Chapter Three - Lecture notes on Ethiopian payroll PDF

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Ethiopian payroll accounting system is based on the newly revised directives that includes amendments on personal income taxes...

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Chapter Three: Ethiopian Payroll System 3.1. Definition and Importance of Payroll Accounting Payroll refers to the processes followed to pay employees for their work. For large companies, payroll can be a huge and difficult undertaking. Even small companies can find payroll challenging because all employers are required by law to maintain certain payroll records and to calculate payroll in particular ways. And of course, employees expect this task to be done on time without error. Payroll costs can be significant in terms of their impact on both current liabilities and operating expenses. Typical payroll costs include salaries, wages, bonuses, employer payroll taxes, and employee benefits. Salaries are fixed amounts that are paid monthly, typically to managerial, sales, and administrative personnel. Wages are based on a rate per hour or per unit of production and are typically paid to clerks, factory workers, and part-time employees. Bonuses are extra amounts paid to employees for outstanding performance. Employee benefits include amounts employers paid on behalf of employees for health insurance, retirement pensions, and vacation, illness, and family leaves. A company’s payroll is important for the following reasons: 1. Employees are sensitive to payroll errors and irregularities, and maintaining good employees 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 most business enterprises. For the foresaid reasons the need for accurate system of handling the payroll of a business is unquestionable. 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.

3.2 A Payroll Register and its Components a. Employee Number: Number assigned to employees for identification purpose when a relatively large number of employees are involved in a payroll register. It could be an identification card of the employees or a simple serial number. b. Name of Employees: this column lists names of employees of the organization. c. Earnings: Money earned by an employee from various sources. This may include. (1) 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. (2) Allowances: money paid monthly to an employee for special reasons, like: i. Position allowance – a monthly allowance paid to an employee for bearing a particular office responsibility. ii. 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. iii. Hardship allowance/or disturbance allowance – a sum of money given to an employee to compensate for an inconvenient circumstance caused by the employer. For example, unexpected transfer to a different and distant work area or location. iv. Desert allowance – a monthly allowance given to an employee because of assignment to a relatively hot region. v. Transportation (fuel) allowance – a monthly allowance to an employee to cover cost of transportation up to his/her workplace if the employer has committed itself to provide transportation service. vi. Cash indemnity allowance: - allowance paid for cashiers to cover the risk of possible cash shortage. (3) 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. 1156/2019 discussed the following about how overtime work should be paid: A worker shall be entitled to be paid at a rate of From office leaving hours to 10.00 p.m. in the evening 10.00 P.m. – 6.00 A.m. Evening – Morning

Normal hours Late Hours

Rest day

Rest day

Holidays

Holidays

One and quarter (1 ½ or 1.5) of the ordinary hour rate One and half (1 3/4 or 1.75) of the ordinary hour Twice (2) of the ordinary hour Two and half (2 ½ or 2.5) of ordinary hours rate.

All in all, the gross earnings of an employee may include the basic salary, allowance and overtime earnings. d. Deductions: are amounts a company subtracts from each employee’s gross earnings. The employer does not keep these deductions but rather pays (“remits”) them to another organization or government agency on behalf of employees. Some deductions are required by law; others are made on a voluntary basis as a service to employees. Deductions required by law, such as: Salary income tax, pension contribution etc. Voluntary deductions are amounts for charitable donations, retirement savings, union dues, medical and dental plans, life insurance, parking fees, and also may other deduction : - Like court order, fines, absence …etc. From the employer’s perspective, payroll deductions create liabilities, not expenses. They are not expenses because they do not directly increase the employer’s salary and wage costs. Instead, they simply redirect part of the salary and wage payments to a government agency or other organization rather than to employees. Some of the common types of deductions in Ethiopia are discussed hereunder. i. 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. 979/2016 - Income Tax Proclamation.

The tax rates under Schedule A are presented below: Employment Income(per month) Birr

Employment Income Tax Rate

Deduction / adjustment (Br.)

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

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, from prospective employment. The Council of Ministers Regulation No. 78/2002 Regulations issued pursuant to the income tax proclamation further exempt the following from income tax. 1. 2.

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

3. 4.

employment, i.e., transportation allowance. Hardship allowance (Disturbance allowance). Amounts paid by employee in reimbursement of traveling expenses incurred on duty. ii. 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 11% of the basic salary of every permanent government employee. Therefore, the total contribution to the pension fund of the Ethiopian government is equal to 18% of the basic salary of all of its permanent employees.

That is, 7% comes from the employees and 11% comes from the employer. For militaries, the employer (government) contributes 18% and the employee contributes 6% of his/her basic salary towards his/her pension trust fund. This enables a permanent employee of a government organization to be entitled to the pension pay when retired provided that the employee satisfies the minimum requirements to enjoy the benefits. Businesses and non-governmental and not-for-profit organizations (NGO’s) also have this kind of 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 retires or leaves employment, a lump sum amount is paid to him/her. iii. Other Deductions A part 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 “idir” and etc. 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 Illustration of Payroll Accounting Omo Nada 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 of December, 2020. Serial

Name of

Basic

Transportation

Overtime

Duration of OT

No.

Employee

Salary

Allowance

worked(hr)

01

Abraham Getu

Br. 7,720

800

4

6:00-10:00 P.M

02

Abdi Tufa

10,200

____

8

Sunday(8:30 – 5:30)

Work

Additional Information: The management of the enterprise usually expects a worker to work 40 hours in a week and during December there are four weeks. -

There were no absentees during the month All employees are permanent

-

Abdi agreed to contribute monthly Br. 800 from his salary as a monthly saving in the credit association of the enterprise.

Required: 1. Compute the following for each employees A. Gross earning B. Taxable income C. Tax to be paid D. Pension contribution E. Total deduction F. Net pay (net employment income) 2.

Record the payment of salary as of Dec. 30, 2001

3.

Record the payment of the claim of the credit association of their enterprise on Jan. 1, 2021.

4.

Record the payment of the withholding taxes and pension contribution to the concerned government body on Jan. 5, 2021.

Computation of Earnings, Deductions, and Net Pay Gross Earnings = Basic salary + Allowance + Overtime Earning

A. Overtime Earning Overtime earning = OT hrs worked x (ordinary hourly rate x relevant OT rate) 1. Abraham: - OT Earning = 4 hours x

Br. 7,720 x 1.5 160 hours

= Br. 289.5

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 = Br. 7,720 160 Hours

-

Therefore, the regular hourly payment = Br. 48.25

The regular hourly payment must be multiplied by the appropriate OT rate as follows: Br. (48.25 x 1.5) x 4 hours …………………… Br. 289. 5 2. Abdi Tufa: - OT Earning = 8 hours x Br. 10,200 x 2 ………... 160 hours

Br. 1,020

B. Gross Earnings Gross Earnings = Basic salary + Allowance + OT Earning 1. Abraham :  

Gross Earnings = Br. 7,720 + Br. 800 + Br. 289. 5 = 8,809. 5 Remember taxable income in this case is Br. 8009.5 because the transportation allowance of Br. 800 is not subject to taxation.

2. Abdi Tufa:  Gross Earnings = Br. 10,200 + Br. 1,020 = Br. 11,220 

The Gross Total Earnings of Abdi consists of the Br.10, 200 basic salary plus the overtime earnings of Br. 1020 which is Br. 11,220.

C. Deductions and Net Pay 1. Abraham:  Gross Total Earnings ………………………………….  Gross Taxable Income (Br.8, 809.5 – Br. 800) ……….. A. Employee Income Tax: i. Progressive method

Br.8,809.5 8,009.5

Earning 0-600

600

Income Tax Rate Exemption

Income tax 0

601 – 1,650

1,050

10%

105

1,651 – 3,200

1,550

15%

232.5

3,201 – 5,250

2,050

20%

410

5,251 – 7,800

2,550

25%

637.5

7,801-8,009.5

209.5

30%

62.85

Total

8, 009.5

ii. Deduction method Income tax = taxable income *tax rat – adjustment = (8,009.5 * 0.3) – 955 = 1447.85

1,447.85

ii. Pension Contribution: Basic salary x 7% = Br. 7,720 x 0.07 ……………………………………540  Total Deduction (Br. 1,447.85 + Br. 540) ……… 1,987.85 2. Abdi : 

Gross Total Earnings ……………………………… i. Progressive method

Br. 11,220

Earning 0-600

600

Income Tax Rate Exemption

Income tax 0

601 – 1,650

1,050

10%

105

1,651 – 3,200

1,550

15%

232.5

3,201 – 5,250

2,050

20%

410

5,251 – 7,800

2,550

25%

637.5

7,801-10,900

3100

30%

930

10,900-11,220

320

35%

112

Total

11,220

2,427

 Deduction method Income tax = taxable income *tax rat – adjustment = (11,220 * 0.35) – 1500 = 2,427 ii. Pension Contribution: (Br. 10,200 x 0.07) ………………………………………………… Br. 714 iii. Credit Association ……………………………………………………… 800.00  Total Deductions (2,427 + 714+ 800)…………………..………. Br. 3,941 NET PAY: Net pay = Gross Total Earnings – Total Deductions 1. ABRAHAM: Net pay = Br. 8,809.5– Br. 1,987.85 Net pay = Br.6, 821.65 2. Abdi: Net pay = Br. 11,220 – Br. 3,941 Net pay = Br. 7,279

Proving the Payroll: Total Earnings: Basic salary (7,720+10,200) ----------------------------------------Br. 17,920 Allowances

---------------------------------------------------------

800.00

Overtime (289. 5 +1020) --------------------------------------------- 1,309.5 Grand Total -------------------------------------------------- Br. 20,029.5 Deductions: Employee Income taxes (1,447.85 +2,427) --------------- Br. 3,874.85 Pension Contributions (540+714) -------------------------Other Deductions ---------------------------------------Total Deductions -------------------------------

1,254 800.00 Br. 5,928.85

Total Net Pay (Br.6, 821.65+ 7,279) ---------------------------------- Br. 14,100.65 Total Deductions plus Net pay --------------------------------

Br. 20,095.5

Journal Entries Related to Accounting for Payroll 2. Recording the payment of salary: Dec. 30, 2020 Salary Expense ……………… 20,095.5 Cash……………………………………

14,100.65

Pension Contribution Payable …………… 1,254 Employees Income Tax Payable ………… 3,874.85 Payment for Credit Association …………. 800.00 Also, on this same date, the Enterprise (as an employer) has to contribute 11% of the basic salary of every permanent employee to the government’s pension trust fund. Therefore, total basic salaries of permanent employees x 11% = (Br. 7,720 + Br. 10, 200+) x 11% = 1,971.2 The following journal entry, therefore, is recorded on Dec. 30, 2020. Dec. 30, 2020 Pension Contribution Expense ………………1,971.2 Pension Contribution Payable ………………1,971.2 3. Recording the payment of deduction from Abdi salary to the Credit Association: Jan. 5, 2021 Payable to Credit Association ………..800.00 Cash ……………………....…………………800.00

4. Recording the payment of employees’ income tax withheld and the 10% pension contribution to the government body: On Jan. 5, 2021 Pension Contribution Payable (1,254+ 1,971.2)….3, 225.2 Employee Income Tax Payable ………………... 3,874.85 Cash ………………………………………. 7,100.05 Omo Nada Enterprise Payroll Register (sheet) For the Month of December, 2021 E.C.

Ser. No.

Name of Employee

Earnings Basic salary

Allowances

Over Time

Gross Earning

Deductions Income Tax

Pension Contr.

Other Deduc.

Total Deduc.

Net Pay

1

Abraham Getu

730

200

22.81

952.81

65.42

29.2

94.62

858.19

2

Bekuma Jirra

1020

____

102

1122

120.8

40.8

461.6

660.4

3

Meymuna Hunduma

5300

____

____

5300

1192.5

212

1404.5

3895.5

4

Tweodros Alemayehu

1470

____

____

1470

176.5

____

____

176.5

1293.5

5

Yetimwork Kebede

950

____

89.06

1039.06

108.35

____

____

108.35

930.71

Br. 9470.00

Br. 200.00

Br. 213.87

Br. 9883.87

Br. 1663.07

Br. 282.00

00.00

Br. 2215.58

Br. 7638.30

Grand Total

Signature

Prepared by _____________________ Checked by ____________________ Approved by __________________...