Paying payroll liabilities

Recording a payroll creates debts: net pay owed to employees, amounts withheld that belong to others, and the employer's own taxes. Paying them is the easy half of payroll bookkeeping, as long as you remember one thing. The expense is already in the books, so a payment only reduces a liability. This page works through each kind of payment with full numbers.

What payroll liabilities are

A payroll liability is anything the business owes because of a payroll it has already recorded. In the exercises there are three of them:

• Wages Payable is net pay owed to employees, when the payroll was recorded before payday.
• Withholdings Payable is everything taken out of employees' pay that still has to be sent on: income tax, employee social insurance and retirement contributions.
• Payroll Taxes Payable is the employer's own taxes on wages, recorded as an expense when the wages were earned.

Each one was created with a credit when the payroll or the employer's taxes were recorded. If the recording side is new to you, start with how to record a payroll journal entry, then come back here.

The rule for every payment

Paying a liability always has the same shape:

The debit reduces what is owed. The credit reduces cash. There is no expense line, because the expense was recorded when the employees did the work. Recording it again on the payment date would count the same cost twice and leave the liability sitting on the balance sheet forever.

The only thinking you need to do is choose the right liability and the right amount. The three worked examples below cover the three payments the exercises ask for.

Worked example 1: paying the net wages

Yesterday Pine Street Dental recorded its payroll: gross wages of $24,886.94, of which $4,230.78 was withheld and $20,656.16 was credited to Wages Payable. That entry looked like this:

Today Pine Street Dental pays the employees their net pay in cash. The question is simply: what does the business owe the employees? It owes the balance of Wages Payable, $20,656.16.

Wages Payable is now back to zero. The $4,230.78 in Withholdings Payable is untouched, because none of that money goes to the employees. It will leave in later payments, to the retirement plan and the tax agency.

Worked example 2: sending retirement contributions to the plan

Pine Street Dental withheld $1,513.94 of pre-tax retirement contributions from employees' pay last month and recorded it in Withholdings Payable. Today it sends the $1,513.94 in cash to Summit Retirement Trust, the plan provider.

It is tempting to think of this as a benefits cost. It is not a new cost at all. The contributions were part of the gross wages, which were expensed in full when the payroll was recorded. The business was only holding the money on the employees' behalf.

If the employer also added its own contribution on top, that extra amount would be a new expense of the employer, recorded when it was earned. The exercises cover only the employees' own contributions, which are always a liability payment.

Worked example 3: paying withheld and employer taxes

The tax payment is the one that needs arithmetic, because two liabilities are paid at once and you have to rebuild each from the rates.

Last month Pine Street Dental's gross wages were $38,168.94. At example rates it withheld income tax of 10% and employee social insurance of 5% of gross wages, recorded in Withholdings Payable. It also owed its own employer social insurance of 5% and unemployment insurance of 1.2% of gross wages, recorded in Payroll Taxes Payable. Each amount was rounded to the cent. Today it pays all of them to the tax agency in cash.

Step 1: rebuild the withheld amounts

$38,168.94 × 10% = $3,816.894, which rounds to $3,816.89. $38,168.94 × 5% = $1,908.447, which rounds to $1,908.45.

Step 2: rebuild the employer's taxes

$38,168.94 × 1.2% = $458.02728, which rounds to $458.03. In this example the employer matches the employees' social insurance at the same rate, so $1,908.45 appears twice: once taken from employees, once paid by the employer.

Step 3: record the payment

One cash payment, two liabilities cleared. Cash is $5,725.34 + $2,366.48 = $8,091.82.

Following the liabilities to zero

A good way to check your work is to follow each liability account from the day it was created to the day it was paid. Using example 3's month:

Each balance rises when the payroll is recorded and falls to zero when it is paid. If a payable account keeps growing month after month, payments are probably being recorded as expenses instead of against the liability. If it goes negative, more was paid than was ever recorded, which usually means a rate or a rounding step was wrong when the payroll was booked.

Why each liability is paid separately

Net pay, retirement contributions and taxes usually go to different places on different dates. Employees are paid on payday. A retirement plan provider may collect contributions soon after each payroll. A tax agency may collect monthly or on another schedule set by local rules. Keeping one liability account for each kind of obligation means that, on any date, the balance sheet shows exactly what is still due to whom. It also means each payment entry has an obvious debit: the account that holds that particular debt.

The one combined payment in the exercises is the tax payment, where withheld taxes and the employer's taxes go to the same tax agency. Even then, the entry debits each liability separately so that both accounts are cleared.

Common mistakes

The exercises check for each of these and tell you which one you made.

Debiting Wages Expense again when paying net wages

Dr Wages Expense $20,656.16, Cr Cash $20,656.16 counts the wages twice: once yesterday when the payroll was recorded, and again today. It also leaves $20,656.16 in Wages Payable for a debt that no longer exists. Debit Wages Payable.

Paying the gross pay

Dr Wages Payable $24,886.94, Cr Cash $24,886.94 hands employees money that was withheld from them. They receive only their net pay of $20,656.16. The withheld $4,230.78 stays in Withholdings Payable until it is paid to the plan and the tax agency.

Debiting Wages Expense for the retirement payment

The $1,513.94 was already part of the wages expensed when payroll was recorded. Sending it to the plan settles the liability in Withholdings Payable.

Debiting Payroll Tax Expense for the retirement payment

Retirement contributions taken from employees' pay are neither a tax nor a cost of the employer. Debit Withholdings Payable.

Expensing the tax payment again

Dr Payroll Tax Expense $8,091.82, Cr Cash $8,091.82 records last month's costs a second time, and treats the employees' withheld money as if it were the employer's expense. Both payables would stay on the books. Debit the two liabilities instead.

Leaving out the employer's social insurance

Paying only the unemployment insurance of $458.03 from Payroll Taxes Payable gives a cash payment of $6,183.37, which is $1,908.45 short. In this example, the employer pays its own social insurance on top of what it withheld from employees, so Payroll Taxes Payable is $2,366.48.

How to check a payment entry

• There is no expense account anywhere in the entry.
• Every debit is to a payable account, and each amount matches what was recorded in that account.
• Cash equals the total of the debits.
• After the entry, the liability being paid is back to zero for that period.

Payroll that straddles a month end has one more step before any of this: an adjusting entry for wages earned but not yet paid, covered in accrued payroll journal entries. For the full three-entry cycle in short, see payroll journal entries.