PAYROLL

ACCOUNTING

CHAPTER THREE
 The term payroll refers to the document prepared to pay
remuneration for the services obtained from
employees for a certain period of time.
 Payroll can also refer to the amount of money paid to
employees for a certain period.
 Accounting for payroll is concerned with the records
and reports associated with the employer-employee
relationships.
 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.
 Definition of payroll related terms

1. Salary and wages

 The term wage refers to payments for employees based on the number of

hours worked or the number of units produced.

 On the other hand, salary refers to payments for employees on monthly or

yearly basis. The amount of salary rate expressed in terms of month or

year
2. The pay period
 It refers to the length of time covered by each payroll payment. Pay

periods for wage workers are usually made on weekly or biweekly. On the
other hand, salaried employees' pay periods are monthly or semi-monthly.
3. The pay day
 It refers to the day, on which wages or salaries are paid to employees,

usually the last day of the pay period.

 Basic records of payroll accounting

 The payroll system consists of input data (time cards or

attendance sheet), a payroll register (to compute the
payroll each pay period), employee earnings card (a
separate record for each employee), paychecks, and a
system for recording both the payroll and the related
employer taxes with appropriate liabilities.
 Basic records of a payroll accounting system include:
1. A payroll register (or payroll sheet)
2. Individual employees' earnings records, and
3. Pay check / Payroll checks
1. Payroll Register
 It is the entire 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. It is a multicolumn report used at the close of
the payroll period for summarizing and computing the data for each
payroll period. The payroll register (sheet) is prepared based on
attendance sheets, punched (clock) cards or time cards.
2. Employee earnings record
 It is a summary of each employee’s earnings, deductions and net pay for

each payroll period and cumulative gross earnings during the year. It is
a separate record kept for each employee.
3. Pay Check
 A business can pay payroll by writing a check for the amount of the net

pay.
 Possible components of payroll register

1. Employee Number: It is the number assigned to employees for

identification purpose when a relatively large number of employees
are involved in a payroll register or some identical names of
employees exist.
2. Name of Employees
3. Gross earnings: Employees earning from various sources
4. Payroll deduction: It is deductions made on the gross earnings of
employees either due to required by government or permitted by the
employee himself/herself.
5. Net Pay: This is the employee’s take home pay received on the
payday. It is the excess of gross earnings over total deductions of an
employee.
6. Signature: When an employee receives his/her pay he will sign to
confirm that he/she has received the net pay.
 Nature of earnings
 Gross earning is the total pay to an employee before payroll deductions for the

pay period.
 It is money earned by an employee from various sources such as from basic

salary, from allowances, from overtime earnings, and from bonuses

1. Basic Salary
 It is a flat monthly salary of an employee for carrying out the normal work of

employment and subject to change when the employee is promoted. It is

monthly salary of an employee that is paid for carrying out the normal work of
employment.
2. Allowances
 It is additional monthly payment to the employee for special reasons, like;

1. Position allowance: Payment to an employee for bearing a particular office

responsibility. The amount of payment for a person for assuming a certain
position.
3. Housing allowance: a monthly allowance given to cover
housing costs of an employee when the employment
contract requires the employer to provide housing but the
employer fails to do so.
4. Hardship / Disturbance allowance: a sum of money
given to an employee to compensate for an inconvenient
circumstance caused by the employer. For instance,
unexpected transfer to a different and distant work area or
location.
5. Desert allowance: a monthly allowance given to an
employee because of assignment to a relatively hot region.
6. Transportation (fuel) allowance: a monthly allowance
to an employee to cover cost of transportation up to the
workplace if the employer has committed itself to
provide transportation service.
 3. Overtime Earning
 Overtime earnings are the amount paid to an employee for
overtime work performed.
 Overtime work is the work performed by an employee
beyond the regular working hours. It is a payment for extra
hours worked beyond the regular working hours or day.
 In Ethiopia, in this respect, Article 33
of proclamation No. 64/1975 discussed the
following points about how overtime work should be paid;
1. A worker shall be entitled to be paid at a rate of one and
one-quarter (1 ¼) times the ordinary hourly rate for
overtime work performed before 10:00 P.M in the evening
western time.
2. A worker shall be paid one and one half (1 ½) times his
ordinary hourly rate for overtime work performed between
10:00 P.M and 6:00 A.M in the morning.
3. A worker shall be paid two (2) times the ordinary hourly
rate for overtime work performed on weekly rest days.
4. A worker shall be entitled to be paid at a rate of two and one
half (2 ½) times the ordinary hourly rate for overtime work
performed on a public holiday.
 4. Bonus
 It is payments on various forms for outstanding
performance of employees, for achieving results
better than usual or due to special events such as
New Year etc.
Summary
Gross Earning = Basic Salary + Allowance + Overtime Earning +
Bonus
Ordinary Hourly Rate = Basic Salary ÷ Normal Working Hours during
the Month
Over Time Earning = Overtime Hours Worked X Over Time Payment
 Nature of deductions
 Payroll deductions are deductions from the gross earnings of an
employee so as to identify the net pay of an employee.
 These deductions can be;
1. Mandatory (Statutory) deduction: deduction enforced or imposed
by law, required by the government such as income tax, pension
contribution from public enterprise
2. Voluntary deduction: these are not enforced by law but are
permitted by the employee himself/ herself such as Credit
association, credit purchase etc
 In our country, some of the deductions against the earnings of
employees are as follows;
  Employment Income Tax/ personal income tax/ withholding tax
 It is taxes levied on the taxable income of employees of an
organization and withheld by the employer until paid to the
tax authority during each month.
 The amount deducted from earning of an employee as income
tax determined based on the rate prescribed by ‘Income Tax
Proclamation’ No. 286/2002;
1. The first 150 birr income from employment shall be exempt
from payment of income tax in all cases
2. The income tax on income over 150 birr shall be charged,
levied and collected monthly according to the following
schedule;
 All earnings of an employee are not subject to taxation, for
instance Proclamation No. 286/2002 states that the following
are not taxable income;
1. Income of casual employees who are not regularly employed,
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 received as a compensation or gratitude in relation
to personal injuries suffered by that person or the death of
another person
 The council of ministers regulation No. 78/2002, a
regulation issued pursuant to the income tax
proclamation further exempts the following from
income tax;
1. Amounts paid to cover the cost of medical treatment
of employees
2. Transportation allowance up to 25% of basic salary but
not exceeding Br 1000
3. Amounts paid to recover traveling expenses incurred
on duty by employees
 Pension Contribution
 A permanent employee within a governmental organization in Ethiopia is
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 the same fund
9% of the basic salary of every permanent government employee. It is
payroll tax expense to the employer organization (9% of the total basic
salary of all permanent employees)
 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.
 This amount is withheld by the employer from each employee on every
payroll and later be paid to the respective government body.
 For militaries, the employer (government) contributes 25% and the
 Other Deductions
 Neither the employer nor the employee has any choice
in deducting taxes from gross earnings.
 However, employees may choose to have additional
amounts deducted for other purposes 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.
EXAMPLLE; ABC Enterprise is a government agency
recently organized around Jimma and its surroundings
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
Serial No. Name of Employee Basic Salary Transportation Overtime worked(hr)
of Meskerem, 2006. Allowance
01 Kiya yishalal Br. 730 150 10 Normal hours (i.e,
before 10:00 PM)

02 Meron chala 1020 500 8 / Late hours (i.e,b/n

10:00PM and 6:00AM)

03 Sifen Beka 5300 1500 6 / Rest days

04 Yosan Daniel 3700 700 10/ Public holidays

05 Fasil Tariku 480

 Additional Information:
 The management of the enterprise usually expects a worker to work 40 hours in a week and
during Mesekerm there are four weeks.
 There were no absentees during the month
 All employees are permanent except Fasil Tariku.
 MERON agreed to contribute monthly Br. 300 from her salary as a monthly saving in the
credit association of the enterprise.
 Required:
1. Prepare a payroll register (sheet) for the enterprise for the month of Meskerem,
2006.
2. Record the payment of salary as of Meskerem 30, 2006.
3. Record the payment of the claim of the credit association of their enterprise on
Tikimt1, 2006.
4. Record the payment of the withholding taxes and pension contribution to the
concerned government body Meskerem, 2006.
5. Compute and recognize the total payroll tax expense for the month of
Meskerem, 2006.
End of chapter