Chapter 3

The Payroll System in an Ethiopian Context

[A] Introduction
Accounting system for payroll and payroll taxes are concerned with the records and reports
associated with 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
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, 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.

[B] Importance of Payroll Accounting

The term Payroll often refers to the document prepared to pay remuneration (compensation)
for the service rendered in a given period of time. Payroll is often used to refer to the total
amount paid to employees for certain period. Payroll includes amounts paid for salaries to
managerial or administrative employees as well as wages paid for manual labor.
Accounting for Payroll (Preparation of payroll) is particularly important because:
1) Employees are highly sensitive to payroll errors and irregularities. to maintain good
employee morale, payroll must be paid on a timely and accurate basis.
2) Payroll expenditures are subject to various government regulations-that is- Both federal
and state governments require that detailed payroll records be kept, and
3) Payroll often represents the largest expense that a Company incurs. That is, the payment
for payroll and related taxes has significant effect on the net income of most business
enterprises.
Definition of Payroll Related Terms
 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, Compensation 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.
 The Pay Period:
A pay period refers to the length of time covered by each payroll payment. Pay periods
for wageworkers are usually made on the weekly or biweekly. On the other hand, salaried
employees` pay periods are monthly or semi-monthly.
 The Pay Day:
The payday 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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A basic record of a payroll accounting system includes:
1. A payroll Register (or sheet)
2. Individual employees` earnings records, and
3. Usually, pay checks
These records are generated from a payroll system that is operated manually or using computers.
 A payroll Register (sheet): is 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 (pay) period. The basis for the preparation of the payroll register
can be the attendance sheets, punched (clock) cards or time cards.
 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.
 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. In
other words, a business can pay payroll by writing a check for 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 be paid by cash at the
organization.
 Gross earnings:

Possible Components of a Payroll Register

A. Employee number: Number assigned to each 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:
i) 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.
ii) Allowance: money paid monthly to an employee for special reasons, like:
 Position Allowance- a monthly allowance paid to an employee for
bearing a particular office responsibility.
 Housing Allowance: a monthly allowance given to cover housing
costs of the individual employee when the employment contract
require the employer to provide housing but the employer fails to
do so.
 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 place 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 his/her workplace if
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 the employer has committed itself to provide transportation
service.
iii) Overtime Earning: overtime work is the work performed by an employee
beyond the regular working hours. Over time 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 be paid at a rate of:
i. One and one-quarter (1 ¼) times his ordinary (regular) hourly rate for overtime
work performed before 10:00 P.M in the evening.
ii. One and one half (1 ½) or (1.5) times his ordinary (regular) hourly rate for
overtime work performed between 10:00 P.M and six (6:00 A.M) in the
morning.
iii. Two (2) times the ordinary (regular) hourly rate for overtime work performed
on weekly rest days.
iv. Two and one half (2 ½) or 2.5 times the ordinary (regular) 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.
D. Deductions: are subtractions made from the earnings of employees required either by the
government or permitted by the employee himself.
II. 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. 286/2002- Income tax proclamation.
The tax rates under Schedule A are presented below:
Employment Income (per month)
From Birr To Birr
0 150 Exempt (Free from tax)
151 650 10%
651 1400 15%
1401 2350 20%
2351 3550 25%
3551 5000 30%
Over 5,000 35%

*in computing and withholding tax, the income tax proclamation dictates that income
attributable to the month of Nehassie and Pagume shall be aggregated (added) and treated as the
income of the one month.
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.

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Short cut to income tax calculation
The tax rates under Schedule A are presented below:
Employment Income (per month)
From Birr To Birr
0 150 No tax (Free from tax)
151 650 (10% X Employment income)- 15*
651 1400 (15% X Employment income)-47.5
1401 2350 (20% X Employment income)- 117.5
2351 3550 (25% x Employment income)-235
3551 5000 (30% x Employment income)-412.5
Over 5,000 (35% x Employment income)-662.5

Employment income or Taxable income abbreviated as EI

* 15= (150 x 0.1) - 0
47.5 = [(150 x 0.15) – 0] + [(500 x 0.15) – (500 x 0.1)] and so forth.
Proclamation No. 286/2002 states that the following are not taxable.
1. Income from employment received by causal 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 or the death of another person.

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-that is- transportation allowance.
3) Hard ship allowance (Disturbance allowance)
4) Amounts paid by employee in reimbursement of traveling expenses
incurred on duty.

III.Pension contribution
Permanent employees of a government organization in Ethiopia are 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
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10% of the basic salary of all of its permanent employees. That is, 4% comes from the employee
and 6% comes from the employer.
For militaries, the employer (government) contributes 16% and the employee contributes 4%
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 enjoy the benefits.
Businesses and non-governmental (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 (total) amount is paid to him/her.

IV. 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 for the
employer, to pay for donation to charitable organization, contribution to “Idir” etc.

Major Procedures (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 arithmetical 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: It must be proved that the earnings equal 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 complies (prepares) it.
5. The payroll should be approved by authorized personnel (individual).
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. The payment of the payroll and income taxes withheld from employees (withholding tax
liability) should be recorded in journal entry form.
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 Internal Revenue Administration, on time.
Illustration 3.1
Ethio Relief Agency pays the salary of its employees according to the Ethiopian calendar
month. The forth coming data relating to the month of Hidar, 19x8
Ser. Name of Basic Monthly OT Duration Basic
No. Employees Salary Allowance hours of OT salary per
Worked work hour
1 Senayit Bahiru Br. 3,200 Br. 100 10 Up to 10 Br.20
P.M.
2 Tesfaye kebede 1,600 --- 8 10 p.m to 10
5 a.m
3 Abdu Mohammed 2,400 --- 6 Weekly 15
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 rest days
4 Helen Degu 1,920 50 -- ---- 12
5 Andinet Asmelash 1,280 50 10 Public 8
Holiday

Note that management of the agency usually expects a worker to work 40 hours in a week and
during Hidar 19x8 all workers have done as they have been expected. Besides, all workers of this
agency are permanent employees except Tesfaye Kebede; the monthly allowance of Andinet
Asmelash is not taxable; Abdu Mohammed agreed to have a monthly Br. 200 be deducted and
paid to the credit Association of the agency as a monthly saving.
Instructions: Based on the above information:
1. Prepare a payroll register (or sheet) for the agency for the month of Hidar, 19x8.
2. Record the payment of salary as of Hidar 30,19x8 using Check No. 41 as a source
documents.
3. Record the payroll taxes expense for the month of Hidar, 19x8. Memorandum No. 006.
4. 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 Tahesas 1, 19x8.
5. Assuming that the withholding taxes and payroll taxes of the month of Hidar, 19x8 have
been paid on Tahesas 5, 19x8 via Check No. 50, record the required Journal entry.
Computations of Earnings, Deductions and Net pays
Overtime Earnings:
Overtime Earnings = Overtime Hours worked x (ordinary (regular) hourly rate x Overtime rate
1. Senayit Bahiru
OT Earnings = 10 hours x (Br. 20/hour x 1.25) --------------Br.250
2. Tesfaye Kebede
OT Earnings = 8 hours x (Br.10/hr x 1.5) --------------------Br.120
3. Abdu Mohammed
OT Earnings = 6 hours x (Br. 15/hr x 2) -------------------Br. 180
4. Helen Degu
OT Earnings = 10 hours x (Br. 8/hr x2.5) -----------------Br. 200
Gross Earnings:
Gross Earnings = Basic salary + Allowance + Overtime Earning
1) Senayit Bahiru
Gross earning = Br. 3,200 + 100 +250 -----------------------------Br. 3,550

2) Tesfaye Kebede
Gross earning = Br. 1,600 + 0 +120 -----------------------------Br. 3,550
3) Abdu Mohammed:
Gross earnings = Br. 2,400 + 0 + 180 ---------------------------Br. 2,580
4) Helen Degu:
Gross earnings = Br. 1,920 + 50 + 0 ----------------------------Br. 1,970
5) Andinet Asmelash:
Gross earnings = Br. 1,280 + 50 + 200 -------------------------Br. 1,530
Deductions: