How to Accrue Payroll for Accurate Financial Reporting

Payroll accrual is a fundamental accounting practice that ensures financial statements accurately reflect a company’s financial position and performance. It involves recognizing payroll expenses in the period they are incurred, even if the actual cash payment to employees or tax authorities occurs in a subsequent period. This method aligns expenses with the revenues they help generate, providing a more precise view of profitability. Accruing payroll is a necessary procedure for any business striving for transparent and reliable financial reporting.

Understanding Payroll Accrual

Payroll accrual is an application of the matching principle, a core concept in accrual basis accounting. This principle dictates that expenses should be recorded in the same accounting period as the revenues they helped to produce. For payroll, the cost of employee labor is recognized when the work is performed, not when the paycheck is issued. This provides a more accurate representation of a business’s financial performance.

Accrual becomes necessary when a pay period spans two different accounting periods, such as when a bi-weekly pay cycle ends on the fifth day of a new month, but the accounting period closes on the last day of the previous month. If payday consistently falls after the close of an accounting period for work performed within that period, an accrual is required. Without accruing payroll, expenses would be understated in one period and overstated in another, distorting financial results.

Accrual basis accounting differs from cash basis accounting. Under the cash basis, expenses are recorded only when cash changes hands, meaning payroll costs are recognized only on the payday. This method can misrepresent a company’s financial health, as it fails to account for obligations incurred but not yet paid. Accrual basis accounting, mandated for most larger businesses and publicly traded companies, provides a more comprehensive financial picture by recognizing liabilities as they arise.

Calculating Accrued Payroll

Calculating the amount of payroll to accrue involves determining all compensation and related costs for the portion of the pay period that falls within the current accounting period but remains unpaid. The first step involves identifying the gross wages earned by employees for the specific days worked within the accrual period. For hourly employees, this means multiplying their hourly rate by the number of hours worked during the relevant days.

Salaried employees’ wages are prorated based on the number of workdays within the accrual period compared to their total workdays in a pay cycle. For instance, if an accounting period ends on a Wednesday, and employees are paid bi-weekly for ten workdays, five of which fall into the new period, the wages for the first five days of the pay period would be accrued.

Beyond gross wages, the calculation must also include the employer’s share of payroll taxes and benefits. Employer payroll taxes include contributions to Social Security and Medicare, known as FICA. As of 2025, the employer’s share of Social Security is 6.2% on wages up to the annual earnings limit, and Medicare is 1.45% on all wages. Employers also contribute to federal unemployment tax (FUTA) and state unemployment tax (SUTA), which have specific wage bases and rates.

Employer-provided benefits, such as health insurance premiums, 401(k) matching contributions, and other fringe benefits, must also be accrued. These costs represent a direct expense to the company related to employee compensation. For example, if health insurance premiums are paid monthly in arrears, the daily portion corresponding to the accrual period would be estimated and included in the total. The sum of these components—prorated gross wages, employer payroll taxes, and employer benefit costs—constitutes the total accrued payroll amount.

Recording Accrued Payroll

Once the amount of accrued payroll has been calculated, the next step involves entering this financial information into the company’s accounting records. This is accomplished through a journal entry. The objective of this entry is to recognize the expense incurred during the current period and establish a liability for the amount owed to employees and related entities.

The journal entry for accrued payroll involves debiting various expense accounts and crediting corresponding liability accounts. For instance, the gross wages component of the accrual is debited to a “Wages Expense” or “Salaries Expense” account. This debit increases the expense, reflecting the cost of labor incurred. The corresponding credit is made to a “Wages Payable” or “Accrued Payroll” liability account, which increases the company’s short-term obligation.

The employer’s share of payroll taxes, such as FICA, FUTA, and SUTA, is debited to a “Payroll Tax Expense” account. This debit increases the company’s tax expense for the period. The corresponding credit for these taxes goes to liability accounts like “FICA Taxes Payable,” “FUTA Payable,” and “SUTA Payable,” acknowledging the amounts owed to tax authorities. Employer-provided benefits, like health insurance premiums or 401(k) matches, are debited to relevant expense accounts, such as “Employee Benefits Expense,” with a credit to a “Benefits Payable” or “Accrued Liabilities” account.

This journal entry is made in the general ledger or through accounting software at the end of the accounting period. The effect of this entry is to increase the company’s expenses on the income statement for the current period, providing a more accurate reflection of profitability. Concurrently, it increases current liabilities on the balance sheet, portraying the financial obligations the company has incurred but not yet paid.

Post-Accrual Considerations

Following the initial recording of accrued payroll, a subsequent action is to make a reversing entry, typically on the first day of the new accounting period. A reversing entry is an optional but frequently used accounting practice designed to simplify the recording of subsequent transactions and prevent potential double-counting of expenses. Its purpose is to clear the accrued liability and expense accounts established at the end of the prior period, setting the stage for normal payroll processing in the new period.

The reversing entry reverses the original accrual journal entry. This means the liability accounts credited during the accrual process are now debited, and the expense accounts debited are now credited. For example, “Wages Payable” would be debited, and “Wages Expense” would be credited for the accrued amount. This action zeroes out the temporary accrued accounts, allowing the full payroll for the new period to be recorded without needing to manually adjust for the portion previously accrued.

Accrued payroll impacts both the balance sheet and the income statement. On the balance sheet, the accrued payroll amount appears as a current liability, under accounts like “Wages Payable” or “Accrued Expenses.” This accurately reflects the company’s short-term obligations to its employees and taxing authorities for work performed. Recognizing this liability is important for stakeholders assessing the company’s financial health and liquidity.

On the income statement, the corresponding payroll expenses (wages, benefits, and payroll taxes) are included in the total expenses for the period in which the work was performed. This ensures the matching principle is upheld, providing a more accurate measure of the company’s profitability. By accruing payroll, businesses present a clearer and more reliable financial picture, enabling better decision-making for both internal management and external stakeholders.