What is Payroll Expense?

Payroll expense is the amount of salaries and wages paid to employees in exchange for services rendered by them to a business. The term may also be assumed to include the cost of all related payroll taxes, such as the employer's matching payments for Medicare and social security.

In a cash basis company, payroll expense is the cash paid during an accounting period for salaries and wages. In an accrual basis company, payroll expense is the amount of salaries and wages earned by employees during the period, whether or not these amounts were paid during that period.

Payroll expense may be the largest expense that a company incurs, especially when it is in a services industry where revenues are directly related to staff hours worked. Conversely, payroll expense may be a much less substantial proportion of total expenses in a business that is asset intensive, such as an oil refinery. In the latter case, a small number of people may be needed to service a large amount of revenue-generating capacity.

Characteristics of Payroll Expense

The key characteristics of payroll expense are as follows:

Includes all employee compensation. Payroll expense covers salaries, wages, bonuses, commissions, and overtime pay, and includes both hourly and salaried employees.
Fixed and variable components. Payroll expense includes salaries and benefits that remain constant regardless of business activity, as well as such variable expenses as overtime, commissions, and bonuses that fluctuate with company performance.
Major operating expense. Payroll is often one of the largest expenses in a company’s financial statements.
Subject to labor laws. Payroll expenses must comply with minimum wage laws, overtime rules, tax regulations, and labor contracts, where non-compliance can lead to legal penalties and fines.
Requires accurate record-keeping. Employers must maintain detailed payroll records for compliance and auditing purposes. These records include hours worked, salary agreements, tax withholdings, and payment dates.

Payroll expense is a major financial obligation that requires accurate management, compliance with labor laws, and proper financial reporting.

Presentation of Payroll Expense

Payroll expense may be included in the cost of manufactured goods or billed services, in which case it is reported within the cost of goods sold section of the income statement. If manufactured goods are not sold in the same period, then payroll expense may be capitalized into the inventory asset until sold. If payroll expense relates to general, selling, and administrative activities, then it is reported as an operating expense in the lower half of the income statement in the period in which it was incurred.