Gross-to-net payroll - Employer on-costs and accruals

Learning Outcomes

After reading this article, you will be able to outline the process for calculating net employee pay and describe the additional payroll costs an employer incurs. You will accurately record employer payroll on-costs and accruals in the general ledger, make the necessary period-end adjustments for unpaid wages and related costs, and explain how these items appear in the financial statements.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand the accounting treatment of payroll from both the employee and employer viewpoints. Revision should focus on:

• Recording gross and net pay for employees, including payroll deductions
• Identifying and accounting for employer on-costs, such as pension contributions and social security taxes
• Applying the accruals concept to wages and related on-costs
• Preparing payroll-related general ledger entries and period-end accruals
• Reporting payroll expenses and liabilities in the financial statements

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.

1. What is typically included as an employer on-cost in gross-to-net payroll accounting?
   1. Employee's gross pay only
   2. Only income tax deducted from pay
   3. Employer's pension contributions and statutory contributions
   4. Employee's expenses

2. Which accounting entries are required when wages for the last week of the year have not yet been paid by year end?

3. True or false? Accrued liabilities for unpaid wages should be classified as current liabilities in the financial statements.

4. Briefly explain the difference between gross pay and net pay from an accounting viewpoint.

Introduction

Employers do not just pay the wages shown on an employee's payslip. In addition to gross wages, they face extra costs directly linked to employment, known as employer on-costs. These often include the employer’s share of social insurance, pension contributions, and sometimes other payroll-related expenses.

Accurate payroll accounting requires careful recording of both the amount paid to employees and the employer’s additional costs. The accruals concept further requires that if part of a payroll period's costs remain unpaid at a period end (for example, if payday falls after the balance sheet date), an accrual must be recorded so that financial statements show all expenses incurred in the period, even when unpaid.

Key Term: gross pay
The total earnings an employee is entitled to before any deductions, such as taxes or pensions, are made.

Key Term: net pay
The amount actually paid to the employee after all deductions (such as income tax, pension contributions, and social insurance) have been made.

Key Term: employer on-costs
Additional payroll costs the employer pays on top of gross wages, such as employer's social security contributions, workplace pension contributions, or other statutory employment costs.

Key Term: accrual
An expense that has been incurred in the accounting period but has not yet been paid at period end, requiring a liability to be recognized.

Gross-to-Net Payroll Calculation

Payroll begins with the gross pay owed to employees. Deductions are then subtracted—these may include income tax, employee national insurance or social security, and employee pension contributions. The balance, net pay, is what is actually paid to the employee.

Employers are generally required to deduct and remit amounts such as tax and social security directly to the authorities.

However, this does not reflect the full payroll expense to the employer. Most employers must also pay extra contributions (on-costs) to tax authorities and pension funds, in addition to the amounts deducted from employees.

Payroll On-Costs

Common employer on-costs include:

• Employer's national insurance, social security, or similar payroll taxes
• Employer’s contribution to employee pension schemes
• Employer's liability insurance charges directly linked to payroll (in some countries)

These costs are additional to net pay and deducted amounts.

Recording Payroll Transactions

The accounting entries for payroll typically involve:

1. Recording the expense for gross payroll and employer on-costs
2. Recognizing the liability for amounts owed to employees and authorities
3. Reflecting cash paid on actual payment dates (not always period-end)

Example Payroll Journal (at period end, before payment)

Worked Example 1.1

A company processes a monthly payroll for its employees, totaling gross wages of $10,000. From this, $1,500 income tax and $800 employee social security are deducted. The employer must also pay $1,200 in employer social security and $400 to a pension scheme.

Question: What are the payroll accounting entries at month end, before the wage payment is made?

Answer:

• Debit Wages and Salaries Expense: $10,000
• Debit Employer On-Costs Expense: $1,600 ($1,200 + $400)
• Credit Wages Payable (Net Pay): $7,700 ($10,000 - $1,500 - $800)
• Credit Tax/Social Security Payable: $2,300 ($1,500 + $800)
• Credit Employer On-Costs Payable: $1,600

Accruals for Payroll and Employer On-Costs

Often, payroll periods do not align with the end of accounting periods. If wage costs have been incurred but not paid by period end, the accruals concept requires an accrual for both the gross wage expense and related on-costs. This ensures the expense is matched to the correct period.

Worked Example 1.2

Wages for the last week of June ($2,500 gross), with associated employer social security of $300, are due to be paid in July. No entry has been made by 30 June.

Question: What adjusting entry is required at 30 June?

Answer:

• Debit Wages and Salaries Expense: $2,500
• Debit Employer On-Costs Expense: $300
• Credit Accrued Payroll Liability: $2,800

When paid in July, the liability is cleared (Debited), and cash is credited.

Exam Warning

Omitting an accrual for unpaid payroll or employer on-costs at period end understates both the expense and the liability, and overstates net profit.

Reporting Payroll and On-Costs in the Financial Statements

• Gross wages and salary expense, plus employer on-costs, appear as expenses in the statement of profit or loss.
• Deductions and employer on-costs that have not yet been paid at the reporting date are shown as current liabilities (e.g., "accrued payroll," "taxes payable," or "social security payable").

Summary

Employer payroll costs involve more than simply paying wages. Accounting must capture gross pay, employee deductions, net pay, and all employer on-costs. The accruals concept requires that payroll and on-costs are reported as expenses for the period they relate to—even if not yet paid—ensuring accurate profit measurement and correct liability reporting at period end.

Key Point Checklist

This article has covered the following key knowledge points:

• The distinction between gross pay, net pay, and employer on-costs
• Typical accounting entries for payroll, deductions, and on-costs
• Use of accruals to account for unpaid payroll and employer costs at period end
• Presentation of payroll expenses and related liabilities in the financial statements

Key Terms and Concepts

• gross pay
• net pay
• employer on-costs
• accrual