Chapter 4 Current Liabilities

Accounting for Payroll

 Identifying Payroll Regulations
 Meaning and Importance of Payroll
The term “Payroll” pertains to all salaries and wages paid to employees. It does not extend to payments
made for personal service by professionals such as certified public accounts, attorneys, and architects such
professionals are independent contractors and payments to them are called fees, rather than salaries or
wages. This distinction is important because government regulations relating to the payments and reporting
of payroll taxes apply only to employees.

The term payroll often refers to the documents prepared to pay remuneration for the service rendered in a
given period of time. The payroll accounting of a time has to be given emphases of significance for the
following reason:

1. Employees are sensitive to payroll errors and irregularities, and maintaining good employee moral
requires that the payroll be paid on a timely, accurate basis.
2. Payroll expenditures are subject to various government regulations.
3. The payment for payroll and related taxes has significant effect on the net income of the most
business enterprises.

Preparing Payroll

The payroll is prepared in the payroll department on the basis of two sources of input:

 Personnel department authorizations and

 Approved time cards.

The payroll department is also responsible for preparing (but not signing) payroll checks, maintaining
payroll records, and preparing payroll tax returns.

 Paying the Payroll

The payroll is paid by the treasurer’s department. Payment by check minimizes the risk of loss from theft,
and the endorsed check provides proof of payment.

If the payroll is paid in currency, it is customary to have a second person count the cash in each pay
envelope and for the paymaster to obtain a signed receipt from the employee upon payment. Thus, if
alleged discrepancies arise, adequate safeguards have been established to protect each party involved.

 Calculating Employees Earnings

Determining the payroll involves computing:
1. Gross earnings.
2. payroll deductions, and
3. Net pay.

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 Gross Earning
Gross earning is the total compensation earned by an employee. The gross earnings of an employee may
include wages, salaries, bonuses, overtime earnings and allowances. The term wages is more correctly
used to refer to payments for manual labor that are paid based on the number of hours worked or the
number of units produced. So they are usually paid when a particular piece of work is completed or for a
period less than a month. The salary for an employee is generally based on a monthly or yearly rate rather
than on an hourly basis.

 OVERTIME EARNINGS
Overtime Work – It is the work performed by an employee beyond the regular working hours or days.

Overtime Earning – Is the amount payable to an employee for overtime work done. In Ethiopia, in this
respect, according to Article 33 of proclamation No.64/1975, the following is discussed about payment for
overtime work.

 Ways/rules of payment for overtime work:

1. A worker shall be entitled to be paid at a rate of One and one quarter (11/4) times his or her
ordinary hourly rate for overtime work performed up to 10 o’clock in the evening (10 P.M.) beyond
his/her regular working hour.
2. A Worker shall be paid at the rate of One and one half (11/2) times his or her ordinary hourly rate
for overtime work performed between 10 o’clock in the evening (10 p.m.) and six o’clock in the
morning (6 a.m.)
3. Overtime work performed on the weekly rest days shall be paid at a rate of two (2) times the
ordinary hourly rate of payment.
4. A worker shall be paid at a rate of two and half (21/2) times the ordinary hourly rate for overtime
work performed on a public holidays.

 ALLOWANCES
Allowance: Money paid monthly to an employee for special reason, which may include:

 Position Allowance: - a monthly sum paid to an employee for bearing a particular office
responsibility, e.g. Head of a particular department or division.
 House allowance: - a monthly allowance given to cover housing costs of the individual employee
when the employment contract required the employer to provide housing but fails to do so.
 Hardship 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. It is sometimes known as disturbance allowance.
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  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 if the employer has committed itself to provide transportation
service.
 Payroll Deductions
As anyone who has received a paycheck knows, gross earnings are usually very different from the amount
actual received. The difference is attributable to payroll deduction. Payroll deductions do not result in
payroll tax expense to the employer. The employer serves only as a collection agency, and it subsequently
transfers the deductions to the government and designated recipients.

 MANDATORY (REQUIRED) DEDUCTIONS

These are deductions made from the earnings of employee that is because it is required by government.

 VOLUNTARY DEDUCTIONS
Employees may voluntarily authorize withholding for charitable, retirement, and other purposes. The
employee should authorize all voluntary deductions from gross earnings in writing. The authorization(s)
may be made individually or as part of a group plan.

Voluntary deductions are such as donations to charitable organization, credit association, repayment of
loan, union dues, health and life insurance.

 INCOME TAX
Employee Income Tax – In Ethiopia every citizen is required to pay income tax from his/her earnings of
employment. The Tax on income from employment over six hundred birr (Birr 600) shall be charged,
levied and collected monthly according to the following schedule: - Schedule of tax collection/deduction
as per Ethiopian Tax Law, According to proclamation, No. 979/2016 issued on 18th August 2016
Negarit Gazeta No.104
Taxable Monthly Income (In Birr) Rate of tax (%) on Every Additional Income
1 0-600,the first 600 0%
2 Over 600 but not exceeding 1,650 on the next 1,050 10%
3 Over 1,651 not exceeding 3,200 on the next 1,550 15%
4 3,201 - 5,250 on the next 2,050 20%
5 Over 5,251 - 7,800 on the next 2,550 25%
6 7,801- 10,900 on the next 3,100 30%
8 Over 10,900 35%

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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 1,650 (10% X EI) – 60
1,651 3,200 (15% X EI) – 142.5
3,201 5,250 (20% X EI) – 302.5
5,251 7,800 (25% X EI) – 565
7,801 10,900 (30% X EI) – 955
Over 10,900 (35% X EI) – 1,500

Generally, taxable income from employment includes salaries, wages, allowances, director’s fees and other
personal emoluments, all payments in cash and benefits in kind. However, the following categories of
payments in cash or benefits in kind are exempted from taxation.
 Exemptions (None Taxable Income)
1. Medical costs incurred by employer for treatment of employees.
2. Transportation allowances paid by employer to its employees.
3. Reimbursement by employer of traveling expense incurred on duty by employees.
4. Traveling expenses paid to transport employees from elsewhere to place of employment and to
return them upon completion of employment.
5. Pension contribution, provident fund and all forms of retirement benefits contributed by employers
in an amount that does not exceed 15% of the monthly salary of the employee.
6. Income from employment received by casual employees who are not regularly employed provided
that they do not work for more than one month for one employer.
 PENSION
Pension contributions – Permanent employees of an organization the employees of which are governed
by the existing regulations of the Ethiopian Public Servants are expected to pay or contribute 7% of their
basic (monthly) salary to the government Pension Trust Fund. This amount should be withheld by the
employer from the basic salary of each employee on every payroll and later be paid to the respective
government body.

On the other hand, the employer is also expected to contribute towards the same fund 11% of the basic
salary of every permanent employee of it. It is this amount often called as Payroll Taxes Expense to the
employer organization (i.e., 11% of the total basic salary of all permanent employees).

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Consequently, the total contribution to the Pension Trust Fund of the Ethiopian Government is equal to
18% of the total basic salary of all permanent employees of an organization (i.e., 7% comes from the
employees and the 11% comes from the employer). This enables a permanent employee of an organization
to be entitled to the pension pay given that the employee has satisfied the minimum requirement to enjoy
this benefit when retired.

4.2.3 Net Pays

Net pay is determined by subtracting payroll deductions from gross earnings. It is sometimes known as
take home pay, the amount collected by an employee on the payday.

Recording the Payroll

Recording the payroll involves maintaining payroll department records, recognizing payroll expenses and
liabilities, and recording payment of the payroll.

 Maintaining of a Payroll Record

Basic Records of a Payroll Accounting System Includes:

1. A payroll register (or payroll Sheet).

2. Individual employees’ earnings records and,
3. Usually, Pay Check.

These records are generated from a payroll system that is operated manually or using computer.

A payroll register (sheet): the entire list of employees of a business along with each employee’s
gross earning, deductions and net pay for particular payroll period. The basis for the preparation of the
payroll register can be the attendance sheets, time cards or punched cards.

Employee Earnings Record: It is summary of each employee’s earnings, deductions, and net pay
for each payroll period and of cumulative gross earnings during the year. It is a separate record kept for
each employee. The individual employee’s earnings record helps the employer organization to properly
summaries and file tax returns.

 Pay Check: An instrument for paying salary if the firm makes payment via writing a check in the
name of each employee for the net pay or a check for the total net pay.

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 Recognizing the Payroll Expense, Liabilities and Recording Payment of the Payroll
Payment by check is made either from the employer’s regular bank account or a payroll bank account.
Each check is usually accompanied by a detachable statement of earnings document that shows the
employee’s gross earnings, payroll deductions, and net pay.

To illustrate, Ethio Relief Agency pays the salary of its employees according to the Ethiopian Calendar
month. The forth-coming date relates to the month of Hidar, 2010.
Basic Monthly OT Hours Duration of OT Basic Salary
Ser. No. Name of Employee Salary Allowance Worked Work Per Hour
01 Senait Bahiru 2,080 100 10 Up to 10 p.m. 13
02 Petros Ephrem 640 - 8 10 p.m. to 6 a.m. 4
03 Abdu Mohammed 1,280 - 6 Weekly Rest Days 8
04 Leilla Jemal 960 50 - - 6
05 Guya Boru 10,000 50 5 Public Holiday 62.5

N.B. Note that management of the agency usually expects a worker to work 40-hours in a week and during
Hidar 2010 all workers have done as they have been expected. Besides, all workers of this agency are
permanent employees except Petros Ephrem. The monthly allowance of Guya Boru is not taxable. Abdu
Mohammed agreed to have a monthly Birr 200 be deducted and paid to the credit Association of the
agency as a monthly saving.
INSTURCTIONS: Based on the above information;
1.Prepare a payroll register (or sheet) for the agency for the month of Hidar, 2010.
2.Record the payment of salary as of Hidar 30, 2010 – using CK. No 41 as a source document.
3.Record the payroll taxes expense for the month of Hidar, 2010 – using Memorandum No. 10.
4.Record the payment of the claim of the credit association of the agency that arose from Hidar’s
Payroll assuming that the payment was made on Tahisas 3, 2010.
5. Assuming that the withholding taxes and payroll taxes for the month of Hidar, 2010 have been paid
on Tahisas 5, 2010 Via Ck. No. 50 & record the required journal entry.
1. Computations of Earnings, Deductions and Net Pay.
OVER TIME EARNINGS:
Over Time Earnings = OT hours worked X Ordinary hourly rate X OT rate

Senait 10 hrs x ( Br. 13 x 1.25 ) = Br 162.50

Petros 8 hrs x ( Br. 4 x 1.5 ) = Br 48.00
Abdu 6 hrs x ( Br. 8 x 2 ) = Br 96.00
Guya 5 hrs x ( Br. 62.5 x 2.5 ) = Br 781.25

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GROSS EARNINGS:
Gross Earnings = Basic Salary + Allowance + OT Earning
1. Senait Br 2,080 + 100 + 162.50 = 2,342.50
2. Petros Br 640 + 0+ 48.00 = 688.00
3. Abdu Br 1,280 + 0+ 96.00 = 1,376.00
4. Leila Br 960 + 50 + 0 = 1,010.00
5. Guya Br 10,000 + 50 + 781.25 = 10,831.25
 Deductions & Net Pays:
1. Senayit:
Gross Taxable Income = Br 2,342.50 Pension contribution:
Employee Income Tax: Basic Salary x 7%
Earning x ITR = IT Br 2,080 x 7% = 145.6
208.9 + 145.6
600.00 0% 0.00 Total Deductions = = 354.5
2,342.5 - 354.5
1,050.00 10 % 105.00 Net Pay. = = Br.1,988
692.50 15 % 103.9
Total 2,342.50 208.9

2. Petros:
Gross Taxable Income = Br 688.00
Pension contribution is zero b/c Petros is a
Employee Income Tax: contractual worker

Earning x ITR = IT Total Deductions = 8.8 + 0.00 = 8.80

600.00 0% 0.00 Net Pay. 688.00-8.80= 679.20

88.00 10% 8.80

Total 688.00 8.80

3. Abdu:

Gross Taxable Income = Br 1,376.00 Pension contribution:

Employee Income Tax: Basic Salary x 7%

Earning x ITR = IT Br 1,280 x 7% = 89.6

600.00 0% 0.00 Credit Ass. Pay. = 200.00

77.60 +89.6 +200.00

Total Deductions = = 367.2

1,376.0 - 367.2=
776 .00 10 % 77.6 Net Pay =
1,008.8
Total 1,376.00 77.6

4. Leila:

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 Pension
Gross Taxable Income = Br 1,010.00 contribution:

Employee Income Tax: Basic Salary x 7%

Earning x ITR = IT Br 960 x 7% = 67.2

600.00 0% 0.00 Total Deductions = 41 + 67.2 = 108.2

410.00 10 % 41 Net Pay = 1,010.00 - 108.2= 901.80

Total 1,010.00 41

5. Guya:
Gross Income= 10,831.25

Gross Taxable Income =Br 10,831.25 - 50 = 10,781.25 Pension contribution:

Basic Salary x 7%
Employee Income Tax: Br 10,000 x 7% = 700.00
2,279.4
+700
Earning x ITR = IT Total Deductions = 2,979.4
600.00 0% 0.00 10,831.25
1,050.00 10 % 105 -2,979.4
1,550.00 15% 232.5 Net Pay = 7,851.85
2,050.00 20% 410.00
2,550.00 25% 637.5
2,981.25 30% 894.4
Total 10,781.25 2,279.4

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 ETHIO RELIEF AGENCY

A PAYROLL SHEET FOR THE MONTH OF HIDAR, 2010

Gross Earning Deduction Net Earning

Name of the
Employee
Basic Over Total Income Total Net
1 Senait Bahiru 2,080.00 100.00 162.50 2,342.50 208.9 145.6 - 354.5 1,988

2 Petros Ephrem 640.00 - 48.00 688.00 8.8 - - 8.8 679.20

3 Abdu Mohammed 1280.00 - 96.00 1376.00 77.6 89.60 200.00 367.2. 1,008.80

4 Leilla Jemal 960.00 50.00 - 1010.00 41 67.20 - 108.2 901.8

5 Guya Boru 10,000.00 50.00 781.25 10,831.25 2,279.4 700.00 - 2,979.4 7,851.85

Total . . . 14,960.00 200.00 1,087.75 16,247.75 2,615.7 1,002.4 200.00 3,818.1 12,429.65

Verified By: Approved By:

Prepared By:

Proving the Payroll:

Total Earnings:
Basic Salary . . . . . . . . . . . . Br. 14,960.00
Allowance ............ 200.00
Over Time ............ 1,087.75
Grand Total Earnings . . . . . . . Br. 16,247.75
Deductions:
Employee Income Tax . . . . . . . . . . . Br. 2,615.7
Pension Contribution . . . . . . . . . . . . 1,002.4
Other ............ ....... 200.00
Total Deduction. . . . . . . . . . . . . . . . . . . 3,818.1
Net Pays Total . . . . . . . . . . . . . . . . . . 12,429.65
Total Deduction, & Net Pay . . . . . . . . . . . Br. 16,247.75
Thus, it is Proved.
2. Recording the Payment of Salary.
Hidar 30, 2005. Salary Expense . . . . . . . . . . 16,247.75
Employee Income Tax Payable . . . . . . . . . 2,615.7
Pension Contribution Payable . . . . . . . 1,002.4
Credit Association Payable ........ 200.00
Cash . . . . . . . . . . . . . ………… …… . 12,429.65 (Ck. No. 41)

Lecture Notes on Principles of Accounting-II, Chapter III 9

3. Recording the Payroll Taxes Expense for Hidar, 2010
Ethio. – Relief Agency incurred Payroll Tax Expense of Br. 1,575.2 during Hidar, 2010. This is determined as
the product of the basic salary of all permanent employees and 11%. This is because the agency has to
contribute 11% of the basic salary of every Permanent Employee to the Government Pension Trust Fund. Thus:
Total Basic Salary of all permanent Employees x 11% = Payroll Taxes Expense

(2,080 + 1,280 + 960 +10,000) x11% = 1,575.2

By the amount of Br. 1,575.2 the agency’s expense, Payroll Taxes Expense, and Pension Contributions Payable
increases. Therefore, the following Journal entry is made as of Hidar 30, 2010

Hidar 30, 2010 Payroll Taxes Expense 1,575.2

Pension Cont. Payable 1,575.2

The source document is an internal office memorandum that indicates the incurrence of this expense.

4. Recording the Payment of Deduction from Abdu’s earnings to the credit association on Tahisas 3, 2010

Tahisas 3, 2010 Credit Association Payable 200

Cash 200
5. Recording the Payment of Withholding and Payroll Taxes to Inland Revenue Authority on Tahisas 5,
2010.
:
From the above accounts you can see that the agency has a total liability of Br. 5,193.30 That is:-
Employee Income Tax Br 2,615.7
Pension contrib.. 2,577.6
Total . . . . . . . . . . . . . . . . . . . . . . . . . . Br 5,193.30

Note also that the total pension contribution payable is equal to 18% of the basic salary of all permanent
employees.
Then, the payment is recorded as follows:
Employees Income Tax Pay. 2,615.7
Pension Contribution Payable 2,577.6
Cash 5,193.30
Ck. No. 50
After the payment of these liabilities have been posted, the above two accounts will have Zero Balances.

Lecture Notes on Principles of Accounting-II, Chapter III 10