Principles of Accounting II, Chapter 3 Ethiopian Payroll system

Chapter 3:

3. Ethiopian Payroll System

3.1. The Importance of Payroll Accounting

The concept of payroll is often referred to the total amount paid to employees of a firm as a

compensation for the service rendered to a firm in a given period of time. The payroll

accounting of a firm has to be given emphases.

1. Employees are sensitive to payroll errors and irregularities, and maintaining good

employees moral requires that the payroll be paid on a timely, accurate basis.

2. Payroll expenditures are subject to various government regulations.

3. The payment for payroll and related taxes has significant effect on the net income of

most business enterprises.

For the foresaid reasons the need for accurate system of handling the payroll of a business is

unquestionable.

3.2. 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. Therefore, they are usually paid when a

particular piece of work is completed or weekly. On the other hand, compensations 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:

The pay period refers to the length of time covered by each payroll payment. Payment

periods for wageworkers are usually made on weekly basis. On the other hand, salaried

employees’ pay periods are monthly or semimonthly.

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
The Pay Day:

The day on which wages or salaries are paid to employees, usually the last day of the pay

period, is known as the payday.

A basic record of a payroll accounting system includes:

1. A payroll register (or sheet),

2. Individual employees earning 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): 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 period. The basics 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 summarize 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.

Gross Earnings: is the total pay to an employee before deductions for the pay period.

Payroll Taxes: These are taxes levied against the employer on the payroll of a firm? It is an

additional payroll related expense to an employer.

Withholding Taxes: These are taxes levied against the earnings of employees of an

organization and withhold by the employer per the regulations of the concerned government.

Payroll Deductions: All the reductions from the gross earnings of an employee such as

withholding taxes, union dues, fines, credit association pays, etc.

Net Pay: The gross earnings after subtracting all the deductions. An employee on the payday

sometimes knows it as take home pay the amount collected.

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
Possible Components of a Payroll Register

1. Employee number: Numbers are assigned to employees for identification purpose when

a relatively large number of employees are included in the payroll register.

2. Name of employees: List of the names of employees.

3. Money earned by an employee(s) of a firm from various sources. It may include:

a. The basic salary or Regular Earning: A flat monthly salary of an employee is that

paid 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 reason, which may

include:

I. Position Allowance: A monthly sum paid to an employee for bearing a

particular office responsibility, e.g. head of a particular department of division.

II. House Allowance: A monthly Allowance given to cover housing costs of the

individual employee when the employment contact requires the employer to

provide housing but fails to do so.

III. 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. It is sometimes known

as disturbance allowance.

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 the work place 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 or days. Overtime earning is the amount payable to an

employee for overtime work done.

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
In Ethiopia, in this respect, according to Article 33 of proclamation No. 64/1975 the following

is discussed about payment for overtime work.

1. A worker shall be entitled to be paid at a rate of one and one quarter (1 1/4) times

his/her ordinary hourly rate for overtime work performed before 10 O’clock in the

evening (10 p.m.).

2. A worker shall be paid at the rate of one and one half (1 ½) times his/her ordinary

hourly rate for overtime work performed between 10 o’clock in the evening (10 p.m.)

and six O’clock in the morning (6 a.m.).

3. Overtime work performed on the weekly rest days shall be paid at a rate of two (2)

times the ordinary hourly rate of payment.

4. A worker shall be paid at a rate of two and half (2 ½) times the ordinary hourly rate for

overtime work performed on a public holiday.

Hence, the gross earnings of an employee may, therefore, include the basic salary, allowances

and overtime earnings. You may find some times other form of earnings such as bonus that is

paid to employees for achieving results better than usual.

d. Deductions: These are subtractions made from the earnings of employees either due to

required by government or permitted by the employee himself.

In our country, Ethiopia, some of the deductions from the earnings of employees include:

a) Employee Income Tax

In Ethiopia, every citizen is required to pay something in the form of income tax from his/her

earnings of employment. In this case, a progressive income tax system that charges higher

rates for higher earnings is applied on the gross earning of each employee by saving the first

600 birr from taxation. According to proclamation, No. 979/2016 that is the future amended

income tax proclamation No. 286/2002 given below exempts the first Br. 600 of the earnings of

an employee from income tax. The money on which a person does not have to pay income tax

is known an exemption.

In accordance with Article 55(1) and (11) of the constitution of the federal democratic republic

of Ethiopia, the new Employment Income tax rate is depicted in the table here below:

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
Employee income tax rate
Ser. No. Monthly Income Applicable Income Tax
In Birr Rate
A B
1 0-600 Exempted
2 601-1650 10%
3 1651-3200 15%
4 3201-5250 20%
5 5251-7800 25%
6 7801-10,900 30%
7 10,901 and above 35%
Generally, taxable income from employment includes salaries, wages, allowances, directors’

fees and other personal employment, all payments in cash and benefits in kind.

However, according to Income Tax Amendment Proclamation the following categories of

payments in cash or benefits on kind are exempted from taxation.

1. Medical costs incurred by employer for treatment of employees

2. Transportation allowances paid by employer to its employees.

3. Reimbursement by employer of traveling expenses incurred on duty by employees.

4. Traveling expenses paid to transport employees from elsewhere to place of employment

and to return them upon completions of employment.

When the number of employees is significant and the payroll is prepared manually then the
above method becomes cumbersome and very difficult to maintain therefore the following
short cut is developed.
Table 1: Employment Income Tax under Deduction Method
TB Range of TEI Tax Rate Deduction EIT Calculation
st
0-600 Exempt - No Tax Payment
1
nd
601-1,650 10% 60 Birr EIT = TEI @ 10% – 60
2
rd
1,651-3,200 15% 142.50 Birr EIT =TEI @ 15% – 142.5
3
th
3,201-5,250 20% 302.50 Birr EIT =TEI @ 20% – 302.5
4
th
5,251-7,800 25% 565 Birr EIT =TEI @ 25%n – 565
5
th
7,801-10,900 30% 955 Birr EIT = TEI @ 30% – 955
6
th
Over10,900 35% 1,500 Birr EIT =TEI @ 35% – 1,500
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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
b) Pension Contributions

Permanent employees of an organization are governed by the existing regulations are

expected to pay or contribute 7% of their basic (monthly) salary to the pension Trust Fund.

This amount should be with held by the employer from the basic salary of each employee on

every payroll and later be paid to the respective government body.

On the other hand, the employer is also expected to contribute towards the same fund 11% of

the basic salary of every permanent employee of it. It is this total amount that we called

earlier as payroll taxes expense to the employer organization (i.e., 11% of the total basic salary

of all permanent employee).

Consequently, the total contribution to the pension Trust Fund of is equal to 18% of the total

basic salary of all permanent employees of an organization (i.e. 7% comes from the employees

and the 11% comes from the employer). This enables a permanent employee of an

organization to be entitled to the pension pay given that the employee has satisfied the

minimum requirements to enjoy this benefit when retired.

C. Other Deductions

Apart from the above two kinds of deductions from employees earnings, employees may

individually authorize additional deductions such as deductions to pay health or life

insurance premiums; to repay loans from the employer or credit association; to pay for

donations to charitable organizations; etc.

Each of the major other deductions may be put in special column in the payroll register.

Ultimately, the sum of the employee’s income tax, pension contributions and other

deductions gives the total deductions from the gross earnings of an employee.

5. The Net Pay: This amount is held in one column of the payroll register representing the

excess of gross earnings over the total deductions of an employee. The column ‘Net pay’

total tells the grand total deductions made from the earnings of employees.

6. Signature: Unless some other document is used, the payroll sheet may be designed to

allow a column for signature of the employees after collection of the net pay.

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
In general, a payroll register should at least show the earnings, deductions and the net pays

along with the names of employees.

DEMONSTRATION PROBLEM

ABC Company has the following information for the month September 30, 2016 and wants to

prepare the payroll register for the month in order to compensate employees.

S/No. Name of Employee Basic Monthly OT Hours Duration of OT

Salary Allowance Worked Work
1 Senayit Bahru 2,080 1,000 10 Up to 10 pm
2 Abdu Kedir 12,800 1,500 6 Weekly Rest Days
3 Kiros Wolde 4,800 500 10 Public Holiday
Note that management of the agency usually expects a worker to work 40 hours in a week

and during September 2016 all workers have done as they have been expected. Besides, all

workers of this Company are permanent employees; the monthly allowance of Kiros is not

taxable; Abdu Kedir 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 information given above:

1. Prepare a payroll register (or sheet) for the agency for the month of Septmebt, 2016.

2. Record the payment of salary as of September 30, 2016 using CK. No 41 as a source

document.

3. Record the payroll taxes expense for the month of September, 2016.

4. Record the payment of the claim of the Credit Association of the agency that arose

from September’s payroll assuming that the payment was made on October 1, 2016.

5. Assuming that the withholding and payroll taxes for the month of September, 2016

have been paid on October 5, 2016 via CK. No. 50, recorded the required journal entry.

Computations of Earnings Overtime Earnings, Deductions and Net Pays:

Overtime Earning = (OT Hrs worked) x (ordinary hourly rate x OT Rate)

1. Senayit: (10hrs) (13) (1.25) = Br. 162.50

2. Abdu: (6hrs) (Br. 80) (2) = Br. 960

3. Kiros: (10hrs) (Br. 30) (2.5) = Br. 750

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
Gross Earnings = Basic salary + Allowance + OT Earnings

1. Senait: Br. 2,080 + 1000 + 162.50 = Br. 3,242.50

2. Abdu: Br. 12,800 + 1,500 + 960 = Br. 15,260

3. Kiros: Br. 4,800 + 500 + 750 = Br. 6,050

DEDUCTIONS AND NET PAYS

1. SENAIT:
Gross taxable income ……………………………………………………………………..Br. 3,242. 50
Employee Income Tax:
Earnings x ITR=IT
600.00 X 0 00.00
1,050.00 X10% 105.00
1,550.00 X15% 232.50
42.50 X20% 8.50
Total 3242.50 346.00
Pension Contribution:
Basic Salary x 7%
Br. 2,080 x7% ………………………… 145.60
Total Deductions ………..………..………..…………………….Br 491.60
Net Pay ………………………………………………………………………………..Br 2,750.90

2. ABDU:
Gross taxable income……………………………………………………………………Br. 15,260.00
Employee Income Tax:
Earning X ITR = IT
600 X 0 % 00.00
1,050X 10 % 105.00
1,550 X 15 % 232.5
2,050X20 % 410
2,550X25 % 637.5
3,100X30 % 930
4,360X35 % 1,526
Total. Br 15,360 Br. 3,841
Pension Contribution:
Br12,800 X 7%.............................. 896
Credit Association pays………200.00
Total Deductions ……………………………………………………….. 4,937
Net Pay …………………………………………………………………………………. 10,323.00

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 Principles of Accounting II, Chapter 3 Ethiopian Payroll system
3. KIROS:
Gross taxable income (his allowance is not subject to tax)
Br. 6,050 - 500 = Br. 5550.00 …………………………………… Br. 5,550.00
Employee Income Tax:
IT=5550*25%-565 ……………………………… 822.5
Pension Cont. Br. 4,800 X7%............………...... 336
Total Deductions ………………………………………………...Br 1,158.50
Net pay ……………………………………………………………...Br. 4,891.50
PAYROLL REGISTER (PAYROLL SHEET)
S No Name of Basic Monthly OT Gross Deduction Net pay Sign
employee Salary Allowance Earning
1 Senayit Bahru 2,080 1,000 162.50 3,242. 50 491.60 2,750.90 ✓

2 Abdu Kedir 12,800 1,500 960 15,260.00 4,937.00 10,323.00 ✓

3 Kiros Wolde 4,800 500 750 6,050.00 1,158.50 4,891.50 ✓

Total 19,680.00 3,000.00 1,872.50 24,552.50 6,587.10 17,965.40

JOURNAL ENTRIES (RECORDING THE PAYROLL)

1. Recording the payment of salary
Sept 30. Salary Expense…………………………………………..24,552.50
Employee income tax payable ……………….…………………………...... 5,009.50
Pension Cont. Payable……………………………………………………….. 1,377.60
Payable to Credit Association………………………………………………. 200.00
Cash…………………………………………………………………………… 17,965.40
2. ABC Company incurred payroll tax expense of Br. 1,372 during September 30, 2016. This is
because the company has to contribute 11% of the basic salary of every permanent
employee to the government pension trust fund. Thus,
Payroll tax expense = Total basic salary of all permanent employees multiplied by 11%
= (2,080 + 12,800 + 4,800) X 11%
= Br. 2,164.8
The following journal entry is made as of September 30, 2016
Pension contribution expense……………….2,164.80
Pension cont. payable………………………………….2,164.80
Recording the payment of deduction from Abdu’s earnings to the credit association
Payable to Credit Association………………………..200
Cash ………………………………………………………… 200
Then, the payment is recorded as follows:
Employees Income Tax Payable ……………..…… 5,009.50
Pension Contribution payable ……………………… 3,542.40
Cash……………………………………………………………………………. 8,551.90
After the payment of these liabilities have been posted, the above two accounts will have zero
balances.

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Principles of Accounting II, Chapter 3 Ethiopian Payroll system
ASSIGNMENT
RAL Company has 10 employees. The pay period of the company is a month. The payroll

clerk has contained the following information for the month of June, 2018

Employee Name Basic Salary Overtime (Br) Allowance (Br)

1. Ahmed Ali 2,700 - -
2. Azeb Mengesha 3,400 500 -
3. Belay Neger 4,200 180 500
4. Mustefa Hussein 5,100 600 -
5. Fakiha Nuri 6,000 120 1000
6. Eskedar Molla 12,850 750 -
7. Fekadu Zewdie 13,850 - 2000
8. Ziyad Abdellah 14,000 - 1000
9. Solomon Sheger 3,100 750 700
10. Hikma Kemal 11,350 700 -
Additional Information:

[a] The payroll register of RAL Co. more or less is the same as the payroll register shown

in the illustration. The deduction columns are the following: Income tax, Idir fund, Union

fees, Pension fund and total deductions.

[b] All employees are to pay Idir fees of:

(1) Birr 20 for all employees whose basis salary is up to Birr 5,000.00.

(2) Birr 30 for all employees whose basic salary is above Birr 5,000.00

[c] All employees are required to pay Union fees of 1% of their basic salaries (assume that

all employees are members of the Labor Union).

[d] Ato Belay Nega, W/t Fakiha Nuri, Ato Fekadu Zewdie and W/ro Hikma Kemal

contribute 5% of their basic salaries to the Credit Association of the Company.

INSTRUCTIONS
1. Prepare the payroll register
2. Prepare a journal entry to record the salary expense for the month of June 2018
3. Prepare journal entries to record the payments of amounts withheld to the concerned
authorities.

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