Accounting for Accrued Vacation – US GAAP Rules

Accrued vacations are entitled absence payments to an employee from the employer when certain conditions are fulfilled. An employer may adopt a certain compensation policy that includes compensated absence.

ASC 710 provides guidelines on the accounting treatment of compensated vacations and the accrued liability for an employer.

Let us discuss how an employer can account for the accrual liability of compensated vacations.

Accrued Vacations – Compensated Absence

Accrued benefits refer to the benefits earned by an employee during the service for an employer but not yet paid. An employer pays these benefits at a specific date after an employee fulfills certain conditions.

Compensated absence or paid vacations are a common form of accrued benefits. Employers entitle their employees to paid vacations. They can include certain terms and conditions such as a specific number of paid leaves, sick leave days, compensated absence in certain conditions, and so on.

An employer needs to accrue the liability and record an expense for the accrued liability of compensated benefits. US GAAP rules provide certain guidelines to employers for the accounting treatment of compensated benefits and vacations.

Accounting for Accrued Compensated Vacations

Compensated vacations may refer to paid holidays, paid vacations, and paid sick leave by an employer for its employees. These benefits are not paid immediately in cash. Usually, an employer has to accrue these benefits and pay an employee at the time of completion of a job contract or retirement from services.

ASC 710 guides on the accounting treatment of compensation vacations. An employer will need to accrue the compensated vacations if the following conditions are fulfilled.

  • The employer’s obligation regarding the employee’s right to receive future compensation is attributable to previously rendered services.
  • The payment to the employee is probable.
  • The payment can be estimated reasonably.
  • The employer’s obligation relates to the employee’s rights that vest or accumulate.

An employer must consider a few points when accounting for compensated benefits. The use of probability largely depends on the professional judgment of the employer.

Similarly, an employer needs to record the compensation when an employee’s rights vest or accumulate. Vesting refers to the entitlement of rights even when an employee is no longer associated with the employer. Accumulated rights are earned but unspent.

The employer will record the estimated costs of benefits in the accounting period in a period when they are earned. The accumulated benefits should be discounted for using a rate that is probable for the employer at the time of an employee’s retirement or when the payment is made.

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How to Calculate Compensated Vacations?

An employer can use any template to calculate the compensated vacations. Generally, an employer can the following steps to calculate the compensated vacations of an employee.

  • Calculate the employees’ compensated vacations for the first period. An employer can use a manual or electronic record-keeping method to record compensated earned vacations.
  • Add and record the total number of work hours earned as compensated vacations.
  • Deduct and record any used compensated vacations. For instance, an employee uses 2 off days as paid sick leave according to the employer’s policy.
  • Calculate the total work hours by using the current work hour rate offered by the employer. It should give the total accrual amount to be recorded.
  • The difference in the accrued amount from the previous accounting period should be adjusted for in the books.

An employer should adjust the differences in calculations of the accrual benefits. If the actual accrual and the calculated accrual amounts differ, then adjust with an adjusting credit or debit entry to the accumulated accrual benefits account.

Vesting and Accrual

Vesting and accrual are important concepts in accounting for the compensated benefits of employees.

Basically, vesting refers to a situation when an employer needs to pay for compensated benefits to an employee even after an employee is no longer associated with the employer. When an employee has the right to unused compensated vacations, the employee’s rights are said to vest.

Vested rights may appear in several cases. For example, if an employee was entitled to 15 paid vacations for one year. The employee had a five years job contract. During the contract, the employee used only 30 out of the 75 entitled vacations.

At contract expiry, even when the employee no longer remains associated with the employer, the vesting rights exist. Thus, an employer should account for the compensated vacations yearly.

The accrual of compensated vacation depends on whether the employee’s rights are vesting or non-vesting. If an employee’s rights are non-vesting, the employer does not require to accrue the liability year-on-year basis.

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Conversely, if the rights are vesting, an employer must accrue the liability. If all or a proportion of compensated benefits is unused and the rights accumulate for the subsequent years, an employer must accrue the liability.

The accrual of vesting rights should be done in a way that the employees’ compensation becomes probable. The amount increases over the years and is adjusted for using an appropriate discounting rate. The amount should be reasonably estimated as well.

Important Types of Compensated Vacations

Compensated vacations can be of different types depending on the policy and contracts made by the employer.

Let us briefly discuss a few commonly used compensated vacation types and the accounting treatment for them.

Sick Leave

ASC 710 states that an employer must account for the accrual liability arising due to accumulated sick leave if the employees’ rights are vesting.

An employer should accrue a liability for sick leave accounting if:

  • Employees are allowed to take vested accumulated sick unpaid leave until retirement. It means if the unused sick leaves are accumulated and carried forwarded by the employer.
  • Employees are paid for sick leave routinely.

ASC 710-10-25-7 states that an employer does not require to accrue a liability for compensated benefits if employees’ rights are non-vesting. In such scenarios, the employer would be unable to make reasonable estimates of future sick pay leave costs.

Sabbaticals

Sabbatical leave is separate from annual paid or unpaid leave for an employee. Sabbatical leave can be offered by an employer with specific conditions such as after completion of service for a minimum (say five years).

ASC 710-10-25-4 states that the accounting treatment of sabbatical leave largely depends on the purpose of the leave. If an employee avails sabbatical leave for an extended time to perform additional duties for an employer, it should not be accounted for under ASC 710 regulations.

Conversely, if an employee takes a sabbatical leave for personal reasons, the employer should accrue a liability. The employer should accrue a liability over years if the policy is to grant extended leave as a sabbatical for unrestrictive time off the work.

An employer would record a compensation expense and a compensation liability over the period of service that entitles an employee to future compensated sabbatical leave. If the employer adopts or amends a sabbatical policy that entitles the employee to additional compensation, the employer should record the changes in the accounting period when the policy is adopted or amended.

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Other Types of Paid absence

The accounting treatment of all other types of paid vacations would largely depend on the employer’s leave policy. For example, an employer may offer additional off days to its employees for certain tasks such as jury duty, participation in a welfare project, etc.

ASC 710 does not offer clear directions on the accounting for medical, insurance, and non-monetary compensation plans. However, an employer may adopt the same policy for these compensations as per guidelines of ASC 710 for other types of leaves.

Deferred Compensation Contracts

The aggregated compensation payment plans that are equal to pension plans are accounted for under the ASC 715 rules. Other deferred employees’ compensation contracts are accounted for under ASC 710 guidelines.

An employee’s contract will largely dictate the accounting treatment of the deferred compensation plan. The accrual of the plan amount should be attributed all over the employee’s service tenure until contract terms are fully met.

ASC 710 states that the accrued amount of the deferred payment plan should not be less than the present value of the compensation payment.

A few key points regarding the deferred payment plans include the following.

  • An employer will accrue only the amount attributable to the current portion of an employee’s service.
  • An employee entitled to deferred compensation must fulfill the service obligations as specified in the contract. These obligations can include:
    • Availability for service
    • Completion of service
    • Specified conditions such as an agreement not to compete post-retirement
    • Privacy and secrecy contracts, and so on.
  • The employer will amortize the deferred payment liability from the date the job contract is signed to the date of termination of the contract.

Deferred payment plans may also include conditions for a lump sum or periodic payments. Also, an employee may entitle another person in case of death during service.

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