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 your chart of accounts to map leave liability and expense general ledger (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):
- Annual holidays;
- Alternative leave;
- Holiday pay 8%.
The payroll system will classify a leave category as a liability 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:
Step 1: Assign a liability account
This could be a generic leave liability account or a liability account specific to a leave category (this depends on how your GL has been set up which sits outside of payroll).
Step 2: Assign an expense account
If you have assigned a liability account against a leave category, you must also assign an expense account.
Step 3: Split by location
Tick this setting if you want the journals to split the associated $ liability and expense by location rather than lumped as one amount/entry. You can only select this option once you have assigned both a liability and expense account to the 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.
For both steps 1 and 2, if a liability and/or expense account does not appear 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 connected (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 manually adding the GL accounts.
An example of setting up the leave provisions in the chart of accounts is as follows:
If there is no liability or expense account assigned to a leave category this simply means that there will be no journal entries to reflect any pay run movements for that leave category.
Leave provisions can also be configured in the 'Location Specific Accounts' section of the chart of accounts. Further information on location specific accounts can be accessed here.
What appears in the journal?
Leave provision entries will appear in a journal when either of the following scenario occurs in a pay run for a mapped leave category:
- When leave has accrued and/or leave entitlement has kicked in;
- When an employee's pay rate changes;
- When a leave adjustment (positive or negative) has been processed;
- When leave and/or 8% holiday pay is paid out on termination;
- When an employee takes leave;
- Any scenario that affects an employee's average weekly earnings, ordinary weekly pay, relevant daily pay or average daily pay, including but not limited to:
- Increase/decrease in employee's rate of pay
- Change to employe's work pattern
- Extra earnings paid such as bonus, commission
Following are examples that provide further detail on the scenarios listed above.
Scenario 1: Employee leave entitlement kicks in
When an employee reaches their leave entitlement date, 4 weeks of annual holidays will accrue in the pay run as follows:
The corresponding journal transaction lines for the annual holiday entitlement will appear as follows:
As this entitlement increases a business' liability, the journal will debit the leave expense and credit the leave liability.
The same principle applies where leave is accrued manually in the pay run, ie using the Actions > Accrue Leave pay run action.
You will also note that in this scenario an additional journal entry will appear to reverse the 8% holiday pay that has been accruing during the employee's leave year period and would otherwise have been paid out to the employee had their employment terminated prior to the annual holidays entitlement kicking in. As the employee's new leave year has commenced the 8% holiday year accruing for the prior leave year now needs to be wiped from the liability. The journal transaction lines for the reversal of the 8% holiday pay accrual will appear as follows:
Scenario 2: Employee takes leave
When an employee takes leave, for eg annual holidays, this is processed in the pay run as follows:
As this action reduces a business' liability, the journal will debit the leave liability and credit the leave expense.
The same principle applies where leave is paid out to an employee on termination of employment.
Scenario 3: Leave adjustment applied in the pay run
In circumstances where an employee's leave balance has to be adjusted using the Actions > Adjust Leave pay run action (for eg incorrect leave category was applied in a previous pay run and this needs to be corrected), the journal entries will reflect these transactions accordingly.
Where a positive leave adjustment is processed (refer to image below), this will increase the employee's leave balance as well as the business' liability.
As such, the journal will entry will debit the leave expense and credit the leave liability, as follows:
Where a negative leave adjustment is processed (refer to image below), this will reduce the employee's leave balance as well as the business' liability.
As such, the journal will entry will debit the leave liability and credit the leave expense, as follows:
N.B. When an employee's leave entitlement kicks in, you will notice that the system will automatically process a positive and negative leave adjustment in that same pay run, as follows:
This is only relevant to businesses using the Annual Holidays leave category made available by default when the business was created, and is a result of the carry over rules configured for the Annual Holidays leave category, which are as follows:
The net result of this system adjustment however is that the employee's leave balance is not affected at all. As such, there will be no journal entry reflecting this type of adjustment.
Scenario 4: Paying out 8% holiday pay upon termination
Where an employee's employment is terminated mid-leave year, the accrued 8% holiday pay must also be paid out. An example of this in the pay run is as follows:
As this payout has reduced the business' holiday pay liability, the journal will debit the leave liability and credit the leave expense.
Scenario 5: Changes to AWE, OWP, RDP or ADP
As stated above, there are many factors that changes the rate of pay applied when paying an employee leave upon taken the leave or upon termination. When each pay run is finalised, the system recalculates affected employees' AWE, OWP & ADP values and an adjustment journal entry is added to account for the difference.
At an individual employee level, the system will look at the leave calculation method option configured in the employee's file. Specifically, this is managed from the employee's Pay Rates screen, under 'Leave Pay Rates'. For a breakdown of each calculation method please see this article.
As an example, if an employee's day based leave is calculated using the ADP method and circumstances have resulted in the rate of pay changing following a finalised pay run, a pay adjustment entry will appear in the journal to indicate as such. Where an employee's ADP rate has increased, the business' liability also increases so the journal entry will debit the leave expense and credit the leave liability, as follows:
If, on the other hand, an employee's ADP rate has decreased so to will the business' liability. Therefore, the journal entry will debit the leave liability and credit the leave expense.
Alternatively, where an employee's day based leave is calculated using the RDP method and the employee's base rate of pay increases/decreases, a pay adjustment entry will appear in the journal to indicate as such. The general formula looks at the new rate vs the old rate and multiples the difference by the employee's leave balance as at the start of the pay period.
Where an employee's ADP rate has increased, the business' liability also increases so the journal entry will debit the leave expense and credit the leave liability, as follows:
In the above example, the employee's annual salary changed from $89,000 to $92,000 and works a 25 hour week. Additionally, the employee has an alternative holiday leave balance of 2 days and works a 5 hour day. As such the $23.08 amount has been calculated as follows:
- $92,000 - $89,000 = $3,000
- $3,000 / 52 weeks / 25 hours = $2.30769, ie the difference in hourly rate
- $2.30769 x 2 days x 5 hours = $23.0769 or $23.08 (rounded to 2 decimal places)
If, on the other hand, an employee's RDP rate has decreased so to will the business' liability. Therefore, the journal entry will debit the leave liability and credit the leave expense.
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 the business' leave liabilities.
To do this, generate a Leave Liability report as at the date of the last pay period end date. Ensure the report is grouped by 'Employee Default Location' and the 'Include Approved Leave' 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.
N.B. At this stage the leave liability report (LLR) does not factor in any public holiday payment owing to an employee on termination that is factored in when calculating the employee's final 8% holiday pay. As such, there may be scenarios where the LLR will vary from the pay run calculations.
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