It is common for companies to accrue its vacation pay expense and liability by using the pay rates at the time of the adjusting entries. If an employee is entitled to a greater amount because of a pay rate increase, the difference is expensed in the accounting period when the actual vacation payment is recorded.
Let's illustrate this with a company that has an accounting year ending on December 31, 2012 and only one employee. The company's handbook specifies that the employee's vacation accrues monthly and that the vacation check will be paid on each July 1. Let's assume that on July 1, 2013 the employee will be entitled to 80 hours of vacation pay at the employee's pay rate on that date. On December 31, 2012 the employee's pay rate is $15 per hour and the company's liabilities include $600 for accrued vacations (80 hours X 6/12 year X $15). On June 30, 2013 the company will report an accrued liability of $1,200 (80 hours X $15). However, on June 10, 2013 the employee received a 3% pay rate increase. This means the employee's vacation check on July 1, 2013 will be $1,236 ($15.45 X 80 hours). The difference of $36 ($1,236 v. $1,200) is simply charged to Vacation Expense in the period of the vacation pay entry. In other words, the vacation pay entry will include a debit to Vacations Payable or Accrued Vacations Liability for $1,200 (the amount that has been accrued in earlier periods) and a debit to Vacation Expense for $36. The credits will include the payroll withholdings and the liability for the net payroll amount or Cash.
As shown above, the additional $36 was simply debited to Vacation Expense in the period of the vacation pay entry. The past monthly accruals were not changed or restated as the estimates and the amount of difference is immaterial.
