Accounting for payroll

CIMA-BA3 · Chapter 18

Accounting for payroll

Gross pay is what the employee earns. The employer deducts the employee’s income tax and other statutory amounts (and, for example, the employee’s pension contribution) and pays the employee the rest — the net pay — then pays the deductions over to the tax authorities and the pension fund. On top of gross pay the employer bears its own payroll taxes and pension contributions, so the total labour cost (the wages expense) is gross pay plus the employer’s costs. In the books, the Wages account collects the expense, and the Wages Control account is credited with everything owed and debited as each amount is paid; any balance left on it is a liability.

1 Introduction

The payroll is the name given to the wages and salaries paid to employees of a company. In this chapter we will consider what elements there are to the payroll and the necessary accounting entries.

2 Gross and net earnings

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Term	Meaning
Gross pay	the total amount earned by the employee
Net pay	the amount paid to the employee after the employer makes deductions for income tax and certain statutory amounts
Total labour cost to employer	employees’ gross pay plus any additional payroll taxes and pension contributions that the employer has to bear

It helps to keep two groups apart:

Deducted from the employee’s gross pay (the employee bears them)	Paid by the employer on top of gross pay (the employer bears them)
Income tax on the employee’s pay	Employer’s payroll tax (for example the employer’s social security contribution)
The employee’s social security (statutory) contributions	The employer’s pension contribution
The employee’s pension contribution, and other agreed deductions such as a trade union subscription

The employer collects the deductions on behalf of the tax authorities and the pension fund and pays them over, together with its own contributions. A question always gives the rates and rules to use; no knowledge of any country’s income tax rules is needed.

An employee is paid at the rate of $10 per hour.

Tax and other deductions amount to 25% for weekly income in excess of $120.

Employer payroll taxes are 10% of gross wages.

If an employee works 46 hours in a week, what are the employee’s gross pay, net pay, and the total amounts that will have to be paid by the employer to the tax authorities?

	$	$
Gross wages (46 × $10)	460
Tax and other deductions (25% × (460 − 120))	(85)
Net pay		375
Payroll taxes (460 × 10%)	46

Total payments by employer to tax authorities = 85 + 46 = $131. The $85 is the employee’s tax, deducted from pay and paid over by the employer; the $46 is the employer’s own payroll tax.

Although not asked, the total cost of employing this person for the week is gross pay 460 + employer’s payroll tax 46 = $506.

3 Accounting for labour costs

Labour costs may be accounted for using a Wages Control account.

Step	Debit	Credit	Amount
1 Wages for the period calculated	Wages account	Wages Control account	the gross wages
2 Employer’s own costs calculated	Wages account	Wages Control account	the additional employer’s costs (payroll taxes, pension contributions)
3 The payment of net wages to the employee	Wages Control account	Cash	the net wages
4 The payment of deductions to the state	Wages Control account	Cash	the employee deductions
5 Payment of other amounts to the state (and to the pension fund)	Wages Control account	Cash	the other amounts due

The Wages account is the expense: after steps 1 and 2 it holds the total labour cost, which goes to the statement of profit or loss. The Wages Control account works like a payable: it is credited with everything the business owes because of the payroll and debited as each amount is paid. Once everything has been paid it has no balance; any credit balance left at the year end is a current liability — for example deductions collected from employees but not yet paid over to the tax authorities.

Record the following transactions in the Wages Control account and the Wages account:

On 31 March, the gross wages are calculated as $45,000; deductions for employees’ taxes are $8,000; deductions for employees’ pensions are $3,000
On 31 March, the employer’s payroll tax is calculated as $4,000 and the employer’s pension contributions as $5,000
On 1 April, the employees are paid the amounts due
On 15 April, the tax authorities are paid the amounts due
On 20 April, the pensions fund is paid the amounts due

Debit	Wages Control Account		Credit
1 April Cash — paid to employees (45,000 − 8,000 − 3,000)	34,000	31 March Wages account — gross wages	45,000
15 April Cash — paid to tax authorities (8,000 + 4,000)	12,000	31 March Wages account — employer’s payroll tax	4,000
20 April Cash — paid to pension fund (3,000 + 5,000)	8,000	31 March Wages account — employer’s pension contribution	5,000
	54,000		54,000

Debit	Wages Account		Credit
31 March Wages Control account — gross wages	45,000	31 March Balance carried down	54,000
31 March Wages Control account — employer’s payroll tax	4,000
31 March Wages Control account — employer’s pension contribution	5,000
	54,000		54,000

The carried down balance at the end of March is brought forward and April’s amount will be added to that and so on, to accumulate the total wages cost for the year.

The total labour cost is 45,000 + 4,000 + 5,000 = $54,000, and the Wages Control account shows who receives it: $34,000 to the employees, $12,000 to the tax authorities and $8,000 to the pension fund. At 31 March, before the payments, the Wages Control account had a credit balance of $54,000 — a liability.

Tunde Bakery in Ibadan calculates its payroll for June 2019 as follows:

	$
Gross wages	18,000
Income tax deducted from employees	2,700
Employees’ social security contributions (6% of gross)	1,080
Employees’ pension contributions (4% of gross)	720
Employer’s social security contribution (8% of gross)	1,440
Employer’s pension contribution (5% of gross)	900

The net wages are paid on 30 June. The income tax and all the social security contributions are paid to the tax authorities on 15 July, and the pension contributions are paid to the pension fund on 20 July.

Required:

Calculate the employees’ net pay.
Calculate the wages expense for June.
Prepare the Wages Control account for June and explain the balance at 30 June.

(a) Net pay = 18,000 − 2,700 − 1,080 − 720 = $13,500.

(b) Wages expense = gross wages 18,000 + employer’s social security 1,440 + employer’s pension 900 = $20,340.

(c)

Debit	Wages Control Account — June 2019		Credit
30 June Cash — net wages paid	13,500	30 June Wages account — gross wages	18,000
30 June Balance carried down	6,840	30 June Wages account — employer’s social security	1,440
		30 June Wages account — employer’s pension	900
	20,340		20,340
		1 July Balance brought down	6,840

The credit balance of $6,840 is a current liability at 30 June: $5,220 owed to the tax authorities (2,700 + 1,080 + 1,440) and $1,620 owed to the pension fund (720 + 900). It is cleared when those amounts are paid in July.

4 Test your knowledge

Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.

Answer the questions one at a time. Your progress is saved so you can leave and come back.

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