What is Accrued Payroll in Manufacturing Accounting?

For small and medium-sized manufacturers, tracking and administering payroll accurately is a critical function. 

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Without it, employees are not paid correctly, and taxes and other governmental contributions are not passed on at the appropriate time or in the appropriate amount.  And both can cause internal as well as legal issues for the company.

Fortunately, there are cloud-based, agile MRP and ERP systems on the market that take the needs of small and medium-sized manufacturers into account by providing payroll accounting in their service offerings.  For many of these systems, payroll functionality may be included as a native element of the software.  And as small to medium-sized companies often use standard accounting software such as QuickBooks or Xero, many MRP and ERP software providers offer the capability to integrate those accounting programs into the software service.

Accrued Method of Accounting

Accrued payroll is an accepted accounting method that is part of the accrued method of accounting, a best practices accounting method accepted by both Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS).  Under the accrued method of accounting, a company reports expenses on their income statement when they match with reported revenues and when no additional benefit is possible.

The focus of this method is on revenues earned and expenses incurred.  This method is different from the cash method of accounting where revenues are only reported when the cash is received.  The benefit of using the accrual method of accounting is that it gives a company a more accurate measure of profitability as entries along the way are recorded as debits and credits against specific line item categories.

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.  As an example, a company paying $3000 in rent in a month the rent would be reported in the month it is incurred and expenses such as utilities, which will not bill until the next month, would be recorded as an estimate.  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.

What is Accrued Payroll?

Accrued payroll consists of wages, bonuses, salaries, commissions and other compensation that have not yet been paid to employees.  It also includes payroll taxes and benefits that are not yet reported.  They are reported as an expense on the income statement for that time period and as a current liability on its balance sheet.

Accrued payroll is a simple calculation.  At the end of a fiscal period (month, quarter, year), a company will record adjustments as entries into their ledger to account for expenses occurred but not yet paid.  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.  Calculations can be simple, with a total of salary, wages listed, or complex, estimating the salary, wages and tax and benefit withholdings as debits and then listing them as line item credits the following period.

Accrued payroll can be determined by using hours worked, where the total hours are then multiplied by the pay rate.  It can also be calculated using a prorated formula.  Both methods are acceptable and will utilize estimates which are then adjusted as needed during the next accounting period.

Benefits of Using Accrued Payroll

There are several benefits to using the accrued payroll method:

  • Simplicity – Accrued payroll is a simple method to set up and calculate.  While the protocols for the estimated accrual levels must be reliable, the simplicity allows SMBs to use an accepted method of payroll accrual in conjunction with software such as QuickBooks or Xero and to tie it into their MRP or ERP system.
  • Cash Flow and Profitability – As part of the GAAP accepted method of accrual accounting, utilizing this method for payroll helps a manufacturer understand their monthly profitability.  As transactions tend to occur over time and incoming revenue rarely matches payment schedules for expenses, the accrued payroll method can ensure that manufacturers have enough cash available to pay staff to keep the factory producing.
  • Investment – For small to medium manufacturers looking to bolster their credibility, investors prefer accrual methodology as it signals both a focus on understanding and managing cash flow as well as that of having a long-term vision.

Small to medium-sized manufacturers must push to remain competitive with larger players in the market.  The decisions they make must always focus on production, building their brand and meeting delivery requirements.   Cloud-based, agile, flexible and accurate MRP and ERP software exists that can help navigate these difficulties and place SMBs on par with larger competitors by automating critical but non-production related functions.  By using these platforms to tie into accounting software such as QuickBooks and Xero, and by using accrued payroll accounting to keep their cashflow in balance, manufacturers can remain nimble while making sure that not only are their staff paid correctly, but that their liabilities and responsibilities are taken care of without having to sacrifice their focus on production.