Moving from a solely operated business to a business with employees is a big day for a small-business owner. However, with the inclusion of a first employee, business owners must be careful to account for employee payroll properly. Understanding payroll accounting rules is important, because violating these rules can lead to misstated financial statements and lead to trouble with tax authorities.

Payroll Expense

As with most expenses, generally accepted accounting principles, commonly referred to as GAAP, prescribe that payroll expenses are recognized as they are incurred. This means it does not matter when the employee is paid, if the employee has worked, the company must recognize an expense. Payroll expenses are found as a component of operating expenses in the company's income statement. The costs are further classified as either general and administrative expenses or selling expenses, based upon the employee's job function.

Accrued Payroll Expense

When employees have performed services for the company but have not yet been paid, GAAP requires that the company recognize a liability for the amount owed to the employee. This is a common occurrence for companies that pay weekly or bi-weekly. If the end of the period does not fall on a payday, there will be funds to be paid that should be recorded as a liability. Accrued payroll expenses can be found in the current section of the company's balance sheet.

Vacation and Sick Time

GAAP rules for accounting for vacation and sick time are concerned with whether it is certain that the balance eventually will be paid. For example, if a company promises two weeks of vacation a year and any vacation balance will be paid upon termination, then the company should accrue a portion of the expense related to the vacation pay each pay period. However, if a company offers sick pay where an untaken balance is not paid out at the end of the period, then the eventual payout is uncertain. In this case, no liability would be recognized. Vacation and sick time liabilities can be found in the current portion of the company's balance sheet.

Payroll Taxes

Small businesses are responsible for remitting the payroll taxes related to employment. When accounting for payroll taxes, the company records a liability for the amount owed to the governmental agency as the payroll taxes are incurred. In many cases, employees will be subject to taxes from national, state and local jurisdictions, and payments must be made to different bodies. As such, it is important to keep accurate records and remit these payments in a timely manner. Payroll tax liabilities can be found in the current portion of the company's balance sheet.