What Does Paid in Arrears Mean?

What does paid in arrears mean? Are there any benefits to paying employees in arrears? How does paying employees in arrears affect my payroll calculations? Keep reading for answers to these and more questions.
What does paid in arrears mean
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What Does Paid in Arrears Mean?

The term “paid in arrears” refers to a payment that is past due. This might be due to the payee missing the payment deadline, or that the payment was scheduled after the service period. It could also be due to a payment being missed by mistake.

An example of getting paid in arrears by mistake could come from an automatic payment not going through for a particular month. The payments go through fine in March and April, but then it doesn’t go through for May. The payment for June would then be in arrears for May, and every month thereafter.

Why Do Companies Pay in Arrears?

Companies often pay their service providers and employee payrolls in arrears. Making payments in arrears is very common for most small businesses. 

Paying at the end of a pay period gives a business the time to secure financing, whether that be through receiving money from those that owe them or just making more sales. It allows for immediate needs to be met with the promise to meet financial obligations later.

Payroll in arrears means paying employees for the previous week’s work. The alternative to this is called current pay, where employers pay at the end of the pay period.

Paying in Arrears After Missing a Payment

Paying in arrears can refer to the strategic decision that companies make to allow for greater accuracy in their payroll. It can also refer to any payment that is behind or paid after the service is performed. 

This means that sometimes you may need to pay in arrears because you made a mistake in calculating payroll or you missed a payment. If an employee works overtime or unexpectedly needs to take time off, you may need to pay in arrears. 

Any type of delayed payment schedule—whether the delayed payment is intentional and regular or rare and out of necessity—is paying in arrears.

Benefits and Downsides of Paying in Arrears

If your organization is considering implementing an arrears payroll, take a look at the pros and cons before you begin. Understanding the benefits and downsides of arrears will help you understand if it is the right fit for your organization. 

Benefits of Arrears Payroll

Paying employees in arrears is a lot simpler and more efficient than the “current pay” method. For starters, if you sent out payroll on the last Friday of the pay period, it would mean the employee would have to clock their Friday time before they actually worked those hours.

"Paying employees in arrears is a lot simpler and more efficient than the “current pay” method."

Additionally, if an employee were to take emergency time off at the end of a pay period, they would be overpaid in the “current pay” system. 

Payroll in arrears allows time for accurate time reporting and calculating things like federal and state tax withholdings, payroll taxes, and benefit deductions. 

Once employees get into the rhythm of the offset payment period, they likely won’t notice the week-long delay. However, if an employee’s hours vary from week to week, it’s important to inform them their paychecks are in arrear format.

Downsides of Arrears Payroll

While paying in arrears guarantees simplicity in some areas, it does bring some possible complications.

The delayed schedule of being behind on payments can make it difficult to interact with other vendors. These vendors may charge a fee for late payments or an increased interest rate.

The delayed schedule may also require adjustment on the part of your employees and customers. New employees could receive their first paycheck weeks after working. New and old customers might need reminders about how the schedule operates.

If paying in arrears is a good fit for your organization, many of the downsides of arrears can be avoided with consistent communication with your vendors, employees, and customers.

What Does Arrears Mean for Your Accounting?

Balancing your budget and finances is important no matter the method of your payments. While paying in arrears gives your company time to balance financial obligations, it can sometimes mean you’re behind on payments. Be wary of paying for too many things in arrears; it’s the same idea as not charging too much to a credit card.

Keep tabs on every company you are paying in arrears and every company that is paying you. Noting when you’ll receive payments will directly affect whether or not you can make your deadlines. If a company paying you is too far back in arrears, you may need to consider suspending business with them until they meet their obligations.

What is an Example of Being Paid Monthly in Arrears?

Some companies choose to pay employees only once a month, but that doesn’t mean you need to wait for them to work a full month before paying them. Consider the following examples of being paid monthly in arrears:

Example #1

Two employees start work at a company in the month of May. Jimmy started work on May 1 and Chris on May 22. 

Even though three weeks passed between their start dates, their pay period ends at the same time on May 30th. The employees will be paid for the work during that month during the first week of June, rather than making Chris wait until June 22 for his first paycheck. 

If your employees are paid in arrears for two weeks of work, which is the norm, you would pay them one week after the pay period.

Example #2

Sarah and Daniel work at the same company. In the middle of their pay period Daniel had an emergency surgery and had to take two weeks off of work to recover. During those two weeks, Sarah worked overtime to finish the projects that she and Daniel were responsible for. 

Because the company that Sarah and Daniel work at pays employees in arrears, the employee operating payroll was able to factor in Daniel’s time off and Sarah’s overtime work instead of trying to projecting the time they would work ahead of time.

Example #3

Jen works payroll at her company. In the middle of the pay period, several new hires arrived at the company, one employee’s salary changed, one employee had to take time off for a family emergency, and the company began filing taxes under a new system.

Many of these changes were difficult to anticipate, but Jen was able to accurately calculate and compensate for each of the changes for each of the employees because her company pays in arrears.

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What is the Opposite of Billing in Arrears?

The opposite of billing in arrears would be “paid in advance,” which is charging before the services are completed. The benefits of this method include getting more money upfront and usually not having to collect as many payments

While getting money in advance is nice for small businesses, it may be hard to get customers to trust your services. If they’re a new customer, they may be unsure of the quality of your product or service and hesitate to pay in full before you deliver. 

Is Salary Paid in Advance or Arrears?

Salary is rarely paid in advance. It’s common practice to pay workers after they’ve completed their work, not upfront. This way employees don’t get paid for days they take off after already being paid for them.

Can You Pay Overtime in Arrears?

Yes, you can pay overtime in arrears. In fact, paying overtime in arrears is much easier than current pay. 

For example, say you have two workers scheduled to work eight hours each, Chris on Wednesday and Mary on Thursday. Chris had to cancel for a medical emergency, and the only person who could cover his shift is Mary. Mary now exceeds 40 hours for the week after picking up the shift and qualifies for overtime. 

"Paying employees in arrears is a lot simpler and more efficient than the “current pay” method."

If payday is Friday and you use the current pay system, you couldn’t properly calculate the schedule change or the overtime pay. 

Paying in arrears gives you time to know workers’ schedules before you pay them, allowing you to calculate both their total hours worked and any overtime bonuses for which they may qualify.

Did you know? You can automate your overtime calculations with Eddy!

How to Transition to Paying in Arrears

If you are making the switch from paying current to paying in arrears, there are a few steps you can take to make the process smoother for yourself and your employees.

First, be aware of how the transition may impact your employees and prepare for it. Help your employees understand the benefits of the new payment schedule. Consider offering a pay advance or letting employees use accrued time off during the week or weeks without pay during the transition.

Carefully consider when to begin to pay in arrears. Give your employees plenty of notice ahead of time. If possible, begin the new pay period on the same day as the old pay period to avoid pay gaps.

To be certain that your plans to switch your payment plan are at the right time and in alignment with local law, speak to an accountant.

Throughout the process of switching to paying in arrears, the most important thing you can do for you employees is communicating early and honestly about the change.

Conclusion

There are some definite benefits to paying in arrears, whether you’re paying your employees or for other products and services. Still, be careful that you don’t get yourself in trouble by getting behind on payments or collections.

We hope this clears up any questions you may have had about paying in arrears. If you’d like us to manage your payroll, visit Eddy’s payroll page to see how we can help your business.

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