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Payroll Liabilities: How to Track and Record Payroll Liabilities

Oct. 16, 2020

Understanding Payroll Liabilities

When preparing accounts, several terminologies are involved.

Understanding them is necessary to carry out accounting functions effectively. One of such terminology is Payroll Liabilities.

While this term may seem complex, you can easily understand it by the individual parts of the word.

What is Payroll?

A payroll is a list of company employees and the amount of money they are each expected to be received.

It also includes other employee’s related information necessary for business decisions.

What is a Liability?

Liabilities are the present obligation of an entity which usually arises from transactions previously carried out.

In simpler terms, a liability is simply what an organization owes to other parties.

What Then is a Payroll Liability?

small business payroll liabilities

A payroll liability can be seen as any type of payment related to employees that an organization owes but has not yet paid.

This means that any amounts owed to employees for work performed are recorded separately from other creditors (account payables).

A payroll liability can include wages an employee earned but has not yet received, any amount withdrawn from the pay of an employee and payable to a third party.

Examples of payroll liabilities include government taxes, insurance companies, and pension houses, and other payroll-related costs.

These liabilities are usually present in every payroll.

This is because most businesses run on accrual bases of accounting. Hence, these liabilities do not last for long.

Payroll liabilities most times include mandatory and voluntary deductions authorized by the employee.

Mandatory deductions are those amounts required by the law to be withdrawn from the employee’s salary by the organization.

It includes; tax, employee insurance, pension contributions, and others.

Voluntary deductions are those authorized by the employee himself such as child support payment, loan payment, union dues, etc.

Importance of Payroll Liability

Every employer of labor needs to know which liability he is responsible for to foster adequate planning.

Comprehensive knowledge of payroll liability is even more essential because the employees are the lifeblood of the organization.

An organization that fails to meet the needs of its employees is not likely to survive in the long run.

Examples of Payroll Liabilities

payroll liabilities

Compensation

This includes regular wages and salaries, overtime pay, retroactive pay, back pay, severance pay, awards, bonuses.

Compensation also includes; commissions, prizes, accumulated sick leave pay, and any other forms of employee compensation.

However, the major form of compensation is wages and salaries.

The main reason for having a payroll is to pay your employees thus it is only natural for one of your liabilities includes those wages. 

Salaries and wages are usually for an agreed period in which the employee works.

After the work is done and before the wage is paid, those wages form part of the payroll liabilities.

Payroll Tax

The most common payroll liability is tax.

When you pay your employees, in addition to the wages, you are also required by law to pay the taxes in two forms.

  • The Withholding Payroll tax – This part of the tax is taken from the salary of your employee and pay to the Government on behalf of the employee.

This is regarded as a liability because you’re to collect this tax from your employee and are liable to pay to the Government.

  • The Payroll Tax Expense – This is the tax that you are required to pay from your own money to the Government.

It is still a payroll tax because the amount of this tax is based on the gross wages of your employees.

  • Cost of payroll service

This is the cost involved in creating and managing your payroll system.

It involves subscription paid if a software program is used. It is the money paid to a third party if they run your payroll system on your behalf.

  • Pension, insurance, and other deductions

Payroll Expense Versus Payroll Liabilities

While payroll liabilities and expenses are both key parts of any payroll system, they are both different and thus should be treated separately.

A payroll expense is simply any expense or cost incurred in the management or running of the payroll system.

That is, an item of cost incidental to the payroll is a payroll expense.

When these items are unpaid during the time they are due, the items are then regarded as payroll liabilities.

Thus payroll liabilities are usually a subset of payroll expenses.

It is important to note that expenses and liabilities in the payroll journal entry offset one another.

What this means is that the expenses and the liabilities cancel each other out.

The amount in the expense account is the total amount you are meant to pay.

It is also the total cost you incurred in the particular accounting period.

While the amount in each liability account tells you either the amount you are supposed to deduct from your employee’s salary.

It is also the amount you owe a third party to whom you must send such money.

Reporting Payroll Expense and Payroll Liabilities

Payroll expenses are usually reported by organizations in their income statement for the period.

The statement of profit or loss and other comprehensive income (income statement) usually should contain all the expenses incurred.

It also contains the income earned during the particular accounting period.

The payroll liabilities go to the organization’s balance sheet (or statement of financial position).

The balance sheet shows the assets an organization owns, the liabilities they owe, and capital required to fund the business.

How to Keep Track of Payroll Liabilities

It is easy to overlook payroll liabilities because they represent money to be paid at a future date.

However, if these liabilities are not taken into account they will most likely cause problems later in the future.

Such problems include; shortage of funds or bankruptcy.

Some steps in tracking payroll liabilities are;

  • Use a reliable system to run payroll.
  • Keep copies of all of your payroll-related documents.
  • Make use of payroll accounting. (Payroll accounting is the use of journal entries to record payroll expenses in your books.)
  • Open a separate payroll bank account
  • Have a cash reserve to cover payroll if money is tight
  • Set reminders

What is The Best Option to Help Small Businesses Track Payroll Liabilities?

payroll liabilities for small businesses

As a result of the nature of payroll liabilities, many small business owners have driven their business to bankruptcy.

Avoiding this involves adequate financial planning and this cannot be done effectively without the help of a professional accountant.

Hiring any accountant takes care of your business finance but hiring KAFT CPA additionally ensures business financial growth and security.

Need an accountant who specializes in medical practices, oil and gas, small business and more?
Book your free 30-minute "Success Check" today.