Unit 4

Payroll and other current liabilities

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 sate 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.
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.
2. The Pay Period: - A pay period refers to the length of time covered by each payroll
payment.
3. 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.
4. 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.
5. Employment income tax: are taxes collected from the earnings of employees by the
employer organization as per the regulations of the government. These have to be submitted

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(paid) to the government because employer organization is only acting as an agent of the
government in collecting these taxes from employees.
6. Payroll Deductions: are deductions from the gross earnings of an employee such as
employment income taxes (withholding taxes), labor union dues, fines, credit association pays
etc.
7. 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.
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 that it will be paid in cash at the
organization for each employee.
1.2 Basic Components of a payroll Register
1. 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
2. Name of employees
Even though it is advisable to assign 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.
3. Earnings
Money earned by an employee from various sources. This may include.
a. 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
b. 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 employee to compensate for inconvenient
circumstance caused by the employer. For instance, unexpected transfer to a difficult and
distant work area.
- Desert allowance- a monthly allowance given to employee because of assignment to a
relatively hot region
- Transportation (fuel) allowance- a monthly allowance to employee to cover cost of
transportation up to the workplace 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. 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:

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 i. 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
ii. 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.
iii. Two times the ordinary hourly rate for overtime work performed on weekly rest days
iv. 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
Earring
4. Deductions: are subtractions made from the earnings of employees required by the
government or permitted by the employee himself. Employment Income Tax,
Pension contribution, Payment to credit association etc 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, 286/2002 – Income
tax proclamation.
The tax rates under schedule A are Presented below
Table 1.1: Personal Income Tax Schedule
Employment Income (Per Month) Difference Income Tax rate
Over Birr To Birr
0 150 150 Exempt( Tax free)
151 650 500 10%
651 1400 750 15%
1401 2350 950 20%
2351 3550 1,200 25%
3551 5000 1,450 30%
0ver 5,000 - - 35%
Taxable income includes payment or gains in cash or in kind received form employment by
individual, including income from former employment or otherwise 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
Table : Personal Income Tax Schedule

Schedule A
Employment income per month Income Tax payable in %
(rate)
Over Birr to Birr
0 600 Exempt threshold
601 1650 10
1651 3200 15
3201 5250 20

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 5251 7800 25
7801 10900 30
Over 10900 35

T1 = Taxable income of employees

15 = (150x0.1) – 0
47.5 = + and so forth
Practically all income of individual may to be taxable. Proclamation No. 286/2002 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:
o Personal injuries suffered by that person
o 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
Name of Basic salary Position Over time Duration of OT
employee allowance Worked (hr) work

Abe be 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 over time 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
0-150 0 = Br 0
151-650 on 500 10% = 50
651-752.81 on 102.81 15% = 15.42
Total income tax………………… Br 65.42
II) Pension contribution
Basic salary X 4% = Br 730 X 0.04 = 29.20
Total deductions (Br 65.42 + 29.20) =Br 94. 62
III) Net pay = Gross earnings – deductions
752.81 – 94.62 =658.19
2- Berihun: Taxable Income: 1122
I) Income tax
Earnings tax rate Income tax
0-150 - Br 0
151-650 on 500 10% 50
650- 1122 0n 472 15% 70 .80
Total income tx…………………… Br 120.80
II) Pension contribution
Basic salary X 4% = 1020 X0.04 = 40.80
III) Payment to credit association = Br 300
Total deductions = 120.80 + 40.80 + 300 = 461.60
IV) Net pay = Gross earnings – deductions
1122 – 461.60 =660.40
3- Chekol : Taxable income = 5600
I) Income tax
Earnings Tax rate Income tax
0-150 - Br 0
151- 650 on 500 10% 50
651—1400 on 750 15% 112.50
1401—2350 0n 950 20% 190.0
2351—3550 on 1200 25% 300.00
3551—5000 on 1450 30% 435.00
5001—5600 on 600 35% 210.00
total income tax--------------------------Br. 1297.50
II) Pension contribution:
Basic salary X 4% = 5300 X 0.04 = 212.00

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 Total deductions = 1297.5 + 212 =1509.5
III) Net pay = gross earnings-- deductions
5600—1509.50 = 4090.50

4-Dagim: gross earnings = 1470

I) Income tax-
Earnings tax rate Income tax
0—150 - Br 0
151—650 on 500 10% 50
651—1400 on 750 15% 112.50
1401—1470 on 70 20% 14.00
Total income tax………………………....Br 176.50
II) Net pay = Basic salary—Income tax
= 1470—176.50 =1293.50
Payroll Register of Enjoy
Enjoy Pay roll Register shee For the month of meskerem

Name of employee Basic salary Allowance Over time Total gross Income Pension Other Total Net pay Sig
Earnings Tax deduction deduction
Abebe 730 - 22.81 752.81 65.42 29.20 - 94.62 658.19
Berihun 1020 - 102 1122 120.80 40.80 300 461.60 660.40
Chekol 5300 300 5600 1297.50 212 - 1509.50 4090.50
Dagim 1470 - 1470 176.50 - - 176.50 1293.50
Total 8520 300 124.81 8944.81 1660.22 282 300 2242.22 6702.59
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……………..1660.22
Pension contribution………………….282.00
Other deductions………………………300.00
Total deductions……………………2242.22
Net pay total………………………....6702.59
Total deductions plus net pay……………8944.81
Journal entry to record Payroll
Salary expense……………….8944. 81
Pension contribution…………282
salary payable…………………………6702.59
Pension payable……………………….282.00
Tax payable…………………………….1660.22
Credit ass. payable………………………300
Journal entry to record Payroll expense:
salary payable……………………………..6702.59
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 Pension payable…………………………..282.00
Credit ass. payable……………………….. 300
Tax payable………………………………..1660.22
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.
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 with in 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 repotted as
current liability and the remaining Br 4,000,000 will continue as long-term liability in the
balance sheet.
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.
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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.