We see it all the time with new clients who have outgrown their old school bookkeepers. The wages line on the profit and loss statement (P&L) doesn’t make sense and a payroll liabilities account on the balance sheet keeps growing. Health insurance is in place, but no benefits expense is showing on the P&L. Something is off! The consequences of incorrectly booked payroll can result in increased income taxes, errors in strategic planning and bumpy audits. Although automatic integrations between the payroll service and the accounting file are now available and can be helpful, they are still not used by many businesses for various reasons.
Here’s how your payroll expenses should look in your financial reporting on a basic level:
Wages categories = gross wages (includes the employee’s tax expense). If you pay an employee $75k a year, this line should reflect the full $75k.
Common mistake: If this number is lower, it could be because the amount that presents at your bank account is simply entered into the books at face value. However, the amount that hits your bank account is often the net amount (wages due after taxes are taken out) by the payroll service. Also, employees should receive their bonuses through payroll and have taxes taken out.
Employer taxes = taxes paid by the employer
Common mistake: Often, a tax payment will present at your bank and that amount is accepted into wages or a tax expense line. However, that tax payment that is clearing your bank account most often includes both employee taxes and employer taxes. Employee taxes are already counted in the employees gross wages discussed above. The only amount that should show on an employer tax line is the portion of taxes that the employer pays over and above what the employee is paid in wages. When this line is correct, an employer can quickly tell what the tax expense associated with having employees. Helpful!
Benefits expense = the cost of benefits paid for by the EMPLOYER
Common mistake: A health bill is paid and the full amount is booked to benefits expense, even though a portion is paid for by the employee and a portion is paid for by the employer.
Payroll liabilities = a balance sheet account that shows taxes withheld from employee checks and taxes owed by the employer.
Common mistake: When taxes are paid, it reduces this account, so this account should go up and down as taxes are submitted. If the account keeps growing, something is off.
Benefits liabilities = a balance sheet account that shows amounts withheld from paychecks for benefits and the employer’s portion of benefits.
Common mistake: When your benefits provider is paid, this account should reduce. If the account isn’t acting as a clearing account, something is off.
So, you’ve discovered your payroll lines are incorrect. What now? To fix previous periods, you should have a savvy accounting consultant examine past periods against payroll service reports and make the proper allocations. Be cautious about reopening periods where tax returns have already been filed. That same consultant should examine the mistakes in the current process and develop a template that can be easily followed for making payroll entries, using the payroll service reports as source data. VenturePack most often books payroll for our clients so they don’t need to worry about it and so that we are confident in supporting audits. However, you will want not only a new process, but a complete employee retraining on the new process if you retain this function in-house.
Another option for some companies is to automatically integrate your payroll system with your accounting system. If you go that route, you need to make darn sure that the setup for the integration is done correctly so that mistakes don’t get perpetuated. For instance, QuickBooks provides integrated payroll that works for many small businesses if they have a proper setup.
The good news is that with a solid process, you’ll have complete accuracy going forward. You will be able to easily support audits and have financial reporting that is helpful at a glance — reflecting the true cost of wages, benefits and employer tax expense.