CHAPTER THREE

Accounting systems for payroll and payroll taxes in Ethiopia

Payroll
Payroll refers to the total amount to be paid to employees as a compensation for the service
rendered to firm in given period of time.
Your employer has a liability to you for your earnings until you are paid with cash or a check.
Your employer has also a liability to deposit taxes withheld. In this chapter we will discuss
current payroll and tax liabilities, pension liabilities from Ethiopian context, and liabilities from
notes payable.
Payroll system (Ethiopian context)
The Importance of Payroll Accounting
Payroll expenditures are significant for various reasons:
1. Employees are sensitive to payroll errors and irregularities. Timely and accurate payroll
payments help to maintain good employees’ moral and motivation.
2. Payroll is subject to government regulations. I.e. both federal and state governments
require that detailed payroll records be kept.
3. Payroll and payroll related taxes constitute a major cost to an employer and affect the net
income greatly. I.e. payroll often represents the largest expense that a company incurs.
The term “payroll” pertains (relates) to all salaries and wages paid to employees. An employee
is a person who is subject to control and direction for the company for which he or she works.
But payments made for personal service by professionals who are independent contractors are
called fees, rather than salaries and wages.
Payroll activities involve four functions
 Hiring employees √ Preparing the payroll
 Time keeping √ Paying the payroll
Determining the payroll: - Determining the payroll involves computing:
A. Gross earnings
B. Payroll deductions and
C. Net pay
A) Gross earnings
Gross earnings, also called gross pay is the total compensation earned by an employee. Gross
pay is the amount that an employee has earned during a pay period before any required or
authorized deductions are subtracted. It includes wages, salaries, allowances, commissions,
bonuses and any compensation earned before deductions.
Gross pay = Basic salaries+ Allowances + Over time earnings + Commissions + Bonuses +
Other earnings.
1. Basic salary or regular earnings: a flat monthly salary of an employee for carrying out
the normal work of employment and subject to change when the employee is promoted.
Salary: the term salary refers to the payment for professional, administrative, managerial,
and clerical employees. The rate of salary is normally expressed in terms of the month or
a year.
Wages: the term wages refers to payment for manual labor, both skilled and unskilled.
Wages are normally based the number of hours worked or a piece of work basis (such as
per unit of a product). Frequently, the term salary and wages are used interchangeably.
2. Allowances: money paid monthly to an employee for special reasons, which may include

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  Position allowance: a monthly paid to an employee of earning a for bearing
particular office responsibility. E.g. Head department
 House allowance: a monthly allowance given to cover housing costs of the
individual employee when the employment contract requires the employer to
provide housing but the employer fails to do so.
 Hardship allowance: a sum of money given to an employee to compensate for an
inconvenient (problematic) circumstance caused by the employer. For instance,
unexpected transfer to a different and distant work area or location.
 Desert allowance: a monthly allowance given to an employee because of
assignment to a relatively hot region.
 Transportation (fuel) allowance: a monthly allowance to an employee to cover
cost of transportation up to her/his workplace if the employer has committed itself
to provide transportation service.
Over time earnings: Over time work is the work performed by an employee beyond the regular
working hours or days. Over time earning is the amount payable to an employee for overtime
work done.
Ordinary hours rate=Basic salary
8*5*4 i.e.one government employee works eight hours a day,
five days in a week and four weeks in a month.
Article 33 of proclamation No. 64/1975 discussed the following about how overtime work
should be paid:
Over time rate
1. Worker shall worker shall be entitled to be paid at a rate of one and one quarter
(1 ¼) times his ordinary hourly rate for overtime work performed before10
O'clock in the evening (10 p.m.).
2. (From 6:00 am to 4:00 pm) be paid at the rate of one and one half (1 ½) times his
ordinary hourly rate for overtime work performed between 10 O’clock in the
evening (10 p.m.) and six O’clock in the morning (6 a.m.)
3. Overtime work performed on the weekly rest days shall be paid at a rate of two
(2) times the ordinary hourly rate of payment.
4. A worker shall be paid at a rate of two and half (2 1/2) times the ordinary hourly
rate for overtime work performed on a public holiday.
Payroll deduction
Payroll deductions may be mandatory or voluntary. Mandatory deductions include deductions
required by law like income tax and pension contribution. The government legislation requires
employers to withhold from the pay of each employee the applicable income tax due on those
wages and salaries. The employer computes the amounts of income tax withhold deductions
according to a government prescribed formula or withholding tax table. Employees may
voluntarily authorize withholdings for charitable, retirement and other purposes. The
employee should authorize all voluntary deductions from gross earnings in writing.
 Income tax
According to the currently applicable income tax rate the first 600 birr income from employment
shall be exempt from payment of income tax. The money on which a person does not have to
pay income tax is an exemption. The income tax rate that is applicable to all taxable income is
given below.
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 Income Tax Calculation

Income bracket(Birr Range

Rate
Up to 600 _ exempted
600 - 1650 1050 10%
1650 - 3200 1550 15%
3200-5250 2050 20%
5250-7800 2550 25%
7800-10900 3100 30%
Above 10900 - 35%

Generally, taxable from employment includes salaries, wages, some allowances, director’s fees
and other personal employment, all payments in cash and benefits in kind. Once taxable income
is determined from gross earnings, the following formula can be used to determine the income
tax as an alternative.
Taxable
Income bracket (Birr) formula
< 600 Exempted
600-1 650 (TI x10%) – 60
1650- 3200 (TI x15%) -142.5
3200- 5250 (TI x20%) – 302.5
5250- 7800 (TI x25%) - 565
7800 – 10900 (TI x 30%) – 955
Above 10900 TI x35%) – 1500

When, TI is Taxable Income or Employment Income

60 = (600 X 0.1) – 0
142.5 = [(600 X .15) – 0] + [(1050 X 0.15) – (1050 X 0.1)] and so forth.
Tax free /exempted payment
The following payments in cash or benefits in kind exempted from taxation.
 Medical cost,
 Transportation allowance (Not more than Br.1000 or 25% of basic salary)
 Hardship allowance.
 Reimbursement of traveling expenses incurred on duty.
Income taxes withheld from employees must be paid promptly (immediately) to the proper
government agency.
 Pension fund
Permanent employees of organizations, which are governed by the existing regulation of the
Ethiopian public servants, are expected to pay or contribute 7% of their basic salary (monthly) to
the government pension trust fund. This amount should be the employee from the basic salary
of each employee on every payroll and later be paid to the respective government body. In
addition, the employer is expected to contribute towards the same fund 11% of the basic salary
of its permanent employees. This 11% contribution of the total basic salary of all permanent
employees is recorded as payroll taxes expense to the employer organization.
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The total contribution to the pension and social security authority (PSSA) equals to 18% of the
total basic salary of all permanent employees of an organization.
An employee will enjoy the benefit of pension if he/she satisfies the minimum requirements of
the authority.
Business and non-governmental not-for profit organization (NGO’s) also have this kind of a
scheme to benefit their employees with some modifications. A fund known as provident fund is
established and both the employer and the employee contribute towards this fund monthly. When
an employee retains or leaves employment, a lump sum amount is paid to him/her.
 Other deductions
These withholdings arise from employee requests, contracts, unions, or other agreements. They
can include amounts for charitable giving, insurance premiums, staff loan repayments and union
dues etc.
B) Net pay (or take home) pay: is determined by subtracting payroll deductions from gross
earnings.
Definition of payroll related terms
Payroll tax expenses: payroll related expenses paid by the employer like 11% contribution
toward pension fund.
Payroll records: employee earnings record, payroll register, payroll checks
Payroll register (sheet)
 The payroll register, which is prepared each pay period, is a detailed listing of the firm’s
total payroll. It shows a pay period, a gross pay, deductions and net pay of each employee
for every pay period.
 Pay period: is the length of time covered by each payroll payment. For wage workers the
pay period are usually made on weekly or biweekly. Salaried employees pay periods are
monthly or semimonthly.
 Attendance sheets, punched (clock) cards, together with information from the personal
records enable to update the employee earnings records and prepare the payroll register.
 It is multi column form used in assembling and summarizing the data needed and prepare
the payroll register.
Employee earnings period
It is a summary of each employee’s earning, deductions and net pay for each payroll period and
of cumulative gross earnings during the year. It is a separate record for each employee.
Pay check/ payroll check
Payment of payroll is usually done by check or in coin and currency. A pay check is an
instrument prepared at the end of paying salary if the firm makes through writing a check in the
name of each employee for the net pay or check for the total net pay. When the payroll register
has been completed and checked, the general journal entries relating to payroll can be made.
The Pay Day: The pay day- is the day on which wages or salaries are paid to employees. This is
usually on the last day of the pay period.
Entries related to payroll
The journal entry for recording the payroll is based on the column totals from the payroll
register. Note that each account debited or credited is a total from the payroll register.
 Recording payroll expenses and liabilities
 Recording the payment of the payroll
 Recording employer payroll taxes

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  Recording payment of withholdings, payroll taxes, and other deductions to each
respective recipient.
Major procedures in payroll accounting
a) Gathering necessary data
b) Preparing the payroll
c) Verifying the payroll
d) Approval of the payroll
e) Recording the payroll expenses and liabilities
f) Recording of the payment of payroll
g) Recording the payroll taxes expenses of the employer
h) Paying and recording with holdings and payroll tax expenses

Problem
Payroll accounting illustration
The following payroll related data pertains to wisdom institute for the month of megabit, 2005.
In the institute, salary is paid on monthly basis and each employee is expected to work for 176
hours per month or 22 working days on that month. As per the personnel department’s
confirmation, all staffs were on duty for the month of Megabit. The pension contribution is 7%
from employees and 11% by the institute on their salary basis. But, this applies only for
permanent employees. Term of employment is permanent except Hanna Birhane.

No Name of employee Basic salary Allowance Over time Duration

Taxable non taxable of hours
1 Belay Zeleke 1848 500 200 10 Week ends
2 Jemal Ahmed 1540 200 150 8 Public holiday

3 Abay Gebru 924 150 100 8 10:00pm-6:00am

4 Hanna Birhane 350 - - - -

Other deductions
No Name of employee Deductions Total

Staff loan Credit association Donation

1 Belay Zeleke 300 100 50 450
2 Jemal Ahmed - 50 50 100

3 Abay Gebru 100 - 20 120

4 Hanna Birhane - - 10 10

Required
1) Prepare a payroll register for the month of Megabit
2) Record payroll expenses and liabilities
3) Record payment of the payroll
4) Record the payroll tax expenses (11% of pension) of the month
5) Record the remittance of withholding taxes and other deductions to each recipient.
6) Computation of Gross earnings, Deduction and Net pay
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 Gross earnings = Basic salary pay + Allowance + Over time earning

Ordinary hours rate=Basic salary

8*5*4

Over time = Hours worked x (ordinary hourly rate x OT rate)

a. Belay Zeleke: 10 hrs x (Br. 10.50 x 2) = Br.210
b. Jemal Ahmed: 8 hrs x (Br. 8.75 x 2.5) = Br.175
c. Abay Gebru : 8 hrs x (Br. 5.25 x1.5) = Br .63
Gross Earnings
1) Belay zeleke: Br. 1848 + 700 + 210 = Br. 2758
2) Jemal Ahmed: Br. 1540 + 350 + 175 = Br.2065
3) Abay Gebru: Br. 924 + 250 + 63 = Br. 1237
4) Hanna Birhane: Br. 350 + 0 + 0 = Br 350
Deductions
Total Deduction =Income tax + Pension contribution + other deductions
Income Tax
1 .Belay Zeleke
Taxable Income = Gross earning – None taxable income
= Br.2758 – 200
=Br.2558
Income tax
600 x 0% = 0.00
1050 x 10% =105.00 (TI x 15%) -142.5
908 x 15 % = 136.2 or = (2558 x 15%) -142.5
= 383.7 – 142.5
Total 2558 241.2 = 241.2

Pension contribution:
Basic salary x 7% Other deductions
= 1848 x 7% Staff loan 300
= 129.36 Credit association 100
Donation 50
Total 450
Total deductions = Br. 241.2 + 129.36 + 450
= Br. 820.56
Net pay = Gross earnings – Total deductions
= Br. 2758 – 820.56
= Br. 1937.44
2. Jemal Ahmed
Taxable income = Gross earnings – Nontaxable income
= Br. 2065 – 150
= Br.1915

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Income tax
600 x 0% = 0
1050 x 10% = 105.00 Pension contribution
(1915 x 15%) – 142.5
265 x 15% = 39.75 or = basic salary x 7%
287.25 – 142.5 = 144.75
1915 144.75 = 1540 x 7% = 107.8

Total deduction = Br. 144.75+ 107.8 + 100 = 352.55

Net pay = Gross earnings – Total deductions
= 2065 – 352.55 = 1712.45

3. Abay Gebru
Taxable income = Gross earnings – Nontaxable income
= 1237 – 100 = 1137.00
Income tax
600 x 0% = 0.00
(TI x10%) – 60
537 x 10% = 53.7 r
= 1137 53.7 = 113.7 – 60
= 53.7
Pension contribution = Basic salary (924) x 7% = 64.68
Other deduction
Staff loan 100
Donation 20
120
Total deductions: 53.7 + 64.68 + 120 = 238.38
Net pay = 1237 – 238.38 = 998.62

4. Hanna
Taxable income =Gross earning – Nontaxable income
= 350 – 0 = 350
Income tax
Earning below 600 is tax exempted. So, Hanna gross earning is below 600
Pension contribution: no pension contribution because she is a temporary (contractual) worker.
Other deductions: Donation = birr. 10
Total deductions 0 + 10 = 10

Net pay = 350 – 10 = 340

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 WISDOM INSTITUTE
PAYROLL REGISTER
For the month of megabit, 2005
No. Name of Earnings Gross Taxable Deductions Total Net pay Signa
employee earnings income Deductions ture
Basic Allowance Over
salary time
Income tax Pension C. others

1 Belay Zeleke 1848 700 210 2758 2558 241.2 129.36 450 820.56 1937.44.
2 Jemal 1540 350 175 2065 1915 144.75 107.8 100 352.55 1712.45
Ahmed
3 Abay Gebru 924 250 63 1237 1137 53.70 64.68 120 238.80 998.62

4 Hanna 350 - - 350 350 - - 10 10 340.00

Birhane
Total 4662 300 448 6410 5960 439.65 301.84 680 1421.91 4988.09

Prepared by: _____________________________Checked by: __________________________Approved by:________________________

1. Salary and benefits expense………………..6,410

Income tax payable…………………………………..439.65
Pension contribution payable………………………..301.84
Staff loan……………………………………………...400
Credit association payable…………….……………..150
Donation payable………..…………………………….130
Salary payable…………………………………………4988.51

2. Salary payable…………………………..4988.51
Cash……………………………………………………..4988.51
3. Payroll tax expenses……………………………474.32
Pension contribution (11%)………................................474.32
(4662 – 350 X 11% = 474.32)

4. Income tax payable……………………..………439.65

Pension contribution payable (18%)…………..776.16
Credit association payable……………………..150
Donation payable………………………………130
Staff loan ……………………………………….400
Cash…………………………………………………..1895.81