CHAPTER - FOUR

Payroll and other current liabilities

Introduction

Section-I: Importance of payroll accounting

Accounting system for payroll and payroll taxes are concerned with the records and reports
associated with the employer-employee relationship. It is important that the accounting system
provide a safeguard to ensure that payments are in accordance to management's general plans
and its specific authorizations.

Employees of an organization are entitled to receive remuneration at regular intervals following

the close of each payroll period.

Pay roll accounting is important for the following reasons:

 Payroll often represents the largest expense that a company incurs

 Both federal and state governments require that detailed payroll records be kept
 Employees are sensitive to payroll errors or irregularities.
 Adequate payroll system safeguards the financial resources of the organization
from misuse and theft

1.1 Definition of payroll related terms

Payroll accounting involves so many generally accepted and standardized terms. This helps to
attain uniformity in the system both within the organization and with other related parties. The
following are the most common terms used in payroll accounting:

1. Salary and Wages: Salary and Wages are usually used interchangeably. However the term
wages is more correctly used to refer to payments to unskilled-manual labor. It is usually
paid based on the number of hours worked or the number of units produced. Therefore,
wages are usually paid when a particular piece of work is completed weekly. On the other
hand, salaries refers to payments to employees who render managerial, administrative or
similar services, and they are usually paid to skilled labor on a monthly or yearly basis.

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 Both wages and salaries are related to an ‘employee,’ that is, individual who works
primarily to one organization and whose activities are under the direct supervision of the
employer.

1. The Pay Period: A pay period refers to the length of time covered by each payroll
payment.
2. The Pay Day: it is the day on which wages or salaries are paid to employees. This is
usually on the last day of the pay period. Usually the last day of the month in Ethiopia.
3. A payroll Register (sheet): is the list of employees of a business along with each
employee’s gross earning; deductions and net pay (take home pay) for a particular pay period.

Then input for payroll register is the employees work hour duration summarized from any of
the following sources:

 Attendance sheets: is where employees sign at the time of arrival in the working area.
It is usually placed in offices and administrative areas.
 Punched (clock) cards; is and electronically recorded card, where each employee will
have his/her own card for registering both at the time entering and leaving the working
place. This mechanism is commonly placed at the gated of manufacturing plants.
 Time cards: is more or less similar to punched card except that the time is manually
written in hand written format by the employee.

4. Gross Earnings: are taxes collected from the earnings of employees by the employer
organization as per the regulations of the government. These have to be submitted (paid) to the
government because employer organization is only acting as an agent of the government in
collecting these taxes from employees.
5. Payroll Deductions: are deductions from the gross earnings of an employee such as
employment income taxes (with holding taxes), labor union dues, fines, credit association pays
etc.
6. Net Pay: Net pay is the earning of and employees after all deductions have been made.
This is take home pay amount collected by and employee on the pay day.

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 8. Pay Check: a business can pay payroll by witting a check for the amount of the net pay. A
check is prepared in the name of each employee and handed to employee. Alternatively a check
for the total net pay of all employees can be prepared so the it will be paid in cash at the
organization for each employee.

1.2 Basic Components of a payroll Register

 Employee Number

Number assigned to employees for identification purpose when a relatively large number of
employees are involved in a payroll register. It is always helpful to assign an identification
number (ID No) to individually identify employees. This is because; sometimes there could be
identical name for two or more employees in an organization

 Name of employees

Even though t is advisable to assign and employee identification number, it does not avoid the
need for including their names. A complete record of employee record should include both the
name and Id No. of the employee.

A. Earnings- Money earned an employee from various sources. This may include.

 Basic Salary – A flat monthly salary of an employee for carrying out the normal
work employment and subject to change with the position of the employee
 Allowances- Money paid monthly to an employee for special reasons, like:
 Position allowance- a monthly paid amount to an employee of assuming a
particular office responsibility
 Housing Allowance – a monthly allowance given to cover housing costs of the
individual employee when the employment contract requires the employer to
provide housing but the employer fails to do so
 Hardship allowance- a sum of money given to and employee to compensate for an
convent circumstance caused by the employer. For instance, unexpected transfer to
a difficult and distant work area.
 Desert allowance- a monthly allowance given to and employee because of
assignment to a relatively hot region

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  Transportation (fuel) allowance- a monthly allowance to and employee to cover
cost of transportation up to the workplace if the employer has committed itself to
provide transportation service.
 Overtime Earning: Overtime work is the work performed by an employee beyond
the regular working hours. Overtime earnings are therefore the amount paid to an
employee for overtime work performed.

Article 33 of proclamation No: 64/1975 discussed the following about how overtime work
should be paid.

A worker shall be entitled to be paid at a rate:

1. one and one-quarter ( 11/4,, 1.25) times his ordinary hourly rate for overtime work
performed before 10:00 P.M in the evening time or 4 o’clock in the evening in Ethiopia
time
2. one and one half (11/2, or 1.5 ) times his ordinary hourly rate for overtime work performed
between 10:00 P.M and six 6:00 A.M in the morning in western time or from 4 o’clock to
12 o’clock in the morning in Ethiopia time.
3. Two times the ordinary hourly rate for overtime work performed on weekly rest days
4. Two and one half ( 21/2, or 2.5 ) times the ordinary hourly rate for overtime work performed
on a public holiday

Gross Earning = Basic Salary + allowances + Overtime Earning

B. Deductions: are subtractions made from the earnings of employees required by the
government or permitted by the employee himself. The following are the most common
deductions from employee’s earning:

 Employment Income Tax: Every citizen is required to pay employee tax to the
government in almost all countries. In Ethiopia also, income tax is charged on the gross
earnings of the employee at the rated indicated under schedule A of the Proclamation
No, 979/2008 – Income tax proclamation

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The tax rates under schedule A are Presented below

Table 1.1: Personal Income Tax Schedule

Employment Income (Per Month) Income Tax payable
Over Birr To Birr
0 600 No tax
601 1650 (10%x TI) - 60.00
1651 3200 (15%xTI) – 142.50
3201 5250 (20%xTI) – 302.50
5251 7800 (25%xTI) – 565.00
7801 10900 (30%xTI) – 955.00
0ver 10,900 - (35%xTI) – 1500.00

Taxable income (IT) includes and payment or gains in cash or in kind received form employment
by and individual, including income from former employment or otherwise or from prospective
employment. In addition to the above income tax schedule of personal income tax, you can
alternatively use the following short cut procedure to calculate monthly income tax of employees

Practically all income of individual may to be taxable. Proclamation No. 979/2008 designates the
following category of income as non-taxable:
1. Income from employment received by casual employees who are not regularly employed
provided that they do not work for more than one month for the same employer in any twelve
months period
2. Pension contribution, provident fund and all forms of retirement benefits contributed by
employers in an amount that doesn’t exceed 15% of the monthly salary of the employee.
3. Payments made to ( an employee ) as a compensation or gratitude in relation to:
 Personal injuries suffered by that person
 The death of another person

Illustration on pay roll registers

Enjoy is a governmental unit established to develop tourist attractions in Amhara regional

state. It has four employees whose salaries are paid according to the Ethiopian Calendar month.
The following data relates to the month of Meskerem, 2000

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 Name of Basic Position Over Duration
employee salary allowance time of OT
Worked work
(hr)
Abebe 730 - 4 6-10 pm
Berihun 1020 - 8 Sunday
Chekol 5300 300 - -
Dagim 1470 - - -

Additional Information

 The employees usually are expected to work for 40 hours per week
 All employees are permanent except Dagim
 Berihun agreed to contribute Br 300 to credit association

Required:

1-calculate the gross earnings, deductions and net pay

2-prepare the payroll register of Enjoy for the month of Meskerem

3-Record the payment of withholding tax, pension contribution

Solution
Gross earnings = basic salary + allowance + Overtime
earnings

A)-Over time earnings and Gross earnings

Over time earnings = OT hrs worked X hourly rate X OT rate

Hourly rate= basic salary

Total monthly working hours

1-Abebe.

OT earnings = 4 hours X(730/ 160 ) X 1.25= Br 22.81

Total Gross earnings of Abebe= basic salary + OT earnings

730 + 22.81= 752.81

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 2- Berihun.

OT earnings = 8 hours X ( 1020/160) X 2 = 102

Total gross earnings of Berihun = 1020 + 102 = 1122

3-Chekol., has not worked overtime work. His gross earnings is basic salary plus his position
allowance= 5300 + 300 = 5600

4- Dagim, has not worked over time work. Gross earnings are his basic salary only.

That is Br 1470

B)- Deductions and net pay

1-Abebe: taxable income= 752.81

I) Income tax:

Earnings tax rate Income tax

0-600 0 = Br 0

752.81 10% = 15.28

Therefore tax = 752.81*10%-60

= 15.28

Total income tax………………… Br 15.28

II) Pension contribution

Basic salary X 7% = Br 730 X 0.07 = 51.10

Total deductions (Br 15.28 + 51.10) =Br 66.38

III) Net pay = Gross earnings – deductions

752.81 – 66.38 =686.43

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 2- Berihun: Taxable Income: 1122

I) Income tax

Earnings tax rate Income tax

1122 10%-60= 52.20

Total income tax…………………… Br 52.20

II) Pension contribution

Basic salary X 7% = 1020 X0.07 = 71.40

III) Payment to credit association = Br 300

Total deductions = 52.20 + 71.40 + 300 = 423.60

IV) Net pay = Gross earnings – deductions

1122.00 – 423.60 =698.40

3- Chekol : Taxable income = 5600

I) Income tax

Earnings Tax rate Income tax

5600.00 25%-565 835.00

Total income tax--------------------------Br. 835.00

II) Pension contribution:

Basic salary X 7% = 5300 X 0.07 = 371.00

Total deductions = 835.00 + 371.00 =1206.00

III) Net pay = gross earnings- deductions

5600—1206.00 = 4394.00

4-Dagim: gross earnings = 1470

I) Income tax-
II) Earnings tax rate Income tax

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 1470 1470*10-60= 87.00

Total income tax………………………....Br 87

III) Pension

Basic salary x 7%= 1470x0.07=102.90

II) Net pay = Basic salary—Income tax

= 1470—87 =1383.00

Payroll Register of Enjoy

Enjoy Pay roll Register sheet for the month of meskerem 2000

Name of Basic salary Allowance Over time Total gross Income Pension Other Total deduction Net pay Sig
employee Earnings deduction
Tax

Abebe 730 - 22. 752 15. 51. 66 686

.00 81 .81 28 10 - .38 .43
Berihun 1,020 - 102. 1,122 52. 71. 300. 423 698
.00 00 .00 00 40 00 .40 .60
Chekol 5,300 300. 5,600 835. 371. 1,206 4,394
.00 00 .00 00 00 - .00 .00
Dagim 1,470 - 1,470 87. 102. 189 1,280
.00 .00 00 90 - .90 .10
Total 8,520.00 300.00 124.81 8,944.81 989.28 596.40 300.00 1,885.68 7,059.13

Proving the payroll

The accuracy of the payroll calculation can be checked using the appropriate journal entry as
follows

Total earnings:

Basic salary--------------------8520

Allowances---------------------300

Overtime-----------------------124.81

Grand total ………………8944.8

Deductions:

Employment income tax……………..989.28

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 Pension contribution………………….596.40

Other deductions………………………300.00

Total deductions……………………1885.68

Net pay total………………………....7059.13

Total deductions plus net pay……………8944.80

Journal entry to record Payroll

Salary expense……………….8944. 80

salary payable…………………………7059.12

Pension payable……………………….596.40

Tax payable…………………………….989.28

Credit ass. payable………………………300.00

Journal entry to record Payroll expense:

salary payable……………………………..7059.12

Pension payable…………………………..596.40

Credit ass. payable……………………….. 300

Tax payable………………………………..989.28

cash……………………………………………8944.81

Section-2: Current liabilities and contingent liabilities

This section introduces you with current and contingent liabilities. Liabilities that are to be paid
out of current assets and are due with in a short time usually with in one year are called current
liabilities.

4.2.1 Nature of current liabilities

Most current liabilities arise from two basic transactions:

 Receiving goods or services prior to making payment

 Receiving payment prior to delivering goods or services.

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 An example of the first type of transaction is accounts payable. Accounts payable arises from
purchase of merchandise for on account. An example of the second type of liability is unearned
rent arising from the receipt of rent in advance.

Some additional examples of current liabilities are wages payable, salary payable, interest
payable and taxes payable.

The current liability section of the balance sheet can contain items that are used to finance
business operations, such as short-term notes payable and the portion of long-term debt that is
due with in the current period.

Notes Payable: Notes may be issued when the merchandise or other assets are purchased. They
may be also issued to creditors to temporarily satisfy an account payable created earlier. Foe-
example, assume That a business issues a-90-day, 12% note for Br 1000, dated August, 1,
2006 to Brothers company for a 1000 overdue account. The entry to record the issuance of the
note is:

Accounts payable ..........1000

Notes payable...................1000

(Issued a 90-day, 12% note on account)

When the note matures, the entry to record the payment of Br 1000 principal and Br 30 interest
(1000 X 12% X 90/360) is as follows:

Notes payable....................1000

Interest expense..................30

Cash---------------------------1030

(Paid principal and interest due on note)

4.2.2: Current portion f long-term liability

Long-term liabilities are often paid back in periodic payments, called installments. Long-term
liability installments that are due within the coming year must be classified as current liability.
The total amount of the installment due after the coming year is classified as current liability.

Example: ADAMA textile purchased Cotton from Humera co For Br 6,000,000, payment to be
made in three equal annual payments in January 2006. Assume a debt of Br.2, 000,000 will due
in the year 2006. The debt of Br 2,000,000 that will due in the current year will be reported as
current liability and the remaining Br 4,000,000 will continue as long-term liability in the
balance sheet.

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 4.2.3: Contingent liabilities

Some past transactions will result in liabilities if certain events occur in the future. These
potential obligations are called Contingent liabilities.

If a contingent liability is probable and the amount of the liability can be reasonably estimated,
it should be recorded in the accounts.

If it is hard to reasonably estimate the amount of the contingent liability, such contingents
should be disclosed to the financial statements. That is such contingents cannot be reported in
the body of the financial statements as current or long-term liabilities.

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