How to Test Accrued Payroll Liabilities

By Maire Loughran from Auditing For Dummies

Making sure the company books its payroll accruals properly is fairly easy. By the time you conduct your audit, all employees whose unpaid payroll transactions should have been accrued have been paid. All you have to do is get payroll records for the first pay period of the new year and pro-rate them.

The concept of accruals is easier to understand when you consider how you personally get paid. Regardless of how often a company pays its employees, paychecks are usually in arrears.

Here’s a typical scenario: You’re paid every two weeks with two weeks in arrears. A paycheck with a date of October 15 is for work you did from September 16 to September 30. Companies pay this way mostly because doing so is easier. It gives the payroll clerks two weeks from receiving the timecards to enter payroll items, investigate any weird reporting, run paychecks, and get them signed (or, in the case of electronically paid employees, get the payroll amounts approved).

When you start a new job, you normally have to wait a pay cycle to get your first paycheck. At the end of the year you receive a W-2 reporting your payroll with the employer for all completed payroll cycles.

Here are the accounts normally debited and credited when accruing payroll transactions, with the affected financial statement in parentheses:

Debit wage expense (income statement)
Credit wages payable (balance sheet)
Credit taxes withheld from the employee’s check (balance sheet)
Credit any optional deductions from the employee’s checks, such as the employee contribution to a pension plan (balance sheet)

And here are the accounts affected when accruing payroll tax expense:

Debit payroll tax expense for all mandatory employer taxes. This includes the FICA match and any taxes for which the employer is solely liable, such as state and federal unemployment tax (income statement).
Credit payroll taxes payable for the same amount as the debit (balance sheet)

Finally, here some accounts affected by other accruals such as accrued vacation pay and accrued postretirement benefits:

Debit the related expense account such as wages or the annual postretirement expense
Credit a liability such as accrued vacation or prepaid/accrued postretirement cost

If a company is trying to cook the books related to the payroll process, it normally understates accruals, which is the reason why completeness is the primary assertion in this area. If accruals are understated, total liabilities are similarly understated, which throws off any ratio analysis (you may plan to do. The understatement of expenses also serves to overstate net income, which isn’t good.