A Word of Advice for Bookkeepers Who Outsource Payroll

This is almost a Public Service Announcement for bookkeepers. I’m writing this because I’ve seen too many payroll entries that make it clear the bookkeeper didn’t know what they were supposed to do.

The Common Situation

• The bookkeeper often has no formal education in accounting or bookkeeping.
• The employer outsources payroll processing.
• The business uses accounting software, but only in a limited way—mostly to create invoices and record bank account expenses. The expenses are recorded via a feed from the company’s bank account.
• When the payroll processor runs payroll, they usually debit the company’s bank account for three amounts:
  1. Net payroll (employees’ take-home pay)
  2. Payroll taxes
  3. Payroll processing fees

Here’s the problem: All three of these amounts often get lumped into the Payroll Expense account in the General Ledger. That’s incorrect — and it creates a distorted view of the company’s financials.

Let’s Break This Down

Payroll Taxes

Payroll taxes include two types of amounts:

1. Employee Withholdings These are amounts taken out of the employees’ paychecks
   • Federal/state income taxes
   • Social Security Medicare (employee portion)
   • Other deductions (e.g. health insurance, 401(k))
2. Employer Payroll Taxes These are additional costs the company must pay:
   • Employer’s share of Social Security and Medicare
   • State Unemployment Insurance (SUI)
   • Federal Unemployment Taxes (FUTA)
   • And other expenses depending on the state.

Why This Matters

• The gross payroll is the total amount earned before any deductions.
• The net payroll is what employees actually receive after deductions. This amount is the Credit to the Cash account.
• The difference between gross and net is made up of employee withholdings — and these are liabilities, not expenses.

When everything is recorded as a payroll expense, you’re overstating costs and misclassifying liabilities.

Your Mission: Fix the Payroll Records

1. Find the Gross Payroll – Get the total gross payroll from your payroll reports. This is the actual payroll expense and must be recorded in the general ledger.
2. Calculate the Difference Between Gross and Net – Subtract the net pay (what employees actually received) from the gross pay.
   This is the amount withheld from employees — and it’s a liability.
3. Record Employee Withholdings as Liabilities – Credit this amount to a payroll liability account (e.g. “Payroll Liabilities”).
4. Determine Employer Payroll Taxes – Review the payroll reports provided by your payroll processor. There should be a section that shows the following: Employer Social Security and Medicare expenses, and other lines for FUTA and SUTA tax expenses.
5. Correct the entry for the amount in the Debit entry titled “Payroll Taxes”. – This is going to take some calculations on your part, but all the numbers must reconcile back to the original amount of the debit entry to your bank account.

Final Tip

Outsourcing payroll doesn’t mean you can ignore the accounting. The processor ensures compliance, but you must record entries accurately. Always request a detailed journal report showing gross pay, net pay, withholdings, and employer taxes — and use that to keep your books squared away.