CHAPTER FOUR

Accounting systems for payroll and payroll taxes

Payroll refers to the amount to be paid to employees for the service they
provide during a period.
The Importance of Payroll Accounting
 Payroll expenditures are significant for various reasons such as:
 Employees are sensitive to payroll errors and irregularities.
 Timely and accurate payroll payments help to maintain good
employees’ moral and motivation.
 Payroll is subject to government regulations.
 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 to all salaries and wages paid to employees.
 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
a) Hiring employees
b) Preparing the payroll
c) Time keeping
d) Paying the payroll
Determining the payroll: -Determining the payroll involves computing:
a) Gross earnings
b) Payroll deductions and
c) Net pay
Gross earning 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.
Basic salary or regular earnings: a flat monthly salary of an
employee for carrying out the normal work..
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.
Conti--
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
Allowances: money paid monthly to an employee for special reasons
House allowance: a monthly allowance given to cover housing costs of the individual
employee
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.
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.
Over time earnings: Over time work is the work performed by an employee
beyond the regular working hours or days.
Conti--
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
a) one and one-quarter (1 ¼) times his ordinary hourly rate for overtime work
performed before 10:00 P.M in the evening.
b) 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.
c) Two times the ordinary hourly rate for overtime work performed on weekly
rest days
d) two and one half (2 ½ ) times the ordinary hourly rate for overtime work
performed on a public holiday.
Payroll deductions
 Payroll deductions may be mandatory or voluntary.
 Mandatory deductions include deductions required by law like income tax.
 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.
 Income Tax Calculation

Income bracket (Birr) Range Tax rate Formula

0-600 exempted
601- 1,650 500 10% (TI x10%) -60
1,651- 3,200 750 15% (TI x15%) -142.50
3201- 5,250 950 20% (TI x20%) -302.50
5251- 7,800 1200 25% (TI x25%) -565
7,801 – 10,900 1450 30% (TI x 30%) - 955
Above 10,900 35% (TI x35%) -1500
Tax free /exempted payment
 The following payments in cash or benefits in kind exempted from taxation.
a) Medical cost
b) Transportation allowance (Not more than Br.1000 or 25% of basic salary)
c) Hardship allowance
d) Reimbursement of traveling expenses incurred on duty
Pension fund
 Permanent employees 7% of their basic salary to pension trust fund.
 the employer is expected to contribute towards the same fund 11%
 The total contribution to the pension and social security authority (PSSA) equals to 18%
 Business and non-governmental not-for profit organization (NGO’s) also have this kind of a scheme
to benefit their employees called provident fund
 When an employee retains or leaves employment, a lump sum amount is paid to him/her.
Other deductions
 These can include amounts for charitable giving, insurance premiums, staff loan repayments and
union dues e.t.c.
 Net (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
 Pay period:is the length of time covered by each payroll payment. For wage workers weekly or
biweekly. Salaried employees pay period’s are monthly or semi monthly.
Attendance sheets, punched (clock) cards, together with information from the personal
records enable to update the employee earnings records 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.
Pay check/ payroll check: Payment of payroll is usually done by check or in coin and
currency.
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
 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 expense
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 AbayGebru 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
 Gross earnings = Basic salary pay + Allowance + Over time earning
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
d) Belay zeleke:Br.1848 + 700 + 210 = Br. 2758
e) Jemal Ahmed: Br. 1540 + 350 + 175 = Br.2065
f) Abay Gebru: Br.924 + 250 + 63 =Br. 1237
g) Hanna Birhane: Br. 350 + 0 + 0 = Br 350
Deductions
Total Deduction =Income tax + Pension contribution + other deductions
a) Income Tax
Belay Zeleke
Taxable Income = Gross earning – None taxable income
= Br.2758 – 200
=Br.2558

(TI x 25%) -235

= (2558 x 15%) -142.50
= 241.20
 Total deductions = Br. 241.20 + 129.36 + 450
= Br. 820.56 Pension Contribution Other deductions
Basic Salary*7% Staff loan 300
1848*7%=129.36 Credit association 100
Donation 50
Net pay = Gross earnings – Total deductions
Total 450
= Br. 2758 – 820.56
= Br. 1,937.44
b) Jemal Ahmed
Taxable income = Gross earnings – Non taxable income
= Br. 2065 – 150
= Br.1915 Pension contribution
Income tax (TI x 20%) – 142.50 = basic salary x 7% Other deductions
(1915 x 15%) – 142.50 = 1540 x 7% = 107.8 Credit Assoc.= 50
144.75 Donation=50
Total= 100

Total Deductions= 144.75+107.80+100=352.55

Net Pay= Gross Earning – Total Deductions
= 2065-352.55= 1712.45
Abay Gebru
Taxable income = Gross earnings – Non-taxable income
= 1237 – 100 = 1137.00
Income tax
(TI x 10%) – 60
= 1137*10%-60
= 53.70
Pension contribution = Basic salary = 924 x 7% = 64.68
Other deduction
Staff loan 100
Donation 20
120
Total deductions: 53.70 + 64.68 + 120 = 238.38
Net pay = 1237 – 238.38 = 998.62
4. Hanna
Taxable income =Gross earning – Non taxable income
= 350 – 0 = 350
Income tax--Exempted
Pension contribution: no pension contribution because she is a temporary (contractual) worker.
Other deductions: Donation = birr. 10
Total deductions 20+ 10 = 30
Net pay = 350 – 30 = 320
 1. WISDOM INSTITUTE
PAYROLL REGISTER
For the month of Megabit, 2005
No. Name of EarningsGross Taxab Deductions Total Net Sign
employee earnin le Deducti pay atur
Basic Allowan Ove gs incom ons e
salary ce r e Income Pension other
time tax C. s

1 Belay Zeleke 1848 700 210 2758 2558 241.20 129.36 450 820.56 1,937.4
4
2 Jemal Ahmed 1540 350 175 2065 1915 144.75 107.8 100 352.55 1,712.4
5
3 Abay Gebru 924 250 63 1237 1137 53.70 64.68 120 238.18 998.82

4 Hanna Birhane 350 - - 350 350 ----- - 10 10.00 340.00

Total 4662 1300 448 6410 5960 439.65 301.84 680 1,421.49 4,988.7
Prepared by: _____________Checked by: ____________Approved by:_________________ 1
 2. 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…………………………………………4988.71

3 Salary payable………………………….. 4988.71

Cash…………………………………………………….. 4988.71

4. Payroll tax expenses……………………………474.32

Pension contribution (11%)………................................474.32
(4662 – 350 X 11% = 474.32)

5. Income tax payable……………………..…439.65

Pension contribution payable (18%)……--776.16
Credit association payable…………………150
Donation payable…………………………130
Staff loan …………………………………400
The End