When running a business, one of the first accounting decisions that every owner has to make is to decide if the company will be on a cash basis or an accrual basis. Companies running on a cash basis record expenses as they are paid. The main difference is that companies under the accrual method record expenses and revenue as they occur. Companies under a cash basis book the entry when cash is paid or received. When it comes to recording salaries, the accounting basis is very important. Recording salaries under the accrual method of accounting can be slightly tricky.
Accrual Method of Accounting
The word accrual in simplest terms means increasing or accumulating. In the accounting world accruals represent the recording of financial events before the exchange of cash. For example, recording the revenue from a customer job before the customer actually sends in the check is a form of accrual accounting. Accrual accounting also means recording financial transactions in the period that they occur regardless of when they are paid. In the case of salaries, this means recording employee wages after the hours are worked but before the payroll check is made. Salaries are typically fixed amounts that are easily calculated; hourly wages require a bit more math to calculate.
Calculating Payroll Expense
Salaried employees typically tend to be exempt employees, meaning they are not eligible for overtime pay. This makes calculating salaries to accrue fairly easy. Many companies pay twice a month, typically on the 15th and 31st of the month. Preparing a journal entry for accrual on a fixed salary paid twice a month means determining the rate of pay that will be accrued. For example a manager making $24,000 a year receives a semi-monthly salary of $1,000. If the manager’s company issues paychecks on the first day of the month for the previous pay period, they most likely will accrue the manager’s salary so that it will show in the end of the month financial statements as a liability.
Booking Salary Journal Entries
When setting up accounts, company accountants often label accounts specifically for accrual basis. In the case of salaries, there is usually an accrued wages and salaries account. To book the journal entry at the end of the month for salaries not yet paid, the account will debit or increase the wage and salary expense account while crediting the accrued wages and salaries account. When the payroll checks are distributed the journal entry will be reversed. The entry to account for the payroll distribution will be a debit to wage and salary expense and a credit to cash. In accounting terms a credit to cash is a reduction.
Accruing salaries is strictly an accounting function, which does not directly affect an employee's paycheck. The act of accruing does help the company with cash flow and budgeting. Other items on the employee paycheck also are accrued including vacation and sick time. As employees earn vacation and sick time the amounts are listed on the balance sheet as a liability. Some companies limit the amount of sick and vacation time accruals because of the ambiguity it can create on the liability side. Putting expiration dates on vacation usage times -- use it or lose it policies -- helps companies manage expenses and cash flow.