MEANING OF PAYROLL ACCOUNTING

The payroll accounting is an accounting function within the

organization that looks into the management, recording,
determination, and analysis of the compensation of the
employees. They work towards the calculation of taxes and
benefits along with the salary given to the employees. In addition,
payroll accounting also includes reconciling for the benefits, and
withholding taxes and deduction related to compensation. The
calculation of payroll is highly influenced by each country’s legal
requirements (it may also depend on state or local city
requirements).Payroll accounting perform the following duties
after setting up the company to hire employees and gathering all
the information related to the employees, the company will need
to follow these steps:
1 Calculate the direct and indirect compensation for labor:
When finishing a month, sum all the costs for direct
compensation, such as salaries and overtime (most of the
withholdings and provisions are calculated based on these
concepts).
2 Then, sum indirect concepts such as commissions and bonuses
(we may have to check whom this federal and state requirements
to see if they should be included in the calculation for withholdings
or deductions).
3 Calculation withholdings and deductions: After determining
the basis for each withholding or deduction according to the
previous step, calculate your employees ‘taxes and wage
deductions according to the applicable requirements.
4 Calculate provision: provisions are accrued expenses that
generate liabilities which are going to be paid in the future. The
expenses that are the result of legal requirements like holidays
and vacations are recognized as provisions in the period they are
incurred, although they are paid in subsequent months. They are
the result of the contractual relationship with the employee.
5 Record entries in the books.
6 Generate payments: After calculating and registering the
accounting entries. Companies need to generate the payments to
employees, government entities (related to withholdings), and
other entities. This process may often be contracted out to third
parties, such as Ceridian.
7 Calculate posterior adjustments to provisions: Due to the
nature of provisions, which are based on estimates, is important
to recalculate and adjust provision if necessary.
The Importance of Payroll and Payroll Accounting:
Payroll accounting is important for 3 reasons: financial
management, legislation compliance and tax management.
Financially, payroll accounting helps ensure a companies to pays
its employee correctly. This includes making sure employees
receive the correct remuneration, and monitoring payroll
expenditure to ensure that the organization in not wasting money
unnecessarily. These three reason are the importance of payroll
and payroll accounting, thus every financial manager should
make an impact in the following three key areas:
Financial management:
 Fully understand the fundamentals of income, expenses and
profit and loss.
 Drafting cash, operational and flexible budgets and financial
statements for sole traders, partnerships, close corporations
and companies.
  Measuring and evaluating financial performance by
examining both the long- and short-term financial goals of a
firm, as well as the various methods of analysis.
Compliance management:
 Apply risk management and eternal controls, as well as
measure returns on net assets, and set fair prices on
company assets.
 Ensuring compliance with applicable laws and procedures
 Articulate legal principles of corporate governance, and drive
the need for compliance courses in any organization.
Tax management
 Controlling the taxation of the businesses, penalties and
interest, VAT, capital gains tax, and the self-assessment
system of taxation.
 Overseeing tax planning, systems and controls, and
organizing fiscal documents.
Resolve and deal with income tax laws disputes and
communicate the legal implications of taxes fraud and
evasion

Definition of payroll related terms:

Before we do our payroll, there are importance terms of payroll
we wanted to know, these are some of it process you must have
known.
The term “payroll” is a general term, and it has several
meanings it can be:
The amount of money paid to all employees in a payday, as in we
ran payroll this morning for tomorrow’s payday.
The financial records of a company relating to the payment of
wages and salaries to employees.
The total record of earnings of all employees for a year.
Gross Pay: is the total paid to an employee each pay period, and
it is determined in different ways for salaried and hourly
employees. For salaried employees, gross pay is stated as an
annual amount. To determine gross pay for a pay period, the
annual salary is divided by the number of pay periods in the year.

For hourly employees, gross pay is the worker's hourly rate times
the number of hours worked in that pay period; overtime is
included in gross pay, too.

Gross pay is the amount reported to the IRS and is the amount
the employee pays income taxes on.

Net Pay: is the amount of pay an employee receives after all

withholding and deductions from gross pay. In other words, net
pay is the amount of the employee's paycheck.

The calculation for net pay begins with gross pay. Then
withholding for federal and state income taxes are taken out, as
well as deductions for FICA tax (Social Security and Medicare).
Finally, discretionary deductions like health plan and retirement
plan amounts are taken out.

Withholding: Refers to amounts taken from an employee's

paycheck for federal and state income taxes. Withholding is
determined for federal income tax by a Form W-4 completed by
the employee at hire, and for state income tax by a state W-4 or
other tax form.

The calculation for withholding includes:

 The employee's gross pay for the pay period.

 Information on the employee's status as salaried or hourly.
 Information on marital status from the W-4 form.
 And information on any additional withholding amounts the
employee directs on the W-4 form.
Overtime : is the additional amounts paid to hourly employees
who work over 40 hours in a week, who work on weekends, or
other additional amounts. The federal minimum overtime
requirement is that overtime must be paid at 1 1/2 times pay rate
for employees who work more than 40 hours in a work week. Of
course, you can pay overtime at higher rates.

Overtime is calculated differently for hourly and salaried

employees. Most salaried employees are exempt from overtime,
but your business may be required to pay overtime to some
lower-paid exempt employees. 

Work Week: is considered as 168 consecutive hours of work in a

seven-day period. This term is used in calculating overtime for
hourly and some salaried employees.

Pay Period: is a recurring length of time over which employee

pay is recorded and paid. Some common pay periods are
monthly, weekly, bi-weekly (every other week) and semi-monthly
(twice a month).  A weekly pay period results in 52 pay periods in
a year.

A bi-weekly pay period results in 26 pay periods in a year, while

semi-monthly pay results in 24 pay periods in a year. The
difference is important in computing total pay for employees for a
year. In some years, there could be an extra 27th pay period,
because of the way the weeks fall at the end of the year.

Compensation: Employee compensation is a term that is often

used instead of using the term "pay," but it is a more general term
that includes other payments to employees. Some other types of
employee compensation that are taxable to the employee include:

 Tip income
 Benefits of using a company car
 Stock options
  Bonuses, awards, and gifts to employees (unless they are
very small)
 Some commuting and transportation benefits
 Some educational benefits
 Other benefits, like meals, may or may not be taxable to
employees, depending on the circumstances

Salaried vs. Hourly Employees: The terms "salaried employee"

and "hourly employee" relate specifically to how these employees
are paid.  Salaried employees are paid an annual salary. Hourly
employees are paid an hourly rate times hours worked.

Exempt vs. Non-exempt Employees: Exempt means "exempt

from overtime." Exempt and non-exempt employees are
categorized typically by the work they do. Exempt employees
(sometimes called a "white collar exemption") work in
professional, managerial, and executive positions. Other workers
are non-exempt. As noted, your business may be required to pay
overtime to some exempt employees.

Components of a Payroll Register

1. Employee number – numbers assigned to employee for identification
purpose. It might be alpha-numeric character when a relatively large
number of employees are included in the payroll register.
2. Name of employees – full name of each employee included in the list
of payroll sheet.
3. Earnings – a benefit in cash or in kind earned by an employee from
various sources of employment.
It may include:

• Disturbance 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. It is sometimes
known as Hardship Allowance.
•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.
• A worker shall be paid at the rate of one and one half (1 ½) times
his 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.)
• Overtime work performed on the weekly rest days shall be paid at
a rate of two (2) times the ordinary hourly rate of payment.
• A worker shall be paid at a rate of two and half (2 1/2) 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
sometimes other form of earnings such as Bonus that is paid to
employees for achieving results better than usual.
Deductions: These are amounts to be subtracted from the earnings of
employees because they are required by government (mandatory
deductions) or permitted by the employee himself (voluntary
deductions. Mandatory deductions include employment income tax and
pension contribution. In our country, some of the deductions against
the earnings of employees are:
a) Employee Income Tax: In Ethiopia every citizen is required to pay
something in the form of income tax from his/her earning of
employment. In this case, a progressive income tax system that charges
higher rates for higher earnings is applied on the gross earnings of each
employee save the first 150 Birr. According to proclamation No.
286/1994 that has become into effect beginning Hamle 1, 1994 E.C.
exempts the first Br 150 of the earnings of an employee from income
tax. The money on which a person does not have to pay income tax is
an exemption. According to the new proclamation, employee income
tax has to be computed based on Schedule “A” as indicated below:
No. Salary Range (ETB) Tax Rate Deduction (ETB)

1. 0 – 600 Birr Non-Taxable –

2. 601-1,650 Birr 10% 60 Birr

3. 1,651 – 3,200 Birr 15% 142.50 Birr

4. 3,201 – 5,250 Birr 20% 302.50 Birr

5. 5,251 – 7,800 Birr 25% 565 Birr

6. 7,801 – 10,900 Birr 30% 955 Birr

7. Over 10,900 Birr 35% 1,500 Birr

Generally, taxable income from employment includes salaries, wages,
allowances, director’s fees and other personal emoluments, all
payments in cash and benefits in kind. However, as per Art 13 of
Proclamation No. 286/2002 and Art 3 of Regulation No. 78/2002. The
following categories of payments in cash or benefits in kind are
exempted from taxation:
• Income from employment received by casual employees
• Income from employment received by diplomatic and consular
representatives; and other persons employed in any Embassy
• Payments made to a person as compensation or gratitude in
relation to personal injuries; or the death of another person.
• Medical Allowance
• Transportation Allowance
• Hardship Allowance
• Per-diem Allowance (Daily Allowance)
• Traveling Expenses
• Income of persons employed for domestic duties
b) Pension Contribution: Permanent employees of an organization the
employees of which are governed by the existing regulations of the
Ethiopian public servants are expected to pay or contribute 7% of their
basic (monthly) salary to the government 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 6% 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 employees).
Consequently, the total contribution to the pension Trust Fund of the
Ethiopian government 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.
Non-government organizations are also using this kind scheme to
benefit their employees with some modifications. This is made in some
NGO'S by keeping a fund known as Provident Fund. Both the
employees and the employer contribute towards this fund monthly.
Ultimately, when an employee is retired or drawn out of work a lump
sum amount is given at once.
c) Other Deductions (Voluntary 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 employees’ income tax,
pension contributions and other deductions gives the total deductions
from the gross earnings of an employee.
The column “Total Deductions” shows the total amount to be deducted
from the earnings of employees.
5. 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 excess of grand total
earnings over grand total deductions made from the earnings of
employees. It is the grand total take- home pay.

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. In general, a payroll register should at least
show the earnings, deductions and the net pays along with the names
of employees

Major Procedures or Activities Involved in Accounting for

Payroll:

Payroll accounting involves a company’s calculation and salary

disbursement for its employees. Business owner find themselves
for a range of accounting responsibilities and becoming familiar
with the payroll to ensure that employees will receive their pay on
time. Payroll and benefits include items such as the salary, wage,
bonus and commission to employees, payroll taxes and overtime
pay. Employer paid benefits such as vacations, sick days,
insurance, holidays, and retirement plans.

There are five basic payroll accounting procedures or

activities and they are as following:

Time reporting-Payroll accounting system include this

procedure as it is the collection of daily, weekly and monthly
records of the individual worker’s worked. Tools like electronic
time-clock and time card help accountant to track and record the
exact number of hours worked by the employees.

Pay computation-one of the tasks in payroll accounting is the

calculation of the payment owed to each employee. This is one of
the most errors in business as some employers sometimes
commit errors in their employee’s rates.

Computation and submission of tax-Employers are responsible

for the submission of the income and payroll tax. Employees
submit the income tax while employers submit the payroll tax.
Payroll accountants calculate the income tax owed by each
employee after calculation of the gross compensation owed. The
accounting department must then submit the taxes on a regular
basis.

Benefits and paid leave-paid holidays and vacations are fringe

benefits earned by employees. These are to be considered as
part of the pay package.

Pay distribution-This is the final task of the payroll accounting

which distributes the worker’s net pay .Pay distribution can be
done through a number of way such as making direct deposits
into checking accounts, mailing checks and distributing cash
personally. Knowing the basic procedures in payroll accounting is
a big help especially when it comes to the computation of the
employee’s wages, when you need a committed accounting
service. Specific accounting solutions actively delivers a range of
services that suit your business and personal needs.