Here are some thoughts from the AccountingCoach...
Paid vacations and paid holidays are fringe benefits earned by employees. They can be considered as part of the pay package. (In other words, employees often work for lower hourly pay rates because the fringe benefits are greater than another employer's benefits.) If an employee earns 10 paid vacation days plus 10 paid holidays each year, the employee is earning 20 days off with pay because she or he is working the other 240 days (5 days per week times 52 weeks = 260 days minus 20 days off). Just as the employee is earning those paid vacation days and holidays when working, the employer is incurring the expense and the liability for the paid vacation days and holidays when the employee is working.
Companies following the accrual-basis of accounting, must be certain that their accounting and financial statements follow the matching principle. This means that expenses and liabilities should be recorded and reported when the company incurs them, not when the company pays them.
I suggest that the holiday and vacation pay be recorded as an expense and liability (remember double-entry) whenever wages are recorded for work performed. Using the example above, the amount to be recorded would be 8.333% (20 days divided by 240 days) of the wages earned when working. In a week when an employee works 40 hours at $10 per hour, there would be an additional journal entry made to debit Vacation & Holiday Expense for $33.33 ($400 X 8.333%) and to credit Vacation & Holiday Payable (or Liability) for $33.33. When an employee enjoys a paid holiday and therefore works only 32 hours during that work week, the accounting would include a debit to Wages Expense $320 and a debit to Vacation & Holiday Payable $80 (the credits would be the normal withholdings and net pay that occur every week). Note that the liability was reduced by the holiday taken. The company must also make the entry to record the routine entry to record and report the vacations and holidays earned by debiting Vacation & Holiday Expense $26.67 ($320 X 8.333%) and crediting Vacation & Holiday Payable $26.67.
When an employee takes a week of vacation, the company should debit Vacation & Holiday Payable $400—thereby reducing the company's obligation. You would not debit expense, because the vacation expense was recorded each week when the employee was earning the vacation by working.
The benefit of "accruing" for vacation and holiday expense will become obvious if a company shuts down for one week and every employee is required to take vacation during that week. If the company prepared an income statement for that week, it will report little or no revenues and will have little or no wages expense during that week. That's good matching and good accrual accounting.
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