How to Account for Payroll – Small Business Guide
Proper payroll accounting is essential for any business, ensuring it has accurate finance reporting, remains compliant with the latest tax regulations, and pays employees correctly. A good accounting system plays a foundational role in managing payroll accounting by simplifying processes, keeping records, ensuring compliance with tax codes, and minimising errors.
Let’s look at some key steps in payroll accounting and how the right software can make all the difference.
Understanding Payroll Accounting
The process involves tracking and managing all employee-related expenses, including salaries, wages, bonuses, tax deductions and benefits. It plays a crucial role in helping you maintain accurate financial records and ensuring compliance with legal requirements set by HM Revenue & Customs (HMRC) in the UK.
The main goals of payroll accounting include:
- Ensuring your employees are paid correctly and on time.
- Recording payroll transactions accurately in your financial statements.
- Complying with employment laws and tax regulations.
- Managing employee benefits and pension contributions.
The First Step: Setting Up a Payroll System
In the UK, companies that employ staff must register with HMRC for the PAYE system before processing a payroll. This allows employers to deduct Income Tax and National Insurance (NI) contributions from employees’ wages.
Choosing the Right Payroll Software
Many businesses use payroll software to automate calculations and ensure compliance with tax regulations. Integrating payroll software with an accounting system can simplify payroll processes, keep records, ensure compliance with tax codes, and minimize errors, making it easier for small business owners to manage their finances effectively. Some of the most popular options include HMRC’s free Basic PAYE Tools, suitable for businesses with fewer than ten employees.
Other popular commercial payroll software include Xero, QuickBooks, and Sage Payroll. Part of our job at Business Accounting Basics is to advise you on the best accounting software available.
Xero is an excellent choice if you want software that’s easy to use, while Sage is ideal for larger businesses. Meanwhile, QuickBooks is fantastic for sole traders.
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Collecting Employee Information
Employers need to obtain key details from employees before processing payroll, including:
- National Insurance number
- P45 or P46 form (for tax code information)
- Bank account details
- Pension scheme enrolment preferences
- Personal details
As an employer, you need to ensure that employee details are secure and up to date. A good way to do this is by using employee forms.
Calculating Payroll
Determining Gross Pay
Gross pay refers to the total earnings before any deductions. It includes salaries or hourly wages, overtime pay, bonuses and commissions, holiday pay and statutory payments (such as sick pay and maternity or paternity pay).
Select a pay period that sets the time frame for calculating and distributing wages, which can be weekly, bi-weekly, semi-monthly, or monthly. The choice of pay period affects payroll accounting, as it dictates when payroll taxes, deductions, and net pay are processed.
Timesheets
If employees work variable hours or on a zero-hour contract, introducing timesheets to record working hours is essential as they are paid an hourly rate. There are several options, including our free timesheet template, some accounting packages or time-clocking software.
Making Statutory Deductions
Employers must deduct the following from employees’ gross pay:
- Income Tax – Deducted using the PAYE system based on the employee’s tax code.
- National Insurance Contributions (NICs) – Employees and employers must contribute to NI, calculated based on earnings.
- Pension Contributions – Under the UK’s auto-enrolment rules, most employees must contribute to a workplace pension scheme.
- Student Loan Repayments – If applicable, deductions are based on the employee’s repayment plan.
Additional Costs to Consider
Employers also have payroll-related expenses, including:
- Employer National Insurance contributions.
- Employer pension payments.
- Other benefits, such as private healthcare or childcare vouchers.
Recording Payroll Transactions
Payroll transactions must be recorded in the company’s accounts to maintain accurate financial accounting records. The key journal entries include the recording of gross wages and employer costs.
When wages are due but not yet paid, you should include:
- Debits like the Wage Expense (Gross Pay), Employer’s NI Expense, and Employer’s Pension Contributions
- Credits like Wages Payable (Net Pay), HMRC Payable (Tax & NI), and Pension Payable
You need to record the wages payable and the bank account when paying employees.
If you are remitting payroll taxes and pension contributions, include:
- Debits HMRC Payable and Pension Payable
- The bank account it’s credited into
This will ensure payroll expenses are correctly recorded in financial statements, so it’s easier to track your business’s financial obligations.
Recording payroll transactions accurately is crucial for maintaining precise financial records and ensuring compliance with accounting standards. This process involves documenting all payroll-related financial activities, such as employee salaries, wages, deductions, and employer contributions.
Important Considerations for UK Payroll:
- Statutory Pay: Remember to account for statutory payments like Statutory Sick Pay (SSP), Statutory Maternity Pay (SMP), etc., which have specific rules and may involve government reimbursements.
- Real-Time Information (RTI):Â You must report payroll information to HMRC in real time each time you pay your employees.
- Auto-Enrolment: Be aware of the auto-enrolment pension duties for eligible employees.
- Payroll Software: Most UK businesses use payroll software to manage these complex calculations and reporting requirements.
It’s crucial to consult with a qualified accountant or payroll professional in the UK for specific guidance on your company’s situation. They can help ensure you comply with all UK payroll laws and regulations.
Managing Payroll Compliance
Employers must report payroll information to HMRC whenever they pay employees through Real Time Information (RTI) submissions. The main types of RTI reports include:
- Full Payment Submission (FPS). Submitted every payday, detailing wages, deductions, and employee information.
- Employer Payment Summary (EPS). Used when reclaiming statutory payments or reporting no payments made in a period.
- P60s and P45s
Employers must provide employees with particular payroll documents, including:
- P60, issued at the end of the tax year, summarises total pay and deductions.
- P45. This is given when an employee leaves, showing earnings and tax deductions for the current year.
To comply with HMRC regulations, businesses must keep payroll records for at least three years, including payslips, tax calculations, and pension contributions.
Common Payroll Mistakes to Avoid
Even small payroll errors can lead to financial penalties or employee dissatisfaction. The most common mistakes include using the incorrect tax code, which can lead to over or under-deductions.
Many businesses fail to submit their RTI reports on time, whilst others miscalculate overtime or holiday pay. Understandably, this can also be a point of contention among staff. Other companies don’t keep payroll records for the required period. Whatever mistakes you might have made in the past, Business Accounting Basics can help you avoid them in the future.
Using reliable software and staying informed about tax updates can help prevent these mistakes.
Keep your Business Running Smoothly in 2025
Effective payroll accounting ensures employees are paid accurately, your tax obligations are met, and your financial records are well-maintained.
By using quality software to record transactions correctly and staying compliant with HMRC regulations, your business can avoid costly errors and run payroll processes accurately.Â
Whether it’s managed in-house or outsourced, proper payroll accounting is essential for financial stability and employee satisfaction.
If you need help learning to account for payroll, explore our latest advice on Business Accounting Basics.
Payroll Accounting FAQ
Do I need a Separate Payroll Bank Account?
A separate payroll bank account is not required. Still, larger businesses may prefer to use a separate bank account as it can make it easier to reconcile payroll and know the money is available for pay runs. It also allows funds available for payroll taxes. Most businesses will use the same bank account for all transactions.
Do I need to give out Payslips?
A payslip is a legal requirement and must be given to an employee on or before payday. Payslips can be either printed or electronic.
Can I Outsource Payroll?
You can outsource payroll. It’s a popular option for businesses of all sizes, offering several advantages, including compliance, saving time, reduced errors and expertise.
How Often Should I Run Payroll?
You can run payroll with the best frequency for the business, some employees with flexible hours may prefer a weekly pay run, but may incur more costs.
