What if an employee's actual vacation payment is greater than the amount that has been accrued?

Let's assume that a company's accounting year ends on December 31 and the company has only one employee who worked the full year. The company's handbook specifies that the employee earns 10 hours of vacation for each month worked. However, the vacation hours for the year accumulate. The total vacation hours earned as of December 31 will be paid to the employee on June 1 of the following year by using the employee's June 1 pay rate.

Next, let's assume that each month the company records an accrual adjusting entry that debits Vacation Expense for $200 (10 hours X $20 per hour) and credits Vacation Liability for $200. As a result, the balance in the balance sheet account Vacation Liability at December 31 is $2,400 (12 months X $200, or 120 hours X $20).

On the following June 1, the employee's pay rate is $20.50 which means the employee's gross vacation pay will be $2,460 (120 hours X $20.50). The June 1 journal entry to record the vacation payment is:

  • Debit Vacation Payable $2,400 (to eliminate the December 31 liability)
  • Debit Vacation Expense $60
  • Credit Cash, Payroll Withholdings, etc. for a total of $2,460

Note that the $60 difference was recorded as Vacation Expense in the year of the payment. The financial statements of the prior year were not restated for the $5 monthly differences. The reason is the prior year's monthly amounts were estimates (not mistakes) and the difference is immaterial.

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