Why payroll is its own discipline

Paying employees is conceptually simple — Dr. Salary Expense, Cr. Bank. But in practice payroll is the most error-prone, regulation-heavy, and politically sensitive area of accounting. India has PF, ESI, professional tax, TDS, gratuity. The US has federal income tax, FICA, state taxes, 401(k). Get any one wrong and the consequences range from employee complaints to multi-lakh penalties.

The three layers of payroll cost

1. Gross salary — what the employee earns before any deductions. Includes basic, HRA, special allowances, performance bonuses.
2. Employee deductions — taken from gross to arrive at net pay. PF (12% of basic), TDS, professional tax, voluntary contributions (NPS, insurance, ESPP).
3. Employer contributions — paid by the company over and above gross. PF employer share (12% of basic), ESI (3.25% if applicable), gratuity provision (4.81% of basic), insurance premiums.

Total cost to company (CTC) = Gross salary + Employer contributions. The “CTC” number you see in offer letters always includes the employer-side statutory costs.

India-specific statutory items

• Provident Fund (PF) — 12% from employee + 12% from employer of basic salary. Mandatory for organisations with ≥20 employees.
• Employee State Insurance (ESI) — 0.75% from employee + 3.25% from employer, applicable when employee’s gross is ≤ ₹21,000/month.
• Professional Tax (PT) — state levy, typically ₹200/month, capped at ₹2,500/year.
• TDS — Tax Deducted at Source. Employer estimates annual tax liability and deducts proportionately each month. Deposited to government by 7th of next month.
• Gratuity — lump-sum payment after 5 years of service. Provision of 4.81% of basic monthly.
• Leave encashment — provision for unused leave that can be cashed out later.

The monthly journal entries

Three entries cover most payroll situations:

1. Record the gross expense and accrue deductions

Dr. Salary Expense                    10,00,000
        Cr. Salaries Payable (net)              6,73,000
        Cr. PF Payable                          1,20,000
        Cr. TDS Payable                         1,80,000
        Cr. PT Payable                              2,000
        Cr. Insurance Deduction                    25,000

2. Record employer’s statutory contributions

Dr. Employer PF Contribution Expense   1,20,000
Dr. Gratuity Provision Expense           48,100
        Cr. PF Payable                          1,20,000
        Cr. Gratuity Provision                    48,100

3. Pay the net salary to employees

Dr. Salaries Payable                   6,73,000
        Cr. Bank                                6,73,000

By the 7th and 15th of next month, PF and TDS are deposited to government:

Dr. PF Payable                         2,40,000
Dr. TDS Payable                        1,80,000
        Cr. Bank                                4,20,000

The month-end cutoff problem

Salaries for March are typically paid on April 5. If you record the expense only when the payment hits, March’s P&L is understated. The fix: accrue at month-end. The entry above (#1) is dated March 31 — the period the work was performed. The cash outflow on April 5 just settles the previously-recorded payable.

Payroll frauds — and how to prevent them

• Ghost employees — phantom names that draw salary. Prevent: monthly reconciliation between HR master and payroll, periodic biometric / face-to-face verification.
• Inflated salaries — collusion to bump pay rates. Prevent: dual approval for hikes, regular HR audits.
• Time-sheet fraud — overstating hours, especially in contract labour. Prevent: punch-in systems, manager sign-off.

Lesson recap

• Payroll has three layers: gross, employee deductions, employer contributions.
• India statutory: PF, ESI, PT, TDS, gratuity, leave encashment.
• Three entries: gross + deductions, employer share, net payment to employees.
• Always accrue at month-end — don’t wait for cash payment date.
• Reconcile HR master and payroll register monthly to catch ghosts.