For small businesses that use the accrual method for accounting, it’s important to record your expenses in the month they’re incurred, even if you pay for them later.
But how do you keep track of payroll expenses if your pay period doesn’t line up perfectly with your accounting period?
The answer to that lies in an accounting tool known as payroll accrual. Let’s see how it works.
What is Payroll Accrual?
Payroll accrual is the total amount of salary, wages, and other compensation, like bonuses and paid time off, that employees have earned but haven’t been paid yet.
In other words, it’s a way of representing an upcoming business expense. You may also hear it referred to as accrued payroll or salary accrual.
After you run payroll, the accrual liability amount gets changed into an expense because you’ve paid it. This change gets reflected in the general ledger using journal entries, which we’ll cover later.
Keep in mind that accruing payroll is only necessary for businesses that use accrual accounting. If you use cash-basis accounting, you only record expenses when you pay for them, so there’s no need to accrue them.
To start, let’s look at what to include in your accrued payroll calculation.
What is Included in Payroll Accrual?
Payroll accrual includes employee salaries and wages as well as other types of compensation, like sales commissions and bonuses.
When you record accrued payroll, you’ll also include payroll taxes because they are expenses that you’ll eventually have to pay.
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How to Calculate Payroll Accrual
The best way to calculate accrued payroll for hourly employees is to multiply their hourly rate by the number of unpaid work hours in the period.
For salaried employees, calculate their daily rate and then multiply it by the number of days they’ve worked but haven’t been paid for yet.
To better understand which work days are unpaid, let’s use an example of what a bi-weekly pay period looks like in January 2023.
- Your employees work Monday through Friday.
- On Friday, January 13, you have a payday for the period of December 30 to January 12.
- On Friday, January 27, you have a payday for the period of January 13 to January 26.
- The pay for January 27, 30, and 31 will be in February.
When you record your monthly expenses for January, you’ll have to account for three unpaid workdays: January 27, 30, and 31. Since your employees worked on those days, you incurred the expense. But you won’t pay for those work days until the next payday in February.
Since you haven’t paid for those days yet, you can’t count them as a payroll expense. Instead, you’ll record them as accrued payroll to show that you owe that money.
Let's look at how to do the payroll accrual calculation for those three days, depending on whether you had an hourly or salaried employee.
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Example 1: Calculating Accrued Payroll for an Hourly Employee
Say you have an hourly employee with the following information:
- Hourly wage: $15
- Total hours worked January 27-31: 20
In this example, we’ll also be calculating the employer’s share of payroll taxes for the Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA). FICA includes Social Security and Medicare.
To calculate your employee’s accrued payroll, follow these steps.
- Multiply the hourly rate by unpaid work hours to get the employee’s gross pay: $15 x 20 = $200
- Calculate your FICA tax expense: 7.65% of $200 = $15.30
- Calculate your FUTA tax expense: 6% of $200 = $12
- Add together the gross pay and taxes to get accrued payroll: $200 + $15.30 + $12 = $227.30
Your total accrued payroll for this employee is $227.30 for the period.
Example 2: Calculating Salary Accrual for a Salaried Employee
For this example, say you have a full-time salaried employee who earns $62,400 per year, and you’re responsible for the following employer’s share of payroll taxes.
To calculate your accrual amount, follow these steps.
- Divide the annual salary by 52 to get the employee’s weekly rate: $62,400 / 52 = $1,200 per week
- Divide the weekly salary by 5 to get the employee’s daily rate: $1,200 / 5 = $240 per day
- Multiply the daily salary by the number of unpaid workdays to get the employee’s gross pay: $240 x 3 = $720
- Calculate your FICA tax expense: 7.65% of $720 = $55.08
- Calculate your FUTA tax expense: 6% of $720 = $43.20
- Add together the gross pay and taxes to get accrued payroll: $720 + $55.08 + $43.20 = $818.28
In this example, your accrued payroll for the salaried employee is $818.28.
Accrual Journal Entries for Payroll Accounting
In accrual accounting, you use an adjusting entry to record expenses that you incurred during the period but haven’t paid for yet. These are also known as unrecognized expenses.
Keep in mind if you have an accountant, CPA, or bookkeeper, they’ll make these entries for you. However, it can be helpful to understand what’s going on so you can better understand your general ledger.
We’ll use the previous example of $818.28 in payroll payable to see how this amount works through your general ledger using journal entries.
January 31: Record the accrued expense in your end-of-the-month closing.
Record the expense on the last day of the month and balance it with a credit to Accrued Wages and Salaries.
|Accrued Wages and Salaries||$818.29|
February 1: Reverse the expense at the beginning of the following month.
Reverse the expense with a credit, which reduces your expenses. In other words, you take the expense off the books until you pay for it later in the month.
|2/1/2023||Accrued Wages and Salaries||$818.28|
February 10 (Payday): Re-record the expense when you make your payroll journal entry.
The debit increases the Wage Expense account, and the Credit decreases the Cash account to show that the cash left your bank account.
Managing Uneven Pay Periods and Accounting Periods with Payroll Accrual
When your pay periods don’t align perfectly with your accounting periods, you can use accrual entries to record pay in the month it's incurred.
To calculate the accrual amount, simply multiply your employee’s hourly wage by the number of unpaid hours. For salaried employees, you multiply the employee’s daily wage rate by the number of unpaid days in the month.
Your bookkeeper or CPA can then do what they do best and make sense of your payroll accounting entries to make sure your expenses get recorded in the period they’re incurred.