Beginner's guide to payroll accounting in India

Register your business

Ensure your business is legally registered and obtain a unique Tax Deduction and Collection Account Number (TAN), as well as registration numbers from statutory bodies such as the Employees' Provident Fund Organization (EPFO),Employees' State Insurance Scheme (ESI), labour welfare fund, and professional tax authorities.

Determine how you want to maintain your books of accounts

After completing the registration process, choose how you want to maintain your business's books of accounts. The three common methods of maintaining accounts are as follows.

• Recording transactions manually: This is a traditional approach where businesses rely on spreadsheets to maintain their accounts. This method is prone to manual errors, can be time consuming, and lacks automation features.
• Hiring an accountant: A few businesses choose to hire an accountant as they bring in their expertise in financial management and ensure accurate reporting of transactions. However, if you are a small business and are stringent with money, this approach can turn out to be costly.
• Choosing an integrated payroll and accounting software: This is the efficient and modern way of organizing your books of accounts. A tightly integrated software like Zoho's can help you achieve seamless data flow, eliminate duplication, and streamline your accounting and payroll processes.

Choose an accounting method

Once you decide how to maintain your books of accounts, the next step is to select the most suitable accounting method for your business.

• Cash accounting: In this, you will be recording transactions when cash is received or paid. It focuses on actual cash inflows and outflows, making it straightforward to implement for small businesses. However, this method may not provide an accurate representation of a business's financial performance.
• Accrual accounting: In this method, revenue and expenses are recorded regardless of the cash flow timing. Revenue is recorded when earned, and expenses are recognized when incurred. Advantages of this approach include accurate representation of business activities, improved tracking of liabilities and receivables, and compliance with accounting standards. However, it requires more complex record keeping, including estimations and adjustments for uncollected revenue and unpaid expenses.

To ensure your business's financial health and growth, it is advisable to assess your accounting needs and opt for an accounting method that aligns with your operations and compliance requirements. Learn more about the pros and cons of each accounting method in this article on different types of accounting methods.

Establish a comprehensive salary structure

A salary structure refers to the framework that defines the different components and their respective proportions in an employee's compensation package. It consists of basic pay, allowances, bonuses, and other benefits.

To create a salary structure, begin by analyzing your business needs, employee job roles, their experience levels, and market benchmarks. Identify the salary components based on the various labor laws laid out by the government and establish a well-defined salary structure.

Pro tip: You can simplify this process by using payroll software that comes with built-in salary components.

Besides promoting transparency and fairness in employee compensation, a thought out salary structure aids in your business's financial planning. It ensures accurate classification of employee compensation and simplifies your chart of accounts.

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Create a chart of accounts for payroll expenses

As a part of your accounting setup, you need to create a chart of accounts for each expense that's part of your payroll.  A chart of accounts is a list that categorizes the financial transactions of a business.  A payroll chart of accounts includes net salary payable, salary on hold, statutory deductions made, employee reimbursements, and other payroll-related expenses.

A typical chart of accounts will look like this:

To set up a payroll chart of accounts, follow the steps below:

1. Analyze your payroll process.
2. Identify relevant accounts.
3. Assign appropriate codes to each account.

If you are new to the process, consider getting help from your accountant and using accounting software with built-in chart of accounts capabilities.

Set up a business bank account

Having a dedicated bank account for your business ensures clear separation between personal and business finances. It allows you to track business income and expenses effectively and reconcile bank accounts.

To create a business bank account, you will need to submit a copy of your business registration certificate, PAN card, proof of address, and proper identification to the bank authority. Research and compare different banks to find the one that offers suitable services for your business.

Configure recurring payments to employees

Once you have created a bank account, implement a systematic process to run payroll for your employees.

Payroll is the routine task of calculating and disbursing employee payments within an organization.

The process involves managing recurring payments such as salaries, deductions, and other benefits. You can automate salary calculation and processing with the help of payroll software. 

Payroll software can help you streamline the process by automating many of the tasks involved, such as calculating deductions, generating pay slips, and issuing payments. This can save businesses time and money, and help to ensure that payroll is processed accurately and on time.

Record salary journal entries

After paying your employees, be sure to record salary journal entries to complete the payroll accounting cycle for that pay period.

A salary journal entry is a record of the salary expenses incurred by a company. 

It is made of two parts: debit and credit. The debit side of the journal entry records the expenses of the salary, while the credit side records the liability to pay the salary. Here's a table representing some of the debit and credit components involved in payroll:

Doing this manually can be a tiring process, leaving room for miscalculations. An integrated payroll and accounting software can help you eliminate errors by automatically generating and posting journal entries based on payroll calculations. It can help you track labor costs and generate reliable financial statements for better decision-making and for compliance purposes.