Vacation and sick day accruals during the pandemic

By Mark P. Holtzman, CPA, Ph.D.

Working and living under COVID-19 restrictions, many employees have deferred vacation and sick days until restrictions are likely to be lifted, resulting in perhaps the greatest buildup of liabilities for compensated absences that we have ever seen.

Accountants and auditors this year need to take special care in computing, disclosing, and auditing liabilities for compensated absences. Furthermore, managers and the people who advise them must begin to think about the financial and operational costs of redeeming these liabilities.

Defining compensated absences

As they work, most employees earn the right to take days off for a variety of reasons, including vacation, illness, personal care, and family time. Employers’ policies may provide for accumulated rights that carry forward to future periods if they are not used in the current period. They may also provide for vested rights that create an obligation to pay for compensated absences even after terminating employment. Companies should take care that their policies are consistent with state and local regulations. Furthermore, companies with operations outside the United States must be mindful to follow the laws of the countries where their employees work.

FASB has labeled these days off as compensated absences. U.S. GAAP requires accruing a liability for the cost of these future absences when all the following conditions exist:

  • The employer’s obligation to pay for future absences arises from employees’ services already rendered;
  • The obligation relates to rights that vest or accumulate;
  • Payment of compensation is probable; and
  • The amount to be paid can be reasonably estimated (FASB ASC Paragraph 710-10-25-1).

This definition makes clear that a company with a “use it or lose it” policy for vacation or sick pay would not need to accrue a liability because their employees’ sick and vacation days do not vest or accumulate.

Entities do not necessarily account for vacation days in the same way as sick days; it is possible for a company to grant vesting rights for vacation days but not even accumulated rights for sick days. Sick days would be accrued if a company permits employees to bank these days and use them as compensated absences, i.e., they accumulate or vest.

The accrual for compensated absences should take into account the substance of the employer’s vacation and sick policies, rather than their form. When an employer’s past practices indicate that employees receive compensated absences above and beyond their legal rights and posted policies, the liability for compensated absences should encompass all reasonably estimable compensation likely to be paid, and not just those compensated absences that employees are legally entitled to.

Accruing for compensated absences

Accountants would best take a balance sheet approach toward accruing compensated absences, estimating the period-end liability and then adjusting the expense accordingly. To prepare an accrual, the accountant should multiply the current pay for each employee by the number of outstanding accumulated and vested absences at the end of the period. Exhibit 1 shows a practical spreadsheet layout for an entity with four employees, listing each employee in a separate row and populating columns for the number of outstanding sick days, the number of outstanding vacation days, and the current pay per day.

For hourly workers, the current pay per day would be computed as the hourly compensation rate on the date of accrual multiplied by the total number of hours to be compensated for one day. The hourly compensation rate should include the related cost of fringe benefits and employer taxes earned. For salaried workers who are paid by the year, divide the annual salary, including the cost of fringe benefits and employer taxes, by the average number of days worked each year.

FASB standards do not prescribe a rate for accruing compensated absences. Accountants can choose between the current rate or the likely compensation rate when the employee will redeem the vacation days, discounted to present value. For the sake of verifiability, many accountants use the current rate.

To compute the accrual for each employee, multiply the total number of days by the pay per day, as shown in Exhibit 1.

Exhibit 1: Spreadsheet format to compute accrual for compensated absences

When accruing a liability for compensated absences, accountants can use historical data and other projections to estimate the likelihood that these rights will be forfeited and discount the estimated liability accordingly. A historical record should indicate the extent to which employees are likely to let compensated absences lapse due to termination, or perhaps overachievement, and help accountants to estimate the compensated absences likely to lapse in the future.

The journal entry to accrue compensated absences would adjust the liability for vacation payable to the balance computed in the spreadsheet. For example, Exhibit 1 shows estimated vacation pay equal to $9,600. Suppose this company already has a liability for vacation payable equal to $6,000. The company would credit vacation pay for the difference, $3,600, with the corresponding debit going to salaries and wage expense, as seen below in Exhibit 2.

Exhibit 2: Debits and credits for compensated absences

In subsequent periods, the company would again estimate the total liability for vacation payable and then adjust the balance of this liability up to the value of the estimate, recording a corresponding debit to salaries and wage expense.

Compensated absences and deferred taxes

Since compensated absences are deductible when paid rather than when accrued, their accrual as a liability gives rise to a temporary difference, generating a deferred tax asset equal to the vacation payable times the effective tax rate. Per Accounting Standards Update 2015-17, Income Taxes: Balance Sheet Classification of Deferred Taxes, deferred tax assets and liabilities are classified as noncurrent.

In the above example, assume that the company has an effective tax rate of 25%. As part of its journal entry to adjust deferred tax assets and liabilities at the end of the period, the company should adjust its deferred tax asset for compensated absences to 25% of the total vacation pay, or $2,400.

Reporting and disclosing compensated absences

Accountants include the accrual for compensated absences with other current liabilities on the balance sheet. If the total liability is material, then it should be reported separately or disclosed in the notes to the financial statements. If the amount to be paid cannot be reasonably estimated (the fourth criteria above), then the company should disclose information about compensated absences in the notes to the financial statements, indicating that an accrual could not be recorded because the amount to be paid could not be reasonably estimated.

Exhibit 3 illustrates a disclosure by Acacia Diversified Holdings indicating that its liability cannot be reasonably estimated.

Exhibit 3: Compensated absences could not be estimated

Exhibit 4 illustrates a balance sheet excerpt reported by Item 9 Labs Corp. for the year ended Sept. 30, 2020, that reports accrued compensated absences separately from other current liabilities.

Exhibit 4: Reporting compensated absences as a separate line in the balance sheet

Exhibit 5 provides a disclosure by PRA Health Services of its accounting policy for accruing compensated absences.

Exhibit 5: Reporting accounting policy for compensated absences

Exhibit 6 provides a footnote disclosure by The Davey Tree Expert Company that includes accrued compensated absences as one item comprising accrued expenses.

Exhibit 6: Disclosing compensated absences as a component of accrued expenses

Sabbatical leaves

A sabbatical leave provides an employee with paid time off after working for an entity for a specified time period. If the purpose of the leave is to perform research or public service to benefit the employer, then the compensation is not attributable to services already rendered and requires no advance accrual. However, if the purpose of the leave is to provide compensated time off without restriction, then an accrual over the requisite service period is appropriate.

The COVID-19 environment

Studies show that during the COVID-19 pandemic, employees on average worked longer hours from home than in the past, essentially converting commuting time into additional work time. However, many of these hardworking employees are not seeing much appeal in a “staycation” at home — where they already do most of their work — or traveling during the pandemic. Instead, many of these employees are choosing to save accumulated and vested vacation and sick days for when travel restrictions are lifted. Anecdotally, compensated absences seem to be accruing at high rates.

For internal control purposes, many companies have mandatory vacation periods — these obviously would need to be taken within the required time frames. Employers that are accumulating significant liabilities should begin to plan for employees to redeem their compensated absences in a way that will not adversely affect operations.

The overriding concern, of course, is that state and local regulations be carefully followed. Managers should pay special attention and familiarize themselves with these regulations or hire experts to assure compliance. That said, employees benefit from vacation and family time in many ways. The quality of employee life helps to maintain employee morale and productivity, avoid unnecessary turnover, and attract the most talented employees. Furthermore, it is obviously important to maintain operations so that employee time off does not stymie production or impair the quality of customer service.

Employers must also consider the perception of fairness and transparency and avoid revising policies retrospectively except in favor of employees. And managers should certainly consider the preferences of employees. Whereas many companies in the past have dealt with doling out vacation time on an ad hoc basis, the COVID-19 buildup in compensated absences may require a more planned and deliberative approach toward balancing accumulated vacation and sick days with continued operations.

And needless to say, accountants who are anxiously anticipating their own vacations during the pandemic should keep in mind that it is 5 o’clock somewhere.

Mark P. Holtzman, CPA, Ph.D., is associate professor and chair of the Department of Accounting and Taxation at Seton Hall University, South Orange, N.J., and associate principal for quality control at Withum Smith + Brown PC. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA’s editorial director, at

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