Chapter 4: Ethiopian Payroll System

3.1. 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 it.
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.
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.

3.1.2. Definition of Payroll Related Terms

Payroll accounting involves so many generally accepted and standardized terms. This helps to attain
uniformity in the system both within the organization and with other related parties. The following are the
most common terms used in payroll accounting:
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.

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2. The Pay Period: refers to the length of time covered by each payroll payment.
3 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.
5. Gross Earnings:
Earnings: is the total compensation earned by an employee. The gross earnings of an
employee may include wages, salaries, bonuses, overtime earnings and allowances.
6. Payroll Deductions: are deductions from the gross earnings of an employee such as employment
income taxes (withholding taxes), labor union dues, fines, credit association pays etc.
7. 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.

3.1.3. 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. It is always helpful to assign an identification
number (ID No) to individually identify employees. This is because sometimes there could be identical
name for two or more employees in an organization.
2. Name of Employees: Even though it is advisable to assign an employee identification number, it does
not avoid the need for including their names. A complete record of employee record should include both
the name and ID No of the employee.
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.

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 c. 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.
Article 33 of proclamation No. 64/1975 discussed the following about how overtime work should be paid:
A worker shall be entitled to the paid at a rate of
i. One and one-quarter (1 ¼) times his ordinary hourly rate for overtime work performed before
10:00 P.M in the evening.
ii. One and one half (1 ½) times his ordinary hourly rate for overtime work performed between
10:00 P.M and six (6:00 A.M) in the morning.
iii. Two times the ordinary hourly rate for overtime work performed on weekly rest days
iv. Two and one half (2 ½) times the ordinary 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 and
overtime earnings.
4. Deduction: are subtractions made from the earnings of employees required by the government or
permitted by the employee himself. The following are the most common deductions from employee’s
earning:
a. 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 N. 286/2002- Income tax
proclamation. The tax rates under schedule A are Presented below:

Employment Income (per month) Difference Income Tax rate

Over Birr To Birr
0 600 600 Exempt (Free from Tax)
601 1650 1050 10%
1651 3201 1550 15%
3201 5250 2050 20%
5251 7800 2550 25%
7801 10900 3100 30% *In computing a
Over 10,900 35% attributable to the
income of one mo
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.

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Short cut to Income Tax Calculation
Employment Income (per month) Income Tax Payable
Over Birr To Birr
0 600 No tax
601 1650 (10% X EI) – 60
1651 3201 (15% X EI) – 142.50
3201 5250 (20% X EI) – 302.50
5251 7800 (25% X EI) – 565
7801 10900 (30% X EI) – 955
Over 10,900 (35% X EI) – 1500
EI = Employment Income or taxable income
Proclamation No. 286/2002 states that the following are not taxable
1. Income from employment received by casual 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
The council of ministers regulation No. 78/2002, 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
4- Amounts paid by employee in reimbursement of traveling expenses incurred on duty.
b. Pension Contribution: Permanent employees of a governmental organization in Ethiopia are expected
to pay or contribute 7% of their basic salary to the governments’ pension trust fund. This amount is
withheld by the employer from each employee on every payroll and later be paid to the respective
government body. The employer is also expected to contribute towards this same fund 9% of the basic
salary of every permanent government employee. Therefore, the total contribution to the pension fund of
the Ethiopian government is equal to 16% of the basic salary of all of its permanent employees. That is,
7% comes from the employees and 9% comes from the employer.

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This enables a permanent employee of a government organization to be entitled to the pension pay when
retiring provided the employee satisfies the minimum requirements to enjoy the benefits. Business and
non-governmental not-for profit organization (NGO’s) 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 and the employee contribute towards this fund monthly. When an employee retains or leaves
employment, a lump sum amount is paid to him/her.
c. 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.
5 Net Pay: Net pay represents the excess of gross earnings over total deductions of an employee.
Signature: The payroll sheet should have a column for signature of the employee to be taken when the
employee collects the net pay.
3.1.4. Major Activities Involved In Accounting for Payroll

The payroll activity is one of the most standardized and uniform activity performed across a given
country. But mind you since it is highly related to tax laws and other regulations of a country it differs
from one country to another. The following activities are the most common ones which are necessary and
useful in order to attain the objectives of the payroll accounting process:
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 to
determine total number of hours or days worked.
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 it’s 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 The payroll - should be approved by an authorized personnel (individual)
6 Paying the payroll – Finally the payment should be made either in cash or by writing a check.
7 The payment of the payroll and income taxes - withheld from employees (withhold doing tax
liability) should be recorded in journal entry form.
8 The withholding tax - must be paid to the relevant government authority in time (promptly) and this is
recorded in journal entry form.

Illustration of a Payroll Register

Zebidar 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 Yekatit, 2005.

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Serial Name of Employee Basic Transp. Overtime Duration of
No. __________________ Salary Allowance worked(hr) OT Work
01 Yonas D. Br.730 200 4 6:00-10:00 P.M
02 Paulos Chala 1020 ___ 8 Sunday (8:30-5:30)
03 Chala B. 5300 ___ ___ ___
04 Eyob T. 1470 ___ ___ ___
05 Daniel Y. 9950 ___ 6 Public Holiday
Additional Information
- The management of the agency usually expects a worker to work 40 hours in a week and during
Yekatit there are four weeks and there were no absentees during the month
- All employees are permanent except Eyob and Daniel
- Paulos agreed to contribute monthly Br. 300 from his salary as a monthly saving in the credit
association of the agency.

Required
1. Prepare a payroll register (sheet) for the agency for the month of Yekatit, 2005.
2. Record the payment of salary as of yekatit 30, 2005 using check stub No. 0123.
3. Record the payment of the claim of the credit Association of their agency on Megabit 1, 2005 use
check stub No. 0124.
4. Record the payment of the withholding taxes and pension contribution to the concerned
government body on Megabit 7, 2005.
5. Compute and recognize the total payroll tax expense for the month of Yekatit, 2005.
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. Yonas
 OT Earning =4 hours X br. 730 X 1.25 = Br. 22.81
160 hours
 NB: Every employee is expected to work 160 hours per month (i.e. 40 hours x 4 weeks)
 You should compute the regular hourly rate first:
Regular Hourly Rate = Monthly salary (Basic Salary)
Total Hours worked in the Month

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 = br. 730
160 Hours
 Therefore, the regular Hourly payment = br. 4.56
The regular hourly payment must be multiplied by the appropriate OT rate as follows:
br. (4.56 x 1.25) x 4 hours-------------------br.
hours-------------------br. 22.81
2. Paulos
 OT Earning = 8 hours X br. 1020 x 2 ----------------br.
----------------br. 102.00
160 hours
3.Daniel
 OT Earnings = 6 hours X br. 9950 x 2.5 -------------br.
-------------br. 932.81
160 hours
GROSS EARNINGS
Gross Earnings = Basic salary + Allowance + OT Earnings
1. Yonas
 Gross Earnings = br. 730 + br. 200 + br. 22.81 = br. 952 .81
 Remember taxable income in this case is br. 752.81 because the transportation allowance
of br. 200 is not subject to taxation.
2. Paulos
 Gross Earning = br. 1020 + br. 102 = br. 1122
 The Gross Total Earnings of Paulos consists of the br. 1020 basic salary plus the
overtime earnings of br. 102, which is br. 1122.
3. Chala
 Gross Total Earnings = br. 5300, which include the basic salary alone.
4. Eyob
 Gross Total Earnings = br. 1470, which is the basic salary.
5. Daniel
 Gross Total Earnings = br. 9950 + 932.81= br. 10882.81
DEDUCTIONS AND NET PAY
1. Yonas:
 Gross Total Earnings-----------------------------------------br. 952.81
 Gross Taxable Income (br. 952.81 – br. 200)------------------------ 752.81
Employee Income Tax:
Earnings X Income Tax Rate = Income Tax
0 – 600---------600 0 br. 00.00
601 – 752.81 on 152.81 10% 15.28
TOTAL br.752.81-----------------------------br. 15.28

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 Pension contribution:
Basic salary x 7%
= br. 730 x 0.07--------------------------------------51.10
0.07--------------------------------------51.10
 Total Deduction (br. 15.28+
15.28+ br. 51.10)
51.10) -------------br. 66.38
NB. The income tax to be deducted from the employee could have been computed by using the shortcut
method as follows:
= (Taxable Income x 10%) – br. 60
= (br. 752.81 x 0.10) – br. 60 = br. 15.28
2. Paulos:
 Gross Total Earning-----br. 1122.
 Employee Income tax
Earning X Income Tax Rate = Income Tax
0 – 600---------600 0 br. 00.00
601 – 1122 on 522 10% 52.20
TOTAL br.1122--------------------------------- br.52.20
br.52.20
 Pension Contribution (br. 1020 x 0.07)--------------------71.40
 Credit Association--------------------------------------300.00
Association--------------------------------------300.00
 Total Deduction-----------------------------------
Deduction-----------------------------------br.
br. 432.6
3. Chala:
 Gross Total Earnings------------------------------------br. 5300.00
 Employee Income Tax
Earning X Income Tax Rate = Income Tax
0 -600 on 600 0 0
601-1650 on 1050 10% 105
1651-3201 on1550 15% 232.50
3201-5250 on 2050 20% 410
5251-5300 on 50 25% 12.50
Total br. 5300.00------------------------------br. 760
 Pension contribution (br. 5300 x 0.07)---------- 371.00
 Total Deductions----------------------------br.
Deductions----------------------------br. 1131.50
4. Eyob:
 Gross Total Earnings------------------------------------br. 1470.00
 Gross Taxable Income--------------------------------------1470.00
Employee Income Tax:
Earning X Income Tax Rate = Income Tax
0 -600 on 600 0 0

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 601-1470 on 870 10% 87
Total br. 1470------------------------- br. 87
NB. No pension contributions because she is not permanent employee of the organization. Therefore,
total deduction is the same as Employee Income Tax, br. 176.50.
5. Daniel:
 Gross Total Earnings--------------------------------------br. 10882.81
Employee Income Tax:
Earnings X Income Tax Rate = Income Tax
0 -600 on 600 0 0
601-1650 on 1050 10% 105
1651-3201 on1550 15% 232.50
3201-5250 on 2050 20% 410
5251-7800 on 2550 25% 637.50
7801 -10882.81 on 3082.81 30% 924.84
Total br. 1039.06------------------------------- br. 2309.84
 Pension contribution should not be computed for Daniel because he is not permanent
employee of the agency. Thus, the only deduction from Daniel’s earnings is the employee
income tax.
NB. It is also possible to compute income tax by using the short-cut method:
Total Income Tax = (Taxable Income x 15%) – 47.5
= (br. 1039.06 x 0.15) – 47.5
= br. 108.36
NET PAY:
Net pay = Gross Total Earnings – Total Deductions
1. Yonas:
Net pay = br. 952.81 – br. (66.38)
Net pay = br. 886.43
2. Paulos:
Net pay = br. 1122 – br. (432.60)
Net pay = br. 689.40
3. Chala:
Chala:
Net pay = br. 5300 – br. (1131.50)
Net pay = br. 4168.50
4. Eyob:
Net pay = br. 1470 – br. (87)
Net pay = br. 1383.
5. Daniel:

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 Net pay = br. 10882.81 – br. 2309.84
Net pay = br. 8572.97
PROVING THE PAYROLL:
Total Earnings:
Basic salary-----------------------------------------------br. 18470
Allowances-----------------------------------------------------200.00
Overtime--------------------------------------------------------1057.61
Overtime--------------------------------------------------------1057.61
Grand Total---------------------------------------br.
Total---------------------------------------br. 19727.62
Deductions:
Employee Income Taxes--------------------------------br. 3224.32
Pension Contributions----------------------------------------493.5
Other Deductions----------------------------------------------300.00
Deductions----------------------------------------------300.00 =
Total Deductions------------------------------br. 4017.82
Net Pay Total------------------------------------------------------br. 15700.
Total Deductions plus Net pay----------------------------------br. 19727.62
The payroll register (or sheet) for Zebidar Rehabilitation Agency prepared for the Month of Yekatit, 2005
is shown below.
Zebidar
Payroll Register (sheet)
For the month of Yekatit, 2005
Ser. Name of Earnings Deductions
No. Employee Basic Allo- Over Gross Income Pension Other Total Net Sign.
salary wance Time Earning Tax Contr. Deduc. Deduc. Pay
01 Yonas D. 730 200 22.81 952.81 15.28 51.10 ___ 66.38 886.43
02 Paulos Ch. 1020 ___ 102 1122 52.20 71.40 300 432.60 689.40
03 Chala T. 5300 ___ ___ 5300 760 371 ___ 1131.5 4168
0
04 Eyob B. 1470 ___ ___ 1470 87 ___ ___ 87 1383
05 Daniel 9950 ___ 932.8 10882.8 2309.8 ___ ___ 2309.8 8572.9
1 4 4 7

Totals 18470 200 1057. 19727.6 3224.3 493.5 300 4017.8 15700.
61 2 2 2

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Prepared by_______________Checked by________________Approved by___________

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