What is the Payroll Procedure?

Payroll Procedure

Payroll procedure refers to the steps a company takes to pay its employees. It involves calculating employee earnings, deducting applicable taxes and other deductions, ensuring the accurate and timely distribution of pay, and recording all these transactions for financial and regulatory purposes.

While the specific steps in the payroll procedure can vary based on the size and nature of the business, the following are the general steps involved:

1. Collect Employee Time Information: The first step is to collect information on how many hours each employee has worked during the pay period. This might be done using time clocks, timesheets, or digital tracking systems. For salaried employees, you might not need to collect hourly data, but you’ll still need to track when they are on leave or absent.
2. Calculate Gross Pay: Next, calculate the gross pay for each employee. For hourly employees, this involves multiplying the hours worked by the rate of pay. For salaried employees, the gross pay would be their salary divided by the number of pay periods in the year. Don’t forget to include any additional compensation, like bonuses or overtime.
3. Calculate Deductions: Then, calculate the amount of money that should be deducted from each employee’s gross pay. This might include federal, state, and local income taxes, Social Security and Medicare taxes, contributions to retirement or health insurance plans, and any other deductions like wage garnishments or union dues.
4. Calculate Net Pay: Subtract the total deductions from the gross pay to calculate the net pay – the actual amount that will be paid to the employee.
5. Pay Employees: Distribute paychecks or direct deposits to employees. The timing of this will depend on your pay schedule (e.g., weekly, bi-weekly, semi-monthly, monthly).
6. Pay Taxes: Pay any employer payroll taxes and remit the employee taxes withheld to the appropriate tax authorities.
7. Record Payroll: Record the payroll transactions in your accounting system. This helps ensure that your financial statements are accurate and that you’re prepared for any audits or inquiries.
8. Prepare and Distribute Payroll Reports and Payslips: These reports help manage the payroll process, track labor costs, and comply with legal requirements. Payslips provide employees with details about their pay, deductions, and net pay.
9. Prepare Tax Forms: At the end of the year, prepare tax forms like W-2s or 1099s for employees and any required reports for tax authorities.
10. Review and Audit: Regularly review your payroll process for any errors or inefficiencies. An audit, whether conducted internally or by an external auditor, can help ensure that your process is accurate, efficient, and compliant with all relevant regulations.

Each of these steps must be done accurately to ensure employees are paid correctly and on time, and that the business remains in compliance with all labor and tax laws. The use of payroll software or a payroll service provider can help streamline these processes and reduce errors.

Example of the Payroll Procedure

Let’s walk through a simplified example of a payroll procedure for a hypothetical company, “ABC Widgets,” that employs both salaried and hourly employees. They use a bi-weekly pay period.

• Collect Employee Time Information: ABC Widgets uses a digital time tracking system. At the end of the pay period, they download a report that shows the number of hours each hourly employee worked. For salaried employees, they note any absences.
• Calculate Gross Pay: For each hourly employee, they multiply the hours worked by the rate of pay. Let’s say one hourly worker, Sam, worked 80 hours at $15 per hour, yielding a gross pay of $1,200. For salaried employees, they determine the regular pay. Let’s say a salaried employee, Jane, earns $52,000 per year, so her gross pay per bi-weekly period is $52,000/26 = $2,000.
• Calculate Deductions: They calculate the tax and other deductions for each employee using current tax tables and deduction information. For example, Sam has a total of $180 in taxes and $50 in healthcare deductions, and Jane has $400 in taxes and $100 in healthcare deductions.
• Calculate Net Pay: They subtract the deductions from the gross pay to arrive at the net pay. So, Sam’s net pay is $1,200 – $180 – $50 = $970, and Jane’s net pay is $2,000 – $400 – $100 = $1,500.
• Pay Employees: On payday, ABC Widgets sends a direct deposit of $970 to Sam and $1,500 to Jane.
• Pay Taxes : ABC Widgets remits the withheld taxes to the appropriate federal and state tax agencies and pays any employer payroll taxes due.
• Record Payroll : They make journal entries in their accounting system to record the gross pay, deductions, net pay, and employer taxes.
• Prepare and Distribute Payroll Reports and Payslips: They prepare a payroll report for management and distribute payslips to Sam, Jane, and all other employees detailing their pay, deductions, and net pay.
• Prepare Tax Forms: At the end of the year, ABC Widgets prepares W-2 forms for all its employees, including Sam and Jane, showing their earnings and tax withholdings for the year.
• Review and Audit: Periodically, ABC Widgets reviews its payroll process for accuracy and compliance. It also has an external audit done once a year.

This example shows the main steps involved in a typical payroll procedure, although the exact process and complexity can vary greatly depending on the size of the company, the type and number of employees, and the specific tax and labor laws applicable.