Chapter 5

Accounting for Payroll in an Ethiopian Context

The term payroll often refers to the document prepared to pay remuneration for the services
obtained form employees for a certain period of time. The payroll accounting of a firm has to be
given due emphases for the following reasons:
1. Employees being sensitive to payroll errors and irregularities- hence, paying employees on a
timely and accurate basis is essential for good employee moral. As a practical experience, an
employee was paid Br 100 higher than his weekly pay and never complained. The next
week, he was paid Br 100 less and has complained to his boss. The boss asked him why he
didn’t complain the previous week when he was paid over. The smart employee responded,
‘’that was the first mistake. I get irritated when such silly mistakes are repeated’’.
2. Payroll expenditures are subject to various government regulations such as employment
income taxes and other withholding taxes in the form of pension.
3. The payment for payroll and related taxes has significant effect on the net income of most
business enterprises especially service giving ones where the majority of operations are
performed and competitive advantage is taken through the human element of the
organization.
Processing payroll of employees requires the preparation of a payroll register (payroll sheet) on the
pay day. 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
period. The basis for the preparation of the payroll register can be the attendance sheets, punched
(clock) cards or time cards. The other major record related to payroll is 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 employee’s earnings record helps the employer organization to properly
summarize and file tax returns.
The following are the possible components of a Payroll Register
1. Employee number-numbers assigned to employee for identification purpose when a
relatively large number of employees are included in the payroll register.
2. Name of employees-list of the name of employees.
3. Earnings: 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 that is paid
for carrying out the normal work of employment and subject to change when the
employee is promoted. For example, an employee may be paid Br 1,600 in order t
accomplish specific activities for 160 hours per month (8 hours per day, five days per
week and four weeks per month). The hourly or ordinary rate is Br 10 i.e. Br 1,600/160
hours.
(b) Allowances- money paid monthly to an employee for special reason, which may
Include:
 Position Allowance- a monthly sum paid to an employee for bearing a particular
office responsibility, e.g. head of a particular department or division.
 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 fails to do so.
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  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 some times known as disturbance
allowance.
 Desert Allowance- a monthly Allowance 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 the work place if the employer has committed itself to
provide transportation service.
(c) Overtime Earnings- 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. In Ethiopia, in this respect, according to current provisions of
employment income tax, income from overtime work is computed as follows.
a. A worker shall be entitled to be paid at a rate of one and one quarter (1 ¼) times his
ordinary hourly rate for overtime work performed before 4 O’clock in the evening local
time (10 p.m.)
b. A worker shall be paid at the rate of one and one half (1 ½) time his ordinary hourly rate
for overtime work performed between 4 O’clock in the evening (10 p.m.) and 12
O’clock in the morning local time (6 a.m.)
c. Overtime work performed on the weekly rest days shall be paid at a rate of two (2) times
the ordinary hourly rate of payment.
d. A worker shall be paid at a rate of two and half (2 ½) times the ordinary hourly rate for
overtime performed on a public holiday.
(d) Bonuses- employees are paid bonuses on various forms for outstanding performance or due
to special events such as Christmas or New Year. Employees may expect such bonuses even
before the employer thinks them of as indicated by the following joke. An employee asked
his employer, ‘’Sir, are you going to give me a Christmas bonus?’’ and the employer
responded may be. The employee asked, ‘’Does it mean Yes?’’, and the employer stated,
‘’might be’’. While the employee demands precise answer, the employer responded no. At
last, the employee begged the employer, ‘’Sir, shall we go back to may be and might be?’’
However, such bonuses given to all employees may not improve the purchasing power of
employees if given to all as shown by the following poem according to a Financial
Management author:
It is at the eve of Christmas and through out the whole nation Your bonus is nothing
due to inflation.
Bonus may be given as a lump sum payment or as a percentage of operating results
(revenues, gross profit, income of different levels etc). Hence, the gross earnings of an
employee may, therefore, include the basic salary, allowances and overtime earnings.
4. Deductions- are subtractions made from the earnings of employees either because it is required
by government or permitted by the employee himself. In an Ethiopian payroll system, 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 a progressive income tax arrangement.
The existing income tax proclamation in Ethiopia (proclamation 286/2002 exempts the first
Br 150 of the earnings of an employee from income tax. The money on which a person does

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 not have to pay income tax is an exemption. According to this proclamation, employee
income tax has to be computed based on the following schedule.
Taxable Monthly Income (In Birr) Rates of tax (%)
1. Over 150 but not exceeding 650 on the next 500 10%
2. Over 650 not exceeding 1,400 on the next 750 15%
3. Over 1,400 but not exceeding 2,350 on the next 950 20%
4. Over 2,350 but not exceeding 3,550 on the next 1200 25%
5. Over 3,550 but not exceeding 5000 on the next 1,450 30%
6. Exceeding 5,000 35%

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, according to Income Tax proclamation, regulation and related directives issued by
tax authorities, the following categories of payments in cash or benefits in kind are
exempted from taxation.
1. Pension or provident fund contributed by the employer not exceeding 15% of basic
salary.
2. Medical costs incurred by the employer for treatment of employees.
3. Transportation allowances paid by employer to its employees up to 25% of basic
salary but not exceeding Br 800 at Federal level and up to 15% of basic salary but not
exceeding Br 600 for Addis Ababa City Administration.
4. Reimbursement by employer of traveling expenses incurred on duty by employees
including traveling expenses towards employment place and back home.
5. Traveling expenses paid to transport employees from elsewhere to place of
employment and to return them upon completion of employment.
6. Amount paid as gratitude for physical work place injury
7. Amount paid for domestic services (house maids and personal guards)
b. Pension Contributions- Permanent employees of a governmental organization are expected
to contribute 5% of their basic (monthly) salary to the Government Pension Trust Fund. This
amount should be withheld 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 7% of the basic salary of every
permanent employee. This amount is called payroll taxes expense and represents another
payroll related expense to the employer organization. Consequently, the total contribution to
the pension Trust of the Ethiopian government is equal to 12% of the total basic salary of all
permanent employees of an organization (i.e. 5% comes from the employees and the 7%
comes from the employer). In the case of non-government organizations and private
institutions, an arrangement to benefit their employees is providing provident Fund. Like
pension contribution, in provident fund arrangements, both the employees and the employer
contribute towards this fund monthly. The percentage varies from organization to
organization and a commonly mentioned one is 10% from the employee and 20% from the
employer. Ultimately, when an employee is retired or drawn out of work, a lump sum
amount is given at once.

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c. Other Deductions- apart from the above two 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 deductions made from the
earnings of employees.
8. 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 excess of grand total earnings over grand total deductions made from the
earnings of employees. It is grand total take-home pay.
6. Signature- in most cases, 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.

Example: The following data were taken from the records of Abraham Company that pays
payroll to its employees according to the Ethiopian Payroll system.

Name Basic Salary Allowance Overtime Duration of OT work

worked
Abel Tena Br 2,400 250 30 hours Up to 10:00 PM
Sara Chala 3,200 500 20 hours 10:00 to 6:00 AM
Nega Girum 1,600 100 10 hours, 18 Weekends, public holiday
hours respectively
Additional Information:
1. All employees are expected to render services of 160 hours per month and all of them
did except Sara Chala who has served only 150 hours.
2. All employees are permanent employees except Abel Tena.
3. The allowance of Nega Girum is not taxable
4. All employees promised to contribute 10% of their basic salary to the credit association
of the Company.
Required:
a. Determine the gross earnings, total deductions and net pay of al employees and
b. record the following journal entries:
I. Payment of net pay to the employees in cash
II. Recognition of the payroll tax expense of the employer.
III. Payment of withholding and payroll tax liabilities to the concerned authority

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Solution:
a. Gross pay, total deductions and net pay computations:
Gross earnings=Basic salary+Over time earnings+Allowance+Bonus
Abel Tena:(Ordinary rate is Br 2,400/160 = Br 15/hour)
Basic Salary= Br 2,400
Over time earnings= 30 hours*1.25*(2400/160)= 562.5
Allowance= Br 250
Gross earnings= Br 2,400 + 562.5+ 250= Br 3,212.5
Pension- 0 (not a permanent employee)
Payable to credit association- 10% of Br 2,400= Br 240
Income tax payable- computed as follows:
0-150 = 0%=0
150-650 = 10% = 50
650-1,400=15%=112.50
1,400-2350=20%=190
2,350-3,212.5 =25%=215.625
Income tax = 50+112.5+190+215.625 = Br 568.125
Total deductions = Br 0+240+568.125 = 808.125
Net Pay = 3,212.5-808.125= Br 2,404.375
Sara Chala: (Ordinary rate is Br 3,200/160 = Br 20/hour)
Gross earnings = Br 3,200+500+ (20*1.5*20)-200 (amount for hours not worked)= Br
4,100
Pension deduction= 5%*Br 3,200= Br 160
Payable to credit association= 10%*3,200= Br 320
Income tax payable= Computed as follows:
0-150 = 0%=0
150-650 = 10% = 50
650-1,400=15%=112.5
1,400-2350=20%=190
2,350-3,550=25%=300
4,100-3,550=30%=165
Income tax = 50+112.5+190+300+165 = Br 817.50
Total deductions = Br 160+320+817.5 = 1,297.50
Net Pay = 4,100 -1,297.5= Br 2,802.50
Nega Girum: (Ordinary rate is Br 1,600/160 = Br 10/hour)
Gross earnings = Br 1,600+100+ (10*2*10) + 18*2.5*10 = Br 2,350
Pension deduction= 5%*Br 1,600= Br 80
Payable to credit association= 10%*1,600= Br 160
Income tax payable= Computed as follows:
0-150 = 0%=0
150-650 = 10% = 50
650-1,400=15%=112.5
1,400-2250=20%=170 (Br 100 allowance is not taxable)
Income tax = 50+112.5+170 = Br 332.5
Total deductions = Br 80+160+332.5 = 572.50
Net Pay = 2350 - 556.5= Br 1,777.5
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 b. Journal entries to be recorded:
1. Net pay
Salary expense…. 9662.5
Income tax payable….1,718.125
Pension payable……….. 240
Credit assoc. payable….. 720
Cash……………….….. 6,984.375
2. Payroll tax expense
Payroll tax expense……….336
Pension contribution payable……336
3. Paying tax and pension liabilities
Income tax payable………….…1,718.125
Pension contribution payable.… 576
Cash………………………….. 2,294.125
4. Paying other liabilities
Payable to credit association … 720
Cash………………………….. 720
Ex. 1- Beza Company pays payroll to its employees based on the Ethiopian payroll system. The
following data pertains to the employees of the company for June 1997:

Name Basic Salary Allowance Overtime worked Duration of OT work

Araya Tigu Br 2,400 150 30 hours Up to 10:00 PM
Sami Cheru 3,200 100 20 hours 10:00 to 6:00 AM
Zenash Tola 1,600 180 20 hours, 16 hours Weekends, public
holiday respectively

Each employee has to work 160 hours but Araya Tigu worked only 150 hours without justifiable
reason and early in June he has also taken Br 1,000 advance out of his salary to be deducted in
four equal installments beginning June 30, 1997. Sami Cheru is not permanent employee of the
company and Zenash Tola informed the company to send Br 200 from her salary to the family at
a distance.
Required:
a. Prepare the payroll register for the month
b. Record journal entries related to the payroll of June. Assume withheld taxes were
paid to the government on July 10, 1997.