GnuCash: Payroll Management, Depreciation, and Owner's Drawing

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Gnucash 2.4 Small Business Accounting: Beginner's Guide

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Manage your accounts with this desktop financial manager application

$26.99    $13.50
by Ashok Ramachandran | March 2011 | Open Source

GnuCash is a personal and small business bookkeeping and accounting software. Designed to be easy to use, yet powerful and flexible, GnuCash allows you to track bank accounts, income, and expenses. As quick and intuitive to use as a checkbook register, it is based on professional accounting principles to ensure balanced books and accurate reports.

In the previous article by Ashok Ramachandran, author of the book Gnucash 2.4 Small Business Accounting: Beginner's Guide, we took a look at why budgets are needed, how to create them, and how to create reports showing budget vs. actual comparison.

In this article we shall cover the following:

  • Employees and payroll: GnuCash doesn't have a payroll module. However, we will show how to enter payroll data for employees. We will also cover employee expense voucher processing.
  • Depreciation: We will recommend ways of setting up accounts for depreciation and making entries.
  • Paying yourself (also known as owner's draw): We will walk through the steps involved in cash withdrawals by the owner.

 

Gnucash 2.4 Small Business Accounting: Beginner's Guide

Gnucash 2.4 Small Business Accounting: Beginner's Guide

Manage your accounts with this desktop financial manager application

  • Help small businesses maintain their books of accounts using feature-packed, easy-to-use GnuCash
  • Written by an author who has "been there, done that": who ran two small businesses, understands the needs of small businesses, and guides you to effectively use GnuCash
  • Instead of simply describing the features of the software, this book focuses on how to use this software to plan, get the right numbers, and make the decisions to reach your business goals
  • While beginners can get started quickly, advanced users will find lots of features such as migrating transaction data and integration with other applications that they didn't know existed or could be used that way
  • Written without accounting jargon and with lots of hands-on tutorials, multiple choice questions to check your understanding, and additional challenges thrown at the more adventurous user, in an easy-to-read style
        Read more about this book      

(For more resources on on this subject, see here.)

Employees and payroll

Payroll is a financial record of salary and benefits provided to an employee. This is one of the more complex transactions in terms of accounting, simply because there are many different deductions and matching payments to be made to various tax authorities and health insurance and other vendors.

Payroll is an expense. Deductions may have to be stored in a short term liability account. This is useful for things such as taxes, which may be paid to the government at a different time from paying employee salaries.

Time for action – making payroll entries in GnuCash

We are going to enter the payroll accounting entries for one employee with appropriate deductions for federal and state income tax and FICA tax:

  1. We have created a spreadsheet of the calculations that we are going to use in making the payroll entries. Take a moment to study the following screenshot:

    GnuCash: Payroll Management, Depreciation, and Owner's Drawing

  2. Create the expense accounts: You need two expense accounts – one Payroll Expenses for gross pay and another Employer FICA Tax for the company contribution to FICA tax.
  3. Create the liability accounts: The tax amounts deducted from the employee's gross pay are owed to the appropriate government agencies. We need to create liability accounts to hold these amounts until they are due. Go ahead and create three accounts, Federal Income Tax, VA Income Tax, and FICA Tax of Account Type Liability with Liabilities as the Parent Account as shown in the following screenshot:

    GnuCash: Payroll Management, Depreciation, and Owner's Drawing

What just happened?

Monthly salaried employees are typically hired with a gross pay. However, when it comes to making payment, there will be several deductions. When you record payroll in GnuCash, it is done with a single split transaction. This split transaction will populate the appropriate expense and liability accounts. If you want to look up any of the payroll details for a particular employee, at any time, you can simply open and view the split transaction.

Net pay

For example, most employees in the US will typically have the following deductions:

  • Federal income tax
  • State income tax
  • FICA tax

There will be other deductions such as county or local taxes, separate deductions for health, dental, and vision insurance, 401(k) or other retirement plan contributions and so on. The net pay thus calculated becomes payable to the employee and it becomes an expense to the business.

Liability accounts

The business owes these deducted amounts to the respective tax authorities. In addition, the bookkeeping system must keep track of company contribution to social security tax, Medicare tax, health insurance, 401(k), and so on. These are also employee-related expenses to the business. However, these payments are not made at the same time as the payroll. So, these amounts must be accumulated in respective liability accounts so that the correct amounts can be paid, when they become due.

Calculation spreadsheet

As we said, GnuCash doesn't have an integrated payroll module. Any calculation of deductions and company contributions must be made outside of GnuCash. This is the reason why we used a payroll calculation spreadsheet in the above tutorial. The spreadsheet can have all the formulas and lookup tables set up so that you can enter the gross salary in one cell and get all the computed values ready to be posted into GnuCash.

Split transaction map

The following split transaction map covers just the three taxes listed previously, of which the federal and state income taxes are entirely payable by the employee, while the FICA tax has an employee contribution and an equal company contribution.

Account

Increase

Decrease

CurrentAssets:Checking

 

Net Salary

Expenses:Salaries

Gross Salary

 

Liabilities:Federal Income Tax

 

Federal Income Tax

Liabilities:VA Income Tax

 

VA Income Tax

Liabilities:FICA Tax

 

Employee FICA Tax

Expenses:FICA Tax

Company FICA Tax

 

Liabilities:FICA Tax

 

Company FICA Tax

Payroll FAQ

Here is a list of frequently asked questions about the payroll process and our answers:

  • Q: If I use a single Payroll account for all employees, how will I see per employee information?
    • A: Use reports to view information for each employee.
  • Q: How do I print payroll checks?
    • A: When making the Payroll entry, enter only the employee name in the Description field. If you decide to use GnuCash's check printing capabilities, the check will automatically be made out to the employee name correctly. If you want to record other information in the transaction besides the employee name, use the Notes field.

Employee and expense voucher

When employees spend their own money on behalf of the business, or they draw a cash advance from the business and need to account for expenses incurred, or they use a company card for business expenses, they need to submit an expense voucher to account for the amounts.

Under the Business menu you will find the Employee menu item with the Employee, Expense Voucher, and Process Payment modules.

Have a go hero – adding more deductions to payroll

Create a payroll transaction showing a deduction for health insurance premium as well.

Gnucash 2.4 Small Business Accounting: Beginner's Guide Manage your accounts with this desktop financial manager application
Published: February 2011
eBook Price: $26.99
Book Price: $44.99
See more
Select your format and quantity:
        Read more about this book      

(For more resources on on this subject, see here.)

Depreciation

When you buy capital assets such as computers, office equipment, cars, office furniture, and appliances, the tax laws may not allow you to write off all of the cost as business expense right away against business income. However, you are allowed to write them off over a period of time. This monthly expense write-off is known as depreciation.

Time for action – making depreciation entries for assets

You bought a computer with a high speed processor, extra memory, and disk space, for $3000, to serve as your small business server. Let us walk through how you will account for the purchase of the capital asset initially and how you will account for the depreciation expense each month:

  1. Create a new account called Office Equipment with Account Type as Asset and Parent Account as Assets.
  2. On the date of purchase make an entry showing an Increase of $3000 in the Office Equipment account and select the Checking Account in the Transfer column.
  3. We are going to apply a straight-line method of $50 depreciation per month over the 60 month period. This is just an example. More details follow in this section about what depreciation rates are allowed by tax laws. On the last day of the month, create a transaction in the Expenses:Depreciation account showing an expense of $50 and select the Office Equipment account as the Transfer account as shown in the following screenshot:

    GnuCash: Payroll Management, Depreciation, and Owner's Drawing

What just happened?

By charging 1/60 of the capital cost each month as depreciation, at the end of the 60 month period, you would have written off the entire value of the capital asset.

Handling repetitive transactions easily
You may find it convenient to set up a scheduled transaction for creating a monthly depreciation entry for each asset.

Typically the Internal Revenue Service (IRS) in US allows you to write off capital assets over the following period:

  • Some manufacturing tools: 3 years.
  • Computers, office equipment, cars, and construction equipment: 5 years.
  • Office furniture and appliances: 7 years.
  • Commercial buildings: 39 years.

The above are just broad indications for you to get the overall picture. IRS also allows you to choose either a straight line or a declining balance method of depreciation. In the straightline method the cost of the asset is depreciated over the life of the asset in equal amounts per year as shown in the following screenshot:

GnuCash: Payroll Management, Depreciation, and Owner's Drawing

In the declining value method, the depreciation is a fixed percentage of the book value. The book value starts as the cost of the asset in the first year. In subsequent years, the book value is the previous year's book value less depreciation for that year. The following screenshot shows the same asset seen in the earlier example, if we apply the declining value method of depreciation:

GnuCash: Payroll Management, Depreciation, and Owner's Drawing

Under certain conditions IRS allows you to deduct the entire cost of an asset in the year you acquire the asset and start using it for business. There are also accelerated depreciation methods that allow more depreciation in the initial years and progressively less later. For new assets put into use in 2009, the US Congress has approved special 50% bonus depreciation. Therefore, you should consult an accountant or a tax consultant to find out what are the best options for your specific situation.

Land, though a capital asset, is typically not allowed to be depreciated.

You can capitalize all the associated costs
In addition to the purchase of the asset itself, any costs associated with getting the asset into a condition so that you can use it should be capitalized. For example, if you buy a piece of equipment, its shipping costs, installation costs, and training of your staff to operate the machine, all these costs can be included in the cost of the equipment.

Have a go hero – applying a different depreciation method

The declining balance method is another form of depreciation allowed, instead of the straight-line method. Create a schedule of depreciation to be applied, to the same asset in our earlier example, using the declining balance method.

Owner's drawing

The Owner's Drawing Account is sometimes known as either the Personal Account, the Withdrawal Account, the Directors Account, or the Partners Account. This type of an account is nothing but a convenient way to distribute business profits to the owner or partners. US tax laws tend to collect income tax from small business owners based on the profits made before accounting for the owner's salary. Any salary drawn by the owner cannot be treated as an expense to the business for the purposes of calculating taxable profits. Therefore, owner's draw is a popular form of paying the owner or partners without causing tax complications.

If, instead you choose to pay the owner or partners a salary, you will have the following disadvantages:

  • You have to exclude this from other employee's salaries, when calculating tax-deductible business expenses.
  • You will not have the flexibility of varying the owner's drawing from month-to-month depending on the profitability of the business.

Whether to pay salary or owner's draw as well as the tax treatment depends on what type of corporation your business is and other factors. What we are showing here is an example. You should seek the advice of an accountant or a tax consultant regarding your specific situation.

Time for action – entering owner's draw in your books

We are going to look at one example where the owner has decided to have an owner's draw of $10,000.

  1. Make sure you have a Drawing Account. If not, create one. This should be of type Equity and have Equity as the Parent Account.
  2. On the last date of the month, write a check from the business account to your personal account and create an entry in the Drawing Account, as shown in the following screenshot, with the Transfer account being the Checking Account and the amount being $10,000.

    GnuCash: Payroll Management, Depreciation, and Owner's Drawing

What just happened?

One prudent approach to paying the owner is a monthly fixed sum as owner's draw to cover the owner's personal expenses. At the end of the year, depending on how well the business has done and the cash position, the owner can draw an annual bonus. This also helps you to visualize the benefits of running your business. How? If you make a monthly withdrawal that is roughly equivalent to what you can earn as a salaried employee, then you can readily see what is the extra benefit that you get by way of an annual bonus by putting in all those 80 hour weeks, running your own business.

If you don't follow the system outlined by us above, there are a few ways in which draws can happen:

  • You write a check to "cash" with no memo
  • You use your business debit card for personal use
  • You use your business ATM card to withdraw funds from the bank for personal use
  • You initiate bank cash transfers from your business to your personal account.
  • You write a check from your business to pay a personal expense.

If you draw cash through any of these means, make sure you enter them in the accounts with a matching increase in the Drawing account.

Talking about a prudent approach, you will owe at least two large chunks of taxes from the owner's draw. There may be others. You need to set aside 15.3% self employment tax every time you draw some amount from the business. This self employment tax is nothing but the 7.65% FICA tax that we saw earlier in the payroll section. Except that now you are paying the employee contribution as well as the company contribution and so it has got doubled. You will also owe estimated income tax that is payable each quarter. So, you will do well to keep these amounts aside before planning to spend the money.

Have a go hero – setting up Drawing accounts for a partnership

Let us say that you have a partnership account with two partners. Set up two Drawing accounts to show the withdrawal of the two partners separately. Please follow the same method as we outlined for creating a drawing account for a sole owner, except create two of those. Also, use each of the partner's names in the account name to clearly identify them. This way each partner's drawing can be tracked separately.

Summary

In this article we covered:

  • Employees and Payroll: Payroll accounting is complex because of the many deductions and the company's contributions. We saw how to make it easier to create them and how to use the Duplicate Transaction capability to reuse them.
  • Depreciation: Tax law allows capital purchases such as office machines and furniture to be written off over a period of time. We saw how to account for the allowed monthly depreciation.
  • Owner's draw: US tax law doesn't allow owners to draw a salary as a business expense. So, the way for the owners to pay themselves is through owner's draw. We showed how to account for that and to make sure that self employment tax is provided for as well.

Further resources on this subject:


Gnucash 2.4 Small Business Accounting: Beginner's Guide Manage your accounts with this desktop financial manager application
Published: February 2011
eBook Price: $26.99
Book Price: $44.99
See more
Select your format and quantity:

About the Author :


Ashok Ramachandran

Ashok Ramachandran is a graduate in Mechanical Engineering and has a Masters in Business Management from the Indian Institute of Technology (IIT) Madras. He started with an engineering career, including the running of two small businesses, and then made a mid-career switch to Information Technology (IT). Currently, he is a senior IT executive in the Washington DC area. His penchant for explaining technology to non-technical users and interest in writing culminated in this book. For other open source software suitable for small medium businesses, you can refer to his website http://smb-soft.com.

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