CHAPTER THREE

PAYROLL ACCOUNTING

3.1. Importance of payroll accounting

Accounting system 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 a safeguard to ensure that payments are in accordance to management's general plans and
its specific authorizations.
Employees of an organization are entitled to receive remuneration at regular intervals following
the close of each payroll period.
Pay roll accounting is important for the following reasons:
 Payroll often represents the largest expense that a company incurs
 Both federal and state governments require that detailed payroll records be kept
 Employees are sensitive to payroll errors or irregularities.
 Adequate payroll system safeguards the financial resources of the organization from
misuse and theft

4.2. Definition of payroll related terms

Payroll accounting involves so many generally accepted and standardized terms. This helps to
attain uniformity in the system both within the organization and with other related parties. The
following are the most common terms used in payroll accounting:
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 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 are related to an ‘ employee,’ that is, individual who works primarily
to one organization and whose activities are under the direct supervision of the employer.
2. The Pay Period: - A pay period refers to the length of time covered by each payroll payment.
3. The Pay Day: it is the day on which wages or salaries are paid to employees. This is usually
on the last day of the pay period. Usually the last day of the month in Ethiopia.
4. A payroll Register (sheet): is the list of employees of a business along with each employee’s
gross earning; deductions and net pay (take home pay) for a particular pay period. Then input
for payroll register is the employees work hour duration summarized from any of the
following sources:

Attendance sheets: is where employees sign at the time of arrival in the working area. It is
usually placed in offices and administrative areas.
Punched (clock) cards; is and electronically recorded card, where each employee will have
his/her own card for registering both at the time entering and leaving the working place. This
mechanism is commonly placed at the gated of manufacturing plants.

Time cards: is more or less similar to punched card except that the time is manually written in
hand written format by the employee.

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5. Gross Earnings: are taxes collected from the earnings of employees by the employer
organization as per the regulations of the government. These have to be submitted (paid) to the
government because employer organization is only acting as and agent of the government in
collecting these taxes from employees.
6. Payroll Deductions: are deductions from the gross earnings of an employee such as
employment income taxes (withholding taxes), labor union dues, fines, credit association pays
etc.
7. Net Pay: Net pay is the earning of and employees after all deductions have been made. This is
take home pay amount collected by and employee on the pay day.
8. Pay Check: a business can pay payroll by witting a check for the amount of the net pay. A
check is prepared in the name of each employee and handed to employee. Alternatively a
check for the total net pay of all employees can be prepared so the it will be paid in cash at the
organization for each employee.

4.3. Basic 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. It is always helpful to assign an identification
number (ID No) to individually identify employees. This is because; sometimes there could be
identical name for two or more employees in an organization

2. Name of employees
Even though t is advisable to assign and employee identification number, it does not avoid the
need for including their names. A complete record of employee record should include both the
name and Id No. of the employee.
3. Earnings
Money earned an employee from various sources. This may include.
A. Basic Salary – A flat monthly salary of an employee for carrying out the normal work
employment and subject to change with the position of the employee
B. Allowances- Money paid monthly to an employee for special reasons, like:
- Position allowance- a monthly paid amount to an employee of assuming a particular office
responsibility
- 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 and employee to compensate for an
convent circumstance caused by the employer. For instance, unexpected transfer to a
difficult and distant work area.
- Desert allowance- a monthly allowance given to and employee because of assignment to a
relatively hot region
- Transportation (fuel) allowance- a monthly allowance to and employee to cover cost of
transportation up to the 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 therefore the amount paid to an employee for
overtime work performed.

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Article 33: of proclamation No: 64/1975 discussed the following about how over time work
should be paid.
A worker shall be entitled to be paid at a rate:
I. One and one-quarter ( 11/4,, 1.25) times his ordinary hourly rate for overtime work
performed before 10:00 P.M in the evening time or 4 o’clock in the evening in Ethiopia
time
II. One and one half (11/2, or 1.5 ) times his ordinary hourly rate for overtime work performed
between 10:00 P.M and six 6:00 A.M in the morning in western time or from 4 o’clock to
12 o’clock in the morning in Ethiopia time.
III. Two times the ordinary hourly rate for overtime work performed on weekly rest days
IV. Two and one half ( 21/2, or 2.5 ) times the ordinary hourly rate for overtime work performed
on a public holiday

To be compute OT the following steps

1 st step: Ordinary hour rate = Basic salary
No. of normal working hours in a month
Basic salary
8*5*4= (160)

2 nd step: Overtime earning = ordinary hour rate * OT rate * No. of hours worked

Gross Earning = Basic Salary + allowances + Overtime Earring

2. Deductions: are subtractions made from the earnings of employees required by the
government or permitted by the employee himself. The following are the most common
deductions from employee’s earning:
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 rated indicated under schedule A of the Proclamation No,
286/2002 – Income tax proclamation.
b. Pension Contribution: Permanent employees a governmental organization in Ethiopia is
expected to pay or contribute 7% 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 11% of the basic salary
of every permanent government employee. Therefore, the total contribution to the pension
fund of the Ethiopian government is equal to 18% of the basic salary of all of its permanent
employees. That is, 7 % comes from the employees and 11 % comes from the employer.
 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.

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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.

The tax rates under schedule A are Presented below

Table 4.1: Personal Income Tax Schedule

Employment Income Income

(Per Month) Tax rate

Over Birr To Birr
Birr
0 600 Exempt (free -
from Tax)
601 1650 10% (10%xT1) -60
1651 3200 15% (15%xT1) -142.50
3201 5250 20% (20%xT1) -302.50
5251 7800 25% (25%xT1) -565
7801 10,900 30% (30%xT1) -955
Over 35% (35%xT1) -1500
10,900

Taxable income includes and payment or gains in cash or in kind received form employment by
and individual, including income from former employment or otherwise or from prospective
employment.
In addition to the above income tax schedule of personal income tax, you can alternatively use
the following short cut procedure to calculate monthly income tax of employees

T1 = Taxable income of employees

Practically all income of individual may to be taxable. Proclamation No. 286/2002 designates
the following category of income as non-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:
 Personal injuries suffered by that person
 The death of another person

The council of minister’s 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.

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 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.
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.
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 registers

Enjoy is a governmental unit established to develop tourist attractions in Amhara regional
state. It has four employees whose salaries are paid according to the Ethiopian Calendar month.
The following data relates to the month of Meskerem, 2000
Name Position Over Duration
of allowance time of OT
employ Basic work
ee salary Worked
(hr)
Abebe 730 - 4 6-10 pm
Berihun 1020 - 8 Sunday
Chekol 5300 300 - -
Dagim 1470 - - -

Additional Information
 The employees usually are expected to work for 40 hours per week
 All employees are permanent except Dagim
 Berihun agreed to contribute Br 300 to credit association

Required:
1-calculate the gross earnings, deductions and net pay
2-prepare the payroll register of Enjoy for the month of Meskerem
3-Record the payment of withholding tax, pension contribution

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 Payroll Register of Enjoy
Enjoy Payroll Register sheet
For the month of meskerem

Name of Basic salary Allowance Over time Total Income Pension Other Total Net pay Sig
employee gross deduction deduction
Earnings
Tax
Abebe 730 -
Berihun 1020 -
Chekol 5300 300
Dagim 1470 -
Total 8520 300

Proving the payroll

The accuracy of the payroll calculation can be checked using the appropriate journal entry as
follows

Total earnings:

Basic salary--------------------xx

Allowances---------------------xxx

Overtime-----------------------xxx

Grand total………………xxxx

Deductions:

Employment income tax……………..x

Pension contribution………………….x

Other deductions………………………x

Total deductions……………………x

Net pay total………………………....x

Total deductions plus net pay……………x

Journal entry to record Payroll

Salary expense……………….8944. 81

Pension contribution…………………….282

Salary payable……………………………6702.59

Pension payable………………………..….282.00

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 Tax payable……………………………..….1660.22

Credit ass. Payable…………………….……300

Journal entry to record Payroll expense:

Salary payable……………………………..6702.59

Pension payable……………………………..282.00

Credit ass. Payable……………………….……300

Tax payable………………………………….1660.22

Cash……………………………………………………8944.81
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
03 Mohammed Modesir 5300 ___ ___ ___
04 Tensay Belay 1470 ___ ___ ___
05 Haile Olango 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 Tenssay 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.

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 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.
Illustration: Ethio Relief Agency pays the salary of its employees according to the
Ethiopian Calendar month. The forth-coming date relates to the month of Hidar,
2004.
        OT Duration of Basic
Ser.   Basic Monthly Hours OT Salary
No. Name of Employee Salary Allowance Worked Work Per Hour
01 Bontu Tola 2,080 100 10 Up to 10 p.m. 13
02 Petros challa 640 - 8 10p.m. to 6a.m 4
03 Abdu Mohammed 1,280 - 6 Weekly Rest Days 8
04 Chaltu Gudeta 960 50 - - 6
05 Yerosa Boru 480 50 10 Public Holiday 3

The agency usually expects a worker to work 40-hours in a week and During Hidar 2004
all workers have done as they have been expected. All workers of this agency are
permanent employees except Petros Challa. The monthly allowance of Yerosa Boru is not
taxable. Abdu Mohammed agreed to have a monthly Birr 200 be deducted and paid to the
credit Association of the agency as a monthly saving.
INSTURCTIONS: Based on the above information;
Compute gross earnings, deductions and net pay of each employee Prepare a payroll
register (or sheet) for the agency for the month of Hidar, 2004.
I. Record the payment of salary as of Hidar 30, 2004 – using CK. No 41 as a source
document.

II. Record the payroll taxes expense for the month of Hidar; 2004 Memorandum No. 10

III. Record the payment of the claim of the credit association of he agency that arose from
Hidar’s Payroll assuming that the payment was made on Tahisas 3, 2004.

Assuming that the withholding taxes and payroll taxes the month of Hidar, 2004 have been
paid on Tahisas 5, 2004 Via Ck. No. 50 recorded the required journal entry.

Practical Exercise (Self-Assessment): The following data relates to the month Nehasse for a given
governmental organization-2002
Overtime earning = Over time hours worked (earnings per hour * Over time rate)
Additional information:
 The workers are expected to work 40 hours in a week an during Nehasse there are 4 weeks
 There were no absentees during the month
 All employees are permanent except Yomiyou
 Burka agreed to contribute monthly Br300 from his salary to credit association

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Required:
1. Compute:
a) Overtime earnings of each employee
b) Gross earnings of each employee
c) Income tax
d) Pension
e) Net pay
S.NO. Basic Allowance Overtime Duration of
Name salary (transportation) worked overtime work
1 Abdi Br730 Br. 200 4 6:00-10pm
2 Burka 1020 ---- 8 Sunday
3 Motuma 5300 ----- ------ ------
4 Toltu 1470 ----- ----- ------
5 Yomiyou 950 ---- 6 Public holiday

2. Prepare payroll register

3. Record payment of salary
4. 4Record payment of the claim of credit association
5. Record payment of withholding tax and pension contribution to concerned government body on
sep.2,2003
NB: Earning per hours = Basic salary/total hours worked during the month