Gross to net calculations - Basic pay, overtime, and allowan...

Learning Outcomes

After reading this article, you will be able to calculate gross and net pay for employees, including basic hourly or salary rates, overtime, and common allowances. You will understand the key components of employee pay, identify the appropriate ledger entries for gross wages and deductions, and apply these concepts to accurately record payroll transactions for ACCA FA1 purposes.

ACCA Recording Financial Transactions (FA1) Syllabus

For ACCA Recording Financial Transactions (FA1), you are required to understand payroll calculations and how to record payroll-related transactions. This article focuses on these exam-relevant syllabus areas:

• Calculating gross pay for hourly, piecework, and salaried employees
• Accounting for overtime pay and allowances
• Identifying statutory and voluntary deductions from pay
• Posting payroll to the general ledger, including gross wages, deductions, and net pay
• Understanding the documentation required in payroll systems

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which one of the following is an allowance that increases an employee's gross pay?
   1. Employer’s pension contribution
   2. Statutory deduction
   3. Shift premium
   4. Tax on earnings

2. Calculate the gross weekly pay for an employee paid $15 per hour for 37 basic hours, who works 5 hours overtime at time and a half.

3. What is the difference between gross pay and net pay?

4. Briefly explain how overtime pay is usually calculated for hourly paid workers.

Introduction

Payroll costs are a significant business expense. Accurate payroll calculations ensure employees are paid fairly and that records comply with ACCA standards. Gross pay forms the starting point—this is not always the amount the employee takes home. Overtime, bonuses, and certain allowances may boost gross pay, while statutory and non-statutory deductions reduce it to net (take-home) pay.

This article explains how to determine basic pay, overtime, and allowances, with practical examples and key ledger postings for exam success.

Key Term: gross pay
Total earnings due to an employee before any deductions, including basic salary or wage, overtime, and allowances.

Key Term: net pay
Take-home pay remaining after all deductions (statutory and voluntary) have been subtracted from gross pay.

Key Term: basic pay
The standard pay an employee earns for agreed hours or output, before overtime or allowances are added.

Key Term: allowance
An additional sum paid to an employee on top of basic pay, such as for shift work, skills, or conditions.

Key Term: overtime
Pay for hours worked beyond the normal contractual hours, usually at a higher rate than basic pay.

Basic Pay

Basic pay is the amount earned for standard working hours under an employment contract. For hourly paid workers, it's calculated as:

Basic pay = Number of hours worked × Hourly rate

For salaried staff, basic pay is usually a fixed annual sum divided over the pay periods (e.g., months or weeks).

Worked Example 1.1

An employee is paid $12 per hour and works 40 basic hours in a week. What is their basic pay for the week?

Answer:
Basic pay = 40 hours × $12 = $480

Overtime Pay

Overtime is paid when employees work more than their contract hours. The overtime rate may be "time and a half" (1.5 × basic rate), "double time" (2 × basic rate), or another agreed rate.

Overtime pay = Overtime hours × Overtime rate

Rates may differ by the day or amount of overtime (e.g., higher pay for weekends or after a threshold number of extra hours).

Worked Example 1.2

A worker’s contract is for 35 hours a week at $18/hour. Last week, they worked 41 hours. Overtime is paid at 1.5 × basic rate.

Answer:
Overtime hours = 41 - 35 = 6 hours
Overtime pay = 6 × ($18 × 1.5) = 6 × $27 = $162
Basic pay = 35 × $18 = $630
Gross pay = $630 + $162 = $792

Worked Example 1.3

A salaried employee earns $31,200 per annum for a 40-hour week. Overtime above 40 hours is paid at time and a quarter (1.25 × hourly rate). In November, the employee worked 46 hours each week.

Answer:
Annual salary: $31,200 ÷ 52 = $600 per week
Hourly rate: $600 ÷ 40 = $15
Overtime per week = 6 hours × ($15 × 1.25) = 6 × $18.75 = $112.50
Gross pay per week (in November) = $600 + $112.50 = $712.50

Allowances

Allowances are extra payments awarded under specific circumstances, such as:

• Shift allowances (for working evenings, nights, or weekends)
• Skills allowances (for language, technical, or hazardous work)
• Responsibility or position allowances

Allowances are usually added to basic pay before other calculations.

Worked Example 1.4

Nia is paid a basic weekly wage of $400. For working the night shift, she receives a $40 shift allowance. This week, she also worked 4 overtime hours at twice the basic rate ($12/hour).

Answer:
Basic pay: $400
Shift allowance: $40
Overtime: 4 × ($12 × 2) = 4 × $24 = $96
Gross pay: $400 + $40 + $96 = $536

From Gross Pay to Net Pay

Gross pay is not what employees actually receive. Deductions reduce it to net pay.

Statutory Deductions

These are required by law, such as:

• Income tax (PAYE)
• Social security contributions

Voluntary Deductions

Agreed between employer and employee, such as:

• Pension contributions
• Charitable donations
• Trade union subscriptions

Net pay = Gross pay – (Statutory deductions + Voluntary deductions)

Worked Example 1.5

Theo earns $600 in gross pay this week, including $50 overtime and a $25 skills allowance. Deductions are $72 tax, $28 social security, and $10 union subscription. What is his net pay?

Answer:
Net pay = $600 – ($72 + $28 + $10) = $600 – $110 = $490

Accounting for Payroll in the General Ledger

Payroll affects several ledger accounts:

• Debit the Wages and salaries expense account with gross pay (including all overtime and allowances).
• Credit Bank with net pay paid out.
• Credit Tax and deduction payable accounts with the summed deductions, until they are paid to authorities.

Worked Example 1.6

For a monthly payroll, total gross pay is $20,000. Statutory deductions total $4,000, voluntary deductions $500, and net pay $15,500 is paid to employees. Post summary ledger entries.

Answer:

• Debit Wages and salaries expense $20,000
• Credit Bank $15,500
• Credit Tax and deduction payables $4,500

Exam Warning

Pay attention to whether an amount is an addition (e.g., overtime or allowance) or a deduction. When posting to the general ledger, record only gross pay in the payroll expense account—deductions must be credited to liability accounts, not subtracted from the expense.

Summary

Gross pay combines basic pay, overtime, and allowances. Statutory and voluntary deductions reduce gross pay to net pay. All elements must be accurately calculated and posted for sound business records and ACCA exam success.

Key Point Checklist

This article has covered the following key knowledge points:

• Distinguish between basic pay, overtime, and allowances in payroll calculations
• Calculate gross pay for hourly, salary, and piecework employees including extra items
• Correctly apply overtime rates and allow for shift/other allowances
• Understand the types and effect of statutory and voluntary deductions
• Reconcile gross pay to net pay for employees
• Record payroll transactions in the general ledger, including distinguishing expense from deductions

Key Terms and Concepts

• gross pay
• net pay
• basic pay
• allowance
• overtime