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.
EXAMPLE PEB 6-4
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?
Analysis
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.
EXAMPLE PEB 6-5
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?
Analysis
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.