Many employees have chosen to postpone using their allotted paid time off until pandemic-related safety concerns subside and COVID-19 restrictions are lifted. As a result, certain employers have seen an increase in accruals. The following guidance can help you evaluate if your company is required to report a liability for “compensated absences”—and how to estimate the proper amount if you are.
Compensated absences and the balance sheet
On a company’s balance sheet, accruals for compensated absences are classified as other liabilities. Under U.S. tax law, companies can’t deduct paid time off until it’s actually paid—so the liability created by compensated absences also creates a deferred tax asset which is equal to the accrual multiplied by the effective tax rate.
The following are classified as compensated absences:
- Paid holidays
- Paid sick leave
- Paid vacation
- Other forms of time off which are earned by employment
Conditions that require an accrual
You should review your company’s policies and procedures for paid time off before quantifying the liability for compensated absences. If your company allows employees to accumulate unused paid time off beyond the end of the year and use it in future years, you may be required to record a compensated absences accrual. You may also be required to record an accrual if your company provides vesting rights to accumulated paid time off balances and these vesting rights require payout after the termination of employment.
Under U.S. Generally Accepted Accounting Principles (GAAP), employers must accrue a liability for the right of an employee to receive compensation for a future absence if the following four conditions are met:
- The employee has earned the right to—but hasn’t yet taken—time off.
- The employee’s rights to paid time off accumulate or vest.
- It’s probable that employees will trigger payment in the future by exercising their right to time off.
- The amount of benefits the employee will receive can be reasonably estimated by the employer.
Applicable laws in the states and countries where your employees live must also be taken into account. These laws may supersede your company’s practices and policies in some cases.
Calculations for accrual
For hourly employees, the liability for compensated absences is equal to the hourly pay rate multiplied by the number of hours per day and the number of accumulated days off. The hourly rate also includes benefits and employer taxes incurred by the company while the employee isn’t at work.
For salaried employees, the calculation involves dividing annual compensation by the number of days worked per year to find the employee’s daily pay rate, then multiplying this amount by the accumulated days off. The initial figure used for annual compensation includes benefits and employer taxes.
Accrual must also be adjusted to account for the probability that an employee will fail to exercise their right to accumulated time off. Employers often use historical data on how employees have behaved in the past to support this adjustment.
Contact us for help
As the COVID-19 pandemic has led to mounting accruals for paid time off, accounting issues related to compensated absences have taken on a new urgency. Many companies want to avoid reporting higher liabilities, but when employees forego time off, it can often harm their well-being, leading to lower productivity and increased turnover.
Contact us today—we can assist you in complying with GAAP financial reporting requirements, and help you brainstorm ways to encourage your employees to maintain a healthy work-life balance.