Employee Loans/Advances aren’t liabilities

In the past few weeks, we’ve covered a lot of payroll topics, from PAYROLL INTEGRATIONS, PAYROLL TAXES to WAGE GARNISHMENTS; however, there is another piece of the puzzle that some small businesses may encounter when it comes to Payroll. Many companies may engage in Employee loans and advances without understanding how to handle them, especially in bookkeeping.

Companies may have questions regarding advances or loans to their employees: What is considered an employee loan or advance? How do we record them in the books? What must we do in the payroll system to ensure deductions are occurring correctly?

Employee Loans v. Employee Advances

An employee loan is money from the business to an employee, much like a traditional loan. However, the loan parameters can vary differently depending on each employer. These parameters include the repayment length and whether the business will charge interest. The length of these employee loans would be multiple months.

An employee advance differs from a short-term loan because it is an “advance” on a paycheck. The company does not charge interest in this type of agreement. The employee accesses their wages before the pay period.

A contract should outline which paychecks will have deductions for the advance. The agreement must include how many pay periods and how much will be taken from each pay period. There are limitations to what percentage of a paycheck the business can deduct. The employee advance should have a length and amount which could paid back in a few paychecks.

These are not expenses for the employer, just like any other loan obtained. If the business charges interest to the employee, it would recognize interest income. There is a thin line between ensuring the company is protected and receiving its money back while finding other ways to support its employees when they are experiencing hardship.

Again, ensure that there are specific terms with the employee on factors such as minimum payment, term, and due date. The business has to prepare for scenarios that include the employee leaving early or being fired, objecting to paying the money back or how long they have to pay the money back, or if the employee falls on hard times.

Another thing that companies need to think about is making sure they have the cash flow to afford to advance part of an employee’s payroll. Compromising the company’s cash flow to support your employees is not a wise business decision.

This employee advance or loan will be shown as a current asset on the books because it is money that the business needs to receive. A current asset is a business’s asset that the company may convert into cash within a year. https://www.investopedia.com/terms/c/currentassets.asp

For accounting, the chart of accounts needs to include either a Payroll Advance or an Employee Loan. The business should track the balances of the employees closely using this account. If the business loans or advances money to the employees often, it may be beneficial to break down the employee loan account by the employee’s name to keep a quick balance for each one.

For categorizing, to get an opening balance in the loan account, the paycheck, Venmo, ACH, and whichever way the business paid the employee needs to be added to that account. Depending on your payroll system, you will set up the mapping to put deductions from the paycheck to reduce the loan account. We will cover the top 3 software deductions set up:

Software Deductions

QuickBooks Online Payroll

1. Go to Payroll, then select Employees.
2. Select your employee.
3. From Deductions & contributions, select Start or Edit.
4. Select + Add deduction/contribution.
5. From the dropdown menu, add the following:

• Deduction/contribution type: Other taxable deductions
• Type: Cash Advance Repayment
• Description: Add a deduction name, such as Cash Advance Repayment.

1. Select Flat amount.
2. Enter the amount to deduct from your employee’s paycheck.
3. If you need to collect the advance over more than one paycheck, enter the total amount owed in the Annual maximum field.
4. When finished, select Save.

ADP

To add deduction codes to your ADP Run account, follow the steps below:

1) Have your payroll admin log into your ADP RUN account

2) Navigate to the settings (usually on the left side of the screen)

3) Under the Payroll Section, select “Earnings and Deductions”

4) Select “Add Deduction” at the bottom of the screen.

5) Select “Loan” in the Category Field

6) Select the deduction you’d like to add from the Deduction dropdown and click “Save.”

Gusto

Steps to Add a Deduction/Benefit:

1. Sign in to your Gusto admin account.
2. Go to the “Benefits” section.
3. Choose the type of benefit or create a “Custom Benefit” if needed. This could be a 401(k), HSA, 529 plan, or a custom benefit like a specific employee advance.
4. Add a name for the benefit/deduction. Identify it (e.g., “Employee Advantage Program,” “401(k) Deduction,” etc.).
5. Enter the “Employee Deduction Per Pay Period.”: This amount will be deducted from the employee’s paycheck each pay period.
6. Enter the “Company Contribution Per Pay Period” (if applicable). This is the amount the company will contribute towards the benefit, which will be tracked for records and year-end taxes.
7. Click “Save & Continue.”
8. Select which employees you want to be deducted for this benefit. You can choose individual employees or groups.
9. Click “Save.”

No matter what payroll software is used, this is a post-tax deduction when setting up an advance or loan deduction. The amount being taken out of the paycheck should not be a guessing game; the agreement mentioned previously should outline this clearly.

Once the deduction is created in the payroll software, the next step is to ensure the mapping depicts what is occurring correctly in the books.

If the business has never had a loan or advance, create the COA account called “Employee Loan/Advance.” The advanced paycheck will be the starting balance of this account. Waterford recommends breaking out different employees in their accounts to keep track of balances more efficiently.

Once there is a starting balance, the last thing to do is map the deduction to the same account. Many people do not remember to add the original paycheck and end up with a negative COA.

The only difference will be if the business charges interest to the employee for the loan instead of an advance. The deduction from the employee payroll would have to be split between two separate accounts: the employee loan and the interest paid. We don’t know of a payroll mapping that will allow the business to break out automatically, but the easiest way would be to do journal entries to correct this.

Overall, once set up, deductions and mapping will continue to reduce until zero. The most important part is to ensure the business tracks the money loaned or advanced to the employees to avoid accidentally misplacing it.

If you’re having trouble understanding how to handle employee loans or advances, please do not hesitate to contact us for advice on mapping or setting up your payroll deductions. We also have a YouTube video that will walk you through the QuickBooks setup, which you can see here: How to Account for and Classify Employee Loans and Advances.

If you need help or you fear that something is going on in your business that you don’t understand, please don’t hesitate to reach out to us here at Waterford Business Solutions by giving us a call at 864-351-0852 or shooting us an email at info at WaterfordBusiness.com.