A business has many expenses. In order to ensure that accurate and timely financial information is available to the business owner(s) or other management to assist with decision making and the tax estimation process, it is vital that these expenses are categorised correctly at the point of entry onto Xero (or any other bookkeeping system used for that matter). One of the major expenses incurred by most businesses is the cost of employing their workforce (i.e. wages/salaries).
As a firm of Chartered Accountants, we help UK business owners with their HMRC and Companies House filing duties (amongst providing other advisory services) leaving them time to concentrate on running their business. Where our clients take care of their own bookkeeping (i.e. the day to day entry of their business transactions), we often find that their weekly or monthly payroll information is either posted incorrectly or omitted completely from their bookkeeping system. This undoubtedly results in an inaccurate profit figure showing up on their profit and loss report – which has a knock on effect of under or overestimating the amount of income tax or corporation tax that the company is likely to have to pay 9 months after the year end. Obviously, we correct such errors when preparing the final accounts and tax return each year – but it is better for all parties involved if the the payroll is posted correctly from the outset.
I have written the following walk-through describing the steps required to ensure that you are entering the cost of employing your team onto Xero correctly. This will result in better data, which produces better management accounting information, which allows you to make better decisions about your business – ultimately enabling you and your family to live a better life. Here we go…
Note: I have assumed that you are using 3rd party payroll software that requires you to manually journal in your payroll figures into your bookkeeping system.
Step 1 > Firstly, you will need to obtain a copy of your ‘Payroll Summary’ report. Our example Payroll Summary report (shown below) is taken from the BrightPay payroll software. The report name, layout and format of the report will differ between payroll packages.
Essentially, you are looking for the report which provides a breakdown of each individual employee’s gross pay figure – including details of all deductions made (e.g. income tax, employee’s national insurance, student loan repayments, employee’s pension contributions etc) before reaching the net pay figure (i.e. the amount which you actually pay into the employee’s bank account).
You will notice that there are 2 employees. The first being a ‘normal’ employee and the second being a director. The payroll journal posting for a director is slightly different to that of other employees.
Step 2 > Open up the manual journal function in Xero, by clicking on ‘Reports’ > ‘All Reports’ > ‘Journal Report’ (under the ‘Accounting’ section) > ‘Add New Journal’.
Note: If you cannot find the Journal function in Xero you may be restricted by your user role level. If this is the case, take a look at these instructions before carrying on to the next step.
Step 3 > Insert the journal details based upon your payroll summary report
Firstly, insert the expense amounts that will show up in the profit and loss report on Xero. If you really want to get things posted onto Xero correctly (whilst simultaneously impressing your accountant) then the Gross Pay amounts should be split up onto different expense codes on Xero. Your accountant will show the split in the full statutory accounts that are created for HMRC purposes. Also, splitting the two provides meaningful and useful information when reviewing your interim management accounts reports on Xero.
Here’s how we post the expense items within the example payroll summary report (shown above):
- Gross Pay – Employee > Xero Account 477 – Salaries (Debit £4,703.45)
- Gross Pay – Director > Xero Account 478 – Directors’ Remuneration (Debit £702.00)
- Employer NICs > Xero Account 479 – Employers National Insurance (Debit £552.20)
Note: If your business makes employer pension contributions at a cost to the employer (as is widely required for most businesses following the introduction of Auto Enrolment) then you will need to add another journal line here and record the employer pension contribution as a Debit £amount to Xero Account 482 – Pensions Costs.
Great! This has now ensured that the payroll cost for this month (a total of £5,957.65) is recorded in the profit and loss account on Xero and we have split the employee’s pay from that of the director.
But don’t stop there as the journal doesn’t balance yet!…
Secondly, insert the liability amounts that will show up in the balance sheet report on Xero. These are amounts that the company owes to other parties (in this case, the company owes the employee their net pay, the director their net pay and HMRC the PAYE and National Insurance amounts due).
- Net Pay – Employee > Xero Account 814 – Wages Payable – Payroll (Credit £3,564.32)
- Net Pay – Director > Xero Account 835 – Directors’ Loan Account (Credit £702.00)
- Tax > Xero Account 825 – PAYE Payable (Credit £743.00)
- Employee NICs > Xero Account 826 – NIC Payable (Credit £396.13)
- Employer NICs > Xero Account 826 – NIC Payable (Credit £552.20)
Then click “Post” to save the journal to Xero.
Note: Just as for the pension cost note above, if your business makes employer pension contributions at a cost to the employer then you will need to add another journal line here and record the employer pension contribution as a Credit £amount to Xero Account 858 – Pensions Payable. If the employee also makes pension contributions via a deduction from their net pay then this amount will also need to get added to Xero Account 858 (but not to an expense code as the expense of the deduction is effectively included in the Gross Pay amount already posted for the employee).
You will notice that the the sum of the liabilities comes to the same figure as the sum of the expenses above (i.e. £5,957.65). If this is not the case when you are posting your own payroll figures then something has been missed or has been posted incorrectly. Perhaps your payroll summary report is not showing all of the deductions properly (e.g. income tax, national insurance, student loan repayments, pension contributions, loan repayments etc). Investigative work will be needed to work out what has gone wrong (hint: looking at the employee payslips should help).
Ok. We’ve now told Xero about the exact cost of the most recent payroll run as well as telling it how much money we need to pay out. Let’s move on to the final stage which is equally as important…
Step 4 > Record the bank payments to employees and HMRC correctly
This stage is equally as important because if the wrong account codes on Xero are chosen, your ongoing profit figure will almost certainly be incorrect… again producing misleading management accounting information that results in misinformed decision making and a potential under-preparation for year end taxes.
Presumably, you use the auto bank feed feature built into Xero that automatically lists all of the bank payments and deposits – ready for coding up to particular Xero accounts.
When you are coding up, it is vital that the net pay amounts paid to employees and directors, PAYE and NIC payments to HMRC and pension contributions to the pension provider (with other deduction possibilities too) are assigned to the correct account code in Xero. Carrying on the example payroll summary figures in this article…
- Net Pay (Employee) – Post the £3,564.32 payment that was made to the employee’s bank account to Xero Account Code 814 “Wages Payable – Payroll”.
- Net Pay (Director) – Post the £3,564.32 payment that was made to the director’s bank account to Xero Account Code 835 “Directors’ Loan Account”.
- HMRC – Post the £1,691.33 payment that was made to HMRC in respect of PAYE, Employer NICs and Employee NICs by splitting the payment into 2 Xero Accounts (£743.00 to Xero Account 825 PAYE Payable and £948.33 to Xero Account 826 NIC Payable).
If you have paid the correct amounts and recorded them correctly (as shown above) then all of the Xero Liability Account Codes (814, 835, 825 & 826) will net off back to £nil – assuming that no other transactions have been posted to those accounts of course.
That is it! All done – until the next pay run at least.
How Enhance Accountancy can help you
We understand that most business owners don’t have the time to take care of the intricacies of the world and accounting and taxation. Most business owners are doing what they do best – running the business. How many people have you heard say “I started my own business because… I am really looking forward to start preparing the accounts and tax returns”. Not many I would suggest (unless they are an accountant by trade of course!).
We provide a monthly or quarterly management accounts preparation service to many of our clients. Normally, our clients take care of the day to day bookkeeping and we make the necessary adjustments (such as ironing out any payroll reconciliation issues!) in order to achieve interim profit & loss and balance sheet reports (along with a report on movements in the key performance indicators that matter to each particular business). Get in touch if you would benefit from up to date financial performance and position reporting throughout the year.
It is our business to understand your business. We get to know our clients in detail – both in terms of their business needs (meeting their financial reporting obligations, carrying out tax planning & other profit improvement advisory services) and also their personal goals in life. This isn’t just lip service. Take a look at our ‘what we do‘ and ‘the numbers that matter‘ pages for more information.
When you are ready, get in touch by calling 01978 280055 or email us today to discuss how we can help.
Managing director of Enhance Accountancy. Chartered Accountant. Helping UK businesses to grow and meet their financial reporting obligations since 2003.