If you are confused about how to go from cash to accrual for accrued payroll and compensation expense, then you are in the right spot! Here is the video explanation that walks through all of the information that is laid out below!

This tutorial will describe the difference between cash and accrual accounting for accrued payroll and compensation expense (salaries, wages, benefits, bonus, etc). You’ll learn how to use the balance sheet method, which can be used to answer almost any cash to accrual (or accrual to cash) question on accrued payroll and compensation expense. We’ll also go through two examples so that you become a master of this method!

Fundamental Difference Between Cash and Accrual for Accrued Payroll and Compensation

Under the cash basis method, we would record compensation expense when employees are actually paid cash or receive their paycheck. Under the accrual method, we would recognize compensation expense when the compensation is earned and not necessarily paid.

So why is there typically a difference between the cash and accrual method?

I’m sure you have wondered why there is a lag between when you “work 2 weeks” and when you actually receive your paycheck right? Under the accrual method, compensation expense must be recognized when it is earned by an employee and not when it is paid. Since there is typically a lag from when the compensation is earned and when it is paid, then we must record the amount to accrued payroll. In the example below, if we did not recognize the compensation expense until it was paid, then compensation expense in Years 1 and Year 2 would not be correctly stated.

What Increases or Decreases Accrued Payroll on the Balance Sheet?

It is critical that you understand what increases or decreases the accrued payroll on the balance sheet. Accrued payroll would increase for compensation that has been earned but is unpaid. Accrued payroll would then decrease when the compensation is paid in cash/check to the employee.

What is Typically Included in Accrued Payroll and Compensation Expense?

It is important to understand what types of compensation are typically included in accrued payroll and compensation. Think of it as basically any payment to an employee. This would include salaries and wages, bonuses (annual, monthly, spot), payroll taxes, benefits, and vacation (paid-time off / PTO).

Journal Entries Impacting Accrued Payroll and Compensation

Let’s run through the journal entries related to compensation and accrued payroll. When an employee earns compensation but it is not yet paid, the company would debit compensation expense and credit accrued payroll to record the liability. Then, when the compensation is paid, the company would debit accrued payroll to remove the liability and credit cash for the cash outflow related to paying the employees compensation.

Example #1 – Cash to Accrual Question

So let’s dive into an example cash to accrual question. If the question tells us the amount of compensation in cash that was paid to employees, then that means we have cash basis information. We’ll likely need to calculate compensation expense under the accrual basis.

We’ll use the balance sheet approach and set up the accrued payroll rollforward. The question gives us the beginning and ending balance sheet balances for accrued payroll. Then, we need to plug in compensation paid (in cash), which was $750 and would be negative. In order for the rollforward to balance, we know that compensation earned but unpaid in the period was $500. The rollforward MUST balance in order for this method to work properly. Always check your math!

Example #2 – Accrual to Cash Question

So this question is similar to the one above, except the question provides us with the compensation earned but unpaid, which means its on an accrual basis. We’ll need to solve for compensation that was actually paid in cash during the period.

Similar to example #1 above, start by plugging in the beginning and ending accrued payroll balances. Next, plug the $1,000 of compensation earned but unpaid into the rollforward. In order for the rollforward to balance, we know that the company paid compensation in cash of $1,250 during the period. The rollforward MUST balance in order for this method to work properly. Always check your math!