Principles of Accounting II Payroll System in Ethiopian Context
Principles of Accounting II Payroll System in Ethiopian Context
Chapter 4
Payroll System in Ethiopian Context
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.
In this chapter, therefore you are expected to acquaint yourself with major payroll
records/documents by working through all the procedures common to most payroll systems such as
the employee’s earnings record, payroll sheet (or register), and journal entries related to payroll.
Each of these concepts is illustrated and discussed by taking into account the current tax law of the
country. As much as possible the text attempts to give you adequate knowledge about payroll
systems in Ethiopia. However, if you come across any confusion or difficulties you can consult the
authorities in the Ministry of Finance and Economic Cooperation(MoFEC) or Ethiopian Revenue
and Customs Authority(ERCA) in your locality, or refer the relevant proclamations especially;
Proclamation No. 979/2016.
2. OBJECTIVES
The main objective of this chapter is to equip students with the basic concepts and technicalities of
payroll preparation in Ethiopian context. The chapter addresses the underlying concepts using which
a payroll can be prepared. It also illustrates the different computations and procedures made by
payroll accountants while preparing periodic payments of employees in an organization.
More specifically, at the completion of the chapter, students should be able to:
Explain the importance of payroll and payroll accounting
Define payroll related terms
Identify the basic components of Payroll Register
Prepare payroll sheet
Compute income taxes and pension contributions as per the rule of a government
Compute and record the payroll for a pay period
Describe and record employer payroll taxes
1 Principles of Accounting II, Summarized Lecture Note: Payroll
3. 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 of irregularities.
To maintain good employee morale, payroll must be paid on a timely and accurate basis.
ii. The pay Period: A pay period refers to the length of time covered by each payroll payment.
iii. 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.
iv. 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.
v. Pay Check; 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.
vi. Gross Earnings: is the total earnings of the employees for a given pay period before
deductions.
vii. 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.
viii. Payroll Deductions : are deductions from the gross earnings of an employee such as
employment income taxes, employee pension contribution (withholding taxes), labor union
dues , fines, credit association pays etc.
ix. Net Pay: 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.
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, 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.
III. 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) times his ordinary (regular) hourly rate for overtime
work performed before 10:00 P.M in the evening. (6:00AM-10:00 PM)
b) One and one half (1½) times his ordinary (regular) hourly rate for overtime work
performed between 10:00 P.M and six (6:00A.M.) in the morning.
c) Two times the ordinary (regular) hourly rate for overtime work performed on
weekly rest days.
d) Two and one half (2½) times the ordinary (regular) hourly rate for overtime work
performed on a public holiday.
All in all, the gross earnings of an employee may include the basic salary, allowance, overtime and
other earnings like bonus.
iv. Solomon Tadesse an employee of Ministry of education has basic monthly salary of Br
3,200 and position allowance of 800birr. During the month of Miyaziya, he worked an
over time of 8 hours in the weekend and 6 hours in public holiday. Gemechis Tola, an
employee of the same entity with basic salary of 2,400 however worked 12hours
overtime of which 5 are in midnight whereas the rest up to 10:00pm.
Compute the gross earning of these two employees.
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d) Deductions: are subtractions made form the earnings of employees required either by the
government or permitted by the employee herself. The following are some of the deductions:
I. Employment Income Tax:- Almost in all countries across the globe, citizens pay tax on
their employment income at different level. 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 979/2016- “Income Tax proclamation”.
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.
The tax schedule is provided hereunder:
Exercise-2
i. What is the total amount deducted as income tax for an employee who earns a basic monthly
Salary of Br. 5,080, a monthly non taxable allowance of Br. 300, and an overtime earning of
Br. 800?
ii. Assume Zemenay Debebe is an employee of MoFEC with monthly basic salary of 10,470
and position and transportation allowances of Br. 600 and 800 respectively. During Miyazia
she worked an overtime of 8 hours up to 10pm and 6hours from 10pm to 6 am.
a) Find her taxable income
b) Compute employment income tax that she pay for this month
5 Principles of Accounting II, Summarized Lecture Note: Payroll
Proclamation No. 979/2016 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:
o Personal injuries suffered by that person
o The death of another person
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, i.e., transportation allowance.
3- Hardship allowance (Disturbance allowance).
4- Amounts paid by employee in reimbursement of traveling expenses incurred on duty.
This enables employee to be entitled for the pension pay when retired provided the employee
satisfies the minimum requirements to enjoy the benefits.
Non-governmental not-for profit organization (NGO’s) also have this kind of scheme to benefit
their employees with some modifications. A fund known as provident fund as established and both
the employer and the employee contribute towards this fund monthly. When an employee retires or
leaves employment, a lump sum amount is paid to her/him.
Exercise-3
1. Identify the federal taxes that most employers are required to withhold from employees?
2. What is the employer share of pension contributions for a permanent employee whose regular
monthly salary of Br. 8,200?
f) 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.
Exercise-4
i. How is Net Pay computed?
ii. Assume an employee’s regular hourly pay is Br. 40, with a time and a half for every hour
worked in excess of 40 during a week. The following data are available:
Assume that according to the tax law transportation allowance in excess of Br. 800 is subject
to employment income tax. Based on the above data, compute the amount of the
employee’s:
a) Employment income tax,
b) Total deductions, assuming the employee is permanent civil servant.
c) Net pay for the current month;
Yenegew Ghoh Enterprise is a government agency recently organized to rehabilitate street children.
It has five employees whose salaries are paid according to the Ethiopian calendar month. The
following data relates to the month of Megabit, 2010.
Additional Information
According to the employment contract every employee works 40 hours in a week as regular
working hours. During Megabit there are four weeks. There were no absentees during the
month
All employees are permanent except Tewodros and Ahmed
Bekuma agreed to contribute monthly Br. 480 from his salary as a monthly saving in
the credit association of the enterprise.
Transportation allowance which is above br. 800 is taxable
Required
1) Prepare a payroll register (sheet) for the enterprise for the month of Megabit,2010.
2) Record the payment of salary as of Megabit 30, 2010 using check stub No. 0123.
3) Compute and record the payroll tax expense for the employer
4) Record the reimbursement of the claim of the credit association of the enterprise on
Miazia 1, 2010. Use check stub No. 0124.
5) Record the payment of the withholding taxes and pension contribution to the concerned
government body on Miazia 7, 2010.
Overtime Earning
Overtime earning = OT hrs worked X (ordinary hourly rate X relevant OT rate)
1. ABRAHAN:
NB Every employee is expected to work 160 hours per month (i.e. 40 hours x 4 weeks)
8 Principles of Accounting II, Summarized Lecture Note: Payroll
You should compute the regular hourly rate first:
Regular Hourly Rate = Monthly salary (Basic Salary)
Total Hours worked in the Month
= br. 10,400
160 Hours
2. BEKUMA:
OT Earning = 8 hours X br.9,600 x 2 ………br. 960.00
160hrs
3. AHMED:
1. ABRAHAM:
Gross Earning = br. 10,400 + br. 1,000 + br. 325 = br. 11,925.00
Remember taxable income in this case is br. 11,125.00 because of the transportation
allowance br. 1,200, br. 800 is not subject to taxation.
2. BEKUMA:
Gross Earning = br. 9,600 + br. 960 = br. 10,560
The Gross Total Earnings of Bekuma consists of the br 9,600 basic salary plus the
overtime earnings of br. 960, which is br. 10,560.
3. MEYMUNA:
Gross Total Earnings = br. 8,000, which is only the basic salary
4. TEWODROS:
Gross Total Earnings = br 7,200, which is the basic salary alone.
5. AHMED:
Gross Total Earnings = br. 4,800 +450.00 = br. 5,250.00
1. ABRAHAM:
Gross Total Earnings ----------------------------------------- br. 11,925.00
Gross Taxable Income (br. 11,925-br.800) --------------- 11,125.00
Total Deductions:
Income tax on br. 11,125 taxable income…………………………..br. 2,393.75
Pension Contribution ( br. 10,400 x 0.07) 728.00
Total Deduction (br. 2,393.75 + br. 728.00) br. 3,121.75
NB the income tax would be computed using the short-cut method as follows:
= (Taxable Income x 35%) – br.1,500
= (br. 11,125 x 0.35) – br. 1,500 = br. 2,393.75
2. BEKUMA:
Gross Total Earning …….. br. 10,560.
Employee Income tax
TOTALE Deductions
Tax on br. 10,560 .................………………. br. 2,213.00
Pension Contribution (br. 9,600x0.07) ………… 672.00
Credit Association ............................. 480.00
Total Deductions ............................... br. 3,365.00
10 Principles of Accounting II, Summarized Lecture Note: Payroll
3. MEYMUNA:
Gross Total Earnings ................... 8,000.00
Employer Income Tax
Total Deductions:
Income Tax on br. 8,000.00 …………….. br. 1,445.00
Pension contribution (br. 8,000x0.07)....... 560.00
Total Deductions ------------------------------ br. 2,005.00
4. Tewodros:
-----------------------------------------------------Gross Total Earnings br. 7,200.00
-----------------------------------------------------Gross Taxable Income 7,200.00
Employee Income Tax:
Pension contribution should not be computed for Ahmed because he is not permanent employee of
the enterprise. Thus, the only deduction from his earnings is the employee income tax.
NB. It is also possible to compute income tax using the short-cut method:
NET PAY:
1. ABRAHAM:
Net pay = br.11, 925.00 – br. 3,121.75
Net pay = br. 8,803.25
2. BEKUMA:
Net pay = br. 10,560.00 – br. 3,365.00
Net pay = br. 7,195.00
NB. Bekuma is saving br. 480.00 that is why his deduction is above Abraham
3. MEYMUNA:
Net pay = br. 8,000 – br. 2,005.00
Net pay = br. 5,995.00
4. TEWODROS:
Net pay = br. 7,200 – br. 1,235.00
Net pay = br. 5,965.00
5. AHMED:
Net pay = br. 5,250.00 –br. 747.50
Net pay = br. 4,502.50
Deductions:
Employee Income Taxes ---------------- br. 8,034.25
Pension contributions ------------------ - 1,960.00
Other Deductions ---------------------- 480.00
Total Deductions --------------- br. 10,474.25
The payroll register (or sheet) for Yenegew Ghoh Enterprise prepared for the Month of Megabit,
2010 is shown below.
Yenegew Ghoh Enterprise
Payroll Register (Sheet)
For the Month of Megabit,2010
Earning Deductions
Ser. Name of Basic Over Gross Income Pensio Other Total Net Pay Sig
No Employee Salary Allowance Time Earning Tax n Deduc. Deduc. n.
s Contr.
01 Abraham 10,400 1,200 325 11925 2393.75 728 - 3121.75 8803.25
Getu
02 Bekuma 9,600 - 960 10560 2213 672 480 3365 7195
Jirra
03 Meymuna 8,000 - - 8000 1445 560 - 2005 5995
Hunduma
04 Tewodros 7,200 - - 7200 1235 - - 1235 5965
A.
05 Ahmed M 4,800 - 450 5250 747.50 - - 747.50 4502.50
Totals
40,000 1,200 1735 42,935 8,034.25 1960 480 10474.25 32460.75
Also, on this same date, the company (as an employer) has to contribute 11% of the basic salary of
permanent employee to the government’s pension trust fund.
Recording the payment deduction form Bekuma’s salary to the credit Association:
Recording the payment of employees’ income tax withheld and the 18% pension contribution of the
government body:
Exercise -1
JIMMA RULAR DEVE’T enterprise, a government owned business, pays is employees salaries
according to the Ethiopian calendar Month. The following data relate to the month of Meskerem,
2010 E. C.
Additional information
All workers are expected to work 40 hours per week and during Meskerem there are 4
weeks. The workers have done as they are expected.
Myron Zewde has worked 10 hours of overtime during Meskerem: 3 hours during ‘Meskel’
and the other 7 hours before 10 p.m.
Yemisratch Fanta has also worked 5 hours of overtime: 2 hours during weekly rest days
and 3 hours between 10 p.m – 6 a.m.
Alemu and Myron received a monthly position allowance of br.350 and br 300 respectively
which are both taxable
Alemu Tolossa agreed to have a monthly deduction of br.250 for credit association.
All workers are permant except Zibrikrik Ayele.
Required :
1. Compute the total deductions and net pay for each employee.
2. Compute (calculate) the total:
a) Withholding Taxes
b) Payroll Taxes
c) Record the payment of salary as of Meskerem 30, 2010.
3. Pass the entry to pay the withholding taxes to the appropriate government unit.
Exercise -2
ABA JIFAR Trading Co. is a private business enterprise. The company pays the salary of its
employees according to the Ethiopian calendar month. The following data relates to the month of
Hidar, 2010.
The organization expects every worker to work 48 hours in a week and during Hidar
there are four weeks and all workers have done as they have been expected.
Ato , Ayselech and W/r, Genet are entitled to get a monthly transport allowance of
birr 1,400 and br. 1,000 respectively.
According to the tax rule, tax should be paid on transportation allowance of br. 800
All workers are permanent except Ziyad Jemal, and they are entitled to a total of 15%
provident fund of which 10 % from the employer and 5 % from the employee.
Ato Seletene Beka and W/t Genet Aychesh have worked 10 hours of overtime each
on public holidays.
Exercise -3
The following data relates to the payroll of the employees of a privately owned business
organization known as “AL- AZAR Retail Enterprise”, for the month of Miazia, 2010 E.C.
Required:
1. Prepare a payroll sheet for the month of Miazia
2. Record the payment of salary as of Ginbot 1,2010
3. Record the recognition of the payroll tax expense as of Ginbot 1,2010.
4. Record the payment of withholding taxes to the proper government units as of Ginbot
15,2010
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