Your financial statements are a snapshot of your business at a given point in time. They're useful, but the reality is that you can't usually stop your business in its tracks while you prepare your statements. Your inventory will continue to change while you're working on the books, you'll still be making sales and placing orders and your staff will still need to be paid. The amounts your staff earn after the last finished pay cycle of the year are referred to as accrued salaries or wages, and you'll need to add those up and adjust your financial statements to reflect them.
What Are Accrued Salaries?
Your financial statements divide the money going in and out of your business into two categories, assets and liabilities. If an account represents money that's owed to your company, that's an asset. You may not have it in your possession yet, but in the normal run of things it will eventually end up in your bank account. The money your company owes to others is a liability, even when it's currently sitting in your accounts, for precisely the same reason. That's what happens at the end of a reporting period when you owe your employees money for shifts they've worked but not yet been paid for. It's a liability you've accrued, or accumulated, just like the lease payments on your equipment or premises.
Why Businesses Utilize Accrued Salaries
If you've borrowed $20 from a friend, it's perfectly OK to make a note in your checkbook a few weeks later when you write a check to pay him back. Things would get ugly in a hurry if you tried to run a business that way, though. That's why it's a principle of accounting that you have to record any expense – including wages – in the period when it's accrued. The wages you owe will show up in two places because most businesses use double-entry accounting. You'll need to record them on your balance sheet as a liability, and on your income statement as an expense. If you don't, your financial statements for the end of the reporting period won't be accurate.
Payroll That's Processed, Payroll That's Not
At the end of your reporting period, whether it's monthly, quarterly or the end of your fiscal year, you'll probably show some dollar value of outstanding salary on your books. That's because it's rare for a business to settle up with employees right at the end of a pay cycle. Usually, there will be a week or more between your payroll cutoff date and payday. If your year-end falls during that week, you'll have a payroll amount that's already been processed and waiting to be issued, and that's what shows on your books. Your accrued salary expenses are different. Most of your staff will also have worked during the days between the end of the pay cycle and the end of your reporting period, and those are the dollar amounts you'll need to make adjustments for.
Making the Entries for Accrued Salaries
The first place you'll need to make an entry is on your balance sheet, on the credit side of the ledger. You'll have an account here called "Wages Payable," or something along those lines. Most times there will be a dollar amount here already, representing the payroll that's already been processed from the previous pay period. This is where you'll add the accrued salaries, once you've calculated a total. On your income statement, on the debit side of your ledger, you'll have a similar account named "Wages Expense" or something similar. You'll add the corresponding amount here. Finally, in most cases, your books will also include a journal that records each transaction. Once you've made your adjustments to the balance sheet and income statement, you'll need to log those to the journal as well. You'll enter the Wages Expense on your journal as a debit, and the Wages Payable as a credit.
Calculating Amounts for Hourly Employees
Your company might have hourly employees, salaried employees or more commonly both. Calculating the outstanding amounts you owe to your hourly employees is relatively straightforward. If you keep formal timesheets in paper or electronic form, you can pull those to find which employees worked which hours. From there, calculate the number of hours worked by each employee, and multiply that by their hourly rate. Review the schedule for the last few days if your business is small enough that you don't need to use formal timesheets. Add up all the scheduled hours, make any necessary reductions for staff who've left early, arrived late or called in sick, and then multiply the actual hours worked by the employee's hourly rate. Finally, add up the totals to arrive at a figure for total accrued hourly wages.
Calculating Amounts for Salaried Employees
Working out the amount of accrued salary for your salaried employees is a bit more complicated, though it's still not especially challenging. Salaries are customarily expressed as a yearly or monthly figure, so you'll need to break those down to a per-day dollar amount. For an annual salary, you might break down the total number of working days in a year and divide the salary by that number. The result will be your employee's daily salary amount. If the salary is monthly, you could use the same method and count actual working days for the month. Some companies work on a 30-day month for accounting purposes, though, so if you fall into that category, you'd need to count days up to your accounting month-end rather than the calendar month-end. Once you've sorted that out, and arrived at a daily figure for each of the employees who have worked during those last few days of the reporting period, you can total that up and have a number for your total accrued salary.
Calculating Overtime, Commissions and Bonuses
Your work isn't quite done once you've worked out the base hourly wages and salaries. Often your employees will have earned extra money in the form of overtime, commissions or bonuses, and those need to be accounted for as well. To calculate overtime for your hourly employees, you'll need to refer to your state's overtime legislation or, if it applies to you, any collective bargaining agreement that sets out a higher premium for overtime. Some staff might also receive on-call pay, a wage differential for working unpopular shifts or danger pay for hazardous duties. You'll have to calculate those amounts individually, for each affected employee. In the same way, you'll need to work out any commissions or bonuses earned by your hourly and salaried staff during the last few days of your accounting period. They'll add to your total accrued salary.
Sick Days and Holiday Pay
Another complication you'll need to deal with is sick days, paid personal days and holiday pay. This is especially true if you use the calendar year as your fiscal year, so your fiscal year-end coincides with the holidays. If you offer paid personal days, they're typically the equivalent of a day's salary for salaried employees or a normal shift – usually eight hours – for an hourly employee. Sick days work in the same way, and they're often taken over the holidays either in place of a personal day or because your staffer has legitimately gotten ill. Holiday pay legislation varies, depending on where your business is based, but in most cases, it boils down to a day's pay for employees who don't work on the holiday and a day's pay at a higher rate for those who do.
Allowing for Taxes and Benefits
Once you've worked out all of those totals, you'll have a figure for all of your actual accrued payroll. Your work still won't quite be done, though, because every dollar of that amount also represents a smaller percentage you owe in the form of state and federal payroll taxes. If your company offers benefits to its employees, or to some classes of employees, those benefits are also considered taxable income. You'll need to work out the per-day dollar value of those benefits and apply them to all of the eligible employees to come up with a final total of your accrued wages, including those benefits. Once those are in place, you can calculate the amount of payroll tax you'll owe. Strictly speaking, that isn't part of the adjustment for accrued wages, but you will have to adjust your tax accounts in the same way since it's all part of the same task.
Allowing for Payroll Processing Expenses
If you use an outside company to handle your payroll for you, there's one final amount you need to account for. That's the amount you pay for your payroll processing, which will vary depending on which provider you use and the service plan you've chosen. Usually, your fees will be on a per-employee-per-month basis, so calculating the amount per day is much the same as calculating the per-day amount for a monthly salary. Multiply the per-employee amount by the number of employees, divide that figure by the number of days in the month, and then multiply that per-day dollar amount by the number of days left over at month-end. If your company is small, you might incorporate this amount directly into the total figure for accrued wages. In larger companies, you probably have a separate account for payroll expense, but as with your payroll taxes, it makes sense to calculate and account for that amount while you're already doing your accrued wages.
How to Adjust Entries for Accrued Salaries
Now that you've worked out all of the dollar amounts involved, you're finally ready to dive back into the books and make the needed adjustments. First, go back to the "Wages Payable" account on the credit side of your balance sheet, or whatever that account is called in your books. You'll already have an entry there for the previous pay period, which is already processed and accounted for. Now you'll place a new entry there, with the description "Adjusting Entry," and add the wages you've calculated for those last few days of the period. If you keep the books yourself you can be more informative and label it "Adjusting Entry for Accrued Wages," or something similar, to help you remember more clearly what you've done. Now, move to your income statement and enter an adjusting entry in exactly the same way on the debit side of your ledger. Finally, log both of those adjusting entries to your journal. If you use a computerized accounting program or a "one-write" manual system, the correct amounts may transfer themselves to the journal without you needing to do it.
Downfalls of Forgetting to Adjust Entries for Accrued Salaries
If you keep your own books or use a bookkeeper who isn't formally trained, it's possible to overlook these adjustments amid the stress and hustle of doing your year-end, quarterly or monthly reports. That's especially true if your fiscal year-end coincides with the calendar year, so you're attending to this while trying to keep up with your personal obligations over the holidays. It's entirely understandable if you've missed the adjustments, but that doesn't mean you're not responsible for keeping your books properly.
Keeping slipshod or inaccurate books can have a number of repercussions. Lenders or potential investors can be wary, and rightly so if they find inaccuracies in your financials. It also means you aren't working with accurate information, which makes management planning harder. If you're in a market where recruiting employees is already a challenge, a reputation for bungling payroll won't help your cause. Finally, failing to calculate your payroll taxes properly can result in fines and unwanted attention from state tax authorities or the IRS. Making the adjustments requires a bit of work on your part – or your bookkeeper's part – but it's well worth the effort to get it right.