CHAPTER 3

ACCOUNTING FOR PAYROLL

3.1. Introduction

In the previous chapter you have discussed the basic accounting principles and practices that are
useful in accounting for the acquisition, use, and disposal of plant assets, as well as the
accounting for intangible assets and natural resources have also been discussed briefly.

In this chapter you will be acquainted with the basics of accounting for payroll and payroll taxes.
Accounting systems for payroll and payroll taxes are concerned with the records and reports
associated with the employer-employee relationship. It is important that the accounting system
provide safeguard to ensure 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 remuneration at regular
intervals following 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 unauthorized payments to employees
and other misappropriations of funds.

Various federal, state, and local laws requires employers to keep accurate payroll records and to
prepare reports and submit to the appropriate governmental units. The law also require
employers t remit the amounts withheld from its employees and for taxes imposed on itself.
These records must be kept for specified periods of time and be available for inspection by those
responsible for enforcement of the laws. Besides, payroll data may be useful in negotiations with
labor unions, in settling employee grievances, and in determining rights to vacations, sick leaves,
and retirement pensions.

Here, in this chapter, you are going to learn intensely and worked through the major concepts
that are common to most payroll systems such as the employee’s earnings record, payroll sheet
(or register), and journal entries related to payroll. Each of these concepts is illustrated and
discussed by taking into account the current tax law of the country. As much as possible the
chapter attempts to give you adequate knowledge about payroll systems in Ethiopia, however, if
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you come across any confusion or difficulties you can consult the authorities in the Ministry of
Finance or Inland Revenue Administration in your locality, or refer the various proclamations
especially; Proclamation No. 286 / 2002, the council of ministers regulation No. 78 / 2002. And
Article 33 or proclamation No. 64 / 1975

3.2. Importance of Payroll accounting

Accounting for payroll is particularly important because:

1- Payroll often represents the largest expense that a company 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 on a timely and accurate basis.
3.3. Definitions of Payroll Related Terms

1. Salary and Wages: Salary and wages are usually used interchangeably. However, the term
wages is more correctly used to refer to payments to unskilled-manual labor. It is usually paid
based on the number of hours worked or the number of units produced. Therefore, wages are
usually paid when a particular piece of work is completed or weekly.

On the other hand, salaries refers to payments to employees who render managerial,
administrative or similar services, and they are usually paid to skilled labor on a monthly or
yearly basis.

Both wages and salaries related to an ‘employee’ is an individual who works primarily to one
organization and whose activities are under the direct supervision of employer.

A self-employed person on the other hand works (gives her services) on a fee basis to various
firms.

2. The Pay Period: A pay period refers to the length of time covered by each payroll payment.

3 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.

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4. A Payroll Register (sheet): is the list of employees of a business along with each employee’s
gross earnings; deductions and net pay (take home pay) for a particular pay period. The payroll
register (sheet) is prepared based on attendance sheets, punched (clock) cards or time cards.

5. Pay Check: A business can pay payroll by writing a check for the amount of the net pay. A
check is prepared in the name of each employee and handed to employees. Alternatively a check
for the total net pay can be prepared for employees to the paid by cash at the organization.

6. Gross Earnings: are taxes collected from the earnings of employees by t he employer
organization as per the regulations of the government. These have to be submitted (paid) to the
government because3d employer organization is only acting as an agent of the government in
collecting these taxes from employees.

7. Payroll Deductions: are deductions from the gross earnings of an employee such as
employment income taxes (with holding taxes), labor union dues, fines, credit association pays
etc.

8. Net Pay: Net Pay is the earning of an employee after all deductions have been deducted. This
is the take home pay amount collected by an employee on the payday.
9.4. Possible Components of a Payroll Register

1. Employee Number
Number assigned to employees for identification purpose when a relatively large number of
employees are involved in a payroll register.

2. Name of Employees

3.6. Earnings
Money earned by an employee from various sources,. This may include.
a. Basic Salary- a flat monthly salary of an employee 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, like:
- Position allowance- a monthly paid to an employee of earning a particular
office responsibility.
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 - Housing 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 circumstance caused by the employer. For instance, unexpected
transfer to aw 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 workplace 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.

Overtime earnings are the amount paid to an employee for overtime work performed.

Article 33 of proclamation No. 64/1975 discussed the following about how overtime work
should be paid:

A worker shall be entitled to the paid at a rate of

i. One and one-quarter (1 ¼) times his ordinary hourly rate for overtime work
performed before 10:00 P.M in the evening.
ii. One and one half (1 ½) times his ordinary hourly rate for overtime work
performed between 10:00 P.M and six (6:00 A.M) in the morning.
iii. two times the ordinary hourly rate for overtime work performed on weekly
rest days
iv. two and one half (2 ½ ) times the ordinary hourly rate for overtime work
performed on a public holiday.

All in all, the gross earnings of an employee may include the basic salary, allowance and
overtime earnings.

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4 Deduction: are subtractions made from the earnings of employees required by the government
or permitted by the employee himself.

a. Employment Income Tax: Every citizen is required to pay

employee tax to the government in almost all countries. In Ethiopia also, income tax is
charged on the gross earnings of the employee at the rates indicated under schedule A of
the Proclamation N. 286/2002- Income tax proclamation.

The tax rates under schedule A are Presented below:

Employment Income Income

(per month) Tax rate
*In computing
Taxable income and withholding
includes any
Over Birr To Birr
0 600 Exempt (Free from Tax) tax, theorincome
payment gains tax proclamation
in cash or I n
601 1, 650 10% dictates
kind thatfrom
received income attributable
employment by
1, 651 3,200 15%
3,200 5,250 20% antoindividual,
the monthincluding
of Nehassie and
income
5,251 7,800 25% Pagumen
from formershallemployment
be aggregated
or
7,801 10,900 30%
(added) and
otherwise or treated
from asprospective
the income
Over 10,900 35%
of one month.
employment.

Short cut to Income Tax Calculation

Employment Income Income
(per month) Tax Payable
Over Birr To Birr
0 600 No tax
601 1, 650 (10% X EI) – 60
1, 651 3,200 (15% X EI) – 142.50
3,200 5,250 (20% X EI) – 302.50
5,251 7,800 (25% X EI) – 565
7,801 10,900 (30% X EI) – 955
Over 10,900 (35% X EI) – 1500

EI = Employment Income or taxable income

60 = (600 X 0.1) – 0
47.5 = [(600 X .15) – 0] + [(1050 X 0.15) – (1,050 X 0.1)]and so forth

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Proclamation No. 286/2002 states that the following are not taxable.
1- income from employment received by casual employees who are not regularly employed
provided that they do not work for more than one month for the same employer in any
twelve months period.
2- Pension contribution, provident fund and all forms of retirement benefits contributed by
employers in an amount that doesn’t exceed 15% of the monthly salary of the employee.
3- Payments made to---- (an employee) as a compensation or gratitude in relation to:
o personal injuries suffered by that person
o the death of another person

The council of ministers regulation No. 78/2002

Regulations issued pursuant to the income tax proclamation further exempts the following from
income tax.

1- Amounts paid by employers to cover the actual cost of medical treatment of employees.
2- Allowance in view of means of transportation granted to employees under contract of
employment, i.e., transportation allowance.
3- Hardship allowance
4- Amounts paid by employee in reimbursement of traveling expenses incurred on duty.

4.b. Pension Contribution

Permanent employees a governmental organization in Ethiopia is expected to pay or contribute
4% of their basic salary to the governments’ pension trust fund.

This amount is withheld by the employer from each employee on every payroll and later be paid
to the respective government body.

The employer is also expected to contribute towards this same fund 6% of the basic salary of
every permanent government employee.

Therefore, the total contribution to the pension fund of the Ethiopian government is equal to 10%
of the basic salary of all of its permanent employees.

That is, 4% comes from the employees and 6% comes from the employer.

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This enables a permanent employee of a government organization to be entitled to the pension
pay when retiring provided the employee satisfies the minimum requirements to enjoy the
benefits.

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.

4.c. Other Deductions

Apart from the above two kinds of deductions, employees may individually authorize additional
deductions such as deductions to pay life insurance premiums, to repay loan from the employer,
to pay for donation to charitable organization, contributions to "ldir" etc.
6.5. Major Activities Involved in Accounting for Payroll

1 Gathering the necessary data - All the relevant information about every employee should be
gathered.

This requires reviewing various documents such as attendance sheets and doing some arithmetic
work.

2 Entering 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 -the grand total for earnings must be checked if its
equal to the sum of the grand totals of deductions and net pays.

4 The accuracy and authenticity of the information - summarized in the payroll should be
verified by a different person from the one who prepared it.

5 The payroll - should be approved by an authorized personnel (individual)

6 Paying the payroll - either in cash or by writing a check.

7 The payment of the payroll and income taxes - withheld from employees (withhold doing tax
liability) should be recorded in journal entry form.

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8 The withholding tax - must be paid to the relevant government authority in time (promptly)
and this is recorded in journal entry form.

ILLUSTRATION ON PAYROLL REGISTOR

Godanaye is a government agency recently organized to rehabilitate street children. It has five
employees whose salaries are paid according to the Ethiopian calendar month. The following
data relates to the month of Yekatit, 1995.

Serial Name of Employee Basic Transp. Overtime Duration of

No. __________________ Salary Allowance worked(hr) OT Work
01 Aregash Shewa Br. ,730 200 4 6:00-10:00 P.M
02 Paulos Chala 1020 ___ 8 Sunday(8:30-5:30)
03 Mohammed Modesir 5300 ___ ___ ___
04 Tensay Belay 9,470 ___ ___ ___
05 Haile Olango 10, 950 ___ 6 Public Holiday
Additional Information
- The management of the agency usually expects a worker to work 40 hours in a week and
during Yekatit there are four weeks.
- There were no absentees during the month
- All employees are permanent except and Tinsae and Haile
- Paulos agreed to contribute monthly Br. 300 from his salary as a monthly saving in the
credit association of the agency.

Required
1. Prepare a payroll register (sheet) for the agency for the month of Yekatit, 1995.
2. Record the payment of salary as of yekatit 30,1995 using check stub No. 0123.
3. Record the payment of the claim of the credit Association of their agency on Megabit 1,
1995 use check stub No. 0124.
4. Record the payment of the withholding taxes and pension contribution to the concerned
government body on Megabit 7,1995.
5. Compute and recognize the total payroll tax expense for the month of Yekatit, 1995.

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Computation of Earnings, Deductions and Net Pay

Gross Earnings = Basic salary + Allowance + Overtime Earning

Overtime Earning
Overtime earning = OT hrs worked X (ordinary hourly rate X relevant OT rate)

1. AREGASH:
 OT Earning = 4 hours X br. 730 X 1.25 = br. 22.81
160 hours
NB Every employee is expected to work 160 hours per month
(i.e. 40 hours x 4 weeks)
 You should compute the regular hourly rate first:
Regular Hourly Rate = Monthly salary (Basic Salary)
Total Hours worked in the Month
= br. 730
160 Hours
 Therefore, the regular Hourly payment = br. 4.56
The regular hourly payment must be multiplied by the appropriate OT rate as
follows:
br. (4.56 x 1.25) x 4 hours-------------------br. 22.81

2. PAULOS
 OT Earning = 8 hours X br. 1020 x 2 ----------------br. 102.00
160 hours

3. HAILE
 OT Earnings = 6 hours X br. 10, 950 x 2.5 -------------br. 1026.56
160 hours
GROSS EARNINGS
Gross Earnings = Basic salary + Allowance + OT Earnings

1. AGEGASH
 Gross Earnings = br. 730 + br. 200 + br. 22.81 = br. 952 .81

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  Remember taxable income in this case is br. 752.81 because the transportation
allowance of br. 200 is not subject to taxation.

2. PAULOS
 Gross Earning = br. 1020 + br. 102 = br. 1122
 The Gross Total Earnings of Paulos consists of the br. 1020 basic salary plus the
overtime earnings of br. 102, which is br. 1122.

3. MOHAMMED
 Gross Total Earnings = br. 5,300, which include the basic salary alone

4. TENSAY
 Gross Total Earnings = br. 9,470, which is the basic salary.

5. HAILE
 Gross Total Earnings = br. 10,950 + 1.026.56= br. 11,976.56

DEDUCTIONS AND NET PAY

1. AREGASH:
 Gross Total Earnings-----------------------------------------br. 952.81
 Gross Taxable Income (br. 952.81 – br. 200)-----------------752.81

Employee Income Tax:

Earnings X Income Tax Rate = Income Tax

0 – 600---------600 0 br. 00.00
601 – 752.81 on 152.81 10% 15.20
TOTAL br. 752.81-----------------------------------------------br. 15,20

Pension contribution:
Basic salary x 7%
= br. 730 x 0.07-------------------------------------------------51.10
 Total Deduction (br. 15.20 + br. 51.10)-----------------br. 66.30

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NB. The income tax to be deducted from the employee could have been computed by using the
short-cut method as follows:
= (Taxable Income x 10%) – br. 60.
= (br. 752.81 x .10) – br. 60 = br. 15.30

2. PAULOS:
 Gross Total Earning-----br. 1122.
 Employee Income tax
= (Taxable Income x 10%) – br. 60.
= (br. 1122 x .10) – br. 60 = br. 52.20

Pension Contribution (br. 1020 x 0.07) ---------------------71.40

 Credit Association--------------------------------------------300.00
 Total Deduction---------------------------------------------br. 423.60

3. MOHAMMED:
 Gross Total Earnings------------------------------------br. 5300.00
 Employee Income Tax
= (Taxable Income x .25%) – br. 565
= (br. 5,300 x .25) – br. 565 = br. 760.00

 Pension contribution (br. 5300 x 0.07)---------------------- 371.00

 Total Deductions------------------------------------------br. 1131.00

4. TENSAY:
 Gross Total Earnings------------------------------------br. 1470.00
 Gross Taxable Income--------------------------------------1470.00
Employee Income Tax:

= (Taxable Income x .30%) – br. 955

= (br. 9,470 x .30) – br. 955= br. 1,886.00

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NB. No pension contributions because she is not permanent employee of the organization.
Therefore, total deduction is the same as Employee Income Tax, br. 1,886.00

5. HAILE:
 Gross Total Earnings--------------------------------------br. 1039.06
Employee Income Tax:
 Employee Income Tax
= (Taxable Income x .35%) – br.1,500
= (br. 11,976.56 x .35) – br. 1,500 = br. 2,691.80

 Pension contribution should not be computed for Haile because he is not

permanent employee of the agency. Thus, the only deduction from Haile’s
earnings is the employee income tax.

NET PAY:

Net pay = Gross Total Earnings – Total Deductions

1. AREGASH:
Net pay = br. 952.81 – br. (94.62)
Net pay = br. 858.19

2. PAULOS:
Net pay = br. 1122 – br. (461.60)
Net pay = br. 660.40

3. MOHAMMED:
Net pay = br. 5300 – br. (1404.50)
Net pay = br. 3895.50

4. TENSAY:
Net pay = br. 9,470 – br. (1,886.00)
Net pay = br 7,594.00
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 5. HAILE:
Net pay = br. 11,976.56 – br. 2,691.80
Net pay = br. 9,284. 76

Todanaye
Payroll Register(sheet)
For the month of Yekatit,1995
Ser. Name of Earnings Deductions
Basic Allo- Over Income Pension Other
No. Employee Gross Total Net Sign.
salary wanc Time Tax Contr. Deduc.
Earning Deduc. Pay
e
01 Aregash Shewa 730 200 22.81 952.81 15.20 51.10 ___ 66.30 858.19
02 Paulos Chala 1020 ___ 102 1122 52.20 71.40 300 423.60 660.4
03 Mohammed 5300 ___ ___ 5300 760 371.00 ___ 1131 3895.5
Mudesir
04 Tensay Belay 9,470 ___ ___ 9,470 1,886 ___ ___ 1,886 7,594.
05 Haile Olango 10,950 ___ 1026.5 11,976. 2,691.8 ___ ___ 2,691.8 9,284,.7
6 56 0 0 6

27,470 1,151 213.87 28,821. 5,405.2 493.50 300 6,198.7 22,622.

Totals
.37 37 67

Prepared by_______________Checked by________________Approved by___________

2. Salary expense_______________

Employee income tax payable__________________

Pension contribution payable------------------------------
Credit association_____________________________
Cash(CK No.)--------------------------------------------------
3. Payroll tax expense------------------

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 Pension contribution payable---------------
()*6%

4. Credit association payable---------------------

Cash-------------------------------------------------------
5. Income tax payable--------------------------------------------------------
Pension contribution payable (11%) --------------------------------------
Cash----------------------------------------------------------------------------

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