Chapter 5

Accounting For the Payroll System in an Ethiopian Context

5.1. THE IMPORTANCE OF PAYROLL AND PAYROLL ACCOUNTING

The term Payroll often refers to any document prepared to pay remuneration to the employee for
the service rendered to an organization in a given period of time. Payroll accounting is an
accounting that is concerned with preparation of payroll and recording and reporting of
remunerations. The payroll accounting of a firm has significance and has to be given emphasis
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 (salary is the largest expense in most businesses)
5.2. DEFINITION OF PAYROLL RELATED TERMS
1. 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 an independent contractor, a self-employed individual who works on
a fee basis to a firm.
2. The Pay Period: The length of time covered by each payroll payment. Pay periods for
wageworkers are usually a weekly or biweekly period. That is, wage is paid either weekly or
biweekly. On the other hand, for salaried employees, the pay periods are a month, semi-month,
quarter, semi-annual, or a year.
3. The Pay Day: The day on which wages or salaries are paid to employees. PAY DAY is
usually the last day of the pay period.
4. A Payroll Register (Payroll 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.

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5. 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 summaries and file tax returns.
6. 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.
7. Gross Earnings: The total pay to an employee before deductions for the pay period.
8. Payroll Taxes: Are taxes levied against the employer on the payroll of a firm. It is the
portion of pension or social security contribution made by the employer. It is an additional
payroll related expense to an employer.
9. Withholding Taxes: These are taxes levied against the earnings of employees of an
organization and withheld by the employer as per the tax laws of the concerned government
10. Payroll Deductions: All the reductions from the gross earnings of an employee such as
withholding taxes, union dues, fines, credit association pays, etc.
11. Net Pay: The net earnings after subtracting all the deductions. It is sometimes known as
take home pay. The amount collected by an employee on the payday.
In the above definitions of payroll related terms, the three are considered the basic records of a
payroll accounting system. These are: (1) A payroll sheet, (2) Individual employees' earnings
records, and (3) Pay checks. These records are generated from a payroll system that is
operated either manually or using computers
5.3. COMPONENTS OF A PAYROLL REGISTER
1. Employee number – numbers assigned to employee for identification purpose. It might be
alpha-numeric character when a relatively large number of employees are included in the
payroll register.
2. Name of employees – full name of each employee included in the list of payroll sheet.
3. Earnings – a benefit in cash or in kind earned by an employee from various sources of
employment. 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:
 Position Allowance - a monthly sum paid to an employee for bearing a particular office
responsibility, e.g. head of a particular Department or Division.

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  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.
 Disturbance 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.
 Desert Allowance – a monthly Allowance given to an employee because of assignment to
a relatively hot region. It is some times known as Hardship Allowance
 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.
1.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.). (From
6:00 am to 4:00 pm)
2.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.)
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.
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 amounts to be subtracted from the earnings of employees because they are required by
government (mandatory deductions) or permitted by the employee himself (voluntary
deductions. Mandatory deductions include employment income tax and pension contribution. In
our country, some of the deductions against the earnings of employees are:
A. Employee Income Tax

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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. 286/1994 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 Schedule “A” as follows:
Employment Income per Range of Tax Per
Month TEI Month
TB Over Birr To Birr Tax Rate
1st 0 150 150 Exempt (0%)
2nd 150 650 500 10%
3rd 650 1,400 750 15%
th
4 1,400 2,350 950 20%
th
5 2,350 3,550 1,200 25%
6th 3,550 5,000 1,450 30%
th
7 5,000 **** 35%
Generally, taxable income from employment includes salaries, wages, allowances, director’s
fees and other personal emoluments, all payments in cash and benefits in kind. However, as per
Art 13 of Proclamation No. 286/2002 and Art 3 of Regulation No. 78/2002, the following
categories of payments in cash or benefits in kind are exempted from taxation.
(a) Income from employment received by casual employees
(b) Income from employment received by diplomatic and consular representatives; and
other persons employed in any Embassy
(c) Payments made to a person as compensation or gratitude in relation to personal
injuries; or the death of another person.
(d) Medical Allowance
(e) Transportation Allowance
(f) Hardship Allowance
(g) Per-diem Allowance (Daily Allowance)
(h) Traveling Expenses
(i) Income of persons employed for domestic duties
B. Pension Contribution
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 with held by
the employer from the basic salary of each employee on every payroll and later be paid to the
respective government body.

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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 that we called earlier as
payroll taxes expense to the employer organization (i.e. 6% of the total basic salary of all
permanent employees). For military forces (police and national defence members), the employer
contributes 16% of the basic salary of every permanent military force.
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 (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 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 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
an employee is retired or drawn out of work a lump sum amount is given at once.
C. Other Deductions (Voluntary 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 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 amount to be deducted 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.
5.4. Major Procedures or Activities Involved in Accounting for Payroll

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 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 the payroll taxes expense 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.
5.5. DEMONSTRATION PROBLEM
Ethio Relief Agency pays the salary of its employees according to the Ethiopian Calendar month. The
forth coming data relates to the month of Hider, 1998.

Name of Basic OT Hrs Duration of BS per

Allowance
S.No. Employee Salary worked OT work hour
01 Senait Bahiru 3,200 100 10 6 AM to 10 PM 20
02 Petros Challa 1,600 __ 8 10 PM to 6 AM 10
03 Abdu Weekly Rest
2,400 6 15
Mohammed __ Days
04 Leilla Jemal 1,920 50 __ __ 12
05 Kirkos Wolde 1,280 50 10 Public Holidays 8

Additional Information:
Note that management of the agency usually expects an employee to work 40 hours in a week
and during Hidar 1998 all employees have worked as they have been expected. Besides, all
workers of this agency are permanent employees except Petros Chala and the monthly
allowance of Kirkos Wolde is not taxable; Abdu Mohammed agreed to have Br 200 be deducted
from his earning and paid to the Credit Association of the Agency as a monthly saving.
Instructions: Based on the above information:

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A. Compute of earnings, deductions and net Pays
B. Prepare a payroll register (or Sheet) for the agency for the month of Hidar, 1998
C. Record the payment of salary as of Hidar 30, 1998 using Ck. No. 41 as a source documents
D. Record the payroll tax expense for the month of Hidar, 1998. Memorandum No.006
E. Record the payment of the claim of the credit Association of the agency that arose from
Hidar's payroll assuming that the payment was made on Tahsas 1, 1998
F. Record the payments of withholding taxes and payroll taxes of the month of Hidar, 19X8
assuming that they have been paid on Tahsas 5, 1998 via Ck. No. 50
A. Computations of Earnings, Deductions and Net Pays
OVERTIME EARNING:
Overtime Earning = OT Hrs Worked @ (Ordinary Hourly Rate @ OT Rate)
1. SENAYIT BAHIRU
 10 hrs @ (20 @ 1.25) = Br 250
2. PETROS CHALLA
 8 hrs @ (10 @ 1.5) = Br 120
3. ABDU MOHAMMED
 6 hrs @ (15 @ 2) = Br 180
4. KIRKOS WOLDE
 10 hrs @ (8 @ 2.5) = Br 200
GROSS EARNINGS:
Gross Earnings = Basic Salary + Allowance + OT Earning
1. SENAYIT BAHIRU
 Br 3,200 + 100 + 250 = Br 3,550
2. PETROS CHALLA
 Br 1,600 + 0 + 120 = Br 1,720
3. ABDU MOHAMMED
 Br 2,400+ 0 + 180 = Br 2,580
4. LEILLA JEMAL
 Br 1,920 + 50 + 0 = Br 1,970
5. KIRKOS WOLDE
 Br 1,280 + 50 + 200 = Br 1,530
DEDUCTIONS AND NET PAY:
1. SENAYIT BAHIRU
Gross Income (Gross Earning) = Br 3,550 and Taxable Income = Br 3,550
Deductions:

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  Employee Income Tax:
Taxable Income Tax
150.00 x 0% = 00.00
500.00 x 10% = 50.00
750.00 x 15% = 112.50
950.00 x 20% = 190.00
1,200 x 25% = 300.00
3,550 652.50
 Pensions Contribution = Basic Salary @ 4% = Br 3,200 x 4% = Br 128.00
Net Pay:
Gross Taxable Income..........................................
Br 3,550.00
Less: Deductions
Employee Income Tax............ 652.50
Pension Contribution.............. 128.00
Voluntary Contribution........... 0.00
Total Deduction........................... 780.50
Net Pay................................................................
Br 2,769.50
2. PETROS CHALLA
Gross Income = Br 1,720 and Taxable Income = Br 1,720
Deductions:
 Employee Income Tax:
Taxable Income Tax
150.00 x 0% = 00.00
500.00 x 10% = 50.00
750.00 x 15% = 112.50
320.00 x 20% = 64.00
3,550 226.50
 Pensions Contribution = Br 0.00, he is a Contractual worker
Net Pay:
Gross Taxable Income..........................................
Br 1,720.00
Less: Deductions
Employee Income Tax............ 226.50
Pension Contribution.............. 0.00
Voluntary Contribution........... 0.00
Total Deduction........................... 226.50
Net Pay................................................................
Br 1493.50
3. ABDU MOHAMMED
Gross Income = Br 2,580and Taxable Income = Br 2,580
Deductions:
 Employee Income Tax:
Taxable Income Tax
150.00 x 0% = 00.00
500.00 x 10% = 50.00
750.00 x 15% = 112.50
950.00 x 20% = 64.00
230.00 x 25% = 57.50

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 2,580 410.00
 Pensions Contribution = Br 2,400 x 4% = Br 96.00
 Voluntary Contribution = Br 200.00 payable to Credit Association
Net Pay:
Gross Taxable Income..........................................
Br 2,580.00
Less: Deductions
Employee Income Tax............ 410.00
Pension Contribution.............. 96.00
Voluntary Contribution........... 200.00
Total Deduction........................... 706.00
Net Pay................................................................
Br 1,874.00

4. LEILLA JEMAL
Gross Income = Br 1,970 and Taxable Income = Br 1,970
Deductions:
 Employee Income Tax:
Taxable Income Tax
150.00 x 0% = 00.00
500.00 x 10% = 50.00
750.00 x 15% = 112.50
570.00 x 20% = 114.00
1,720 276.50
 Pensions Contribution = Br 1,920 x 4% = Br 76.80
Net Pay:
Gross Taxable Income..........................................
Br 1,970.00
Less: Deductions
Employee Income Tax............ 276.50
Pension Contribution.............. 76.80
Voluntary Contribution........... 0.00
Total Deduction........................... 353.30
Net Pay................................................................
Br 1,616.70
5. KIRKOS WOLDE
Gross Income = Br 1,530 and Taxable Income = Br 1,530 – 50 = Br 1,480
Deductions:
 Employee Income Tax =150 @ 0% + 500 @ 10% + 750 @ 15% + 80 @ 20% = Br
178.50
 Pensions Contribution = Br 1,280 @ 4% =Br 51.20
Net Pay:
Gross Taxable Income..........................................
Br 1,530.00
Less: Deductions
Employee Income Tax............ 178.50
Pension Contribution.............. 51.20
Voluntary Contribution........... 0.00
Total Deduction........................... 229.70

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 Net Pay................................................................
Br 1,300.30
B. Preparing a payroll register (or Sheet)
ETHIO RELIEF AGENCY
Payroll Register (Sheet)
For Month of Hidar 1998
Pay Day: Hidar 30,19x8

Earnings Gross Deductions Gross Net

Earning Ded. Pay
Ser Name of Allo Pensi
Basic Over- Income Other
i. Employe w. on
Salary time Tax Ded.
No e Ded.
Senayet 100.0 250.0 128.0 2,769.5
01 3,200.00 3,550.00 652.50 __ 780.50
B. 0 0 0 0
Petros 120.0 1,493.5
02 1,600.00 __ 1720.00 226.50 __ __ 226.50
Ch. 0 0
180.0 1,874.0
03 Abdu M. 2,400.00 __ 2,580.00 410.00 96.00 200 706
0 0
1,616.7
04 Leila J. 1,920.00 50.00 __ 1,970.00 276.50 76.80 __ 353.30
0
Kirkos 200.0 1,300.3
05 1,280.00 50.00 1,530.00 178.50 51.20 __ 229.70
W. 0 0
10,400.0 200.0 750.0 11,350.0 1,744.0 352.0 200.0 2,296.0 9,054.0
Totals
0 0 0 0 0 0 0 0 0
Proving the Payroll:
Total Earnings:
Basic Salary........................................................................ Br 10,400.00
Allowance........................................................................... 200.00
Overtime............................................................................. 750.00
Total Earnings................................................ Br 11,350.00
Deductions:
Employee Income Tax..........................................................Br 1,744.00
Pension Contribution............................................................352.00
Other deductions...................................................................200.00
Total Deductions..........................................................Br 2,296.00
Total Net Pays..............................................................9,054.00
Total Deductions & Net pay........................... Br 11, 350.00
C. Recording the Payment of Salary on Hidar 30, 1998
Salary Expense............................................................................... 11,350
Employee Income Tax Payable..................................... 1,744
Pension Contribution Payable....................................... 352
Credit Association Payable............................................ 200
Cash............................................................................... 9,054
Ck. No. 41

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D. Recording the Payroll Tax Expense for Hidar, 19X8
Ethio - Relief Agency incurred payroll tax expense of Br 528 during Hidar, 19X8. This is
determined as the product of the basic salary of all permanent employees and 6%. This is
because the agency has to contribute 6% of the basic salary of every permanent employee to the
government pension trust fund. Thus,
 Payroll Tax Expense = Total Basic Salary of all permanent Employees @ 6%
 Payroll Tax Expense = (3,200 + 2,400 + 1,920 + 1,280) @ 6% = Br 528
By the amount of Br 528 the agency's expense, payroll taxes expense, and pension contributions
payable increase. Therefore, the following journal entry is made as of Hidar 30, 1998:
Payroll Tax Expense.......................................................................
528
Pension Contribution Payable.......................................528
Memorandum No. 006
The source document is an internal office memorandum that indicates the incurrence of this
expense.
E. Recording the payment of the claim of the credit Association
Credit Association Payable......................................... 200
Cash........................................................... 200
F. Recording the payments of withholding taxes and payroll taxes of the month
Look at the account balances before payment:
Employee Income Tax Payable Pension Contribution Payable
1,744 (2) 352.00 (2)
528.00 (3)
880.00

From the above accounts you can see that the agency has a total liability of Br 2,639. That is the
sum of Br 1,744.00 Employee Income Tax payable and Br 880.00 Pension Contribution payable
(1,744.00 + 880.00 = 2,624). Note also that the total pension contribution payable is equal to
10% of the basic salary of all permanent employees. That is, Br 8,800 x 10% = Br 880. T hen,
the payment is recorded as follows:
Employee Income Tax Payable................................... 1,744
Pension Contribution Payable.................................... 880
Cash.......................................................... 2,624
Ck. No. 50
After the payment of these liabilities have been posted, the above two accounts will have zero
balances.

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