How to Calculate a Payroll Accrual Liability
One of the main responsibilities for an accountant or bookkeeper is to properly account for all expenses in the period in which they are working. Payroll is a major expense for most companies, and getting it wrong can result in major accounting problems.
Most companies report expenses monthly, and then summarize them quarterly and for the year. Some expense, such as rent, may fit nicely in the books since they are paid each month. Others, such as supplies, are ordered when needed, and must be accrued properly.
Employees earn salary and wages when they work. Some companies pay employees monthly or semi-monthly, but many more pay weekly or bi-weekly, that is, every two weeks.
For those companies, there will be many months where the end of the month does not fall on payday. This will result in some days where expense has been generated, but is not paid, and will not be expensed by the payroll system.
If the company pays in arrears, meaning they pay sometime after the end of the pay date, another step is involved. Accounting firms have to go undergo this process.
Example of a Payroll Accrual Period
Assume that a company pays employees every Friday. March 26 falls on a Friday this year, and the payroll system automatically debits expense and credits cash for the two pays in March.
Businesses are almost always operate on an accrual basis, meaning they need to record expense in the period in which it occurs. If employees work on Monday, Tuesday, or Wednesday (or Saturday or Sunday, for that matter) March 27-31, the payroll system will not record any expense in March for these days, since the checks are not cut until April. Expenses will be understated.
It is necessary to accrue expenses for any hours worked in the month after the payroll ends. Accounting should debit expense and credit a liability, since the money will be owed but not paid as of March 31.
Calculating the Payroll Accrual
There are several possible methods for calculating the amount of the accrual.
- If the timekeeping system is adequate to gather the number of hours worked accurately, accounting can multiply the hours times and hourly rate. In more complicated payrolls, there may be questions about whether hours are accurately tracked to make this accurate, especially regarding vacation time.
- If the books are open long enough, accounting can look at the first payroll in April and pro rate the payroll between March and April.
- Another method is to estimate the unpaid days based on the prior payroll, or maybe the last two payrolls. This is quick, but may give unreliable estimates if something changes considerably.
Specifically, if there are normally five work days, and as n this case there are three unpaid days, multiply three/fifths (60%) times the prior payroll to get the amount to accrue. Be sure to reverse the accrual in April.
Pay Dates after the Pay Ending Date
If payments are made in arrears, for instance, the pay checks are paid out on April 2 for pay ending date of March 26, the basis for the unpaid days is the pay ending date of March 26.
In addition to the liability for the unpaid days of March 27-31, the entire pay ending should be recorded as an accrual in March, crediting the liability, since there will not be a credit to cash until April, when the checks are paid.