Wages vs Salary In Accounting

You already know that employees are paid either through a wage or a salary, but do you know the differences between the two?

As a small business owner, you will do well to familiarize yourself with both general information and accounting concepts surrounding these compensation methods. 

Wages are paid on an hourly basis. The amount of money paid to an employee per hour will be determined before the start date. A salary, on the other hand, is an annual amount paid to an employee on a set schedule. The payment schedule is determined before the start date. 

There are clear differences and nuances to be aware of when it comes to each compensation method. It’s imperative to know about all of these when you’re running a small business. In this article, we will go over all of these topics and more. If you’re interested, then keep on reading!

Definitions of Salaries and Wages

Before you decide whether you want to pay employees a salary or a wage, it would be helpful to know exactly what each compensation method entails. In this section, we will take a deep dive into each topic. 

Salary Definition

A salary is defined as an annual payment amount distributed to an employee on a specific schedule. The amount of the salary will depend on the level of expertise that the employee brings to the table and the perceived difficulty of the job.  A salary is not based on a set number of hours, rather it is based on a job.

Before someone begins their work as a salaried employee, it’s important to have a conversation with them about their preferred salary. At that time, you should inform them of the pay frequency for your company. 

Salaries are often paid using the following pay frequencies:

• Monthly - every month. 
• Weekly - every week.
• Bi-monthly - twice a month, 24 payments a year. 
• Bi-weekly - every two weeks, 26 payments a year.

You can offer any of these pay frequencies to employees. 

A salary is paid out at a fixed amount each time. There won’t be any variations in the salary payouts regardless of the number of hours worked. This will make calculating a paycheck amount easy. 

Example of Salary

Imagine a situation where a high-level executive gets paid a salary of $150,000 per year. If you pay the employee monthly, you would divide this salary by 12 and arrive at a paycheck amount of $12,500 per month. If the same employee is to be paid bi-weekly, meaning every two weeks, you would have to divide the yearly salary by 26 (being that there are 52 weeks in a year). This would come out to approximately $5,769 every two weeks. 

Wage Definition

A wage, on the other hand, is a term used to signify an hourly rate. When this compensation method is used, the hours worked are tracked using a system, whether it be a physical timesheet or a digital time tracker.

Wage payout amounts may vary a bit between pay periods due to the following: 

• Differences in the number of hours worked. Since this type of compensation is dependent on the number of hours worked, whenever an employee works more or less than expected, this will change the payroll payout for the employee. 
• Time was taken off for sickness or leave. Depending on your policies regarding sick days and leave, off time will also affect the payment amount for a specific pay period. 

The most common pay frequencies used for paying employee wages are monthly or bi-weekly (every two weeks). 

Example of Wages

An hourly employee, who is paid an hourly wage, will get paid per hour worked. The majority of full-time hourly workers work 40 hours per week. If a retail employee has an hourly pay rate of $20 and will be paid monthly, their monthly paycheck will be $3200. This $3200 covers payment for 160 hours (40 hrs per week) at a rate of $20 per hour. The paycheck amount can be adjusted for a bi-weekly pay schedule. 

The Differences Between Salaries and Wages

For comparison’s sake, let’s look at the differences between salaries and wages in a table.

For hourly employees who want to work overtime, there are a couple of conditions that they must meet. First, they have to work 40 hours in the pay period. Next, they have to obtain express consent from their manager. Salaried workers do not have the option to receive overtime even if they work more than 40 hours as their pay is based on a job rather than the number of hours worked. 

Recording Salaries vs. Wages

Now that you know a ton of helpful information about wages and salaries, now it’s time to talk about how to record salaries and wages in your financial books.

Accrual based accounting is the preferred method of accounting, especially when it comes to payroll accounting. The following section will fill you in on how to record salaries using the accrual accounting method. 

Recording Wages

There is a two-step process for recording wages, and understanding both of these steps is crucial to the accuracy of your books. 

Recognizing the Wage Expense

In accrual accounting, you need to acknowledge the wage expense when it has been earned by the employee regardless whether it has been paid. To do this, you need to record a debit to the “wage expense” account in the payment amount. You will then need to record a credit to the “wages payable” account for the same amount. The wages payable indicates the payroll has been earned but not yet paid. 

As the Wage Expense is Paid

When the wage expense is paid to the employee, it’s at this point that you need to make an adjusting entry to show that cash was paid. 

To do this, you must record a debit to the “wages payable” account for the same amount you paid the employee. Then you need to record a credit to the “cash” account for the same amount. 

Recording Salaries

To record a salary, there are two specific steps that you need to go through.

Before Money is Paid Out

First, you need to make an entry right when the salary has been accrued (the employee has worked through the pay period). Note that no money has changed hands at this point. The accounting action only signifies that a salary payment is due. 

You will need to record a debit to the “salary expense” account for the amount of money that is due and then record a credit to the “salary payable” account for that same amount. 

As Money is Being Paid Out

To signify that money is going out to pay the employee’s salary, you’ll need to make another journal entry. 

To do this, you should record a debit to the salaries payable account for the salary amount and then credit the cash account for the same amount. 

Taxes Payable

Wages and salaries include tax expenses (FICA), health insurance expenses, and other liabilities, and these must also be accounted for in your financial books.

To recognize your taxes that need to be paid, you should make a separate journal entry. 

Record each tax expense on its own line as a debit to the appropriate expense account, and then record a credit for each of the dollars amounts to the “payable” accounts for each expense. 

For instance, if you have a health insurance expense, you would debit “health insurance expense” for the appropriate dollar amount, and then you’d credit the “health insurance payable” account.  

If you have more than a few employees, payroll journal entries can get out of control quickly. This is because the more entries you manually enter, the higher the probability for mistakes. It is recommended to use an automated payroll system if you have more than about five employees. 

Final Thoughts

Now you know what salaries and wages are, the main differences between them, and how to record them. We hope that this article has provided some clarification for you on the subjects of salaries and wages.