Chapter Three

Accounting For Payroll in the Ethiopian context

Payroll: - Refers to the total amount paid to employees of a firm as a compensation for the services
rendered to the firm for a certain period of time.

Importance of payroll accounting:-

Payroll expenditures are usually significant for several reasons:

 Employees are sensitive to payroll errors or irregularities, because any employee expects the
accurate regular payment. The payroll is paid on timely accurate basis.
 Payroll expenditures are subject to various federal& state regulations
 The amount of these payroll expenditures & related payroll taxes has significant effect on the
net income of most business enterprises.

2.2. Definition of Payroll Related Terms

1. Wages:
Wages: Wages means the regular payment to which the worker is entitled in return for the
performance of the work that he/she performs under contract of employment.
employment.

In other words the remuneration for manual labor both skilled & unskilled

 Is stated on an hourly, weekly or piece of work basis.

2 Salary:
Salary: - Is payment received by employee (payment for managerial, administrative or similar
activities) for regular or normal working hours.
hours. The regular workings hours may vary from
country to country and organization to organization even within the same country.
In Ethiopia, normal working hours shall not exceed 8 (eight) hours per day or 48 (Forty eight) hours
a week. Normal working hour’s means the time during which a worker actually performs work or
avails him/herself for work in accordance with law, collective agreement, or work rules.

 The rate of salary is ordinarily expressed interims of monthly, semi-annually or annually.

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3. Employee: refers 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 fee basis to a firm.

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 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.
Formats of Payroll Register (sheet)

ABC Company

Payroll Register (sheet)

For the Month of Sept,

Sept, 2009
2009

No Name of Employee Earnings Deductions

Basic Over Allowance Total Income Pensio Credit Others Total Net pay Sign
salary Time Gross tax n association deduction
Earnings s

Prepared by _______ Verified by ________ Approved by________

Components of payroll Register (Sheet):

(Sheet):

A) Employee Number:
Number: - is assigned to employees for identification purpose when relatively large numbers of employees are
involved in payroll sheet.
B) Name of Employee:
Employee: - Lists an individual who works primarily to one organization under the supervision of the employer.

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C) Earnings – money earned by an employee(s) of a firm from various sources. It may include:
I. Basic Salary:
Salary: – Is a flat monthly salary of an employee for carrying out the normal work of
employment

- Is subject to change when the employee is promoted

II. Allowances: – money paid monthly to an employee for special reasons,

reasons, which may include:

a) Position allowance: – Is a monthly sum paid to an employee for holding (bearing) a

particular office responsibility. For example a special payment to collage Dean.
Faculty dean, vice dean, department head etc for holding office responsibility.
b) House allowance: - is monthly allowance given to cover housing costs of the
individual employee when the employment contract requires the employer to provide
housing but failed to do so.
c) Desert allowance: - is monthly allowance given to employees who are assigned in
relatively hot areas.
areas. The desert allowances vary from the temperature to temperature
and organizations to organizations. For example, if the employee is working in very
hot area: say over 40 degrees Celsius, the desert allowance can be 40% of the basic
salary. If he/she is working in hot area, say 30 to 40 degree Celsius, the desert
allowance can be 30% depending on either relevant rule or collective agreement.
d) Hardship allowance (Disturbance allowance):–
allowance):– is a sum of money given to an
employee to compensate for inconvenient circumstances caused by the employer.
employer.
Example- unexpected transfer to different and distance work area or location.
e) Transportation (fuel) allowance: - is monthly allowance given to employees to cover
cost of transportation when the employment contract includes a predetermined term to
provide transportation service from home to place of employment and from place of
employment to home, but when the employer fails to provide this service.
f) Others:
Others: - Like educational, Medical, representation, cash fault (cash indemnity) and
meal (lunch) allowances.
III. Overtime Earnings:
Earnings: - is income from overtime work done during a specific payroll period.

 Overtime work is the work performed by an employee beyond the regular working hours or
days. Over time earning depends on the duration of over time work done.

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  To determine the over time income, first we have to compute the Regular Hourly rate or the
ordinary Hourly Rate.
Rate. This is the payment per hour for regular or normal working hours. It
is determined as follows.
BsicSalary
Regular Hourly Rate (RHR) = Re gularworkinghours

 A worker who works over time shall be entitled to the following overtime payments in addition to
his/her normal salary.

1. In the case of works performed between 6(six) O’clock in the morning (6 A.M) and 10 (ten)
O’clock in the evening (10PM), the employee is entitled to be paid at the rate of one and one
quarter (1 ¼) multiplied by the regular hourly Rate.
Overtime Rate = 1.25 x RHR (Regular Hourly Rate)
Rate)

2. In the case of night works performed between 10 (ten) O’clock in the evening (10P.M) and 6
(Six) O’clock in the morning (6 A’M), the employee is entitled to be paid at the rate of 1 ½
multiplied by the regular Hourly rate
Over time Rate =1.5 x Regular Hourly Rate

3. In the case of works performed on weekly rest day,

day, the employee is entitled to be paid at the rate
of 2(two) Multiplied by regular Hourly rate.
Overtime Rate = 2x Regular Hourly Rate

NB- The Ethiopian Rest day fall on a Sunday and is granted simultaneously to all of the workers of
the task unless otherwise determined by a collective agreement to some other day of the week. We may
assume employee rest days to be weekends. But it can also be one of the weekdays.

4. In the case of works performed on public holidays,

holidays, the employee is entitled to be paid at the rate
of 2 (two) and one half (2 ½) multiplied by regular hourly rate
Overtime Rate= 2.5 x Regular Hourly Rate

NB.
NB. The overtime earning rate in higher academic institutions for academic staff is not the same as
above. The over time rate is the same for an instructor whether she/he teaches during daytime, or
evening.

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Generally, Gross earnings are composed of Basic salary, allowances, over time earnings and other
earnings.

Thus,
Gross Earnings = Bsasic Salary + Allowance + Overtime +Other earnings

D) Deductions:
Deductions: - are subtractions made from the total (gross) earnings of an employee. Some of these
deductions are mandatory and others are permitted (authorized) by the employee
him/herself (voluntary deductions).

1. Mandatory deduction includes- Employee income tax &

- Pension contributions

1- Mandatory deductions

a) Employee Income tax:

tax: - is a mandatory deduction from earnings, which is required (authorized)
by the government.

 Every citizen is required to pay employment tax to the government in almost all countries. Except
for certain types of employment, all employers’ must withhold a portion of the earning of their
employees for payment of the employees’ liability for federal income tax. The amount that must
be withheld from each employees earning differs according to the amount of gross pay.
 In Ethiopia, income tax is deducted from an employee whose earning exceeds Br 600.
600.
According to this proclamation, the tax rates and the respective income range are shown in the
following table:
Employment Income Tax Rate (in %) Deduction
(Per month) (in Birr)

Over Birr To Birr

0 600 0% -

601 1,650 10 % 60.00

1,651 3,200 15 % 142.50

3,201 5,250 20 % 302.50

5,251 7,800 25 % 565.00

7,801 10,900 30 % 955.00

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 Over 10,900 35 % 1500.00

NB- The Ethiopian employment income tax rate is a progressive income tax that charges higher rates
for higher earnings.

Exemptions

According to Article 3 of council ministers Regulations No. 78/2002 and Article 13 of income tax
proclamation No. 286/2002, the following payments in cash or benefits in kind are exempted from
employment income tax:

 Amounts paid by employers to cover the actual cost of Medical treatment of employees
 Amounts of traveling expenses paid to transport employees recruited from else where to place of
employment on Joining and to return them upon completion of employment.
 Pension contribution, provident fund and all forms of retirement benefits contributed by
employers in an amount that does not exceed 15 % of the monthly salary of the employee.

Computation of Taxable income and personal income tax

Taxable income:
income: - It is an income subject to taxation. It is determined as follows:

Taxable Income = Gross Income – Exemptions

The employment income tax can be computed in the following ways:

1. Progressive Method – The tax is computed progressively based on Employment income tax rate.
2. Deduction Method – Income Tax is determined by multiplying the Gross income excluding direct
exemptions by the tax rate of each tax bracket less the given deductions for each tax bracket.
It is determined as follows:

601-1650 Gross Salary after exemptions X 10% - 60

1,651-3200 Gross Salary after exemptions X 15% - 142.5
3,201-5250 Gross Salary after exemptions X20% - 302.5

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 5,251-7800 Gross Salary after exemptions X 25% -565
-565
7,801-10900 Gross Salary after exemptions X 30% - 955
Above 10900 Gross Salary after exemptions X 35% - 1500
Employment Income Tax = (Gross income - direct exemptions) X Tax Rate – Deduction.
Deduction.

b) Pension contribution

 In Ethiopia, Permanent employees of government organizations are required to pay or contribute

7% of their basic salary to their pension plan. This amount is withheld by the employer from each
employee on every payroll data and latter paid to social security authority. The employer is also
required to contribute to employees’ pension plan 11%
11% of the basic salary of every permanent
government employee. Therefore, the total contribution to the pension trust fund is equal to
18%
18% of the employee’s basic salary.
 This enables a permanent employee of a Government organization to get benefit monthly from
pension fund when they are retired, given that the employee has satisfied the minimum
requirements to enjoy this benefit. For example, if he/she serves for 10 years in government
organizations before retirement, the employee will be the beneficiary.
 Private and NGOs in Ethiopia also are required to use this kind of scheme to benefit their
employees, and the employer and the employees contribution are made to a fund known as
provident fund.
fund. Although both the employer and the employees are required to contribute
to this fund, their contributions vary from organizations to organizations
2. Voluntary deductions (Other deductions) - are deductions permitted or authorized by the employee
him/self, which includes: Contribution to credit association, Contributions to idir and the like, Bank loan
(repayment of loan), Health and life insurance, Donation to charitable organizations, Absentees, Penalty
and others - Like court order, fines, etc.

E) Net pays (Take home pay):

pay) is the difference between the gross earning of an employee and the total
of the deductions. Net pay = Gross Earning – Total deductions

F) Signature:-when
Signature: an employee receives his/her pay he will sign to confirm that he have received the
net pay

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 Illustration

Commercial Bank of Ethiopia Adama Branch pays the salary of its employees according to the
Ethiopian calendar month. The forth-coming date relates to the month of September, 2009
2009..

No Name of Basic Monthly Regular Over time Duration of over

Employee salary Allowanc hourly Rate Hours worked time work
e

01 Biniam Hailu Br 4,160 200 26 10 6 AM-10 PM

02 Kebede Petros 1.280 - 8 8 10 PM to 6 AM
03 Abdu Mohammed 2,560 - 16 6 Weekly Rest days
04 Jemal Mulugeta 1,920 100 12 - -
05 Kiros Teklu
Teklu 960 300 6 10 Public holiday

Additional information

 Regular working hours 40 hours in a week and during September, 2009

2009 all workers have done as
they have been expected.
 All workers of this Bank are permanent employees except Kebede Petros.
 The monthly allowance of Kiros Teklu is not taxable.
 Abdu Mohammed agreed to have a monthly Br 200 be deducted and paid to the credit
association of the Bank as a monthly saving.
 All employees agreed to contribute starting from this month their one month salaries equally
within 8 months for the current food shortage crises to Disaster prevention and awareness
commission (DPAC).

Instructions: Based on the above information; compute

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 1. Overtime earnings of each employees
2. Gross earning of each employees
3. Total deductions of each employees
4. Net pay (Take home pay) of each employee
5. Prepare payroll Register (sheet) for the Bank for the month of September, 2001
6. Record the payment of salary as of September 2001 using check No
No 40 as a source document
7. Record the payroll taxes expense for the Month of September 2001

Solution

1. Overtime (OT) Earnings of each employee

Overtime earning (OT) = (OT Rate x ordinary hourly rate) x No of OT hours worked

No. Name Computation Overtime earnings

1 Biniam Hailu (1.25 X Br 26 ) X 10 hrs = Br 325
2 Kebede Petros (1.5 X Br 8) X 8 hrs = Br 96
3 Abdu Mohammed (2X Br 16 ) X 6 hrs = Br 192
4 Jemal Mulugeta - -
5 Kiros Teklu (2.5 X Br 6) X 10 hrs = Br 150

2. Gross Earnings of Each employee

Gross Earning = Basic salary + allowance+ OT earnings

No. Name Computation Gross earnings

1 Biniam Hailu 4160 + 200 + 325 4,685

2 Kebede Petros 1280 + 0 + 96 1,376

3 Abdu Mohammed 2560 + 0 + 192 2,752

4 Jemal Mulugeta 1920 + 100 + 0 2,020

5 Kiros Teklu 960 + 300 + 150 1,410

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 3. Total deductions and net pay of each employee

Total deductions = Mandatory (compulsory) deductions + voluntary deductions

Mandatory deduction = Employee Income tax + Pension

Voluntary deduction = Credit association and others

1. Biniam Hailu

Employee income tax Pension contribution Other deductions Total deduction

(4685*0.2) - 302.5 4160*0.07 DPAC= 4160/8

TOTAL = 634.5 Br = 291.2 Br = 520 Br 1445.7

Net pay = Gross Earning – Total dedudtion

Net pay for Biniam = 4685 – 1445.7 = Br 3239.3

2. Kebede Petros

Employee income tax Pension contribution Other deductions Total deduction

(1376*0.15) - 142.5 Pension contribution is zero 1280/8
because the employee is a
contractual worker
TOTAL = Br b77.6 Br = 0 Br 160 Br 237.6

Net pay = Gross Earning – Total dedudtion

Net pay for Kepede = 1376 – 237.6 = 1138.4

3. Abdu Mohammed

Employee income tax Pension contribution Other deductions Total deduction

(2752*0.15) - 142.5 2560*0.07 (2560/8) + 200
TOTAL = Br 270.3 = Br 179.2 = Br 520 = Br 969.5

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 Net pay = Gross Earning – Total dedudtion
Net pay for Abdu = 2752 – 969.5 = 1782.5

4. Jemal Mulugeta

Employee income tax Pension contribution Other deductions Total deduction

(2020*0.15) – 142.5 1920*0.07 1920/8
TOTAL = Br 160.5 = Br 134.4 = Br 240 = Br 534.9

Net pay = Gross Earning – Total dedudtion

Net pay for Jemal = 2020 – 534.9 = 1485.10

5. Kiros Teklu

Employee income tax Pension contribution Other deductions Total deduction

Taxable income 14410- 960*0.07 960/8
300 = 1110
IncomTax = (1110*0.1)
- 60
TOTAL = Br 51 = Br 67.2 = Br 120 = Br 283.2

Net pay = Gross Earning – Total dedudtion

Net pay for Kiros = 1410 - 238.2 = 1171.8

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5 -Payroll Register (Sheet) for the Bank for the Month of Sept, 2001

Commercial Bank, Adama Branch

Payroll Register (Sheet)

For the month of Sept, 2009

2009

Earnings Deductions
Cont.to Other Total
No Name Basic Salary Allowance Over Time Gross Earnings Income Tax PC DPAC deduction deduction Net Pay Signature
Biniam Hailu 4,160
1 200 325 4,685 634.5 291.2 520 0 1445.7 3,239.30
Kebede Petros 1,280
2 0 96 1,376 77.6 0 160 0 237.6 1,138.40
Abdu Mohammed 2,560
3 0 192 2,752 270.3 179.2 320 200 969.5 1,782.50
Jemal Mulugeta 1,920
4 100 0 2,020 160.5 134.4 240 0 534.9 1,485.10
Kiros Teklu 960
5 300 150 1,410 51 67.2 120 0 238.2 1,171.80
Total 10,880 600 763 12,243 1193.9 672 1360 200 3425.9 8,817.10

Prepared by ______________________ Verified by _________________________ Approved by ____________________

Proving the payroll

NB- Total Gross Earnings = Total deductions + Total Net pay

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 6. Payment of salary as of September 2009
2009 using check No
No 40 as a source document
Salary expense…………………12,243
expense…………………12,243

Employee’s income tax payable……..1,193.9

payable……..1,193.9

Pension contribution payable ………...672

………...672

Credit association payable…………...200

DPAC payable……………………….1,380
payable……………………….1,380

Cash…………………………………8,817.1
Cash…………………………………8,817.1

7. The bank has to contribute 11%

11% of the basic salary of every permanent employee to the
government pension trust fund. Thus;

Payroll taxes expense = total basic salary of all permanent employees X 11%.
11%.

= (4160
(4160 + 2560 + 1920 + 960)
960) X 11%

Payroll taxes expense = 9600*0.11 = 1056

By the amount of Br 1056 the company’s expense, payroll taxes expense, and pension
contributions payable is increase. Therefore, the following journal entry is made as of September
30, 2009
2009:

Payroll tax expense…………1056

expense…………1056

Pension contribution payable….1056

payable….1056

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