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Chapter 4

THE PAYROLL SYSTEM IN AN ETHIOPIAN CONTEXT


A. The Importance of Payroll Accounting
The term payroll often refers to the document prepared to pay remuneration for the service
rendered in a given period of time. The payroll accounting of a firm has to be given emphases of
significance for the following reasons:
1. Employees are sensitive to payroll errors and irregularities, and maintaining good
employee 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 enterprises.
B. 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 labor 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 for a period less than a month. 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 and independent contractor, a self-employed
individual who works on a fee basis to a firm.
The Pay Period:
The Pay Period is the length of time covered by each payroll payment. Pay periods for
wageworkers are usually made on weekly or biweekly. On the other hand salaried employees
pay periods are monthly or semi-monthly.
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 PAY DAY.
Basic Records of a payroll accounting system includes:
1) A payroll register (or sheet),
2) Individual employees earnings records, and
3) Usually, pay checks.
These records are generated from a payroll system that is operated manually or using
computers.
i)A Payroll Register (Sheet): the entire list of employees of a business along with each
employees 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.
ii) Employee Earnings Record: It is a summary of each employees earnings, deductions,
and net pay for each payroll period and of cumulative gross earnings record helps the
employer organization to properly summaries and file tax returns.
iii) 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.
iv) Grosse Earnings: The total pay to an employee before deductions for the pay period.
v) Payroll Taxes: Are taxes levied against the employer on the payroll of a firm? It is an
additional payroll related expense to an employer.
vi) 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.
vii) Payroll Deductions: All the reductions from the gross earnings of an employee such as
withholding taxes, union dues, fines, credit association pays, etc.
viii) Net Pay: The gross earnings after subtracting all the deductions. It is sometimes known
as take home pay- the amount collected by an employee on t he payday.
C. Possible Components of a Payroll Register.
1. Employee number numbers assigned to employee for identification purpose when a
relatively large number of employees are included in the payroll register.
2. Name of employees list of the name 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 reason, which may
include:
i. Position Allowance a monthly sum paid to an employee for bearing a particular
office responsibility, e.g. head of a particular department or Division.
ii. House Allowance a monthly allowance given to cover housing costs of
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 some times 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 Earnings:


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 of proclamation
No.64/1975 the following is discussed about payment for overtime work.
i) A worker shall be entitled to be paid at a rate of one and one quarter (1.25) time his
ordinary hour rate for overtime work.
ii) A worker shall be paid at the rate of one and one half (1.5) times his ordinary hourly
rate overtime work performed between 10 Oclock in the evening (10 p.m.) and six
Oclock in the morning (6 a.m.)
iii) Overtime work performed on the weekly rest day shall be paid at a rate two (2) times
the ordinary hourly rate of payment.
iv) A worker shall be paid at a rate of two and half (2.5) 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 earning. 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, some of the deductions
against the earnings employees are:
(a) Employee Income Tax:
In Ethiopia every citizen is required to pay something in the form of income tax from his/her
earning 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 save the first 150 Birr.
According to proclamation No.286/2002 that has become into effect beginning Hamle 1, 1994
E.C. exempts the first Br 150 of the earnings of an employee from income tax. The money on
which a person does not have to pay income tax is an exemption. According to the new
proclamation, employee income tax has to be computed based on the following schedule.
Proclamation 286/2002
Taxable Monthly Income Rates of tax (%) on Every
(In Birr) Additional Income
1 Less than 150
2 Over 150 but not exceeding 650 on the next 500 10%
3 Over 650 not exceeding 1,400 on the next 750 15%
4 Over 1,400 but not exceeding 2,350 on the next 950 20%
5 Over 2,350 but not exceeding 3,550 on the next 1,200 25%
6 Over 3,550 but not exceeding 5000 on the next 1,450 30%
7 Over 5,000 35%

Generally taxable income from employment includes salaries, wages, allowances, directors fees
and other personal emoluments 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.
1. Medical costs incurred by employer for treatment of employees.
2. Transportation allowances paid by employer to its employees.
3. Reimbursement by employer of traveling expenses incurred on duty by employees.
4. Traveling expenses paid to transport employees from else where to place of Employment
and to return them upon completion of employment.

(b) Pension Contribution


Permanent employees on 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 with held by
the employer from the basic salary of each employee on every payroll and later be paid to the
respective government body.
On the on the hand the employer is also expected to contributed towards the same fund 6% of
the basic salary of every permanent employee of it. It is this total amount that we called earlier
as payroll taxes expenses to the employer organization (i.e. 6% of the total basic salary of
permanent employee).
Consequently, the total contribution to the pension Trust Fund of the Ethiopian government is
equal to 10% of total basic salary of all permanent employees of an organization (i.e. 4% comes
from the employees and the 6% comes from the employer). This enables a permanent employee
of an organization to be entitled to 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 scheme to benefit their employees with
some modifications. This is made in some NGIS by keeping a fund known as provident Fund
Both the employees and the employer contribute towards this fund monthly. Ultimately, when
and employees is retired or drawn out of work a lump sum amount is given at once.
(c) Other Deductions
Apart from the above two kinds of deductions from employees earnings, employees may
individually authorized additional deductions as deductions to pay health or life insurance
premiums; to repay loans from the employer or credit association; to pay for donations to
charitable organizations; 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
gives the total deductions from the gross earnings of an employee.
The column Total Deductions shows the total deductions made from the earnings of
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 excess of
grand total earnings over grand total deductions made from the earnings of employees. It is the
grand total take- home pay.
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 names of employees.

D. Major procedures or Activities Involved in Accounting for Payroll.

1. Gathering the Necessary Data. All the relevant information about every employee
should be gathered. This activity requires reviewing various documents and to do some
arithmetic work.
2. Including the names of employees along with the gathered data such as earnings,
deductions and net pays in the appropriate columns of the payroll register.
3. Totaling and proving the payroll register. It must be proved that the grand total earnings
equal the sum of the grand totals of deductions and net pays in the register.
4. The accuracy and authenticity of the information summarized in the payroll should be
verified by a different person from the one who compiles it.
5. The payroll is approved by the authorized personnel.
6. Paying the payroll either in cash (this may be after cashing a check issued for the total net
pay of the payroll) or issuing a check for every individual employee for the net amount
payable to each employee.
7. Recording the payment of the payroll and recognition of the withholding tax liabilities.
8. Recording thee payroll taxes expenses of the employer.
9. Paying and recording withholding and payroll tax liabilities to the concerned authority,
in our case to Inland Revenue Administration, on time.

DEMONSTRATION PROBLEM

Metebaber Agency pays the salary of its employees according to the Ethiopian Calendar month.
The forth coming data relates to the month of Hider, 1998 E.C.
OT
S. Name of Basic Monthly hours Duration of OT Basic Salary
No Employee Salary Allowance worke work Per hour
d
01 Semait Gobeze Up to 10 p.m.
Br. 3,200 100 10 20
02 Petros Chala 1.600 -- 8 10 p.m. to 5 a.m. 10
03 Abdi Jemal Weekly rest days
2,400 -- 6 15
04 Leilla Beza
1,920 50 -- -- 12
05 Kiros Wolde 1,280 50 10 Public Holidays 8

N.B. Note that management of the agency usually expects a worker to work 40 hours in a week
and during Hidar 1998 all workers have done as they have been expected. Besides, all workers
of this agency are permanent employees except Petros Chala; the monthly allowance of Kirkos
Wolde is not taxable; Abdi Jemal agreed 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 agency for the month of Hidar, 1998.
2. Record the payment of salary as of Hidar 30, 1998 using Ck. No. 41 as a source
documents.
3. Record the payroll taxes expense for the month of Hidar, 1998. Memorandum No.006
4. Record the payment of the claim of the credit Association of the agency that arose from,
Hidar payroll. Assuming that the payment was made on Tahesas 1, 1998.
5. Assuming that the withholding taxes and payroll taxes of the month of Hidar, 1998 have
been paid on Tahesas 5, 1998 via Ck. No. 5o, recorded the required Journal entry.

Computations of earnings deductions and net pays

Overtime Earnings:
Overtime Earning = OT Hrs worked x (ordinary hourly rate x OT Rate)
1. Senayit
10 hrs x (20 x1.25) = Br. 250
2. Petros
8 hrs x (10 x 1.5) = Br. 120
3. Abdi
6 hrs x (15 x 2) = Br. 180
4. Kiros
10 hrs x (8 x 2.5) = Br. 200

Gross earnings:
Gross Earnings = Basic Salary + Allowance + OT Earning
1. Senayit
Br. 3200 + 100 + 250 = Br. 3,550
2. Petros
Br. 1,600 + 0 + 120 = Br. 1,720
3. Abdu
Br 2,400 + 50 + 0 = Br. 2,580
4. Leila
Br 1,920 +50 + 0 = Br. 1,970
5. Kirkos
Br 1,280 + 50 + 200 = Br. 1,530

DEDUCTIONS AND NET PAYS:

1. SENAYIT

Gross taxable income Tax:


Employee Income Tax:
Earning x ITR = Income Tax
Br. 150.00 x 0 00.00
500.00 x 10% 50.00
750.00 x 15% 112.50
950.00 x 20% 190.00
1200.00 x 25% 300.00
Total 3,550.00 652.50
Pension contribution:
Basic salary x 4%
Br. 3200 x 4% 128.00
Total deductions 780.50
Net pay Br. 2769.50
2. PETROS
Gross Taxable Income = Br. 1,720
Employee Income Tax:
Earning ITR = Income Tax
Br. 150 0% 00.00
500 10% 50.00
750 15% 112.50
320 20% 64.00
Total 1,720.00 226.50

Pension Contribution
is zero as he is a
Contractual worker 00.00
Total Deductions 226.50
Net Pay Br. 1493.50

3. ABDI
Gross Taxable Income = Br. 2,580
Employee Income Tax:
Earning ITR = Income Tax
Br. 150 0% 00.00
500 10% 50.00
750 15% 112.50
950 20% 190.00
230 25% 57.50
Total 2,580 410.00

Pension Cont.:
Br. 2400 4% = 96.00
Credit Asso. Pay 200.00
Total deductions . . . . . . . . . . 706.00
Net Pay . . . . . . . . . . . . . . . . . 1874.00

4. LEILA
Gross Taxable Income = Br. 1970
Employee Income Tax:
Earning ITR = Income Tax
Br. 150 0% 00.00
500 10% 50.00
750 15% 112.50
570 20% 114.00
Total 1970 276.50
Pension Cont.
Br. 1920 4% = 76.80
Total Deduction . . . . . . . . . . . . 353.30
Net Pay . . . . . . . . . . . . . . . . . . . Br. 1616.70

5. KIRKOS
Gross Taxable Income (his allowance is not
subject to tax) = Br. 1530 50 = 1480
Gross Earning . . . . . . . . . . . . . . . . . . . . . Br. 1530
Employee Income Tax:
Earning ITR = Income Tax
150 0% 00.00
500 10% 50.00
750 15% 112.50
80 20% 16.50
Total 1480 178.50
Pension Contr.:
Br. 1280 4% = 51.20
Total Deductions . . . . . . . . . . . . . . 229.70
Net Pay . . . . . . . . . . . . . . . . . . . . .Br. 1,300.30
Note: ITR means Income Tax Rate

Proving The payroll:


Total Earnings:
Basic Salary . . . . . . . . . . . . . . . . . Br. 10,400.00
Allowance . . . . . . . . . . . . . . . . . . 200.00
Overtime . . . . . . . . . . . . . . . . . . . . 750.00
Grand Total Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . Br. 11,350.00

Deductions:
Employee Income Tax . . . . . . . . . Br. 1,744.00
Pension Contribution . . . . . . . . . . 352.00
Other . . . . . . . . . . . . . . . . . . . . . . 200.00
Total Deductions . . . . . . . Br. 2,296.00
Net Pays Total . . . . . . . . . 9,054.00
Total Ded, & Net Pay . . . . . . . . . . . . . . . . . . . . . . Br. 11,350.00 Thus, it is proved.

Ethio Relief Agency


Payroll Register (Sheet)
For Month of Hidar 198

Earnings Deductions
Gross
Name of Employee
No Basic Overti (total) Pension Other Total Dedu. Net Pay
Employee Allow. Income
Salary me Earning Deduc. Deduc.
Tax

01 Senayet Bahru 3200 100 250 3550 652 50 128 00 ---- -- 780 50 2769 50

02 Petros Chala 1600 ---- 120 1720 226 50 ---- -- ---- -- 226 50 1493 50

03 Abdu Mohammed 2400 ---- 180 2580 410 00 96 00 200 00 706 00 1874 00

04 Leila Jemal 1920 50 ---- 1970 276 50 76 80 ---- -- 353 30 1616 70

05 Kirkos Wolde 1280 50 200 1530 178 50 51 20 ---- -- 229 70 1300 30

Total 10400 200 750 11350 1744 00 352 00 200 00 2296 00 9054 00

2. Recording the payment of salary.

198 Hidar 30 Salary Expense . . . . . . . . . . . . . . . . 11, 350


Employee Income Tax Payable . . . . . . . . . . . . . . . . . . . 1,744
Pension Contribution payable . . . . . . . .. . . . . . 352
Credit Association ERA . . . . . . . . . . . . . . . . . . . . . . . . 200
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,054
CK. No. 41

3. Recording the Payroll Taxes Expense for Hidar, 1998

Metebaber Agency incurred payroll tax expense of Br. 528 during Hidar, 1998. This is because
the agency has to contribute 6% of the basic salary of every permanent employee to the
government pension trust fund.
Thus,
(Total Basic Salary Payroll Taxes of all permanent Employees) x 6% = Payroll Expense
(3,200 + 2,400 + 1,920 + 1,280) X 6% = Br. 528
By the amount of Br. 528 the agencys expense, payroll taxes expense, and pension
contributions payable increase.
Therefore, the following journal entry is made as of Hidar 30, 1999:
Payroll Taxes Expense . . . . . . . . . . . . . . . . . . . . . . . . . 528
Pension Contribution Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 528
Memorandum No. 0006
The source document is an internal office memorandum that indicates the incurrence of this
expense.

4. Recording the payment of deduction from Abdis earnings to the credit association.

Credit Association. 200


Cash 200
Ck No. 42
5. Recording the payment of with holding and payroll taxes to the Inland Revenue
Administration on
Tahsas 5, 1998 E.C.

Look at the account balances before payment:

Employee Income Tax Payable Pension contribution Payable

1,744 352
528
870

From the above accounts you can see that the agency has a total liability of Br. 2,097.40. That
is
Employee income tax . Br. 1,744.00
Pension contribution. 870.00
Total ... Br. 2,614.00

Note also that the total pension contribution payable is equal to 10% of basic salary of all
permanent employees. That is Br. 7,200 x 10% = Br. 720. Then, the payment is recorded
as follows:
Employees Income Tax Payable.. 1,744.00
Pension Contributions Payable .. 870.00
Cash ..2,614.00

After the payment of these liabilities have been posted, the above two accounts will have
zero balances.

Exercises
Exercise 1. Payroll data of a government hotel, National Hotel, for the month of Hamle, 1998 are
given
below:
Regular Over Time in Hours
Name Basic Hourly Allowance Up to 10 PM 10PM-6AM Rest Holidays
Salary Rate Days
Abesha Br. 600 Br. 3.00 Br. 200 10 - 4 -
Belete 420 2.10 - 20 10 - 5
Tegbaru 980 4.90 100 - 5 - 8

Besides, Belete is a contractual employee and the allowance to Abesha is free of income tax.

Required:
1. Prepare payroll register
2. Record on page I of a two column general journal:
a. the payment of salary on Hamle 30
b. the recognition of payroll tax expense, and
c. the payment of the amounts owed in connection with the Hamle, 1998
payroll and of payroll tax to the government on Nehase 5, 1998
Exercise 2. A permanent employee of a government organization with a basic monthly salary of
Br. 640.00 and monthly Allowance of Br. 100.00 have worked 20 overtime hours during days in
the weekends of the current month. This employee usually works 160 hours in a month to earn
his basic salary.
Based on the above information answer the following questions:
1. The ordinary hourly rate of this employee is equal to ____________.
2. The gross earnings of the above employee is ____________.
3. The amount of employee income tax and pension contribution deductions are
respectively
________________________.

Exercise 3. W/t Kedija, the employee of CMN Agency, government owned, has worked 10
hours, 8 hours and 12 hours, during the holidays, after mid night on working days and
weekends respectively in a given month. In the same month, she has earned a regular monthly
salary of Br. 1,120 as the result of working 140 regular working hours. Determine her gross
overtime earnings for the month.

Exercise 4. Using the following payroll data of Paradise Restaurant government owned, for the
month of Sene, 1998,
1. Compute the:
a) Income tax deductions from each employee,
b) Pension contribution by each employee, and
c) Employers payroll tax expense
2. Prepare journal entries to record the:
a) Payment of salary to employees
b) Employers payroll tax expense
c) Payment of the deductions and payroll taxes to the government at the
beginning of the following month.

Employee Name Basic Salary OT Earning


Derbe Reta Br. 200.00 Br. 50.00
Rahel Amde 400.00 200.00
Michael Girma 300.00 400.00

5. Assuming that the ordinary hourly rate of Rahel is Br. 2.00 and all of her overtime hours
were performed during weekly rest days, how may overtime hours did she perform?