CHAPTER THREE: Accounting for payroll and payroll tax in Ethiopia

3.1. INTRODUCTION
Accounting systems for payroll and payroll taxes are concerned with the records and reports
associated with the employer-employee relationship. Well-designed accounting system has a
mechanism that ensures payroll payments should be in accord with the employment contract duly
signed by both parties based on the prevailing labor laws in that jurisdiction.
All employees of an organization expect and are entitled to receive their remuneration at regular
intervals following the closing 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 timely. The
system must also provide adequate safeguards against unauthorized payments to employees and other
misappropriations of funds.
The federal and regional states require employers to keep accurate payroll records that should be
submitted to the appropriate authorities within the time limits prescribed in the respective laws.
Employers should also reimburse the amount withheld from individual employees along with their
own pension contribution within the time frame prescribed there. In addition, these records must be
kept for specified periods of time to make them available for any enquiry that may arise from the
regulatory bodies. 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.
3.2. Payroll and importance of payroll accounting
Payroll: It is the compensation of a business must pay to its employees for a set period or on a
given date. On the other hand, list of employees who are paid by the company.
IMPORTANCE OF PAYROLL ACCOUNTING
Accounting for payroll is particularly important because:
I. Payroll often represents the largest expense that a company incurs.
II. Both federal and state governments require that detailed payroll records be kept and
III. Employees are sensitive to payroll errors or irregularities. To maintain good employee
morale payroll must be paid on a timely and accurate basis.
3.3. Definition of payroll related terms
1. Salary and Wages: Salary and wages are usually
used interchangeably.

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  Wages: is refer to payments to unskilled-manual labor. It is usually paid based on the number
of hours worked or the number of units produced. Therefore, wages are usually paid when a
particular piece of work is completed or weekly.
 Salaries: refers to payments to employees who render managerial, administrative or similar
services, and they are usually paid to skilled labor on a monthly or yearly basis.
2. The Pay Period: A pay period refers to the length of time covered by each payroll payment.
3. The Pay Day: The pay day- is the day on which wages or salaries are paid to employees. This is
usually on the last day of the pay period.
4. A Payroll Register (sheet): is the list of employees of a business along with each employee’s
gross earnings; deductions and net pay (take home pay) for a particular pay period. The payroll
register (sheet) is prepared based on attendance sheets, punched (clock) cards or time cards.
The employees work hour duration may come from:
Attendance sheet- is where employees sign at time of arrival in the working area. Its usually
placed in office or admin area
Punched or clock card : its electronical record card in large industries ; employees will have
their own card for registered both at time of entering & leaving at work place.
Time card : its similar to punched card except but its manually written
5. Pay Check: A business can pay payroll by writing a check for the amount of 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 the paid by cash at the organization.
6. Gross Earnings: is the total earnings of the employees for a given pay period before
deductions.
7. Withholding Taxes: are taxes collected from the earnings of employees by the employer
organization as per the regulations of the government. These have to be reimbursed (paid) to the
government because employer organization is only acting as an agent of the government in
collecting these taxes from employees.
8. Payroll Deductions: are deductions from the gross earnings of an employee such as
employment income taxes (withholding taxes),, employee pension contribution (withholding
taxes), labor union dues , fines, credit association pays etc.
9. Net pay: is the earning of an employee after all deductions have been made. This is the take
home pay amount collected by an employee on the payday
III.4. POSSIBLE COMPONENTS OF A PAYROLL REGISTER

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 I. Employee Identification Number: - Number assigned to 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.
II. Name of Employee: This column lists names of employees of the organization.
III.Earnings: Money earned by an employee from various sources. This may include.
1. 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.
2. 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,
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.
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.
IV. Overtime Earning: - Overtime work is the work performed by an employee beyond the regular
working hours. Overtime earnings are the amount paid to an employee for overtime work
performed.
In Ethiopia, the hourly rate of overtime work varies depending on the time period in which the work
is performed. Accordingly, a worker shall be entitled to be paid at a rate of:
A. One and One –quarter (1¼ or 1.25) times his ordinary (regular) hourly rate for overtime work
performed before 10:00 P.M in the evening. (6:00AM-10:00 PM) in Western time or 4 o’clock in
the evening in Ethiopian time.
B. One and one half (1½ or 1.5 ) times his ordinary (regular) hourly rate for overtime work
performed between 10:00 P.M and six (6:00A.M.) in the morning Western time. 4 o’clock to 12
o’clock in the morning in Ethiopian time.

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C. Two times the ordinary (regular) hourly rate for overtime work performed on weekly rest days.
D. Two and one half (2½ or 2.5 ) times the ordinary (regular) hourly rate for overtime work
performed on a public holiday.
Gross earning = basic salary + allowance + overtime earning
V. Deductions: are subtractions made from the earnings of employees required either by the
government or permitted by the employee yourself. The following are some of the deductions:
1. 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 979/2016- Income tax proclamation.
Schedule A employment income tax
Employment Income(Per month) Difference
No From Tax rate Deduction
1 0 - 600 600.00 Exempt -
2 601 - 1,650 1,050.00 10% 60.00
3 1651 - 3,200 1,550.00 15% 142.50
4 3201 - 5,250 2,050.00 20% 302.50
5 5251 - 7,800 2,550.00 25% 565.00
6 7801 - 10,900 3,100.00 30% 955.00
7 Over 10,900 - 35% 1,500.00
Calculations of Deductions
60 = (600 x 0.10) or 1650*0.10-0.10*(1650-600)=165-105=60
142.5 = 600 x 0.15 + 1050 x 0.05
302.50 = 600 x 0.20 + 1050 x 0.10 +1550 x 0.05 and so forth

In other ways tax amount should be computed as follows: Tax amount = taxable income X tax rate –
tax deduction
Taxable income: is an income excluding non-taxed income
Employment income per month Income tax payable
From Birr To Birr
0 600 No tax
601 1650 (10% X EI)-60
1651 3200 (15% X EI) -142.5
3201 5250 (20% X EI) -302.5

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 5251 7800 (25% X EI)-565
7801 10900 (30 X EI)-955
Above 10900 ( 35% X EI )-1500

Exemptions in accordance to Proclamation No. 979/2016

An amount paid by an employer to cover the actual cost of medical treatment of an employee;
An allowance in lieu of means of transportation granted under a contract of employment; The
maximum tax-exempt allowance is currently set at 2,200 Birr per month, but the allowance
cannot exceed 25% of an employee’s salary. It is also important to note that the allowance
does not cover instances in which an employer arranges for, or gives, a vehicle to a staff
member who then uses it to travel between their residence and place of work.
Hardship allowance;
Transport expenses and per diem payments to an employee travelling on a tour of duty; The
maximum tax-exempt allowance is currently set at 2,200 Birr per month, but the allowance
cannot exceed 25% of an employee’s salary.
Travelling expenses paid to an employee recruited from place other than the place of
employment on joining or completion of employment.
Contributions by an employer to a pension, provident, or other retirement fund for the benefit
of an employee provided the monthly total of contributions does not exceed 15% of the
monthly employment income of the employee;
An amount as compensation for personal injury or the death on another person;
Cash indemnity allowance paid by an employer to an employee, but only to the extent that the
allowance compensates the employee for shortfalls on money counts;
Income from employment received by unskilled employee working for the same employer
whether continuously or intermittently for not more than thirty (30) days within any twelve
month period; provided, however, that the tax payable on income from employment received
by a casual employee working intermittently for the same employer for more than thirty (30)
days within twelve months period shall be calculated only on the income received by that
employee from the last employment;
2. Pension contributions

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  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
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 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 to enjoy this benefit when retired.
3. Other Deductions: Apart from the above two kinds of deductions, employees may individually
authorize additional deductions such as deductions to pay life insurance premiums, to repay loan
from the employer, to pay for donation to charitable organization, contributions to "ldir" etc.
Total deduction= Employment income tax + Pension Contribution + Other Deductions
VI. Net Pay: Net Pay represents the excess of gross earnings over total deductions of an
employee.
VII. Signature: The payroll sheet should have a column for signature of the employee to be taken
when the employee collects the net pay. This works only when the payroll system is working
manually. In an electronic payment system, signature may not be required as the transfer is
made electronically directly to the individual accounts.
XYZ is a governmental unit established to develop tourist attractions in Amhara National
Regional State. It has four employees whose salaries are paid according to the Ethiopian Calendar
month. The following data relates to the month of Megabit, 2010.
Name of Basic Position Over time Duration of
employee salary allowance worked(hr OT work
)
Natinael 1,200.00 - 4 Before 10 pm
Berihun 4,000.00 - 8 Sunday

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 Tsedalu 15,000.00 750.0 - -
0
Dawit 6,500.00 - - -
Additional Information
 The employees usually are expected to work for 40 hours per week
 All employees are permanent except Dawit
 Berihun agreed to contribute Br 800 to credit association
Required; based on the above information
1) Prepare a payroll register sheet for the month of Megabit 30, 2010.
2) Record the payment of salary for the month of Megabit 30, 2010.
3) Record the payment of the claim of the credit association of their agency on Miazia 3, 2010.
4) Record the payment of withholding taxes and pension contribution to the concerned government
body on Miazia 10, 2010.