CHAPTER FOUR

Accounting for Payroll /Employee benefit in the Ethiopian

context

4.1 Importance of Payroll

The term payroll often refers to the documents prepared to pay remuneration for the
service rendered in a given period of time. The payroll accounting of a time has to
be given emphases of significance for the following reason:

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

good employee 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 the most business enterprises.

4. Payroll and related fringe benefits often constitute a substantial percentage of

current liabilities. In addition, employee compensation is often the most
significant expense that a company incurs. Add to labor costs such fringe
benefits as health insurance, life insurance, life insurance, disability
insurance, and so on, and you can see why proper accounting and control of
payroll are so important.

It should be emphasized that payroll accounting involves more than paying

employees’ wages. Companies are required by law to maintain payroll records for
each employee, file and pay payroll taxes, and comply with numerous tax laws
applicable to employee compensation. Accounting for payroll has become much
more complex as a result of these regulations.

The term “Payroll” pertains to all salaries and wages paid to employees. Managerial,
administrative, and sales personnel are generally paid salaries, which are often
expressed in terms of a specified amount per month or per year. In contrast, store
clerks, factory employees, and manual laborers are normally paid wages, which are
based on a rate per hour or on a piecework basis (such as per unit of product).
Frequently, the terms “salaries” and “wages” are used interchangeably.
 The term “Payroll” does not extend to payments made for personal service by
professionals such as certified public accounts, attorneys, and architects such
professionals are independent contractors, and payments to them are called fees,
rather than salaries or wages. This distinction is important because government
regulations relating to the payments and reporting of payroll taxes apply only to
employees.

4.2 Determining the Payroll Payments

Determining the payroll involves computing:
1. gross earnings.
2. payroll deductions, and
3. net pay.

4.2.1 Gross Earning

Gross earning is the total compensation earned by an employee. The gross earnings
of an employee may include wages, salaries, bonuses, overtime earnings and
allowances.

Wages, Salary and Bonus

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 produces, So they
are usually paid when a particular piece of work is completed or for a period less
than a month.

The salary for an employee is generally based on a monthly or yearly rate rather
than on an hourly basis. These rates are then applied ratably to the payroll periods
used by the company. Most executive and administrative positions are salaried.

Many companies have bonus agreements for management personnel and other
employees. Bonus arrangements may be based on such factors as increased sales or
net income. Bonus may be paid in cash and /or granting executives and employees
the opportunity to acquire shares of stock in the company at favorable prices (called
stock option plans).

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, such as
architects, attorneys.
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 Article 68 of proclamation
No.1156/2019, 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 half (1.5) times
his or her ordinary hourly rate for overtime work performed up to 10 o’clock
in the evening (10 P.M.) beyond his/her regular working hour.

2. A Worker shall be paid at the rate of One and three fourth (1.75) times his or
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 (21/2) times the ordinary
hourly rate for overtime work performed on a public holidays.

Allowances

Allowance: 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.

House allowance: - a monthly allowance given to cover housing costs of the

individual employee when the employment contract required the employer to
provide housing but fails to do so.

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 different and distant work area or location. It is some times known as
disturbance allowance.
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 the work place if the employer has committed itself to
provide transportation service.

4.2.2 Payroll Deductions

As anyone who has received a paycheck knows, gross earnings are usually very
different from the amount actually received. The difference is attributable to payroll
deduction. Payroll deductions do not result in payroll tax expense to the employer.
The employer serves only as a collection agency, and it subsequently transfers the
deductions to the government and designated recipients.

Mandatory (required) deductions

These are deductions made from the earnings of employee that is because it is
required by government.

Income Tax

EMPLOYEE INCOME TAX – In Ethiopia every citizen is required to pay 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 earnings
of each employee. According to proclamation No. 979/2016, which further amended
the income tax, proclamation No. 286/2002 the first Birr 600 of the earnings of an
employee is exempted from income tax. The money on which person does not have
to pay income tax is an exemption.

The income tax proclamation 979/2016 stated the following about employment
income tax and its computations:

The Tax on income from employment over six hundred birr (Birr 600) shall be
charged, levied and collected monthly according to the following schedule: -

Taxable Monthly Income (In Birr) Rate of tax (%) on

Every Additional Income
1 0 to 600 0
2 Over 600 but not exceeding 1650 10%
3 Over 1650 not exceeding 3,200 15%
4 3,201 - 5,250 20%
5 5,251 - 7,800 25%
5 7,801 - 10,900 30%
6 Over 10,900 35%

The following table shows the other methods to compute income tax on taxable
earning within certain bracket:

No. If GE Range (ETB) The employment income tax

Multiply by Tax Rate Deduct (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, the following categories of payments in cash or benefits in kind are

exempted from taxation.

1. Medical costs incurred by employer for treatment of employees.

2. Transportation allowances paid by employer to its employees (not exceeding
Birr 300), hard ship allowance.
3. Reimbursement by employer of traveling expense incurred on duty by
employees and per diem payments.
4. Traveling expenses paid to transport employees from else where to place of
employment and to return them upon completion of employment.
5. Pension contribution, provident fund and all forms of retirement benefits
contributed by employers in an amount that does not exceed 15% of he
monthly salary of the employee.
6. Income from employment received by casual employees who are not
regularly employed provided that they do not work for more than one month
for one employer.

Pension

Pension contributions – 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 11% of the basic salary of every permanent employee of it. It is this amount
often called 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 requirement too
enjoy this benefit when retired.
Non-government organizations are also using this kind of scheme to benefit their
employees with some modifications. 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.

Voluntary Deductions

Employees may voluntarily authorize withholding for charitable, retirement, and

other purposes. The employee should authorize all voluntary deductions from gross
earnings in writing. The authorization(s) may be made individually or as part of a
group plan. Voluntary deductions are such as donations to charitable organization,
credit association, repayment of loan, union dues, health and life insurance.

4.2.3 Net Pays

Net pay is determined by subtracting payroll deductions from gross earnings. It is

sometimes known as take home pay, the amount collected by an employee on the
payday.

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 deduction made from
the earnings of employees.

4.3. Recording the Payroll

Recording the payroll involves maintaining payroll department records, recognizing
payroll expenses and liabilities, and recording payment of the payroll.
4.3.1 Maintaining a Payroll Record
Basic Records of a Payroll Accounting System Includes:
1. A payroll register (or payroll Sheet).
2. Individual employees’ earnings records and,
3. Usually, Pay Check.

These records are generated from a payroll system that is operated manually or
using computer.

A payroll register (sheet): the entire list of employees of a business along with
each employee’s gross earning, deductions and net pay for particular payroll period.
The basis for the preparation of the payroll register can be the attendance sheets,
time cards or punched cards.

Employee Earnings Record Its is 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 summaries
and file tax returns.

Pay Check

An instrument for paying salary if the firm makes payment via writing a check in he
name of each employee for the net pay or a check for the total net pay.

4.3.2 Recognizing The Payroll Expense, Liabilities And Recording Payment Of

The Payroll
Payment by check is made either from the employer’s regular bank account or a
payroll bank account. Each check is usually accompanied by a detachable statement
of earnings document that shows the employee’s gross earnings, payroll deductions,
and net pay.
ILLUSTRATION
To illustrate, Ethio Relief Agency pays the salary of its employees according to the
Ethiopian Calendar month. The forth-coming date relates to the month of Hidar.
OT Duration of Basic
Ser. Basic Monthly Hours OT Salary
No. Name of Employee Salary Allowance Worked Work Per Hour
01 Senait Bahiru 10,080 1000 10 Up to 10 p.m. 42
02 Petros challa 6,480 - 8 10p.m. to 6a.m 27
03 Abdu Mohammed 3,120 - 6 Weekly Rest Days 13
04 Baheru Wolde 360 500 10 Public Holiday 1.5
N.B. Note that management of the agency usually expects a worker to work 240-
hours in a month and during Hidar all workers have done as they have been
expected. Besides, all workers of this agency are permanent employees except
Petros Challa. The monthly allowance of Baheru Wolde is not taxable. Abdu
Mohammed agreed to have a monthly Birr 1000 be deducted and paid to the credit
Association of the agency as a monthly saving.

INSTURCTIONS: Based on the above information;

1. Prepare a payroll register (or sheet) for the agency for the month of Hidar
2. Record the payment of salary as of Hidar 30– using CK. No 41 as a source
document.
3. 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 Tahisas
3.
4. Assuming that the withholding taxes and payroll taxes the month of Hidar,
have been paid on Tahisas 5,Via Ck. No. 50 recorded the required journal
entry.
1. Computations of earnings, deductions and net pay.
OVER TIME EARNINGS:

Over Time Earnings = OT Hrs worked (ordinary hourly rate x OT Rate)

Senait : 10 hrs x ( Br. 42 x 1.25 ) = Br 525

Petros : 8 hrs x ( Br. 27 x 1.5 ) = Br 324
Abdu : 6 hrs x ( Br. 13 x 2 ) = Br 156
Baheru : 10 hrs x ( Br. 1.5 x 2.5 ) = Br 37.5

GROSS EARNINGS:
Gross Earnings = Basic Salary + Allowance + OT Earning

1 Senait : Br + 1000 + 525 = Br

. 10,080 11,605
2 Petros : Br + 0 + 324 = Br
. 6,480 6,804
3 Abdu : Br + 0 + 156 = Br
. 3,120 3,276
5 Baheru : Br + 500 + 37.5 = Br
. 360 898
 Deductions & Net Pays:
1. Income Tax
No. GE (ETB) The employment income tax
( Taxable
income)
1 Senait 11,605 35%*11,605-1500=2,561.75
2 Petros 6,804 25%*6804-565=1,136
3 Abdu 3,276 20%*3276-302.50=352.70
4 Baheru 397.50 No tax

ETHIO RELIEF AGENCY

A PaYROLL SHEET FOR THE MONTH OF Hidar, 2015

Gross Deductio
Earning n
Basic Over Total Income Total Net
Name of the Other
No Employee Salary Allowance Time Earning Tax Pension s Deduction Payment Sig.
1 Senait Bahiru 10,080 1000 525 11,605.00 2561.75 705.60 3267.35 8,337.65
2 Petros Challa 6,480 0 324 6,804.00 1,136 0 1136.00 5,668.00
3 Abdu Mohammed 3,120 0 156 3,276.00 352.70 218.40 1000 1571.10 1,704.90
5 Baheru Wolde 360 500 37.5 897.50 0 25.20 25.20 872.30
Total . . . 20,040 1,500 1,043 22,583 4,050 949 1,000 6,000 16,583

Verfied
Prepared By: By: Approved By:
2. Recording The Payment of Salary.
Hidar 30,. Salary Expense . . . . . . . . . . 22,583.00
Employee Income Tax Payable . . . . . . . . . 4,050.00
Pension contribution Payable . . . . . . . 949.00
Credit Association – ERA . . . . . . . . . . . 1000.00
Cash . . . . . . . . . . . . . . . . . ……………… .16,583
(Ck.No.41)

3. Recording The Payroll pension expense for Hidar.

Ethio. – Relief Agency incurred pension expense of Br. 1,491.60 during Hidar. This
is determined as the product of the basic salary of all permanent employees and
11%. This is because the agency has to contribute 11% of the basic salary of every
Permanent employee to the government pension trust fund.
Thus:
Total Basic Salary Payroll pension expense Pension on
Of all permanent Employees x 11% = Expense
(10,080 + 3,120 + 360 ) x11% = Br 1,491.60

Hidar 30,2015 Payroll pension Expense 1,491.60

Pension cont. Payable 1,491.60
(M10)
The source document is an internal office memorandum that indicates the incurrence
of this expense.

4. Recording The Payment of Deduction from Abdu’s earnings to the credit

association on Tahsas 3,2015.

Tahsas 3, 2015 Credit Association 1000

Cash 1000

5. Recording the Payment of Withholding and Payroll taxes to tax authority

Note also that the total pension contribution payable is equal to 18% of the basic
salary of all permanent employees. That is: Br 4,800 x 18% = Br. 864

Then, The payment is recorded as follows:

Employees Income Tax Pay 4050.00
Pension Contribution Payable 2440.60
Cash 6,490.60
Ck. No. 50
After the payment of these liabilities have been posted, the above two accounts will
have Zero Balances.
(1). W/t Kedija, the employee of CMN Agency, gov’t owned, has worked 10 hours, 8 hours
and 12 hours, during the holidays, after mid night on working days and weekends respectively
in a given month. In the same month, she has earned a regular monthly salary of Br1,120 as
the result of working 140 regular working hours.
Determine her gross overtime earnings for the month.
(2). Using the following payroll date of paradise Restaurant, gov’t owned, for the month of
Sene, 1988.
Compute the:-
Income tax deductions from each employee,
Pension contribution of each employee, and
Employer’s payroll tax expense

Employee Name Basic Salary OT Earning

Derbe Reta Br. 200.00 Br. 50.00
Rahel Abera 400.00 200.00
Michael Girma 300.00 400.00

Assuming that the ordinary hourly rate of Rahel is Br 2.00 and all over time hours were
performed during weekly rest days, how many overtime hours did she perform?

(1). Payroll date of government hotel, Andinet Hotel, for the month of Hamle, 1995
is given below:

Regular Overtime in hours

Basic Hourl Upto 10 p.m - Rest
y
Name Salar Rate Allowan 10 p.m 6 a.m. Days Holidays
y ce
Abera B 600 B 8 B 200 10 - 4 -
r r r
Abebu 420 2.1 - 20 10 - 5
Belete 980 4.9 100 - 5 - 8
Abebu is contractual employee and the allowance given to Abera is free from
income tax.
Required:
1.) Prepare payroll register
2.) Record on Page 10 of a two column general Journal:
(a) The payment of salary on Hamle 30.
(b) The recognition of payroll tax expense and
(C) The payment of the amounts owed in connection with the Hamle,
2015 payroll to the government on Nehassie 5, 2015.