Learning Outcomes
After reading this article, you will be able to calculate gross pay and net pay for employees on various pay structures. You will identify, distinguish, and apply statutory and non-statutory payroll deductions, interpret payslips, and prepare basic wages analysis. You will also learn to record payroll costs and deductions in the accounting system and explain the significance of gross-to-net calculations in business reporting.
ACCA Recording Financial Transactions (FA1) Syllabus
For ACCA Recording Financial Transactions (FA1), you are required to understand how wages, salaries, and deductions are calculated, analysed, and accounted for. In your revision, focus on:
- Calculating gross pay for hourly, salaried, and output (piecework) workers
- Identifying and applying statutory versus non-statutory payroll deductions
- Understanding the required content and function of payslips
- Analysing and recording net pay and payroll costs in accounting records
- Producing payroll summaries for management analysis and control
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the difference between gross pay and net pay? Give an example of a statutory and a non-statutory deduction.
- Which deductions must every employer apply by law, and which are optional for the employee?
- What information must be included on an employee's payslip?
- Identify which accounts are affected when recording gross pay, deductions, and the payment of net pay in the books.
Introduction
Payroll calculations are a regular and significant part of business record-keeping. Businesses must pay employees correctly and on time, provide complete payslips, and ensure statutory obligations, such as tax and state benefit deductions, are met. Accurately processing payments from gross pay to net pay, and recording payroll costs for management and reporting, are essential skills for ACCA FA1 candidates.
Key Term: gross pay
The total amount earned by an employee before any deductions.Key Term: net pay
The amount paid to an employee after all deductions; also called 'take-home pay'.
GROSS PAY CALCULATION
Determining gross pay is the first step in payroll accounting. It includes all pay before deductions.
Types of Employee Pay Structures
- Hourly paid: Pay is based on the number of hours worked times the hourly rate.
- Salaried: Employee receives a fixed annual amount, split equally across pay periods.
- Piecework: Employee is paid for each unit produced or task completed.
- Bonuses, overtime, commission: Extra payments added to basic pay.
Worked Example 1.1
A production worker earns $12 per hour and works 36 basic hours plus 5 hours overtime at 'time and a half.' What is the total gross pay for the week?
Answer:
Basic pay: 36 × $12 = $432
Overtime rate: $12 × 1.5 = $18
Overtime pay: 5 × $18 = $90
Gross pay: $432 + $90 = $522
PAYROLL DEDUCTIONS
Once gross pay is calculated, deductions reduce this figure to net pay. Deductions can be statutory (required by law) or non-statutory (voluntary).
Key Term: statutory deductions
Payroll deductions that employers must make under the law, such as income tax and social security or state benefit contributions.Key Term: non-statutory deductions
Payroll deductions that are optional and require written employee authorisation, such as pension contributions, union dues, or charitable donations.
Statutory Deductions
Employers are legally required to withhold and remit these amounts on behalf of employees:
- Income tax (according to personal tax codes or thresholds)
- Social security / national insurance contributions
Non-Statutory Deductions
Applied only with the employee's consent:
- Employee pension contributions
- Trade union or professional membership fees
- Voluntary savings, charity donations, or other agreed schemes
Worked Example 1.2
An employee’s gross pay is $1,200. The employer deducts $180 income tax, $70 national insurance, $25 union subscription, and $10 charity donation. Calculate total deductions and net pay.
Answer:
Statutory deductions: $180 (tax) + $70 (NI) = $250
Non-statutory deductions: $25 + $10 = $35
Total deductions: $250 + $35 = $285
Net pay: $1,200 – $285 = $915
Exam Warning
Statutory deductions are required even if an employee objects. Non-statutory deductions require the employee’s written agreement. If you mix these up, you may select the wrong figures when calculating net pay in your exam.
PAYSLIP REQUIREMENTS
Every employee must receive a payslip when paid. It summarises gross pay, all deductions, and net pay.
Key Term: payslip
A summary document issued to an employee with each payment, showing gross pay, all deductions, and net pay.
Payslips generally show:
- Employee's name and period covered
- Gross earnings (including overtime or bonuses)
- Each deduction, with details
- Net pay (amount payable to the employee)
Worked Example 1.3
A monthly payslip shows:
Gross pay $2,100; income tax $270; social insurance $110; employee pension $65; union $5. What is the employee’s take-home pay?
Answer:
Total deductions: $270 + $110 + $65 + $5 = $450
Net pay: $2,100 – $450 = $1,650
ACCOUNTING FOR PAYROLL COSTS
Employers often incur payroll costs above the gross pay, such as their own state benefit and pension contributions.
Key Term: wages analysis
The breakdown and examination of wage and salary costs by type, deduction, and department for internal monitoring, reporting, and control.
For accounting:
- Gross pay and employer contributions are business expenses
- Net pay and deducted amounts are treated as liabilities until paid
Worked Example 1.4
A business pays weekly: gross pay $900, employer insurance $50, employee deductions $220 (tax, insurance, etc). What is the total cost to the business? What amounts are disbursed?
Answer:
Total payroll expense: $900 (gross) + $50 (employer insurance) = $950
Payments: $680 (net pay to employees), $220 (to tax and insurance authorities)
Worked Example 1.5
A monthly payroll summary for three staff:
Gross wages $5,100
Employer pension $135
Statutory deductions $950
Non-statutory deductions $30
Show journal entries in the books.
Answer:
Debit Wages Expense: $5,100 + $135 = $5,235
Credit Bank (net pay): $4,255
Credit Tax/Pension/Deduction payables: $950 + $30 + $135 = $1,115
WAGES ANALYSIS AND CONTROL
Analysis of gross pay, deductions, and net pay provides management with information to:
- Check accuracy of payments and deductions
- Monitor payroll costs by period or department
- Prepare required financial and regulatory reports
- Permit timely payment of deductions to relevant bodies
Summary
Gross to net calculations start by establishing gross pay, applying statutory and non-statutory deductions, issuing a payslip, and recording amounts within the accounting system. Clear wages analysis supports compliance and gives management information for control and planning.
Key Point Checklist
This article has covered the following key knowledge points:
- How to calculate gross pay for hourly, salaried, and piecework staff
- Distinction between statutory and non-statutory deductions
- Calculation of net pay and use of payslips
- Recording and analysing payroll costs and deductions in accounting
- Producing clear wages analysis for control and reporting
Key Terms and Concepts
- gross pay
- net pay
- statutory deductions
- non-statutory deductions
- payslip
- wages analysis