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CHAPTER 3: PAYROLL ACCOUNTING / ETHIOPIAN CASE/

1. The Importance of payroll Accounting

Definition: The term payroll refers to the document prepared to pay remuneration for the
service rendered in a given period of time.

 Payroll contains the total amount paid to employees as a compensation for

services they rendered in a particular period.

Importance (objective) of Payroll Accounting

 To process data such as hours /days worked, pay rates, and payroll deductions so
that the firm can:
 Provide accurate & timely cash (pay checks)
 Provide explanations of payroll data
 protect payroll transactions against fraud
 control wages & salary expenses

2. Definition of payroll related terms

 Salary & Wages

 Wages - refers to payments for manual labor that is paid based on the
number of hours worked or the number of units produced.
 Wages are usually paid when a particular piece of work is completed or for
a period less than a month.
 Salaries: - refers to compensations to employees on monthly or annual
basis.
 Pay period: - The length of time covered by each payroll payment.
 Pay period for wage workers are usually made on weekly or biweekly
basis
 Salaried employees’ pay periods are on monthly basis.

 Pay Day: the day on which wages or salaries are paid to employees usually the
last day of the pay period.

 Gross Earnings (Gross pay): the total amount of salary, wages, commissions,
fees, allowances of any type or any other employee compensations before taxes
and other deductions are taken out.
 The total pay to an employee before deductions for the pay period.
 Gross pay (GP) = Basic Salary + Over time + Allowances
 Payroll Taxes: Are taxes levied against the employer on the payroll of a firm.
 Additional payroll related expense to an employer.

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 Withholding Taxes: - are taxes levied against the earnings of employees of an

organization and withheld by the employer per the
regulations of the concerned government.

 Payroll Deductions- All the reductions from the Gross earnings of an employee
such as withholding taxes, union dues, fines, credit
association pays, etc.
 Net pay: - The amount that the employee takes home.
 The gross earnings after subtracting all the deductions
 Is also known as take – home pay.

Basic Records of a payroll accounting system includes:

 Payroll register (or sheet)

 Individual employees' earnings records, and
 pay checks
Payroll Register (sheet):- the entire list of employees of a business along with each
employee’s gross earnings, deductions and net pay for a particular payroll period.
 The basis for the preparation of payroll register can be the attendance
sheets or time cards.
Employee Earnings Record: is a summary of each employee’s earnings, deductions,
and net pay for each payroll period and of commutative gross earnings during the year.
 Is a separate record kept for each employee.
 The individual employees’ earnings record helps the employer
organization to properly summarize and file tax returns.
Pay check: An instrument for paying salary if the firm makes payment via writing a
check in the name of each employee for the net pay or a check for the total net pay.

3. Possible Components of a payroll Register

A. Employee Number- number assigned to each employee for identification

purposes, when a relatively large number of employees are included in the
payroll registers.

B. Name of employees – List of the name of employees

C. Earnings - money earned by an employee /s/ of a firm from various sources.

 Sources of earnings may include

a- Basic salary or regular earning: A flat monthly salary of an employee

that is paid for carrying out the normal work of employment and subject
to change when the employee is promoted.
b- Allowances - money paid monthly to an employee for special reason,
which may include:
i- Position Allowance- a monthly sum paid to an employee for
bearing a particular office responsibility.

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E.g. Head of a particular department or division

ii- House Allowance- a monthly allowance given to cover housing

costs of the individual employee when the employment contract
required the employer to provide housing but fails to do so.

iii- Hardship Allowance: - a sum of money given to an employee to

compensate for an inconvenient circumstance caused by the
employer.
E.g. unexpected transfer to a different and distant work area or
location
 Hardship allowance is sometimes known as disturbance
Allowance.

iv- Desert Allowance- a monthly allowance given to an employee

because of assignment to a relatively hot region.

v- Transportation (Fuel) Allowance:- a monthly allowance to an

employee to cover cost of transportation up to the work place if the
employer has committed itself to provide transportation service.

c- Overtime Earnings: - Overtime work is the work performed by an

employee beyond the regular working hours or days.
 Overtime earning is the amount payable to an employee
for overtime work done.
 In Ethiopia according to article 33 of proclamation No. 64/1975 the
following is discussed about payment for Overtime work.

 A worker shall be entitled to be paid at a rate of one and one quarter (1 ¼)

times ordinary hourly rate for over time work performed before 10
O’clock in the evening (10 p.m.)

 A worker shall be paid at the rate of one and one half (1 ½) times ordinary
hourly rate for overtime work performed between 10 O’clock in the
evening (10 p.m.) and Six o’clock in the morning (6 am)

 Overtime work performed on the weekly rest days shall be paid at a rate of
two (2) times the ordinary hourly rate of payment.

 A worker shall be paid at a rate of two and half (2 ½) times an ordinary

hourly rate for overtime work performed on a public holiday.

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D. Payroll Deductions
 Payroll deductions refer to amounts deductible from employees'
Gross pay to arrive at Net pay of the employee.

 Are subtractions made from the earnings of employees because it

is required by government or permitted by the employee himself.

 Some of the deductions against the earnings of employees are:

a- Employee Income Tax

 Every citizen is required to pay something in the form of Income tax from
his/her earning of employment

 A progressive income tax system that charges higher rates for higher
earnings is applied on the gross earnings of each employee.

 The now existing proclamation in Ethiopia, proclamation no 286/1994

which became effective since Hamle 1, 1994 E.C., exempts the first Br
150 of the earnings of an employee from income tax.

 Taxable income refers to all income from employment including salaries,

wages, allowances etc.

 The money on which a person does not have to pay income tax is an
exemption.

 According to the recent proclamation, employee income tax has to be

computed based on the following schedule.

No. Salary Range (ETB) Tax Rate Deduction (ETB)

1. 0 – 600 Birr Non-Taxable -
2. 601 – 1,650 Birr 10% 60 Birr
3. 1,651 – 3,200 Birr 15% 142.50 Birr
4. 3,201 – 5,250 Birr 20% 302.50 Birr
5. 5,251 – 7,800 Birr 25% 565 Birr
6. `7,801 – 10,900 Birr 30% 955 Birr
7. Above 10,900 1,500 Birr

 Generally, taxable income from employment includes salaries, wages,

allowances, director’s fees and all payments in cash and benefits in kind.
 Income Tax Amendment proclamation No 30/1992 issued on October 12,
1992 stated that the following categories of payments in cash or benefits
in kind are exempted from taxation.

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 Medical costs incurred by employer for treatment of

employees
 Transportation allowances paid by employer to its
employees.
 Reimbursement by employer of traveling expenses
incurred on duty by employees
 Traveling expense paid to transport employees from
elsewhere to place of employment and to return upon
completion of employment.
b- Pension Contributions
 Permanent employees of an organization the employees of which are
governed by the existing regulations of Ethiopian public servants are
expected to pay or contribute 7% of their basic (monthly) salary to the
government pension Trust Fund.
 This amount should be with held by the employer from the basic salary
of each employee on every payroll and later be paid to the respective
government body.
 On the other hand, the employer is also expected to contribute towards
the same fund 9% of the basic salary of every permanent employee of
it.
This total amount (9% of the total basic salary of all permanent
employees) is the amount of payroll taxes expense for the employer.
 The total contribution to the pension Trust Fund of the Ethiopian
government is equal to 16% of the total basic salary of all permanent
employees of an organization. i.e.
 7% comes from the employees &
 9% comes from the employer
This enables a permanent employee of an organization to be entitled to
the pension pay given that the employee has satisfied the minimum
requirements to enjoy this benefit when retired.
 Non- government organizations are also using this kind of scheme to
benefit their employees with some modifications.
 It is made in some NGO’s by keeping a fund known as provident fund.

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 Both the employees and the employer contribute towards this fund
monthly.
 Ultimately, when an employee is retired or drawn out of work a lump
sum is given at once.
c- Other deductions
 Apart from income taxes and pension deductions from employees
earnings, employees may individually authorize additional deductions
such as deductions to
 pay health or life insurance premiums
 re pay loans from the employer or credit association
 Pay for donations to charitable organizations etc.
 Each of the major other deductions may be put in special column in
the payroll register.
 Ultimately, the sum of the employees’ income tax, pension
contributions and other deductions gives the total deductions from the
gross earnings of an employee.
 The column “Total Deductions” shows the total deductions made from
the earnings of employees in the payroll register.

E. The Net pay

 This amount is held in one column of the payroll register representing
the excess of gross earnings over the total deductions of an employee.
 The column’ Net pay’ total tells the excess of grand total earnings over
grand total deductions made from the earnings of employees.
 It is grand total take-home pay.
F. Signature
 Unless some other decumbent is used, the payroll sheet may be
designed to allow a column for the signature of employees after
collection of the net pay.

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 In general, a payroll register should at least show the earnings,

deductions and the net pays along with the names of employees.
 Major Activities or Procedures Involved In Accounting for Payroll

1. Gathering the Necessary Data: All the relevant information about every employee
should be gathered.

2. Including the name of employees along with gathered data such as earnings,
deductions and net pays in the appropriate columns of the payroll register.

3. Totaling and proving the payroll register. It must be proved that the grand total
earnings equal the sum of the grand total of deductions and net pays in the
register.

4. The accuracy and authenticity of the information that is summarized in the payroll
should be verified by a different person other than the one who compiles it.
5. The payroll is approved by appropriate personnel.

6. Paying the payroll either in cash (this may be after cashing a check issued for the
total net pay of the payroll) or issuing a check for every individual employee for
the net amount payable to each employee.

7. Recording the payment of the payroll and recognition of the withholding tax
liabilities.
8. Recording the payroll taxes expense of the employer.
9. Paying and recording withholding and payroll tax liabilities to the concerned
authority.
Exercises
1. A permanent employee of a governmental organization with a basic monthly
salary of Birr 640 and monthly allowance of Birr 100 has worked 20 overtime
hours during days in the weekends of the current month. This employee
usually works 160 hours in a month to earn his basic salary.
Required
Based on the above information calculate
A. The ordinary hourly rate of the employee
B. The Gross earning of the employee
C. The amount of employee income tax and pension contribution
deductions.
2. Ethio Relief Agency pays the salary of its employees according to the
Ethiopian calendar month. The forthcoming data relates to the month of Hidar
1994.

Ser Basic Monthly OT hours Duration of OT

No Name of Employee salary Allowance worked work

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01 Senait Bahiru 3,200 200 10 Up to10p.m

02 Petros Chala 1,280 - 8 10 p.m to 5a.m

03 Tesgaye Tadele 1,600 - 6 weekly rest days

-
04 Leilla Jemal 1,440 100 -
public rest days
05 Kirkos Wolde 960 100 10

The management of the agency usually expects a worker to work 40 hours in a

week and during Hidar 1994 all workers have done as they have been expected.

Besides, all workers of this agency are permanent employees except Petros Chala;
the monthly allowance of Kirkos Wolde is for transportation; Tesgaye Tadele
agreed to have a monthly Birr 200 be deducted and paid to the Credit Association
of the agency as a monthly saving.

Required:
1) Prepare a payroll register (or sheet) for the agency for the month of Hidar, 1994.
2) Record the payment of salary as of Hidar 30, 1994.
3) Record the payroll tax (pension contributed by the agency) for the month of Hidar.