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How to do Payroll Accounting In 4 Steps

If you’re a business owner with employees, chances are you deal with payroll routinely. Part of that involves keeping your books accurate and compliant.

Since multiple laws are relevant to payroll taxes and benefits, payroll accounting can be a complex process. Between paying different types of workers and reporting upkeep, payroll can quickly drain much needed resources for your business.

Read on for tips on for what you need to know to set up your payroll process.

What is payroll accounting and what matters?

As a small business owner, you record your payroll expenses in your books using payroll journal entries. Entries entered in your payroll account include the following:

  • Taxable income earned by employees
    • Gross wages
    • Salary
    • Bonuses
    • Commissions
    • Overtime pay
    • Other taxable income
  • Employees’ Portion Of Payroll Withholdings
    • Employee portion of Social Security tax
    • Employee portion of Medicare tax
    • Federal income tax
    • State income tax
    • Health benefits
    • Saving plan
    • Wage garnishment
    • Other withholdings
  • Employer’s Portion Of Payroll Withholdings
    • Employer portion of Social Security tax
    • Employer portion of Medicare tax
    • State and federal unemployment tax
    • Worker compensation insurance
    • Health benefits
    • Saving plan
    • Sick leave and vacation pay
    • Other withholdings

1. Get yourself ready to pay employees

To get yourself ready to pay employees, use this checklist as a starting guide.

  • Get an Employer Identification Number (EIN) number. An EIN number is used by the Federal government to track all tax payments made by a business.You can get one for free from the IRS.


  • Decide your pay structure. Decide whether you’ll be paying employees an annual salary or hourly, and how often you will pay them.


  • Determine the benefits you will offer. For each benefit you offer, figure out how much you and your employer will contribute in order to participate in the plan.


  • Buy Workers’ Compensation Insurance. Workers’ compensation is used to protect employees who are injured or become sick because of the job. It is required for every state except Texas.


  • Fill out the paperwork for each employee. You will typically need to fill out an I-9 form, W-4 form, and direct deposit authorization form, if applicable, for each employee.

2. Calculate paychecks

To avoid common errors, it is best to set up a system for calculating paychecks. The formula for calculating net pay for an employee is:

Net Pay = Employee Gross Pay – (Employee portion of Social Security + Medicare + Federal withholding + Other Deductions)


If you’re unsure of where to find update to date resources to help you get started on paying your employees, feel free to reach out to us for the latest information.


3. Record your payroll

You will need to set up payroll accounts on your chart of accounts list to record payroll. The chart of accounts is a list of accounts used to organize all your business’ financial transactions.

The accounts you will need to set up will generally be an expense or liability account. An expense is a cost incurred from doing business. A liability is money that you owe to others. An asset is cash.

You will need to set up these common accounts on your chart of accounts to track all to track payroll-related activities.

Account NameAccount TypeIncrease ByDecrease By
Gross WagesExpenseDebitCredit
Health Insurance (Employer’s Portion)ExpenseDebitCredit
401K Employer MatchExpenseDebitCredit
Federal WithholdingLiabilityCreditDebit
FICA PayableLiabilityCreditDebit
State Disability PayableLiabilityCreditDebit
Workers CompensationLiabilityCreditDebit
Health Insurance (Employee’s Portion)LiabilityCreditDebit
401K Employee ContributionLiabilityCreditDebit
Accrued Vacation PayableLiabilityCreditDebit
Accrued Sick PayableLiabilityCreditDebit

In general, you will debit Gross Wage Expense, credit all of the liability accounts, and credit the cash account when you record payroll. To understand the basics of payroll accounting, look at the following journal entry for a $1,000 payroll:

Expenses (gross wages) are debited. Liabilities (federal withholding, state withholding, FICA Payable) are credited.

Account NameDebitCredit
Gross Wages1000
FICA Payable120
Federal Withholding100
State Withholding50
Wages Payable730

After you pay the employee, you will need to make another entry.  Your liabilities decrease (debit) since you no longer owe wages. Your cash decrease (credit) because you paid the employee.

Account NameDebitCredit
Wages Payable730

When you pay employer taxes, you need to make more journal entries. You need to reverse the payable entries with a debit and decrease the cash account with a credit.

Account NameDebitCredit
FICA Payable120
Federal Withholding100
State Withholding50
FICA (Employer Portion) Payable120
Federal Unemployment Payable10
State Unemployment Payable25

If you don’t want to spend time recording manual journal entries, we can help you set up your payroll process. Not only will it make your payroll process more manageable, but it will minimize common errors.

4. File and pay your payroll taxes

Payroll reporting requirements varies at the federal, state, and local levels. You should double check what the requirements are for your particular state and local area. For simplicity, we’re going to look at the requirements for federal.

Below are the tax forms you need to complete in order to file.

  • Form W2
    • W2’s provide employees with a summary of the wages paid and deductions withheld for the tax year. This form must be filed with the SSA (Social Security Administration) and mailed to employees by January 31 for the preceding tax year.
  • Form W3
    • This form summarizes all employee issued W2 forms. It has to be filed with the SSA along with all W2 forms by January 31 for the preceding tax year.
  • Form 940
    • Form 940 is used for reporting payments made for unemployment taxes and must be filed annually. You may have to submit payments more than once a year. It is due on January 31 for the preceding tax year.
  • Form 941
    • Used for reporting social security and medicare taxes (FICA) withheld from all employee paychecks and the employer share of social security and medicare tax. It’s due 1 month after the end of each quarter.

If you need more direction on how to do payroll accounting, Roy Cooper CPA can help. We can help you navigate the complexities of getting your payroll process properly set up and automate manual tasks for you.

Still have questions about payroll accounting? Just ask Roy.