Chapter 4

3.3 Ethiopian Payroll System

In accounting, payroll refers to the amount paid employees for services they provided during the period.
A company’s payroll is important for the following reasons:
 Employees are sensitive to payroll errors and irregularities.
 Good employee morale requires payroll to be paid timely and accurately.
 Payroll is subject to federal and state regulations.
 Payroll and related payroll taxes significantly affect the net income of most companies.

Liability for Employee Earnings

Salary usually refers to payment for managerial and administrative services. Salary is normally expressed
in terms of a month or a year. Wages usually refers to payment for employee manual labor. The rate of
wages is normally stated on an hourly or a weekly basis. The salary or wage of an employee may be
increased by bonuses, commissions, profit sharing, or cost-of-living adjustments. Hence, employee
salaries and wages are expenses to an employer.

Accounting Systems for Payroll and Payroll Taxes

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. Here,
in this section, we are going to discuss deeply and work-through the major concepts that are common to
most payroll systems such as the employee’s earnings record, payroll sheet (or register), and journal
entries related to payroll. Each of these concepts is illustrated and discussed by taking into account the
current tax law of the country. As much as possible it attempts to give you adequate knowledge about
payroll systems in Ethiopia, however, if you come across any confusion or difficulties you can consult the
authorities in the Ministry of Finance or Inland Revenue Administration in your locality, or refer the
various proclamations especially; Proclamation No. 286/2002, the Council of Ministers Regulation
No.78/2002, Proclamation No. 345/2003, Proclamation No. 714/2011 and Proclamation No. 64/1975
(Article 33).

Definition of Payroll Related Terms

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1. Salary and Wages: salary and wages are usually used interchangeably. However, the term wages is
more correctly used to refer to payments to skilled and 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 refer to
payments to employees who render managerial, administrative or similar services, and they are
usually paid to expert 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. Self-employed person
on the other hand works on a fee basis to various firms.

2. Pay Period: a pay period refers to the length of time covered by each payroll payment.
3. 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. 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. Pay Check: A business can pay payroll by writing a check for the amount of the net pay. A check is
prepared in the name of each employee and handed to employees. Alternatively a check for the total
net pay can be prepared for employees to the paid by cash at the organization.
6. Gross Earnings: gross earnings of an employee may include the basic salary, allowance and
overtime earnings.
7. Withholding taxes: income tax withheld from employees' salary/wages and paid directly to the
government by the employer. Withholding taxes are taxes collected from the earnings of employees
by t he employer organization as per the regulations of the government. These have to be submitted
(paid) to the government because3d employer organization is only acting as an agent of the
government in collecting these taxes from employees.
8. Payroll Deductions: are deductions from the gross earnings of an employee such as employment
income taxes (withholding taxes and pension contribution), labor union dues, fines, credit association
pays etc.
9. 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.

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.
2. Name of Employees
3. Earnings: Money earned by an employee from various sources,. This may include.
(a) Basic 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- 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.

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  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
aw 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.
(c) Overtime Earning: Overtime work is the work performed by an employee beyond the regular
working hours. And 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:

 One and one-quarter (1¼) times his ordinary hourly rate for overtime work performed
before 10:00 pm in the evening.
 One and one half (1½) times his ordinary hourly rate for overtime work performed
between 10:00 pm and six (6:00 am) in the morning.
 Two (2) times the ordinary hourly rate for overtime work performed on weekly rest days
 Two and one half (2 ½) times the ordinary hourly rate for overtime work performed on a
public holiday.

4. Deductions
Deductions are subtractions made from the earnings of employees required by the government or
permitted by the employee himself. These include:

(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 No. 286/2002 - Income tax proclamation. The tax rates under Schedule A are presented
below:
Employment Income (per Employment Income Deduction / adjustment (Br.)
month) Tax Rate
Birr
0-600 Exemption 0
601 – 1,650 10% 60
1,651 – 3,200 15% 142.5
3,201 – 5,250 20% 302.5
5,251 – 7,800 25% 565
7,801-10,900 30% 955
over 10,900 35% 1,500

Note: In computing and withholding tax, the income tax proclamation dictates that income attributable to
the month of Nehassie and Pagume shall be aggregated (added) and treated as the income of one month.
Taxable income includes any payment or gains in cash or in kind received from employment by an

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individual, including income from former employment or otherwise or from prospective employment.
Short cut to Income Tax Calculation
Employment Income (per
month) Income Tax Payable
From 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
EI = Employment Income or taxable income
15 = (600X 0.1) – 0
147.5 = [(600 X 0.15) – 0] + [(1,050 X 0.15) – (1050 X 0.1)] and so forth
 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.
 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.
 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

Regulations issued pursuant to the income tax proclamation further exempt the following from income
tax.
 Amounts paid by employers to cover the actual cost of medical treatment of employees.
 Allowance in view of means of transportation granted to employees under contract of employment,
i.e., transportation allowance.
 Hardship allowance
 Amounts paid by employee in reimbursement of traveling expenses incurred on duty.

(b) Pension Contribution:

Retirement Benefits: Industrial life generally breaks joint family system. The saving capacity of the
employees is very low due to level wage, high living cost and increasing aspirations of the employees and
his family members. As such employers provide some benefits to the employees after retirement and
during old age, with a view to create a feeling of security about the old age to create a feeling of security
about the old age. Pensions and provident funds benefits are called retirement benefits.

Pensions: A pension represents a fixed payment, made regularly to a former employee or his surviving
dependents, provided an employee has fulfilled specific conditions of employments for a specific length
of time. Pension plans are considered for long service and are not incentives to work more efficiently or
effectively unless the premium is tied to a stock option plan. Furthermore, it is the amount of money that
each government permanent employee contributes towards a fund, which up on the employees retirement,
will be drawn up on to finance the participant’s welfare. The contributions of pension funds are made only
from the basic salary of the employee and contributions are made by only permanently employed worker
i.e. workers employed on a contract basis do not contribute to the pension fund.

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Types of Pension Fund
There are two types of such funds:
1. Public service civilian pension fund
2. Public service military pension fund

One of the significant changes introduced by the new Ethiopian pension laws is the substantial increase in
the amount of pension contribution by the beneficiary and the government/employer. Until June 2011,
only the public sector was covered by the pension scheme. Starting from July 2011 those (employees and
employers) in the private sectors started making a contribution following the first private organization
employees pension law. So what is the amount to be contributed by employees, employers and the public
organs (the government)? The following table summarizes the contributions to be made from each
respective party according to the proclamation no.714 and 715.

In the previous (now repealed pension law) the amount of pension contribution by public servants
including military and police officers was 4% of their gross salary. However, there was a significant
variation in the contribution to be made by the government for public servants as compared to the
contribution to military and police officers. According to article 5 and 6 of the repealed Public Servants’
Pensions Proclamation No. 345/2003 the contribution of the government to public servants pension was
6% whereas it was 16% for military and police pension.

The same variation is also reflected in the new public servants proclamation no 714/2011. The 16%
government contribution has now risen to 25%, almost 1/4 th of the gross salary of military and police
officers. On the contrary the government contributes only 7% for public servants.
Just refer to the following table for the specific percentage of contribution by each of the parties with the
responsibility of pension contribution under the new pension laws.
Type of pension fund Public office (Employer) Military and police officers
Military and Police 25% 7%
Service Pension Fund 1st year = 18% 1st year = 5%
2nd year = 20% 2nd year = 6%
3rd year = 22% ≥ 3rd year =7%
≥ 4th year = 25%

Type of pension fund Public office(Employer) Civil servants

Civil service Pension 11% 7%
Fund 1st year =7% 1st year = 5%
2nd year = 8% 2nd year = 6%
3rd year = 9% ≥ 3rd year =7%
≥4th year =11%

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Provident fund: - it refers to retirement plans of employees of private business organizations and other
non-governmental organizations (NGOs). Provident fund is similar to pension fund. However, it is kept
by the employer i.e., the employer serves as a trustee for its employees. The amount contributed by
employees of private business or NGOs is called provident fund contribution. The amount of
contribution to the provident fund is determined as per the agreement of the employer and the employee.
The amount contributed to provident fund varies from organization to organizations.

Type of pension fund Employer Employee

(Private organizations) (Private organizations)
Private Employees 11% 7%
Pension Fund 1st year =7% 1st year = 5%
2nd year =8% 2nd year = 6%
3rd year = 9% ≥3rdyear =7%
≥4th year = 11%

(c) Other Deductions:

In addition to the above two kinds of deductions from employees earnings, employees may individually
authorize deductions such as deductions to pay health or life insurance premiums, to pay loans from the
employer or credit association to pay for donation or charitable organizations; contributions to social
affairs like "Idir" "Equb"; etc.

Each of the major other deductions may be put in special column in the payroll register. The sum of all
the above-mentioned deductions (income tax, pension contribution, and other deductions) gives the total
deduction from the gross earnings of an employee.

5. Net Pay:
This amount is held in one column of the payroll register representing the excess of gross earnings over
the total deductions of an employee. The column net pay total shows the grand total around that will be
received by employees. It is called take home pay.

6. Signature:
Unless some other document is used; the payroll sheet may be designed to allow a column of a signature of
the employees after collection of the net pay.

Major Procedures or Activities Involved in Accounting for Payroll

1. Gathering the necessary data - all the relevant information about every employee should be gathered. This
activity requires reviewing various documents and to do so some arithmetic work.
2. Including 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. It must be proved that the grand total earnings equal to the sum
of the grand totals of deductions and net pays in the register.
4. The accuracy and authenticity of the information summarized in the payroll should be verified by
different person from the one who compiles it.
5. The payroll is approved by the authorized personnel
6. Paying the payroll either in cash or issuing a check for every individual employee for the net amount
payable to each employee.

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7. Recording the payment of the payroll and recognition of the withholding tax liabilities.
8. Recording the payroll tax expense of the employer
9. Paying and recording withholding and payroll tax liabilities to the concerned authority in our case to the
Inland Revenue Authority, on time.

Flow of Data in a Payroll System

Illustration of a Payroll Register

Addis Garment Factory, a public business organization, pays the salary of its employees according to the
Ethiopian calendar month. The forth-coming data related to the month of Hidar, 2015.
Basic Monthly OT hours
S/N Name of Employee Duration of work
salary allowance worked
01 Hussien Kedir 9,800 400 15 Up to 10:00pm.
6 hours up to 10:00pm.
02 Fatuma Ali 6,500 200 12
6 hours on public holiday
03 Hibo Ahmed 4,600 - 6 Weekly Rest days
04 Abdi Tekel 3000 100 - -
15 hours on weekly rest days &
05 Mohamed Dek 2000 100 20
5 hours during public holidays

Additional information
The management of the organization usually expects all workers to work 160 hours in a month and during
the month of Hidar, 2015 all workers have done as expected. Besides, all workers of the organization are
permanent employees except Abdi Tekel. 50% of the monthly allowance of Hussien Kedir and 100% of
the monthly allowance of Mohamed Dek is not taxable. Fatuma and Hussien agreed to contribute monthly
of Br 100 each for a charity organization (for Hope project).

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Instructions:
Based on the above information:
1. Prepare a payroll register for the organization for the month of Hidar 2015.
2. Record the payment of salary as of yHidar31, 2015using cash.
3. Record the payroll tax expense for the month of January.
4. Record the payment of the claim of the Charitable organization that arose from January, 2022 payroll
assuming that the payment was made on Tahsas 5, 2015.
5. Assuming that the withholding taxes and payroll taxes of the month of January, 2022 have been paid on
Hidar 6, 2015, record the required journal entry.

Solution
1. A payroll is registered in the payroll register. A payroll register is a multi-columnar form used to
organize the payroll data of an organization at the end of each pay period. A payroll register would
include: Employee number, names of employees, earnings of each employee, deductions, net pay, and
signature. Hence, these inputs should be prepared as follows:

a) Overtime earning (OT)

OT = OT hours worked X (ordinary hourly rate X OT rate) Ordinary hourly rate = basic salary
 required monthly working hours
Name of Basic Required Monthly
S/N Ordinary Hourly Rate
Employee Salary Working Hours
01 Hussien Kedir 9,800 160 hours Br 9,800/160 = Br 60
02 Fatuma Ali 6,500 160 hours Br 6,500/160 = Br 40.625
03 Hibo Ahmed 4,600 160 hours Br 4,600/160 = Br 28.75
04 Abdi Tekel 3000 160 hours Br 3000/ 00160 = Br 18.75
05 Mohamed Dek 2000 160 hours Br 2000/160 = Br 12.5

01. Hussien Kedir

OT = 15 hrs x (Br 60 x 1.25) = Br 1,125
02. Fatuma Ali
OT = 6 hrs x (Br 40.625 x 1.25) = Br 304.69 +
OT = 6 hrs x (Br40.625 x 2.5) = Br 609.38
Br 914.2
03. Hibo Ahmed
OT = 6 hrs x (Br 28.75 x 2.0) = Br 345.00
04. Mohamed Dek
OT = 15 hrs x (Br 12.5 x 2.0) = Br 375.00 +
OT = 5 hrs x (Br 12.5 x 2.5) = Br 156.25
Br 531.25
b) Gross Earnings
Gross Earnings: is total amount of money earned by an employee from various sources. Example includes
basic salary, allowance, and overtime.
Gross earnings = Basic salary + Allowance + OT earnings

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 S/N Name of Employee Basic Monthly OT Gross
Salary Allowance Earnings Earnings
01 Hussien Kedir 9,800 400 1,125 11,325
02 Fatuma Ali 6,500 200 914.2 7,614
03 Hibo Ahmed 4,600 - 345 4,945
04 Abdi Tekel 3000 100 - 3,100
05 Mohamed Dek 2000 100 531.25 2,631
Total 25,900 800

c) Deductions and net pay

Gross Taxable Income = Gross Earnings – Non Taxable Allowances
Pension Contribution = 7% x Basic Salary  from employees' basic salary

Gross Non Taxable Gross Taxable

S/N Name of Employee
Earnings Allowances Income
01 Hussien Kedir 11,325 200.00 11,125
02 Fatuma Ali 7,614 - 7,614
03 Hibo Ahmed 4,945 - 4,945
04 Abdi Tekel 3,100 - 3,100.00
05 Mohamed Dek 2,631 100.00 2,531
Total 29,615 29,315

01. Hussien Kedir

Gross Earning Income Br 11,325
Income tax = (35% X 11,125) – 1,500 = Br 2,393.75.
Pension contribution = 7% x 9,800 = 686.00
Charity contribution (other deduction) = 100.00
Total Deductions 3,179.75
Net Pay Br 8,145.25

02. Fatuma Ali

Gross Earning Income Br 7,614
Income tax = (25% X 7,614) – 565 = Br 1,338.5
Pension contribution = 7% x 6,500 = 455.00
Charity contribution (other deduction) = 100.00
Total Deductions 1,893.5
Net Pay Br 5,720.5

03. Hibo Ahmed

Gross Earning Income Br 4,945.00
Income tax = (20% X 4,945) – = Br 686.5
Pension contribution = 7% x 4,600 = 322
Total Deductions 1,008.50
Net Pay Br 3,936.50

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04. Abdi Tekel
Gross Earning Income Br 3,100.00
Income tax = (15% X 1,000.00) – 142.5 = Br 322.50
Pension contribution = no pension (b/c not permanent) = 0.00
Total Deductions 322.50
Net Pay Br 2,777.50

05. Mohamed Dek

Gross Earning Income Br 2,631.25
Income tax = (15% X 2,531.25) – 142.5 = Br 237.2
Pension contribution = 7% x 2000 = 140.00
Total Deductions 377.2
Net Pay Br
2,254.05

2. Record the payment of salary as o fHidary 30,2015 using cash.

Salaries expense………………………. 11,529.37

Income tax payable …………………4,978.45
Pension contribution payable …………. 1,603.00
Charity contribution …………………… 200.00
Cash ……………………………………. 22,834

3. Record the payroll tax expense for the month of Hidar

Payroll tax expense = 11% of basic salary of permanent of employees (from employer)
Payroll tax expense = 11% x22,900= 2,519

Payroll tax expense ………………….......... 2,519.00

Pension contribution payable ……………. 2,519.00

From employees = 7% x 8,700 = 1,603..00

+ From employer = 11% x 8,700 = 2,519.00
Total pension contribution towards the gov’t pension trust fund =4,122.00

4. Record the payment of the claim of the Charitable organization that arose from Hadar, 2015payroll
assuming that the payment was made on Tahsas 5, 2015.

Charity contribution ………………… 200.00

Cash ………………………………………... 200.00

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 Addis Garment Factory
Payroll Sheet
For the month ended as Hidar , 2015

Earnings Deductions
Total
Name of Gross Employ
S/N Monthly OT Pension Other De duction Net Pay Signature
Employee Basic Earnings ment
Allowanc Contributio Deductio s
Salary Income
e Earnings n ns
Tax
1 Hussien Kedir 9,800 400 1,125 11,325 2,393.75 686 100 3,179.75 8,145.25
2 Fatuma Ali 6,500 200 914 7,614 1,338.50 455 100 1,893.50 5,720.70
3 Hibo Ahmed 4,600 345 4,945 686.5 322 1,008.50 3,936.50
4 Abdi Tekel 3000 100 3,100 322.5 322.50 2,777.50
5 Mohamed Dek 2000 100 531 2,631 140 377.2 2,254
237.2
Total 25,900 800 2,915 29,615 4,978 1,603 200 6,781 22,834

5. Assuming that the withholding taxes and payroll taxes of the month of Hidar, 2015have been paid on Tahasas 6, 205, record the required journal
entry.

Income tax payable ……………………… 4,978

Pension contribution payable …………… 1,603
Cash ……………………………………………….. 6,781

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Compiled by Ibrahim J.