The accounting equation is assets = liabilities + owner’s equity. Accountants use this equation every day to determine how certain accounts affect a company’s balance sheet or income statement. Assets represent what a company owns. Liabilities represent what a company owes to others. Owner’s equity represents the difference between assets and liabilities, or what the investment made by owners of a company is worth. The accounting equation must always remain in balance.
Payroll accounts include salaries and wage expenses, payroll tax expenses and expenses incurred by the employer for employee benefits. Additionally, payroll accounts include payables such as federal and state withholding tax payable, FICA and FUTA payable, health insurance payable and net payroll payable.
Increases to the Accounting Equation
Liabilities increase when a credit entry is made to record payables such as FICA tax payable, federal or state income tax withholdings payable, garnishments payable, 401K payable, health insurance payable or other fringe benefits payable by the employer. All payable accounts increase liabilities until they are paid by the company.
Decreases to the Accounting Equation
Assets decrease when a company pays liabilities associated with payroll. For example, when a company files its quarterly payroll tax returns and pays the balances due for FICA and federal income tax withholdings, a debit is made to the payable accounts, FICA payable and federal income tax withholdings payable. A debit entry decreases the liabilities. To keep the accounting equation in balance, the corresponding decrease on the asset side of the equation is a credit to the company’s cash account.
Affect on Owner's Equity
Payroll expense accounts include salaries and wages, payroll tax expense and fringe benefit expense accounts. All expense accounts are recorded as a decrease to owner’s equity in the accounting equation presented. This decrease indicates that the owner’s investment in the company has decreased due to the cost of payroll to the company.
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