ASC 710 describes the accounting for compensated absences, such as vacations, holidays, sick pay, and sabbaticals.

Excerpt from ASC 710-10-25-1

An employer shall accrue a liability for employees' compensation for future absences if all of the following conditions are met:

  1. The employer's obligation relating to employees' rights to receive compensation for future absences is attributable to employees' services already rendered.
  2. The obligation relates to rights that vest or accumulate. Vested rights are those for which the employer has an obligation to make payment even if an employee terminates; thus, they are not contingent on an employee's future service. Accumulate means that earned but unused rights to compensated absences may be carried forward to one or more periods subsequent to that in which they are earned, even though there may be a limit to the amount that can be carried forward.
  3. Payment of the compensation is probable.
  4. The amount can be reasonably estimated.

The estimated cost for compensated absences is recognized in the periods in which the benefits are earned, which would generally precede the date of vesting. ASC 710-10-25-2 provides an example in which a two-week vacation benefit vests at the beginning of the second year of employment with no pro rata payment in the event of termination during the first year. It indicates that the benefit should be considered earned for work performed in the first year (i.e., before vesting). The obligation recognized should consider estimated forfeitures due to turnover, if reasonably estimable. Unlike a pension or OPEB obligation, the resulting liability for compensated absences during employment is generally not discounted. However, if a client elects to discount their obligation, the expected future payments to be discounted should contemplate the rates of pay expected to be in effect when the payments are made.
The criterion in ASC 710-10-25-1(b) that the employer's obligation must relate to rights that vest or accumulate does not mean that vesting must have occurred before an accrual is recorded. Rather, if the employees' rights eventually vest, the liability should be accrued in the periods in which the employees provide service toward earning the benefit. Further, the requirement to accrue a liability for nonvesting rights to compensated absences, such as vacation pay or sick pay, depends on whether the unused rights expire at the end of the year in which they are earned or can be carried forward to succeeding years. If unused rights accumulate and are available in subsequent years, a liability should be accrued to the extent it is probable employees will be paid and the amount can be reasonably estimated, even if the right never vests (i.e., will become payable upon termination).

6.4.1 Vacation benefits that lapse

If the rights to any unused vacation time expire at the end of the fiscal year, then no accrual is necessary (i.e., the rights neither accumulate nor vest). However, when the vacation entitlement is based on the employee's anniversary date rather than the reporting entity's fiscal year end, vacation earned by employees from their anniversary date but unused as of the reporting entity’s fiscal year end should be accrued.
Question PEB 6-4 considers the accounting for a vacation policy under which employees vest in their full year allotment of vacation on the first day of the year.
Question PEB 6-4
Under PEB Corporation's vacation policy, employees fully vest in the current year's vacation on January 1 provided they have been employed during the prior year. If the employee leaves PEB Corporation during the year, the employee is entitled to a payout of the unused vacation on the employee's termination date. The employee must use the vacation during the current year and will lose any unused vacation at the end of the year (December 31). Should PEB Corporation accrue a liability as of December 31 for the cost of employees' vacation pay that vests on January 1?
PwC response
Yes. Under PEB Corporation's policy, vacation that vests on January 1 of year 2 is earned in year 1. Thus, PEB Corporation should accrue for that vacation during year 1 since all of the criteria of ASC 710-10-25-1 are met. This is consistent with the example in ASC 710-10-25-2.

Question PEB 6-5 considers the accounting for vacation pay that can be carried forward.
Question PEB 6-5
PEB Corporation's vacation policy allows employees to carry forward earned and untaken vacation for use in future periods. However, if an employee leaves PEB Corporation, they are not entitled to cash payment for earned but unused vacation. Should PEB Corporation record an accrual for earned but unused vacation?
PwC response
Yes. ASC 710 requires an accrual to be recorded for rights that vest or accumulate. The fact that employees will not be paid for unused vacation if they leave PEB Corporation means the rights do not vest. However, if vacation benefits can be carried forward to be used in future periods, then the rights accumulate. An accrual should be recorded to the extent compensated absences are earned and available for use in future periods. Some may question whether payment is "probable" in this fact pattern, as required by ASC 710. Probability of payment is not merely a function of whether a cash payment will be made to an employee upon departure but also includes a payment made when the employee is paid his or her regular salary during an absence (i.e., while on vacation). Appropriate estimates of forfeitures can be incorporated in calculating the accrual.

Example PEB 6-4 illustrates the accounting for a vacation pool.
Accounting for a vacation pool
PEB Corporation offers each employee the right to contribute unused vacation time to a "pool." Any vacation time employees do not use, or contribute to the pool, is forfeited at the end of the fiscal year. Time contributed to the pool expires after three years. Eligible employees may apply to draw time from the pool (i.e., take vacation), up to a limit of two weeks per year. A committee of PEB Corporation managers reviews each application, and if the applicant satisfies three criteria, the committee must grant the applicant's request to draw time from the pool. The criteria are (1) completing a minimum tenure at PEB Corporation, (2) exhausting all other paid time off, and (3) achieving a minimum annual performance rating. During the time off, a successful applicant receives his or her normal pay from PEB Corporation, the same as if the applicant were using his or her own vacation. If the applicant leaves PEB Corporation before using the granted time off, it is forfeited, will not be returned to the pool, and will not be paid in cash. PEB Corporation has operated this plan for a number of years as a means to provide employees greater flexibility in taking their vacation and has experienced a high level of utilization of the pooled vacation benefits.
Should PEB Corporation record a liability for vacation time contributed to the pool?
Yes. PEB Corporation should accrue a liability for the vacation pool because the benefits meet the criteria in ASC 710-10-25-1, Compensated Absences.
  • Payment of compensation for the pooled vacation is probable and reasonably estimable based on PEB Corporation’s historical experience. PEB Corporation’s ability to exercise discretion over granting time from the pool could affect the conclusion as to whether payment of compensation is probable and reasonably estimable. However, in this case, PEB Corporation's committee has no discretion to deny an application that meets the stated criteria.
  • The pooled vacation time is attributable to service employees rendered in a period prior to when it will be used (i.e., only earned but unused vacation can be contributed to the pool).
  • Although the pool of benefits do not vest (i.e., cannot be converted to cash), the benefits are carried forward from one fiscal year to the next and therefore are deemed to accumulate as described in ASC 710-10-25-1(b).
Accordingly, PEB Corporation should accrue a liability for the time contained in the pool at the balance sheet date, measured based on its estimate of the probable benefit payments.
If the employer has discretion to accept or reject applications based on subjective factors, accrual may not be appropriate until the discretion is exercised. The employer’s past practice and all other relevant facts and circumstances should be considered before determining that an accrual should not be made.

Example PEB 6-5 illustrates the accounting for vacation at interim dates.
Accounting for vacation at interim dates
Under PEB Corporation's vacation policy, employees earn their current year's vacation as they provide service during the year and must use the vacation during the current year or will lose any unused amounts at the end of the year (December 31).
Should PEB Corporation record an accrual for the cost of employees' vacation at interim balance sheet dates?
The vacation benefits provided by PEB Corporations’ policy do not meet the criteria in ASC 710-10-25-1 as the rights do not vest or accumulate. Therefore, PEB Corporation would not accrue a liability for these benefits as of year end. These types of plans are often referred to as “use it or lose it” plans.
Based on the general principles of ASC 270-10-45-1 that the usefulness of interim information rests on the relationship that it has to the annual results of operations, typically, no accrual at an interim balance sheet date will be required in this situation. Specifically, each interim period would be viewed primarily as an integral part of an annual period and can follow the same accounting policies that are used at year end. However, it would also be acceptable to record an accrual as of an interim period based on ASC 270-10-45-7(b) for an estimated expenditure (such as vacation pay) to be made in a later interim period within the same fiscal year.
If, however, the vacation entitlement is based on the employee's anniversary date rather than PEB Corporation's fiscal year end, an accrual for vacation pay is necessary at each interim and annual reporting date reflecting the accumulated vacation time as of the reporting date that can be utilized in a subsequent interim or annual period.

6.4.2 Sick pay benefits

ASC 710-10-25-7 states that an employer is not required to accrue a liability for nonvesting accumulating rights to receive sick pay benefits. In developing ASC 710, the FASB concluded that estimates of future sick pay would be too unreliable and too costly to develop to justify such a requirement. In addition, the Board observed that it would be unlikely that probable payments would be material unless the rights to sick pay vest or are otherwise payable without an illness-related absence. In those cases (i.e., if employees are (a) allowed to take vested accumulated unused sick pay benefits before retirement or (b) routinely paid sick pay benefits without an illness-related absence) a liability should be accrued. ASC 710 does not prohibit an employer from accruing a liability for nonvesting accumulating sick pay benefits, provided the criteria of ASC 710-10-25-1 are met. The way an employer actually administers sick pay benefits should determine the appropriate accounting, regardless of the form of an employer's policy.
The discussion of sick pay in the guidance contemplates a policy that provides pay for occasional sick days (that is, absences that occur for a limited time and on an irregular basis as a result of sickness or similar conditions). Occasional sick days would exclude extended periods of continuous absence due to sickness (e.g., absences spanning several weeks or more at a time). In addition, the number of days covered by an employer's plan for occasional sick days cannot exceed the total number of days that a person would normally be absent in any given year for periodic illnesses. For example, if an employer compensates employees for up to 15 sick days a year, the accounting for those benefits would be covered by ASC 710-10-25-7 because the arrangement involves benefits for occasional sick days. Thus, an employer in that situation has a choice of either accruing or not accruing a liability for nonvesting accumulating sick pay. On the other hand, if an employer compensates employees for up to six months of sick days a year, that arrangement would provide benefits for more than occasional sick days, and would not be covered by the exception in ASC 710-10-25-6, even if the plan describes the benefit as sick pay. Judgment is needed to determine whether the terms of a plan provide benefits for occasional sick days or something more.
Example PEB 6-6 illustrates the application of the exception to recognition of a liability for a plan that provides benefits for occasional sick days.
Exception from recognition of a liability for a plan that provides benefits for occasional sick days
PEB Corporation provides employees with sick pay benefits for ten sick days per year. Any unused sick days can be carried forward and used for absences caused by illness in subsequent years (they accumulate). However, employees forfeit all unused sick days when they leave PEB Corporation (they do not vest). PEB Corporation does not recognize a liability for nonvesting accumulating sick pay benefits under the exception in ASC 710-10-25-7.
The value of accumulated unused sick days has grown to a significant amount that is material to PEB Corporation's financial statements. Most of the employees now have available accumulated unused sick days that far exceed the number of days an individual would normally be absent in a given year for periodic illnesses. For example, some have as many as 180 days available to them and could take those days all in one year if needed for health-related absences.
Is it appropriate for PEB Corporation to continue to apply the exception in ASC 710-10-25-7?
Yes. Even though the number of available sick days exceeds what would be deemed to be occasional sick days, the unused sick days accumulated under a plan that provides benefits each year for occasional sick days. Thus, the plan continues to qualify for the exception in ASC 710-10-25-7, and PEB Corporation is not required to accrue a liability. The fact that employees have not used all of their sick days and the unrecorded liability for accumulated sick days could be considered to be more akin to a short-term disability plan, which would not qualify for the exception, does not change the nature of the underlying plan from one under which employees earn the right to receive benefits for occasional sick days.

6.4.3 Sabbaticals

ASC 710-10-25-4 states that the appropriate accounting for a sabbatical leave depends on its purpose. If the leave is granted to perform some service to benefit the employer, the compensation is not attributable to services already rendered and a liability should not be accrued. However, a liability should be accrued over the service period required to earn a sabbatical if the leave is granted to provide compensated unrestricted time off for past service and the other accrual conditions are met.
Compensation expense and a liability should be recorded over the period of time the service entitling the employee to the future compensated absence is rendered. If, through the adoption or amendment of a policy, the employee is entitled to additional compensated absences for past services, the expense should be recognized in the period the policy is adopted or amended.
Question PEB 6-6 considers the accounting for a sabbatical.
Question PEB 6-6
An employer provides an employee with a right to a one-year compensated sabbatical after rendering five years of service. The employee is not required to perform any direct or indirect services for or on behalf of the employer during the sabbatical. Does the right to the sabbatical accumulate?
PwC response
Yes. As described in ASC 710-10-25-5, an employee's right to a compensated absence under a sabbatical (a) that requires the completion of a minimum service period and (b) for which the benefit does not increase with additional years of service, is considered accumulating pursuant to ASC 710-10-25-1. Therefore, assuming all of the other conditions of ASC 710-10-25-1 are met, the compensation cost associated with the sabbatical should be accrued over the requisite service period.
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