Payroll accounting is the process of calculating employee salaries, deducting applicable taxes and statutory contributions, and recording these transactions accurately in the books of accounts. It affects three key areas of accounting: salary expenses, liabilities such as PF, ESI and TDS payable, and cash or bank accounts for net salary payments. Since these accounts are interconnected, an error in one can lead to inaccuracies across the others.
What are the components of an employee's payroll?
A payslip is built in layers, and each layer feeds a different accounting entry.
Gross salary
Gross salary includes Basic Pay, Dearness Allowance (DA), House Rent Allowance (HRA) and other fixed allowances mentioned in the employee's offer letter. Basic Pay and DA together form the basis for most statutory deductions, making them more significant for payroll calculations than the total Cost to Company (CTC).
Variable pay
Variable pay includes overtime, incentives and bonuses. These amounts are added to the employee's gross wages in the month they are paid. This is important because Employees' State Insurance (ESI) eligibility is determined based on gross wages rather than basic pay alone.
Deductions
Payroll deductions are classified into two categories:
- Statutory deductions: Mandatory deductions required by law, such as Provident Fund (PF), Employees' State Insurance (ESI), Professional Tax, and Tax Deducted at Source (TDS).
- Voluntary deductions: Deductions authorised by the employee, such as loan repayments, insurance premiums, or other agreed recoveries.
Net pay
Net pay is the amount the employee receives after all deductions have been made. It is calculated as:
Net Pay = Gross Salary + Variable Pay − Total Deductions
Which statutory deductions apply to payroll in India?
Four deductions typically appear on an Indian payslip, and each has its own rules.
Provident Fund
PF is a mandatory retirement savings scheme for establishments employing 20 or more employees. Both the employer and employee contribute 12% of the employee's Basic Pay and Dearness Allowance (DA). Of the employer's contribution, 8.33% is allocated to the Employees' Pension Scheme (EPS), subject to a ₹15,000 monthly wage ceiling, while the remaining amount is credited to the employee's PF account.
Employees' State Insurance
ESI provides medical and social security benefits to eligible employees. It generally applies to establishments with 10 or more employees (or 20 or more in some states) where an employee's gross monthly wages do not exceed ₹21,000 (₹25,000 for persons with disabilities).
The employer contributes 3.25%, while the employee contributes 0.75% of gross wages. Unlike PF, ESI is calculated on gross wages, including overtime, rather than Basic Pay. Once an employee becomes eligible, ESI contributions continue for the entire contribution period even if their wages exceed the prescribed limit during that period.
Professional Tax
Professional Tax is a state-level tax deducted from employee salaries where applicable. Since it is governed by individual state laws, the rates, slabs, and applicability vary from state to state, and some states do not levy Professional Tax at all. Employers are responsible for deducting the applicable amount each month and remitting it to the respective state government.
Tax Deducted at Source (TDS)
Under Section 192 of the Income Tax Act, employers must deduct Tax Deducted at Source (TDS) from employee salaries based on the employee's estimated annual taxable income. The tax is typically deducted in equal monthly instalments and is adjusted during the financial year to account for investment declarations, other disclosed income, eligible deductions, and the tax regime selected by the employee.
What are the key steps in the payroll accounting process?
Payroll accounting generally follows a fixed sequence each pay cycle.
- Finalise attendance and leave records: Confirm attendance, leave, overtime and other time-related data for the payroll period, as these directly affect an employee's gross pay.
- Calculate gross pay: Add Basic Pay, Dearness Allowance (DA), House Rent Allowance (HRA), other fixed allowances and any variable pay such as overtime, incentives or bonuses.
- Apply payroll deductions: Deduct all applicable statutory deductions (PF, ESI, Professional Tax and TDS) along with any authorised voluntary deductions to arrive at the employee's net pay.
- Record payroll entries: Post the payroll in the books of accounts by debiting salary expense and crediting the relevant liabilities, including net salary payable, PF payable, ESI payable, Professional Tax payable and TDS payable.
- Reconcile payroll before disbursement: Verify that attendance records, payroll calculations and payroll registers match before processing payments. This helps identify discrepancies early and reduces payroll errors.
- Disburse salaries and remit statutory dues: Pay employees their net salary and deposit statutory deductions with the respective authorities.
Conclusion
Payroll accounting is less about the arithmetic and more about applying the right base to the right deduction, on time, every month. Getting PF, ESI, professional tax and TDS calculated correctly at the source avoids far more rework than fixing a payroll register after the fact. TallyPrime automates gross pay calculation, statutory deductions and payroll journal entries in a single run, which reduces the manual reconciliation this process otherwise demands.
