Gross-to-net payroll - Statutory and voluntary deductions

Learning Outcomes

After completing this article, you will be able to explain the difference between gross and net pay, identify and distinguish between statutory and voluntary payroll deductions, and prepare basic payroll calculations for inclusion in accounting records. You will also understand how these payroll components impact the statement of profit or loss and the statement of financial position.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand how payroll and associated deductions are recorded and how they impact the financial statements. Revision for this topic should focus on:

• The differences between gross pay and net pay for employees
• Identification and treatment of statutory deductions such as income tax and national insurance
• Identification and treatment of voluntary deductions such as pension contributions or charitable donations
• The preparation of basic payroll calculations, including deduction schedules
• The double-entry bookkeeping required for payroll expenses, tax liabilities, and net pay
• The implications of payroll entries for profit or loss and the financial position

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 of the following is a statutory deduction from gross pay? a) Union subscription
   b) National Insurance contribution
   c) Private medical insurance
   d) Pension scheme donation (employee’s choice)
2. An employee earns a gross monthly salary of $2,000. Statutory deductions total $350, and voluntary deductions total $50. What is the net pay?
3. True or false? Charitable giving which is formally arranged via payroll may be treated as a voluntary deduction from gross pay.
4. In which financial statement would you expect to see employer’s payroll tax liabilities?

Introduction

Employers must account for all amounts paid to employees, not just the direct wages or salaries. Total pay—known as gross pay—is subject to several deductions before the employee receives their earnings as net pay. Understanding these deductions is essential to properly record payroll transactions, meet legal obligations, and prepare accurate accounts for the business.

This article will help you separate statutory deductions (legally required) from voluntary deductions (optional or employee-elected) and understand their impact on payroll calculations and financial statements.

Key Term: gross pay
The total amount of salary, wages, or other remuneration earned by an employee before any deductions are applied.

Key Term: net pay
The amount actually paid to the employee after all deductions—statutory and voluntary—are subtracted from gross pay.

Gross-to-Net Payroll Explained

Payroll calculations begin with gross pay and proceed by deducting both statutory and voluntary amounts to arrive at net pay.

Gross Pay Components

Gross pay typically includes basic salary, overtime, bonuses, and other taxable benefits. This is the starting point for deduction calculations.

Statutory Deductions

Statutory deductions are legally mandated amounts an employer must deduct from an employee’s gross pay and remit to the relevant authorities. These deductions ensure compliance with tax and social security law.

Key Term: statutory deduction
A deduction from an employee’s pay that is required by law, such as income tax or social insurance contributions.

Common statutory deductions include:

• Income Tax—such as PAYE (Pay As You Earn) in the UK
• National Insurance Contributions (or similar social security taxes)
• Student Loan Repayments (where required by law)
• Any other deductions explicitly required by government regulation

Employers must calculate and deduct these amounts accurately and submit them to government agencies by required deadlines.

Voluntary Deductions

Voluntary deductions are optional and occur only with the employee’s written (or otherwise documented) consent. These amounts can vary by employer and employee preference.

Key Term: voluntary deduction
A deduction from an employee’s pay that is not required by law but arranged at the request or agreement of the employee.

Examples include:

• Pension contributions above statutory minimum
• Union subscriptions
• Charitable giving (e.g., “give as you earn” schemes)
• Approved salary sacrifice schemes (for certain benefits)
• Private health insurance premiums

Employers must ensure that no deduction (statutory or voluntary) leaves an employee with net pay below the legally protected minimum (where applicable).

Basic Payroll Calculation Process

The typical workflow for payroll is:

1. Calculate gross pay based on contracted salary and any additional earnings.
2. Deduct all statutory amounts (e.g., tax, national insurance) to determine taxable and insurable income.
3. Deduct all authorised voluntary amounts (e.g., pension, union dues).
4. The result is the net pay to be transferred to the employee.

A summary formula is:

Net pay = Gross pay – total statutory deductions – total voluntary deductions

Employers also often have to pay additional employer’s contributions (e.g., employer’s share of national insurance or pension), which increase total payroll costs but do not affect net pay.

Worked Example 1.1

A part-time employee earns gross pay of $1,200 per month. Statutory deductions are $180 for income tax and $96 for national insurance. Voluntary deductions include $24 for pension and $10 for a staff savings scheme.

What is the employee’s net pay, and what amounts should be recorded as liabilities in the employer’s accounts?

Answer:
Net pay = $1,200 – ($180 + $96) – ($24 + $10) = $890. The employer must record $276 ($180 + $96) as a liability to tax authorities, $24 as a liability to the pension provider, and $10 to the savings scheme until remitted.

Worked Example 1.2

An employee’s gross monthly earnings are $2,700. Statutory deductions are PAYE $370, National Insurance $220. Voluntary deductions are $70 for a union and $60 for an optional health plan.

Calculate the net pay and the breakdown of liabilities.

Answer:
Net pay = $2,700 – ($370 + $220) – ($70 + $60) = $2,050. The employer records:

• $590 as PAYE/NI payable to government
• $70 as union dues payable
• $60 as health plan payable

Accounting Treatment of Payroll Deductions

Employers credit the full gross pay as an expense (wages or salaries) in the statement of profit or loss.

The corresponding entries are:

• Debit: Wages and salaries (total gross cost)
• Credit: Cash at bank (net pay, paid to employees)
• Credit: Payables for statutory and voluntary deduction balances (separate liability accounts for each)

These payables remain on the statement of financial position until paid to the appropriate external parties. Non-payment or late payment of statutory amounts can result in penalties.

Key Term: payroll liabilities
Amounts owed by the employer to third parties (e.g., tax authorities, pension funds) due to payroll deductions but not yet paid.

Worked Example 1.3

During a month, a business runs a payroll for employees with gross wages totalling $10,000. Statutory deductions are $2,000; voluntary deductions are $500.

What are the accounting entries?

Answer:

• Debit Wages and salaries (expense) $10,000
• Credit Cash at bank (net pay to employees) $7,500
• Credit Payables (statutory deductions) $2,000
• Credit Payables (voluntary deductions) $500

Implications for Financial Statements

• The employer’s gross pay is charged as an expense in the profit or loss account.
• Liability balances for unpaid deductions appear as current liabilities until payments are made.
• Employers must ensure they distinguish statutory from voluntary deductions in their records for compliance and audit purposes.

Revision Tip

Keep clear schedules for all payroll deduction balances. Separate payroll control accounts for statutory and voluntary deductions help prevent errors when remitting payments, and ensure compliance with legal deadlines.

Exam Warning

Do not confuse employees’ deductions (from pay) with employer’s payroll costs (such as employer NIC/pension, which do not reduce employee net pay). Both must be recorded but appear separately in the accounts.

Summary

Gross pay is the starting figure for payroll accounting. Statutory deductions must be withheld and remitted by law, while voluntary deductions require employee consent. The correct calculation of net pay and accurate recording of deduction liabilities is essential for employers, and errors can lead to financial penalties or misstatements in company accounts.

Key Point Checklist

This article has covered the following key knowledge points:

• The distinction between gross pay and net pay in payroll accounting
• Identification and examples of statutory deductions from payroll
• Identification and examples of voluntary payroll deductions
• Basic calculation steps from gross pay to net pay
• Recording payroll transactions and deduction liabilities in accounting records
• Impact of payroll transactions on the financial statements

Key Terms and Concepts

• gross pay
• net pay
• statutory deduction
• voluntary deduction
• payroll liabilities