accounting professionals at the end of a business’s accounting period to provide an accurate reflection of a company’s finances.

Payroll organisation

Here are the 10 tips you should know in order to have a successful payroll organisation:

1. Determine whether your employees should be salaried or paid on an hourly basis.
2. Determine how often do you want to pay your employees – monthly, weekly, bimonthly
3. Classify your workers under full-time employees, interns, independent contractors
4. Pick the best software that suits your business needs
5. Simplify your payroll accounting process to save time and money
6. Keep track of everything
7. Automate state and federal taxes to avoid mistakes
8. Factor is raises and benefits, if any
9. Find out if you need employer ID numbers
10. Create a budget to avoid any last minute surprises

Also read: What is public accounting & what are the important services offered?

Payroll expense

Payroll expense can be described as the amount of wages and salaries given to employees by a business in exchange for their services. The term also assumes to include the cost of all related payroll taxes such as Medicare, Social security, etc. Additionally it includes the amount businesses pay in taxes to federal, state, and local agencies.

However, the tax withholdings from employee paychecks are not part of payroll expenses since they have already been included in the gross wages. Payroll expense is generally the largest expense incurred by a company, so it is important to manage payroll expenditures effectively and efficiently.

Accrued payroll

Accrued payroll is a sum of wages, salaries, bonuses, and other payroll related expenses that have been earned by a company’s employees. This amount has not been paid yet or recorded in the company’s general ledger accounts. It represents a liability for the employer. The concept of accrued payroll is only used on an accrual basis of payroll accounting.

The accrued payroll is an expense that is yet to be paid out to the employees in the future. It is one of the ways in which a business can track its upcoming expenses in advance without any unexpected surprises.

Also read: 10 Best accounting calculators and how to use of them

How does payroll work?

Let us look at some of the general steps that each business follows in order to manage payroll efficiently,

• Step 1: Ensure the paperwork of all the employees is complete and up to date.
• Step 2: Set up a payroll schedule based on how often you wish to pay your employees.
• Step 3: Calculate gross pay of your employees. Take into consideration if the employees are salaried, hourly workers, or have done overtime.
• Step 4: Make necessary deductions including health care plan, social security, taxes, etc.
• Step 5: Pay your employees
• Step 6: Keep record of the payments made.

Payroll types

There are three basic types of payroll accounting:

• Initial Recordings

Under initial recordings, the record of the gross wages earned by the employee is maintained. It also includes the withholdings from the employee salary. The initial recordings also include and account for employment taxes.

• Accrued Wages

The accrued wages are the wages that a business owes to the employees in lieu of their services but is yet to make the payments.

• Manual Payments

The manual payments are the payments made when employees terminate their services to the business. Accounting officials use this line item to clear out the dues of the employees who have resigned.

Also read: What is fund accounting? Key principles, & responsibilities

Payroll bookkeeper

Payroll bookkeepers are the ones collecting and managing the data. Bookkeeping involves recording, storing, and retrieving financial transactions on a consistent basis. For the most part, bookkeeping is straightforward and transactional. While the role of a payroll bookkeeper may seem slightly different, they play equally important roles when it comes to handling business transactions.

Accountants need bookkeepers to meticulously keep all the data ready for interpretation and analysis. Both accountants and bookkeepers work in tandem to help businesses make smart financial decisions. Payroll bookkeepers are the ones who provide a snapshot of all business finances of a company.

Payroll tax accountant

A payroll tax accountant is responsible for processing salary payments to employees. Their major responsibilities include calculating salaries, updating payroll accounting systems with employee related information, preparing internal and external tax reports, conducting internal tax audits, etc. A payroll accountant usually possesses a degree in accounting along with in-depth knowledge of applicable laws.

Their day-to-day role may include addressing payroll enquiries from employees, issuing timely paychecks, maintaining payroll files, updating payroll systems, and many more. A payroll accountant is someone who is detail-oriented and well proficient in processing salaries in a timely manner on a regular basis.

Also read: Expanded accounting equation | Key principles

Payroll calculations

The payroll calculations involve the determination of gross pay, followed by tax deductions to arrive at net pay. The calculation of payroll is a highly regimented process. The payroll calculation must be done meticulously to ensure there are no mistakes in the amount of net pay calculation.

1. How to do payroll accounting?

There are seven step to follow to do payroll accounting with ease:

• Set up payroll accounts in your chart of accounts. It includes a mixture of expenses and liabilities.
• Calculate taxes and other deductions to find out how much should be withheld from the employee wages.
• Gather payroll reports to get a breakdown of payroll transactions.
• Record payroll expenses in your books.
• Record payables are the record of entry for the amount that you owe but haven’t paid to the employees yet
• Double-check your records for accuracy
• Transition accounting periods so that paid liabilities are no longer payables.

Also Read: Stock Consultant | An ultimate read for best results

2. How to record payroll taxes in QuickBooks?

Recording a payroll tax in QuickBooks for a prior tax period:

• From the left Menu, select Taxes
• Select Payroll tax
• Select Enter Prior Tax History
• Select Add Payment
• Enter the required payment information
• Select OK

Recording a payroll tax that is currently due:

• From the left Menu, select Taxes
• Select Payroll tax
• Select Pay Taxes
• On the Pay Taxes page, select Record payment for the tax you want to pay.
• For the Payment Date, select Other and enter the actual date the payment was made.
• Enter the cheque number.
• Select Approve and print

Also read: Economic profit – How to calculate economic profit

3. How to record payroll journal entries?

A journal entry is best described as the record of credits and debits. If you are using automatic payroll software, then there is no need to make entries as it automatically creates entries when an invoice is generated. However, in the case of a manual accounting software, the entries have to be made often.

While recording payroll, Gross Wage Expense will be debited and liability accounts and cash accounts will be credited. Gross wages will appear on the profit and loss or income statement whereas the liability and cash account will appear in the balance sheet.

Payroll journal entry example

Payroll transactions are recorded in a general ledger and can be either used in a manual accounting system or in accounting software. Let’s take an example to understand this in detail.

XYZ Corp has one employee Jane Smith who is paid on a weekly basis. The below payroll journal entry example shows her gross wages, payment withholdings, and XYZ company’s cost.

Also read: Fair value accounting – Basics on fair value accounting

Payroll journal entry template

Journal entry #1

The first entry must show your employee’s gross wages, payroll taxes withheld, deductions, and net pay.

Journal entry #2

Make a second entry when you give a paycheck to your employee.

Journal entry #3

Third entry is made when you need to pay employer taxes and remit withheld taxes.

Also read: Tax accounting – Basics on tax accounting & 5 key principles

Payroll chart

A payroll chart or a chart of accounts provides a complete listing of each type of account. It provides a logical structure used to easily record all sorts of information and to add or remove accounts. It is like a map of all your financial transactions that help you guide through your past and future spends. A payroll chart makes it easier to understand what transactions are being recorded in each of your accounts.

A properly created payroll chart is also helpful in following proper accounting standards which aid in making better business decisions in the future.

Also read: Total cost formula – How to calculate total cost?

Payroll for dummies

Payroll can be complicated for beginners, and there’s little room for error. To make payroll accounting easy to understand one should look at the following payroll systems. The below payroll system ranked higher in terms of ease-of-use and user reviews. These are the three most easy to use payroll for dummies.

• Rippling is a cloud-based platform designed to help users take care of their company’s payroll, benefits, and onboarding.
• Zenefits is a core HR suite that helps streamline onboarding, benefits, payroll, etc.
• Netchex is a cloud-based platform used by companies of all sizes to manage the entire employee lifecycle.

Megha Goel

Megha is a content writer with sharp technical skills, owing to her past experience in networking and telecom domains. She focuses on various topics including productivity, remote work, people management, technology, market trends, and workspace collaboration.

Do you want to learn about the mark to market accounting method? In this post, we deep dive into the basics of mark to market accounting.

Mark to market accounting

Mark to market accounting is an accounting method that involves measuring the fair value of an asset or a liability that can fluctuate over time. The fair value can be assessed on the basis of current market conditions. In this article, we’ll learn more about mark to market accounting.

Also read: A guide to expanded accounting equation

What is mark to market accounting? 

Mark to market accounting means can be defined as recording the value of the balance sheet assets and liabilities at current market value. The reason behind mark to market accounting is to provide the real picture and the value is more relevant as compared to its past value. The aim is to provide a fair appraisal of the company’s financials.

The mark to market principle was largely adopted in the 20th century. Mark-to-market is a tool that can affect values on either side of the balance sheet depending on the market conditions. For example, the stocks held in an individual’s demat account are marked to market every day.

Why is mark to market accounting needed? 

The need for a method like mark to market accounting is to prevent market manipulations from happening. It ensures maximum transparency by fairly estimating the real value of an asset, a company’s financial situation, or an account at any given point of time.

Mark to market accounting was an alternative to the popular historical cost accounting methodology, where an asset’s cost was evaluated based on its original price. This method failed to provide the actual value of the asset in the current times as the information used was outdated and irrelevant to the current market scenario.

Also read: Fund accounting | A complete guide

How is marked-to-market calculated?

Mark to market profit and loss calculations help you understand how much profit or loss you incurred during a given period, regardless of whether the positions were open or closed. Marked to market calculations assume that all open positions and transactions are settled at the end of the day and new positions are opened the next day.

For the purpose of simplification, Marked to market calculations are split into:

1. Calculations for transactions during the statement period, referred to as tranaction MTM on the statement
2. Calculations for positions open at the beginning of any day, referred to as prior period MTM on the statement

• Marked to market Profit/Loss= Position MTM + Transaction MTM – Commissions
• Position Marked to market = (Current Closing Price – Prior Closing Price) x Prior Quantity x Multiplier
• Transaction Marked to market = (Current Closing Price – Trade Price) x Current Quantity x Multiplier

Advantages of mark to market accounting 

Mark to market accounting methodology has several advantages as compared to the previous historical cost accounting method,

• Reflects the actual value of an asset

The calculated asset value is genuine and informative as it is calculated based on the current market scenario. It doesn’t rely on historical or outdated data in any form.

• Reduces risk level

Mark to market accounting can alert a company whether its current state is good enough to justify investments or predict future performance.

• Beneficial for both the parties

Mark to market accounting brings benefits on both macro and micro level.

Also read: 10 Best accounting calculators and how to use of them

Disadvantages of mark-to-market accounting

Like any other metric or methodology in the financial world, mark to market has its own flaws. While it successfully overcomes a lot of issues, it also falls short on some.

• Might produce inaccurate results during volatile periods

The higher the market fluctuation, the more distorted and unstable portfolio or asset value estimations are produced.

• Fails to contextualize information

This is not a major disadvantage but mark to market accounting cannot tell how the price at the closing bell was formed.

• Momentum dependency

Momentum dependency can harm valuations during economic distress such as low liquidity, economic downturns, etc.

Also read: Accounting Ratios | All you need to know

Mark to market example

Let us look at some of the mark to market accounting examples to understand it better,

1. Let’s assume there are two parties who are agreeing to enter a contract over 30 bales of cotton at $150 per bale with a 6-month maturity period. It takes the value of security to $4500 ($150 * 30). At the end of the next trading day, the prices per bale increases to $155. The trader in a long position will collect $150 from a trader in a short position [$155 – $150]. If the situation is reversed, the trader in the short position will collect from the trader in the long position.
2. Another example is of a farmer who is anticipating the increase in price of apples. The farmer considers taking a long position in 20 apple contracts on a particular day. Assuming each contract represents 10 bushels, the farmer is heading against a price of 200 bushels of apples. Let’s say the price of one contract is $5 on that day, the account of the farmer will be credited with $10,000. Now the farmer will either make profit or loss depending on the change in price everyday.
3. Available for sale is the most common example of mark to market accounting. Such an asset can either be in the form of debt or equity purchased to sell the securities before it reaches its maturity. In cases of securities which do not have maturity, these securities will be sold before a long period for which these securities are generally held.

Also read: A complete guide to Public accounting 

Mark to market accounting Enron collapse

During the 1990s, Enron exploited a loophole in the mark to market accounting method to skyrocket its natural gas business profits. The Enron mark to market method misled investors and allowed Enron to continue operating its business on a non-existent budget. Enron accounting method enabled deception that let Enron book more revenue than they were actually earning. It also helped them keep losses and debt out of their balance sheets.

All this structure became so twisted that no one pieced together the dependencies between Enron’s deals. The mark to market accounting method distortions by Enron hid the true nature of the problems brewing underneath. And once the stock prices fell, Enron began to crumble.

In order to minimize losses, banks asked for return of collateral but Enron didn’t have it. Ultimately Enron had to file for bankruptcy and the Enron mark to market accounting strategy had failed.

Mark to market losses

Mark to market losses are the losses generated due to an accounting entry error rather than the actual sale of a security. Mark to market losses can occur when the assets are valued at the current market value. Several assets are revalued at the new market price after they experience a price decline from their original cost leading to mark to market loss.

A mark to market accounting loss is similar to a paper loss, the holder doesn’t experience any capital loss in both the cases, as the assets have not been actually sold.

A real example of mark to market losses was during the financial crisis of 2008 and 2009. The equity and real estate market went into a free fall. All the banks had to revalue their books to reflect the current prices of their assets at that time, resulting in a significant mark to market loss.

Also read: 3 steps on how to setup a successful tax consulting business

What is fair value adjustment journal entry?

An accounting adjustment is required in case of any increase or decrease in the fair value of held-for-trading security. An accountant achieves this by debiting an increase or crediting a decrease in the fair-value change to an account called ‘securities fair value adjustment’, which is a sub-account of the asset account for trading securities. Journal entries are made to record the increase in the fair value of a financial asset, or the decrease in the fair value of a financial liability. Another entry is made to recognize the tax implications caused due to the fair value gain or loss.

What is the mark to market futures?

In securities trading, the price or value of security, account, or portfolio is recorded as part of the mark to marketing accounting to reflect the current market value instead of the book value. This record is generally maintained in a futures account to ensure that margin requirements are being met satisfactorily. Daily marketing to market reduces counterparty risk for the investors in Futures contracts.

Mark to market futures indirectly reduce credit risk by ensuring that at the end of any trading day, after the daily settlements are made, there will not be any outstanding obligations.

Also read: What is materiality accounting & 5 practical examples

Differentiate futures vs fair value 

Futures indicate where the market will be heading towards over the next few sessions, whereas fair value is the futures rate before the market opening adjusts for purchasing shares at the opening. Fair value is the cost of buying shares based on the value of the stock market futures that expire at the next expiry date.

Investors expect the market to rise, when futures are higher than the fair value, whereas if the futures value is lower compared to fair value, the market is likely to fall on opening. Futures rate changes as soon as trading commences.

Megha Goel

Megha is a content writer with sharp technical skills, owing to her past experience in networking and telecom domains. She focuses on various topics including productivity, remote work, people management, technology, market trends, and workspace collaboration.