When people go on a vacation, they depending on local regulation may have to be paid up front before leaving or the payment shall continue as regular monthly salary, however the rule is that people do have to get paid when they are on vacation. Fact of the matter is that they can go on a holiday even with short notice and you have to be prepared to make the upfront payment to them if so required by local law.

In fact, as a general rule, your balance sheet should always reflect the liability you owe to your employees when it comes to vacations. For an example, when an employee decides to leave the post for good, he or she is entitled to all those vacation days and also respective payment.

So what some companies do is simply accruing a certain percentage of monthly salaries to vacation pay reserve account every month. If let’s say the employees are allowed to take 28 days off with full pay, the reserve should essentially be in the amount of one month’s payroll expense more or less depending of course on the days people have to receive. As an example, when accruing for the reserve in December, if you have all the employees having their vacation in summer and all of them have give or take 14 days on their reserve in mentioned December, the reserve amount on the balance sheet should be in the amount of roughly half of the monthly salary expense.

Simple math says that if the reserve is a 100 and you have 12 months to get it full, the monthly percentage is around 8-9%. However, when preparing annual accounts, the reserve needs to be adjusted to reflect the actual liability. Generally it’s calculated as follows: days to receive multiplied by the daily pay (normally an average of last 6 or so months). Obviously what must be also included, are the taxes (social contribution etc).

In summary, do make sure your vacation pay reserve is as up to date and reasonable as possible and when needed, do the required adjustments.