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What is payroll accounting? A guide for small business owners

7 min read
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Payroll accounting can be difficult, complicated and, frankly, a bit boring. But it’s also crucial to be on top of it. In addition to staying on the right side of Her Majesty’s Revenue and Customs (HMRC) and avoiding hefty fines, good payroll accounting is crucial to running a stable business. 

Read on to learn what payroll accounting is, how to record it and how you can benefit from using payroll software.

QuickBooks guide to payroll accounting UK

What is payroll accounting?

As we explain in this article, ‘payroll’ means any tax withheld from a worker’s salary by an employer, who then pays the tax to the government on the worker’s behalf. 

Payroll accounting, then, is the process by which an employer works out and records the payroll tax payments they make, as well as payments for employer compensation and employer taxes.

This requires working out the gross and net pay for all employees for the period of payment - whether that’s monthly or more frequently.

In order to process payroll, you need to:

  • look after personnel data

  • run payroll and work out payroll taxes

  • maintain employee forms

You’re also obligated to prepare and file end of year payroll accounting reports. These reports allow HMRC to clearly see and confirm any benefits, expenses and taxes that your business has paid.

These reports also involve your employees as they’ll receive a P60, which gives a breakdown of their yearly gross and net pay, as well as a breakdown of taxes and National Insurance contributions.

Types of payroll accounting entries

When recording payroll, it’s important to keep clear and consistent records. Crucially, you need to make sure that you’re entering data as you go - don’t just leave it to the end of the accounting period!

Payroll accounting entries come in three forms: initial recordings, accrued wages and manual payments. 

  1. Initial recordings - Also known as originating entries, initial recordings are the type of entry you’ll deal with most often. This is because they’re exactly what they sound like: the first record of every transaction. They should include the gross wages earned by your employees, all withholdings from those wages and any employer taxes you owe on those wages. 

  2. Accrued wages - Accrued wages are recorded at the end of each period of accounting, and show the amount of wages you owe to employees that haven’t yet been paid. These are liabilities, not expenses - a distinction we’ll get into below. 

  3. Manual payments - Finally, manual payments are used to keep track of any adjustments you have to make outside your usual accounting periods. If an employee stops working for you, for instance, or you have to make any unplanned payments, these would be recorded as manual payments.

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How do you do payroll accounting?

Now that we’ve outlined the different types of records to keep, we can explore how you actually go about doing it. Let’s break it down into simple steps. 

  1. Record expenses - Calculate the gross amounts you need to pay, and debit your business accounts for those amounts.

  2. Record liabilities - Calculate the specific liabilities you need to pay on each gross transaction, and credit those amounts to your liabilities control accounts.

  3. Pay - Transfer the money from your liabilities account to the proper recipient - HMRC for taxes and national insurance, and your workers’ current accounts for their wages.

  4. Transition - Finally, at the end of each accounting period, close out your books, zero your accounts and begin producing records for the new accounting period.

One of the most important aspects of payroll accounting is making sure you’ve calculated wages, salaries, deductibles and taxes correctly - especially for the year end reports. 

Using an automated payroll system, or an integrated system with your current accounting software, makes it much easier to work these figures out. Otherwise, you run the risk of relying on Excel spreadsheet formulas, calculations and manual data entry to get you by.

We all know how easy it is to hit the spacebar and delete a formula in Excel, and not noticing until it’s too late. There’s also no data verification over the sheet, which can lead to human error and mistakes.

It’s crucial that you begin proper payroll accounting techniques as soon as you employ your first staff member. You should also stay compliant with payroll guidelines, legislation and regulatory requirements. This means keeping up to date with tax rates - which could change annually - and tracking employee data like holiday allowances, statutory sick pay, overtime, benefits and even stock options.

For a more detailed look at what you need to do to fully comply with payroll, see the UK government’s page exploring this issue.

Is payroll a liability or an expense?

As you’ll surely have seen by now, recording payroll accounting isn’t as simple as noting down what you take from your business account and what you credit to your employees. To help keep straight on what you’re recording, where and why, let’s explore liabilities and expenses

In simplest terms, expenses are the costs your business incurs by operating, while liabilities are amounts that your business owes. 

In practice, you should treat gross wages as expenses. This is the amount that your business must remove from its accounts to pay your workers. 

Within this gross expense, however, businesses have liabilities. Some, such as National Insurance, are payments removed from a worker’s wages and sent to the government. Others, like the wages themselves, are owed to the workers. 

Even if you’ve transferred the money out of your business’s account, the amount remains a liability until it is paid. That is, until it reaches its proper recipient’s account. 

For example, if you run payroll every month, your employees’ wages for the work they did over the course of that month are liabilities - costs you owe that you must pay. Once you’ve done so, they become expenses - costs you have paid.

Payroll, then, is an expense at the end of each accounting period. Until it is paid, it is a liability.

What does a payroll accounting system provide?

Don’t worry if this all sounds complicated - in truth, it is. And that’s why most small business owners use a payroll accounting system to ensure they’ve done everything properly. 

Using a payroll accounting system can provide a huge range of benefits, allowing you to:

  • Keep things simple by linking your accounts and presenting all relevant information together. 

  • Look after your workers by ensuring that they get paid properly and on time. 

  • Stay up to date with the latest changes to tax codes and payroll compliance requirements. 

  • Keep IT costs down by running your accounts smoothly from a single source. 

In short, it’s a great way to keep your stress levels low and stay on the right side of HMRC.

Integrating payroll with your accounting software

Simply everything by integrating your payroll system with your accounting software to save time and improve accuracy.

Integrating the two systems carries significant benefits, such as:

  • Eliminating the possibility of transposition errors There’s no need to copy and paste the figures from your online payroll calculator or third party payroll service into your accounting service

  • Improve efficiency in data reporting and budgeting Payroll figures can be combined into budgets, making it easier to spot figures that are over budget. This gives you the information you need efficiently, allowing you to make informed decisions, quickly.

  • Confidently track Changing Tax Rates The points your employees hit particular tax thresholds can change at any time, depending on progression and payrises.

  • Maintaining one central source for all employee data Integrating your accounting and payroll softwares makes it much easier to complete forms, such as a P60. QuickBooks streamlines the process to make the actual data entry for these forms as seamless as possible.

  • Improving billing and matching hours to job As a business owner, understanding which jobs are most profitable, and why, is essential to growing your business. Having all your data in one system makes for complementary reporting, allowing you to drill down and see what’s affecting your bottom line.

  • Keeping tax tables up to date An automated system with regularly scheduled updates keeps you safe when you start making deductions. The correct numbers are inputted automatically, ensuring complete data integrity and consistency.

The majority of accountants recommend their clients use a fully integrated accounting and payroll system to manage all aspects of the business. From bookkeeping, to inventory management, to payroll, having integrated systems ensures maximum time management, reliability and accuracy.

We hope this article has helped explain some of the complicated world of payroll accounting. To learn more about business accounting and how QuickBooks can help, why not browse some more posts on our small business blog?

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