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Updated Feb 15, 2024

What Is Payroll Accounting?

Payroll accounting helps employers stay on top of what they owe employees and understand how worker compensation impacts cash flow.

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Dock Treece, Business Strategy Insider and Senior Writer
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This guide was reviewed by a Business News Daily editor to ensure it provides comprehensive and accurate information to aid your buying decision.

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Accounting is a critical part of every business, but have you heard of payroll accounting? As the name suggests, this narrow focus of accounting focuses on everything to do with payroll, not just salaries and wages, but benefit costs and payroll taxes too. A huge benefit of payroll accounting is a better understanding of the cost of each employee, which is the key to smart business growth. Whatever industry your company is in, the best accounting software and leading payroll services can improve your understanding of payroll accounting and its impact on your bottom line.

Editor’s note: Looking for the right accounting software for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is payroll accounting and why is it important?

Payroll accounting is a system of tracking business expenses related to payroll. This includes individual employee compensation as well as payroll taxes, employer portions of federal benefit withholdings, employee benefit payments and other deductions. Payroll accounting ensures you not only keep careful track of your payroll expenses, but also comply with local, state and federal employment laws and don’t run afoul of any tax rules.

Without payroll accounting, you can’t get an accurate view of the total cost of your employees. That makes it difficult to understand the incremental cost of each additional employee you hire and challenging to decide whether to hire full-time employees, contractors or part-time hourly workers when you need to add to your workforce.

Payroll accounting is very different from other types of accounting, such as financial and managerial. Like financial accounting, payroll accounting involves recording and categorizing company transactions, but it focuses exclusively on employee-related expenses. Unlike managerial accounting, payroll accounting requires no complex analysis on which to base business decisions.

Key TakeawayKey takeaway
Payroll accounting is an accounting process that focuses only on the expenses related to employees, including salaries and wages, payroll taxes, the costs of benefits, and paid time off.

What types of expenses fall under payroll accounting?

When doing payroll accounting, you’ll consider the following personnel-related expenses:

Expense

What it is

Employee compensation

Salary, commissions, tips

Payroll taxes

Federal, state or local taxes paid on employee wages

FICA taxes

Employer portions of Medicare and Social Security payments for employees

Employee benefit payments

401(k) match payments, health insurance premiums and other costs of offering benefits

Other benefits

Tuition reimbursement, child care and other fringe benefits

While payroll processing software automatically deducts employees’ portions of their benefit payments from their paychecks, payroll accounting doesn’t include these payments because the business isn’t paying them. Rather, these payments are discretionary for employees and come directly out of employee funds.

Payroll accounting also doesn’t include rent, utilities, office supplies, inventory or any other business expenses that aren’t related to employee compensation or benefits, nor does it relate to taxes other than payroll taxes and FICA payments. Sales, excise and company income taxes, for example, are all excluded from payroll accounting records.

TipTip
Employers are typically required by law to keep paycheck records, though for how long may vary.

How to set up payroll accounting

Payroll accounting can seem complicated, but accounting software makes it a lot easier. It’s critical to set up your payroll accounting process properly in order to get an accurate picture of your payroll expenses and to ensure compliance with labor and tax laws.

Here are the six steps to set up and conduct payroll accounting for your small business:

  1. Set up accounting software. Without decent accounting software, you’ll have to track all of your expenses manually, which can be quite difficult. The right accounting software can make this much easier. See our recommendations below.
  2. Create accounts for each expense type. As part of your accounting software setup, you’ll need to set up accounts for each expense that’s part of your payroll, including employee compensation, commissions, bonuses, payroll taxes, 401(k) matching and FICA withholding.
  3. Set up recurring payments to employees. Once you set up your accounting software, you can integrate the program with an online payroll solution to process payroll and issue regular payments to your employees.
  4. Categorize payment portions. Break up your payments to employees into various categories for each covered expense (Medicare, taxes, etc.). That way, your records group like expenses together.
  5. Process payments. As your employees complete their work, you’ll make regular payments to them, tracking all of the business’s portions of those payments in your accounting software.
  6. Reconcile regularly. Even if you use payroll software to issue the payments to your employees and categorize them automatically, it’s still vital to double-check these payments routinely to ensure they are accurate and broken down correctly in your records.

In addition to these routine functions, payroll accounting can help with a lot of other accounting processes, including financial accounting. This allows you to get a more detailed look at your employee-related expenses. You can also run reports that break down your expenses by category and make it easier to prepare tax filings and other forms.

How accounting software can help with payroll

Accounting software is a critical tool for small businesses, and it’s especially helpful for administering and tracking employee payroll. With the right accounting software, you can process individual payments, set up automatic payments or integrate with third-party payroll providers. You can also get a better idea of the total cost of your employees by tagging expenses and running detailed reports.

Here are some tasks you can accomplish with accounting software that helps with payroll:

  • Program automatic payments. With the right software, you can set up regular payments for each pay run without relying on a separate payroll solution. (Some have native payroll processing functionality, while others require integrations.) Automating the process saves you time and frees up resources for more pressing tasks.
  • Break down payments. Each payment to each employee can be broken down into the appropriate categories for better tracking.
  • Create detailed accounting reports. You can compile payment records for a single pay run or over a certain time period. You can also track changes in your payroll expenses over time as the size and makeup of your workforce changes.
  • Integrate with other systems and data. Accounting software can integrate with other financial programs, including your financial accounting records. Most software can even export records to files you can review via spreadsheet software.
  • Start, stop or alter payments. You can add, remove or change payments as employees join or leave your company, as their compensation changes, if they move and the taxes applied to their paychecks change, or if tax rates change.

While accounting software has many benefits – especially for payroll accounting – it doesn’t do everything. Most importantly, while accounting software can give you a big leg up when you’re preparing tax forms for your small business, most accounting software doesn’t have features for automatic preparation or submission of tax filings. For that, you may need to use separate software or an online portal offered by your local taxing authorities. Most payroll services, however, are capable of filing your payroll taxes for you.

Did You Know?Did you know
Accounting software and payroll software often tightly integrate since most businesses’ biggest expense is labor costs. Use these integrations to streamline payroll operations and reduce inconsistencies in your financial records.

Best accounting software for payroll accounting

Among our picks for the best accounting software, we recommend the below platforms for payroll accounting:

  • Xero: Within Xero’s reports module, it’s easy to generate a payroll activity summary. Just select a date range and an employee or group of employees, and you’ll quickly receive a clear report with well-organized data. Read our Xero review to learn about the other features that come with this accounting platform.
  • FreshBooks: When you use FreshBooks, you can download a CSV file with all your payroll information for a certain period. Reports can include overtime hours, federal and state taxes, net pay, and employer costs. Check out our FreshBooks review to explore the additional tools and services included in this accounting software.
  • ZarMoney: ZarMoney offers payroll tax reports alongside far more inventory management features than most accounting platforms. This solution is thus equally great for payroll accounting and overall business reporting. Explore the tools you get with this program via our ZarMoney review.
  • Wave Financial: You can use Wave Financial to run payroll wage and tax reports for a current quarter, a past quarter or any other period. There’s also a separate benefits and deductions report so you can see how much you’re spending on employees beyond their salaries. Learn more about this free accounting platform through our Wave Financial review.

Best payroll services

Accounting software reports on your payroll but may not actually process it; that’s where payroll services often come into play. Below are some of the best payroll services that integrate seamlessly with accounting software for powerful reporting and reliable employee payments:

  • OnPay: Unlike many other payroll vendors, OnPay offers only one pricing package, so you get all of the platform’s features no matter what. These include full integrations with accounting software platforms QuickBooks Online and Xero. Check out our OnPay review to learn what else you get with this payroll service.
  • Gusto: This payroll solution pairs employee payment automation with extensive HR and compliance services. It also integrates thoroughly with QuickBooks, Xero, ZarMoney and FreshBooks. Explore this platform’s payroll and HR features via our Gusto payroll review.
  • Paychex: With Paychex’s payroll software, you get complete integrations with Oracle NetSuite, QuickBooks and Xero. Paychex also offers a robust employee onboarding suite alongside its standard payroll tools. Read our Paychex payroll review to learn all about this platform.
  • Papaya Global: This payroll software, which offers global workforce management services, integrates well with Oracle NetSuite. Pairing Papaya Global and Oracle NetSuite streamlines labor cost analysis for growing or international organizations. Our Papaya Global review further details this provider’s payroll and professional employer organization (PEO) services.

Payroll accounting is crucial for smart growth

Understanding the cost of an employee is nearly impossible without accurate payroll accounting records. Whether you run payroll in-house or outsource to a payroll service, be sure to closely integrate your payroll operations with your accounting software. This not only paints a clearer picture of how much each employee costs your company, but also helps you plan the expansion of the business and determine when to bring on new hires. Smart business owners keep close tabs on every penny coming in and going out, especially considering the largest expense: your people.

Max Freedman contributed to this article.

author image
Dock Treece, Business Strategy Insider and Senior Writer
Dock David Treece is a finance expert who has extensively covered business financial topics, including Small Business Administration (SBA) loans and alternative lending. He is the Senior Vice President of Marketing at BNY Mellon and the former Editorial Manager at Dotdash. He also previously worked as a financial advisor and registered investment advisor, as well as served on the FINRA Small Firm Advisory Board. Dock brings more than 17 years of experience, including his time as an entrepreneur co-founding and managing a small business. His entrepreneurial background gives him firsthand insight into the challenges small business owners face and the tools and tactics they can use to succeed.
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