Principles of Accounting II

Chapter 3

Current Liabilities , Contingencies &

Ethiopian Payroll System
 Objectives
1. Define and give examples of current liabilities.
2. Prepare journal entries for
After studying thisshort-term notes
payable and disclosure
chapter, for the current portion
you should
of long-term debt.
be able to:
3. Describe the accounting treatment for
contingent liabilities and journalize entries for
product warranties.
4. Define payroll and payroll related terms
5. Determine employer liabilities for payroll,
including liabilities arising from employee
earnings and deductions from earnings.
 Objectives
5. Describe payroll accounting systems that
use a payroll register and compute net pay
of employees and record on a general
journal.
6. Use the quick ratio to analyze the ability of
a business to pay its current liabilities.
 Section 1

Current Liabilities & Contingencies

The Nature of Current Liabilities
Liabilities that are to be paid out of
current assets and are due within a
short time, usually within one year,
are called current liabilities.

 Accounts payable
 Notes payable
Examples:
 Unearned rent
 Taxes payable
 Wages payable
 Current portion of long
term debt
 Short-Term Notes Payable
A firm issues a 90-day, 12% note for $1,000,
dated August 1, 2006 to Murray Co. for a
$1,000 overdue account.

Aug. 1 Accounts Payable—Murray Co. 1 000 00

Notes Payable
1Issued
000 00a 90-day, 12% note on
account.
 Short-Term Notes Payable
On October 30, when the note matures, the
firm pays the $1,000 principal plus $30
interest ($1,000 x .12 x 90/360).

Oct. 30 Notes Payable 1 000 00

Interest Expense 30 00
Cash 1 030 00
Issued a 90-day, 12% note on
Appears on the
account.
income statement as
an “Other Expense.”
 Short-Term Notes Payable
Bowden Co. (Borrower) Coker Co. (Creditor)
Description Debit Credit Description Debit Credit

Mdse. Inventory 10,000 Accounts Receivable 10,000

Accounts Payable 10,000 Sales 10,000
Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500

May 31. Bowden Co. purchased merchandise on

account from Coker Co., $10,000, 2/10, n/30.
The merchandise cost Coker Co. $7,500.
 Short-Term Notes Payable
Bowden Co. (Borrower) Coker Co. (Creditor)
Description Debit Credit Description Debit Credit

Mdse. Inventory 10,000 Accounts Receivable 10,000

Accounts Payable 10,000 Sales 10,000
Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500

Accounts Payable 10,000 Notes Receivable 10,000

Notes Payable 10,000 Accounts Receivable 10,000

May 31. Bowden Co. issued a 60-day, 12%

note for $10,000 to Coker on account.
 Short-Term Notes Payable
Bowden Co. (Borrower) Coker Co. (Creditor)
Description Debit Credit Description Debit Credit
July 30. Bowden Co. paid Coker Co. the
Mdse. Inventory
amount due10,000
on the noteAccounts
of MayReceivable 10,000
31. Interest:
Accounts Payable 10,000 Sales 10,000
$10,000 x 12% x 60/360 = $200.
Cost of Mdse. Sold 7,500
Mdse. Inventory 7,500

Accounts Payable 10,000 Notes Receivable 10,000

Notes Payable 10,000 Accounts Receivable 10,000

Notes Payable 10,000 Cash 10,200

Interest Expense 200 Interest Revenue 200
Cash 10,200 Notes Receivable 10,000
 Discounted Notes Payable
On August 10, Cary Company issues a $20,000,
90-day note to Rock Company in exchange for
inventory. Rock discounts the note at 15%.

Aug.10 Merchandise Inventory 19 250 00

Interest Expense 750 00
Notes Payable
Proceeds
20 000a 90-day,
Issued 00 note to Rock Discount: $20,000
Co. discounted at 15%.
x .15 x 90/360

Discount rate
 Discounted Notes Payable

On November 8 the note is paid in full.

Nov. 8 Notes Payable 20 000 00

Cash 20 000 00
Paid note due.
Contingent
Liabilities
 Product Liability
On June 30, a company sells a product for $60,000
on which there is a 36-month warranty. Past
experience indicates that repairs of defects cost 5%
of the sales price over the warranty period.

June 30 Product Warranty Expense 3 000 00

Product Warranty Liability
3 000 00
Warranty expenses projected for
June, 5% of $60,000.
 Product Liability
On August 16, a customer needed a
defective part replaced. Cost to the
company was $200 for the part.

Aug.16 Product Warranty Payable 200 00

Supplies
200 00
Replaced defective part under
warranty.
 Accounting Treatment of
Contingent Liabilities
Likelihood
of Accounting
Occurring Measurement Treatment
Probable Estimable Record
Liability
Contingency Not Disclose
Estimable Liability

Disclose
Possible
Liability
 Section 2

Payroll System in Ethiopian Context

 After studying this section, you should be able to:
Explain the importance of payroll and payroll accounting
Define payroll related terms
Identify the basic components of Payroll Register
Prepare payroll sheet
Compute income taxes and pension contributions as per the rule
of a government
Compute and record the payroll for a pay period
Describe and record employer payroll taxes

4/27/23 PAII Ch03 18

 Importance of Payroll Accounting

• Accounting for payroll is particularly important

because:
 Payroll often represents the largest expense that a
company incurs.
 The tax authority require that detailed payroll
records be kept, and
 Employees are sensitive to payroll errors of
irregularities. To maintain good employee morale
payroll must be paid on a timely and accurate basis.

4/27/23 PAII Ch03 19

 DEFINITION OF PAYROLL RELATED
TERMS
• Salary and Wage
• The Pay Period
• The Pay Day
• Pay Check
• Gross Earnings
• Payroll Taxes
• Payroll Deductions
• Net Pay
• Payroll Register (sheet)
4/27/23 PAII Ch03 20
 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER
Components of payroll register are column headings and
subheadings in which we enter different characters and
money values that enable us determine net pay of
employees. These includes :
• Employee ID and Name
• Earnings
• Deductions
• Net pay and
• Signature

1) Employee Number & Name of Employee: the first two columns of

a payroll register are usually devoted to enter an employee ID and
his/her name.

4/27/23 PAII Ch03 21

 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
2) Earnings

These are 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

4/27/23 PAII Ch03 22

 POSSIBLE COMPONENTS OF A PAYROLL REGISTER,
cont’d…
2) Earnings
b) Allowances: money paid for assuming additional responsibilities or
for different reasons which includes the following:
– Position allowance: - a monthly allowance paid to an employee for
bearing 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 / 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.
– 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 his/ her workplace if the employer
4/27/23 has committed itself to provide
PAII Ch03transportation service. 23
 POSSIBLE COMPONENTS OF A PAYROLL REGISTER,
cont’d…
2) Earnings
c) 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.

In Ethiopia, the overtime hours work by employee is calculated and paid as

follows:
A worker shall be paid at a rate of
 One and One –quarter (1¼) times his ordinary (regular) hourly rate for
overtime work performed before 10:00 P.M in the evening. (6:00AM-10:00
PM)
 One and one half (1½) times his ordinary (regular) hourly rate for overtime
work performed between 10:00 P.M and six (6:00A.M.) in the morning.
 Two times the ordinary (regular) hourly rate for overtime work performed
on weekly rest days.
 Two and one half (2½) times the ordinary (regular) hourly rate for overtime
work performed on a public holiday.
4/27/23 PAII Ch03 24
 POSSIBLE COMPONENTS OF A PAYROLL REGISTER,
cont’d…
2) Earnings

d)Other earning:-
income received by the
employee other than the above three(basic
salary, allowance and overtime) is also added
together to determine gross earning. Bonus
is best example here.
• Therefore, the gross earnings of an
employee may include the basic salary,
allowance, overtime and any other
earning received in cash or in kind
4/27/23 PAII Ch03 25
 Illustration
Solomon Tadesse an employee of Ministry of education has
basic monthly salary of Br 3,200 and position allowance of
800birr. During the month of Miyaziya, he worked an over
time of 8 hours in the weekend and 6 hours in public
holiday. Gemechis Tola, an employee of the same entity
with basic salary of 2,400 however worked 12hours
overtime of which 5 are in midnight whereas the rest up to
10:00pm.

Required
Compute the gross earning of these two employees.

4/27/23 PAII Ch03 26

 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions

These are subtractions made from the earnings of

employees required either by the government or
permitted by the employee herself.
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 taxable
earnings of the employee at the rates indicated under
schedule A of the proclamation No 979/2016 presented
below:

4/27/23 PAII Ch03 27

 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions: a) Employment Income Tax
Employment Income Tax Rate(Recently Revised)

Taxable Income
From To On the next Tax Rate
Zero Br. 600 Br.600 0% (Exempted)
601 1,650 1,050 10%
1,651 3,200 1,550 15%
3,201 5,250 2,050 20%
5,251 7,800 2,550 25%
7,801 10,900 3,100 30%
Above 10901 35%

4/27/23 PAII Ch03 28

 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions: a) Employment Income Tax
Employment Income Tax Rate

We may use the deduction approach as an alternative

Employment Income Income
(per month) Tax Payable
From Birr To Birr
Zero Br. 600 No tax (free from 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

4/27/23
Above 10901
PAII Ch03 (35% X EI)-1500 29
 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions : a) Employment Income Tax
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.

Proclamation No. 286/2002 states that the following are not taxable.
• Income from employment received by causal 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:
– Personal injuries suffered by that person
– The death of another person
4/27/23 PAII Ch03 30
 POSSIBLE COMPONENTS OF A PAYROLL REGISTER,
cont’d…
3) Deductions : a) Employment Income Tax

The council of ministers regulation No. 78/2002,

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 only for the amount not exceeding
25% of employee salary or 1,000 birr.
• Hardship allowance (Disturbance allowance).
• Amounts paid by employee in reimbursement of traveling
4/27/23
expenses incurred on duty.
PAII Ch03 31
 Illustration
Assume Zemenay Debebe is an employee of MoFEC
with monthly basic salary of 2,720 and position and
transportation allowances of Br. 600 and 800
respectively. During Miyazia she worked an
overtime of 8 hours up to 10pm and 6hours from
10pm to 6 am.

Required
1) Find her taxable income
2) Compute employment income tax that she pay for
this month

4/27/23 PAII Ch03 32

 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions
b) Pension Contributions
Permanent employees of a governmental and private organizations in
Ethiopia are expected to pay or contribute 7%(change each year) of
their basic salary to the pension trust fund. This amount is withheld
by the employer from each employee on every payroll period and
later be paid to the respective government body.
The employer is also expected to contribute towards the same fund
11% of the basic salary of every permanent employee. Therefore,
the total contribution to the pension fund is equal to 18%(for this
year) of the basic salary of all of its permanent employees.
This enables a permanent employee to be entitled to the pension
pay when retired provided the employee satisfies the minimum
requirements to enjoy the benefits

4/27/23 PAII Ch03 33

 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions : b) Pension Contributions

Non-governmental not-for profit organization

(NGO’s) also have this kind of scheme to
benefit their employees with some
modifications.
A fund known as provident fund as
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
4/27/23
paid to him/her. PAII Ch03 34
 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
3) Deductions
c) Other Deductions
Apart from the above two kinds of
deductions, employees may individually
authorize additional deduction such as
deductions to pay life insurance
premiums, to repay loan from the
employer, to pay for donations to
charitable organization, contributions to
“Idir” etc.
4/27/23 PAII Ch03 35
 POSSIBLE COMPONENTS OF A PAYROLL
REGISTER, cont’d…
4) Net Pay
Net Pay represents the excess of gross earnings over
total deductions of an employee.
5) Signature
The payroll sheet should have a column for signature of the
employee to be taken when the employee collects the net
pay.

4/27/23 PAII Ch03 36

 Sample Payroll Register
      XYZ Company           

  Payroll
  For the Month of Miyazia 2006    
Earnings Deductions
Gross Total
Allowance Overtim Earning Income Pensio Deductions
E ID Employee Name Basic Salary s e Others s Tax n Others Net Pay Signature
                         
                       
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         
                         

  Total                  
Prepared By:_________________ Cheked By:_____________________ Approved By:____________________

4/27/23 PAII Ch03 37

 Illustration
Ethio Relief Agency (gov) pays the salary of its employees according to the Ethiopian Calend
month. The forth coming data relates to the month of Miyazia, 2006 EC.
Name of Basic Allowanc OT Hrs Duration of BS per
S.No. Employee Salary e worked OT work hour

01 Senait Bahiru 3,200 100 10 6 AM to 10 PM 20

02 Petros Challa 1,600 __ 8 10 PM to 6 AM 10
03 Abdu Mohammed 2,400 __ 6 Weekly Rest Days 15
04 Leilla Jemal 1,920 50 __ __ 12
05 Kirkos Wolde 1,280 50 10 Public Holidays 8
Additional Information:
Note that management of the agency usually expects an employee to work 40 hours in a week
and during Miyaziya 2006 all employees have worked as they have been expected. Besides, all
workers of this agency are permanent employees except Petros Chala and the monthly
allowance of Kirkos Wolde is not taxable; Abdu Mohammed agreed to have Br 200 be deducted
from his
earning and paid to the Credit Association of the Agency as a monthly saving.

Instructions: Based on the above information:

•Compute of earnings, deductions and net Pays
•Prepare a payroll register (or Sheet) for the agency for the month of Miyazia 2006
•Record the payment of salary as of Miyazia 30 2006using Ck. No. 41 as a source documents
•Record the payroll tax expense for the month of Miyazia 2006. Memorandum No.006
•Record the payment of the claim of the credit Association of the agency that arose from
Miyazias payroll assuming that the payment was made on Ginbot 1 2006
•
4/27/23 Record the payments of withholding taxes and payroll taxes of the month of Miyazia
PAII Ch03 38
assuming that they have been paid on Ginbot 10 via Ck. No. 50
 End
Chapter 3
4/27/23 PAII Ch03 39