Accrued vacation pay is the amount of vacation time that an employee has earned as per a company's employee benefit policy, but which has not yet been used or paid. This is a liability for the employer. The following discussion of accounting for accrued vacation pay can also be applied to holiday pay. The calculation of accrued vacation pay for each employee is:
Calculate the amount of vacation time earned through the beginning of the accounting period. This should be a roll-forward balance from the preceding period. This information can be maintained in a database or electronic spreadsheet.
Add the number of hours earned in the current accounting period.
Subtract the number of vacation hours used in the current period.
If the amount already accrued for the employee from the preceding period is lower than the correct accrual, then record the difference as an addition to the accrued liability. If the amount already accrued from the preceding period is higher than the correct accrual, then record the difference as a reduction of the accrued liability.
Example of Accrued Vacation Pay
For example, there is already an existing accrued balance of 40 hours of unused vacation time for Fred Smith on the books of ABC International. In the most recent month that has just ended, Fred accrued an additional five hours of vacation time (since he is entitled to 60 hours of accrued vacation time per year, and 60 / 12 = five hours per month). He also used three hours of vacation time during the month. This means that, as of the end of the month, ABC should have accrued a total of 42 hours of vacation time for him (40 hours existing balance + 5 hours additional accrual - 3 hours used).
Fred is paid $30 per hour, so his total vacation accrual should be $1,260 (42 hours x $30/hour). The beginning balance for him is $1,200 (40 hours x $30/hour), so ABC accrues an additional $60 of vacation liability.
Use it or Lose it Policy
What if a company has a "use it or lose it" policy? This means that employees must use their vacation time by a certain date (such as the end of the year), and can only carry forward a small number of hours (if any) into the next year. One issue is that this policy may be illegal, since vacation is an earned benefit that cannot be taken away (which depends on the law in each state). If this policy is considered to be legal, then it is acceptable to reduce the accrual as of the date when employees are supposed to have used their accrued vacation, thereby reflecting the reduced liability to the company as represented by the number of vacation hours that employees have lost.
Pay Raise Effects
What if an employee receives a pay raise? Then you need to increase the amount of his entire vacation accrual by the incremental amount of the pay raise. This is because, if the employee were to leave the company and be paid all of his unused vacation pay, he would be paid at his most recent pay rate. If a company awards pay raises to all employees during the same time period in each year, this can result in a sudden jump in the vacation expense accrual.
There may be situations where a sabbatical leave is granted so that an employee can perform public service or research that benefits the employer in some manner. In this situation, the compensation paid to the employee is not related to prior services rendered, and so should not be accrued in advance. In the more likely event that a sabbatical is based on prior services rendered, the employer should accrue the cost of the sabbatical during the required service period.