ASC 710: Accounting for Compensated Absences

The Financial Accounting Standards Board (FASB) provides the accounting standards that guide practices in the United States. Accounting Standards Codification (ASC) 710, Compensation-General, addresses the accounting for various forms of employee compensation. The standard’s function is to ensure that companies properly account for the liabilities they incur as a result of employee services.

ASC 710 provides a framework for how to calculate and record these liabilities. It is one of several standards that address employee compensation, with others covering topics like retirement benefits. The standard provides guidance on different types of compensation, including compensated absences, deferred compensation, and lump-sum payments under union contracts.

Scope of Compensated Absences

Compensated absences refer to payments for employee absences such as vacation, illness, and holidays, for which it is expected that employees will be paid. The accounting for these absences is a part of ASC 710, which can include sabbatical leave and other similar paid time off arrangements.

A distinction is made between rights that “accumulate” and those that “vest.” Rights that accumulate are those that can be carried forward to future periods, even if there is a limit on the amount. Vested rights are those for which an employer has an obligation to make a payment even if an employee terminates their employment. These rights are not contingent on an employee’s future service.

A company’s specific policies determine whether an absence requires potential accrual. For example, a “use-it-or-lose-it” vacation policy, where unused days expire at the end of the year, would not require a liability to be accrued. In contrast, a policy that pays out unused vacation days upon termination would require an accrual.

If sick pay benefits vest, meaning they are paid out after termination, an accrual is required. If sick pay benefits accumulate but do not vest, accrual is permitted but not mandatory. This is because the payment for accumulated sick pay is often contingent on a future event, such as an actual illness.

Accrual Criteria for Compensated Absences

ASC 710 outlines four specific conditions that must all be met for a company to be required to accrue a liability for compensated absences. The four criteria are that the employer’s obligation is attributable to employees’ services already rendered, the obligation relates to rights that vest or accumulate, payment of the compensation is probable, and the amount can be reasonably estimated.

The first condition means the employee has already performed the work to earn the time off. For example, if an employee earns two weeks of vacation per year, the obligation for that vacation time is earned as the employee provides services throughout the year.

The second condition relates to rights that vest or accumulate. An example of this would be a sabbatical leave that is earned after a minimum service period, and the cost of this leave should be accrued over the required service period.

The third condition is that payment of the compensation is probable. For vacation pay, this is generally considered probable. For sick pay, it may not be, as payment is often contingent on a future illness.

The final condition is that the amount can be reasonably estimated. If the first three conditions are met but the amount cannot be reasonably estimated, the company is required to disclose that fact in its financial statements.

Measurement and Recognition

Once all four criteria for accrual have been met, the company must measure and recognize the liability. The accounting standard does not specify whether to use an employee’s current or future pay rate. Instead, a company should use its best estimate of the amount needed to settle the obligation, which often uses current pay rates but should also incorporate other known factors, such as scheduled pay increases.

When determining the amount of the accrual, companies should also consider anticipated forfeitures. The amount accrued should be reduced by the estimated amount of benefits that employees are expected to forfeit, for example, due to turnover. This ensures that the liability on the balance sheet is not overstated.

The accrued amount is recorded as a liability on the balance sheet, typically as a current liability, and as an expense on the income statement. The company should also disclose its accounting policy for compensated absences in the footnotes to its financial statements.