Read on to learn the basics of accrued liabilities to keep your small business cash flow on track. Accrued payroll can be determined by
using hours worked, where the total hours are then multiplied by the pay
rate. Both methods are acceptable
and will utilize estimates which are then adjusted as needed during the next
accounting period.

In the case of payroll, the amount to accrue will depend on an estimate of the amount of services employees will provide by the period end but will not be paid until after the end of the period. For example, a company’s accounting period ends on the last day of the month. Meanwhile, the employee worked until the fifth of the following month.

Accrued payroll example

And sometimes, you might use credit to make these purchases, resulting in accrued liabilities. At the end of a calendar year, employee salaries and benefits must be recorded in the appropriate year, regardless of when the pay period ends and when paychecks are distributed. For example, a two-week pay period may extend from December 25 to January 7. Accrued liabilities only exist when using an accrual method of accounting.

For instance, accrued interest payable to a creditor for a financial obligation, such as a loan, is considered a routine or recurring liability. The company may be charged interest but won’t pay for it until the next accounting period. The benefits of this method of
accounting allow a company to best determine the performance and profitability
of the operation as well as its financial status and cash flow. This allows for a more
accurate measure of the company’s profitability for that month if estimated
expenses are correct. In the following
month, adjustments can be made to the estimates to true them to actual. Similarly, cash bonuses earned in one period and paid in the next warrant a payroll accrual.

Payroll taxes (FICA), health insurance, and retirement contributions

After you pay the accrued expense, you make adjusting entries in your payroll journal to offset the expense account. Whether you need to accrue payroll depends on how your employees are paid. This step is vital when recording your journal entries in the books.

By understanding accrued liabilities, you will be able to see your company’s cost commitments for each accounting period. This is then reversed when the next accounting period begins and the payment is made. The accounting department debits the accrued liability account and credits the expense account, which reverses out the original transaction. I’m sure you have wondered why there is a lag between when you “work 2 weeks” and when you actually receive your paycheck right? Under the accrual method, compensation expense must be recognized when it is earned by an employee and not when it is paid.

Don’t forget to reverse payroll accruals

With every month they work for you, your employees earn a certain amount of paid time off, for example 2 days for each month worked. First, you need to determine how much you owe your employee in wages. To do so, multiply your employee’s (gross) hourly wage with the number of hours worked during the pay period for which you want to calculate accrued payroll. Labor costs can account for up to 70% of a business’s overall operating expenses, a major part being direct payroll costs. Since payroll has a significant impact on an organization’s cash flow, it’s crucial to keep track of payroll expenses as they accrue over the course of a pay period.

This is an outstanding amount, making it an employer’s liability. While a company can intentionally extend their payables to suppliers, delaying payment of an accrued expense like accrued wages is more unintentional and stems from mismatches in timing. On the other hand, a decline in the accrued wages balance occurs when the company fulfills the payment obligation to their employees (and results in less cash on hand). The accounting term “accrued wages” describes the unpaid compensation not yet paid by a company to employees for the services they have already provided. Businesses that offer employees defined vacation and sick time need to track how much they’d walk away with if they left the company. With every payroll accrual, update how much your employee earned in vacation and sick time.