Payroll Accounting

Definition and Impotence

Payroll accounting is an essential accounting activity of any business those

employs workers. Whether a business employs one worker or hundred thousand,
it must properly account for employees earning and comply the rules and laws
that affect the hiring and paying of employees.

The area of payroll accounting involves calculating the earning of employees and
the related withholding for taxes and other deductions, recording the results of
payroll activities and preparing the payroll tax returns.

Payroll Records and Preparation

Payroll register: - this is a multi column register (form) for the payment of
salaries at the end of the payroll period.

The number of the columns and their design differs from one organization to
another, depending on the types of compensation and deduction.

The source document for preparing the payroll register is obtained from the
following sources.
 Letter of employment
 Letter of Promotion
 Letter of Demotion
 Attendance list
 Time cared
 Relevant payroll and labor proclamation
Payroll Components

1. Employee Name and Employee ID

2. Earning Columns (parts)
a. Basic Earning /Salary/: - Monthly salary of an employee that is paid
for carrying out the normal work of employment. Basic earning
refers to the amount agreed between the employer and the employee
at a time of employment, and will be clearly stated in the letter of
employment.
b. Allowance: - Additional monthly payment to the employee for one
of the following reasons
  Position allowance: - Sum paid for a person for assuming a
certain position.
 Acting allowance: - sum paid to compensate the difference,
when the basic salary of a person who assumes a
responsibility is less than the salary intended for the position
that he/she is assuming.
 Housing allowance: - to cover for house facility
 Transportation /fuel/ allowance: - to cover the cost of
transposition
 Cash indemnity allowance: - allowance paid for cashiers to
cover the risk of possible cash shortage.
 Others like desert allowance, hardship allowance,
representation allowance…etc.
c. Over time payment: - is a payment for extra hours worked beyond
the regular working hours or day.
Gross /earning/ Salary: - is computed by totaling all the earning 9i.e
Basic Salary + Allowances, if any + Overtime payment, if any)
d. Taxable income: - includes all earning except for non taxable
allowances. In our context Transportation (fuel) allowance is the
only non taxable allowance up to certain limit.
3. Deduction: - These are subtractions form the gross earning, so as to
identify the net pay of an employee.
a. Statutory deduction: - deduction enforced or imposed by low.
Example: Salary income tax, pension contribution form
public enterprise …etc.
b. Voluntary deduction: - these are not imposed but are voluntary
deductions
Example: Credit association, credit purchase …etc.
c. Others: - Like court order, fines, absence …etc.
4. Net pay: - the net pay is the difference between the gross earning of an
employee and the total of the deductions.
5. Signature: - When an employee receives his/her pay he will sign to
confirm that he have received the net pay.
The payroll Register and Ethiopia Payroll System
Relevant Income tax and labor proclamations
Income Tax: - government proclamation no17/1994 E.C.
This proclamation defines the applicable tax regime for monthly
employment earning.
Ser. No. Monthly Income Applicable Income Tax Rate
 In Birr
A B
1 0-150 Exempted
2 151-650 10%
3 651-1400 15%
4 1401-2350 20%
5 2351-3550 25%
6 3551-5000 30%
7 5001 and above 35%

Income Tax Calculation: -

Earning per tax rate range X Tax Rate = Salary income tax
The first Br 150 0% 0
The next 500 (650-150) 10% 50.00
The next 750 (1,400-650) 15% 112.50
The next 950 (2,350-1,400) 20% 190.00
The next 1,200 (3,550-2,350) 25% 300.00
The next 1,450 (5,000- 3,550) 30% 435.00
The next above 5,000 “x” (X -5,000) 35% = .35* (x- 5,000)
Example if the salary of employee Y is Br 7, 530.00, the salary income tax will be

Earning per tax rate range X Tax Rate = Salary income tax
The first Br 150 0% 0
The next 500 (650-150) 10% 50.00
The next 750 (1,400-650) 15% 112.50
The next 950 (2,350-1,400) 20% 190.00
The next 1,200 (3,550-2,350) 25% 300.00
The next 1,450 (5,000- 3,550) 30% 435.00
The next 2,530 (7,530 -5,000) 35% 885.50
Total Salary income tax 1,973.00

When the number of employees is significant and the payroll is prepared

manually then the above method becomes cumbersome and very difficult to
maintain therefore the following short cut is developed.

Gross Taxable Monthly Income Applicable Income Tax Rate Tax Exemption in Birr
In Birr
Ser. No.
A B C
1 0-150 Exempted 0
2 151-650 10% (AB)-15.00

3 651-1400 15% (AB)-47.50

4 1401-2350 20% (AB)-117.50

5 2351-3550 25% (AB)-235.00

6 3551-5000 30% (AB)-412.50

7 5001 and above 35% (AB)-662.50

Example
If A person Earns Tax Net Pay
1. Br 450/month, then (450  10%) - Br 15 Br 30.00 Br 420.00
2. Br 3000/month, then (3000  25%) – Br 235 Br 515.00 Br 2,485.00
Labor Proclamation No. 42/1985
Defines the basic legal frame work for contract of employment, regular working
hours limit, overtime rates, compensation pay, leave benefits, employment
termination procedures …etc.
 Maximum regular working hours 8hrs/day
 Extra hours worked beyond working hours are over times; and are
compensated based on the following rates.

From office leaving hours to One and quarter (1 ¼ or 1.25) of

10.00 p.m. in the evening Normal hours the ordinary hour rate
10.00 P.m. – 6.00 A.m. One and half (1 ½ or 1.50) of the
Evening - Morning Late Hours ordinary hour

Rest day Rest day Twice (2) of the ordinary hour

Two and half (2 ½ or 2.5) of
Holidays Holidays ordinary hours rate.

Example: Amin Super Markethas the following information for the month
Meskerem 30, 1995 and wants to prepare the payroll register for the month in
order to compensate employees.

Additional Information
 There are 22 working days (Monday – Friday) at 8 hour and 4 Saturdays
at 4hours.
The total Working hours
22days @ 8hrs = 176
4days@ 4hrs = 16
 192hrs
 Any over time payment is compensated as per the labor proclamation.
Ordinary hour rates

1. Ato Abebe Nasir Br 2,200 = Br 11.46

192
2. W/t Samra W/ Gorgis Br 480 = 2.5
192
3. W/ro Fresenit Beyene Br 1,200 = 6.25
192
4. Ato Marshal Habtamu Br860 = 4.48
192
5. Ato Hassun Ali Br 900 = 4.69
192
6. W/ro Radia Ahemed Br 400 = 2.08
192
Overtime Payment amount =
Overtime rate X Overtime Worked X Basic Salary/ Hour
1. W/t Samra W/ Gorgis 8hrs on holyday
Over time payment amount = 8hrs at 2.5 (2.5) = Br 50.00
2. Ato Marshal Habtamu 3hrs on rest days
Over time payment amount = 3hrs at 4.48(2) = Br 26.88
3. Ato Hassun Ali 7hrs, late hours
Over time payment amount = 7hrs at 4.69(1.5) = Br 49.25
6. W/ro Radia Ahemed 10hrs on normal hours
Over time payment amount = 10hrs at 2.083(1.25) =Br 26.04
 The payroll register

Income Tax Calculation Based on the short cut formula

Gross Taxable Monthly Income Applicable Income Tax Rate Tax in Birr
In Birr
Ser. No.
A B C
1 Ato Abebe Nasir (2320* .25) -117.50 346.50
2,320.00
2 W/t Samra W/ Gorgis (530* .10) -.15.00 38.00
530.00
3 W/ro Fresenit Beyene (1,350*.15) - 47.5 155.00
1,350.00
4 Ato Marshal Habtamu (886.68*.15) - 47.5 85.50
886.68
5 Ato Hassun Ali (1,049.25*.15) - 47.5 109.89
1,049.25
6 W/ro Radia Ahemed (426.04*.10) – 15.00 27.60
426.04
Or

1. For Ato Abebe Nasir you could calculate with out the formula as
shown bellow
Earning per tax rate range X Tax Rate = Salary
income tax
The first Br 150 0% 0
The next 500 (650-150) 10% 50.00
The next 750 (1,400-650) 15% 112.50
The next 920 (2,320-1,400) 20% 184.00
Total Salary income tax
346.50

Journals entries for payroll based on the payroll register

After preparing the payroll register Amin Super Marketmade the final
payment on Meskerem 30, 1995. The journal entry required to record the
payment of the salary is shown bellow.