Bookkeeping – A Simple Payroll (Lesson 31)

In Lesson 30 it was explained how the payroll account structure uses parent-child accounts. This lesson is a part of the daily operations section of bookkeeping illustrating an actual payroll entry. If you haven’t done so yet, please read: Payroll – An Introduction. The introduction article explains the respective math involved and the associated tax obligations. In addition, it illustrates the reconciliation process. For this lesson I’m going to walk you through the payroll step by step. But first let me set this up for you continuing with the five employees from Lesson 30.

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The five employees all work for a small carpet cleaning business. Three work as technicians in the field and the owner does some work but spends most his time marketing. The fifth employee is the office manager/bookkeeper/receptionist/scheduler/etc. Payday is on Friday for all work completed through Tuesday night. Time sheets must be submitted prior to noon on Wednesday. The following is the pay schedule:

Employee Assignment Pay Officer
. ‘A’ Technician $13.00/Hr No
. ‘B’ Technician $12.50/Hr No
. ‘C’ Helper $9.00/Hr No
. ‘D’ Office Manager $27,000/Yr No
. ‘E’ Manager $36,000/Yr Yes

Again, for the purposes of this lesson, payroll is a weekly event.

Step 1 – Receive, Vouch and Approve Time Sheets

The time sheets from the field workers identify the customer and the amount of time involved in cleaning the carpet. The time includes travel to the job site. Each employee is allotted 30 minutes of time at the end of each day to return the van and put away tools. Each employee is also allotted 30 minutes in the morning to get supplies, tools and work orders for the day.

It is the office manager’s job to vouch (confirm) each job completed. In addition the bookkeeper indicates the value of each job on the time sheet. Once completed, the sheets go to the owner for endorsement.

Once the owner approves each time sheet it is returned to the office manager for payroll processing. Remember it is his money that is paid to the employees. It is up to him to decide if the value paid to an employee is worth the work completed. Do not take on this responsibility as a bookkeeper. Also, if approval happens at check signing time, any discrepancy creates a lot of mathematical corrections along with book entry adjustments. Get the signature of the time sheets first before processing.

Step 2 – Calculating the Payroll

Now it is time to do the math aspect of payroll. Most accounting software programs have built-in payroll modules to calculate this for the bookkeeper. Even without the software the process is straight forward. Determine gross wages; calculate employee taxes and employer taxes. If in doubt, use a spreadsheet software to assist you in calculating the values. Here is the schedule for the five employees for their respective gross wages.

Gross Wages
Employee Hours Rate Gross Wage
‘A’ 39.5 $13.00 $513.50
‘B’ 37.0 $12.50 462.50
‘C’ 17.0 $9.00 153.00
‘D’ Salary $27,000 519.23
‘E’ Salary $36,000 692.30
Total Gross Wages $2,340.53

Next, determine employee taxes. Most accounting software payroll modules have the tax withholding formulas built into their respective databases. If doing this manually use Circular E from the Internal Revenue Service for federal withholding. There are basically three tables to choose from:

Single
Married
Head of Household

Each table has sub-tables for a paycheck period (frequency). The first sub-table is weekly. To understand the employee’s marital status review their W-4 form for their indicated status.

State income taxes (nine states do not have income taxation on payroll for individuals – Florida, Texas, Tennessee, Nevada, Washington, South Dakota, New Hampshire, Wyoming, and Alaska) use a similar table system to calculate the withholding. Social Security is always 6.2% and Medicare is 1.45%.

A rule of thumb is federal withholding will average 8 to 14% depending on the gross wages earned (the higher the gross wage the greater the percentage of withholding). State income taxes average 5 to 6% of gross wages.

The following is the employee withholding schedule:

Employee Taxes
Employee Gross Wage Federal Tax SS Medicare State Tax Net Check
‘A’ $513.50 $49.00 $31.84 $7.45 $26.00 $399.21
‘B’ 462.50 37.00 28.68 6.71 23.00 367.11
‘C’ 153.00 10.00 9.49 2.22 11.00 120.29
‘D’ 519.23 54.00 32.19 7.53 36.00 389.51
‘E’ 692.30 77.00 42.92 10.04 51.00 511.34
Totals $2,340.53 $227.00 $145.12 $33.95 $147.00 $1,787.46

Next are the employer taxes. As a function of payroll, employers pay two distinct groups of payroll taxes. The first group is a matching of both social security at 6.2% of gross and Medicare at 1.45% of gross. The second group is unemployment taxes for both federal and state purposes. Both unemployment taxes use gross wage limits to calculate the tax. In effect the first $7,000 of each employee’s gross wages are taxed at .6%. Each state uses a different threshold and tax rate. Federal Unemployment Tax is called FUTA. State Unemployment Tax is called SUTA. For most full time employees the tax is accrued by the end of June of each year. If hiring a new employee in the later part of the year the tax accrues until this employee’s gross wages exceed $7,000 in the current calendar year. The process starts all over at the beginning of a new calendar year.

Here is the employer’s schedule:

Employer Taxes
Gross    Matching     Unemployment
Employee Wages   SS    Medicare FUTA SUTA
‘A’ $513.50 $31.84 $7.45 $3.08 $9.86
‘B’ 462.50 28.68 6.71 2.78 8.88
‘C’ 153.00 9.49 2.22 .92 2.94
‘D’ 519.23 32.19 7.53 3.12 9.97
‘E’ 692.30    42.92 10.04   4.15 13.29
Totals $2,340.53 $145.12 $33.95 $14.05 $44.94

Now that the hard part is done, it is time to process the payroll.

Step 3 – Processing the Payroll

Payroll is processed using the payroll journal. There is a separate entry for each employee. The final line item in the entry is a credit to a cash account, customarily the payroll account. The line item includes a check number which is the check handed to the employee. A check is NOT printed at this time.

The entry assigns values to particular accounts. The most commonly used account is the payroll liabilities account. The payroll liabilities account is a control account where governmental authorities are the third parties.

Remember, each employee serves a different role in the company and therefore their respective wages are assigned to one of several labor accounts. With this business there is production labor and management labor in cost of services rendered. Over in the expenses section under the parent group of ‘Management’ are officer’s salaries and office wages. The respective employer taxes are assigned to the corresponding payroll tax account. Here is the journal entry for Employee ‘A’.

Payroll Journal
Entry on 03/17/16 – Payroll for Employee ‘A’
Account Control ID Description DR CR
CSR-Labor/Prod 39.5 Hrs@$13.00/ea $513.50
P/R Liabilities 941-Fed Federal Withholding $49.00
P/R Liabilities 941-SS Social Security W/H 31.84
P/R Liabilities 941-Med Medicare W/H 7.45
P/R Liabilities ST Rev State Withholding 26.00
CSR-Labor/Taxes SS-Match 31.84
CSR-Labor/Taxes Medicare Match 7.45
CSR-Labor/Taxes FUTA 3.08
CSR-Labor/Taxes SUTA 9.86
P/R Liabilities 941-SS SS-Match 31.84
P/R Liabilities 941-Med Medicare Match 7.45
P/R Liabilities FUTA FUTA 3.08
P/R Liabilities SUTA SUTA 9.86
Payroll Checking Ck# 2319 (Net Amount) 399.21
$565.73 $565.73

Legend
CSR – Cost of Services Rendered section of the Income Statement
941-Fed – Internal Revenue Service reporting federal withholding using Form 941, Federal Withholding line.
941-SS – IRS reporting Social Security withheld and employer match using Form 941, Social Security line.
941-Med – IRS reporting Medicare withheld and employer match using Form 941, Medicare reporting line.
ST Rev – Respective state income tax withholding paid to the Department of Revenue/Taxation.
FUTA – IRS, Form 940
SUTA – Respective state’s unemployment department or Department of Revenue

This is a complex entry requiring multiple lines of debits and credits. It still must remain in balance per the dual entry requirement. Note that the debits equal the credits.

I want to point out a couple of interesting aspects of the above entry. Notice it starts out with the actual gross wage, I suggest this because as the bookkeeper you use the value for reference throughout the entry. Over time it will become almost instinct to determine the respective withholdings. Also, the employee’s deductions are entered first then the employer’s tax obligations.

Each tax line value for the employer’s obligations has an equal offset assigned to payroll liabilities. Some bookkeepers enter all the debit side part of the complex entry first then the credit side to payroll liabilities with a final credit to checking. They do this for all the tax obligations, both the employee and employer share. I personally prefer to do the employee’s debits and credits first; then the employer’s matching and other employer tax obligations.

The bookkeeper may enter one summation debit and one summation credit. However, it will make reconciliation at the end of each month and especially at the end of the quarter more difficult. In addition, payroll taxes are paid using the EFTPS system which requires separation of the tax obligations.

As I pointed out early on this step, the final line item is the net check that will be disbursed to the employee. Set the respective check aside for when it is time to print.

PAYROLL ENTRY SHOULD START WITH GROSS WAGES EARNED AND END WITH THE NET CHECK AMOUNT PAID TO THE RESPECTIVE EMPLOYEE.

The above example is a basic payroll entry. For beginners it looks daunting; but as experience is acquired it will seem simplistic. Now I am going to complicate this processing a little to help you understand the importance of making a good payroll journal entry.

Of the five employees, three are oriented to production; which is charged to cost of services rendered, labor. The office manager’s compensation shows up in the expenses section of the income statement under the parent account of ‘Management’. But recall that the owner divides his time between field work and his overall management duties. The owner spends 25% of his time conducting field work and the balance of his time in his management/ownership role.

His compensation breakout is as follows:

Cost of Services/Labor/Management – 25% of $692.30 = $173.08
Expenses/Management/Officer’s Salary – 75% of $692.30 = $519.22

Note that his labor value does not end up in production labor but in management labor. Back in Lesson 30 it was explained about the importance of the tax compliance requirements and financial reporting advantages of a good accounting structure. To assist you in understanding this, here is the account structure for Cost of Services, Labor account:

Cost of Services Rendered
Labor (Parent-Child Structured Account)
– Production
– Management
– Payroll Taxes

This division of gross wages begs the question, ‘Do I break out the employer’s taxes too?’.

Yes, I encourage a breakout of the taxes. If the value for his production management role were less than $100, it would be of little benefit to separate employer taxes. There are two different methods to break out these employer taxes for a split role. The first is the net method whereby two separate debit entries are utilized for each of the four tax lines related to the employer matching taxes. Or, the gross method whereby 25% of the total tax for this employer is debited to production payroll taxes and a credit is assigned for the same amount to management payroll taxes. I prefer the latter (gross method) for two reasons.

It is much easier to enter; and
It allows the accountant to better understand the allocation formula when reviewing both account ledgers (Expenses/Management/Payroll Taxes and Cost of Services Rendered/Labor/Payroll Taxes).

Do you notice something interesting with entering the employer payroll taxes for this particular employee (Officer/Owner)? The net method requires two debit entries to the respective payroll tax accounts (one to Labor/Payroll Taxes under Cost of Services Rendered and the other to Management/Payroll Taxes in the Expenses section of the Income Statement) and one credit entry to Payroll Liabilities. The two debit entries sum up to equal the total amount for that one particular employer matching tax (Social Security or Medicare). The gross method follows the traditional entry format for all four taxes then a single dual line (not a dual entry) transferring 25% of the aggregated value of both taxes combined. This dual line addition in the entry debits Cost of Services Rendered/Labor/Payroll Taxes for 25% of the total employer matching taxes and credits Expenses/Management/Payroll Taxes for the same amount. Some bookkeepers will create a separate dual entry after processing this particular employee’s payroll entry to transfer the tax amounts. This occurs frequently because many payroll processing software programs do not allow you to modify their respective generated entry.

Now let’s take a look at this entry in full using the gross method to transfer employer taxes for the owner’s compensation to production labor taxes.

Payroll Journal
03/17/16 – Payroll Entry for Employee ‘E’
Account Control ID Description DR CR
Exp/Mgmnt/Officer’s Salary Weekly Salary of $692.30 (75%) $519.22
CSR/Labor/Mgmnt Weekly Salary of $692.30 (25%) 173.08
P/R Liabilities 941-FED Federal Withholding 77.00
P/R Liabilities 941-SS Social Security Withheld 42.92
P/R Liabilities 941-Med Medicare Withheld 10.04
P/R Liabilities ST Rev State Income Taxes 51.00
Exp/Mgmnt/Taxes Social Security Match 42.92
Exp/Mgmnt/Taxes Medicare Match 10.04
Exp/Mgmnt/Taxes FUTA 4.15
Exp/Mgmnt/Taxes SUTA 13.29
P/R Liabilities 941-SS Social Security Match 42.92
P/R Liabilities 941-Med Medicare Match 10.04
P/R Liabilities FUTA FUTA 4.15
P/R Liabilities SUTA SUTA 13.29
CSR/Labor/Payroll Taxes 25% Allocation of Taxes 17.60
Exp/Mgmnt/Payroll Taxes 25% Allocation of Taxes 17.60
Payroll Checking Check # 2323 to Employee ‘E’ 511.34
. $780.30 $780.30

Remember the gross method adds two more lines of data to the entry. The employer taxes are added up and multiplied by 25%. Then 25% is simply transferred to Cost of Services Rendered/Labor/Payroll Taxes from the Payroll Tax account under Management in the Expenses section of the income statement. The net method would require a separate 25% of each tax (four of them in total) assigned to the tax account in labor.

Step 4 – Review and Approval

Once the payroll is completely processed the bookkeeper reviews each entry to verify accuracy. In addition, a report is printed that identifies the following:

Employee’s paycheck information including gross wages, taxes withheld and net check amount;
Employer obligations by employee for matching and unemployment taxes;
Summation of each of the tax obligations in total grouped by control ID as follows:
- 941 Set
  - Federal Withholding
  - Social Security (12.4% of Gross Wages)
  - Medicare (2.9% of Gross Wages)
- State Withholding
- FUTA
- SUTA
Check Disbursement Schedule for all checks to employees and electronic disbursements to the tax authorities

The owner then initials each and authorizes preparation of all checks and disbursements.

Step 5 – Cut Checks, Sign and Deliver

The last step is easy. Print the checks, have the owner sign them, insert into envelopes and hand them out on payday.

Many employers now use electronic payments to bank accounts. I encourage this but there is an electronic delay of two days (normal processing time). If using this type of system, time sheets need to get the bookkeeper by Monday morning, two days earlier. In effect the entire process is shifted ahead by the electronic processing time. Timing is critical when processing payroll.

Summary – A Simple Payroll

A simple payroll is a five step process:

Receive, vouch and approve the time sheets;
Calculate the payroll;
Process the payroll by entering the data via the payroll journal;
Review and approve; AND
Print, Sign and Deliver

The next lesson in this series explains the various payroll cycles. Act on Knowledge.

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