CHAPTER FOUR

Accounting systems for payroll and payroll taxes

Payroll

Your employer has a liability to you for your earnings until you are paid with cash or a check.
Your employer has also a liability to deposit taxes withheld. In this chapter we will discuss
current payroll, tax liabilities, pension liabilities from Ethiopian context, and liabilities from
notes payable.

Payroll system (Ethiopian context)

The Importance of Payroll Accounting

Payroll refers to the amount to be paid to employees for the service they provide during a period.
Payroll expenditures are significant for various reasons.

1. Employees are sensitive to payroll errors and irregularities. Timely and accurate payroll
payments help to maintain good employees’ moral and motivation.
2. Payroll is subject to government regulations.
3. Payroll and payroll related taxes constitute a major cost to an employer and affect the net
income greatly.

The term “payroll” pertains to all salaries and wages paid to employees. An employee is a
person who is subject to control and direction for the company for which he or she works. But
payments made for personal service by professionals who are independent contractors are called
fees, rather than salaries and wages.

Payroll activities involve four functions

 Hiring employees
 Time keeping
 Preparing the payroll
 Paying the payroll

Determining the payroll

Determining the payroll involves computing

a) Gross earnings
b) Payroll deductions and
c) Net pay

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Gross earnings

Gross earnings, also called gross pay is the total compensation earned by an employee. Gross
pay is the amount that an employee has earned during a pay period before any required or
authorized deductions are subtracted. It includes wages, salaries, allowances, commissions,
bonuses and any compensation earned before deductions.

Gross pay = Basic salaries + Allowances + Commissions + Bonuses + Other earnings

1. The basic salary or regular earnings

Salary: the term salary refers to the payment for professional, administrative, managerial,
and clerical employees. The rate of salary is normally expressed in terms of the month or
a year.
Wages: the term wages refers to payment for manual labor, both skilled and unskilled.
Wages are normally based the number of hours worked or a piece of work basis (such as
per unit of a product). Frequently, the term salary and wages are used interchangeably.
2. Allowances: money paid monthly to an employee for special reasons, which may include

- Position allowance a monthly paid to an employee of earning 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 the employer fails to do so.
- Hardship allowances a sum of money given to an employee to compensate for an
inconvenient circumstance caused by the employer. For instance, unexpected
transfer to a new different and distant work area or location.
- Desert allowance a monthly allowance given to an employee because of
assignment to a relatively hot region but not paid to all hot areas.
- 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.
3. Over time earnings
Over time work is the work performed by an employee beyond the regular working hours
or days. Over time earning is the amount payable to an employee for overtime work
done. The minimum rate for over time payment is set by the government legislations and
is presented below.
Over time rate
I. Before 10:00 PM in the evening 11/4 x ordinary hourly rate
II. Between 10:00 PM 6:00AM 11/2 x ordinary hourly rate
III. On the weekly rest days (weekends) 2 x ordinary hourly rate
IV. On a public holy day 21/2 x ordinary hourly rate
4. Bonuses

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 Payroll deductions
Payroll deductions may be mandatory or voluntary. Mandatory deductions include
deductions required by law like income tax. The government legislation requires
employers to withhold from the pay of each employee the applicable income tax due on
those wages and salaries. The employer computes the amounts of income tax withhold
deductions according to a government prescribed formula or withholding tax table.
Employees may voluntarily authorize withholdings for charitable, retirement and other
purposes. The employee should authorize all voluntary deductions from gross earnings in
writing.
 Income tax
According to the currently applicable income tax rate the first 600birr income from
employment shall be exempt from payment of income tax. The income tax rate that is
applicable to all taxable income is given below.
Taxable income range tax rate (%)
Per-month
From Birr to Birr
0-600 Birr 600 Non taxable
601-1650 Birr 1050 10%
1651-3200 Birr 1550 15%
3201-5250 Birr 2050 20%
5251-7800 Birr 2550 25%
7801-10900 Birr 3100 30%
Over 10900 Birr - 35%

Generally, taxable income from employment includes salaries, wages, some allowances,
director’s fees and other personal employment, all payments in cash and benefits in kind.
Once taxable income is determined from gross earnings, the following formula can be
used to determine the income tax as an alternative.

Taxable
Income bracket (Birr) formula
< 600 exempted (non taxable)
601-1650 Birr (nx10%) -60
1651-3200 Birr (nx15%) -142.5
3201-5250 Birr (nx20%) -302.50
5251-7800 Birr (nx25%) -565
7801-10900 Birr (n×30%) - 955
Over 10900 Birr (nx35%) -1500
When n, is total taxable income
60= (600x0.1)-0

142.5= [(600 X .15) – 0] + [(1050 X 0.15) – (1050 X 0.1)] and so forth

Tax free /exempted payment

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The following payments in cash or benefits in kind exempted from taxation.

 Medical cost
 Hardship allowance
 Transportation allowance but it should not be greater than 1,000 or 1/4 th of his/her
basic salary
 Reimbursement of traveling expenses incurred on duty

Income taxes withheld from employees must be paid promptly to the proper government agency.

 Pension fund

Permanent employees of organizations, which are governed by the existing regulation of the
Ethiopian public servants, are expected to pay or contribute 7% of their basic salary (monthly) to
the government pension trust fund. This amount should be the employer from the basic salary of
each employee on every payroll and later be paid to the respective government body. In addition,
the employer is expected to contribute towards the same fund 11% of the basic salary of its
permanent employees. This 11% contribution of the total basic salary of all permanent
employees is recorded as payroll taxes expense to the employer organization.

The total contribution to the pension and social security authority (PSSA) equals to 18% of the
total basic salary of all permanent employees of an organization. An employee will enjoy the
benefit of pension if he/she satisfies the minimum requirements of the authority.

In case of NGO’s a provident scheme is applied this is contributed at a specified percentage.

Both the employees and the employer contribute towards this fund monthly. The total amount of
the fund will be payable to an employee at the time of retirement or resignation.

 Other deductions

These withholdings arise from employee requests, contracts, unions, or other agreements. They
can include amounts for charitable giving, insurance premiums, staff loan repayments and union
dues etc.

Net (or take home) pay: is determined by subtracting payroll deductions from gross earnings.

Payroll tax expenses: payroll related expenses paid by the employer like 11% contribution
toward pension fund.

Payroll records: employee earnings record, payroll register, payroll checks

Payroll register (sheet)

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  The payroll register, which is prepared each pay period, is a detailed listing of the firm’s
total payroll. It shows a pay period, a gross pay, deductions and net pay of each employee
for every pay period.
 The payroll period is the length of time covered by each payroll payment. For wage
workers the pay period are usually made on weekly or biweekly. Salaried employees pay
periods are monthly or semimonthly.
 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.
 Attendance sheets, punched (clock) cards, together with information from the personal
records enable to update the employee earnings records and prepare the payroll register.
 It is multi column form used in assembling and summarizing the data needed and prepare
the payroll register.

Employee earnings period

It is a summary of each employee’s earning, deductions and net pay for each payroll period and
of cumulative gross earnings during the year. It is a separate record for each employee.

Pay check/ payroll check

Payment of payroll is usually done by check or in coin and currency. A pay check is an
instrument prepared at the end of paying salary if the firm makes through writing a check in the
name of each employee for the net pay or check for the total net pay. When the payroll register
has been completed and checked, the general journal entries relating to payroll can be made.

Entries related to payroll

The journal entry for recording the payroll is based on the column totals from the payroll
register. Note that each account debited or credited is a total from the payroll register.

 Recording payroll expenses and liabilities

 Recording the payment of the payroll
 Recording employer payroll taxes
 Recording payment of withholdings, payroll taxes, and other deductions to each
respective recipient.

Major procedures in payroll accounting

a) Gathering necessary data

b) Preparing the payroll
c) Verifying the payroll
d) Approval of the payroll
e) Recording the payroll expenses and liabilities
f) Recording of the payment of payroll

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 g) Recording the payroll taxes expenses of the employer
h) Paying and recording with holdings and payroll tax expenses

Payroll accounting illustration

The following payroll related data pertains to wisdom institute for the month of megabit, 2005.
In the institute, salary is paid on monthly basis and each employee is expected to work for 176
hours per month or 22 working days on a month. As per the personnel department’s
confirmation, all staffs were on duty for the month of Megabit. The pension contribution is 7%
from employees and 11% by the institute on their salary basis. But, this applies only for
permanent employees. Term of employment is permanent except Hanna Birhane.

No Name of employee Basic salary Allowance Over time Duration

Taxable non taxable of hours
1 Belay Kalau 1848 500 200 10 Weekends
2 Jemal Ahmed 1540 200 150 8 Public holiday

3 Muse Abera 8600 400 500 13 Before 10: PM

(evening)
4 Hanna Birhane 350 - - - -

Other deductions

No Name of employee Deductions Total

Staff loan Credit association Donation

1 Belay Kalau 300 100 50 450
2 Jemal Ahmed - 50 50 100

3 Muse Abera 400 300 100 800

4 Hanna Birhane - - 10 10

Required

1) Prepare a payroll register for the month of Megabit

2) Record payroll expenses and liabilities
3) Record payment of the payroll
4) Record the payroll tax expenses (11% of pension) of the month
5) Record the remittance of withholding taxes and other deductions to each recipient.
6) Computation of Gross earnings, Deduction and Net pay

Gross earnings = Basic salary pay + Allowance + Over time earning

I) Over time = Overtime Hours worked x (ordinary hourly rate x OT rate)

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 a. Belay Kalau: 10 hrs x (Br. 10.50 x 2) = Br.210
b. Jemal Ahmed: 8 hrs x (Br. 8.75 x 2.5) = Br.175
c. Muse Abera: 13 hrs x (Br. 48.86 x1.25) = Br 794.03

II) Gross Earnings

1) Belay Kalau: Br. 1848 + 700 + 210 = Br. 2758

2) Jemal Ahmed: Br. 1540 + 350 + 175 = Br.2065
3) Muse Abera: Br. 8600 + 900 + 794.03 = Br. 10,294.03
4) Hanna Birhane: Br. 350 + 0 + 0 = Br 350

III) Deductions

Total Deduction =Income tax + Pension contribution + other deductions

Income Tax

1. Belay Kalau
Taxable Income = Gross earning – None taxable income
= Br.2758 – 200
=Br.2558
Income tax
600 x 0% = 0.00 or (n x 15%) -142.5

1050 x 10% = 105 = (2558 x 15%) -142.5

908 x 15 % = 136 = 383.7-142.5=241.2

Total 2558 241.2

Pension contribution:

Basic salary x 7%

Employee Pension - Basic Salary x 7%

= 1848 x 7%

= 129.36

Other deductions

Staff loan + Credit association + Donation

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 300+ 100+ 50=450

Total deductions = Br. 241.2 + 129.36 + 450

= Br. 820.56

Net pay = Gross earnings – Total deductions

= Br. 2758 – 820.56

= Br. 1937.44

2. Jemal Ahmed

Taxable income = Gross earnings – Nontaxable income

= Br. 2065 – 150

= Br.1915

Income tax

600 x 0% = 0 or (n x 15%) – 142.5

1050 x 10% =105 = (1915 x 10%) – 142.5

265 x15%=39.75 = 287.25 – 142.5

1915 144.75 = 144.75

Pension contribution

= Basic salary x 7%

= 1540 x 7% = 107.8

Other deduction

Credit association + Donation

= 50+50 =100

Total deduction = Br. 144.75 + 107.8 + 100 = 352.3

Net pay = Gross earnings – Total deductions

= 2065 – 352.3 = 1712.7

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 (C) Muse Abera
Total income = Gross earnings – Nontaxable income
= 10294.03 – 500 = 9794.03
Income tax
600 x 0% = 0.00 or (n x 30%) – 955 = 9794 – 955 = 1983.2
1050 x 10% = 105
1550x15%=232.5
2050x20%=410
2550x25%=637.5
1994.03 x 30% = 598.2
9794.03 1983.2

Pension contribution = Basic salary (8600) x 7% = 602

Other deduction
Staff loan +credit association+ Donation
400+ 300 +100=800
Total deductions: 1983.2 + 602 + 800 = 3385.2
Net pay = 10294.03 – 3385.2 = 6908.83
d) Hanna
Taxable income =Gross earning – Nontaxable income
= 350 – 0 = 350
Income tax
No taxable income

Pension contribution: no pension contribution because she is a temporary (contractual) worker.

Other deductions:

Donation 10

Total deductions =10

Net pay = 350 – 10 = 340

1. WISDOM INSTITUTE

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 PAYROLL REGISTER

For the month of megabit, 2005

No Name of Earnings Gross Taxable Deductions Total Net pay Signa

employee Basic Allowa Over earnin income Deductio ture
salar nce time gs ns
Income Pensio other
y tax n C. s
1 Belay 1848 700 210 2758 2558 241.2 129.36 450 820.56 1937.44
Kalau
2 Jemal 1540 350 175 2065 1915 144.75 107.8 100 352.3 1712.7
Ahmed
3 Muse 8600 900 794.03 10294. 9794.03 1983.2 602 800 3385.2 6908.83
Abera 03
4 Hanna 350 - - 350 - - - 10 10 340.00
Birhane
Total 12338 1950 1179.0 15467. 14,267.03 2369.15 839.16 1360 4568.06 10898.97
3 03

Prepared by: __________________Checked by: ___________________Approved by:___________________

2. To record payroll expense and liability.

Salary and benefits expense………………..15,467
Income tax payable…………………………………..2369.15
Pension contribution payable……………………….839.16
Staff loan………………………………………….……..700
Credit association payable…………….……………….450
Donation payable………………………………….…....210
Salary payable……………………………………...10898.97
3. To record payment of payroll.
Salary payable…………………………..10,898.97
Cash……………………………………………..10,898.97
4. To record payroll tax expense.
Payroll tax expenses……………………………1318
Pension contribution (11%)………..........................................1318
(12338 – 350 X 11% = 1318)
5. To record remittance of withholding taxes and other deductions.
Income tax payable……………………..…….2369.15
Pension contribution payable (18%)…………..2157.16
Credit association payable……………………..450
Donation payable………………………………210
Staff loan…………………………………….…700
Cash………………………………………………………5886.31

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