4.

2 Accounting for payroll system in Ethiopian context

4.2.1 INTRODUCTION
A business periodically pays employees for their services. The money paid for an employee's services is
known as a salary. The period covered by a salary payment is called a pay period. Not all businesses base
their salary payments on the same length of time. A pay period may be weekly, biweekly, semimonthly,
or monthly. The same procedure is used for figuring a salary regardless of the length of the pay period.
Various methods of recording payroll are used by different organizations.
The method used depends on the number of employees and the type of office equipment available. To
facilitate the preparation of payroll, many business use automated data processing equipment. The basic
accounting principles are the same regardless of whether manual or automated methods are used. In this
topic, most of the accounting principles and procedures related the payroll systems in Ethiopia context
will be discussed thoroughly.
4.2.2 OBJECTIVES OF PAYROLL SYSTEM
Accounting for payroll is particularly important because:
1. payroll often represents the largest expenses that any organization incurs
2. both Federal and State governments require that detailed payroll records be kept, and
3. Employees are sensitive to payroll errors or irregularities. To maintain good employee morale payroll
must be paid timely and accurately.
4..2.3 DEFINITION OF PAYROLL RELATED TERMS
Before undertaking the detailed discussion of payroll accounting, a brief description of the following
terms will be helpful.
1. Salary and wage
Salary is a fixed amount of compensation paid per week, per month, or even per year, no matter how
many hours are worked during the designated period. The employer and employee determine the
employee’s salary by mutual agreement before the employee begins to work for the employer.
Management personnel are generally compensated by salary.
Wage is the amount of income paid to an employee, calculated by multiplying a wage rate (per hour, per
day, or per unit of product output) by actual employee activity (so many hours or days worked or so much
output produced). Wage is usually paid to production workers and employees working on a contract basis.
Both salaries and wages relate to an employee who works primarily to one employer and whose activities
are under the direct supervision of the employer.
2. Deductions
Deduction from gross earnings of an employee can be as per government regulation, employees request,
court order, and so on.
There are two types of deductions:
2.1. Voluntary Deductions: These types of payroll deductions are deductions at request of the
employee. Examples of voluntary deductions include employee’s credit and saving plan,
contribution for HIV/AIDS patients, contributions for charitable organizations, labor union dues,
and insurance premiums. The employer’s role in these types of deductions is perform a service
by acting as an intermediary between the employee and the organization that is to receive the
deductions.
2.2. Involuntary Deductions: Unlike voluntary deductions, these types of deductions are made
because the law or the employer’s policy requires. Examples of involuntary deductions include
employment income tax, pension or provident fund contribution, and more often deductions
ordered by court.
Both voluntary and involuntary deductions from the employee’s income do not revert to the
employer. Instead, the employer acts as a collector, passing the amount deducted on to the proper
recipient. Thus, the amounts of employee deductions are the employer’s current liabilities until
they are paid to the appropriate organization.
3. The pay period
 A pay period is a period for which a payroll payment covers, usually a calendar month. The pay
period is often set depending on the employee’s payroll payment policy, such as a week, 15 days, or a
month.
4. The pay day
The pay day is the day on which salaries or wages for the specific pay period is officially paid to
employees. Note, however, that a payday may vary from one organization to the other. It also differs
among organizations that follow Gregorian calendar month and business that follow Ethiopian
calendar month. Most often, a pay day in most organizations is set before the last day in most
organizations.
5. Gross earnings
Is a total income an employee is entitled to earn during a specified pay period before any deductions
are made. The distinguishing features of a gross earnings is that the same employee can earn a
different amount of gross earning in different pay periods as a result of such factors as overtime.
6. Net pay
A net pay often referred as “Take Home” pay, is the net earning of an employee often all deductions
for the Gross Earnings. In other words, it is Gross Earnings less Deductions.
7. A payroll register (sheet)
A payroll register is a multi-columned document in which all employee’s compensations (earnings)
and all the deductions are originally recorded. The source documents for the payroll register can often
be a time clock card on which the employee’s salary (wage rate) and the number of hours that the
employee has worked during the pay period are recorded and, attendance sheets. The various columns
in the payroll register become summary entries in the appropriate ledger accounts. Detailed
discussions of the various parts of the payroll register will be made in the subsequent sections.
8. A pay check:
Some organizations pay their employee’s by writing checks for the amount of the net pay. In such
case, the employer prepares the check in the name of each employee and hands over to the employee
for disbursement. Alternatively, other organizations pay their employees through banks by directly
depositing each employee’s net pay to their individual bank accounts (saving accounts). The most
common mode of salary payment, however, is through the company’s cashier; the company prepares
a check for the total of the period’s net pay in the name of the cashier and then the cashier collects the
cash for payment to each employee within the compounds of the organization.
9. A business periodically pays employees for their services: - The money paid for employees’ services
is known as a salary or wage.
The term salary is usually applied to payment for managerial, administrative or similar services. The rate
of salary is ordinarily expressed, usually, in terms of a month. Payment for a manual labor, both skilled
and unskilled is commonly referred to as wage and it is stated in hourly, weekly or piecework basis. In
practice the terms salary and wage are used interchangeably.
10. Payroll: - The total amount paid to all employees for a pay period is called a payroll.
11. Payroll Tax: - Taxes based on the payroll of a business is called payroll taxes. A business is required
by law to pay certain payroll taxes. All payroll taxes are based on employee's earnings.
12. Withholding Tax: - The amount of money deducted from salaries earned by employees and withheld
by the employer on behalf of other parties. Examples, include income tax and pension contribution.
13. The Payroll Register (payroll sheet): - A business form on which all payroll information is recorded
is called a payroll register. A payroll register is a multi-columnar form used to organize the payroll
data of an organization at the end of each pay period.
14. Employee’s earnings record: -employee’s earnings record is a summary of employees’ earnings,
deductions, and net pay for each pay period. It is a separate record kept for each employee’s earnings,
deductions, and net pay for each pay period.
4.2.4 COMPONENTS OF A PAYROLL REGISTER
In this section of this chapter, we will discuss the most common components of a payroll register in
detail. As defined in the previous section, a payroll register is a document maintained by the employer on
which all records relating to every employee’s data is recorded.
The most common components that a payroll register may contain are as follows:
1. The payroll period 6. Net pay
2. Employee number 7. Employee’s signature
3. Employee’s name
4. earnings
5. Deductions
1- The payroll period payroll register should contain a payroll for which the payroll register is
prepared. The payroll period helps the users of the payroll register to simply identify one period
from the other.
- Payroll for the month 200x
- Payroll for the period from to 200x.
2- Employee number Employee number may be a sequential number or a code designed for
identifying each employee. It is very important for companies with a large number of employees.
3- Employee name: In addition to employee number, full name of each employee to be included in
that specific payroll register should be described in a payroll register.
4- Earnings: The earnings sections of a payroll register is a section which contains the various
sources of an employee’s income for the payroll period.
The most common sources of an employee’s income, elements of employee’s earnings, are discussed in
brief as follows:

Basic Salary
Basic salary is a fixed amount (ordinary salary) of salary per a given pay period, set by the mutual
agreement of the employer and the employee. It is the most frequent source of income for the employee
and is a basis for the other related earnings of an employee.
Basic salary usually remains fixed until the employee is promoted or if there is increment in salary.
Allowances
An allowance is the amount of money paid periodically to an employee for some specific reasons such as
supporting, compensating the employee for inconveniences that result while working for the company.
Common types of allowances
i) Position allowance
Position allowance is a type of earning paid to an employee for holding a particular responsibility
in the office. It may also be paid to employees who are covering additional responsibility beyond
his position. For example, a chief accountant in a company may receive a position allowance if
his supervisor (finance manager) is sick for a longer period or if the position of his supervisor is
vacant and he covers that position’s responsibility. (Note, however, that his position allowance
will terminate if his supervisor maintains the position back or if the vacant position is filled by
another person.).
ii) Hardship allowance:
This type of allowance is given to an employee when he/she is exposed to an inconvenient
working environment (due to the nature of the job or if the inconvenience is caused by the
employer). For instance, an employee suddenly transferred to a different or distant working area
may receive a hardship allowance as a compensation.
 iii) Housing allowance
Companies that maintain a policy in their contractual agreements to provide a house for their
employees, especially for very important staffs, sometimes, though, if the company fails to
fulfill the service, it will compensate the employee by paying him/her a specified amount to
cover the housing rent. This type of allowance is referred to as a housing allowance.
iv) Desert allowance
This type of allowance is paid to an employee as a compensation for the assignment or transfer
to desert/hot locations.
v) Transport/fuel allowance:
Companies that maintain a policy to provide a transport service to their employees pay their
employees a transport allowance to cover their transportation costs up to their work place, if
the company fails to provide the service. Fuel allowance, on the other hand, is usually paid to
employees who are individually given a company’s car and or for employees who use their
private car for the company’s use (mostly Top Management Personnel). Hence, a fuel
allowance is paid to them to cover their fuel cost.
vi) Cash indemnity allowance:
Cash indemnity allowance is a special type of allowance paid to cashiers who are responsible for
the custody of company’s cash. The objective of cash indemnity allowance is to compensate
cashiers for cash shorts that may result from payments made by cashiers for the company’s
normal operation during a specific period.
vii) Other allowances
These types of allowances are paid to employees for compensating employees for reasons other
than the above categories. For example, employees working in factories where there is dust from
machineries, employees working in chemical industries may be given a special allowance for
milk.
Overtime Earnings
An overtime earning is another source of income for an employee. It is a payment made to employees
working in excess of the normal (regular) working hours in a given period, set by the company. In
addition, it is also paid for works performed during official “Non-working-days” declared by government.
Overtime payment is calculated by multiplying the excess hours worked by the hourly regular salary rate
and by applying the appropriate overtime rate set by the government. Basic salary or wage rate is a basis
for calculating the hourly regular salary rate of an employee.
In Ethiopian context, Article 33 of proclamation No. 64/1975 sets the following overtime rates to be
applied in calculating payments for overtime worked.
i) One-and-one quarter (1 ¼) times the ordinary hourly rate for overtime works performed
before 10:00 PM in the evening.
ii) One-and-one half (1 ½) times the ordinary hourly rate for overtime works performed between
10:00 PM in the evening and 6:00 AM in the morning.
iii) Two (2) times the ordinary hourly rate for work performed on week-ends (weekly rest days).
iv) Two-and-one-half (2 ½) times the ordinary hourly rates for work performed on public
holidays.
In calculating overtime payments, it is very important to properly identify and describe the time of
overtime performance in order to classify the overtime work to the above overtime rate categories. It is
also important to consider the normal (regular) working hours of the company in that specified period and
determine the regular hourly salary or wage.
Gross earning of an employee for the specific pay period is, therefore, the sum of basic salary, allowance,
and overtime earning.
Other Conditional Payments (Earnings)
In this types of earnings, an employee or employees are paid some amount of money depending on the
occurrence of some specified conditions. The distinguishing characteristics of these payments are that
they don’t frequently appear in a payroll.
Two common categories of conditional earnings
i) Vacation, holiday, and leave pays: These kinds of earnings, commonly referred to as
“compensated absences”, are payments to be made for employees usually as a compensation for
serving the organization. The right to such payment usually depends on the length of
employment, and may increase often an employee completes a specified number of years of
service.
ii) Bonus and profit sharing plans: contractual agreements covering royalties or employee
compensations sometimes call for conditional payments in an amount dependent on revenue or
income for an accounting period. Some organizations may also provide their employees with a
bonus, to encourage or motivate performance, which does not necessarily depend on the
organization’s profitability. Others may also entitle their employees to share some amount of
money from the profit of the company. In general, the term “bonus” is commonly used to
describe payments of these kinds.
Examples of bonus may include 1 month basic salary, as a New Year gift, sharing of 20% Net income of
a company among employees, and etc.
Hence the gross earnings of an employee may therefore, include the basic salary, allowance and overtime
earnings (Gross earnings = basic salary + allowances + overtime).
Deduction
In the early section of this chapter, we have defined deductions as subtractions from an employees
earning as a requirement by government or by the request of the employee himself. These deductions can
further be categorized into two as (1) Voluntary and (2) Involuntary Deductions. The next part of
discussion will cover the most common types of deductions in brief.
Employment Income Tax
Employment income tax is collected from an employee’s earning a tax for earning a tax collector for the
government and later pays the withhold tax to the appropriate government body.
In the Ethiopian context, citizens deriving income from employment are required to pay income
tax.Proclamation No.979 /2008 discussed the following income tax:
Every person deriving income from employment is liable to pay tax on that income at the rate specified in
Schedule ‘A’, set out in Article 11 of this proclamation. As it can be seen in Schedule ‘A’ below, the first
Birr 600 (one hundred fifty Birr) of employment income is excluded from taxable income.
Schedule A
Employment Income Tax Rate
Employment Income (per month) Income Tax Payable (%)
Over Birr To Birr
0 600 Exempt threshold (free)
601 1.650 10
1.651 3,200 15
3,201 5,250 20
5,251 7,800 25
7,801 10,900 30
Over 10,900 35
Schedule A also clearly sets the maximum percent of income tax payable as 35% for all income in excess
of Birr 10,900 per month.
Article 10 of proclamation No. 979/2008 also states that employers have an obligation to withhold the tax
from each payment to an employee and to pay to the Tax Authority the amount withheld during each
calendar month. In applying the preceding income attributable to the month of Nehassie and Pagumen
shall be aggregated and treated as the income of one month.
According to this proclamation, taxable income includes any payment or gains in cash or in kind received
from employment by an individual, including income from former employment or otherwise or from
prospective employment.
To illustrate the calculation of income tax payable to the Tax Authority, we shall look at the following
example. If an employee earns a basic salary of Birr 975 per month, the amount of income tax withheld
by his employer will be:
In this case Taxable Income = Basic Salary
= 2,975
Income Tax = (0 X 600) + (10% X (1,650 – 600)) + (15% X (2,975 -1,650))
= 0 + (10% X 1,050) + (15% X 1,325)
= 0 + 105 + 198.75
= 303.75
Therefore, the company withholds Birr 303.75 of income tax from the employee.
In the example above if the same employee earns an overtime of Birr 440 in the same month, the amount
of tax to be deducted will be:
Taxable Income = Basic Salary + Overtime Earning
Taxable Income = Birr 2,975 + Birr 440 = Birr 3,415
Income Tax = (0 X 600) + (10% X (1,650 – 600)) + (15% X (3,200 – 1,650)) + 20% X (3,415 – 3,200)
= (0 X 600) + (10% X 1050) + (15% X 1550) + (20% X 215)
= 0 + 105+232.5 + 43
= 380.50
Birr 380.50 is the amount of tax to be paid by the employee for the month.
Simple short cut to calculate Income Tax.
Employment Income (per month) Income Tax Payable (%)
Over Birr To Birr
0 600 Tax Free
601 1.650 (0.1 X TI) – 60
1.651 3,200 (0.15 X TI) – 142.50
3,201 5,250 (0.2 X TI) – 302.50
5,251 7,800 (0.25 X TI) – 565
7,801 10,900 (0.3 X TI) – 955
Over 10,900 (0.35 X TI) – 1,500

Note: The numbers at the right side of the minus sigh indicate the amount of income that doesn’t apply to
that specific tax rate. In other words, those numbers are derived by multiplying the tax rate differences
between the preceding tax rates and the rate applicable to that specific income category by the amount of
income subjected to tax in the preceding tax categories. For example, Birr 60 in the 10% tax category is
derived as Birr 600 X (10% - 0%), i.e. 10% of non-taxable income (Birr 600). In the same manner, Birr
142.50 in the 15% tax category is derived as
= Birr 600 X (15% - 0%) + Birr (1,650 – 600) X (15% - 10%)
= Birr 90+ Birr 52.5 = Birr 142.50
The same trend is followed for the rest of income tax rate categories.
In the above two examples of income tax we can use the short cut method that will result the same figure.
In the first case (Taxable Income = Basic Salary (Birr 2,975) taxable income of birr 2,975 lies in the 15%
tax category. Hence,
Income Tax = (0.15 X TI) – 142.50
= (0.15 X 2,975) – 142.50
= 446.25 –142.50 = 303.75 Birr
While in the second case where Taxable Income is Birr 3,415, which lies in the 20% tax rate category.
Income Tax = 0.2 TI – 302.50
= (0.2 X 3,415) – 302.50
= 683 – 302.50 = 380.5 Birr
Non-Taxable Incomes: the Ethiopian income tax proclamation No. 286/2002 identified the following
income categories as non-taxable:
a. Income from employment received by casual employees who are not regularly employed
provided that they do not work for more than one (1) month for the same employer in any twelve
(12) months period.
b. 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.
c. Payment made to a person as compensation of a gratitude in relation to:
a. Personal injuries suffered by that person
b. The death of another person
d. Income from employment received for their service by diplomatic and consular representatives,
other persons employed in any embassy, legation, consulate or mission of a foreign state
performing state affairs are usually exempted from tax.
As indicated in the Ethiopian Council of Ministers income tax regulations No. 87/2002 the following
categories of payments in cash or benefits in kind are excluded from computation of income taxable
under schedule ‘A’ of proclamation No. 979/2008.
- Amount paid by employers to cover the actual cost of medical treatment of employees (medical
allowance);
- Allowances in line of means of transportation granted to employees under the contract of
employment;
- Hardship allowances;
- Amount paid to employees in reimbursement of traveling expenses included in duty;
- Amounts of traveling expense paid to employees recruited from elsewhere than the place of
employment on joining and completion of employment or in case of foreigners traveling expenses
from or to their country, provided that such payments are made pursuant to specific provisions of
the contract;
- Allowances paid to members and secretaries of boards of public enterprises and public bodies as
well as to members and secretaries of study groups set by the federal or regional government;
- Income of persons employed for domestic duties:
Pension/Provident Fund Contribution
In addition to income tax deductions, pension/provident fund contributions is another common type of
deductions from employee’s income. Governmental organizations in Ethiopia are expected to provide
their permanent employees with a plan that will entitle their employees to a pension plan during
retirement. Every permanent employee is expected to contribute 7% of his/her basic salary as a
contribution to the government’s pension plan. The amount of contribution by the employee is withheld
by the employer in each payroll month and later paid to the concerned governmental body.
The employer, on the other hand, is expected to contribute 11% of every permanent employee’s basic
salary in each payroll month towards the same pension fund. Therefore, the total amount of pension
contribution to every permanent government employee will be 105 of his/her basic salary for each payroll
month, i.e. 11% by the employer + 7% from the employee’s basic salary.
Equivalent to the pension plan of Governmental Organizations, private business and Non-Governmental
Not-for-Profit Organizations (NGO’s) also provide their permanent employees with a provident fund
scheme. The amount of contribution, however, may differ from one organization to the other. Most
commonly, the employee contributes 5% of his/her basic salary while the employer contributes 10% of
the employee’s basic salary every payroll month.
Thus, the total amount of provident fund contribution by the employee and the employer is monthly
deposited to the recipient organization, such as banks, with each permanent employee’s name. This fund
is established so that the employee receives a lump sum amount when he/she leaves the employer
organization or, sometimes, when the employee faces a serious problem.
Some organizations in Ethiopia also have both pension and provident fund for their permanent
employees. This is common to organizations previously owned by government and later transferred to
private ownership; permanent employees acquired with the organization continue to contribute for
pension plan and permanent employees hired after the organization is privatized will contribute towards a
provident fund.
We shall consider the possibility to have both pension and provident fund deductions in one payroll
register, and treat each fund in accordance.
Other Deductions:
Apart from the above two major types of deductions, employees may voluntarily or involuntarily be
required to deduct and pay some amount of their earnings for reasons such as the following:
 Donations to charitable organizations
 Contribution to HIV/AIDS patients
 Deductions for payment of credit purchases from the company
 Deductions for the repayment of loan
 Payment for insurance premiums
 Contribution to credit and saving associations
 Contribution to “IDIR”, Labor Union dues, and etc.
 Deductions ordered by court due to such reasons as divorce
The employer, like in the above two types of deductions, acts as a mediator or trustee to follow and
deduct the specified amounts and pay to the concerned organization or beneficiary.
All types of deductions, until they are paid to the appropriate recipient, will remain to be current liabilities
of the employer organization. Thus, in preparing payroll for a specific period, we should be very careful
in calculating and handling those deductions.
Net Pay (Take Home Pay)
The net pay section of a payroll register refers to the amount of net earning the employee receives after
all the above deductions are made from the gross earnings of the employee in a given pay period. In other
words, Net Pay = Gross Earnings – Deductions.
Employee’s Signature
The final or last column of a payroll register shall be provided for the signature of each employee to
ensure he/she collected the net pay correctly.
In addition to the above seven components, a payroll register should include name and signature of those
who prepared, verified, and approved the payroll.
4.2.5 RECORDING OF PAYROLL RELATED DATA ON PAYROLL REGISTER
Accounting systems for payroll and payroll taxes and withholdings are concerned with the records and
reports associated with the employer-employee relationship. Various federal, State and Local Laws
require that employers accumulate certain specified data in their payroll records for each payroll period.
Moreover, employers are further expected to record data for each employee. Periodically, reports of such
data must be submitted for the appropriate governmental agencies and remittances made for amounts
withheld from employees and for the employer’s share of payroll liability.
Records of each period must be maintained and be available for inspection by those responsible for
enforcement of the laws. In addition, payroll data may be useful for negotiations with labor unions, in
settling employee grievances and in determining rights to vocations, sick leaves, retirement pensions, and
termination pays.
Appropriate records of payroll related data may also be useful for management in accessing, analyzing,
and evaluation of the various sub-divisions’ performance.
Steps in preparing payroll related data:
1. Gathering of necessary data: Before preparing the payroll register, the first step is to collect all
the necessary information about every employee qualified for payroll. This stage includes, among
 other things, the analysis of attendance records, time cards, and all inputs related to the addition
or deletion of employees.
2. Entering data to the payroll register: Along with the information gathered in the first step, all
the necessary inputs to prepare the payroll register such as the name of employees, earnings, and
all deductions are entered into the appropriate columns of the payroll register.
3. Totaling and proving the payroll register: After the data is entered in each column of the
register, all the sub totals and grand totals of each column should be checked and cross verified to
ensure the arithmetic accuracy.
The sum of all the sub totals of deductions and the net pay should be equal to the total of gross earnings.
4. Verification of the payroll register: The accuracy and authenticity of the payroll must be
verified by a different person other than the one who prepared it. The source documents used to
prepare the payroll register should be used as a reference to check the completeness of the payroll
register.
5. Authorization: The payroll register should be approved by authorized personnel other than those
who prepared and verified the payroll register.
6. Paying the payroll: Net pay of employees should be paid to each employee either in cash or by
writing checks.
7. Recording of payroll related data: The total salary expense, liabilities for withholdings, and all
payroll related liabilities should be recorded in journal entry form.
8. Payment and recording of payroll related liabilities: The liabilities for employee’s
withholdings and liabilities of the employer must be paid and recorded to the appropriate
accounts.
PAYROLL REGISTER
The multicolumn form used in assembling and summarizing the data needed at the end of each payroll
period, often referred to as the payroll register, is the basis for recording payroll related data in the
appropriate accounts.
The nature of most of the data appearing in the payroll register is evident from the columnar headings.
Supporting documents for the preparation of the register can also be important inputs for the classification
of some specific items such as other deductions, and the related accounts to be affected by those items.
The number of hours worked, earnings, and deductions must be put in the appropriate columns. The sum
of al the deductions for each employee must be deducted form the gross earnings to yield the amount to
be paid. Recording the check numbers in the payroll register as the checks are written eliminates the need
to maintain other detailed records.
A sample payroll register of a government organization, illustrated (below) in the next page, is used for
the purpose of illustrating the recording payroll related data in the examples used hereafter.
The total earnings (gross earnings) column of the payroll register is used to accumulate the total wages or
salaries to be charged to the expense accounts.
The format of the payroll register aids the determination of arithmetic accuracy before checks are issued
to employees and before the summary amounts are formally recorded. Specifically, all columnar totals
should be cross verified, and the miscellaneous deductions must also be summarized by account
classification.
 TEST ENTERPRISE
Payroll Register
For the Month Ending Tikimt 30, 2010
Ser. Name of Earnings Gross Deductions Total Net
No. Employee Basic Allow Over Earning Income Pension Other Deductio Pay
Salary ance time s Tax Contri Deduct n
01 AbrehamMoges* 1020.00 - 108.40 1128.40 52.84 71.40 - 124.24 1004.16
02 Daniel Kasa 730.00 - 94.70 824.70 22.47 51.10 - 73.57 751.13
*
03 DawitMitiku 1490.00 200.00 - 1690.00 89 104.30 - 193.30 1496.70
04 FanayeAbitew 2340.00 300.00 - 2640.00 208.50 163.30 - 372.30 2267.70
05 TesfayeMengistu 3650.00 400.00 - 4050.00 427.50 255.50 320.00 683 3367.
06 ZinashChala 980.00 - 98.20 1078.20 47.82 68.60 - 116.42 961.78
Total 10,210.00 900.00 3011.30 11,411.30 848.13 714.70 320.00 1,562.83 9,848.47
*
Non-permanent employees
Note: TesfayeMengistu is repaying a bank loan of Birr 320.00 per month.
All allowance are non-taxable income
Recording Employees Earnings
The payroll register as a posting medium in a manner like that in which the voucher register and check
register are used. Alternatively, it may be used as a supporting record for a compound journal entry that
records the payroll data.
In the sample payroll register, the entry to record the employees’ earnings will be as follows:
Salaries expense.................................................................11,411.30
Income Tax Payable.................................................................848.13
Pension payable........................................................................714.70
Payable to bank........................................................................320.00
Salaries payable........................................................................ 9,848.47
The total expense incurred for the services of employees is recorded by the debits to the salary
expense accounts. These debits can be further classified as sales salary, office salary, and so on.
Amounts withheld from employees’ earnings have no effect on the debits to these accounts. The
four credits in the above entry represent increase in specific liability accounts.
Recording payment of payroll
One of the principal outputs to most payroll systems is a series of payroll checks at the end of each pay
period for organizations using checks as a mode of payment to employees. The data needed for this
purpose are provided by the payroll register, each line of which applies to an individual employee. It is
possible to prepare the checks solely by reference to the next amounts (net pay) column of the register.
However, the customary practice is to provide each employee with a statement of the details of the
computation. The statement may be entirely separate form the check or it may be in the form of a
detachable stub attached to the check.
It is necessary to note that the entire amount paid can be recorded as a single item, regardless of the
number of employees. There is no need to record each separately because all of the details are available in
the payroll register for future reference. For organizations paying their employee in cash other than
payroll checks, the same procedure of recording checks is followed. In the illustration above the entry to
record payment of salary would be:
Salaries payable................................ 9,848.47
Cash..................................................9,848.47
Payment of salaries for the month of Tikimt 30, 2010
However, when employees are paid by checks drawn on the regular bank account and a voucher system is
used, it is necessary to prepare a voucher for the net amount to be paid the employees. The voucher is
then recorded in the voucher register as a debit to salaries payable and a credit to accounts payable, and
payment is recorded in the check register in the usual manner as a debit to accounts payable and credit to
cash.
Recording and paying payroll taxes
Each time the payroll register is prepared, the amounts of all employees’ entering the tax base are listed in
respective taxable earnings columns. In the sample payroll register illustrated previously, the amount of
tax withheld form employees is recorded as a liability, income tax payable for the amount of Birr
1,525.70. Therefore, the journal entry to record the payment of this liability may include a debit to a
liability account and a credit to cash as below:
Income Tax Payable..........................848.13
Cash..................................................848.13
Payroll tax for the month of Tikimt 30, 2010
Recording of other payroll withholdings
We have said in the previous sections, that employer is an intermediary between the employee and the
recipient. In this sense, the employer is so far liable for those employee’s withholdings until they are paid
and must keep the record for them. The procedure to record these liabilities is shown in the previous
compound entry, and the payment of these liabilities is recorded in the same manner as the payroll tax.
For example, the payment of bank loan withheld from employees in the illustration is made as:
Payable to bank.................................320
Cash..................................................320
Payment of employee deduction to bank
4.2.5 CONTROLLING AND RECORDING PAYROLL WITHHOLDINGS
Internal Control over Payroll Systems
It is important that the accounting systems provide safeguard to insure that payments are in accord with
management’s general plans and its specific authorizations.
All employees of an organization expect and are entitled to receive their remunerations at regular
intervals followings the close of each payroll period. Regardless of the number of employees and the
difficulties in computing the amounts to be paid, the payroll system must be designed to process the
necessary data quickly and assure payment of the correct amount to each employee. The system must also
provide adequate safeguards against payments to factious persons and other misappropriation of funds.
As the number of employees and the mass of data increase, the number of individuals needed to manage
and process payroll data likewise increases. Such characteristics, together with the relative magnitude of
labor costs, indicate the need for controls that will assure the reliability of the data and minimize the
opportunity for misuse of funds.
The cash disbursement controls discussed in the previous chapter dealing with cash are applicable to
payrolls. Thus, the use of the voucher system and the requirement that all payments be supported by
vouchers are desirable. The addition or deletion of names on the payroll should be supported by written
authorizations from the personnel department. It’s also essential that employees’ attendance records be
controlled in such a manner as to prevent errors and abuses. Employee identification cards or badges may
also be used in this connection to assure that all salaries and wages are paid to the proper individuals.
In most firms, payroll, or compensation of employees, is a major business expenditure from period to
period. Because payroll expenditures are made in a relatively small amounts per employee on a periodic
basis, they may contain errors due to carelessness or even fraud on the part of dishonest employees. For
reasons like this, therefore, internal control over the payroll process are extremely important and of
considerable help in accounting for payroll.
Liabilities for employees’ Fringe Benefits
In addition to salaries and wages and allowances, many organizations provide their employees with a
variety of employee benefits. As one of the resources of an organization, the human resource is the most
valuable asset of the employer. Hence, organizations provide their employees with these benefits to
attract and retain, and also to motivate so that the employee can feel that he/she belongs to the
organization and hence will exert efforts towards the achievement of overall organizational objectives.
These types of benefits, often referred to as fringe benefits may take a variety of forms. The most
common forms of employee fringe benefits can be vocation pays, employee pension or provident fund,
training and education assistance, medical expense, and health, life, and disability insurance.
In order to match revenues with expenses of a given period, the employer must recognize the cost of such
fringe benefits as an expense of the period during which the employee earns the benefits, regardless of
whether the employer pays part or all of the cost of those fringe benefits.
In the next part of this section, description for the application of accounting principles to fringe benefits is
made, using the vocation pays and pension/provident fund as examples.
Liability for pension/provident fund
We have defined pension for permanent employees. In addition to the employee’s share of 4% of his/her
basic salary, the employer contributes 11% of the employee’s share has be treated as part of the salary
expense and a liability of the employer. Like wise, the employer’s share of the pension plan must also be
recorded in the accounting records of the employer. Thus, the share of the employer for the fund in a
given period is debited to the operating expense account, pension expense, and a liability account,
pension payable, is credited for the recognition of the expense.
In the sample payroll register of test enterprise, the employer’s share of pension plan for the four
permanent employees, 11% of Birr 10,210 is recorded as:
Pension expense................................1.123.10
Pension payable................................1,123.10
Pension expense for the month of Tikimt 30, 2010
On the other hand, payment of this liability, pension payable, for both the employer and employee’s
share, to the appropriate government organization should be recorded as:
Pension payable................................1,837.80
Cash..................................................1,837.80
Payment of pension contributions for the month of Tikimt 30, 2010
Note: Birr 1837.80 is the total balance in the pension payable account (Birr 1123.10 + Birr 714.70)
The same recording procedure is applied to provident fund except for the use of provident fund expense
and provident fund payable instead of pension expense and pension payable.
Liability for Vocation Pay
As one of the conditional payments for employees, most employees are granted some vocation pay
liability as the vocation privilege is earned, so that revenues and expense of the period would match.
Employees record will help as a basis for the determination of each employee’s vocation pay privilege for
a given period so that the employer can simply calculate the amount of vocation pay to be applied for the
current period.
Once the number of vocation days per year for an employee is obtained form employee’s records, the
next step will be to allocate these days per month. To calculate the amount of vocation pay for the month,
we use basic salary per day in the same manner as overtime, and multiply by the number of vocation days
for the month. The amount obtained in such manner is then recorded as a debit to vocation pay expense
and a credit to a liability account, vocation pay payable. Depending when it’s to be paid, the vocation
liability will be classified in the balance sheet as either current liability or a long term liability.
When the payroll in which the employees are paid for their vocation is prepared, vocation pay payable
would be debited, and salaries payable and the appropriate account for recording taxes and withholdings
would be credited.
Exercise - 1
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, 2010.

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

 salary allowance worked
01 AbebeKebede 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/MedihinAlemu 1600 _____ 6 Weekly Rest days
04 SelamawitTeshome 900 100 _____ ______
05 TesemaTollosa 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 and 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 and 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 2010.
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, 2010
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.