How to Record a Payroll Journal Entry

A payroll journal entry is a fundamental accounting record that captures the financial impact of employee compensation and related costs for a business. It provides a comprehensive overview of how money is allocated for wages, taxes, and benefits, ensuring accurate financial statements. This entry is standard practice for businesses of all sizes, essential for tax compliance and presenting a true picture of a company’s financial health.

Core Components of Payroll

Payroll involves several distinct elements that collectively determine the total cost of employee compensation. Gross wages represent the total amount of money earned by an employee before any deductions are taken out. This includes regular salary or hourly pay, overtime, commissions, and bonuses.

Employee deductions are amounts withheld from an employee’s gross pay. These commonly include Federal Income Tax Withholding (FITW) and State Income Tax Withholding (SITW), which are remitted to government authorities on the employee’s behalf. Additionally, employees contribute to Social Security and Medicare, collectively known as Federal Insurance Contributions Act (FICA) taxes, with the employee portion being 6.2% for Social Security up to an annual wage base and 1.45% for Medicare. Pre-tax deductions, such as health insurance premiums or 401(k) contributions, reduce an employee’s taxable income, while post-tax deductions, like wage garnishments or union dues, are taken after taxes are calculated.

Beyond employee deductions, employers incur their own set of payroll costs and taxes. Employers also contribute to FICA taxes, matching the employee’s portion for Social Security and Medicare. The Federal Unemployment Tax Act (FUTA) requires employers to pay a federal unemployment tax, while the State Unemployment Tax Act (SUTA) imposes a state-level unemployment tax. Furthermore, businesses often pay for a portion of employee benefits, such as employer-sponsored health insurance premiums or matching contributions to 401(k) plans.

Identifying Accounts for Payroll Entries

Accurate payroll recording requires specific general ledger accounts that categorize the various financial transactions. Expense accounts capture the costs incurred by the business related to employee compensation. Wages Expense, or Salaries Expense, is used to record the total gross wages earned by all employees. Payroll Tax Expense accounts for the employer’s share of FICA, FUTA, and SUTA taxes. Benefits Expense is utilized to record the employer’s contributions towards employee benefits, such as health insurance premiums or retirement plan matching.

Liability accounts are established to track amounts owed by the business to employees, government agencies, or other third parties. Wages Payable, or Salaries Payable, represents the net pay due to employees after all deductions have been withheld but before the cash is disbursed. Separate payable accounts are created for each type of tax withheld, such as Federal Income Tax Payable, State Income Tax Payable, FICA Payable, FUTA Payable, and SUTA Payable.

Additional liability accounts are necessary for other withheld amounts and employer contributions that will be remitted to external entities. These include Health Insurance Payable for premiums owed to insurance providers and 401(k) Contributions Payable for funds due to retirement plan administrators. An asset account, typically Cash, is used to record the actual outflow of funds when net pay is distributed and when taxes or benefits are remitted.

Calculating Payroll Entry Amounts

Gross pay is determined by multiplying an employee’s hourly rate by the hours worked, or by their fixed salary amount, and adding any commissions, bonuses, or overtime pay.

Employee withholdings are then calculated based on gross pay and various tax regulations or employee elections. Federal Income Tax Withholding (FITW) and State Income Tax Withholding (SITW) amounts are generally determined using tax withholding tables provided by the IRS and state tax authorities. For FICA taxes, the employee portion is 6.20% for Social Security on wages up to the annual wage base and 1.45% for Medicare on all wages. Pre-tax deductions, such as health insurance premiums or 401(k) contributions, are typically fixed amounts per pay period or a percentage of gross pay.

Net pay is derived by subtracting all employee deductions from the gross pay. Employer payroll taxes are calculated based on the same gross wages, with the employer matching the employee’s FICA contributions (6.20% for Social Security and 1.45% for Medicare). FUTA tax is generally 6.0% on the first $7,000 of wages paid to each employee, though most employers receive a credit that reduces the effective rate. SUTA rates vary by state and employer experience, applied to a specific wage base that differs by state. Employer-paid benefits, such as the employer’s share of health insurance premiums or 401(k) matching contributions, are determined by benefit plan terms.

Constructing the Payroll Journal Entry

Creating the payroll journal entry involves applying the principles of double-entry bookkeeping. The first part of the entry records the gross wages and all employee deductions. Wages Expense is debited for the total gross wages. Correspondingly, various liability accounts are credited for the amounts withheld from employee pay; these include Federal Income Tax Payable, State Income Tax Payable, and the employee’s portion of FICA Payable.

Additional credits are made to other liability accounts for pre-tax and post-tax deductions, such as Health Insurance Payable and 401(k) Contributions Payable. The net amount owed to employees is credited to Wages Payable.

The second part of the journal entry accounts for the employer’s payroll taxes and benefits. Payroll Tax Expense is debited for the employer’s share of FICA, FUTA, and SUTA taxes. Correspondingly, the employer’s portion of FICA Payable, FUTA Payable, and SUTA Payable are credited as liabilities. If the employer contributes to employee benefits, Benefits Expense is debited, and the relevant liability accounts, such as Health Insurance Payable or 401(k) Contributions Payable for employer matching, are credited.

Finally, two subsequent entries complete the payroll process. When net pay is disbursed to employees, Wages Payable is debited, and Cash is credited to reflect the outflow of funds. Later, when the accumulated tax and benefit liabilities are remitted to the respective government agencies or providers, the specific payable accounts are debited, and Cash is credited.

Example:
If gross wages are $10,000, employee FITW is $1,000, employee SITW is $300, employee FICA is $765, pre-tax health is $150, and net pay is $7,785. Employer FICA is $765, FUTA is $60, SUTA is $200, and employer health is $300.

Payroll Journal Entry:

Wages Expense Dr. $10,000
Federal Income Tax Payable Cr. $1,000
State Income Tax Payable Cr. $300
FICA Payable Cr. $765 (employee portion)
Health Insurance Payable Cr. $150 (employee portion)
Wages Payable Cr. $7,785

Payroll Tax Expense Dr. $1,325 (Employer FICA $765 + FUTA $60 + SUTA $200)
FICA Payable Cr. $765 (employer portion)
FUTA Payable Cr. $60
SUTA Payable Cr. $200

Benefits Expense Dr. $300 (Employer health)
Health Insurance Payable Cr. $300 (employer portion)

Payment of Net Pay:

Wages Payable Dr. $7,785
Cash Cr. $7,785

Payment of Liabilities (example):

Federal Income Tax Payable Dr. $1,000
State Income Tax Payable Dr. $300
FICA Payable Dr. $1,530 (total employee + employer)
Health Insurance Payable Dr. $450 (total employee + employer)
FUTA Payable Dr. $60
SUTA Payable Dr. $200
Cash Cr. $3,540