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This blog post is written for Canadian businesses. U.S.-based companies should refer to How to Structure Paid Time Off Plans Like a Pro.

Small business owners have a decision to make when it comes to Vacation Pay. As delightful as vacations can be, the complexities of vacation payroll can sometimes leave you wishing for a vacation day.

Vacation pay is one of those areas in payroll where there are great variations between employers, including differences in the vacation pay rate, the number of vacation weeks provided, the earnings on which vacation pay is accrued and when vacation time and pay are given. There are even some employers that don’t accrue vacation pay at all and others that accrue time instead of dollars.

The multicultural country that we are, we have managed to distil vacation payroll into the following  “standardized” processes:

Four Basic Ways to Process Vacation Pay in Canada

1. Paid Each Pay Period

vacation payroll option 1

The first method doesn’t involve an accrual at all. Each pay period, employees are paid the vacation pay owing on the vacationable earnings paid in that pay period.

This vacation policy is the simplest method of processing vacation pay and is often used for casual, part-time or seasonal employees whose earnings vary from one pay period to the next. For example, paying vacation pay on every pay cheque means employers do not have to carry a liability for vacation pay on their balance sheets.

It also has the advantage of avoiding paying vacation pay on vacation pay, in those jurisdictions where vacation pay is itself an earning on which vacation pay would otherwise be accrued. However, from the employee perspective, it has the disadvantage that no actual vacation pay or other earnings are received when vacation time is later taken.

2. Paid Vacation Time

Paid vacation time means employees are paid their regular salary or wages while off work on vacation. This amounts to salary continuance, to the extent that some employers don’t even bother to show vacation pay as a separate item on the pay statement.

Paid vacation time is commonly used for employees on a fixed salary or for hourly-paid employees who work a set number of hours. Under this method, employers often set the vacation time entitlement – measured in hours or days – at the start of every year and then reduce this entitlement as employees take vacations.

Apart from this seeding, paid vacation time means employers don’t have to otherwise formally accrue vacation pay, rather simply track the time taken by employees. However, any time not taken will still have to be reported as a liability on audited financial statements.

If paid vacation time is provided to employees who also receive exception pay, such as bonuses or sales commissions, employers will have to ensure that their provincial employment standards minimums have been met at the end of every vacation entitlement year.

For example, an employee whose base salary is $52,000 a year is given 3 weeks paid vacation. If the employment standards require vacation pay at 4% and the employee had vacationable exception pay in excess of $26,000, 3 weeks paid vacation would not meet the minimum requirements: $52,000 plus $26,000, at 4% is $3,120, whereas 3 weeks base salary is only $3,000.

3. Accrued Hours/Pay Current

This method means employers accrue vacation owing based on time, rather than as dollars.

For example, for employees entitled to 2 weeks of vacation time and whose regular work hours are 80 in a bi-weekly pay period, an employer might accrue vacation entitlements as 3.25 hours earned in every pay period, to an annual maximum of 80 hours.

When vacation time is taken in the subsequent year, it’s paid out as 80 hours at the employee’s current rate. Just as for paid vacation time, when time is accrued, rather than dollars, employers must ensure that the current, regular pay for the time taken meets the applicable employment standards minimums.

For example, these may not be met if hourly pay rates are reduced or if employees have vacationable exception pay, such as overtime (overtime is vacationable in all jurisdictions).

This method also means employers have to keep accurate records of employee vacation time entitlement balances, additions to this each pay period and any reductions for time taken or for time entitlements cashed out.

4. Accrued Hours/Pay Balance

When accruing vacation pay based on dollars, the calculation is done each pay period based on a percentage of the employee’s vacationable earnings.

For example, an employee entitled to 2 weeks of paid vacation calculates to accruing vacation pay at 4% of vacationable earnings. Vacationable earnings are any earnings paid to the employee that qualify to have vacation pay calculated on them, for example, regular earnings, commissions and overtime pay.

These can vary depending on provincial employment standards. When vacation pay dollars are accrued, based on vacationable earnings in a vacation entitlement year, employers have to track the following:

– The accrued vacation balance owing at the start of each entitlement year.

– The accrued vacation pay earned on vacationable earnings paid to the employee during the year.

–  Any vacation pay either cashed out or paid when vacation time is taken by the employee.

When audited financial statements are required, any vacation pay accrual balances have to be reported on these as a current liability.

This brings us to the end of this wonderful article that summarizes the four possible ways that a company in Canada can handle their vacation pay.

Honestly, all this vacation payroll talk is making us wish for sunny beaches and minty mojitos! Hopefully, this article will clarify all your burning questions on this topic, but if not, please drop us a line and we’d love to chat more about vacations… oh wait, I mean vacation payroll.

Syndicated content from author Alan McEwen for the Wagepoint blog. This article was originally published on the HR reporter blog.

The advice we share on our blog is intended to be informational. It does not replace the expertise of accredited business professionals.