How to Record Payroll and Vacation Accruals the Right Way (BC Small Businesses)
Once your payroll schedule is set, the next step is understanding how to capture payroll costs properly in your books. If you haven’t already, start with our Payroll Deductions Guide for Canadian Small Businesses — it covers how to choose your pay frequency, calculate CRA withholdings, and set up your first payroll cycle.
This post builds on that foundation by walking through the accounting side of payroll — how to record each pay run, accrue vacation time, and stay compliant when pay periods cross over December 31. It’s not just a cheque to your employee: every pay run includes several moving parts — wages, employer costs, government remittances, and vacation accruals — each of which lands in a different spot on your balance sheet and income statement.
🧾 Download the Payroll Schedule Template
Following along with payroll calculations is much easier when you can see the numbers in action.
To help you, we’ve included the same Payroll Schedule Template used in this article — a pre-built Excel file that includes:
Semi-monthly pay period dates for 2025
CRA remittance tracking columns
Vacation and sick day accrual sections
Example journal entries for each pay run
Breaking Down Payroll Accounting
Every pay period, your business incurs a few key expenses:
- Employee wages — the gross pay your staff earns before deductions.
- Employer portions of CPP and EI — mandatory contributions matched by the employer.
- Vacation earned — time off that builds up with each pay period, even if not taken right away.
Those costs form the expense side of your payroll entry. On the other side are the liabilities — the amounts you owe until payments are made. This includes the employee’s net pay, CPP and EI withholdings, income tax, and the vacation owed.
In practical terms, you’re recording both: (1) the cost of employing someone, and (2) the obligation to pay those amounts later (to your employee or to the CRA).
Recording Payroll Each Pay Period
- Recognize payroll expenses — wages, employer CPP/EI, and vacation earned.
- Create matching liabilities — Payroll Payable (net pay), CPP/EI Payable, Vacation Payable, and Payroll Tax Payable.
This ensures your books record both the cost and the obligations associated with payroll.
When You Pay Employees and Remit to the CRA
On payday, clear the liabilities:
- Employee net pay comes out of Payroll Payable.
- CPP, EI, and income tax are remitted and cleared from the related payable accounts.
- Vacation Payable remains until time off is taken or paid out.
Your income statement already shows the full cost of payroll, and your balance sheet shows what’s still owed — giving a clean, accurate month-end picture.
Handling Vacation Accruals
Vacation pay continues to accrue with each pay run. When the employee takes time off, you reverse part of the liability — moving it from Vacation Payable back to Vacation Expense. If they leave the company with unused vacation, that balance is paid out directly from the accrual you’ve been maintaining.
Putting It All Together
Each payroll cycle follows a simple rhythm:
- Accrue the expense.
- Record the liability.
- Pay and clear it later.
Following this sequence ensures:
- Financial statements reflect what was actually earned.
- CRA filings reflect what was actually paid.
- Your payroll records stay clean and reconcilable at year-end.
Accruals: Why They Matter
In proper accrual accounting, payroll expenses are recognized as they’re earned, not when the payment leaves your bank. This ensures each pay period’s costs line up with the time the employee actually worked — which gives a much more accurate picture of profitability and cash flow.
Vacation pay is a perfect example. Each pay period, an employee earns a small slice of their annual entitlement (for instance, 4.69 hours or roughly $120 if they earn $50,000 a year). You record that amount as an expense and a liability — meaning you’ve acknowledged the cost, even though no cash has changed hands yet.
Cross-Year Pay Periods: CPP, EI & Tax Withheld
When a pay period spans the calendar year-end — for example, wages earned December 21, 2025 to January 5, 2026 — it introduces extra bookkeeping and remittance considerations.
For CRA purposes, the deductions for Canada Pension Plan (CPP), Employment Insurance (EI), and income tax are determined by when the payment is made, not strictly when the work was done. Here’s how that plays out:
- The gross pay may include both December 2025 and January 2026 work time.
- When you issue the cheque or remit the amounts in January 2026, you apply the 2026 deduction rates, thresholds, and tables — even though part of the work was in 2025.
- Consequently, the entire pay run becomes a 2026 tax event: employee and employer CPP/EI premiums and income tax withheld all fall under the 2026 reporting rules.
Why this matters:
- Annual maximums for CPP and EI reset on January 1.
- For T4 reporting, amounts are tied to the year in which payments are made, not the year the income was earned.
- From an accrual viewpoint, you still capture the December labour expense in 2025, but the statutory deduction obligations align with the January 2026 payment.
What Appears on the T4
The T4 slip reports employment income that was paid in the year, not necessarily earned in that year. CRA guidance is clear: “Report income in the year in which you made the payment, not the year in which the employee earned the income.”
Source: CRA T4001, Employers’ Guide to Payroll Deductions and Remittances.
Example: If your final pay period runs December 21, 2025 – January 4, 2026 and is paid January 5, 2026:
- Gross pay → 2026 T4
- CPP/EI withheld → 2026 T4
- Income tax withheld → 2026 T4
- Employer CPP/EI → Expensed in 2025 (not on T4)
- Vacation earned → Accrued in 2025 (not on T4)
How to Handle the Accrual on the Employer’s Side
From the CRA’s standpoint, deductions are based on the payment date. But for accurate financial reporting, your December financials should still include the cost of the labour performed before year-end — even if the payment happens later.
Guiding Principle: Accrue using prior-year rates, remit using new-year rates. Your books stay GAAP-compliant, and your CRA filings remain accurate.
The Takeaway
Payroll is one of the largest recurring expenses for most small businesses — and one of the most misunderstood. By applying accrual principles correctly and understanding how CRA’s cash-based reporting intersects with your year-end books, you’ll keep both your accounting and your compliance airtight.
Your December statements stay accurate. Your January remittances stay compliant. And your year-end reconciliations become straightforward — exactly what every small business owner (and their accountant) hopes for.
