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 is 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

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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.
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 requires 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,

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 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 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.
Labour Proclamation No. 1156/2019 discussed the following about how overtime work should
be paid:
Overtime is the work done in excess of the normal daily hours of work. A worker may not be
compelled to work overtime except in case of accident (actual or expected), force majeure,
urgent work, or substitution of absent workers assigned on work that runs continuously without
interruption. Overtime work may not exceed 4 hours in a day or 12 hours in a week. If a worker
works beyond the stipulated working hours during the week days, i.e., 8 hours a day and 48
hours a week, he/she is entitled to an overtime premium as follows:
o 150% of normal hourly rate for overtime work between 06 a.m. to 10 p.m.;
o 175% of normal hourly rate for overtime work between 10 p.m. to 06 a.m.;
o 200% of the normal hourly rate for work on a weekly rest day; and
o 250% of the normal hourly rate for work 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.
a. 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

0 600 Exempt (Free from tax)
601 1650 10%
1651 3200 15%
3201 5250 20%
5251 7800 25%
7801 10,900 30%

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 Over 10,900 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.
Short cut to income tax calculation
The tax rates under Schedule A are presented below:
Employment Income (per month)

From Birr To Birr

0 600 No tax (Free from tax)
601 1650 (10% X Employment income)- 60*
1651 3200 (15% X Employment income)-142.5
3201 5250 (20% X Employment income)- 302.5
5251 7800 (25% x Employment income)-565
7801 10,900 (30% x Employment income)-955

Over 10,900 (35% x Employment income)-1500

Employment income or Taxable income abbreviated as EI

* 60= (600 x 0.1) - 0
142.5 = [(600 x 0.15) – 0] + [(1050 x 0.15) – (1050 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.
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b. Pension contribution: Permanent employees of a government organization in Ethiopia are
expected to pay or contribute 7% 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 11% of the basic salary of every permanent government employee.

Therefore, the total contribution to the pension fund of the Ethiopian government is equal to 18%
of the basic salary of all of its permanent employees. That is, 7 % comes from the employee and
11% comes from the employer.

For militaries, the employer (government) contributes 25% and the Military and police Officers
contribute 7% 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.

c. 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

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 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
Ethio Relief Agency pays the salary of its employees according to the Ethiopian calendar
month. The forth coming data relating to the month of Miazia, 2009
Ser. Name of Basic Monthly OT Duration Basic
No. Employees Salary Allowance hours of OT salary per
Worked work hour
1 Senayit Bahiru Br. 7,200 Br. 500 10 Up to 10 Br.45
P.M.
2 Tesfaye kebede 4,800 --- 12 10 p.m to 30
5 a.m
3 Abdu Mohammed 4,000 --- 6 Weekly 25
rest days
5 Ahmedel Ahmed 11,200 600 10 Public 70
Holiday

Note that management of the agency usually expects a worker to work 40 hours in a week and
during Miazia, 2009 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
Ahmedel Ahmed 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 Miazia, 2009.
2. Record the payment of salary as of Miazia, 2009 using Check No. 41 as a source
documents.
3. Record the payroll taxes expense for the month of Miazia, 2009. Memorandum No. 006.
4. Record the payment of the claim of the Credit Association of the agency that arose from
Miazia`s payroll. Assuming that the payment was made on Ginbot 1, 2009.
5. Assuming that the withholding taxes and payroll taxes of the month of Miazia, 2009 have
been paid on Ginbot 5, 2009 via Check No. 50, record the required Journal entry.

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