Compensated Absence Accounting - Overview
A compensated absence is employee time off with pay, which can arise in such situations as sick leave, holidays, vacations, and jury duty. To account for compensated absences, it is not necessary to separately recognize them when they are earned and used within the same period, since it is typically rolled into the general compensation expense. However, they must be charged to expense and recorded as a liability when they are earned and their use is deferred to a later period.
An employer should accrue a liability for compensated absences payable to employees for their future absences, but only if all of the following conditions are met:
- The payment obligation for future absences is based on employee services already rendered
- The amount of the obligation can be reasonably estimated
- Payment is probable
- The obligation is for employee rights that vest or accumulate
When calculating the amount of the accrual, you can factor in the amount of anticipated forfeitures. Also, you should record the accrual in the year in which employees earn the compensation. If the cost associated with an expected compensated absence is immaterial, as is typically the case with jury duty compensation, it is not necessary to accrue the expense in advance; instead, these costs are charged to expense as incurred, and should have no notable effect on the income statement.
If a compensated absence has non-vesting rights and the rights expire at the end of the year in which they are earned, then you do not have to accrue a liability for future absences, since there may never be a related payout to an employee.
Compensated Absence Accounting - Examples
Example 1: The accrued vacation policy of Hostetler Corporation is to grant employees the vested right to two weeks of paid vacation at the beginning of their second year with the company. If they are terminated or leave the company at any time before the day on which the vesting occurs, Hostetler does not compensate them for any portion of the vacation time.
Despite the absence of vesting during the first year of employment, the vacation accrual is essentially earned by employees during their first year, so Hostetler should accrue the related compensation expense during the first year, less an allowance for forfeitures caused by turnover.
Example 2: Hostetler Corporation pays its employees 50 percent of their normal compensation if they are called for active military duty, and for the entire period of their military service. However, if they are not called for duty, then the benefit expires. Since the right expires, Hostetler should not accrue for this type of compensated absence.