Accounting Systems for Payroll and Payroll Taxes

Unit 6: Accounting Systems for Payroll and Payroll Taxes

6.1 Introduction

In the previous chapter you have discussed the basic accounting principles and practices that are useful in accounting for the acquisition, use, and disposal of plant assets, as well as the accounting for intangible assets and natural resources have also been discussed briefly.

In this chapter you will be acquainted with the basics of accounting 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 requires employers to keep accurate payroll records and to prepare reports and submit to the appropriate governmental units. The law also require employers t remit the amounts withheld from its employees and for taxes imposed on itself. 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 chapter, you are going to learn intensely and worked 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 the chapter 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. And Article 33 or proclamation No. 64 / 1975  

 

6. 2 importance of payroll accounting

Accounting for payroll is particularly important because:

  1. Payroll often represents the largest expense that a company incurs.
  2. Both federal and state governments require that detailed payroll records be kept and
  3. Employees are sensitive to payroll errors or irregularities. To maintain good employee morale payroll must be paid on a timely and accurate basis.

 

6. 3 definition of payroll related terms

  1. Salary and Wages: Salary and wages are usually used interchangeably. However, the term wages is more correctly used to refer to payments to 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 refers to payments to employees who render managerial, administrative or similar services, and they are usually paid to skilled 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.
    A self-employed person on the other hand works (gives her services) on a fee basis to various firms.
  2. The Pay Period: A pay period refers to the length of time covered by each payroll payment.
  3. The Pay Day: The 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. A 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: 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.
  7. Payroll Deductions: are deductions from the gross earnings of an employee such as employment income taxes (with holding taxes), labor union dues, fines, credit association pays etc.
  8. Net Pay: 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.

 

6.4  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.

  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:
    • 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.
    • 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.
  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. 64/1975 discussed the following about how overtime work should be paid:

A worker shall be entitled to the paid at a rate of

  1. one and one-quarter (1 ¼) times his ordinary hourly rate for overtime work performed before 10:00 P.M in the evening.
  2. One and one half (1 ½) times his ordinary hourly rate for overtime work performed between 10:00 P.M and six (6:00 A.M) in the morning.
  3. Two times the ordinary hourly rate for overtime work performed on weekly rest   days
  4. two and one half (2 ½ ) times the ordinary hourly rate for overtime work performed on a public holiday.

All in all, the gross earnings of an employee may include the basic salary, allowance and overtime earnings.

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

  1. 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 N. 286/2002- Income tax proclamation.

The tax rates under schedule A are Presented below:

Employment Income

(per month)

Income

Tax rate

 Over Birr

To Birr

 

Exempt (Free from Tax)

0

150

 151

 650

10%

 651

 1400

15%

1401

  2350

20%

2351

  3550

25%

3551

  5000

30%

Over 5,000

 

35%

*In computing and withholding tax, the income tax proclamation dictates that income attributable to the month of Nehassie and Pagumen shall be aggregated (added) and treated as the income of one month.

Taxable income includes any payment or gains in cash or I n kind received from employment by an 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

Over Birr

To Birr

 

   0

150

No tax

151

650

(10% X EI) – 15

651

1400

(15% X EI) – 47.5

1401

2350

(20% X EI) – 117.5

2351

3550

(25% X EI) – 235

3551

5000

(30% X EI) – 412.5

Over 5,000

 

(35% X EI) – 662.5

EI = Employment Income or taxable income

15 = (150 X 0.1) – 0

47.5 = [(150 X .15) – 0] + [(500 X 0.15) – (500 X 0.1)]and so forth

Proclamation No. 286/2002 states that the following are not taxable.

  1. 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.
  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 made to---- (an employee) as a compensation or gratitude in relation to:
    • personal injuries suffered by that person
    • the death of another person

The council of ministers regulation No. 78/2002

Regulations issued pursuant to the income tax proclamation further exempts the following from income tax.

  1. Amounts paid by employers to cover the actual cost of medical treatment of employees.
  2. Allowance in view of means of transportation granted to employees under contract of employment, i.e., transportation allowance.
  3. Hardship allowance
  4. Amounts paid by employee in reimbursement of traveling expenses incurred on duty.

The above employment tax rate has been revised by the year 2008 as listed below: 

Revised Employment Income Tax Rates

No

Employment Income (per-month) birr

Employment income tax rates

Deduction in birr

1

0-600

0%

0

2

601-1650

10%

60

3

1,651-3,200

15%

142.50

4

3,201-5,250

20%

302.50

5

5,251-7,800

25%

235

6

7,801-10,900

30%

955

7

Over 10,900

35%

1,500

 

4.b. Pension Contribution

Permanent employees a governmental organization in Ethiopia is expected to pay or contribute 4% 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 6% of the basic salary of every permanent government employee.

Therefore, the total contribution to the pension fund of the Ethiopian government is equal to 10% of the basic salary of all of its permanent employees.

That is, 4% comes from the employees and 6% comes from the employer.

This enables a permanent employee of a government organization to be entitled to the pension pay when retiring provided the employee satisfies the minimum requirements to enjoy the benefits.

Business and non-governmental not-for profit organization (NGO’s) also have this kind of a 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 retains or leaves employment, a lump sum amount is paid to him/her.

4.c. Other Deductions

Apart 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 "ldir" etc.

5. 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.

 

6.5 major Activities involved in accounting for payroll

  1. Gathering the necessary data - All the relevant information about every employee should be gathered.
    This requires reviewing various documents such as attendance sheets and doing some arithmetic work.
  2. Entering 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 -the grand total for earnings must be checked if its equal to the sum of the grand totals of deductions and net pays.
  4. The accuracy and authenticity of the information - summarized in the payroll should be verified by a different person from the one who prepared it.
  5. The payroll - should be approved by an authorized personnel (individual)
  6. Paying the payroll - either in cash or by writing a check.
  7. The payment of the payroll and income taxes - withheld from employees (withhold doing tax liability) should be recorded in journal entry form.
  8. The withholding tax - must be paid to the relevant government authority in time (promptly) and this is recorded in journal entry form.

 

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