PROCESS PAYROLL

Accounting for Ethiopian Payroll systems

This guide will also assist you to attain the learning outcome stated in the cover page. Specifically,upon
completion of this Learning Guide, you will be able to –
 Understand the importance of payroll accounting
 Define payroll related terms
 Describe the components of a payroll register
 Calculate employees’ gross earnings and deductions and net pay.
 Enter employee pay period details, earnings and allowances, and deductions in payroll recordin
accordance with source data
 Prepare payroll in accordance with the Ethiopian Income Tax legislation
 Prepare journal entries to record the payroll.

 What does the term "Payroll" Mean?

 The concept payroll is often referred to the total amount paid to employees of a firm as a compensation
for the service rendered to a firm in a given period of time
 The distribution of paychecks (physical or electronic) to employees each payday, as in "I finished doing
payroll yesterday." The financial records for employee wages/salaries, withholding, deductions, bonuses,
pay for time not worked (holidays, vacations, sick time, etc.) and other items on employee paychecks.
 It can also mean the record of total earnings of all employees for a company in a fiscal year.
Payroll processing describes the preparation of paychecks (including withholding and deductions), distribution
of paychecks, and payment and porting of payroll taxes. Options for payroll processing include doing it yourself
with accounting software, hiring a bookkeeper, or engaging a payroll service. It is the financial record of
employees' salaries, wages, bonuses, net pay, and deductions
Payroll is Total amount required to pay workers and employees during a week, month or other period. Pay
sheet which records wage rates, deductions, and net pay.
OBJECTIVES OF PAYROLL SYSTEM

Accounting for payroll is particularly important because:

1. payroll often represents the largest expenses that any organization incurs
2. Payroll expenditures are subject to various government regulations. both Federal and State
governments require that detailed payroll records be kept, and
3. Employees are sensitive to payroll errors or irregularities.
4. To maintain good employee morale payroll must be paid timely and accurately.
5. Employees are sensitive to payroll errors and irregularities,
6. The payment for payroll and related taxes has significant effect on the net income of most business is
unquestionable.
Moreover, since the payroll related payment is highly subject to certain fraudulent activities it is imperative
that businesses need to properly design their payroll system so that it safeguards the company’s assets
against unauthorized payments of payroll and the accuracy as well as reliability of the accounting records is
assured pertaining to payroll. Some of the possible frauds that can be made on the payroll system are the
following:
 Adding fictitious employees to the payroll
 Listing terminated employees on the payroll
 Using unauthorized pay rates
 Overstating working hours
 Issuing duplicate payroll checks
 Not deducting employees’ absent time
 Making incorrect totals on the payroll register
II. Definition of Payroll Related Terms
Salary or Wages:
Salary and wages are usually used interchangeably. However, the term wages is more correctly used to
refer to payments for manual labour that are paid based on the number of hours worked or the number of
units produced. So, they are usually paid when a particular piece of work is completed or weekly. On the
other hand, compensations to employees on monthly or annual basis are termed as salaries.

It must be clear that when we say an employee, we refer to an individual who works primarily to an
organization and whose activities are under the direction and supervision of the employer. Hence, an
employee is different from an independent contractor, a self-employed individual who works on a fee basis
to a firm.
The Pay Period:
The length of time covered by each payroll payment. Pay period for wage workers are usually made on
weekly or biweekly. On the other hand, salaried employees’ pay periods are monthly or semimonthly.
The Pay Day:
The day, on which wages or salaries are paid to employees, usually the last day of the pay period, is known
as the payday.

Basic records of a payroll accounting system include:

1. A payroll register (or sheet)
2. Individual employees’ earnings records, and
3. Usually, pay checks.
These records are generated from a payroll system that is operated manually or using computers.
A Payroll Register (Sheet): The entire list of employees of a business along with each employee’s gross
earnings, deductions and net pay (or the take home pay) for a particular payroll period. The basis for the
preparation of the payroll register can be the attendance sheets, punched (clock) cards or time cards.
Employee Earnings Record: It is a summary of each employee’s earnings, deductions, and net pay for
each payroll period and of cumulative gross earnings during the year. It 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.
Gross Earnings: The total pay to an employee before deductions for the pay period.
Payroll Taxes: Are taxes levied against the employer on the payroll of a firm. It is an additional payroll
related expense to an employer.
Withholding Taxes: These are taxes levied against the earnings of employees of an organization and
withheld by the employer per the regulations of the concerned government.
Payroll Dedications: All the reductions from the gross earnings of an employee such as withholding taxes,
union dues, fines, credit association pays, etc.
Net Pay: The gross earnings after subtracting all the deductions. An employee sometimes knows it as take
home pay, the amount collected on the payday.

Lo2:- . Payroll preparation

The input of information to the payroll department consists of hours reported by the timekeeping
department, and authorized names, pay rates and payroll deductions received from the personnel
department. The output of the payroll department includes preparing (but not signing) payroll checks,
maintaining individual employee records of earnings and deductions, as well as making regular reports to
the government showing employees earnings and taxes withheld. Upon the completion of this learning
objective, the trainee will able to

 understand the nature of a payroll register

 describe the components of a payroll register
 calculate employees’ gross earnings and deductions and net pay
 Enter properly all components in to appropriate column of a payroll register.

Nature of a Payroll Register

It is a multi-column form used in assembling and summarizing the data needed for each payroll period. It
shows the entire list of employees of the business along with each employee’s gross earnings, deductions
and net pay (or take-home pay) for a particular payroll period. It is a detailed listing of the firm’s total
payroll.
The pay period is the length of time covered by each payroll payment. For wage workers the pay periods
are usually made on weekly or bi-weekly. Salaried employees’ pay periods are monthly or semi-monthly.
Attendance sheets, punched (clock) cards or time cards, together with information from the personnel
records enable to update the employee earnings record and prepare the payroll register. Once the
preparation of the payroll register is completed it should be verified and approved by concerned
officials.

Possible Components of a Payroll Register

1. Employee number: Numbers assigned to employees for identification purpose when a relatively
large number of employees are included in the payroll register.
2. Name of employees: List of the names of employees
3. Earnings: money earned by an employee(s) of a firm from various sources. It may include:
a. The 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 reasons, which may include.
i. Position Allowance: A monthly sum paid to an employee for bearing a particular office
responsibility, 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 requires 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. For instance, unexpected transfer to a different and distant
work area or location. It 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 Earning
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, in this respect, according to Article 33 or proclamation no. 64/1975 the following is stated
about payment for overtime work.
 A worker shall be entitled to be paid at a rate of one and one quarter (1 ¼) times his ordinary hourly
rate for overtime 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 his 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 a.m.)
 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 the ordinary hourly rate for overtime work
performed on a public holiday.
Hence the gross earnings of an employee may, therefore, include the basic salary, allowances and overtime
earnings. You may find sometimes other form of earnings such as bonus that is paid to employees for
achieving results better than usual.
4. Deductions
These are subtractions made from the earnings of employees that is because it is required by government or
permitted by the employee himself.
In our country, Ethiopia, some of the deductions against the earnings of employees are:-
a. Employee Income Tax
In Ethiopia every citizen is required to pay something in the form of income tax from his/her earnings of
employment. In this case a progressive income tax system that charges higher rates for higher earnings is
applied on the gross earnings of each employee. According to the amended income tax proclamation no.
286/2008 the tax on income from employment over one hundred fifty (Br 600) shall be charged, levied and
collected according to the following income tax rates.
Tax rate for personal income tax:
Income level Tax rate Deductions
0 – 600 0% 0
601 -1,650 10 % 60
1,651 -3,200 15 % 142.50
3,201 – 5,250 20 % 302.50
5,251 – 7,800 25 % 565
7,801 – 10,900 30 % 955
>10,900 35 % 1,500

Generally, taxable income from employment includes salaries, wages, allowances, director’s fees and other
personal employment, all payments in cash and benefits in kind.
However, according to 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.
 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 expenses paid to transport employees from elsewhere to place of employment and to
return them upon completion of employment.
b. Pension Contributions
Permanent employees of an organization, the employees of which are governed by the existing regulations
of the 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 withheld 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 11% of the basic
salary of every permanent employee of it. It is this total amount we called earlier as payroll taxes expense
to the employer organization (i.e., 18% of the total basic salary of all permanent employee).
Consequently, the total contribution to the pension trust fund of the Ethiopian government is equal to 18%
of the total basic salary of all permanent employees 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.
Ultimately, when as employee retired or drawn out of work a lump sum amount is given at once.
c. Other Deductions
Apart from the above two kinds of deductions from employees earnings, employees may individually
authorize additional deductions such as deductions to pay health or life insurance premiums; to repay loans
from the employer or credit association; to pay for donations to charitable organization; 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 given the total deductions from the
gross earnings of employees.

5. 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 grand total deductions made from
the earnings of employees.

6. Signature
Unless some other document is used, the payroll sheet may be designed to allow a column for signature of
the employees after collection of the net pay. In general, a payroll register should at least show the
earnings, deductions and the net pays along with the name of employees
MAJOR PROCEDURES OR ACTIVITIES INVOLVED IN ACCOUNTING FOR PAYROLL

1. Gathering the necessary data. All the relevant information about every employee should be gathered.
This activity requires reviewing various documents and to do so some arithmetic work.
2. Including the names of employees along with the 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 to the
sum of the grand totals of deductions and net pays in the register.
4. The accuracy and authenticity of the information summarized in the payroll should be verified by
different person from the one who compiles it.
5. The payroll is approved by the authorized personnel
6. Paying the payroll either in cash 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 tax expense of the employer
9. Paying and recording withholding and payroll tax liabilities to the concerned authority in our case to
the Inland Revenue Authority, on time.
Controlling and Recording Payroll Withholdings
 Internal control for payroll systems
 Liabilities for employs' fringe benefits, vacation pay, pension, health, and life and disability
insurance

Addis Tire Factory

Payroll Register
For the Month Ended, Tir 30,1995
S.N Name of employee Sex Earnings Gross Deductions Total Net

Basic Allow. OT Earnings Income Pension Others Deduction Pay

salary
Earnings Tax

01 Abebe Kebede M

02 Fatuma Ali F

03 G/Meidihin M

04 Selamawit Teshome F

05 Tesema Tollosa M

Grand total

Prepared by_______________Checked by________________Approved by___________

Recording Payroll Related Data of a Business Firm

Upon the completion of this learning objective, the trainee will able to
 Record Salary expenses and payroll liabilities
 Record salary payment
 Record payroll expense
 Record payment of payroll liabilities and other withholdings
When the payroll register has been completed and checked, the general entries relating to payroll can be
made based on the column totals from the payroll register. Note that each account debited and credited is
the total from the payroll register entries related to payroll:
1. Entry for employees’ salaries, various payroll deductions, and net pay
2. To record payment
 3. To record payment of withholding and
4. payroll tax liabilities
Recording the payment of salary on Tir 30,
Tir 30 Salary expense---------------------------XXXX
1995 Cash-----------------------------------------XXX
Income tax payable-----------------------XXX
Pension payable----------------------------XXX
Payable to hope enterprise----------------XXX

N.B
1. The amount of cash paid to the employee is equal to the net pay amount on the payroll register.
2. Salary expense is equal to the gross earnings of the employees on the payroll register, which is also
equal to the sum of total deductions and net pay.
3. Recording payroll tax expense
In Ethiopian case all government organizations are required by law to contribute 7% of the basic salary of
each permanent employee to the pension fund. This means that the total pension contribution is 18% of the
basic salary of permanent employees of which 7% is contributed by the employees and the remaining 11%
is contributed by the employer organization. Therefore, the payroll tax expense of Addis Tire Factory will
be: Basic salary of permanent employees X 11%
The journal entry to record the payroll tax expense will be
Tir 30 Payroll tax expense-----------------XXX
1995 pension payable------------------------XXX
(4) To record the payment of cash to hope enterprise
Yekatit 5, Payable to hope enterprise----------------XXX
1995 Cash------------------------------XXX
(5) Payment of withholding and payroll tax on Yekatit 6, 1995.

The journal entry to record the payment of withholding taxes and payroll tax will be
Yekatit 6, 1995 income tax payable---------------------------XXXX
Pension payable--------------------------------XX
Cash-------------------------------------------------XXXXX
ILLUSTRATION I
Addis Tire factory, a public business organization, pays the salary of its employees according to the
Ethiopian calendar month. The forth-coming data related to the month of Tir, 1995.

S.N Name of Employee Basic Monthly OT hours Duration of work

salary allowance worked
01 Abebe Kebede 3800 400 15 Up to 10 P.M.
02 Fatuma Ali 2500 200 12 6 hours up to 10 P.M.
6 hours on public holiday
03 G/Medihin Alemu 1600 _____ 6 Weekly Rest days
04 Selamawit Teshome 900 100 _____ ______
05 Tesema Tollosa 400 100 20 15 hours on weekly rest days and
5 hours during public holidays

Additional information
 The management of the organization usually expects all workers to work 160 hours in a month
 During the month of Tir 1995 all workers have done as expected.
 Besides, all workers of the organization are permanent employees except G/Medhin.
 50% of the monthly allowance of Abebe and 100% of the monthly allowance of Selamawit is not taxable.
 Fatuma & Abebe agreed to contribute monthly of Birr 100 each for a charity organization (Hope enterprise).
Instructions:
Based on th above information
1. Prepare a payroll register for the organization for the month of Tir 1995.
2. Record the payment of salary as of Tir 30, 1995 using cash.
3. record the payroll tax expense for the month of Tir
4. record the payment of the claim of the Charitable organization that arose from Tir’s payroll assuming that
the payment was made on Yekatit 5, 1995
5. Assuming that the withholding taxes and payroll taxes of the month of Tir, 1995 have been paid on Yekatit
6, 1995, record the required journal entry.