Understanding Backpayment Made Easy

August 1, 2023by Crystal Payroll


Welcome to another informative guide from Crystal Payroll! Today, we explore a crucial yet often overlooked aspect of payroll management – backpay. 

Keeping a careful watch on any backpay your employees might be owed is an important part of maintaining fair and transparent payroll processing. Knowing what backpay is and how it works helps keep your business on track financially, and it ensures that your employees are paid fairly for their work. Backpays are an important part of New Zealand’s payroll legislation and knowing what they are will help you stay compliant with the Holidays Act 2003, ensuring your business doesn’t end up like the Ministry of Education, who owe school staff in NZ over $38 million in backpay for underpaid holiday entitlement.

In this article, we’ll explain everything about backpay. We’ll go over what it is, how it works, and why it matters in the New Zealand business context. We’ll also walk you through how to manage it effectively.

Here’s a quick overview of what we’ll be covering:

  • What is backpay?
  • Why backpay occurs and why does it matter?
  • How to handle backpay
  • Understanding the different types of income and how they can affect your backpay
  • How to Use Crystal Payroll to easily process and calculate backpay
  • Conclusion: The importance of backpay

Join us as we explore the ins and outs of backpay, and learn how Crystal Payroll can make managing backpay a breeze.

What is Backpay?

The term ‘backpayment’ refers to a situation in payroll management where an employee must be compensated for income not received from the current or past pay periods. It’s an adjustment in the salary to make up for any shortfall that occurred due to an underpayment or miscalculation. This could be due to an administrative error, a miscalculation in hours worked, or an overdue salary raise, among other reasons.

In New Zealand, it’s crucial to correct such discrepancies promptly and accurately. A timely resolution is crucial for upholding a positive employer-employee relationship and also ensures compliance with the NZ employment laws, which mandate that employees should receive all wages they are entitled to.

Why Does Backpay Occur and Why is It Essential?

Backpay arises for a variety of reasons. Here are some of the main causes of backpay:

  • Miscalculations or Administrative Errors: These are simple mistakes that can occur during payroll processing. Perhaps there’s a data entry error or a miscalculation when computing hours worked or rates of pay. It’s a common scenario, and the discovery of such an error usually leads to the issuance of backpay to rectify the discrepancy.
  • Changes in Employment Agreements: Sometimes, employment terms can change midway through a pay period, such as a pay increase, pay equity or a promotion. If the change isn’t immediately accounted for in the payroll, it can lead to underpayment, thus necessitating backpay.
  • Delayed Pay Increases: If an agreed-upon pay rise is not implemented on time, an employer will need to issue backpay to make up the difference. For instance, if an employee was supposed to receive a pay increase from July, but it was only applied in August, they would be owed backpay for that one month.
  • Overtime Pay: backpay can also come into play when overtime hours worked by an hourly waged employee were inadvertently left unpaid or underpaid. If an employee has put in extra hours and these haven’t been appropriately compensated, backpay would be required.
  • Holiday Pay: New Zealand’s employment laws mandate certain payments for public holidays, alternative holidays, bereavement leave, and sick leave. If an employee hasn’t been accurately paid for these, backpay is used to adjust their pay to the correct amount.
  • Unpaid Regular Hours: Sometimes, due to administrative oversight or miscommunication, an employee might not be paid for their regular hours of work. In such cases, backpay is used to compensate for these unpaid regular hours.

Essentially, backpay situations boil down to two main categories:

  • Backpay for Wrong Pay Rate: This occurs when an employee’s hours are paid at an incorrect rate. For instance, if there’s a post-dated increase in an employee’s pay rate, any hours worked since the date of that increase would need to be compensated at the new, higher rate. This results in backpay to make up for the difference between the old and new rate.
  • Backpay for Missed Hours: This situation arises when an employee has worked certain hours that were missed out in an earlier pay. The employer would then need to issue backpay to compensate the employee for those missed hours.

Backpay is not just about rectifying these discrepancies. It’s a crucial aspect of preserving fairness and trust in the employment relationship. By ensuring that employees are properly compensated for their work, employers foster a respectful and transparent work environment. It also helps businesses comply with New Zealand’s employment laws and avoid potential legal disputes or penalties.

Backpaying Simplified

Calculating and disbursing backpay might seem daunting, so here’s a simplified step-by-step guide:

  1. Identify the cause of underpayment and the period it pertains to.
  2. Determine the correct payment rate and the hours for which the employee was underpaid.
  3. Multiply the hours by the pay rate to calculate the gross backpay.
  4. Adjust for tax and other deductions to calculate the net backpay.
  5. Add the backpay amount to the employee’s subsequent payroll.

Remember, the goal is to ensure that the employee receives the full compensation they’re entitled to. Therefore, if there have been multiple underpayments, each should be calculated separately to ensure accuracy.

The process above, while simple in theory, can get complex in practice especially when dealing with multiple employees or a high frequency of underpayments. Adjusting for tax considerations, coupled with the intricate calculations needed for gross and net pays, can add another layer of complexity to the process. This is where using a robust payroll system can drastically simplify your tasks and ensure accuracy.

Categorising Earnings: Understanding the Different Types of Income

When processing backpay, it’s essential to understand the different types of income as defined by the payroll system. These different types of income will play a part in knowing whether your backpayment will affect an employee’s annual leave pay rates or not.  

Here’s a quick breakdown:

Ordinary Income

This refers to income earned during regular work hours and income that affects the “Ordinary Weekly Pay” calculation. It is defined in the HA03 as any regular payments an employee may receive with exception to reimbursements or discretionary payments. The key difference between Ordinary Income is the term “regular”. In the context of backpay, ordinary income typically accounts for less than four weeks’ worth of wages. It’s included in gross earnings calculations and affects both the Ordinary Weekly Pay (OWP) and Average Weekly Earnings (AWE) for annual leave pay rates.

Conditional Income

This is income earned beyond regular work hours, including overtime, bonuses, and commission. For backpay, it’s typically more than four weeks’ worth of wages. While it’s also included in gross earnings, it only affects the AWE for annual leave pay rates. Note that overtime and commissions can be ordinary income if they are “regular”. By default, Crystal Payroll treats all overtime as Ordinary Income as Employment New Zealand recommends erring on the side of caution. Conditional Income is simply all payments made to staff that form part of the gross earnings, but are irregular enough that they should not form part of the Ordinary Weekly Pay calculation. e.g., you may be paid weekly, but receive a commission once a month. In that case it would be “irregular”, and conditional income.

Excluded Income

These are discretionary payments such as annual bonuses, one-off accommodation allowances, or non-taxable payments such as reimbursements. These are not included in the gross earnings and therefore, do not affect the annual leave pay rates.

Gaining a clear understanding of these income categories is key to accurately processing backpay and remaining compliant with New Zealand’s employment laws. As we delve into how Crystal Payroll can aid in your backpay management in the next section, we’ll see how leveraging a reliable payroll system can make these classifications more accessible and the payroll process as a whole more streamlined. With Crystal Payroll, you’re not just simplifying your payroll operations, you’re opening the door to clearer insights, less stress, and more confidence in your compliance.

Navigating Backpayment with Crystal Payroll: Backpay Processing Made Easy

Dealing with backpay can be a complex task, but with Crystal Payroll, you have a reliable payroll system that makes the process a breeze. 

Backpayment Methods

Our payroll system offers flexible and intuitive tools designed to tackle different backpay scenarios with three different methods:

  1. Adjusting the Current Period: If you spot a payroll discrepancy within a pay period that hasn’t been filed yet, simply make the necessary adjustments and pay the difference.
  2. Backpays through Allowances: For periods that have been filed, backpay can be issued in the next period as an Allowance. Just select the appropriate backpay allowance item, enter the amount, and you’re good to go.
  3. One-Off Pay Periods: If an entire period of income was missed and has already been filed, you can create a one-off pay period to issue the backpay. (generally used only when the whole income is missed, as partial income will cause an under calculation of the PAYE)

Remember, the choice of method depends on the specifics of each situation, so in the next section we will be covering which method should be used in those specific situations. When in doubt, revisit the guidelines provided in this blog, or contact our expert team for assistance.

Backpayment Methods with Different Scenarios

It’s important to note that each method of backpayment should be used with a specific scenario to ensure you are correctly paying the right amount in a timely manner. Each scenario depends on whether the pay period has been filed or how urgently the employee requires their backpay.

Here are the three scenarios in which you would need to use each method.

The employee was underpaid in the current period, which has NOT yet been filed with the IRD. In this case, you would use Method 1:

  1. Unapprove the “Take Home Pay” (Note the underpaid Take Home Pay amount) and also unapprove the “Time & Income”.
  2. Make the necessary adjustments e.g. add the missing hours to be paid or amount underpaid from change in pay rate.
  3. Reapprove “Time & Income” and ‘Take Home Pay”.
  4. This will now show the backpay included in the “Take Home Pay” amount. (Paying the difference of what you noted down before processing the backpay.)

The employee was underpaid, the pay period has been filed, and they can wait to be paid in the next pay period. In this situation, you would use Method 2:

  1. In the next pay period, use the Allowance function in “Time & Income”.
  2. Click Set Up Allowance Items. Multiple backpay allowance items will be available.
  3. Select the appropriate one and proceed.
  4. Close that tab and enter the backpay amount.
  5. Change the income type to either Ordinary (less than 4 weeks’ worth of income) or Conditional (More than 4 weeks’ worth of income) based on the period of the backpayment.

The employee was not paid last week, and the pay period has already been filed. In this case, you would use Method 3:

  1. Create a one-off pay period in “Process a Pay” – “Pay Period List”.
  2. Select the Pay period number you wish to create a one-off for.
  3. Go to “Time & Income” and process the pay for that particular employee.
  4. Please note, this should only be done when you have to backpay the entire income. If it’s only a partial backpayment, the PAYE may be under-calculated, resulting in additional PAYE due at the end of the financial year. The diagram below shows the underpaid PAYE with the following legend –
    Green: Gross Earnings from the partial incomes added together
    Yellow: PAYE from the separate pay-runs added together (incorrect PAYE amount)
    Pink: Correct PAYE amount using the PAYE calculator (try our free PAYE calculator to calculate your PAYE accurately yourself) of the whole amount
    Red: PAYE difference between the correct and incorrect and therefore what would need to be paid back at the end of the year

Backpayment Checklist

Here is a quick checklist that will help you know which method to use.

Is the pay already filed?

  1. If no, make the changes in the pay period itself and pay any difference. (Method 1)
  2. If yes, is it the whole income or partial income?
  1. If whole income, create a one-off pay period. (Method 3)
  2. If partial income, does the employee mind waiting?
  1. If no, is it for greater than four weeks’ worth of income? (Method 2)
    1. If yes, make a conditional allowance in the next pay period.
    2. If no, make an ordinary allowance in the next pay period.
  2. If yes, create a one-off pay period, but the PAYE may be under calculated and you may have to pay additional PAYE at the end of the tax year. (Method 3)

Wrapping Up: Ensuring Fair Compensation with Backpay

Backpay isn’t just a correction to payroll errors. It’s a testament to your commitment to fair and accurate compensation for your employees. Understanding what it is, why it happens, and how to correctly process it are key steps in maintaining transparency and trust in the workplace.

While the calculations and tax implications may seem challenging, remember that Crystal Payroll is here to help you navigate the intricacies of backpay. Our tools are designed to make the process straightforward, ensuring you’re always compliant with New Zealand’s payroll legislation.

Remember, at the end of the day, your employees are your most valuable asset. Ensuring they’re paid accurately and fairly for their hard work is not just a legal requirement – it’s the right thing to do. If you have further questions about processing backpay or any other payroll matter, don’t hesitate to reach out to us at Crystal Payroll. We’re always here to help!

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