Accounting How Are Salaries Tracked on a Journal Entry

Dummies guide to Salary Journals in Accounting packages.

A man doing his taxes using a calculator and pencil on a white background

As part of my work in upgrading legacy accounts packages to Enterprise systems, I have to bring forward the opening balances into the new set of accounts. This is usually done at the end of a financial year, or VAT quarter and the summaries of the transactions should be the same as the amounts as per the previous period on the old system. (i.e. the bank balances must be same otherwise the bank reconciliations would be out)

To do this I check a number of financial reports including the trial balance and balance sheets. The trial balance is a summary of all the debits and credits that have accumulated in the system. The balance sheet is a statement of what is owned by the business, as against to what it owes others, to get a true picture of what the company is worth.

Pay As You Earn (PAYE) and National Insurance Contributions (NIC )

One line I always look out for, and is usually missing, is the Pay As You Earn (PAYE) and National Insurance Contributions (NIC ), the taxes that are owed to HMRC from employees' wages. On further investigation I usually find that the accounts have updated from the bank account which does not necessarily capture everything that is owed.

The way PAYE system works is that whatever is paid to employees, within a given payroll period (usually the 6th of the month to the 5th of the next month) the tax and employees NI is deducted and Employers NI (Kind of payroll tax) is charged to the company. The total amount owing is then paid to HMRC two weeks later by the 19th.

For most organisations they calculate their wages a few days prior to paying their employees at the end of the month. That means you should always have an amount owing to HMRC for payroll run from the previous period. One multinational company I was working for only declared what had hit the bank, meaning they were declaring the PAYE/NIC owing for the previous month, not the month the debt was actually incurred. That meant their balance sheet was out and it was not picked on their consolidated return, meaning that the true position of the company was out by 20k.

Payroll Functionality

To avoid this it is important to think about what the payroll function actually does. When payroll is calculated that is when the expense has to be recognised and the amount owing stated. To do this we need a 4 line journals see below.

IT-EBS Salary Journal

Salary Journal	Dr	Cr
Liability HMRC (PAYE/NIC)		70
Liability Net Wages		100
Expense Salaries	150
Expense Employers NI	20

The credit side increases the amounts owed, in this case to HMRC, and "Nett Wages" what is to be paid to staff.  The debit side recognises the expense of the overall salaries and the additional cost of employers NI.  In essence it is exactly the same process as posting a suppliers invoice which increases liabilities, with creditors control, and the expense is declared to the P&L, but the bill is paid 30 days later.  Notice that no amount of money has hit the bank account. The process of running payroll notifies the company of the cost of employing staff, and who they owe money to.

The first transaction is the payment of staff which usually happens on the last day of the month.  You do not put this as bank to salaries as the expense has already been stated in the original journal and would lead that amount being double processed.  Instead it releases amounts owed in "Nett Wages" just as if you were paying down a suppliers invoice. If there is a "credit" amount still left in the Nett Wages control account this warns you that you still owe money to staff.  If in "debit" then an overpayment has occurred and you can take efforts to reclaim the money.

The journal below shows the result of paying staff from the bank account and clearing the Nett Wages.  Notice that there is nothing left in the "Nett Wages" Account.

Paying Staff	Dr	Cr
Liability Net Wages	100
Bank Account		100

End of Month	Dr	Cr
Liability HMRC (PAYE/NIC)		70
Liability Net Wages
Bank Account		100
Expense Salaries	150
Expense Employers NI	20

At the end of the month the only amounts that should be owing is to HMRC.   The Expenses of Staff Salaries is a gross amount, which includes income tax and Employees NI, as these two elements are deductions from an employee's pay packet and have nothing to do with the company's expense.  The only extra line is Employers NI which is an extra charge to the company for employing staff and needs to have its own line in the profit and loss statement.  As these are expenses they are cumulative amounts, added together from previous months, to be declared as expenses against the company's profit at the end of the year.

The final part of the transaction the bank pays down the PAYE/NIC incurred in the previous month.  The result is now all of the amounts that have been owing from the balance sheet are now cleared, leaving the account free for the next payroll process.

Paying HMRC	Dr	Cr
Liability PAYE/NIC	70
Bank Account		70

19th of following  Month	Dr	Cr
Liability HMRC (PAYE/NIC)
Liability Net Wages
Bank Account		170
Expense Salaries	150
Expense Employers NI	20

By using this method it is easier to keep track of payments made to the Revenue and make sure that the taxes owed balance with returns declared.  In this way it keeps the accounting records accurate and helps keep track of payments made to others.

Malcolm Ford
IT-EBS

See our related article on salary journals updated to include pension contributions.

See our services page for both Mac, Windows and Cloud based Payroll software we provide. There is an extensive collection of financial planning tools available from our downloads sections.

Accounting How Are Salaries Tracked on a Journal Entry

Source: https://it-ebs.co.uk/news/dummies-guide-to-salary-journals/

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