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ACCOUNTS AND BUDGET SERVICELEVEL IV

Learning Guide
Unit of CompetenceEstablish and Maintain a Payroll System
Module Title Establishing and Maintaining a Payroll System
LG Code: EIS ACB4080812

TTLM Code: EIS ACB4M08 0812

TTLM Development Manual Date: July 2018

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Training, Teaching and Learning Materials

INTRODUCTION

Welcome to the module “Establish and Maintain a Payroll

System”. This learner’s guide was prepared to help you achieve the required
competence in “Accounts and Budget Support Level III ”. This will be the source
of information for you to acquire knowledge attitude and skills in this particular
occupation with minimum supervision or help from your trainer.

Summary of Learning Outcomes

After completing this learning guide, you should be able to:

Lo1:- . Record payroll data
Lo2:- . Payroll preparation
Lo3:- . Handle payroll enquiries
Lo4:- . Maintain payroll
How to Use this TTLM

o Read through the Learning Guide carefully. It is divided into sections

that cover all the knowledge, skills and attitude that you need.
o Read Information Sheets and complete the Self-Check at the end of
each section to check your progress
o Read and make sure to Practice the activities in the Operation Sheets.
Ask your trainer to show you the correct way to do things or talk to
more experienced person for guidance.
o When you are ready, ask your trainer for institutional assessment and
provide you with feedback from your performance.

TTLM Development Manual Date: July 2018

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Lo1:- . Record payroll data

Information Sheet

The Importance of Payroll Accounting

The concept payroll is often referred to the total amount paid to employees of a
firm as a compensation for the service rendered to a firm in a given period of time.
The payroll accounting of a firm has to be given emphases of significance for the
following reasons (as stated in the book entitled “Accounting Principles” by Fees
and Warren, Page 297).

1. Employees are sensitive to payroll errors and irregularities, and maintaining

good employees moral requires that the payroll be paid on a timely, accurate
basis.
2. Payroll expenditures are subject to various government regulations.
3. The payment for payroll and related taxes has significant effect on the net
income of most business is unquestionable.

Moreover, since the payroll related payment is highly subject to certain fraudulent
activities it is imperative that businesses need to properly design their payroll
system so that it safeguards the company’s assets against unauthorized payments of
payroll and the accuracy as well as reliability of the accounting records is assured

TTLM Development Manual Date: July 2018

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pertaining to payroll. Some of the possible frauds that can be made on the payroll
system are the following:

 Adding fictitious employees to the payroll

 Listing terminated employees on the payroll
 Using unauthorized pay rates
 Overstating working hours
 Issuing duplicate payroll checks
 Not deducting employees’ absent time
 Making incorrect totals on the payroll register

Thus, separation of duties on the functions of payroll activities is essential for

strong internal control over payrolls in order to protect the above-mentioned
methods of stealing money from company. Payroll activities involve four
functions: hiring employees, timekeeping, preparing the payroll, and paying the
payroll. For an internal control system to work effectively these four functions
should be assigned to different departments or individuals.

1. Hiring (Personnel) Department

The work of the employment or personnel department begins with interviewing

and hiring job applicants. When a new employee is hired, the personnel department
prepares records showing the date of employment, the authorized rate of pay, and
payroll deductions. The personnel department sends a written notice to the payroll
department records to place the new employee on the payroll. Changes in pay rates
and termination of employees will be recorded in personnel department records.

TTLM Development Manual Date: July 2018

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When a person’s employment is terminated, the personnel department should

notify the payroll department to remove the employee’s name from the payroll.

2. Timekeeping
Another area in which internal control is important is timekeeping. Hourly
employees are usually required to record time worked by “ punching “ a time
clock. The time of arrival and departure are automatically recorded by the
employee when he or she inserts a time card into the clock. Time clock procedures
are often monitored by a supervisor or security guard to make sure an employee
punches only one card. At the end of the pay period, the employee’s supervisor is
generally required to approve the hours shown by signing the time card. When
overtime hours are involved, approval by a supervisor should be mandatory to
guard against unauthorized overtime. The approved time card is then sent to the
payroll department. For salaried employees, a manually prepared weekly or
monthly time report kept by a supervisor may be used to record time worked.

3. Preparing the payroll

The input of information to the payroll department consists of hours reported by

the timekeeping department, and authorized names, pay rates and payroll
deductions received from the personnel department. The output of the payroll
department includes preparing (but not signing) payroll checks, maintaining
individual employee records of earnings and deductions, as well as making regular
reports to the government showing employees earnings and taxes withheld.

TTLM Development Manual Date: July 2018

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4. Paying the Payroll

The payroll is paid by the treasure’s department. Payment by check minimizes the
risk of loss from theft, and the endorsed check provides proof of payment. For
good internal control, payroll checks should be prenumbered, and all checks
should be accounted for. All checks must be signed by the treasurer (or a
designated agent) an their distribution to employees should be controlled by the
treasure’s department. Checks may be distributed by the treasurer or paymaster.
The distribution of paychecks by the paymaster provides assurance that paychecks
will not continue to be issued to fictitious employees who have been terminated.
The paymaster should not, however, have responsibility for hiring or firing
employees, timekeeping, or preparation of the payroll. If the payroll is paid in
currency, it is customary to have a second person count the cash in each pay
envelope and for the paymaster to obtain a signed receipt from the employee upon
payment.

The separation of duties among the payroll related activities that are described
above makes very difficult for employees to commit a payroll fraud. The people in
personnel have no authority to prepare payrolls or write checks. Those in
accounting cannot increase or decrease payroll deductions on individual
employees, nor can they sign the payroll checks. The treasurers can writer checks,
but only those authorized, and he or she cannot record entries in the general
ledger. It is worth noting that such system is essential for large companies, but not
for small companies where the owner knows all the few employees

TTLM Development Manual Date: July 2018

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II. Definition of Payroll Related Terms

Salary or Wages:

Salary and wages are usually used interchangeably. However, the term wages is
more correctly used to refer to payments for manual labour that are paid based on
the number of hours worked or the number of units produced. So, they are usually
paid when a particular piece of work is completed or weekly. On the other hand,
compensations to employees on monthly or annual basis are termed as salaries.

It must be clear that when we say an employee, we refer 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 a fee basis to a firm.
The Pay Period:
The length of time covered by each payroll payment. Pay period for wage workers
are usually made on weekly or biweekly. On the other hand, salaried employees’
pay periods are monthly or semimonthly.
The Pay Day:
The day, on which wages or salaries are paid to employees, usually the last day of
the pay period, is known as the payday.

Basic records of a payroll accounting system includes:

1. A payroll register (or sheet)
2. Individual employees’ earnings records, and
3. Usually, pay checks.

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These records are generated from a payroll system that is operated manually or
using computers.

A Payroll Register (Sheet): The entire list of employees of a business along with
each employee’s gross earnings, deductions and net pay (or the take home pay) for
a particular payroll period. The basis for the preparation of the payroll register can
be the attendance sheets, punched (clock) cards or time cards.

Employee Earnings Record: It is a summary of each employee’s earnings,

deductions, and net pay for each payroll period and of cumulative gross earnings
during the year. It is a separate record kept for each employee. The individual
employees’ earnings record helps the employer organization to properly
summarize and file tax returns.

Pay Check: An instrument for paying salary if the firm makes payment via writing
a check in the name of each employee for the net pay or a check for the total net
pay.

Gross Earnings: The total pay to an employee before deductions for the pay
period.
Payroll Taxes: Are taxes levied against the employer on the payroll of a firm. It is
an additional payroll related expense to an employer.

Withholding Taxes: These are taxes levied against the earnings of employees of an
organization and withheld by the employer per the regulations of the concerned
government.

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Payroll Dedications: All the reductions from the gross earnings of an employee
such as withholding taxes, union dues, fines, credit association pays, etc.

Net Pay: The gross earnings after subtracting all the deductions. An employee
sometimes knows it as take home pay, the amount collected on the payday.

TTLM Development Manual Date: July 2018

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Lo2:- . Payroll preparation

Information Sheet

Possible Components of a Payroll Register

1. Employee number: Numbers assigned to employees for identification

purpose when a relatively large number of employees are included in the
payroll register.
2. Name of employees: List of the names of employees
3. Earnings: money earned by an employee(s) of a firm from various sources.
It may include:
a. The basic salary or regular earning.

A flat monthly salary of an employee that is paid for carrying out the normal work
of employment and subject to change when the employee is promoted.

b. Allowances: Money paid monthly to an employee for special reasons,

which may include.
i. Position Allowance: A monthly sum paid to an employee for
bearing a particular office responsibility, head of a particular
department or division.

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ii. 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 fails to do so.
iii. Hardship Allowance: A sum of money given to an employee to
compensate for an inconvenient circumstance caused by the
employer. For instance, unexpected transfer to a different and
distant work area or location. It is sometimes known as
disturbance allowance.
iv. Desert Allowance: A monthly allowance given to an employee
because of assignment to a relatively hot region.
v. Transportation (fuel) Allowance: A monthly allowance to an
employee to cover cost of transportation up to the work place 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 or days. Overtime earning is the amount payable to an employee for
overtime work done.
In Ethiopia, in this respect, according to Article 33 or proclamation no. 64/1975 the
following is stated about payment for overtime work.
 A 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 before 10
o’clock in the evening (10 p.m).
 A worker shall 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.)

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 Overtime work performed on the weekly rest days shall be paid at a rate of
two (2) times the ordinary hourly rate of payment.
 A worker shall be paid at a rate of two and half (2 ½) times the ordinary
hourly rate for overtime work performed on a public holiday.

Hence the gross earnings of an employee may, therefore, include the basic salary,
allowances and overtime earnings. You may find sometimes other form of
earnings such as bonus that is paid to employees for achieving results better than
usual.

4. Deductions
These are subtractions made from the earnings of employees that is because it is
required by government or permitted by the employee himself.

In our country, Ethiopia, some of the deductions against the earnings of employees
are:-
a. Employee Income Tax
In Ethiopia every citizen is required to pay something in the form of income tax
from his/her earnings of employment. In this case a progressive income tax
system that charges higher rates for higher earnings is applied on the gross
earnings of each employee.

According to the amended income tax proclamation no. 286/2002 the tax on
income from employment over one hundred fifty (Br 150) shall be charged, levied
and collected according to the following income tax rates.
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Rates of Tax (%) on every

Taxable Monthly additional Income
≤ 600 Exempt 0

601-1650 10% 60

1651-3200 15% 142.50

3201-5250 20% 302.50
5251-7800 25% 565
7801-10900 30% 955
>10900 35%
1500

Generally, taxable income from employment includes salaries, wages, allowances,

director’s fees and other personal employment, all payments in cash and benefits in
kind.

However, according to income tax amendment proclamation no. 30/1992 issued on

October 12,1992 stated that the following categories of payments in cash or
benefits in kind are exempted from taxation.
 Medical costs incurred by employer for treatment of employees.
 Transportation allowances paid by employer to its employees.
 Reimbursement by employer of traveling expenses incurred on duty by
employees.

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 Traveling expenses paid to transport employees from else where to place of

employment and to return them upon completion of employment.

b. Pension Contributions
Permanent employees of an organization,the employees of which are governed by
the existing regulations of the Ethiopian public servants are expected to pay or
contribute 4% of their basic (monthly) salary to the government pension trust fund.
This amount should be withheld by the employer from the basic salary of each
employee on every payroll and later be paid to the respective government body.
On the other hand, the employer is also expected to contribute towards the same
fund 6% of the basic salary of every permanent employee of it. It is this total
amount we called earlier as payroll taxes expense to the employer organization
(i.e., 6% of the total basic salary of all permanent employee).
Consequently, the total contribution to the pension trust fund of the Ethiopian
government is equal to 10% of the total basic salary of all permanent employees of
an organization to be entitled to the pension pay given that the employee has
satisfied the minimum requirements to enjoy this benefit when retired.

Non-government organizations are also using this kind of scheme to benefit their
employees with some modifications. This is made in some NGO’s by keeping a
fund known as provident fund. Both the employees and the employer contribute
towards this fund monthly. Ultimately, when as employee retired or drawn out of
work a lump sum amount is given at once.

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c. Other Deductions
Apart from the above two kinds of deductions from employees earnings,
employees may individually authorize additional deductions such as deductions to
pay health or life insurance premiums; to repay loans from the employer or credit
association; to pay for donations to charitable organization; etc.

Each of the major other deductions may be put in special column in the payroll
register. Ultimately, the sum of the employees’ income tax, pension contributions
and other deductions given the total deductions from the gross earnings of an
employees.

5. The Net Pay

This amount is held in one column of the payroll register representing the excess
of gross earnings over the total deductions of an employee. The column “Net
Pay” total tells the grand total deductions made from the earnings of employees.

6. Signature

Unless some other document is used, the payroll sheet may be designed to allow a
column for signature of the employees after collection of the net pay. In general, a
payroll register should at least show the earnings, deductions and the net pays
along with the name of employees.
.

TTLM Development Manual Date: July 2018

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Lo4:- . Maintain payroll

Demonstration Problem

ABC Company pays the salary of its employees according to the Ethiopia calendar
of Hidar 1996.

Basic
Basic Monthly OT Duration of Salary
S.N Name of Salary Allowanc hours OT work Per Hour
o Employee e worked
1 SenaitBahru 2080 100 10 UP to 10 P.M. 13
2 PetrosChala 640 --- 8 10 P.M to 5 4
A.M.
3 Abdu 1280 --- 6 Weekly rest 8
Mohammed days
4 Leila Jemal 960 50 --- --- 6
5 KirkosWoldie 480 50 10 Public Holiday 3

N.B.
Note that management of the agency usually expects a worker to work 40 hours in
a week and during Hidar, 1996 all workers have done as they have been expected.
Besides, all workers of this agency are permanent employees except PetrosChala;
the monthly allowance of KirkosWoldie is not taxable; Abdu Mohammed agreed
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to have a monthly Br. 200 be deducted and paid to the credit association of the
agency as a monthly saving.

Instructions:
Based on the above information
1. Prepare a payroll register (or sheet) for the company for the month of Hidar,
1996.
2. Record the payment of salary and accrued liabilities as of Hidar 30, 1996
using Ck. no. 1641 as a source document.
3. Record the payroll taxes expense for the month of Hidar, 1996.
4. Record the payment of the claim of the credit association of the
company,and other payroll related liabilities to the concerned
authorities(withholding taxes,and payroll taxes) that arouse from Hidar’s
payroll assuming that the payment was made on Hidar’s 1, 1996 via Ck.
no.1650

Self Check 1
Ethiopia for Better, a governmental organization pays salary of its employees
according to the Ethiopian calendar month. The following data relates the month
of Tkimt, 1996 E.C.

Basic

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Name of Basic OT Duration of OT Monthly Salary

S.No. Employee Salary hours work Allowance Per Hour
Worked
1 TizitaDagne 640 10 Weekly rest 100 4
days
2 MamoRegassa 1280 7 Public holiday --- 8
3 Ali Temam 1920 9 10 P.m. –5 A.m 150 12
4 BerihuGebre 320 --- --- --- 2
5 NigistAbebe 3520 12 Up to 10 P.m 300 22

Additional Information:

 An employee is expected to work 176 hours in a month and during Tkimt,

1996 all employees have done as they have been expected.
 All employees are permanent employees except AtoMamoRegassa
 The monthly allowance of Ato Ali Temam is not taxable
TizitaDagne agreed to have a monthly Br 150 be deducted and paid to the
organization’s credit association as a monthly saving

Instructions: Based on the above Information

1. Prepare a payroll register (or sheet) for the organization for the month of
Tikimt, 1996 E.C.
2. Record the payment of salary and the accrued liabilities as of Tikimt 30,
1996 E.C. using check no. 03391
3. Record the payroll taxes expense for the month of Tikimt, 1996
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4. Record the payment of the claim of the credit association of the

company,and other payroll related liabilities to the concerned
authorities(withholding taxes,and payroll taxes) that arouse from Tikimt’s
payroll assuming that the payment was made on Tikmit’s 1, 1996 via Ck.
no.03395
Exercise – 2

Admin.
No Employees Basic Salary Overtime Allowa.
1. AyeleLema 270 --- ---
2. AzebMebrahtu 340 50 ---
3. Belay Nega 420 180 50
4. BirzafDebesay 510 60 ---
5. DendirTenkir 600 120 100
6. KidaneBeyene 285 75 ---
7. FekaduZewdie 380 --- 50
8. GetachewDesta 400 --- 100
9. Solomon Hailu 310 75 70
10. ZenaMelaku 135 70 ---

Additional Information:

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a) The payroll register of RAL Co. more or less is the same as the
payroll register shown in the illustration. The exceptions are the
deduction columns. The deduction columns are the following:
Income tax, Idir fund, union fees, pension fund and total deductions.
b) All employees are to pay Idir fees of:
1. Birr 2 for all employees whose basic salary is up to Birr 500,000
2. Birr 3 for all employees whose basic salary is above Birr 500
c) All employees are required to pay union fees of 1% of their basic
salary (assume that all employees are members of the Labour Union).
d) Ato Belay Nega, AtoDendirTenkir, AtoFekaduZewdie and
AtoZenaMelaku contribute 5% of their basic salary to the Credit
association of the company.

Instruction:

1. Prepare the payroll register for the month of Tir, 1996

2. Prepare a journal entry to record the payment of salary and the accrued
liabilities for the month of Tir, 1996
3. Record the payroll taxes expense for the month of Tir, 1996
4. Record the payment of the claim of the credit association of the company,
and other payroll related liabilities to the concerned authorities (withholding
taxes, and payroll taxes) that arouse from Tir’s payroll assuming that the
payment was made on Tir 1, 1996 via Ck. no.1050

TTLM Development Manual Date: July 2018

Compiled by: Acct department