An online retailer of golf accessories that sells shoes, gloves, and club bags is growing. The business now employs five full-time staffers and the owner is concerned about foul-ups with employee paychecks, withholding taxes, and covering worker benefits. The business needs to organize its payroll accounting, and quickly. Here’s how it can implement payroll accounting, and adhere to best practices for small businesses.
What is payroll accounting?
Payroll accounting is the process of calculating, recording and paying employees, as well as associated expenses. Those include income taxes withheld from employees’ paychecks, payroll taxes for Social Security and Medicare, employee benefits such as dental and health insurance premiums, and any employer contributions to a pension or retirement plan.
Businesses need payroll accounting systems to understand the total cost of each employee and to ensure they’re fulfilling their tax and legal obligations as an employer. Because labor often is one of a business’s biggest expenses, knowing these costs can help a business owner decide whether to hire full-time employees, part-time workers, or contractors.
Payroll accounting best practices
Small businesses need to establish a reliable payroll system to do payroll accounting correctly. A short list of best practices to help you get started includes:
- Use online payroll software
- Keep accurate records
- Follow relevant laws and regulations
- Classify employees correctly
- Establish regular pay periods
Use online payroll software
Software automates and organizes many manual and error-prone activities involved in payroll accounting. This probably is the single best thing a business can do to manage payroll, because it can save time and money. Software can help you organize a payroll system according to the scale of the company’s operations and number of employees.
Keep accurate records
Well-organized payroll records let a small business owner spend less time finding or dealing with paperwork. That lets them devote more time to seeking new customers and expanding the business. Records could be stored in the form of encrypted electronic records or in physical cardboard file folders. The former is more secure and easier for small business owners to manage.
Follow relevant laws and regulations
Make sure you’re adhering to relevant federal and state laws. Various laws require employers to pay workers minimum wages and overtime; bar employers from discriminating against women, minorities, and those with disabilities; and require employers to pay into unemployment insurance funds and pay prevailing union wages for workers on federal projects.
Classify employees correctly
Properly classifying employees as full time, part time, or contractors is critical, with potentially big consequences for mistakes. For example, say you decide to treat full-time workers as independent contractors, without withholding any state or federal income taxes from their pay. If the government learns of this, your business could owe back taxes, interest, and penalties, as well as fines for improperly classifying the workers.
Establish regular pay periods
Establish a regular calendar for disbursing employee paychecks, and deadlines for submitting withheld employee state and federal income taxes, FICA taxes, and any voluntary employee contributions to retirement plans and supplemental health and life insurance coverage. Note that you must set aside enough cash to meet payroll obligations accurately and in a timely manner. Accountants generally recommend that payroll expenses not exceed 30% of a business’s gross revenue. Direct deposit streamlines delivery of pay to employees, eliminates the manual tasks of cutting and mailing checks, and avoids the risk of checks getting lost in the mail.
3 things to consider in setting up payroll accounting
- Adhere to laws that apply to small and medium-size businesses
- Factor in benefits when calculating total compensation
- Choose a payroll software program
Taking a few critical steps can make the process of setting up a payroll accounting system easier.
1. Adhere to laws that apply to small and medium-size businesses
Businesses must adhere to applicable laws and regulations for compensating employees, withholding and paying employee federal and local income tax, funding employee benefits, and paying employee self-funded contributions to retirement plans, such as 401(k)s. Some federal laws apply to all businesses, regardless of the size, while smaller businesses may be exempt from other requirements, such as paid family leave time.
2. Factor in benefits when calculating total compensation
A business owner should include the cost of benefits when establishing employee compensation. For example, an employee with gross wages of $40,000, with a combined $15,000 in employer-funded health and dental insurance and retirement-plan contributions, represents a total $55,000 compensation expense to the business. Benefits in this case amount to about 27% of total compensation, which the business owner might use as a reference for future payroll decisions.
3. Choose a payroll software program
Software can automate tedious processes, many of which are prone to human error. You can shop for software that—among other things—schedules payments to employees and government agencies, coordinates administering employee benefits, and makes payroll information on full-time, part-time and contract workers readily accessible. Some software providers also have international payroll programs that meet labor and benefits standards in other countries.
Payroll accounting FAQ
What is the accounting process for payroll?
The payroll accounting process has several steps:
- Tally each employee’s total compensation, including benefits.
- Calculate deductions and tax withholdings based on the personal information each employee provided.
- Estimate accrued expenses for future payments, including for holidays and vacations.
- Enter all calculations in the company’s financial records.
- Based on those calculations, make payments to employees, to governments for withheld taxes, and to third parties such as retirement and health plan administrators.
What are an employer's responsibilities for withholding and paying payroll taxes?
Laws require employers to withhold all federal and state income and payroll taxes from employee pay. The employer must send those tax payments based on deadlines set by government agencies.
What are some best practices for maintaining accurate and up-to-date records in payroll accounting?
The list of smart payroll practices for small businesses is long, but it could include:
- Software. Choose a software program for small business payroll; this will save a business owner time and energy.
- Classification. Properly classify employees.
- Schedule. Establish an automated calendar for paying employees and for making required payments for company-provided fringe benefits.
- Funding. Provide sufficient funding for payroll expenses. A business owner doesn’t want paychecks bouncing or employee income taxes forwarded late to the government.
Is payroll an HR or an accounting responsibility?
Smaller businesses may find it more convenient for human resources staff to oversee payroll functions, while bigger businesses and corporations often use a payroll accountant. The choice may depend on the number of workers a business has, and whether they are full time, part time, or contractors.
What are common payroll accounting regulations to be aware of as an employer?
Federal regulations apply to all businesses, while state regulations vary. The most important federal regulations about payroll accounting include withholding employee income tax; mandatory minimum wage and overtime pay; equal pay for men and women doing similar work; and withholding for Social Security taxes and Medicare taxes.