31 Jan Calculating Vacation Pay
Explaining Vacation Pay (and why it doesn’t make sense)
Clients have asked from time to time about how vacation pay is calculated. On the surface, in a typical province, the legislation may say that each employee starts out entitled to 2 weeks of vacation at 4% their gross wages (this rate varies depending on your province). Seems simple enough, right? So, an employee takes a day off, you pay them their regular daily wage, and that’s that.
… But it’s wrong!
It may seem like you did the right thing, but in actual fact, you’ve short changed the employee without even knowing it. But don’t worry! Payroll Connected is brutally honest. So if you’re using our software to calculate your payroll (which you can try for 30 days completely free) then rest assured the calculation is correct. However, let’s dive into what actually goes on with vacation pay, and why it’s not as simple as a “regular’s day pay”.
To explain, here’s an example with two employees. One works the same regular 40 hours every week. We’ll call him Reg. The other works a changing number of hours each week. We’ll call him Chan. Both employees get 2 weeks of vacation a year, both get $15.00 / hr, both are paid bi-weekly (26 pay periods a year), and both accrue vacation pay at a rate of 4%.
Though both employees get the same rate, Chan works less hours than Reg, so it wouldn’t make sense for both employees to get the same Vacation Pay amount for taking a day off. Rather, Chan should get less since they work less hours.
First, let’s address the vacation days. Two weeks a year, is actually only 10 business days. So, to figure out how many vacation ‘days’ you earn every pay check, just divide 10 days by 26 pay periods:
10 days / 26 pay periods = 0.384615 days earned per pay period
Like this, it takes 3 pay periods to earn a full day off (and a bit). 0.384615 x 3 = 1.153845 days
Second, vacation pay is pretty easy to figure out as well! If Reg works his regular 8 hour day at $15 per hour, he will earn $120.00 in wages per day.
Now $120 per day times 10 days per pay period is $1,200.00 in gross wages per paycheck.
So, for vacation pay, just take $1,200 times 0.04 (4%) to get $48.00 per pay period.
Like this, in 3 pay periods, Reg will earn $48 x 3 = $144.00 in vacation pay.
Simple, right? Well, maybe not as simple as you think…
Using Vacation Pay
Here’s where things get complicated. To help, let’s start with a table that shows what Reg and Chan earn over the next few pay periods. Remember that Chan’s numbers are odd because he works an irregular schedule so his Gross Pay varies:
|Vac Pay Earned|
Now let’s say they each want to take a day off. To get what Chan is owed for 1 day off, just take the total Vacation Pay saved up, divide it by the number of Vacation Days saved up, and Ta-Da! You arrive at the Vacation Pay for 1 day off: $210.55 / 1.923075 = $109.49
Simple, right? No questions yet, I bet.
Now let’s look at Reg’s day off. As you may remember, they earn $120.00 per day.
Just like before, take the vacation pay accrued of $240.00 and divide it by the vacation days earned to arrive at the Vacation Pay for 1 day off: $240.00 / 1.923075 = $124.80
This is $4.80 more than their usual day’s pay! But why? (By the way, Chan got a bit more than their regular day’s pay too)
The Devil’s in the Details
When accruing Vacation Days, the legislation is pretty easy to understand. One day earned equals one day off. Done!
When accruing Vacation Pay however, the legislation only states the RATE that an employee EARNS on each pay period. No where does it state they get ‘a regular day’s pay for a vacation day off’. As such, it ends up that at a 4% accrual, the employee actually earns a little bit more than a regular day’s pay. To help illustrate this, consider the following way of looking at it:
For Reg, they earn $120.00 / day. And $120 x 10 days per two weeks = $1,200.00 per bi-weekly pay period. Ten Vacation Days is also what they’re allowed to take in a year, right?
So, in a flawed way of thinking, one would assume that 10 * $120 = $1,200.00 in Vacation Pay is what they will get in a year as well. But let’s take a further look ahead to the end of the year.
If we take $1,200 per pay period, and multiply it by all 26 pay periods, if paid bi-weekly, we get:
$1,200.00 x 26 = $31,200.00 is Reg’s annual wages.
Now multiply that by the 4% Vacation rate, and we get: $31,200 * 0.04 = $1,248.00 Vacation Pay! Again, it comes out slightly higher than their regular $1,200.00 pay check.
One thing to remember with Reg though: Even though he almost always works an 8 hour day, if he works even one shift less than usual, the Vacation Pay Accrued amount will be less for that one period, and thus the fair payout of one day used (when they use vacation time by taking a day off) will be slightly less as well because of it (since the total vacation pay accrued is divided by the total vacation days accrued to arrive at a per day Vacation Pay amount).
It Varies from Province to Province
For example, in British Columbia and Saskatchewan, employees actually earn vacation pay on top of vacation pay! Also, the types of earnings that Vacation Pay is earned on can vary quite a bit as well. Always read your province’s legislation to get a clear picture.
Vacation Accrual in Payroll Connected
Some things to consider when working in Payroll Connected regarding Accrued Vacation Pay:
An 8 Hour work Day
Payroll Connected assumes a regular work day is 8 hours long. Why? Because we needed to use some number to delineate a work day, so 8 hours made the most sense as it is a standard work day in most provinces. That means if an employee wishes to use a Vacation Day, schedule them using the ‘Vac’ department for an 8 hour shift, even if they don’t usually work a full 8 hours a day. This way if they only want to take a half day of Vacation, they can be scheduled for a 4 hour shift to do so, and so on.
Careful When Accepting a Vacation Pay-Out
If an employee wishes to get some Vacation Pay PAID OUT (in the ‘Income +/-‘ tab), take some special consideration to the long term. If they take Vacation Pay without requesting Vacation Days be used up as well, then their Vacation Pay will be diluted later on when they do take Vacation Days.
For example, if they have 5 Vac Days and $500.00 Vac Pay saved up, that would give them $500 / 5 days = $100.00 per day when they take vacation time off.
However if they ask to be paid out $150.00 of their vacation pay without adjusting the vacation days, the system will still do the same $350 / 5 days calculation when they take time off later on, to only give them $70.00 per vacation day took off.
The smarter thing to do is to ask them to request a number of days to be paid out, and then the system will automatically calculate the amount of Vacation pay based on that request. For example, instead of requesting $350.00 be paid out, they should ask for 1.5 days to be paid out, because the system will then calculate: $500 / 5 = $100 -> $100 x 1.5 days = $150. Like this, when they take vacation time off later on, they’ll still be getting paid their usual $350 / 3.5 days = $100.00 per vacation day.