CHAPTER NINE- PAYROLL ACCOUNTING

9.0 Learning Objectives………………………………………………………………..
9.1 Introduction………………………………………………………………………..
9.2 Payroll……………………………………………………………………………...
9.3 Gross Pay…………………………………………………………………………..
9.4 Methods of Calculating Gross Pay ……………………………………………......
9.4.1 Time-Based System……………………………………………………………
9.4.2 Performance Related Systems…………………………………………………….
9.4.3 Straight Salary……………………………………………………………………..
9.4.4 Bonus Schemes…………………………………………………………………….
9.4.5 Types of Bonus Schemes…………………………………………………………..
9.4.5.1 Halsey Premium Plan……………………………………………………………
9.4.5.2 Rowan Plan………………………………………………………………………
9.4.5.3 Comparison of Halsey Plan and Rowan Plan……………………………………
9.5 Allowable Deductions and Reliefs…………………………………………………
9.6 Net Pay…………………………………………………………………………….
9.7 Accounting Entries………………………………………………………………...

CHAPTER NINE

PAYROLL ACCOUNTING

9.0   Learning Objectives

After you have studied this chapter, you should be able to:
• Define and explain payroll
• Explain the difference between gross salary, net salary and take-home pay
• Explain and calculate the difference between employee‟s and employer‟s social security contributions
• Calculate the net salary or pay of an employee where his or her gross pay, statutory and other deductions and personal income tax schedule are given
• State the control procedures required in the management of payroll
• Demonstrate ability to record payroll activities in the accounting records of a business organisation

9.1   Introduction
In this chapter you will learn how to calculate the salary or pay of employees and the various deductions that are made from the gross pay before calculating the income tax. You will also learn how to use the progressive personal income tax schedule to calculate the income tax of an employee. You will learn why statutory deductions like social security contributions are made and how they are calculated. Finally you will learn what types of reliefs are available to employees and how they are adjusted before the employees‟ net pay is calculated.

9.2   Payroll

Payroll may be defined as a record showing the names of employees, rates of pay, hours worked, bonuses, allowances, gross earning (salaries), statutory deductions and other contributions withheld during a given pay period.  In simple terms, payroll may be understood as a document showing for each worker his gross earning, any deductions (statutory and otherwise) made from his gross earning and the net amount payable to him in a particular pay period.

The objectives of payroll accounting are to process information such as; Hours Worked, Pay Rate, Gross Earning, Deduction and Net Pay (salary). Business organisations record information relating to employees‟ pay due to the following:

1) Payroll usually constitutes the most significant or material obligation or expense in most business establishments.

2) Business organisations are required by law to send returns on their payroll including the amount of income tax deducted at source to the tax authorities.

3) It is used for cost control purposes, usually in the form of variance analysis.
4) It is also the basis upon which most tax clearance certificates are prepared.

Employees are usually paid either a wage or a salary. Wages refer to the type of employee remuneration package that is time based. In this situation the rate of pay is given as a fixed amount per hour for number of hours actually worked or of those who reported for duty. Salary, though time based, is quoted on an annual basis.

In Ghana and Nigeria all employees are taxed under the PAYE (Pay-as-You Earn) system. This is a form of withholding tax system where the employer is legally required to deduct at source the income tax and social security contributions from the wages or salaries of employees and pay the same to the tax authorities. This therefore means that the employee will not have to wait till the end of the year for him to personally pay his tax liabilities to the state. The PAYE tax is a monthly phenomenon which is seen as an estimate and as such may result in overpayment or underpayment of an employee‟s income tax liability.  

9.3 Gross pay or earning is the total amount of wages or salaries that employees earn in a particular period before statutory deductions and others are made.  In Ghana, gross pay is the consolidated income of an individual earned from employment. The consolidated salary of an employee may consist of the following components:
• Basic Salary
• Leave allowance
• Responsibility allowance
• Transport allowance
• Overtime allowance
• Risk allowance
The two main remuneration methods often used are:  Time based system and Piecework system.  Others include:  Straight salary, bonuses, commission and allowances.
 
9.4.   Methods of calculating Gross pay
Methods of remuneration refer to the basis used in calculating wages of workers.  In the preparation of payroll, the organisation must initially determine the employee‟s Gross Salary or wages using the most appropriate remuneration plan adopted by the firm.

9.4.1  Time Based System
In this system of remuneration, employees are paid according to number of hours actually worked multiplied by a fixed amount or rate.  This simply means that the longer the period for which an employee works, the larger his or her gross pay will be. This method of remuneration is usually employed in the manufacturing industries.
The payment to the employees is based on this formula:

Earnings = Clock hours x Rate per hour

Advantages
• It is simple to understand and administer
• Wage negotiations (changes) can be easily affected
• It has stood the test of time
• It provides incentive for longer period of work
• It facilitates cost control Disadvantages
• There is no incentive to improve productivity and efficiency
• It is not a sound accounting practice to pay all employees in the grade the same rate irrespective of performance.
• Cost of supervision under this method is very high •  It is not a very good basis for cost control.
• It does not encourage innovation.

9.4.2   Performance related Systems
Under this system, the remuneration in terms of wages or salaries that is paid to each employee is dependent on his or her level of output, performance or services rendered.  Workers are normally given a fixed sum per unit of output so that the higher one‟s output the larger his gross pay or salary.  Casual labour, cooks, painters, contractors etc. are often paid by this method. The payment to the employee is based on the formula below:

Earnings = Number of units produced x rate per unit

Advantages
• It attracts higher grade worker (scholars and “macho” men).
• It provides direct incentive for innovations, efficiency and high productivity without any difficulty of individual piecework rates.
• It is simple to understand and administer.
• It facilitates cost control.
• It has stood the test of time.

Disadvantages
• Output may exceed target if proper supervision is not carried out.
It results in competition for higher grade workers thereby increasing the cost per output.
• Shoddy work or inferior goods will be made, if proper supervision is                                                      not put in place.
• It does not take into account individual disabilities.

9.4.3    Straight Salary
Under this method of remuneration, employees are paid a fixed amount annually with a constant increase per annum. This is usually referred to as the notch system and is usually stated as follows:
Gross Pay = ¢10,000,000 x¢ 2,000,000 – ¢18,000,000.
The above statement means that this employee will receive ¢10,000,000 for the first year of his engagement. Thereafter his gross pay will increase by ¢2,000,000 every subsequent year following the date of his employment. This increment will not continue when it gets to ¢18,000,000 until he or she is promoted to the next grade.  It must however be noted that the gross pay under this method does not depend on the number of hours worked or output produced.

9.4.4   Bonus Schemes
These are schemes which are used to reward exceptional employees by   paying bonuses on top of these normal earnings mentioned above. Such incentives vary from one company to the other. The main purpose of providing these incentives is to encourage workers to produce their best for the company.

9.4.5  Types of Bonus Schemes
9.4.5.1  Halsey Premium Plan

This plan was introduced by F. A. Halsey in 1891. The plan simply combines the time and piece rate systems. The main features of this plan are as follows:
a. Workers are paid at a rate per hour for the actual time taken to perform a task.
b. A standard time is set for each piece of work, job or operation.
c. If a worker takes standard time or more than the standard time to complete his work, he is paid wages for the actual time taken by him at the time rate.
d. If a worker takes less than the standard time, he is paid a bonus equal to 50 % of the time saved at the time rate fixed.
Under this system, total earnings of a worker are equal to wages for the actual time taken by him plus a bonus. The formula for calculating bonus and total earnings under this incentive plan is:
Bonus = 50% of [Time saved x Time rate]
Total earnings = Time rate x Time taken + 50% of [Time saved x Time rate]
    Illustration 9.1
            Standard time (or Allowed time) = 250 hours.
            Wages rate per hour                     = ¢15
Actual time taken                         = 220 hours

Thus time saved = 250hrs – 220hrs = 30hrs.
Bonus = 50% [30hrs x ¢15] = ¢225
Total earnings = ¢15 x 220hrs + 50% [30hrs x ¢15] = ¢3,525
 

Advantages of Halsey Plan.
1. It is easy to understand.
2. It guarantees a minimum time wages to all the workers. This means that slow or lazy and relatively inefficient workers have nothing to fear on the plan.
3. The benefits resulting from saving in time is equally divided between workers and the employer.
4. Bonus is separately calculated for each job. As a result any time saved by a worker on a particular job is not adjusted against excess time taken by him on another job.

Disadvantages of Halsey Plan
1. Workers do not like the employer to share the benefits of time saved by them.
2. It does not provide the employer with full protection against high rate setting.
3. Extra efficiency of a worker is not fully recognised and rewarded.

9.4.5.2 Rowan Plan

This plan is similar to the Halsey incentive plan mentioned above. The difference lies in the calculation of bonus. The main features of Rowan Plan are as follows:
a. Wages are paid on time basis for the actual time worked by the worker
b. A standard time is determined for each piece of work or job.
c. If a worker completes his work in standard time or in more than the standard    time, he is paid wages for the time actually taken by him.
d. If a worker completes his work in less than the standard time, he is entitled to a bonus.
e. The Bonus is calculated as the proportion of wages of actual time taken which     the time saved bears to the standard time.

The formula for calculating bonus and total earnings under this incentive plan is:

 Bonus =    Time saved      x Time taken x Time rate
Time allowed

Total earnings = (Time taken x Time rate) + Bonus

Illustration 9.2
            Standard time (or Allowed time) = 250 hours.
            Wages rate per hour                     = ¢15
Actual time taken                         = 220 hours

Bonus = 30 hrs    x 220 hrs x ¢15 = ¢396
250 hrs

Earnings = (220 hrs x ¢15) + ¢396 = ¢3,696


Advantages of Rowan Plan
1. Just like Halsey plan, it provides guaranteed minimum wages to workers.
2. It protects the employers against loose rate setting.
3. It pays a higher bonus than that under the Halsey plan up to 50% of the standard time saved.
4. The worker is not induced to rush through the work if time saved is more than 50% of the standard time, the bonus increases at a decreasing rate.
5. It provides good incentives for comparatively slow workers and beginners.

Disadvantage of Rowan Plan
1. The calculation of bonus is complicated and may not be easily understood by workers who may suspect the employers‟ motives.
2. In case of extra efficient workers, bonus is less than under Halsey Plan. This is true when the time saved is more than the time taken.

9.4.5.3  Comparison of Halsey Plan and Rowan Plan

1. Bonus. When time saved increases, bonus under Halsey Plan also keeps increasing. But under the Rowan Plan, when time saved increases, bonus increases only when time saved is up to 50% of the standard time allowed. Thereafter the amount of bonus begins to decline. Bonus under the two plans is the same when time saved is exactly 50%. Before 50% of standard time saved, bonus under Rowan Plan is higher than that of Halsey Plan and after 50% of the time saved, bonus under Rowan plan is lower than that of Halsey Plan. For example under Rowan plan, a person who has saved 60% of time allowed earns the same amount of bonus if he saves 40% of the time allowed.
2. Earnings per hour. Under both plans earnings per hour of workers keep on increasing. But the rates of earnings under the two plans differ. When time saved is less than 50% of time allowed , the rate of increase in per hour earnings is higher in Rowan Plan whereas when time saved is more than 50% of time allowed , the rate increase in per hour earnings is higher in Halsey Plan. At 50% time saved, earnings per hour under both schemes are the same.

3. Effect on labour cost. Labour cost per unit decreases as production increases up to the standard time allowed; thereafter, it continues to decrease but not at a faster rate.
Rowan plan cost per unit is higher than under Halsey Plan until time saved is 50% of time allowed .Thereafter it is lower and soon becomes significantly lower. At 50% time saved, labour cost per unit is the same under both plans.

9.5       Allowable deductions and reliefs
These are statutory deductions and others that are expected to be deducted from the gross salary of an employee at the end of a given period. In Ghana these deductions include the following:

a. Income Tax
b. 5% employee‟s Social Security Contributions
c. employees‟ provident fund
d. Any percentage contribution towards a Special retirement fund by an employee
e. Medical Insurance
f. Union/Senior Staff Dues or Welfare Fund Contributions
g. Repayment of Employees Advances or Loan from Employers
h. Hire Purchase Deductions
i. Others

The first two deductions (income tax and social security contribution) are compulsory in Ghana. However, the other deductions will depend on the regulations of the company in question and the employees own preferences.

9.6  Net Pay
This is the excess of the gross pay or salary over statutory deductions and income tax.
It is often called disposable income or “take home pay”.  It is the pay the worker actually takes home for a given period.

At the beginning of each Government fiscal year (1st January in the case of Ghana), the Minister of Finance presents the Budget to Parliament. In Nigeria, the President presents the Appropriation bill to the National assembly a few months before the commencement of a fiscal year (1st January). After due processes the bill is passed into law and becomes the Appropriation Act.

The budget statements contain the rates of income tax and any deductible reliefs for the following year. Due to the annual changes in rates and reliefs, the rates of income tax used in the computations in this book are for illustration purposes only. The calculation of income tax and net pay is as follows:
Income tax:
  ¢
Basic Salary  xxxxx
Add Other Cash allowances   xxxxx
Total Consolidated Salary  xxxxx
Less Statutory deductions and reliefs  xxxxx
Taxable Pay or Salary  xxxxx
Income Tax = (Taxable pay x rate of tax)
Net Pay:  xxxxx
Total Consolidated Salary  xxxxx
Less Statutory deductions  xxxxx
Taxable pay or salary  xxxxx
Income Tax  xxxxx
Net Pay or Salary  xxxxx

Illustration 9.3               
Mr Victor Kakapo has been in the employment of Pacheco Limited since January, 1 2005 on a salary scale of ¢50,000,000 per annum. For the year 2005 his entitlements were as follows:
  ¢
Inconvenience allowance  5,000,000
Leave allowance  3,000,000
Risk allowance  4,000,000

He is married with two children attending secondary schools in Ghana. He contributes to the social security scheme. He qualifies for the following reliefs:
  ¢
Marriage                                                        300,000
Child education         480,000
Aged dependent for two  400,000

You are required to calculate Mr. Victor Kakapo‟s Income tax and Net pay in 2005 using the income tax rates below.

 Income   Tax rate
 ¢
First      1,800,000 0 %
Next      1,800,000 5 %
Next      4,800,000 10 %
Next    27,600,000 15 %
Next    33,000,000 20 %
Exceeding    69,000,000
  28%
Computation of Mr. Victor Kakapo‟s Taxable Pay
¢ ¢
Basic Salary (2005)   50,000,000
Inconvenience allowance     5,000,000
Leave allowance     3,000,000
Risk allowance     4,000,000 Consolidated Salary  62,000,000
Less Statutory deductions & reliefs:
5% Social security    2,500,000
Marriage       300,000
Child education       480,000
Aged dependent        400,000     3,680,000
Taxable Pay   58,320,000




Computation of Mr. Victor Kakapo‟s Income Tax
 Income   Tax rate  Tax amount
 ¢   ¢
First      1,800,000 0%               -
Next      1,800,000 5%         90,000
Next      4,800,000 10%       480,000
Next    27,600,000 15%    4,140,000
Next    22,320,000 20%    4,464,000
Total    58,320,000    9,174,000
 


Therefore Victor Kakapo‟s Net Pay for 2005 is:

Basic Salary    50,000,000
Add Cash allowances   12,000,000 Total Consolidated Salary   62,000,000
Less:
5% Social security  2,500,000
Less Income tax
Net Pay or Salary


9.7  Accounting Entries

For the purpose of Accounting, the entries in the pay slips are passed in the general journal to record the payments made at the end of the given pay period.

1. When Liabilities/Expenses are due
• Debit Wages/Salaries Account with the Gross Salary.
• Credit Provident Fund Account.
• Credit Income Tax Account.
• Credit Medical Insurance Account
• Credit Union Dues Account
• Credit any Other Deduction Account
• Credit Payroll Payable Account with Net Salary or Wages.
• Credit 12.5% Employer‟s Social Security Fund Account
• Debit Employer‟s Social Security expenses Account (i.e. contribution)

2. When Expenses or Liabilities are Paid

• Debit provident fund account and credit Cash/Bank account with the amount paid • Debit Income tax account and credit cash/bank with the sum paid.
• Debit any other deduction account and credit cash/bank account with the amount paid.
• Debit payroll payable account and credit cash/bank account with the amount paid.
• Debit 12.5% Employer‟s Social Security Fund Account and credit cash or bank account with the amount paid.