What Are Payroll Accruals and How Do They Work?

Payroll accruals represent an accounting method used by businesses to accurately reflect expenses incurred for employee compensation and related costs during a specific period, even if the actual payment occurs later. This practice ensures that a company’s financial statements provide a precise picture of its financial position and operational performance. By recognizing these expenses when they are earned by employees, rather than when cash is disbursed, businesses can align their financial reporting with the economic realities of their operations.

Understanding Payroll Accruals

Payroll accruals are rooted in the accrual basis of accounting, specifically upholding the matching principle. This principle mandates that expenses should be recognized in the same accounting period as the revenues they helped generate. For payroll, this means the cost of employee labor and associated benefits is recorded as an expense in the period the work was performed, regardless of the pay date.

Several components contribute to payroll accruals. These include unpaid wages and salaries for work completed by employees up to the end of an accounting period, but for which payday has not yet arrived. Accrued paid time off (PTO), such as vacation or sick leave that employees have earned but not yet utilized, also forms a significant part of these liabilities. Additionally, employer-related payroll taxes, such as FICA, FUTA, and SUTA taxes, are accrued on these earned but unpaid wages.

Employer contributions to benefit programs, including health insurance premiums and retirement plan contributions, also fall under payroll accruals when they relate to the current period’s work but are scheduled for later payment. For instance, if health insurance premiums for the last week of a month are due in the following month, they are accrued in the current period.

Calculating Payroll Accruals

Calculating payroll accruals involves estimating the total amount of payroll-related expenses that have accumulated but remain unpaid by the close of an accounting period. The first step typically involves identifying the last regular payroll date and the precise end date of the accounting period being analyzed.

Next, businesses determine the number of days or hours worked by employees between the last payroll run and the period-end cutoff. For salaried employees, this might involve prorating their annual or bi-weekly salary based on the number of days worked within the accrual period. For hourly employees, the calculation uses their recorded hours multiplied by their respective hourly rates. For example, if a bi-weekly payroll covers 10 working days, and the period ends 4 days after the last payroll, 40% of the bi-weekly salary or wages would be accrued.

Beyond direct wages, associated employer taxes and benefits must also be estimated. FICA taxes (Social Security and Medicare) require matching employer contributions. For 2025, the Social Security tax rate is 6.2% for both employers and employees on wages up to $176,100, and the Medicare tax rate is 1.45% for both parties with no wage limit. FUTA tax is typically 6.0% on the first $7,000 of an employee’s wages, though credits for state unemployment taxes can reduce the net federal rate to 0.6%. SUTA rates vary by state and employer experience, often ranging from 0.35% to over 6% on a state-defined wage base (e.g., $7,000 to $15,000 annually).

Estimates for accrued benefits, such as health insurance premiums or retirement contributions, are based on the number of employees and the company’s specific benefit plans. These calculations often rely on historical payroll data, established pay rates, and contractual obligations with employees or benefit providers.

Recording Payroll Accruals

Once the payroll accruals are calculated, they are entered into the company’s accounting system through journal entries. This recording process ensures that the financial statements accurately reflect the company’s financial obligations and expenses for the period. The typical journal entry involves debiting an expense account, which increases the reported expenses on the income statement, and crediting a liability account, which increases the amount shown as owed on the balance sheet.

Specifically, “Wages Expense” or “Payroll Expense” would be debited for the accrued wages, while “Accrued Wages Payable” or “Accrued Payroll” would be credited. Similarly, for accrued payroll taxes, “Payroll Tax Expense” would be debited, and “Accrued Payroll Taxes Payable” would be credited. For accrued benefits, “Employee Benefits Expense” would be debited, and “Accrued Employee Benefits Payable” would be credited.

The impact of payroll accruals is evident on both the balance sheet and the income statement. On the balance sheet, accrued payroll amounts are presented as current liabilities, typically under accounts such as “Accrued Expenses” or specifically “Accrued Payroll.” This classification signifies that these are obligations due within one year.

On the income statement, the corresponding payroll expenses, including wages, taxes, and benefits, are recognized in the period they were incurred due to the accrual entry. By recording these expenses, the income statement provides a more precise measure of profitability, as it matches the costs of labor with the revenues generated during the same period.

Subsequent Handling of Accruals

At the beginning of the subsequent accounting period, these accrual entries are typically reversed. This reversal clears the temporary liability and expense accounts established in the prior period. For example, the “Accrued Wages Payable” account, which was credited in the previous period, would now be debited, and the “Wages Expense” account, which was debited, would now be credited.

When the actual payroll is processed and paid, the full amount of the payroll, including the portion that was previously accrued, is recorded as a regular payroll expense and a cash outflow. This subsequent recording involves debiting the appropriate expense accounts (e.g., Wages Expense, Payroll Tax Expense) and crediting the Cash account. The reversal entry ensures that the portion of the expense already recognized through the accrual is not double-counted when the full payroll is later recorded.

This two-step process—accruing an expense in one period and then reversing it and recording the actual payment in the next—is a standard practice in accrual accounting. It ensures expenses are allocated to the period work was performed, providing a clear representation of financial performance. This method also maintains organized accounting records, preventing distortions in financial reporting caused by the timing difference between when work is done and when payment is made.