Payroll
What is payroll?
Payroll is an end-to-end process by which an organization compensates its employees for the work that they do. It often includes usual salary, bonus, incentives, and prosperity sharing plans, along with other statutory deductions and benefits. The process ensures compliance with labor and tax laws for accurate and timely payments. This function is typically shared between HR, finance, and payroll teams.
How do you calculate payroll?
Payroll is often calculated based on the below formula:
Net pay = Gross pay - Deductions
Gross pay is the total amount an employee earns before any statutory deductions like taxes. For hourly employees, this is calculated by multiplying the hourly rate by the total hours worked. For salaried employees, it’s usually their annual salary divided by the number of pay periods. Gross pay may also include additional earnings such as overtime pay, bonuses, and region-specific allowances (e.g., Dearness Allowance, Housing and Rental Allowance, and Entertainment Allowance).
It’s important to note that in some regions, gross pay already factors in certain allowances and benefits before deductions are applied. Deductions often include professional tax, provident fund, health insurance premiums, income tax, and other statutory contributions.
What are the steps involved in payroll processing?
Payroll is processed in three steps:
Pre-payroll activities
The first step is to develop a comprehensive payroll policy for your organization. It often includes compensation structure, pay schedule, payroll frequency, time tracking procedures, overtime policies, holiday pay, and other important terms based on the regional payroll laws. During onboarding, essential employee details—such as their name, address, PAN number, SSN number, bank details, designation, department, and more—are collected. Before every payroll cycle, the payroll team typically collects information regarding an employee's attendance, leave, loss of pay, shift and bonus details, arrears, and reimbursements (if applicable). These details are then validated to ensure the payroll process remains accurate and compliant.
Payroll calculation
Once all the inputs are validated, the net pay is calculated by subtracting all the deductions, withholdings, and taxes from gross pay. The actual amount that employees have to be paid every month is calculated in this step.
Gross pay + Applicable allowances – Deductions, withholdings, and taxes = Net pay
Post-payroll activities
In this stage, the net pay is disbursed to employees, most commonly through direct bank transfers. In some cases, cash or check payments are used. The payroll team is also responsible for generating and distributing payslips to employees. Additionally, compliance-related tasks, such as recording payroll expenses in financial systems, remitting withheld taxes and contributions to government bodies, and preparing payroll reports for audits, are completed.
What are the challenges involved in payroll processing?
Here are some challenges involved in payroll processing:
- Keeping up with regional, ever-changing payroll laws and statutory regulations
- Classifying employees based on their employment types (full-time, part-time, freelancers, contract employees, and interns) and managing diverse pay structures
- Overcoming errors in complex calculations related to employee pay, overtime, and other tax deductions
- Managing multiple payroll documents for compliance
- Relying on manual processes, including the use of Excel spreadsheets
- Protecting sensitive employee information, including employee bank details, from data breaches
What are the different components of payroll?
Some of the core components of payroll include base salary, regional benefits (like Housing and Rental Allowance and Dearness Allowance), transport allowance, reimbursements, overtime pay, and other tax deductions like income tax, professional tax, and provident fund.
However, these payroll components can differ based on regional payroll laws. Payslips in U.S. organizations can include components like student loan repayment deductions, pension deductions, and more. Payslips in the UAE can include components like cost of living allowance, children social allowance, and general pension and social security authority deduction.
What are the different methods of processing payroll?
Manual payroll calculation:
Members of the HR team make use of spreadsheets or paper-based processes to calculate gross pay, allowances, deductions, and net pay.
Outsourced payroll calculation:
The organization outsources payroll processing, tax filing, and compliance management to third-parties.
Automated payroll software: Integrated HR and payroll software is used to calculate and disburse employee payments.
What is a payroll cycle?
A payroll cycle refers to the period between two pay runs, starting at the beginning of the payroll period and ending on the day when employees are paid. It usually encompasses different activities involved in calculating employee payroll, from tracking working hours and attendance to disbursing payments.