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The Payroll Miracle

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Blog Writer Glasses and Penb-1  The other day, I read an article that states that a new HR Company has developed a Payroll System in 60 days that runs the payroll by itself without any user intervention and it does it by using HR data with the click of a button.  Well, well, I said to myself, this is really genius and magic. If someone can do that, that is not only disruptive, but revolutionary – that is like saying that I have developed a magic stick that you can put in the ocean and it will turn ocean salt water to drinking water in a second. Wow that is incredible and miraculous. Since I have spent most of my adult life dealing with payroll and the intricacies of payroll in many countries, I said to myself I should write this blog to explain the payroll, its meaning, and its complexities, and why it cannot be done as this company claims. With all due respect, the claim made by this company in the said article is plain ridiculous, misleading and aberrant. So I’m going to be short and to the point to explain what are payroll and the intricacies of payroll and why you cannot have a system that run the payroll without any human intervention as the said company claims.

What is Payroll?

Simply stated, Payroll is the calculation of the remuneration (money) that the employer must pay the employee for work rendered by the employee during a certain period of time.  This definition is minimalistic and naïve in the sense that it refers to the calculation of what the employer must pay its employee for work rendered during a period of time, but it does not refer or qualify that the remuneration of the employee includes not only the wage to be paid, but allowances, benefits, and other compensations that the employer must pay to the employee as well as the deductions and taxes that must be deducted from the employee’s salary and taxes and benefits that must be paid by the employer on behalf of the employee based on a pre-agreed employment agreement and based on local, state, and federal labor laws. A more comprehensive definition of the payroll is provided in the following section.

Payroll Definition

Payroll is defined as:

  1. Calculation of Net Salary to be paid to the employee by the employer for work rendered by the employee during specific period of time (pay period). In addition, the payroll includes other processes that need to be conducted after calculation the Net Salary of the employee. These will be discussed in the section, Remaining Part of the Payroll Definition.
  2. The above Net Salary is derived from the employee Gross Salary after deducting the voluntary and involuntary deductions, taxes, and benefits owed by the employee during the pay period
  3. The above Gross Salary is calculated by adding all the Earnings, Allowances, Commissions, Bonuses, and Expenses owed to the employee for work rendered during the pay period and based on pre-agreed employee agreement between the employee and employer
  4. The above Earnings are calculated based on the agreed on Earning Types that the employee supposed to be paid during the Pay Period. Earning Types may include Regular Earning (Basic Salary), Overtime Earning, Shift Differential Earning, and other earnings. The Earnings are fixed for Salaried Employees, while they are variable for Hourly Employees. Hourly Employees’ Earnings calculation is based on the Hours Worked during the Pay Period. And that is why an Hourly Employee must submit a Time Sheet at the end of the Pay Period (Work Period).
  5. The above Allowances are calculated based on the agreed on Allowance Types that the employee supposed to be paid during the Pay Period. Allowance Types may include Meal Allowance, Transportation Allowance, Hazardous Work Allowance, Uniform Allowance, Travel Allowance, etc. The Allowances can be fixed or variable. Each allowance type may have different calculation method and can be function of earnings or hours worked or some other variables such as miles traveled during the Pay Period, number of dependents, seniority, assigned job, etc.
  6. The above Commissions are calculated based on the agreed on Commission Types and Calculation Method to be used in calculating the said Commissions that the employee supposed to be paid during the Pay Period. Commission is calculated based on specific pre-agreed Performance Target, such as Sales made by the employee, Cost Reduction achieved by the Employee, etc. Commission calculation methods can be very complex and can involve many variables depending on the commission. Note that commissions may not be paid at the end of each pay period, and may be paid using different pay calendar/period (Commission Pay Period).
  7. The above Bonuses are calculated based on the agreed on Types of Bonus and Calculation Method to be used in calculating the said Bonus that the employee supposed to be paid during the Pay Period. Bonuses can be pre-agreed or can be decided at the discretion of the Employer. Bonuses are usually linked to employee performance and can be a fixed value or variable. Bonuses are usually not recurring every pay period; they are paid few times per year.
  8. The above Expenses are paid to the employee as a reimbursement of expenses incurred by the employee doing work on behalf of the Employer during the Pay Period. Such expenses may include Taxi Fares, Car Rental, Airfares, Meals, etc. The Expenses are determined based on Expense Claims submitted by the Employee at the end of Pay/Work Period.
  9. The above Benefits are calculated based on the agreed on Benefit Types that the employee supposed to be provided and/or contribute to by both employer and employee during the Pay Period. Note here we are not using the word “Paid”; we are using the words “Provide” and “Contribute”. The reason is that a Benefit does not result in money to be paid to the employee, but it is non-monetary remuneration to the employee such as a Heath Care Insurance/Plan, 401K Retirement Plan, etc. In certain cases both the Employee and Employer contribute to the Benefit and the befit results in a deduction from the employee Gross Salary.
  10. Deductions are amounts deducted from the employee other than benefits contributions. There are two types of deductions: Voluntary Deductions, these are deductions that the employee elects to deduct from his/her pay/salary such as Union Fees, Charity Contribution, and others, this varies from employee to employee and usually this is a fixed amount. Involuntary Deductions, this is a deduction from the employee pay/salary that must be deducted from the employee with or without employee’s consent, example garnishment, loan payment, fines, etc. Deductions are usually fixed and may have a start and end date. And they can be one-time non-recurring.
  11. Taxes are money that must be deducted from the Taxable Income of the employee as per city, state, and federal/country tax laws. Payroll taxes are paid by the employee and employer. The tax calculation methods vary from country to country, state to state, and even in certain cases from city to city. Tax calculation methods can be very complex an may involve many variables such as paid Earnings, paid Allowances, paid Commissions , Paid Bonuses, Benefits contributions, Deductions, Number of Dependents, Year to Date Earnings, Year to Date Deductions, Job/Wok Type (Nature of Work), Employee Age, Location of Work (if employee is working outside the country), and many other variables.

Now that we have defined the payroll (Net Salary) elements or Gross Variables, let us put this in a simple equation to provide a more formal definition of the Payroll:

Payroll := Calculation(NS, Employeej,PPi)

where:

NS is the Net Salary
PPi  is a specific Pay Period in the Year

NS (PPi) = GS(PPi)  – D(PPi)  –  EBC(PPi)) – Taxes (PPi)

where:

GS is Gross Salary
D represents the deductions
EBC represents Employee Benefits’ Contributions

Where:

GS(PPi) = ∑(Ej, PPi) + ∑(Aj, PPi) + ∑(Cj, PPi) + ∑(Bj, PPi) + ∑(Xj, PPi)

D(PPi) = ∑(Dj, PPi)

EBC(PPi) =∑(EBCj, PPi)

Taxes (PPi) = functionk(TIj, PPi)

(TIj, PPi) = GS(PPi) – Exemptions(PPi)

(Ej, PPi) = functionl(RH, OTHp,LHl, PPi)

(Aj, PPi) = functionq(Ej, PPi)

(Cj, PPi) = functionz(PGj, PPi)

E := Earning
A := Allowance
C := Commission
B := Bonus
X := Expense
D := Deduction
EBC := Employee Benefit Contribution
RH := Regular Hours Worked
OTH := Overtime Hours Worked
LH : Leave Hours
TI := Taxable Income

Note that the above Net Salary calculation method addresses only payroll for employees that are paid for time worked, not by piecework. Piecework based payroll requires different calculation method.

Payroll Data Source

Now that we have provided an accurate definition of the Payroll, Net Salary portion, we need to define the sources of the data used to calculate the employee pay. Before addressing the source of the data, first we need to understand the nature (types) of payroll data. There two types of Payroll Data. (1) Static Data or almost static/fixed data that seldom changes or infrequently changes, and (2) Variable Data that that changes from each pay period.

Payroll Static Data Source

Payroll Static data comes from Employee Baseline Record which is captured by the HR Department (or HR System) during employee hiring and consist of the following:

  • Employee Demographics
  • Employee Addresses
  • Employee Dependents
  • Employee Bank Detail
  • Employee Job and Organization Detail
  • Employee Compensations including Earnings, Allowances, Benefits, Bonuses, and Commissions
  • Involuntary and Voluntary Deductions
  • Tax Withholding Data (W4 and State Tax Withholding Forms Data)
  • Normal Work Hours, Overtime Hours Entitlement
  • Leave Entitlements

Payroll Variable Data

Payroll variable data changes from pay period to pay period, specifically for Hourly Employees, and in some cases for salaried employees and the source of this data is as follows:

  • Time sheet submitted by the employee at the end of each pay period
  • Leave Requests (Leave Taken) during the Pay Period. The leave requests are submitted by the HR Department (through the HR System)
  • Expense claims submitted by the employee at the end of each pay period
  • Employees Sales Reports submitted by the Sales Department in case employees are paid commissions
  • Employees Performance Appraisal Reports in case Employees are paid Bonuses
  • Employees Loans and Advances submitted by the Financial Department
  • Pay Exceptions that may happen during the pay period and this may include a onetime allowance, bonus, commission, and/or a deduction and this comes from HR Department (HR System)
  • Changes in regular compensations that may happen during the pay period, and these come from HR Department (HR System)

Note that the Payroll Variable Data has to be loaded every pay period.

Now you are starting to see why the Payroll cannot run by itself on a click of a button as that article/company claims.

Remaining Part of the Payroll Definition

The Payroll Definition that we have provided above pertains only to the portion of the employee net salary calculation. There are other processes that need to be executed as part of the payroll cycle and these include:

Direct Bank Transfer (DBT/ACH)

This payroll process consists of generating the Direct bank Transfer file that contains the employee paycheck/net salary for the pay period, which is sent to the employer banks to the electronically transfer the paycheck to the employees’ bank accounts. If the employer pays employees from different banks, multiple DBT files have to be generated and each has a different format.

Payroll JV

This is the payroll journal that includes the Payroll Cost GL Transactions, Debit and Credit Cost Transaction by payroll account and cost center that will be posted to the Financial System (General Ledger) to post the Pay Cost for the Pay Period.

Tax Agencies Payments

Payroll Tax withholding need to be paid to the State and Federal Tax Agencies based on specific payments  schedule and at the end of each pay period the Tax Agencies Payment Reports need to be generated and paid.

Third Party Payments

This payroll process consists of generating the third party payments for benefits plans such as Health Insurance, 401K, and others. This can be done through a report with a check or can be done through an electronic  transfer depending on the agreement between the third party payee and the employer,

Paycheck Printing

If employer is paying employees by check, then checks need to be printed verified and mailed to the employees.

Conclusion

Now that we have defined the meaning of payroll including Net Salary Calculation, Payroll Data and Data Sources, and Payroll Processes, I hope you agree that “there is no such thing as a Payroll System that Runs by Itself” as this new HR Company claims in the Article I have read. There are many HR and Payroll Systems in the market, from small systems to large enterprise HRMS/Payroll Systems. And none of these including those that cost millions of dollars can run the payroll with one click of a button. Some of them are more integrated than others and easier to use than others, but to make a claim that there is a system that runs the payroll by itself without user intervention is a Big Fallacy.


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