Leave Accrual

A fundamental misunderstanding exists regarding when entities should recognise leave expenses. Many organisations believe accrual is necessary only when unused leave can be converted to cash upon employee departure. This is not the case. Leave accruals affect the financial statements directly, and understanding when they arise is an important part of financial statements preparation.

An Illustration

Consider an entity paying an employee $25,000 annually across 260 workdays, with 10 days of accumulating paid annual leave entitlement. If the employee takes no leave in Year 1 but uses 20 days (10 carried forward plus 10 from the current year) in Year 2, how should the service value be allocated?

The daily service value equals $100 ($25,000 divided by 250 working days). Year 1 service value is $26,000, creating a $1,000 excess that should be accrued. This approach applies regardless of whether the leave is vesting.

What does IAS 19 say about leave accrual?

IAS 19 Employee Benefits addresses this requirement:

An entity shall recognise the expected cost of short-term employee benefits in the form of paid absences during the period when employees render service that increases their entitlements.

The standard distinguishes between:

• Accumulating paid absences — carried forward to future periods and require accrual, whether vesting or non-vesting.
• Non-accumulating paid absences — lapse if unused and are recognised when absences occur.

What is the difference between accumulating and non-accumulating leave?

Accumulating absences carry forward if the current period entitlement is not fully used. Non-accumulating absences do not carry forward and provide no cash payment for unused entitlement. Typical examples include sick pay, maternity leave, and jury service.

There is an important complexity here. When leave periods differ from accounting periods, non-accumulating leave may become accumulating. For example, consider a calendar-year leave period with a 31 March accounting year-end. Sick leave that would ordinarily lapse at calendar year-end has not yet lapsed at the reporting date. Employees still have a future entitlement, and the leave should be accrued as at 31 March.

Should the full outstanding leave balance be accrued?

While common practice accrues the total outstanding leave balance, this is not technically correct. The standard requires measurement at expected cost, meaning accrual is appropriate only for the portion of leave anticipated to be used or encashed. Full accrual applies only when leave is vesting in its entirety.

Key Takeaways

1. Accrue for accumulating paid leave regardless of whether cash payment is available on departure.
2. Accrue only the portion expected to be utilised or encashed.
3. Leave that does not ordinarily carry forward may still be accumulating if accounting and leave periods are misaligned.