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Introduction to Payroll – Using Xero as an Example

· 7 min read
Shan Xiao
Shan Xiao
Developer & Bookkeeping Learner

Payroll is how a company pays its employees.

1. Basic Payroll Responsibilities & Key Terminology​

Employer Obligations​

  • Pay employees correctly and on time according to their employment agreement
  • Withhold tax (PAYG withholding) from employee wages on behalf of the ATO
  • Calculate and pay superannuation (super) contributions to employees' nominated funds
  • Report payroll information to the ATO via Single Touch Payroll (STP)
  • Maintain accurate records of hours worked, leave taken, and payments made
  • Comply with Fair Work requirements (minimum wages, leave entitlements, pay slips)

Key Terminology​

Basic Payroll Terms​

  • Gross Pay — total earnings before any deductions (base salary + allowances + overtime)
  • Net Pay — the amount the employee actually receives after all deductions (take-home pay)
  • Pay Run — the process of calculating and distributing employee payments for a pay period
  • Pay Period — the regular interval for paying employees (weekly, fortnightly, or monthly)
  • Ordinary Time Earnings (OTE) — the standard earnings used to calculate super contributions
  • Leave Entitlements — employee rights to paid or unpaid time off (annual leave, sick leave, etc.)
  • Pay Slip — a record provided to the employee detailing their pay, deductions, and entitlements

Xero-Specific Terms​

  • Pay Calendar — a schedule in Xero that defines pay periods and payment dates for a group of employees
  • Pay Template — the per-employee configuration in Xero that assigns earnings lines, deduction lines, super fund, and leave entitlements
  • Pay Items — configurable components in Xero that define types of earnings (ordinary hours, overtime, bonuses), deductions (union fees, salary sacrifice), and reimbursements

ATO-Specific Terms​

  • ATO (Australian Taxation Office) — the government agency responsible for administering Australia's tax and super systems
  • Single Touch Payroll (STP) — ATO system where payroll information is reported each time a pay run is processed
  • PAYG (Pay As You Go) Withholding — a system where employers withhold a portion of an employee's wages each pay cycle and remit it to the ATO on their behalf, covering the employee's expected income tax liability for the year
  • Superannuation (Super) — mandatory employer contribution to an employee's retirement fund (currently 11.5% of ordinary time earnings in Australia)
  • Tax File Number (TFN) — a unique identifier issued by the ATO to each taxpayer
  • Super Guarantee Charge (SGC) — a penalty imposed by the ATO when employers fail to pay super on time

2. Structure of Xero Payroll​

Xero's payroll module is organised into several key areas:

Payroll Settings​

  • Organisation details — business name, ABN, and registered address
  • Pay items — define earnings (ordinary hours, overtime, bonuses), deductions (union fees, salary sacrifice), and reimbursements
  • Leave types — configure annual leave, personal/sick leave, long service leave, and any custom leave types
  • Superannuation — set up default super funds, contribution rates, and compliance settings
  • STP configuration — connect to the ATO for Single Touch Payroll reporting

Employees​

  • Personal details — name, date of birth, address, TFN, emergency contacts
  • Employment details — start date, employment type (full-time, part-time, casual), employment basis
  • Pay template — assign earnings lines, deduction lines, super fund, and leave entitlements specific to each employee
  • Tax settings — TFN declaration details, tax scale, HELP/HECS debt, tax offset claims
  • Bank account — employee's bank details for electronic payment
  • Opening balances — if migrating mid-year, enter year-to-date totals for earnings, tax, and super

Leave​

  • Leave balances — view current accrued leave for each employee
  • Leave requests — employees can request leave; managers approve or decline
  • Leave history — record of all leave taken and accrued

Timesheets​

  • Timesheet entry — employees or managers enter hours worked per day
  • Earnings mapping — timesheet hours map to specific pay items (ordinary hours, overtime, etc.)
  • Approval workflow — timesheets can require approval before being included in a pay run

Pay Calendars​

  • Calendar types — weekly, fortnightly, twice-monthly, or monthly
  • Period start/end dates — define when each pay period begins and ends
  • Payment date — the date employees receive their pay

3. Payroll Process Using Xero (MVP Workflow)​

Part A: Initial Setup (One-Time)​

  1. Create a pay calendar — choose the pay frequency (e.g., monthly) and set the period start/end dates and payment date
  2. Add employee(s) — enter personal details, TFN, bank account, employment type, and start date
  3. Set each employee's pay template — assign an earnings line (e.g., ordinary hours or salary), super fund, and super rate
  4. Verify STP is connected — ensure Xero is linked to the ATO for Single Touch Payroll reporting

That is enough to run a pay run. Timesheets, leave types, and additional pay items can be added later as needed.

Part B: Each Pay Period​

  1. Open the pay run for the current period — Xero auto-populates each employee's gross pay from their pay template
  2. Review the calculated figures — gross earnings, PAYG withholding (calculated automatically from ATO tax tables), super, and net pay
  3. Post the pay run — this records the payroll transaction in Xero's ledger, creating journal entries that feed into the Activity Statement:
    • W1 (Total salary, wages and other payments) — sourced from gross wages posted by the pay run
    • W2 (Amount withheld from payments shown at W1) — sourced from PAYG withholding calculated during the pay run
  4. Lodge STP — Xero prompts you to submit the pay run data to the ATO; confirm the ATO accepts the submission
  5. Pay the employee(s) — use Xero's batch payment file or integrated payment service to transfer net pay to employee bank accounts

4. Tax Filing & Reporting (Australia)​

Single Touch Payroll (STP)​

  • What it is — a reporting mechanism where employers report payroll information to the ATO each pay run
  • What is reported — gross wages, PAYG withholding, super liability, and employee details
  • When to report — on or before each pay day
  • STP Phase 2 — expanded reporting includes more granular income types, country codes, and employment conditions

PAYG Withholding​

  • Employers withhold tax from employee wages based on ATO tax tables
  • Withheld amounts are reported via STP and paid to the ATO
  • PAYG withholding is reported on the Business Activity Statement (BAS), typically quarterly
  • Labels on BAS: W1 (total wages paid) and W2 (total PAYG withheld)

Superannuation Guarantee​

  • Employers must pay super at the Super Guarantee rate (11.5% of OTE as of 2025–26)
  • Super must be paid at least quarterly, by the 28th day after the end of each quarter
  • Payments are made to employees' nominated super funds via a clearing house (e.g., Xero's integrated super, or the ATO Small Business Super Clearing House)
  • Failure to pay on time incurs the Super Guarantee Charge (SGC), which is not tax-deductible

BAS Reporting​

  • Quarterly BAS includes PAYG withholding amounts (W1 and W2 labels)
  • If also registered for GST, the BAS combines GST and PAYG reporting
  • Lodge and pay by the BAS due date for each quarter

End-of-Year Finalisation​

  • At the end of the financial year (30 June), employers must complete an STP finalisation
  • This confirms that all payroll data for the year is accurate and complete
  • Finalisation deadline: 14 July for employers with 20+ employees; 31 July for smaller employers
  • Once finalised, employees can see their income statement (formerly payment summary) in myGov — no need to issue paper payment summaries

Key ATO References​