PAYG Instalment Posting

Here’s a comprehensive guide on how to make a double-entry accounting entry for a PAYG instalment. While these examples are specific to instalments paid to the Australian Taxation Office (ATO), the fundamental accounting principles can be applied to similar prepaid tax systems in your jurisdiction.

This guide provides a clear, step-by-step process for both companies and sole traders.

The Key Concept: It's a Prepayment, Not an Expense

The most important thing to understand is that when you pay a PAYG instalment, you are pre-paying your future income tax bill. You are not incurring an expense at that moment.

• Wrong: Treating the payment as a "Tax Expense" on your Profit & Loss statement during the year. This would incorrectly reduce your reported profit.
• Correct: Treating the payment as an Asset on your Balance Sheet. You are essentially giving money to the tax office to hold on your behalf until your final tax liability is calculated.

Step 1: Recording Quarterly PAYG Instalment Payments

This initial step is identical whether you are a company or a sole trader. The goal is to show that cash has left your business bank account and is now an asset — a credit held by the tax office.

Chart of Accounts Setup

First, ensure you have the correct account in your Chart of Accounts. If you don't, you'll need to create it.

• Account Name: Prepaid Income Tax
• Account Type: Current Asset

This is crucial. It must be a Balance Sheet account, not an Expense account.

The Double Entry

Let's say you pay a $2,500 PAYG instalment from your business bank account. Create a "Make Payment"

The impact of this entry is visible on your Balance Sheet. While the net effect on your total assets is zero, the composition has changed: your cash has been exchanged for a new asset, Prepaid Income Tax. This account tracks the cumulative credit you hold with the tax office, which will be cleared at the end of the financial year. With each quarterly payment, this balance will grow; for instance, after four instalments of $2,500, the account will total $10,000.

Step 2: The Year-End Adjustment

This is where the process diverges based on your business structure. The year-end journal entry is fundamentally different for companies and sole traders.

A) For Companies and Trusts: Recognising a Business Expense

A company is a separate legal entity from its owners. Therefore, its income tax is a legitimate business expense. At year-end, you must record this expense and apply your prepayments against it.

Scenario: You paid $10,000 in instalments, but your accountant determines your actual income tax expense for the year is $11,500.

The Year-End Journal:

Explanation:

• This entry records the full tax expense on your Profit & Loss statement.
• It clears the Prepaid Income Tax asset account to zero.
• It creates a liability showing the remaining $1,500 owed to the tax office.

After completing this step, you’ll see the updated results on the balance sheet, and the profit has changed. The total income tax expense is now recorded in the profit and loss statement.

B) For Sole Traders: Recording a Personal Drawing

As a sole trader, you and your business are the same legal entity. Income tax is a personal liability, not a business expense. Therefore, you must not record an "Income Tax Expense" on your business's Profit & Loss statement. Payments made from the business for personal tax are treated as Owner's Drawings.

The Year-End Journal:

Explanation:

• This entry moves the total amount of tax paid during the year into your Owner's Drawings account.
• It correctly clears the Prepaid Income Tax asset without affecting your business profit.

⚠️ Final Payment: The remaining $1,500 is now recorded as a liability in the Income Tax Payable account. When you make this final payment to the tax office, code the outgoing bank transaction directly to the Income Tax Payable account to clear the balance.

🛟 The Simpler Alternative for Sole Traders

As a sole trader, you can skip the two-step process and use a simpler method. Because the end result is a drawing, you can code the payments directly to Owner's Drawings each quarter.

This method is faster and requires no year-end adjustment, but it mixes tax payments with other personal drawings. The "Best Practice" method provides a cleaner audit trail by specifically tracking tax prepayments in their own asset account. Ask your accountant which method they prefer.

Common Mistakes to Avoid

Leave the tax code blank. This ensures the payment does not incorrectly appear on your activity statements.

Confusing PAYG Instalments with PAYG Withholding:

1. PAYG Instalments are prepayments of your business's income tax.
2. PAYG Withholding is the tax you withhold from employee wages and pay to the tax office on their behalf. This is always a liability account (PAYG Withholding Payable), as it's money you owe from the moment you withhold it.

By following this two-step process, your financial statements will accurately reflect your profit during the year and the correct tax expense and liability at year-end.