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February 22, 2022

Payroll Expense: Meaning and Calculation

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Employee costs

Most business owners cannot immediately answer how much each employee costs them. As a rule, they ignore this topic, pointing to the lack of time and doubts that this will somehow help optimize the business. However, these costs often make up a significant portion of all the business costs. Thus, understanding each component of the total cost of having each individual who works in your business can help you optimize these costs.

First, let’s divide all the costs associated with maintaining an employee into groups:

  • Direct costs. This is the first thing that comes to everyone’s mind, namely the paycheck you write to your employees;
  • Indirect costs. These are not as obvious at first because not everyone associates office desks, computers, pencils, and other expenses incurred as a result of hiring an employee with payroll;
  • Losses: These are funds that an employer spent or did not earn due to employee’s fault or due to poor set up and management of the work process.

When you think about and calculate indirect costs, you can count the uniforms, professional development of employees, reimbursement of travel expenses, organization of workspace (furniture, computer, phone, supplies, etc.), etc. What losses can the employee be to blame? For example, absenteeism, being late, or simply bad performance of work (e.g. failure to meet deadlines).

Therefore, in order to avoid such losses, we advise you to control all processes in your company: from production departments and marketing department to the work of loaders and drivers. Analysis of costs and losses helps not only to optimize the business as a whole, but also allows you to find ways to save money for your company. Today, we are going to dive a little deeper into the topic of payroll expenses, so you can know exactly what it means for your company and how much these expenses add up for your business, including any associated taxes.

Payroll Expense: Meaning and Calculation

Explanation of payroll expense

Payroll expense is how much the employer has to pay hourly and salaried workers. This item may also include all the mandatory taxes and, possibly, benefits. Payroll can be viewed as a reward for work that is based on the qualifications of the worker, complexity, quantity, quality, and conditions of work, as well as all the other related items, such as benefits and commissions.

Payroll expenses can be shown as a separate item in the expense section of the Income statement. This is a type of variable cost for a business. The cost of goods made or services provided can be greatly affected by the amount of payroll expense the employer incurs, especially in businesses that provide services.

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Calculation

To start calculating the payroll expense, you will start with gross pay, which is based on the salary agreed upon, time worked, or work completed. You should compute the payroll for work actually performed on the basis of documents confirming its completion if you have a fixed pay rate for each unit employees produce or timesheets.

In addition to regular pay, overtime, sick and vacation pay, as well as any commissions and bonuses are also included in the calculation. This will be the total payroll expense that your business has incurred. However, you might also want to add the taxes on the payroll to the total, so let’s discuss these next.

Payroll taxes

Unfortunately, the payroll process does not end after the computation of the base pay. Now, you would be subtracting taxes and various deduction items from the paycheck of your employee and note to yourself how much you owe as the entity who hired these individuals in taxes associated with payroll.

The calculation of taxes you withhold is based on the documents your employees are required to fill out during the hiring process. In addition, there are specific deductions that are from the gross pay to arrive at the actual amount the employee will be able to deposit at their bank.

Deducting various taxes from the paycheck does not mean you get to keep this money. in fact, you as an employee, are not only obligated to make sure the IRS gets the tax money withheld from the employees, but you should also match the Medicare and Social Security withholdings made for each and every employee. These funds will also go to the government.

As you can see, calculating the wages themselves is relatively simple. However, when it comes to any type of taxes, things get complicated. So, for the next step, you might consider seeking professional help to at least help you get started and make sure you are doing everything correctly.

Payroll journal entries

Every time you pay your employees, you will need to make two journal entries. They will always look the same no matter how many paychecks you make and only the numbers will differ from payroll to payroll. These journal entries will present a total for all the payments you made to all of your employees together for that period.

The first entry will be written to record gross wages, withholdings, and net pay. In other words, you will put in your book anything that has to do with the employee’s pay. The other journal entry will be made to reflect your tax expense, which you can remember as an employer entry because you are recording your portion of OASDI and HI and tax on payroll, which are just applicable to the employers.

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Author: Charles Lutwidge

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