Payroll journal entries

Payroll looks complicated because so many amounts are involved, but the bookkeeping comes down to three entries. Record the wages, record the employer's own payroll taxes, then pay what is owed. This page works through each one with real numbers and explains which accounts move and why.

The three payroll entries at a glance

Every payroll cycle produces the same pattern:

1. Record the payroll. Employees earned their gross wages. Some of that was withheld and the rest was paid to them.
2. Record the employer's payroll taxes. The business owes its own taxes on those wages, on top of gross pay.
3. Pay the liabilities. Later, the business pays the amounts withheld and its own taxes to the government.

Before the entries, a few terms:

• Gross wages are what employees earned before anything was taken out. This is the cost of their work to the business.
• Withholdings are amounts taken out of employees' pay for taxes and benefits. The business holds this money for someone else, so it is a liability until it is paid over.
• Net pay is gross wages minus withholdings: the cash employees actually receive.
• Employer payroll taxes are the business's own taxes on wages. They are not taken from employees. They are an extra expense.

The accounts used in the exercises are Wages Expense, Withholdings Payable, Payroll Tax Expense, Payroll Taxes Payable and Cash. Keeping the two payables separate makes it easy to see what came from employees and what is the employer's own cost.

Entry 1: recording a payroll

Northside Print Shop's employees earned $7,099.38 in gross wages this week. $1,490.87 was withheld from their pay for taxes and benefits, and the rest was paid in cash.

Work it out in three questions:

• What did the business use up? A week of employees' work, worth the full gross wages. Expenses increase with a debit, so debit Wages Expense $7,099.38.
• What does it now owe? The $1,490.87 withheld belongs to the government and benefit providers, not to the business. Liabilities increase with a credit, so credit Withholdings Payable.
• What did it pay? The rest: $7,099.38 − $1,490.87 = $5,608.51. Cash decreases with a credit.

The entry balances: one debit equals the two credits. The key idea is that Wages Expense is the gross amount. The business spent the full $7,099.38 on wages, even though only $5,608.51 left the bank account today. The other $1,490.87 will leave later, when the withholdings are paid over.

Where do the gross wages and withholdings come from? From the payroll calculation: hours, rates, overtime and deductions. If you want to see how those numbers are built, the spreadsheet side is covered in payroll calculations in Excel.

Entry 2: recording employer payroll taxes

Juniper Landscaping owes $679.20 in employer payroll taxes on this week's wages, to be paid next month.

This is a cost of having employees, separate from their wages. It is an expense now, because it relates to this week's work, and a liability until it is paid.

Notice that no cash moves. The expense is recorded when it is incurred, not when it is paid. That is the matching idea behind accrual accounting: the cost lands in the same period as the wages that caused it.

Why not use Withholdings Payable here? Because that account holds money taken from employees. The employer's own taxes never touched an employee's paycheck. Using a separate account, Payroll Taxes Payable, keeps the two obligations clear when it is time to pay them.

Entry 3: paying the payroll liabilities

Harbor Bakery paid the government $4,219.51 in cash: $3,308.30 withheld from employees' pay and $911.21 of employer payroll taxes, both recorded last month.

The expenses were recorded when the wages were earned. This payment only settles what is owed. Two liabilities go down, which is a debit to each, and Cash goes down, which is a credit.

Check the arithmetic: $3,308.30 + $911.21 = $4,219.51. After this entry, both payable accounts are back to zero for that period, and no new expense has been recorded. That is the right result, because the expense was already counted last month.

Following the money through the accounts

It helps to see how the three entries connect. Take the pattern as a whole:

• Wages Expense holds gross wages. Payroll Tax Expense holds the employer's taxes. Together they are the full cost of the payroll on the income statement.
• Withholdings Payable and Payroll Taxes Payable rise when the payroll is recorded and fall when the amounts are paid. Between those two dates they appear on the balance sheet as current liabilities.
• Cash goes down twice: once for net pay to employees, and once when the liabilities are paid.

If you ever see a payable account that keeps growing period after period, it usually means payments were recorded as expenses instead of against the liability.

Trace one liability from start to finish. After Northside's payroll entry, Withholdings Payable has a credit balance of $1,490.87. Nothing else touches it until the payment date. When Northside pays that amount over, the entry debits Withholdings Payable $1,490.87 and credits Cash $1,490.87, and the balance returns to zero. Over the whole cycle, Cash went down by $5,608.51 plus $1,490.87, which is $7,099.38: exactly the gross wages recorded as expense. The timing of the cash differs, but the totals agree. That is a useful test for any payroll you record.

Why withholdings are a liability, not an expense

Beginners often ask why the withheld amount is not simply part of an expense account. The answer is ownership. The employee earned the full gross wage, and that whole amount is the business's cost, already in Wages Expense. The business then keeps part of the employee's pay back and promises to send it to someone else. Until it does, it is holding money it owes. That is the definition of a liability.

Treating withholdings as a second expense would count the same cost twice. Treating them as income would be worse: the business never earned that money. Keeping them in a payable account shows exactly what is owed and to whom, and it empties when the payment is made.

Common mistakes

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

Crediting all of the gross pay to Cash

A tempting shortcut is Dr Wages Expense $7,099.38, Cr Cash $7,099.38. It balances, but it says Northside paid out the whole amount and owes nothing. Employees received only $5,608.51. The withheld $1,490.87 is still owed and belongs in Withholdings Payable.

Recording Wages Expense at net pay

The other direction: Dr Wages Expense $5,608.51, Cr Cash $5,608.51. This matches the cash paid but understates the cost of the payroll by $1,490.87, and the liability for the withholdings is missing completely. Wages Expense is always the full gross amount.

Using Withholdings Payable for employer taxes

For Juniper Landscaping, crediting Withholdings Payable instead of Payroll Taxes Payable gets the amount right but the account wrong. Withholdings Payable is for money taken from employees' pay. The employer's own taxes go to Payroll Taxes Payable.

Putting every line on the opposite side

Debiting Payroll Taxes Payable and crediting Payroll Tax Expense would decrease both accounts. When an expense is incurred and still owed, the expense goes up (debit) and the liability goes up (credit). In the payment entry the reverse happens: paying a liability decreases it (debit) and decreases Cash (credit). If every line of your entry looks backwards, check the direction of each account.

Recording the payment as an expense again

For Harbor Bakery, Dr Payroll Tax Expense $4,219.51, Cr Cash $4,219.51 counts the cost twice: once last month when it was recorded, and again now. It also leaves both payables sitting on the balance sheet. Paying a liability reduces the liability, not expenses.

How to check your entries

• Debits equal credits in every entry.
• In the payroll entry, Wages Expense equals gross wages, and cash plus withholdings equals gross wages.
• Employer taxes create an expense and a payable, with no cash.
• The payment entry has no expense line, only payables and Cash.

Related topics: if you are new to debits and credits, start with journal entry practice problems. Wages earned but not yet paid at the end of a period are covered in accrued expenses adjusting entries.