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What Is Payroll Accounting?

Dock Treece
Dock Treece
Business News Daily Contributing Writer
Updated Jun 29, 2022

Payroll accounting helps employers stay on top of what they owe employees and how it will impact cash flow.

  • Payroll accounting is narrowly focused on all business expenses associated with employees.
  • Accounting software can make payroll accounting easier.
  • Payroll accounting can help businesses expand strategically and avoid overextending themselves.
  • This article is for small business owners and accountants who want to understand payroll accounting and how it relates to broader accounting practices.

Accounting is a critical part of every business, but have you heard of payroll accounting? As the name suggests, this narrow focus of accounting aims at everything that has 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 growth. Whatever industry your business is in, the best accounting software can improve your understanding of your payroll accounting and its impact on your bottom line.

Why is payroll accounting 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 systems ensure that 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. This makes it difficult to understand the incremental cost of each additional employee you hire, and also to decide whether to hire full-time employees, contractors, or part-time hourly workers when you need to add to your workforce.

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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?

ExpenseWhat it is
Employee compensationSalary, commissions, tips
Payroll taxesFederal, state or local taxes paid on employee wages
FICA taxesEmployer portions of Medicare and Social Security payments for employees
Employee benefit payments401(k) match payments, health insurance premiums and other costs of offering benefits
Other benefitsTuition reimbursement, child care and other fringe benefits


While payroll processing systems automatically deduct 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 coming directly out of employee funds.

Payroll accounting doesn’t include rent, utilities, office supplies, inventory, or any other 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.

How to set up payroll accounting

Processing payroll can be complicated, but accounting software makes it a lot easier. It’s important 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 payroll accounting for your small business:

  1. Set up accounting software. Without decent accounting software, you will have to track all of your payments manually, which can be quite difficult. The right accounting software can make this much easier.
  2. Create accounts for each expense type. As part of your accounting software setup, you’ll have 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 program the software to 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.).
  5. Process payments. As your employees complete their work, you’ll make regular payments to them, tracking all your business’s portions of those payments in your payroll accounting program.
  6. Reconcile regularly. Even if you have payroll software that issues the payments to your employees and categorizes them automatically, it’s still important to check these payments routinely to ensure they are accurate and broken down correctly.

Once you’ve set up your payroll accounting system, you can process payments yourself or through a third-party payroll service. You can also run reports that break down your expenses by category and make it easier to prepare tax filings and other forms.

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.

How accounting software can help you with payroll

Accounting software is a critical tool for small businesses, and it is 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 help with payroll:

  • Program automatic payments. With the right software, you can set up regular payments for each pay run. 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.
  • 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. Accounting software can integrate with other financial programs, including your financial accounting records. Most software can even export records to files that 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.

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 reduce inconsistencies in your financial records.

Payroll accounting crucial for smart growth

Understanding the cost of an employee is nearly impossible without clear 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 business, but 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 – the people.

Image Credit:

wutwhanfoto / Getty Images

Dock Treece
Dock Treece
Business News Daily Contributing Writer
Dock David Treece is a contributor who has written extensively about business finance, including SBA loans and alternative lending. He previously worked as a financial advisor and registered investment advisor, as well as served on the FINRA Small Firm Advisory Board. He previously held FINRA Series 7, 24, 27, and 66 licenses.