CHAPTER FOUR

ETHIOPIAN PAYROLL SYSTEM

Introduction
Payroll and related fringe benefits often make up a large percentage of current liabilities.
Employee compensation is often the most significant expense that a company incurs. Payroll
accounting involves more than paying employees’ wages. Companies are required by law to
maintain payroll records for each employee, to fi le and pay payroll taxes, and to comply with
numerous state and federal tax laws related to employee compensation. Accounting for
payroll has become much more complex due to these regulations.

The term “payroll” pertains to both salaries and wages. Managerial, administrative, and sales
personnel are generally paid salaries. Salaries are often expressed in terms of a specified
amount per month or per year rather than an hourly rate. Store clerks, factory employees, and
manual laborers are normally paid wages. Wages are based on a rate per hour or on a
piecework basis (such as per unit of product). Frequently, people use the terms “salaries” and
“wages” interchangeably.

The term “payroll” does not apply to payments made for services of professionals such as
certified public accountants, attorneys, and architects. Such professionals are independent
contractors rather than salaried employees. Payments to them are called fees. This distinction
is important because government regulations relating to the payment and reporting of payroll
taxes apply only to employees.

4.1 Introduction about Labor Law in Ethiopia

As per Ethiopia labor law number 1156/2019, Employer means a person who has an
employment relationship with an employer in accordance with Article 4 this Proclamation.
Where a contract of employment is terminated, wages and other payments connected with the
termination due to the worker shall be paid within seven working days from the date of
termination; provided, however, that the time of payment may be extended where the worker
delays, because of his own fault, to return property or any sum of money which he received
from or is due to the employer.

Wages” means the regular payment to which a worker is entitled in return for the
performance of the work that he performs under a contract of employment. The following
payments shall not be considered as wages:
a) Over-time pay;
b) Amount received by way of per-diems, hardship allowances, transport allowance,
relocation expenses, and similar allowance payable to the worker on the occasion of
travel or change of his residence;
c) Bonus;
d) Commission;
e) Other incentives paid for additional work results;
f) Service charge received from customers.

1
Wages shall be paid in cash, provided, however, that where the employer and workers agree,
it may be paid in kind. Wages paid in kind may not exceed the market value in the area of the
payment in kind and in no case may exceed 30% of the wages paid in cash. Unless agreed
otherwise, wages shall be paid on working days and at the place of work.

The employer shall keep a register of payment specifying the gross pay and method of
calculation of the wage, other remunerations, the amount, and type of deduction, the net pay
and other relevant particulars on which the signature of the worker is a fixed unless there is a
special arrangement. The employer shall have the obligation to make the register accessible
and to explain the entries thereof, to the worker upon the latter’s request. The fact that a
worker has received without protest the amount indicated on the register shall not constitute
waiver of his right to any part of his wages that was due.

Normal hours of work shall not exceed 8 hours a day or 48 hours a week. Where the
circumstances in which the work has to be carried out are such that normal hours of work
cannot be distributed evenly over the individual week, normal hours of work may be
calculated as an average over a period longer than one week, provided, however that the
average number of hours over a period shall not exceed eight hours per day or forty-eight
hours per week.

Work done in excess of the normal daily hours of work fixed in accordance with the
provisions of this Proclamation shall be deemed to be overtime. A worker may not be
compelled to work overtime; however, overtime may be worked whenever the employer
cannot be expected to resort to other measures and only where there is:
a) Accident, actual or eminent;
b) Force-majeure;
c) Urgent work;
d) Substitution of absent workers assigned on work that runs continuously without
interruption.

4.2. Definition and 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
4.3. Definition of payroll related terms

2
Definition: The term payroll refers to the document prepared to pay remuneration for the
service rendered in a given period of time. Payroll contains the total amount paid to
employees as a compensation for services they rendered in a particular period.

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, it is 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 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.

5. Employment income tax: 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 an 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.

3
7. Net Pay: Net pay is the earning of employees after all deductions have been made.
This is take home pay amount collected by 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 that
it will be paid in cash at the organization for each employee.

4.4. A Payroll Register and its Components

A. Employee Number: Number assigned to employees for identification purpose when a
relatively large number of employees are involved in a payroll register. It could be an
identification card of the employees or a simple serial number.

B. Name of Employees: this column lists names of employees of the organization.

C. Earnings: Money earned by an employee from various sources. This may include.
(1) 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.

(2) Allowances: money paid monthly to an employee for special reasons, like:
i. Position allowance; a monthly allowance paid to an employee for bearing
a particular office responsibility.
ii. 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.
iii. Hardship allowance/or disturbance allowance; a sum of money given to
an employee to compensate for an inconvenient circumstance caused by
the employer. For example, unexpected transfer to a different and distant
work area or location.
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 his/her workplace if the employer has
committed itself to provide transportation service.
vi. Cash indemnity allowance; allowance paid for cashiers to cover the risk
of possible cash shortage.

(3) 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.

4
Article 33 of proclamation No. 1156/2019 discussed the following about how overtime work
should be paid. A worker shall be entitled to be paid at a rate of

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

D. Deductions: are amounts a company subtracts from each employee’s gross earnings. The
employer does not keep these deductions but rather pays (“remits”) them to another
organization or government agency on behalf of employees. Some deductions are
required by law; others are made on a voluntary basis as a service to employees.
Deductions required by law, such as: Salary income tax, pension contribution etc.
Voluntary deductions are amounts for charitable donations, retirement savings, union
dues, medical and dental plans, life insurance, parking fees, and also may other deduction
: - Like court order, fines, absence …etc.

From the employer’s perspective, payroll deductions create liabilities, not expenses. They
are not expenses because they do not directly increase the employer’s salary and wage
costs. Instead, they simply redirect part of the salary and wage payments to a government
agency or other organization rather than to employees.

Some of the common types of deductions in Ethiopia are discussed hereunder.

i. 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 No. 979/2016 - Income Tax Proclamation.

Taxable income includes any payment or gains in cash or in kind received from employment
by an individual, including income from former employment, or otherwise, from prospective
employment.

5
The Council of Ministers Regulation No. 78/2002 Regulations issued pursuant to the income
tax proclamation further exempt 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. Specially, the following conditions
should be considered in transport allowances;
A. For federal institution employees; transportation allowances exempt from
tax payable for the employee is only up to 1/4 th of the total salary of the
employee in any circumstance or the amount of transportation allowances
exempted from tax must not be more than 800 birr.
B. For regional level employees, transportation allowances exempt from tax
payable for the employee is only up to 15% of the total salary of the
employee in any circumstance or the amount of transportation allowances
exempted from tax must not be more than 600 birr.
3. Hardship allowance (Disturbance allowance).
4. Amounts paid by employee in reimbursement of traveling expenses incurred on
duty.
5. Allowances paid to members and secretaries of board of public enterprises and
pubic bodies as well as to member and secretaries of study group set by the federal
or regional government.
6. Desert allowances to the extent of 25% of the basic salary
7. Subject to reciprocity, income from employment, received for service rendered in
the exercise of their duties by diplomatic and consular representatives and other
person employed in any embassy and who are national of that state and bearers of
diplomatic passport.
8. Pension contribution provident fund and all forms of retirement benefits
contributed by employers in an amount that does not exceed 15% of the monthly
salary of the employee.
9. Income from employment received by causal employees who are not regularly
provided that they do not work for more than one month for the same employer in
any twelve month.

ii. Pension Contribution

Permanent employees of a governmental organization in Ethiopia are 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. For militaries, the employer (government) contributes 18% and the
employee contributes 6% of his/her basic salary towards his/her pension trust fund.

This enables a permanent employee of a government organization to be entitled to the

pension pay when retired provided that the employee satisfies the minimum requirements to

6
 enjoy the benefits. Businesses and non-governmental and not-for-profit organizations
(NGO’s) also have this kind of 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 retires or leaves employment, a
lump sum amount is paid to him/her.

iii. Other Deductions

A part 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 “idir” and etc.

E. Net Pay
Net pay represents the excess of gross earnings over total deductions of an employee.

F. Signature
The payroll sheet should have a column for signature of the employee to be taken when the
employee collects the net pay.

Illustration of Payroll Accounting

Dilla University is government Public entity established before 20 years and settled in
Dilla town. It has 5 new employees who are working for the month of November, 2014
E.C. The following data are raw facts for the month of November, 2014 E.C.
S no Name of Basic Allowances OT Duration of OT work
Employees salary Position Transportat Medical Hrs
ion
DU001 Gezahegn Chale 11,520 2,000 1,200 2,000 24 10 hours on weekend and the
remaining from 10 PM-6 PM
DU002 Aberash Wako 5,760 - 1,000 1,000 12 8 hrs from office leaving -10 PM
and the remaining on weekend
DU003 Samuel Terefe 3,264 1,500 800 1,000 10 All hrs in public holiday
DU004 Hikma Ali 1,728 - 800 1,000 5 All in public holiday
DU005 Biruk Lema 7,680 2,000 750 1,200 15 During weekend rest day

Additional Information:
The management of the enterprise usually expects a worker to work 48 hours in a week
and during November there are four weeks.
There were no absentees during the month except for Biruk Lema (he was absent for 6
working hours without any justification and as a result he was penalized the working
hours payment).
All employees are permanent except Hikma ali
Gezahegn agreed to contribute monthly Br. 1,000 from his salary as a monthly saving in
the credit association of the University.
All employees are expected to pay 8% of the basic salary for GRED.

7
Required:
1. Compute the following for each employees
A. Gross earning
B. Taxable income
C. Tax to be paid
D. Pension contribution
E. Total deduction
F. Net pay (net employment income)

2. Record the payment of salary as of November 30, 2014 E.C.

3. Prepare a payroll register/sheet of November, 2014 E.C.

4. Record the payment of the claim of the credit association of their enterprise on
November 30, 2014 E.C.

5. Record the payment of the withholding taxes and pension contribution to the
concerned government body on November 30, 2014 E.C.
Solution

Hence, let’s calculate the OT for all employees.

Name of Normal Hourly OT Duration Relevant OT rate OT earning
employee rate Hrs
Gezahegn Chale 10 Weekend 10*60*2=1,200
= =60 birr 14 10 PM-6 AM 14*60*1.75=1,470 =2,670
Aberash Wako 8 Up to 10 PM 8*30*1.5=360
= = 30 birr 4 Weekend 4*30*2=240 =600
Samuel Terefe 10 Public 10*17*2.5=425 =425
= = 17 birr

Hikma Ali 5 Public 5*9*2.5=112.5 =112.5

= = 9 birr

Biruk Lema 15 Weekend 15*40*2=1,200 =1,200

= = 40 birr

Then, now we can compute the gross earnings, which is summarized in the following table
Name of employee Basic salary OT earning Allowances Gross earning
Gezahegn Chale 11,520 2,670 5,200 19,390
Aberash Wako 5,760 600 2,000 8,360
Samuel Terefe 3,264 425 3,300 6,989
Hikma Ali 1,728 112.5 1,800 3,640.50
Biruk Lema 7,680 1,200 3,950 12,830
Total 29,952 5,007.5 16,250 51,209.50

Now we can compute total deductions

8
 Based on this specification, first we have to compute the income tax expense as deduction from
gross earring for all employees. But all earnings are not taxed, so first, we have to compute taxable
income and then we can compute income tax as follows.
Name Taxable income Tax rate Deduction Income tax
Gezahegn Chale 11,520+2000+400+2,670=16,590 0.35 1500 16,590*0.35-1500=4,306.50
Aberash Wako 5,760+200+600=6560 0.25 565 6560*0.25-565=1,075
Samuel Terefe 3264+1,500+425=5189 0.20 302.50 5189*0.2-302.50=735.50
Hikma Ali 1,728+112.5=1840.5 0.15 142.50 1840.5*0.15-142.50=133.58
Biruk Lema 7,680+2000+1200=10,880 0.30 955 10,880*0.30-955=2309

The second deduction is pension contribution for permanent employees only. Thus, we will show the
pension contribution for all employees except for Hikam Ali (since she is temporary, she will not pay
pension).
Name of employee Basic salary Pension from employee Pension from employer Total pension withhold
Gezahegn Chale 11,520 11,520*0.07=806.40 11,520*0.11=1,267.20 2,073.60
Aberash Wako 5,760 5,760*0.07=403.20 5,760*0.11=633.60 1,036.80
Samuel Terefe 3,264 3,264*0.07=228.48 3264*0.11=359.04 587.52
Hikma Ali 1,728 She is temporary employee, so no pension
Biruk Lema 7,680 7,680*0.07=537.60 7,680*0.11=844.8 1,382.4

All employees are subject to pay 8% of the basic salary for GRED contribution, so it is
computed as follows. Additionally, Gezahegn will pay birr 1000 for credit and Biruk will be
penalized.

Name of employee Basic salary GRED GRED contribution Credit association Fines
contribution rate in birr payment
Gezahegn Chale 11,520 0.08 921.6 1,000
Aberash Wako 5,760 0.08 460.8
Samuel Terefe 3,264 0.08 261.12
Hikma Ali 1,728 0.08 138.24
Biruk Lema 7,680 0.08 614.4 240

Now, we can summarize the total deduction as follows

Name of employee Income tax Pension GRED Credit Fines Total deduction
Gezahegn Chale 4,306.50 806.40 921.6 1,000 7,034.50
Aberash Wako 1,075 403.20 460.8 1,939.00
Samuel Terefe 735.50 228.48 261.12 1,225.10
Hikma Ali 133.58 - 138.24 271.82
Biruk Lema 2309 537.60 614.40 240 3,461.00
Total 8,559.58 1,975.68 2,396.16 1,000 240 13,,931.42

Finally, we can compute the net pay for each employee as follows
Id number Name Gross earning Total Deduction Net pay
DU001 Gezahegn Chale 19,390 7,034.50 12,355.5
DU002 Aberash Wako 8,360 1,939.00 6,421.00
DU003 Samuel Terefe 6,989 1,225.10 5,763.90
DU004 Hikma Ali 3,640.5 271.82 3,368.68
DU005 Biruk Lema 12,830 3,461.00 9,369.00
Total 51,209.50 13,931.42 37,278.08

9
Proving the payroll
Total earning;
Basic salary ……………………………….29, 952.00
OT earning ………………………………… 5,007.50
Allowances ……………………………..…16,250.00
Grand total ……………………….51, 209.50
Deduction
Employee income tax …………………………...8,559.58
Pension …………………………………………...1,975.68
GRED contribution……………………………….2, 396.16
Fines ………………………………………………...240.00
Credit association payment ……………………....1,000.00
Total deduction ………………………………….13, 931.42
Total net pay ……………………………………37, 278.08
Total deduction plus net pay…………………...51, 209.50

4.5. Recording Payroll Related Journal Entries

The following payroll related events are common to be recorded in payroll book.

10
4.6. Completing Payroll Sheet Payable

Individual Assignment (10%)

Eftah is a government agency recently organized to rehabilitate elders and mental
disordered people. It has five employees whose salaries are paid according to the Ethiopian
calendar month. The following data relates to the month of Nehassie, 2008.
Transp. Overtime

11
Serial Name of Employee Basic Allowance worked Duration of OT Work
no. salary (hrs.)
01 Aregash Shewa Br. 7300 1,300 4 Before 10 pm
02 Paulos Chala 1,520 700 8 Sunday (8:30-5:30)
03 Mohammed Musa 4,800 2000 - -
04 Tensay Belay 11,470 - - -
05 Haile Olango 950 1000 6 Public Holiday

Additional Information
 The management of the agency usually expects a worker to work 48 hours in a week
and during Nehassie, there were four weeks.
 There were no absentees during the month
 All employees are permanent except Tensay and Haile
 Aregash & 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 Nehassie 30, 2008.
2. Record the payment of salary as of Nehassie 30, 2008.
3. Record the payment of the claim of the credit Association of their agency on Meskeren 1, 2009.
4. Compute and recognize the payroll tax expense for the month of Nehassie 2008.
5. Record the payment of the withholding employment income taxes of Nehassie 2008.
6. Record the payment of pension contribution to pension trust fund on Meskerem 7,
2009.

-----------------//---------------

12