Accrued Payroll – An Explanation


Accrued payroll is a current liability composed of four sections. The first is the amount of payroll earned by staff and not yet processed or paid. The second is the dollar value of personal time off accumulated for each employee aggregated into one number. The third consists of payroll taxes owed to the respective governmental authorities and the final section comprises the accumulated benefits payable such as health insurance, retirement contributions, and amounts owed to third parties as deductions from the gross payroll. This article explains each section and how the amount(s) is reported in the current liability section of the balance sheet.

This article is at the introductory level for most small business and the more technical and in-depth aspects of accrued payroll are covered in other articles.

History

Until the mid-1930’s, the most common method of handling payroll was to pay employees on a weekly basis for earnings through that day. It was not uncommon for the stage coach to deliver the payroll bank box to the paymaster and he would in turn pay all employees with cash for wages earned. The precursor to the modern day bank of Wells Fargo was their stagecoach delivery system. There was no legal requirement to withhold taxes or social security taxes as these particular payroll items did not come into play until the 1930’s. Only the truly high earners had to pay income taxes. The Second World War was the impetus for the modern day tax withholding system and transfer of those taxes by the employer to the government.

It is no longer as simple as it was 100 years ago. Today, each small business has to address their payroll in accordance with their own governmental compliance and benefit(s) program. The payroll is much more complex and this drives the need for the owner of a small business to truly understand how much the business owes to the employees and on behalf of the employees for items earned and unpaid at the end of each accounting period. The following explains each section of the accrued payroll and the final section illustrates the reporting format for a small business.

Wages Earned and Unpaid

At the end of the accounting cycle, many businesses have not actually paid their employees for the time worked since the prior payroll. This can sometimes have a significant dollar value associated with these unpaid earnings. If your business is a truly small operation, e.g. less than 5 employees and you are on a cash basis of accounting, you will not need to be concerned with calculating this value. But if you are under the accrual concept of accounting and you have more than 5 employees, you should calculate the dollar value earned by the staff and post this dollar amount to a current liability account called Wages Earned and Unpaid. It is relatively simple, create a spreadsheet and each row on the spreadsheet is a staff member. Multiply the numbers of hours worked by their hourly wage and enter this dollar amount in a cell in a wages earned column. As an alternative, you may calculate the percentage of their salary earned. Total the earnings. The change is calculated by subtracting the prior accounting period aggregated amount from the current period calculation and the adjustment is made to the Wages Earned & Unpaid account. The offset is posted in the Profit and Loss Statement in the wages section. 

If the accumulated dollar amount for the Wages Earned & Unpaid exceeds $1,000, it is wise to post the estimated matching payroll taxes associated with the wages too in this account (not in payroll taxes owed).

Personal Time Off (PTO)

Most employers provide vacation and sick time to their staff. This vacation and sick time has a threshold of time requirement with the company prior to vesting in this benefit, in many situations at least 90 days of work must be completed prior to vesting.  This works similarly to the earned wages above. Use a spreadsheet to calculate vacation earned, sick time earned, and any other personal time earned per employee. Convert this time into hours and multiply by the current wage of the employee. The final dollar value is multiplied by 1.0765 to adjust for the tax aspect of the dollar value of the PTO. The final aggregated dollar value is booked to a current liability line labeled Personal Time Off or PTO. The offsetting dollar value is booked to the profit and loss statement.

In some companies, employees earn time off without pay. You may wish to track this on the same spreadsheet, but there is no need to post any dollar value to this item. Examples include maternity leave, sabbatical leave, or seasonal variances (summers off for teachers, wintertime off for summer resort staff, or downtime associated with natural cycles of fishing, farming, or governmental regulations).

Payroll Taxes

With each paycheck issued an employer is required to withhold Social Security taxes, Medicare taxes, federal income taxes, state income taxes and in some situations, local income taxes. In addition, the employer has to match the Social Security and Medicare payroll tax. Finally, all employers are obligated to pay Federal Unemployment Taxes and State Unemployment Taxes (FUTA and SUTA). This section of Accrued Payroll is the total dollar value associated with these taxes. All payroll software automatically posts this information as the payroll is generated (run). Most small business use QuickBooks Pro to process payroll and QuickBooks automatically calculates the dollar amount and post the taxes to four separate accounts. You can redirect the software to post the accrued taxes to just one account by merging the accounts together. As actual payments are made, the payment amount is subtracted from the amount owed to keep a balance of taxes accrued and payable.

Benefits and Third Party Obligations

As a small business grows, the owner begins to offer benefits to his employees. One of the first benefits typically offered is a matching retirement contribution. Usually the owner does this to help himself more than helping the staff. Many lower paid employees rarely take advantage of a matching amount. In addition to retirement benefits, health insurance is the most expensive benefit provided to employees. As the benefits accrue and the business is obligated to pay the benefits, the dollar amount is posted here and  an offset for the expense is posted to the profit and loss statement. Other benefits accrued and posted include:

  • Other forms of medical insurance (dental, vision, cancer, AFLAC program etc.)
  • Education benefits
  • Life Insurance Premiums
  • Other forms of retirement contributions (annuities, thrift savings, & nonqualified plans)

In addition to benefits, many employees are obligated to pay certain sum amounts to third parties. The most common form of this is child support. Other types of obligations are tax liens, payroll deductions for credit issues, or health savings account contributions. These are all third parties sending you some form of a legal document or payment agreement for the employee’s participation or compliance. 

All of the above items are combined as one dollar amount in this section of the accrued payroll.

Reporting Format

Almost any accounting software allows a single account to combine the dollar amounts from several sub accounts. The four sections above are considered sub accounts as illustrated below:

Current Liabilities
Accounts Payable                                   $ZZ,ZZZ
Accrued Payroll:
   Wages Earned & Unpaid        $Z,ZZZ
   Personal Time Off                    Z,ZZZ
   Payroll Taxes                            Z,ZZZ
   Benefits & Obligations             Z,ZZZ
   Sub-Total Accrued Payroll                    ZZ,ZZZ
Other Current Liabilities                          ZZ,ZZZ
Total Current Liabilities                  $ZZZ,ZZZ

In a typical balance sheet report the owner sees one aggregated amount for accrued payroll. Detail reports can break out the accrued payroll into the four sections as illustrated above. If further detail is required, the spreadsheets tallying the respective amounts can be provided or payroll journals can vouch for the dollar amounts owed for payroll taxes and benefits & obligations.

Summary – Accrued Payroll

As payroll becomes more complicated and the company grows, the owner should convert his current liabilities section of the balance sheet to reflect the concept as outlined above. Accrued payroll comprises four sections. Wages earned and unpaid reflects the dollar value of total wages not processed at the end of the accounting period. Personal time off is the dollar value of the accumulated vacation and sick time benefit earned by staff.  Payroll taxes are the amounts owed to the respective governmental authorities for the respected taxes withheld and/or matched by the employer. Finally, the benefits accrual identifies the total dollar value owed for benefits either earned or deducted from an employee’s paycheck and owed to third parties. This includes any third party obligations (voluntary and legal). Act on Knowledge.

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