How to Make Payroll Journal Entries: A Small Business Guide

The Blueprint guide to recording payroll transactions with journal entries.

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The No. 1 thing I’ve learned since I started my career in accounting is that there's always more to accounting for an event than you’d think.

When you purchase a new truck, you don’t expense it right away; it gets depreciated over many years. When you sell inventory, you have a seemingly infinite number of processes and methods you could use to account for it.

And in payroll accounting, you have several different journal entries to make, first to accrue liabilities, and then to make payments.

In this article, we’ll go over how to make payroll general ledger entries and why liabilities must first be accrued for payroll and related accounts.

Overview: What is a payroll journal entry?

Payroll journal entries are what an accountant (or in many cases the small business owner) uses to record business activity. Each entry affects at least two accounts that are typically on different sides of the accounting equation:

Assets = Liabilities + Owners Equity

Each journal entry has debits and credits that must add up to the same number. Accounts on the left side of the equation increase when debited and decrease when credited, and vice versa for accounts on the right side.

The most basic payroll entry involves crediting cash and debiting wage expenses. The cash account (an asset) decreases, and wages are an expense account that decreases equity. Unfortunately, doing payroll is never this basic.

Types of payroll journal entries

Recording the payroll process with journal entries involves three steps: accruing payroll liabilities, transferring cash, and making payments.

1. Accrue short-term wage liabilities

Accounting rules stipulate that expenses and liabilities should be accrued when they are incurred. For this reason, it’s important for businesses to carefully track the wages owed to employees.

Many companies pay employees on a bi-weekly schedule. Payroll is processed sometime before the payments are sent at a scheduled time every other week.

As part of the payroll process, companies have to make journal entries to recognize the expense for wages and labor burden (benefits and taxes) and balance those entries with liabilities for the same amount until employees are paid.

2. Move cash to payroll account

It's a good practice to open a separate bank account to be used for payroll. The separate account makes it easier to track all outgoing payments (payroll and taxes) and transfer only the amount needed from the operating account to the payroll account to cut down on embezzlement.

3. Make payments

The final step is to make the payments. As direct deposits are sent to employees and the IRS pulls the EFTPS (Electronic Federal Tax Payment System) payment, journal entries are made to show cash paying down the liabilities.

How to record payroll entries

Payroll journal entries are typically done instantaneously by your payroll software, but we'll go over them here with fictitious numbers to better understand how payroll works.

Step 1: Wage accrual

Each pay period, pay is calculated based on time cards and salary amounts and then expensed. Wages are debited to increase the expense account, and wages payable is credited to increase the liability account. Here’s how the wages journal entry looks:

Date Account Debit Credit
06/01/2020 Salaries and Wages $15,000
06/01/2020 Wages Payable $15,000

Some companies expense part of the wages under cost of goods sold with an account called direct labor. For example, a construction company would expense all wages related to open jobs as "direct labor" and all wages related to overhead as "salaries and wages."

At the end of the period, the amount in direct labor is moved into cost of goods sold with a closing entry. Here’s an example of the journal entry under this scenario:

Date Account Debit Credit
06/01/2020 Salaries and Wages $5,000
06/01/2020 Direct Labor $10,000
06/01/2020 Wages Payable $15,000

The key to doing journal entries is to ensure that the total amount debited and credited is the same so that the general ledger will remain balanced.

Step 2: Labor burden and other payroll deductions accrual

Labor burden and payroll deductions also need to be accrued. Examples of these items include:

  • FICA: The employee and employer portions of Social Security and Medicare taxes.
  • Tax withholding: Federal and state income tax withholding.
  • FUTA and SUTA: Federal and state unemployment taxes.
  • Health and dental insurance: Employer and employee portions.
  • 401k: Employer and employee portions.
  • Workers comp: Employer expense.
  • Vacation and sick time: Accrued amount for the payroll period.
  • Garnishments: For child support or as otherwise directed by court order.

The wages and labor burden accruals would generally be done at the same time. I’ve broken them up here to illustrate which of these accruals are deducted through salaries and wages (because they are withheld from the employee) and which are payroll expenses charged to the employer:

Date Account Debit Credit
06/01/2020 Salaries and Wages $4,650
06/01/2020 Employee FICA Payable $800
06/01/2020 Federal W/H Payable $1,500
06/01/2020 State W/H Payable $700
06/01/2020 Employee Health Insurance Payable $600
06/01/2020 Employee 401k Payable $750
06/01/2020 Garnishments Payable $300
06/01/2020 Payroll Expense $3,522
06/01/2020 Employer FICA Payable $800
06/01/2020 FUTA Payable $2
06/01/2020 SUTA Payable $45
06/01/2020 Employer Health Insurance Payable $900
06/01/2020 Employer 401k Payable $750
06/01/2020 Workers Comp Payable $275
06/01/2020 Accrued Vacation $500
06/01/2020 Accrued Sick Time $250

If the payroll chart of accounts were any bigger, King Kong would climb up it to swat at planes. Don’t be intimidated by the amount of entries needed for this step. If you use a good payroll program they will all be done automatically.

Step 3: Move cash to payroll account

The next step is to move cash from the operating account to the payroll account in anticipation of all cash payments going out. We’ll move the sum of the above numbers excluding accrued vacation and sick time.

Those liabilities are not paid out in cash; instead, the liability is debited when vacation or sick time is used.

Date Account Debit Credit
06/01/2020 Payroll Account $22,422
06/01/2020 Operating Account $22,422

Step 4: Send direct deposit payments

Once the cash has been transferred, it’s time to upload the ACH file to the payroll account to send out direct deposit payments. In this entry, we will clear out the accrued wages and show the reduction in cash.

Date Account Debit Credit
06/05/2020 Wages Payable $15,000
06/05/2020 Payroll Account $15,000

Step 5: Make EFTPS and third-party payments

The final step is making all payments with the IRS EFTPS and other third parties, such as insurance companies, 401(k) vendors and state agencies. This step will eliminate all current payroll liabilities other than the accrued vacation and sick time.

Date Account Debit Credit
06/05/2020 Employee FICA Payable $800
06/05/2020 Federal W/H Payable $1,500
06/05/2020 State W/H Payable $700
06/05/2020 Employee Health Insurance Payable $600
06/05/2020 Employee 401k Payable $750
06/05/2020 Garnishments Payable $300
06/05/2020 Employer FICA Payable $800
06/05/2020 FUTA Payable $2
06/05/2020 SUTA Payable $45
06/05/2020 Employer Health Insurance Payable $900
06/05/2020 Employer 401k Payable $750
06/05/2020 Workers Comp Payable $275
06/05/2020 Payroll Account $7,422

Let the software do the work

While it's certainly worth understanding how to make payroll journal entries, in reality, the cost/benefit ratio to doing the work yourself is skewed once you have more than five employees.

Good payroll software will allow you to focus on other tasks while it does the dirty work behind the scenes making journal entries.

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