What is Accrued Compensation and How Does it Work?
Part of ensuring stable financial management for companies is being aware of their financial situation at all times. In the workforce industry, this concept is highlighted by accrued compensation, also known as accrued payroll or accrued wages.
Organizations often implement payroll accrual to facilitate better budgeting and decision-making. It allows them to adhere to accounting standards and gives them a clear and comprehensive view of the company’s current liabilities—especially accrued expenses.
In this article, we’ll dive deeper into accrued compensation including its definition, types, calculation, examples, and FAQs. Read on to learn more.
What is accrued compensation?
Accrued wages or compensation refers to the unpaid compensation that the employer owes to employees for services already provided. This includes the total amount of wages, salaries, and employee benefits during a specific accounting period. To calculate accrued compensation, use the formula below:
Accrued compensation = Earned wages + Additional compensation + Employer taxes
Organizations usually implement payroll accrual to predict future expenses and manage their tax obligations. This accounting technique is crucial for budgeting, making better pay decisions, and avoiding unexpected financial burdens to maintain the company's financial health.
Labor cost forecasting is important o making better pay decisions as a competent organization. Compensation Software utilizes global market data to help companies easily manage their pay practices even across several job families, departments, or divisions.
Is payroll accrual important?
Yes, payroll accrual allows companies to have an accurate record of employee salaries, both paid and owed. It also helps maintain an organization's expense account and balance sheet, the same reason why they also often record accrued expenses. The following are key reasons why payroll accrual is important:
Effective cash flow management
Accurate financial reporting
Better pay decisions
Accountability and pay transparency
Compliance with accounting standards
On the other hand, a lot of people confuse the key differences between accrued expenses vs accrued payroll. Accrued expenses represent a company's costs incurred such as rent and utility expenses, typically reflected in its financial statements. For more accurate cash basis accounting techniques, including legal or tax advice, organizations hire licensed professional accountants.
Types of accrued payroll
Employee salary is not the only type of compensation that can be accrued during a pay period, other benefits and tax contributions must also be considered. Below are the most common types of accrued payroll in HRM:
Hourly wages
Employee salaries
Bonuses
Commissions
Unemployment taxes
Other state and local taxes
Pay transparency is crucial for offering competitive compensation in the workforce industry. Compensation Software allows you to access a consolidated view of an employee’s total compensation statement, making calculations and assessments easier.
How do you calculate accrued compensation?
To calculate the accrued wages, you have to add all of the relevant types of accrued payroll for an employee. Here’s a simple step-by-step guide that you can follow:
Identify the applicable pay period.
Calculate the employee’s earned and accrued wages. For hourly employees, just multiply the hourly rate by the actual number of hours worked. For salaried employees, calculate the daily rate.
Make sure to include additional compensation such as bonuses, commissions, and overtime pay.
Determine the relevant employer taxes including other state and local taxes, unemployment, and FICA.
Compute the accrued salary or compensation by adding everything together.
Accrued compensation examples
To understand the concept of accrued payroll better, let’s look at some examples:
Situation 1: Hourly employees
Employee A works as a sales associate for company ABC and has an hourly rate of $25 per hour. He is paid bi-weekly and works 40 hours per week. In addition to this, he just earned a $1,000 commission and another $1,500 performance bonus during the same pay period.
How much would Employee A’s total accrued wages be if company ABC owes him $800 in payroll taxes?
Solution: The most effective way of calculating employee A’s total accrued salary is by computing the components of his accrued payroll one by one:
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Earned wages = $25 x 40 hours x 2 weeks
Earned wages = $2,000
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Additional compensation = $1,000 + $1,500
Additional compensation = $2,500
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Employer taxes = $800
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Accrued compensation = $2,000 + $2,500 + 800
Accrued compensation = $5,300
Situation 2: Salaried employees
Employee B works for company DEF with the compensation details below. How much would be the total accrued wages of employee B?
| Pay period | Bi-weekly |
| Monthly salary | $15,000 |
| Bonus | $500 |
| Performance incentive | $750 |
| Medicare tax rate | 1.45% |
| Social Security tax rate | 6.2% |
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Earned wages = $15,000/2 (bi-weekly)
Earned wages = $7,500
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Additional compensation = $500 + $750
Additional compensation = $1,250
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Employer taxes = Social Security + Medicare
Employer taxes = ($7,500 x 1.45%) + ($7,500 x 6.2%)
Employer taxes = $108.75 + $465
Employer taxes = $573.75
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Accrued compensation = $7,500 + $1,250 + $573.75
Accrued compensation = $9,323.75
With the help of Compensation Software, you can efficiently create, edit, and model salary structures to manage your organization’s unique compensation practices. It also features a customizable dashboard to tailor-fit relevant data and insights depending on your needs.
FAQs
Here are some frequently asked questions about accrued wages:
What is the difference between accrued and deferred compensation?
Accrued payroll refers to the unpaid compensation that the employer owes to employees for services already provided. On the other hand, deferred compensation refers to a portion of an employee's income that is intentionally set aside and paid out in future cash payments. This is usually done at retirement to potentially lower an employee's taxable income.
Is accrued compensation considered debt?
Yes, accused compensation is technically a debt owed by companies to employees for the service they already provided. Simply put, it's part of a company's accrued liabilities reflected in its income statement.
Is accrued compensation the same as accounts payable?
No, accrued compensation and accounts payable are not the same. Although they are both considered liabilities, they don't pertain to the same type of goods or services purchased. Accrued payroll is a type of accrued expense that has already occurred but not yet paid, such as employee wages.
On the other hand, accounts payable refers to the amount owed by companies to suppliers for products or raw materials. These could also be treated as prepaid expenses where companies pay in advance a consumable budget intended for supplies.
What is the 2.5-month rule for accrued compensation?
The 2.5-month accrual rule is one of the generally accepted accounting principles in the US related to compensation deductions for businesses. This accrual accounting rule allows a company to deduct compensation expenses when they are received 2 and a half months after the end of each tax year.
Example: Company 123 accrues a total of $200,000 in employee bonuses for the tax year 2024. If the company pays these bonuses by March 15, 2025, then the company can deduct these compensation expenses from tax year 2024. If it's paid at a later date, then it can only be deducted from tax year 2025.
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