How to set up the provision for leave liabilities in your payroll journal

Many businesses using an accrual based accounting system prefer to keep up to date figures on leave liabilities without having to manually calculate and journal these figures into their Balance Sheet. To automate this process, you can configure the Chart of Accounts to map leave liability and expense GL accounts. Once mapped, your payroll journals will then include the associated cost of any leave liabilities on a per pay run basis.   

What are leave liabilities?

Leave liabilities are any leave types that must be paid out to an employee upon termination. Examples include (but are not limited to):

1. Annual leave;
2. Time in Lieu/RDO;
3. Long Service Leave (in specific cases - more detail provided further below).

The payroll system will treat a leave category as a liability, for Chart of Account purposes, where the leave category setting 'Exclude from termination payout' is unticked. As such, and as a starting point to setting up leave liability provisions, ensure that all the leave categories set up in your business have this setting correctly applied.

Setting up Chart of Accounts

To configure the leave provisions, go to Payroll Settings > Chart of Accounts. Click on 'Leave Provisions' from the  Primary Accounts section to expand the details. For any leave category you want tracked in the journal, complete as follows:

1. Assign a liability account: this could be a generic leave liability account or a liability account specific to a leave category (and this depends on how your GLs have been set up which sit outside of payroll). If the liability account(s) are not appearing in the dropdown list this means they have not been brought across from the accounting platform or they have not been manually added to the payroll platform. Depending on the journal service you have linked (ie whether it is API based or a file export based journal) you will see either 'Import Accounts' or 'Manage Accounts'  on the top right hand side of the screen. Click on this button to then follow the process of importing the relevant GL accounts from your accounting platform or to manually add the GL accounts.
2. Assign an expense account: If you have assigned a liability account against a leave category, you must also assign an expense account.
3. Accrue from contingent period: This setting is only relevant (and activated) for leave categories that have the Leave Category Type setting assigned to 'Long Service Leave'. This setting then requires the user to set a 'Standard Contingent Period' and 'Standard Entitlement Period'. With regards to long service leave, the contingent period is that period before an employee's entitlement period where, upon termination, the employee can still be paid out their accrued entitlement based on certain circumstances. By default, if the 'Accrue from Contingent Period' is not ticked the liability for long service leave will only start appearing in journals for employees that have reached their entitlement period. Ticking that setting means the liabilities will start appearing sooner but only once the employee has reached their contingent period (which is based off their start date).
4. Split by location: Tick this setting if you want the journals to split the associated liability and expense by location rather than appear as one lump sum amount. This setting only works if you have assigned a liability and expense account to a leave category. N.B. The employee's primary location will be the location used to assign the leave provisions, not the location where the employee worked. 

An example of setting up the leave provisions in the Chart of Accounts is as follows:

The leave provisions settings can also be configured in the 'Location Specific Accounts' section of the Chart of Accounts screen. N.B. If you have Location Specific Accounts set up and wish to 'Accrue from contingent period' you will need to ensure this option is ticked for all locations where the employees work.

Generating the journal

Journal entries for leave provisions will appear in a journal when either of the following scenario occurs:

• When leave is accrued for a leave category that has been mapped in the Chart of Accounts;
• When leave is taken using a leave category that has been mapped in the Chart of Accounts;
• When an employee's pay rate changes;
• When a leave adjustment has occurred using a leave category that has been mapped in the Chart of Accounts;
• When leave is paid out upon termination for a leave category that has been mapped in the Chart of Accounts.

Now, assuming that the annual leave category has been mapped in the Chart of Accounts and an employee's pay for the pay period is as follows:

The corresponding journal transaction lines for the accrued annual leave provisions will appear as follows:

The amount is calculated by multiplying the employee's (base) pay rate x the number of annual leave hours accrued in the pay run. N.B. If an employee was also entitled to annual leave loading, the dollar value of the loading component will also be added to the provision amount.

Now say the employee took annual leave during the pay period:

The leave provisions for the employee will appear as per below. The leave taken reduces the liability and is classed as a debit, rather than a credit. 

N.B. When salary sacrifice deductions are processed in a pay run, this amount will be deducted from the highest wage expense and allocated to super in the journal. In the instance an employee has taken paid leave for the entire pay run the salary sacrifice will deduct this amount from the leave category and allocate to super, in effect reducing the leave expense.

How are pay adjustments managed in the journal?

When an employee's pay has been adjusted (be it an increase or decrease), an adjustment transaction line will appear in the journal for any leave category that has been mapped to the Chart of Accounts.

The amount is calculated as the difference between the new rate vs the old rate multiplied by the employee's leave balance as at the start of the pay period. For eg, an employee's pay increased from $20 per hour to $25 per hour and at the start of the pay run the employee had an annual leave balance of 20 hours. Any leave accrued in the pay run will be calculated at the new hourly rate so the adjustment line in the journal will only deal with the leave balance prior to the pay run. 

The $100 is the result of multiplying the 20 hours balance by the difference of $5 per hour. On the reverse side, if an employee's pay was reduced from $25 to $20 per hour, the amount will still appear as $100 however as the rate reduction has reduced the leave liability, the liability amount will appear as a debit rather than a credit.

Migrating existing leave provisions in your financials

This section applies to businesses who have already been processing pay runs and have never tracked leave provisions in their balance sheet but want to start now. Remember that the above functionality only tracks leave activities on a per pay run basis. This means you will need to manually journal existing liabilities in your accounting platform in order to get a full picture of any leave liabilities of the business.

To do this, generate a Leave Balances report as at the date of the last pay period end date. Ensure the report is grouped by 'Employee Default Location' and the 'Hide Leave Values' setting is unticked. Export the report in excel or csv - this will provide you the current dollar value of all leave liabilities against each location. Use this data to then transfer to your accounting platform.

A special note regarding long service leave: if you want to track long service leave take note of whether you want to apply it from the contingent or entitlement period. Then, make sure you only record the liabilities for the employees that have reached either their contingent or entitlement period (depending on what period setting you have applied).

If you have any questions or feedback please let us know via support@yourpayroll.com.