CHAPTER FOUR

ETHIOPIAN PAYROLL SYSTEM

4.1. Nature of Payroll

Payroll refers to the document prepared to pay remuneration for the services obtained from
employees for a certain period of time. Accounting systems for payroll and payroll taxes are
concerned with the records and reports associated with the employer-employee relationship. It is
important that the accounting system provide safeguard to ensure that payments are in
accordance with management’s general plans and its specific authorizations.

All employees of an organization expect and are entitled to receivtheir 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, the 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.

Various federal, state, and local laws require employers to keep accurate payroll records and to
prepare reports and submit to the appropriate governmental units. The law also requires
employers to remit the amounts withheld from its employees and for taxes imposed on it. These
records must be kept for specified periods of time and be available for inspection by those
responsible for enforcement of the laws. Besides, payroll data may be useful in negotiations with
labor unions, in settling employee grievances, and in determining rights to vacations, sick leaves,
and retirement pensions. Generally, a company’s payroll is important for the following reasons:
1. Employees are sensitive to payroll errors and irregularities.
2. Good employee morale requires payroll to be paid timely and accurately.
3. Payroll is subject to various government regulations.
4. Payroll and related payroll taxes significantly affect the net income of most companies.

4.2. Overview of Ethiopian Labor Laws

It is essential to ensure worker-employer relations are governed by basic principles of rights and
obligations with a view to enabling workers and employers to secure durable industrial peace;
sustainable productivity and competitiveness through cooperative engagement towards the all-
round development of our country. According to the Labor Proclamation No. 1156/2019,
“Employer” means a person or an undertaking that employs one or more natural persons in
accordance with an employment contract. Also, a “Worker” means a person who has an
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employment relationship with an employer in accordance with an employment contract.
Accordingly, the elements of a contract of employment are:
(1)A contract of employment shall be deemed formed where a natural person agrees directly
or indirectly to perform work for and under the authority of an employer for a definite or
indefinite period or piece of work in consideration for wage;
(2)A contract of employment shall be stipulated clearly and in such manner that the parties
are left with no uncertainty as to their respective right and obligation under the terms
thereof;
(3)A contract of employment shall specify the type of employment and place of work, the rate
of wages, method of calculation thereof, manner and interval of payment and duration of
the contract;
(4)A contract of employment shall not be concluded for the performance of unlawful or
immoral acts;
(5)The contract of employment shall not laydown less favorable conditions forth employee
than those provided for by law, collective agreement or work rules.

According to the Labor Proclamation No. 1156/2019, every worker shall have the following
obligations:
(1) To personally perform the work specified in his contract of employment,
(2) To follow instructions given by the employer based on the terms of the contract and work
rules,
(3) To handle with due care all equipment and tools entrusted to him for work,
(4) To report for duty always in fit mental and physical conditions,
(5) To give all proper aid when an accident occurs or an imminent danger threatens life or
property in a workplace without endangering his safety and health,
(6) To inform immediately the employer any act which endangers himself or co-workers or
which prejudice the interests of the Undertaking
(7) To comply with the provisions of this Proclamation, collective agreement, work rules and
directives issued in accordance with the law.

4.3. Overview of Ethiopian Pension Laws

Pension is a cash payment to retired employees. According to the Proclamation No.1267/2022 of
public servant’s pension fund proclamation, 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% (seven percent) of their basic or monthly salary to the
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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.

Also, according to the stated proclamation, on the other hand, the employer is also expected to
contribute towards the11% (eleven percent) of the basic salary of every its permanent
employees. It is this total amount that we called earlier as payroll taxes expense to the employer
organization, that 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, that 7%
comes from the employees and the 11% comes from the employer, and this enables a permanent
employees 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.

Also, according to the Private Organization Employees' Pension Proclamation No. 715/2011, and
amended Proclamation No. 908/2015, non-government organizations are using this kind of
scheme to benefit their employees with some modifications. This is made in some non-
government organizations (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 retired or drawn out of work, a lump sum amount is given at once.

4.4. Overview of Ethiopian Employment Income Tax

Every citizen is required to pay employee tax to the government in almost all countries. So,
according to the Ethiopian Federal Income Tax Proclamation No. 979/2016, 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. The proclamation provides for the taxation of income in
accordance with the following schedules:

(1)Schedule “A” - income from employment,

(2)Schedule “B” - income from rental of buildings,
(3)Schedule “C” - income from business,
(4)Schedule “D” - other income,
(5)Schedule “E” - exempt income, income that comes within Schedule “E” is not subject to
tax.

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According to the Ethiopian Federal Income Tax Proclamation No. 979/2016, employment
income tax shall be imposed for each calendar month at the rate or rates specified in the
following table below, on an employee who receives employment income during the month. In
Ethiopia, income tax is charged on the gross earnings of the employee at the rates indicated
under schedule “A” of the stated income tax proclamation. Accordingly, the tax rates under
schedule “A”, employment income tax rate, are presented as follow;
Employment Income (per month) Income Tax rate Deductions
From Birr To Birr Tax rate Birr
0 600 Exempted 0
601 1,650 10% 60
1,651 3,200 15% 142.5
3,201 5,250 20% 302.5
5,251 7,800 25% 565
7,801 10,900 30% 955
Over 10,900 35% 1,500

Note that, in computing and withholding tax, the income tax proclamation dictates that income
attributable to the month of Nehassie and Pagumen shall be aggregated (added) and treated as
the income of one month. The 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 or from prospective employment. Also, the following table shows a short cut to income
tax calculation;
Employment Income (per month) Income Tax Payable
From Birr To Birr
0 600 Exempted
601 1,650 (10% X Taxable Income) – 60
1,651 3,200 (15% X Taxable Income) – 142.50
3,201 5,250 (20% X Taxable Income) – 302.50
5,251 7,800 (25% X Taxable Income) –565
7,801 10,900 (30% X Taxable Income) – 955
Over 10,901 (35% X Taxable Income) – 1,500

Note that, the gross earnings of an employee may include the basic salary, allowance and
overtime earnings. Also, the deductions for each tax bracket are computed as follow:

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 Deduction for each tax bracket is computed as follows;
Tax Bracket Computation of deductions;
(Birr)
(1) 0-600 0
(2) 601-1650 600X10%-0%(600-0) = 60Birr
(3) 1651-3200 1650X15%-10%(1650-600)=247.5-105 = 142.5 Birr
(4) 3201-5250 3200X20%-15%(3200-1650)-10%(1650-600)=640-232.5-
105=302.5Birr
(5) 5251-7800 5250X25%-20%(5250-3200)-15%(3200-1650)-10%(1650-
600)=1312.5-410-232.5-105=565 Birr
(6) 7801-10,900 7800X30%-25%(7800-5250)-20%(5250-3200)-15%(3200-1650)-
10%(1650-600)=2340-637.5-410-232.5-105=955Birr
(7) Over 10,900 10,900X35%-30%(10,900-7,800)-25%(7,800-5250)-15%(3200-
1650)-10%(1650-600)=3815-930-637.5-410-232.5105 = 1,500 Birr

Also, the proclamation states that the following are not taxable:
Income from employment received by casual 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.
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.
Payments made to an employee as a compensation or gratitude in relation to, personal
injuries suffered by that person, and the death of another person.

Also, the council of ministers regulation Number 78/2002, regulations issued pursuant to the
income tax proclamation further exempt the following from income tax:
Amounts paid by employers to cover the actual cost of medical treatment of employees.
Allowance in view of means of transportation granted to employees under contract of
employment, i.e., transportation allowance.
Hardship allowance, which is allowance paid due to an employee to compensate for an
inconvenient circumstance caused by the employer.
Amounts paid by employee in reimbursement of traveling expenses incurred on duty.
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4.5. Preparation of Payroll Register
The payroll register is a multicolumn report used for summarizing the data for each payroll
period. A payroll register (sheet) is the entire list of employees of a business along with each
employee’s gross earnings, deductions and net pay (gross earnings less total deductions) for a
particular period.
Possible Components of a Payroll Register
Although payroll registers vary by company, a payroll register normally includes the following
columns:
I. Employee number: Numbers assigned to employees for identification purpose when a
relatively large number of employees are included in the payroll register.
II. Name of employees
III. Earnings: money earned by an employee(s) and includes:-
A. The basic salary or regular earning- A flat monthly salary of an employee which is
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:
 Position Allowance: A monthly sum paid to an employee for bearing a particular office
responsibility.
 House 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.
 Hardship Allowance: A sum of money given to an employee to compensate for an
inconvenient circumstance caused by the employer.
 Desert Allowance: a monthly allowance given to an employee because of assignment to
a relatively hot region.
 Transportation (Fuel) Allowance: A month 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
normal working hours and days.

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  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 1.25 times his/her ordinarily hourly rate for
overtime work performed before 10 o’clock in the evening (10 p.m.).
2. A worker shall be entitled to be paid 1.5 times his/her ordinarily hourly rate for overtime
work performed between 10 o’clock in the evening (10pm) and six o’clock in the
morning (6a.m.)
3. Overtime work performed on the weekly rest days shall be paid at a rate of 2.00 times
the ordinarily hourly rate of payment.
4. A worker shall be entitled to be paid 2.5 times his/her ordinarily hourly rate for overtime
work performed on a public holiday.
 Gross earning = Basic salary + Allowance + Overtime Earning
IV. Deductions: These are subtractions made from the earning that is because it is required
by government or permitted by the employee himself.
A. Employee Income Tax: it is explained above.
B. Pension Contributions: it is explained above.
C. Other deductions: Apart from the above two 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
associations; to pay for donations to charitable organizations; etc.
Gross deductions = Income Tax Payable + Pension Contribution Payable + Other deductions
D. The net pay: represents the excess of gross earnings over the total deductions.
E. Signature: Signed by employee after net pay is collected. Payroll register should at least
show the earning, deductions and the net pays along with the names of employees.
Example of payroll registers (Sheet).
No Name Earnings Taxable Deductions Net Signa
Regula O Total income Tax Pen. Other Total Pay ture
r T
1 Mulu 500 50 550 550 40 35 75 475
Abebe

Example: The following data were taken from the records of XYZ Co. for July 2006 E.C. that
pays payroll to its employees according to Ethiopian payroll system.
Name Basic salary allowance Overtime worked Duration of overtime work
Abel Br.4,400 550 30hrs Up to 10:00pm

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Sara 7,200 500 20hrs 10:00pm-6:00am
Nega 3,600 300 10hrs Weekends
18hrs Public holiday

Additional information:
1. All employees are expected to render services of 160hrs per month and all of them did it.
2. All employees are permanent employees except Abel.
3. The allowance of Nega 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, taxable income, total deductions and net pay of all
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 withhold and payroll tax liabilities to the concerned authority?
Solution:
Abel
Gross earnings
Gross earnings=basic salary+ overtime+ allowance
Ordinary rate=4,400/160= Br.27.5/hr
Overtime earnings= 30hrsx1.25xBr.27.5= Br.1031.25
Gross earnings=4,400+1031.25+550=Br.5,981.25

Taxable income = Br. 5,981.25

Total deductions
Pension =0(not a permanent employee)
Payable to credit association=10%x4, 400=Br.440
Income tax payable= 0-600 (0%) =0
601-1,650 (10%) =105
1,651-3,200 (15%) =232.5
3,201-5,250 (20%) =410
5251-5981.25 (25%) =182.8

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Income tax=105+232.5+410+182.8=Br.930.3
Total deductions=0+440+930.3= Br.1370.3
Net pay
Net pay=gross earnings-total deductions=5,981.25.5-1,370.3=Br.4,610.95

Sara
Gross earnings
Gross earnings=basic salary+ overtime+ allowance
Ordinary rate=7,200/160= Br.45/hr
Overtime earnings= 20hrsx1.5xBr.45= Br.1350
Gross earnings=7,200 +1,350+500=Br.9,050
Taxable income = Br.9,050
Total deductions
Pension =7%xBr.7, 200= Br.504
Payable to credit association=10%x7, 200=Br.720
Income tax payable= 9,050 * 30% - 955 = Br.1,760
Total deductions=504+720+1,785= Br.2,984

Net pay
Net pay=gross earnings-total deductions=9,050-3,009=Br.6,066

Nega
Gross earnings
Gross earnings = basic salary + overtime + allowance
Ordinary rate=3,600/160= Br.22.5/hr
Overtime earnings= 10hrsx2xBr.22.5 +18hrsx2.5xBr.22.5= Br.1,462.5
Gross earnings=3,600 +1,462.5+300=Br.5,362.5

Taxable income = Br.5,362.5-300 = Br.5,062.5

Total deductions
Pension =7%xBr.3, 600= Br.252
Payable to credit association=10%x3, 600=Br.360
Income tax payable= 5,062.5 * 20% - 302.5 = Br.710
Total deductions=252+360+1,785= Br.1,322
Net pay
Net pay=gross earnings-total deductions=5,362.5-1,322=Br.4,040.5
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 a. Journal entries
i. Salary expense------20,393.75
Income tax payable--------3,400.3
Pension payable--------------756
Credit asso. Payable------1,520
Cash------------------------14,717.45
(When net paid by employer)
ii. Payroll tax expense---------3,400.3
Pension contribution payable-----3,400.3
(When employer recognized the pension contribution)
iii. Income tax payable-------3,400.3
Cash-----------------------------3,400.3
(When employer paid income tax to government)
Pension contribution payable--------756
Credit asso. Payable--------------------1,520
Cash--------------------------------2,276
(When pension and credit association payment were made by employer)
Exercise
1. Beza Company pays payroll to its employees based on the Ethiopian payroll system. The
following data were show to the employees of the company for August 2006 E.C.

Name Basic salary Allowance Overtime worked Duration of overtime

work
Araya Tigu Br.3,000 150 30hrs Up to10:00pm
Sami Cheru 3,500 200 20hrs 10:00pm-6:00am
Zenash Tola 2,000 150 20hrs Weekends
16hrs Public holiday

Each employee has to work 160hrs, but Araya Tigu worked only 150hrs without justification
reason and early in August he has also taken Br.1, 000 in advance out of his salary to be
deducted in four equal installments beginning from August 2005 E.C. 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:

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 a. Prepare the payroll register for the month of August.
b. Record journal entries related to the payroll of August. Assume withheld taxes were paid
to the government on September 6, 2007 E.C

ASSIGNMENT-2 (GROUP) ON:

CHAPTER THREE: CURRENT LIABILITIES

Instruction: you are required to discuss and prepare written materials on at least the following
contents of the third chapter:
3.1. The nature of liabilities
3.2. Classification of liabilities
3.3. Types of current liabilities
3.4. Presentation of current liabilities on the balance sheet

Note that each group are expected to do a separate unique assignment!!!!

Deadline: After Two weeks (16/03/2017 E.C)

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