What is accrued payroll?

Labor costs can account for up to 70% of a business’s overall operating expenses, a major part being direct payroll costs. Since payroll has a significant impact on an organization’s cash flow, it’s crucial to keep track of payroll expenses as they accrue over the course of a pay period. 

One way of doing so is accrued payroll. Here you read what accrued payroll is, how it is calculated and why every business should keep an eye on its payroll accrual.

Accrued payroll (also known as payroll accrual) is the accumulated amount of salaries, wages and other compensation your employees have earned during a pay period, but which still needs to be paid out to them. In this sense, payroll accrual describes your business’s payroll liabilities, i.e. how much you owe in payroll.

In addition, the term accrued payroll can also refer to an accounting method which is used to track and record outstanding payroll expenses for better cost control and budgeting. In other words, payroll accrual is the process during which you add up all your payroll liabilities.

In this context, you often come across the term accrual accounting. Accrual accounting is a form of accounting where businesses basically record pending expenses that haven’t been paid yet, as well as incoming payments that are yet to hit the company’s accounts. 

When talking about accrued payroll in terms of a company’s payroll liabilities, it’s important to know that payroll accrual isn’t just limited to accrued salaries and wages. Instead, accrued payroll refers to all payroll expenses a business incurs as part of their employee compensation strategy. This includes:

• Salaries and hourly wages (this refers to gross pay)

• Commissions

• Bonuses (e.g. 13th salary)

• Income tax and accrued payroll taxes (federal and state income tax, employer-paid payroll taxes and more)

• Social security contributions (pension insurance, health insurance, unemployment insurance and more)

• Employee benefits like annual leave or parental leave

You may wonder why it’s important to account for paid time off in accrued payroll. One of the reasons why payroll accrual should also take into account expenses like PTO is that you’ll have to pay out earned (but unused) annual leave days to employees who decide to leave the company.

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Calculating payroll accruals basically means adding up all outstanding payroll liabilities for each employee—and then, of course, adding up those sums to determine the total for the whole of your staff. Here are the different steps you need to follow for each employee. 

Calculate your employee’s wages

First, you need to determine how much you owe your employee in wages. To do so, multiply your employee’s (gross) hourly wage with the number of hours worked during the pay period for which you want to calculate accrued payroll.

Add any commissions, bonuses and overtime pay

Next, you have to account for bonuses or commissions your employees are entitled to under the clauses of their individual employment contract. These additional pay elements need to be added to the employee’s gross wages. 

The same goes for overtime. Overtime usually needs to be compensated with a wage supplement, which is why pay for additional hours needs to be calculated separately. Once you’ve calculated overtime pay, you can add this to the sum of what you owe your employee. 

Include employer-paid payroll taxes and social security contributions

In most countries of the world, social security contributions are shared between employee and employer. While the employee share is already accounted for in their gross pay, the employer share needs to be factored in separately when calculating accrued payroll. 

Social security contribution rates vary from country to country, but mostly include premiums for health, long-term care, unemployment, accident and pension insurance of some sort. Calculate your employer contribution to each of these insurances as well as what you owe in employer payroll taxes. Again, add the calculated amounts to the gross wages, bonuses and overtime pay.

Account for your employee’s earned PTO entitlement

With every month they work for you, your employees earn a certain amount of paid time off, for example 2 days for each month worked. These earned leave days must be accounted for in your accrued payroll—even if the employee isn’t taking any paid time off during that pay period—because they represent a payroll liability that still needs to be paid.  

To wrap up the calculation of your accrued payroll costs, you then simply add your employee’s accrued PTO entitlement to the other payroll liabilities mentioned above, and repeat the process for the rest of your employees.

Let’s take the example of a company in the construction industry which pays its employees once a week based on their hours worked. The pay period runs Wednesday through Tuesday, with payday falling on the Friday of the same week. The business has five employees, each of whom has an hourly wage of $20. 

Now let’s assume that the business wants to create a balance sheet one day before the end of the pay period and therefore needs to calculate what amounts they have currently accrued in payroll. The payroll accrual would then be the sum of the hourly wages, commissions, bonuses and other compensation elements, plus the payroll taxes the business needs to pay. 

If the employees have collectively worked a total of 140 hours since the beginning of the pay period for which wages are calculated, this would lead to the following payroll accrual: 

• Accrued wages and salaries: 140 x $20 = $2,800 (gross pay)

• Commissions, bonuses, overtime: $0

• Employer-paid payroll taxes and other insurances: $600

• Total payroll accrual: $3,400

We’ve already talked about the difference between accrual accounting and cash accounting. Since the latter only accounts for cash transactions coming in or out of the business’s bank balance, it doesn’t capture the company’s financial situation as accurately as accrual accounting. 

Yet knowing the exact amount of its accrued payroll liabilities at any given moment of each pay period is crucial for any business to ensure that the necessary funds are available when payday comes around. This is especially important in cases where there is a time lag between the end of the pay period and the pay date. 

Payroll is a major part of a company’s monthly expenses. Businesses that don’t keep track of their payroll liabilities risk being surprised by an unexpectedly high payroll sum at the end of the payroll run. Especially in months where the business has faced many other expenses, funds have often dried up by the time payday comes around, which means the business has to go into an overdraft to pay its employees. Payroll accrual can help prevent overdraft since the business knows exactly what they owe in payroll for that particular month.

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What’s more, keeping track of accrued payroll facilitates better financial planning, since it allows the leadership team to deduct the accrued amounts reserved for payroll from the currently available funds to get a clear picture of the organization’s financial situation. This way, the management can draw up a budget for other projects and investments with confidence, because they don’t have to worry about pending payroll liabilities. The information on how much the company has accrued in payroll costs is also important when creating a balance sheet, as shown in the example above.

In addition to improving budgeting and financial planning, payroll accrual can be used to reduce errors in payroll. In order to calculate accrued payroll, payroll expenses are determined in advance, which includes the calculation of salaries, wages, taxes and more. Making these calculations upfront instead of last minute makes payroll errors less likely.