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What is payroll accounting? A guide for small business owners UK

Payroll accounting is confusing, complicated - and absolutely crucial. In this post, we break it down for UK small business owners.

5 min read

Payroll accounting can be difficult, complicated and, frankly, a bit boring. But it’s also crucial to be on top of it. In addition to staying on the right side of Her Majesty’s Revenue and Customs (HMRC) and avoiding hefty fines, good payroll accounting is crucial to running a stable business. 

Read on to learn what payroll accounting is, how to record it and how you can benefit from using payroll software.

QuickBooks guide to payroll accounting UK

What is payroll accounting?

As we explain in this article, ‘payroll’ means any tax withheld from a worker’s salary by an employer, who then pays the tax to the government on the worker’s behalf. 

Payroll accounting, then, is the process by which an employer works out and records the payroll tax payments they make, as well as payments for employer compensation and employer taxes.

Types of payroll accounting entries

When recording payroll, it’s important to keep clear and consistent records. Crucially, you need to make sure that you’re entering data as you go - don’t just leave it to the end of the accounting period!

Payroll accounting entries come in three forms: initial recordings, accrued wages and manual payments. 

  1. Initial recordings - Also known as originating entries, initial recordings are the type of entry you’ll deal with most often. This is because they’re exactly what they sound like: the first record of every transaction. They should include the gross wages earned by your employees, all withholdings from those wages and any employer taxes you owe on those wages. 

  2. Accrued wages - Accrued wages are recorded at the end of each period of accounting, and show the amount of wages you owe to employees that haven’t yet been paid. These are liabilities, not expenses - a distinction we’ll get into below. 

  3. Manual payments - Finally, manual payments are used to keep track of any adjustments you have to make outside your usual accounting periods. If an employee stops working for you, for instance, or you have to make any unplanned payments, these would be recorded as manual payments.

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How do you do payroll accounting?

Now that we’ve outlined the different types of records to keep, we can explore how you actually go about doing it. Let’s break it down into simple steps. 

  1. Record expenses - Calculate the gross amounts you need to pay, and debit your business accounts for those amounts.

  2. Record liabilities - Calculate the specific liabilities you need to pay on each gross transaction, and credit those amounts to your liabilities control accounts.

  3. Pay - Transfer the money from your liabilities account to the proper recipient - HMRC for taxes and national insurance, and your workers’ current accounts for their wages.

  4. Transition - Finally, at the end of each accounting period, close out your books, zero your accounts and begin producing records for the new accounting period.

For a more detailed look at what you need to do to fully comply with payroll, see the UK government’s page exploring this issue.

Is payroll a liability or an expense?

As you’ll surely have seen by now, recording payroll accounting isn’t as simple as noting down what you take from your business account and what you credit to your employees. To help keep straight on what you’re recording, where, and why, let’s explore liabilities and expenses

In simplest terms, expenses are the costs your business incurs by operating, while liabilities are amounts that your business owes. 

In practice, you should treat gross wages as expenses. This is the amount that your business must remove from its accounts to pay your workers. 

Within this gross expense, however, businesses have liabilities. Some, such as National Insurance, are payments removed from a worker’s wages and sent to the government. Others, like the wages themselves, are owed to the workers. 

Even if you’ve transferred the money out of your business’s account, the amount remains a liability until it is paid. That is, until it reaches its proper recipient’s account. 

For example, if you run payroll every month, your employees’ wages for the work they did over the course of that month are liabilities - costs you owe that you must pay. Once you’ve done so, they become expenses - costs you have paid.

Payroll, then, is an expense at the end of each accounting period. Until it is paid, it is a liability.

What does a payroll accounting system provide?

Don’t worry if this all sounds complicated - in truth, it is. And that’s why most small business owners use a payroll accounting system to ensure they’ve done everything properly. 

Using a payroll accounting system can provide a huge range of benefits, allowing you to:

  • Keep things simple by linking your accounts and presenting all relevant information together. 

  • Look after your workers by ensuring that they get paid properly and on time. 

  • Stay up to date with the latest changes to tax codes and payroll compliance requirements. 

  • Keep IT costs down by running your accounts smoothly from a single source. 

In short, it’s a great way to keep your stress levels low and stay on the right side of HMRC.

We hope this article has helped explain some of the complicated world of payroll accounting. To learn more about business accounting and how QuickBooks can help, why not browse some more posts on our small business blog?