Chapter Four

4. Ethiopian Payroll System

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 accord with management’s general plans and its
specific 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, 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 itself. 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.
4.2. Importance of Payroll Accounting
Accounting for payroll is particularly important because:
 Payroll often represents the largest expense that a company incurs.
 Both federal and state governments require that detailed payroll records be kept and
 Employees are sensitive to payroll errors or irregularities. To maintain good employee
morale payroll must be paid on a timely and accurate basis.

3.3.2. Definition of Payroll Related Terms

1. Salary and Wages: Salary and wages are usually used interchangeably. However, the term
wages is more correctly used to 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. On the other hand, 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. Both wages and salaries related
to an ‘employee’ is an individual who works primarily to one organization and whose activities are
under the direct supervision of employer. A self-employed person on the other hand works (gives
her services) on a fee basis to various firms.
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.

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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. Employee income tax: tax: are taxes collected from the earnings of employees by the employer
organization as per the regulations of the government. These have to be submitted (paid) to the
government because employer organization is only acting as an agent of the government in
collecting these taxes from employees.
7. Payroll Deductions: are deductions from the gross earnings of an employee such as employment
income taxes (with holding taxes), labor union dues, fines, credit association pays etc.
8. Net Pay: Net Pay is the earning of an employee after all deductions have been deducted. This is
the take home pay amount collected by an employee on the payday.
3.3.3. Possible components of a payroll register
1. Employee Number
Number assigned to employees for identification purpose when a relatively large number of
employees are involved in a payroll register.
2. Name of Employees
3. Earnings
Money earned by an employee from various sources. This may include.
A. Basic Salary-
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.
B. Allowances- money paid monthly to an employee for special reasons, like:
 Position allowance-
allowance- a monthly paid to an employee of earning 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-
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.
 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 her workplace if the employer has committed itself to provide transportation
service.
C. Overtime Earning: Overtime work is the work performed by an employee beyond the
regular working hours.

Over time schedule Over time rate

Before 10:00 P.M in the evening. One and one-quarter (1.5) times overtime work performed
Between 10:00 P.M and six (6:00 One and one half (1.75) times overtime work performed
A.M) in the morning.
on weekly rest days Two times
on a public holiday Two and one half (2 ½) times

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All in all, the gross earnings of an employee may include the basic salary, allowance and overtime
earnings.
4 Deduction: are subtractions made from the earnings of employees required by the government
or permitted by the employee himself.

a. Employment Income Tax: Every citizen is required to pay employee income 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 N.
286/2002- Income tax proclamation.
The tax rates under schedule A are Presented below:
Income brake Income Tax Tax Tax Liability
in Birr rate Deduction
0 – 2, 000 Exempt (Free ---- Nil
From Tax)
2,001 – 4,000 15% 300 (Taxable Income * 15* ) - 300
4,001 – 7,000 20% 500 (Taxable Income * 20* ) - 500
7,001 – 10,000 25% 850 (Taxable Income * 25* ) - 850
10,001 – 14,000 30% 1,350 (Taxable Income * 30* ) – 1,350
Over 14,000 35% 2,050 (Taxable Income * 35* ) – 2,050

Note;-
Note;- 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.
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.
3.3.4. Major 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 arithmetic 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 -the grand total for earnings must be checked if its
equal to 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 prepared it.

5. Approval of the payroll - should be approved by an authorized personnel (individual)

6. Paying the payroll - either in cash or by writing a check.

7. Journalizing the payment of the payroll and income taxes - withheld from employees
(withhold doing tax liability) should be recorded in journal entry form.

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 8 The withholding tax - must be paid to the relevant government authority in time (promptly)
and this is recorded in journal entry form.
Example
Assume Dream is a government agency recently organized to Environmental protection. It has five
employees whose salaries are paid according to the Ethiopian calendar. The following data relates to the
month of September 2018 E.C
Serial Name of Employee Basic Transp. Overtime Duration of
No. __________________ Salary Allowance worked (hrs.) OT Work
01 Nigusie Chekol 4,500 1,200 9 6:00 - 10:00 P.M
02 Sikay Zeleke 7,800 ___ 10 Sunday (8:30-5:30)
03 Tariku Lema 11,400 ___ 6 10:00 P.M – 6:00 A.M
04 Tizazu Bezabh 6,000 1,500 ___ ___
05 Zemenu Girum 15,000 200 8 Public Holiday
Additional Information
- The management of the agency usually expects a worker to work 40 hours in a week and
during September there are four weeks.
- There were no absentees during the month
- All employees are permanent except Sikay and Triku
- Zemenu agreed to contribute monthly Br. 1,000 from his salary as a monthly saving in
the credit association of the agency.
- Transportation Allowance is taxable when it exceed Br. 200
Required
1. Prepare a payroll register (sheet) for the agency for the month of September 2018.
2. Record the payment of salary as of September 30\2018 using check stub No. 4261.
3. Record the payment of the claim of the credit Association of their agency on October 1,
2018 use check stub No. 04263.
4. Record the payment of the withholding taxes and pension contribution to the concerned
government body on october7, 2018.
5. Compute and recognize the total payroll tax expense for the month of October, 2018.
Computation of Earnings, Deductions and Net Pay

Gross Earnings = Basic salary + Allowance + Overtime Earning

Overtime Earning
Overtime earning = OT hrs worked X (ordinary hourly rate X relevant OT rate)

1. Nigusie:
 OT Earning = 9 hours X = br. 4,500 X 1. 5..….…... br. 379.6875
160 hours
2. Sikay
 OT Earning = 10 hours X br.
br. 7,800 x 2 …………………….. br. 975
160 hours
3. Tariku
 OT Earnings = 6 hours X br. 11,400 x 1.75 …………..…. br. 748.125
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 160 hours
4. Zemenu
 OT Earnings = 8 hours X br.
br. 15,000 x 2.5 ……..………….. br. 1,875
160 hours
GROSS EARNINGS
Gross Earnings = Basic salary + Allowance + OT Earnings

1. Nigusie
 Gross Earnings = br. 4,500 + br. 1,200 + br. 380 ………… br. 6,080
 Remember taxable income in this case is br5, 880 because the transportation
allowance of br. 200 is not subject to taxation.
2. Sikay
 Gross Earning = br. 7,800 + br. 975 …………………… br.8,775
3. Tariku
 Gross Earnings = br. 11,400 + 748 …………….…….. br. 12,148,
4. Tizazu
 Gross Earnings = br. 6,000 + 1,500 ………………………7,500
5. Zemenu
 Gross Earnings = br. 15,000 + 200 + 1,875 ……….……. br. 17,075
DEDUCTIONS AND NET PAY
1. Nigusie:
 Gross Earnings ……………………………………………..…. br. 6,080
 Taxable Income (6,080 – 200) ……….………………………...…. 5,880
 Employment Income Tax (5,880 *20%) – 500……….………...…. 676
Pension contribution:
 Basic salary x 7% (br. 4,500 x 0.07) ………………….…….….….. 315
 Total Deduction ( 676+ 315) ………………………….….…..…br. 991

2. Sikay:
 Gross Earning …………….……………………………………... 8,775
 Taxable Income ………………………………………….……… 8,775
 Employment Income Tax (8775 *25%) -850 …………………... 1,344
 Non pension, B\c he is temporary employee
 Total Deduction …….……………………………………...…br.
…….……………………………………...…br. 1,344
3. Tariku:
 Gross Earnings ……………………………………….…… 12,148
 Taxable Income …………………………………………… 12,148
 Employment Income tax (12,148 *30%) – 1,350 ….....….... 2,294
 No pension, B\c he is non-permanent worker
 Total Deductions ……………………………….….…… br. 2,294
4. Tizazu
 Gross Earnings …………………………………………… 7,500
 Taxable Income ………………………………………….. 7,300

 Employment Income Tax (7,300 *25%) – 850 ………….. 975

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  Pension = basic salary * 7% = (6,000 *0.07) ……………. 420
 Total deduction …………………………………………. 1,395
5. Zemenu:
 Gross Earnings …………………………….…………… 17,075
 Taxable income (17,075 – 200) …………………………. 16,875
 Employee Income Tax
Earning bracket Taxable Income Tax Rate Income Tax
0 – 2000 0 -- Nil
2,001 – 4,000 2,000 15% 300
4,001 – 7,000 3,000 20% 600
7,001 – 10,000 3,000 25% 750
10,001 – 14,000 4,000 30% 1,200
Over 14,000 2,875 35% 1,006
 Total Employment income tax ……………………...... 3,856
 Pension contribution (15,000 * 0.07) …………………1,050
 Other deduction ……………………………………… 1,000
 Total Deductions(3,856 + 1,050 + 1,000) …………… 5,906
Net pay = Gross Total Earnings – Total Deductions

1. Nigusie:
 Net pay = Gross Earning – Total Deduction = 6,080 – 991 = 5,089
2. Sikay:
 Net pay = Gross Earning – Total Deduction = 8,775 – 1,344 = 7,431
3. Tariku:
Tariku:
 Net pay = Gross Earning – Total Deduction = 12,148 – 2,294 = 9,854
4. Tizazu:
 Net pay = Gross Earning – Total Deduction = 7,500 – 1,395 = 6,105
5. Zemenu:
 Net pay = Gross Earning – Total Deduction = 17,075 – 5,906 = 11,169
Dream Agency
Payroll Register (sheet)
For the Month of September 2018
Ser. Name of Earnings Deductions
No. Employee Basic Allow Over Gross Income Pension Other Total Net Sign.
salary ance Time Earning Tax Contr. Deduction. Deduction. Pay
01 Nigusie Chekol 4,500 1,200 380 6,080 676 315 ___ 991 5,089
02 Sikay Zeleke 7,800 ___ 975 8,775 1,344 ___ ___ 1,344 7,431
03 Tariku Lemma 11,400 ___ 748 12,148 2,294 ___ ___ 2,294 9,854
04 Tizazu Bezabh 6,000 1,500 ___ 7,500 975 420 ___ 1,395 6,105
05 Zemenu Girum 15,000 200 1,875 17,075 3,856 1,050 1,000 5,906 11,169
44,700 2,900 3,978 51,578 9,145 1,785 1,000 11,930 39,648

Prepared by_______________Checked by________________Approved by___________