A woman wearing a white T-shirt and a yellow scarf sits at a desk in front of a computer monitor. The monitor screen shows a calendar with Monday through Friday marked with the dates 3 through 7. Blocks of various colors designate events like "Finalize budget" and "Team photoshoot."
When setting paid time off policies, businesses must choose how much PTO to offer, how the time off will accrue and expire, and at what rate employees will be paid. — Getty Images/grinvalds

Paid time off (PTO) is a commonly offered employee benefit that allows employees to take time away from work without losing pay. Though not federally mandated, many states require employers to offer a certain amount of accrued paid leave to part- and full-time employees, often based on the number of hours they work.

Organizations can offer a variety of PTO plans — from flexible accrual banks to a “use it or lose it” policy — but no matter which one the business chooses, the policy needs to be managed by the accounting department. Read on to discover the best ways to record PTO in accounting for small businesses.

Steps to recording PTO in accounting

Accountants, bookkeepers, and directors of finance can follow these steps to record accrued PTO in the accounting department of an organization to avoid liability.

  • Calculate the accrued PTO. To calculate accrued PTO, find the amount of vacation time earned through the beginning of the accounting period, add the number of hours earned in the current accounting period, then subtract the number of vacation hours used in the current period. Finally, multiply the resulting number by the employee's hourly wage rate to calculate the correct accrual.
  • Update internal spreadsheets or software. Once the accrued PTO is accounted for, be sure to update any other internal documents, spreadsheets, or software (if it doesn’t update automatically) to ensure books stay clean, organized, and up-to-date.
  • Determine your PTO liability. The Financial Accounting Standards Board (FASB) requires employers to accrue a liability for compensating employees if they have earned, but not yet taken, paid vacation benefits – meaning employers must be able to pay out any earned, unused PTO. However, the same requirement doesn’t necessarily apply to future sick pay, paid holidays, or other similarly compensated absences until employees use those benefits.

[Read more: How To Structure PTO]

‘Use it or lose it’ PTO vs. rollover PTO vs. unlimited PTO

Depending on the type of policy offered, PTO accruals will look different:

  • “Use it or lose it” policies stipulate that if an employee doesn’t use the allotted number of paid time off days in a year, the benefits do not roll over to the next year, nor is unused time paid out.
  • Rollover PTO allows employees to keep some or all of their unused PTO days after a one-year period ends, or receive a payout for the unused time off. Not every state allows a no-rollover PTO policy, and some states only allow businesses to have no-rollover policies, with certain exceptions.
  • Unlimited PTO policies, which put no caps on the number of paid time off, can help employers avoid some concerns about accruals, rollover PTO, and payouts. However, employers must be prepared to implement policies about PTO scheduling to ensure they can cover an unlimited number of days off for each employee.

Businesses choosing to pay out accrued PTO at an employee’s starting rate rather than their current rate must make every effort to set expectations and maintain consistency.

A small business should consider how its PTO policy will impact its bottom line. Teams using no-rollover policies or unlimited policies don’t have to worry about issuing payouts at the end of a period, but they should consider the liability potential. Teams that adopt rollover policies need a highly organized tracking system and documentation to keep track of PTO use, accrual, and payouts.

How pay raises impact PTO

Often, an employer can dictate the rate at which vacation is paid out. Of the two choices — paying out at an employee’s current rate or their starting rate — many businesses choose to pay out accrued PTO at an employee's current rate to simplify administrative tasks.

Businesses choosing to pay out accrued PTO at an employee’s starting rate rather than their current rate must make every effort to set expectations and maintain consistency. Employees should know the policy when they start and have the opportunity to ask questions during onboarding. The employer will need to keep track of each employee’s PTO accrual with the correct rate of pay.

Some states, like California, require businesses to pay out accrued vacation leave at the employee's current rate of pay. As more state and federal regulations emerge from the effects of the Great Resignation, business owners and financial decision-makers should consult relevant laws carefully when developing a PTO payout process that’s fair, consistent, and legal.

[Read more: Inexpensive Employee Benefits and Perks for Startups]

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