Chapter 3: The Ethiopian Payroll System

• Definition and Importance of Payroll System

•Accounting systems for payroll and tax are concerned with
the record and the report associated with the employer-
employee relation.
•All employees of an organization accept and are entitled to
receive their remuneration at regular interval following the
close of each payroll period.
•Regardless of the number of employee and difficulty in
•computing the amount 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.
• Various federal, states and local laws require employer to keep
accurate payroll records and to prepare report and submit to the
appropriate government unit.
•Payroll data may be useful in negotiation with labor unions, in setting
employee grievance, and in determining rights to vacation, sick leaves
and retirement pension.
• Importance of Payroll Accounting
•Accounting for payroll is particularly important because:
Payroll often represent often the largest expense that a company incurs
Both federal and regional governments require that detailed payroll
records be kept.
Employees are sensitive to payroll errors or irregularities. To maintain
good employee moral, payroll must be paid on timely and accurate
basis.
Definition of Payroll Related Terms
• Payroll accounting involves so many generally accepted
and standardized terms. This helps to attain uniformity in
the system
•The following are the most common terms used in payroll
accounting.
A.Salary and Wages: are usually used interchangeably.
• wage is more correctly used to refer to payments to
unskilled-manual labor.
•Salaries refers to payments to employees who render
managerial, administrative, or similar services, and they are
usually paid to skilled labor on monthly or yearly basis.
B.The Pay Period: a period refers to the length of time covered by each payroll
payment.
C.The pay day: is the day on which wages or salaries are paid to employees. Usually
the last day of the month in Ethiopia.
D.A Payroll Register (Sheet): is the list of employee’s gross earnings; deductions and
net pay (take home pay) for a particular pay period.
E.Gross Earning: are taxes collected from the earnings of employees by the employer
organization as per the regulations of the government.
F.Payroll Deduction: are deductions from the gross earnings of an employee such as
employment income taxes (withholding taxes), labor union dues, fines, credit
association pays etc.
G.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 at the pay day.
Net Pay = Gross Earning –
Total Deduction
H.Pay Check: a business can pay payroll by writing a check for the amount of the net
pay.
Payroll Records and Components
• Basic Components of a Payroll Register
•1. Employee Number
•2. Name of Employee
•3. Earnings
•a. Basic Salary: a flat monthly salary of an employee
for carrying out the normal work of employment and
subject to change with the position of the employee.
•b. Allowances: money paid monthly to an employee
for special reasons, like: Position, Housing, Hardship, Desert,
Transportation (fuel) allowance
 Possible Components of a payroll
Register
1. Employee number:- Numbers assigned to employee for
identification purpose.
2. Name of employees: - list of the name of employees.
3. Earnings: - money earned by an employee(s) of a firm
from various sources.
It may include:-
a. The basic salary (Regularly Earning):- A flat monthly salary of an
employee that is paid for carrying out the normal work of
employment and subject to change when the employee is promoted
or demoted.
b. Allowances:- money paid monthly to an employee for special
reason, which may include:
 Cont…
 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
• 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 monthly allowance
to an employee to cover cost of transportation up to the
work place.
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•c. Overtime Work: is the work done in excess of the normal daily hours of
work. Normal hours of work shall not exceed eight hours a day or forty
hours a week.
• Circumstances in which over time work is permissible
• A worker may not be compelled to work over time. However overtime
may be worked whenever the employer cannot be expected to resort to
other measures and only where there is: -
Accident, actual or threatened
Force – majeure (unexpected circumstance such as, war)
Urgent work and
Substitution of absent workers assigned on work that runs continuously without
interruption.
•Overtime work of an individual worker shall not exceed 2 hours in a day or
20 hours in a month or 100 hours in a year;
 however, this is applied for organizations specified in the labor proclamation
307/2003, Article 67 (2).
• A worker shall be entitled to be paid at a rate of:
 Overtime work performed between 6 am in the morning and10 pm in the
evening shall be paid 1 1/4) times his ordinary hourly salary rate times OT hrs .
 Overtime work performed during night time between 10 pm and 6 am in the
morning shall be paid 1 1/2) times his/her ordinary hourly salary rate times OT
hrs.
 Over time work performed on the weekly rest days shall be paid at a rate of two
(2) times the ordinary hourly salary rate times OT hrs.
 overtime work performed on a public holiday shall be paid two and half (2 1/2)
times his/her ordinary hourly salary rate times OT hrs
 Where public holiday coincides with another public holiday or falls on a rest
day designated by Labor Proclamation 377/2003 or any other special law, the
workers shall be entitled to only one payment for working on such day.
• Ordinary Hourly Salary Rate = Monthly Basic Salary
• Normal Working Hours per Month
• Gross Earning = Basic salary + Allowance +Overtime
 Cont…
• 4. Deductions: are subtractions made from the
earnings of employees required by the government
or permitted by the employee himself.
• Employment income tax is a tax on the earnings of
an employee. The government collects this tax from
any individual employees. Employment income
includes any payment or gain in cash or in kind
received from employer by the employee subject to
certain exemptions.

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The Employee at the rate indicated under schedule A of the Proclamation No. 286/2002

Income Per Month Difference Income Tax Deduction

(c = b-a) Rate *
Over Birr (a) To Birr (b)      

0 600 600 Exempt 0

601 1,650 1,050 10% 60*
1,651 3,200 1,550 15% 142.5
3,201 5,250 2,050 20% 302.5
5,251 7,800 2,550 25% 565
7,801 10,900 3,100 30% 955
Over 10,900     35% 1,500

*see table 3.2 how to compute

 Cont…
 The following categories of payments in cash or benefits in
kind are exempted from taxation.
i. Medical costs incurred by employer for treatment of
employees.
ii. Transportation allowances paid by employer to its
employees (not exceeding Br 800) however, it is not more
than 1/4 of basic salary.
iii. Reimbursement by employer of traveling expense incurred
on duty by employees.
iv. Traveling expenses paid to transport employees from
elsewhere to place of employment and to return them upon
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 Cont…
• b. Pension contribution: Permanent employees of governmental
organizations in Ethiopia are expected to pay or contribute 7% of their
basic salary to the governments’ pension trust fund.
•The employer is also expected to contribute towards this same fund of
11% of the basic salary of every permanent government employee.
• Business and non-governmental and not-for-profit organization also
have this kind of a scheme to benefit their employees with some
modifications. A fund known as provident fund is established and
both the employer (up to 15%) and the employee (2%) contribute
towards this fund monthly.
 Cont…
• c. Other deductions:-
 Health or life insurance premiums
 To repay loan from the employer
 Credit associations
 To pay for donations to charitable and etc.
 total Deduction (TD) = IT + PC + Other Deduction
• 5. Net pay: representing the excess of gross earnings over the total
deductions of an employee.
• Signature

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Method of Employment Income Tax computation
•The most widely used employment income tax computation methods
are progression and deduction.
A.Progression Method
•The amount of tax is calculated for each layer of tax bracket by
multiplying the given rate under schedule “A” for each additional layer.
•E.g. 3.1 Assume Ato Tolossa Tadesse earned an amount of Br. 5,275
subject to income tax; his employment tax is calculated using
progression method as follows.
• Earning x Tax Rate = Income Tax
 600 - 0 = 600 x 0% = 0
 1,650 - 600 = 1,050 x 10% = 105.0
 3,200 - 1,650 = 1,550 x 15% =232.5
 5,250 -3,200 = 2,050 x 20% = 410
 5,275- 5,250 = 25 x 25% = 6.25
 Total 5,275 753.75
B. Deduction Method
• In preparation of payroll most organizations used the
following short cut formula to compute employment
income tax.
• Income Tax = (Gross taxable Income x Tax Rate) -
Deductions
•E.g. 3.2 assume Ato Tolossa Tadesse earned an amount
of Br. 5,275 subject to income tax; his employment tax is
calculated using deduction method as follows.
•Income Tax = (Gross taxable Income x Tax Rate) - Deductions
• Income Tax = 5275 x 25% - 565
• = 1,318.75 - 565 = Br 753.75
•E.g. 3.3 Bahir Dar edible oil Factory pays the salary of its
employee’s according to the Ethiopian Calendar month to the
Federal Government Tax Authority.
•The forth coming data relates to the month of Yekatit, 2004.
S. Name of Basic Transport OT Duration of Basic
No.
AaaEmployee salary Allowance Hours OT Work Salary per
 Aa Work Hour
01 Martha Feleke 4,800 900 10 Up to 10 pm 30
02Aa Alemu Mekonnen 1,920 -- 8 10 pm to 5 am 12
03Aa Selamu Bogale 2,400 -- 6 Weekly rest 15
days
04Aa Semia 2,160 600 -- -- 13.5
 Aa Mohammed
05 Destaw Negash 1,440 100 10 Public holiday 9
 Aa
A
• N.B. Note that management of the factory usually expects
a worker to work 40 hours in a week and during Yekatit
2004 all workers have done as they have been expected.
Besides, all workers of this factory are permanent
employees except Alemu Mekonnen; Selamu Bogale
agreed to have a monthly Br 300 be deducted and paid to
the Credit Association of the Factory as a monthly saving.
Income tax proclamation No. 286/2002 and directive
regulation No. 78/2002 Article 3/h/ states that
Transportation allowance exempted from tax payable for
employee and in any circumstance the amount of
transportation allowance exempted from tax must not be
more than birr 800 birr. If transportation allowance is
above ¼ of basic salary the excess amount should be
subjected to income tax.
•Required:
1.Prepare a payroll register sheet for the factory for the
month of Yekatit , 2004.
2.Record the payment of salary as of Yekatit 30, 2004 using
CK. No. 41 as a source document.
3.Record the payroll tax expense for the month of Yekatit,
2004 memorandum No. 10
4.Record the payment of the claim of the credit Association
of the Factory that arises from Yekatit’s payroll assuming
the payment is made on Megabit 1, 2004.
5.Assuming that the withholding taxes and payroll taxes of
the month of Yekatit, 2004 have been paid on Megabit 5,
2004 via CK. No. 50 record the required journal entry.
Solution
•1st Computing Overtime Earning:
•The overtime earning is calculated with the following
formula
•Overtime Earning = OT Hrs Worked x (Ordinary Hourly Rate x OT Rate)
 Aaa
Employee
Aaa OT Hrs Worked x (Ordinary Overtime Earning
Name
Aaa Hourly Rate x OT Rate)
 Aaa
Martha F 10hrs x (Br. 30 x 1.25) = Br. 375
 Aa
Alemu
Aa M 8hrs x (Br. 12 x 1.5) = Br. 144
Selamu B 6hrs x (Br. 15 x 2) = Br. 180
Destaw N 10hrs x (Br. 9 x 2.5) = Br. 225
•2nd Computing Gross Earning
•Gross earning is calculated with the following formula:
•Gross Earning = Basic Salary + Allowance + OT Earning
 Aaaaa Name
• Employee Basic Salary + Allowance + OT Earning = Gross Earning
Martha F Br. 4,800 + 900 + 375 = Br. 6,075
A M
• Alemu Br. 1,920 + 0 + 144 = Br. 2,064
aaa B
• Selamu Br. 2,400 + 0 + 180 = Br. 2,580
Semia M Br. 2,160 + 600 + 0 = Br. 2,760
Destaw N Br. 1,440 + 100 + 225 = Br. 1,765
•3rd Computing Deductions and Net pays:
Martha F.
Gross Earning = Br. 6,075 Pension Contribution (PC) =
Gross Inc. for tax =6,075-800 = Br. 5,275 Basic Salary x 7%
or Br. 4,800 x 7% = Br. 336
Total deduction = IT + PC
(4,800+100+375 = 5,275)
= Br. 753.75 + 336
Income Tax (IT) = 5,275x25% - 565 = Br. 1,089.75
= 1,318.75 – 565 Net Pay = Gross income-Total Deduction +
= Br 753.75 Allowance
= (5,275 – 1,089.75) +800
= Br. 4,985.25
 Alemu M.
Aaaa
• Gross Earning = Br. 2,064 Total deduction = IT + PC
Income Tax (IT) = 2,064 x 15% - 142.5 = Br. 167.1 + 0
= 309.6 – 142.5 = Br. 167.1
Net Pay = Gross income-Total Deduction
= Br 167.1
+ Allowance
Pension Contribution (PC): Pension
= 2,064 – 167.1 + 0
contribution is zero as he is a = Br. 1,896.9
contractual worker PC = 0

Selamu B.
Gross Earning = Br. 2,580 - Credit Asso. Pmt: Br. 300
Income Tax (IT) = 2,580 x 15% - Total deduction = IT + PC + Credit Asso. Pmt.
142.5 = Br. 244.5 + 168 + 300
= Br. 712.5
= 387 – 142.5
Net Pay = Gross income-Total Deduction +
= Br 244.5
Allowance
Pension Contribution (PC) = 2,580– 712.5
Basic Salary x 7% = Br. 1,854.9
Br. 2,400 x 7% = Br. 168
Semia M.
Gross Earning = Br. 2,760 Pension Contribution (PC)
Non-taxable transport allowance is 1/4th of basic Basic Salary x 7%
salary: 0.25 x 2,160 = 540 Br. 2,160 x 7% = Br. 151.2
Total deduction = IT + PC
Gross Income for tax calculation2,760-540 = Br 2,220
= Br. 190.5 + 151.2 = Br. 341.7
Or basic salary + taxable transport allowance Net Pay = Gross income-Total Deduction +
2,160 + 60 = 2,220 Allowance
Income Tax (IT) = 2,220 x 15% - 142.5 = (2,220 – 341.7) +540
= 333 – 142.5 = Br 190.5 = Br. 2,418.3
Destaw N.
Gross Earning = Br. 1,765 Total deduction = IT + PC
Gross Inc. for tax = 1,765-100 = Br. 107.25 + 100.8
= Br. 1,665 = Br. 208.05
Income Tax (IT) = 1,665 x 15% - 142.5 Net Pay = Gross income-Total Deduction +
= 249.75–142.5 Allowance
= Br 107.25 = (1,665 – 208.05) +100
Pension Contribution (PC) = Br. 1,556.95
Basic Salary x 7%
Br. 1,440 x 7% = Br. 100.8
1.Preparation of Payroll Register
• Bahir Dar edible Oil Factory
• For the Month of Yekatit
 pay Date: Yekatit 30, 2004 E.C
S. Name of Earnings Gross Deduction Total Net Pay  
No Employee
Aaa (total) Deductio
 Aaa Earnin n
Basic Transport Overtim g Employee Pension Other     Si
Deduction
 Aaa salary Allowance e Income Deducti g.
Tax on
 Aaa
01 Martha F 4,800 900 375 6,075 753.75 336 -- 1,089.75 4,985.2  
 Aa
5
02 Alemu
Aa M 1,920 -- 144 2,064 167.1 -- -- 167.1 1,896.9  
0
03 Selamu
Aa B 2,400 -- 180 2,580 244.5 168 300 712.5 1,867.5  
0
 Aa
04 Semia M 2,160 600 -- 2,760 190.5 151.2 -- 341.7 2,418.3  
 Aa 0
05 Destaw N 1,440 100 225 1,765 107.25 100.8 -- 208.05 1,556.9  
 Aaaa 5
Total 12,72 1,600 924 15,244 1,463.10 756.00 300 2,519.10 12,724.  
 Aaa 0 90
2. Recording the payment of salary
 Yekatit 30, Salary Expense ………….. 15,244
 2004 Employee Income Tax Payable … 1,463.10
 Pension Contribution Payable …. 756.00
 Credit Association …………. 300
 Cash ………………………… 12,724.90
3. Recording the payroll Taxes Expense for Yekatit , 2004
 Payroll Tax expense = Total Basic Salary of all permanent
Employees X 11%
 = (4,800 + 2,400 + 2,160 + 1,440) X 11% = 10,800x0.11 = Br.
1,188
 Payroll Taxes Expenses …………. 1,188
 Pension Contribution Payable ……1,188
4. Recording the payment of withholding and payroll taxes to the Inland
Revenue Administration on Megabit 1, 2004:
Employee Pension Contribution
Income tax payable payable
1,463.10 (2) 756.00 (2)
1,188.00 (3)
1,463.10 1,944.00

•
 Employee income tax: …………… Br. 1,463.10
 Plus: pension contribution ………...Br. 1,944.00
 Total …………………………. Br. 3,407.10

 Employee Income Tax Payable ………1,463.10

 Pension Contributions payable ………. 1,944.00
 Cash …………………………………3,407.10
• Individual Assignment on Payroll
 E.g 3.4 and 3.6
End of Chapter 3