04 May 2020
One of the government measures announced to support entities employing key workers during coronavirus was an extension of the window that employees can take their annual leave. FRS 102 (section 28 ‘Employee Benefits’) requires entities to accrue for any short-term employee benefits. Despite the reference to key workers in the government announcement, the change to the legislation applies to all businesses.
What does the legislation and FRS 102 say?
Employees in the UK who have not taken all of their statutory annual leave entitlement due to coronavirus may now be able to carry it over into the next two leave years under the amended regulations.
The regulations will allow up to four weeks of unused leave to be carried into the next two leave years, easing the requirements on business to ensure that workers take statutory amount of annual leave in any one year, hence allowing the business to avoid a breach of employment law.
The change is aimed at allowing businesses under pressure from the impacts of coronavirus the flexibility to better manage their workforce, while protecting workers’ right to paid holiday.FRS 102 requires entities to accrue for any short-term employee benefits.
This means that entities build up accruals for the undiscounted cost of any unused paid annual leave if it is expected to be settled wholly before 12 months after the end of the reporting period. This is commonly known as a “holiday pay accrual”.
Short-term employee benefits (if expected to be settled wholly before 12 months after the end of the annual reporting period in which the employees render the related service) include items such as:
- wages, salaries and social security contributions;
- paid annual leave and paid sick leave;
- profit-sharing and bonuses; and
- non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current employees. (FRS 102.28.4)
Long term employee benefits are recognised as a cost, as entitlement to the benefit is earned, but due to their long-term nature, they are recognised at the expected present value of the liability.
Practical impact and interpretation for preparers
The main difference arising from the change in law is that unused paid annual leave could now roll over into a period longer than 12 months. This may create a long-term employee benefit for all or a portion of the holiday pay accrual with accounting and tax consequences.
The cost of these long-term benefits is recognised in the period that the benefit is earned, but due to their long-term nature, this cost should be measured at the expected net present value of the liability.
It is, however, unlikely that the discounting to net present value will be material, and it will also be somewhat challenging to obtain a reliable estimate to when holiday will be used, and so the undiscounted amount is likely to be acceptable in practice.
As set out in the taxation article, as the holiday pay accrual may not unwind within 9 months of the year end this may have current and deferred tax consequences, with a negative tax cash impact.
How does this change in law impact for the entity’s year-end close process?
Entities will firstly need to determine if they will permit holiday carry forward in accordance with the amended regulations. They then need to determine (as usual) the number of unused holiday days for their employees at end of the accounting period. They will need to consider the cost value of unused holiday expected to be used within the next 12 months. This will involve making judgements about when in the next 2 years employees will use their carried over holiday allowance.
Entities will need to accrue for the net present value of unused holiday expected to be used between 12 months and 24 months, which will, where material and able to be reliably measured, be subject to an appropriate discount rate. Management judgement will be required to determine an appropriate discount rate, if any.
Where material, additional disclosures will be required including:
- the nature of long-term benefits provided, the liability recognised and if applicable any funding put in place to meet these liabilities;
- the accounting policy applied for short-term and long-term holiday pay accruals; and
- any significant judgements made eg expected timing of use of accrued holiday and determination of an appropriate discount rate.
- Entities will need to decide if they will take advantage of this change in law. They will need to notify their work force and put in place new procedures to manage the roll forward of the holiday allowance over two years.
- Entities should take advice of an employment law specialist to understand the risks if staff cannot take their statutory entitlement.
- Entities should consider the corporation tax consequences of allowing holiday to be carried forward for more than 9 months from the year-end.
- Entities should already have measures to track unused holiday entitlement and include a consideration of holiday requirement in their year-end close process as this is required by FRS 102.
- The entity’s judgement of how and when holiday is taken should be consistent with the entity’s policies, including communications with clients. It should also be consistent with staff utilisation assumptions used in trading projections that underpin going concern and any other value in use exercises.
Ultimately the element of non-current pay and impact of discounting may be immaterial depending on the facts and circumstances of the business.