Accounting for short-term employee benefits under IAS 19: salaries, bonuses, profit-sharing, the thirteenth-month salary and paid absences, and key differences between IFRS and VAS

Entities commonly incur salaries, bonuses and annual leave for their employees and commit to a thirteenth-month salary under labour contracts. Many entities already recognise these items on an accrual basis; however, where an entity still recognises them on a cash basis within the period - in particular where it has not accrued unused leave days carried forward to the following year - differences arise that must be addressed when applying IAS 19. Under IAS 19 – Employee Benefits, the obligation arises when the employee renders service, irrespective of when the entity makes payment; this gives rise to a liability at the end of the reporting period for benefits that have accrued but remain unpaid.

Key conclusions

• Short-term employee benefits are benefits (other than termination benefits) expected to be settled wholly within twelve months after the end of the annual reporting period in which the employees render the related service (IAS 19.8). They comprise four categories: wages and social security contributions; paid absences; profit-sharing and bonuses; and non-monetary benefits (IAS 19.9).
• Recognition principle: when an employee renders service, the entity recognises the undiscounted amount of short-term employee benefits expected to be paid in exchange for that service as a liability and recognises an expense, unless another Standard permits or requires the amount to be capitalised into the cost of an asset (IAS 19.11). Because of their short-term nature, no discounting is applied.
• Accumulating paid absences (those carried forward to future periods) give rise to an obligation as the employee renders service, even where the benefit is not paid in cash on leaving employment (IAS 19.13–15). This is the most significant difference from common practice in Vietnam.
• Bonuses and the thirteenth-month salary are recognised if, and only if, the entity has a legal or constructive obligation to make payment as a result of a past event, and the amount of the obligation can be estimated reliably (IAS 19.19).

What items are short-term employee benefits and on what basis are they recognised?

IAS 19.8 defines short-term employee benefits as benefits (other than termination benefits) expected to be settled wholly within twelve months after the end of the annual reporting period in which the employees render the related service. They comprise four categories: wages, salaries and social security contributions; short-term paid absences; profit-sharing and bonuses payable within twelve months; and non-monetary benefits (such as medical care, housing, transport, and free or subsidised goods or services) for current employees.

The recognition principle is set out in IAS 19.11: when an employee renders service during a period, the entity recognises the amount of short-term employee benefits expected to be paid for that service as a liability (an accrued expense), after deducting any amount already paid; and recognises it as an expense, unless another Standard requires or permits the benefit to be included in the cost of an asset (for example, IAS 2 – Inventories, IAS 16 – Property, Plant and Equipment).

The underlying accounting principle is that the obligation is recognised by reference to when the employee renders service, not when the entity makes payment. The reason lies in a fundamental principle of financial reporting: the service the employee has rendered gives rise to a present obligation of the entity; that obligation meets the definition of a liability under the Conceptual Framework as soon as the service is rendered, rather than when the payroll payment falls due. Because short-term employee benefits are expected to be settled wholly within twelve months, the effect of the time value of money is immaterial, and the Standard therefore does not require discounting.

Paid absences: distinguishing accumulating from non-accumulating

IAS 19.13 divides paid absences into two types, and the accounting for each differs fundamentally.

• Accumulating paid absences are absence entitlements that may be carried forward and used in future periods where the current period’s entitlement has not been fully used.

For accumulating paid absences, the service rendered by the employee in the current period increases an entitlement that may result in additional payments in future periods. This means that when an employee works in the current period they receive not only that period’s salary but also progressively accumulate an entitlement to paid leave for future use. When unused leave days are carried forward to a later period, the entity may have to continue paying salary during the days on which the employee is absent and renders no service. Because this leave entitlement has been accumulated by the employee through current-period service, the related expense and obligation must be recognised in that same period, rather than deferred until the employee actually takes the leave. The fact that unused leave is not settled in cash when the employee leaves employment does not eliminate the obligation; it only affects the number of leave days expected to be actually used, and therefore the measured amount of the obligation.

For accumulating paid absences, the entity recognises the expected cost as the employee renders service that increases their entitlement to leave (IAS 19.13(a)) — that is, recognition takes place progressively over the period, rather than being deferred until the employee actually takes the leave.

Example:

In 20X1, an employee is entitled to 12 days of leave; they have used only 10 days; the remaining two days are carried forward to 20X2.

At 31 December 20X1, those two leave days have become an entitlement of the employee. If they use these two days in 20X2:

+ the entity must still pay salary but receives no service on the two days of leave;

+ this leave entitlement arose from the fact that the employee worked in 20X1.

Therefore, in substance, the cost of the two days of leave relates to service rendered in 20X1, and does not arise only when the employee takes leave in 20X2.

The rationale for this requirement is that, if the entity waited until the following year to recognise the expense, there would be a mismatch between periods: 20X1 would benefit from all of the employee’s service without recognising the full cost, while 20X2 would have to recognise salary expense for a period in which it received no corresponding service.

• Non-accumulating paid absences are absence entitlements that are not carried forward: the current period’s entitlement lapses if unused, and the employee is not entitled to a cash payment in lieu on leaving employment. For this type, the entity recognises an expense only when the absence actually occurs (IAS 19.13(b)); no liability is recognised before that point, because the employee’s service does not increase the value of any benefit carried forward to a future period.

The rationale for this requirement is that the benefit is not accumulated through the rendering of service. The benefit becomes an expense only when the absence event actually occurs. When the employee actually takes leave, the entity pays salary for that leave period and recognises the expense at the time the leave is taken.

A point often misunderstood: accumulating paid absences may be either vesting (the employee is paid for unused leave days on leaving employment) or non-vesting. IAS 19.15 confirms that an obligation arises even for non-vesting accumulating paid absences, because the very fact that the employee still holds accumulated leave entitlement increases the number of leave days for which the entity must pay salary in the future. In other words, the entity does not escape the obligation merely because no cash is payable when the employee leaves — the obligation lies in the salary payable for the leave days that will be used.

As to measurement, IAS 19.16 provides that the obligation for accumulating paid absences is measured as the additional amount the entity expects to pay as a result of the unused entitlement that has accumulated at the end of the reporting period. The point to note is that measurement is based on the number of days expected to be used — taking into account the order in which old and new leave days are used and the possibility that part of the entitlement may lapse (because the employee leaves before using it in full, or the entitlement expires under policy) — rather than the total number of leave days remaining on record.

When are bonuses, profit-sharing and the thirteenth-month salary recognised?

IAS 19.19 requires an entity to recognise the expected cost of profit-sharing and bonus payments if, and only if, two conditions are met simultaneously: the entity has a present legal or constructive obligation to make the payment as a result of a past event; and the amount of the obligation can be estimated reliably. A present obligation exists if, and only if, the entity has no realistic alternative but to make the payment.

The “constructive obligation” condition is noteworthy in the Vietnamese context. IAS 19.21 states that, in some cases, even without a legal obligation to pay a bonus, an entity may have a constructive obligation arising from a past practice of payment that has created a valid expectation to the extent that the entity has no realistic alternative but to pay. Where the payment of a year-end bonus has become an established practice giving employees a reasonable basis for expectation, and the entity has no realistic alternative but to pay, the constructive obligation is recognised even in the absence of any binding contractual term.

As for the thirteenth-month salary specifically, where it is committed under the labour contract or a collective labour agreement, it is a legal obligation that accrues progressively as the employee renders service during the year. The entity therefore accrues this amount throughout the period and recognises a liability at the end of the reporting period for the service already rendered, rather than recognising the whole amount at the time of actual payment (typically in January of the following year). Because this amount is expected to be settled within twelve months, it falls within short-term employee benefits and is not discounted.

Comparison between VAS and IFRS

Worked examples: accumulating leave, non-accumulating leave and the thirteenth-month salary

Example 1 – Accumulating paid absences

Joint Stock Company A is a trading company. Under its labour rules, each employee is entitled to 12 days of annual leave; unused days may be carried forward, up to a maximum of 5 days, to the following year (accumulating paid absences) and are not paid in cash on leaving employment (non-vesting). Carried-forward leave days may be used only in the immediately following year and may not be carried further into a second year; any portion unused by the end of the following year lapses.

Data for 20X1:

• Opening liability for accumulating leave at the beginning of the year (1 January 20X1): VND 180 million (equivalent to 150 leave days). During 20X1: employees used 120 leave days carried forward from 20X0; the remaining 30 leave days from 20X0 were not used and lapsed on 31 December 20X1, because the policy does not permit further carry-forward into a second year.
• During 20X1, employees accumulated a total of 1,250 leave days, of which: 20X1 leave days used within 20X1: 1,000 days; unused 20X1 leave days carried forward to 20X2: 250 days. Based on turnover rates and past leave-usage patterns, the entity expects only 220 of these 250 days to be actually used (30 days are expected to lapse through expiry or employees leaving). Under the entity’s leave policy, leave carried forward from a prior year is used before leave arising in 20X2; accordingly, all 220 days expected to be used are expected to result in additional payments by the entity.
• Average salary cost per leave day: VND 1.2 million.
• During 20X1, the company had 10,000 paid days (comprising working days and paid leave days), with total salary cost of VND 12,000 million, of which:

+ salary cost for 8,880 working days (10,000 days – 1,000 days for 20X1 – 120 days for 20X0): VND 10,656 million.

+ salary cost for 1,000 days of 20X1 paid leave: VND 1,200 million.

+ salary cost for 120 days of 20X0 paid leave used in 20X1: VND 144 million.

Movement in the leave obligation:

Journal entries (assuming the expense is recognised in profit or loss, with no inventory production or capitalisation involved)

Recording the payroll during 20X1

Dr Salary expense – actual days worked (P/L)      10,656
Dr Salary expense – 20X1 leave used (P/L)           1,200
Dr Liability for accumulating leave (B/S)               144
Cr Payables to employees (B/S)                             12,000

On payment of the 20X1 salaries

Dr Payables to employees (B/S)                    12,000
Cr Cash (B/S)                                                   12,000

Treatment of the 30 lapsed 20X0 leave days

As the entity no longer has an obligation for these 30 days, the liability is reversed:

Dr Liability for accumulating leave (B/S)                              36
Cr Employee benefit expense – accumulating leave (P/L) 36

Recognising the year-end obligation for 20X1 leave

Dr Employee benefit expense – accumulating leave (P/L) 264
Cr Liability for accumulating leave (B/S)                              264

In practice, an entity often does not separately track and record, within the period, the portion of salary cost relating to time the employee actually worked and the portion relating to paid leave days. Instead, the entire salary cost incurred is recorded through the normal payroll process, and at the reporting date, the entity records an adjustment for the difference between the required closing liability for unused paid absences and the existing carrying amount of that liability in the accounting records.

Example 2 – Non-accumulating paid absences

Joint Stock Company A is a trading company in Country X. Under its labour rules, each employee is entitled to 12 days of leave per year. Leave must be used in the year in which it arises; any unused days may not be carried forward to the following year, are not paid in cash, and automatically lapse on 31 December each year.

Data for 20X1:

• Total leave days to which employees were entitled: 1,250 days, of which leave days actually used during the year: 1,000 days; leave days unused at 31 December 20X1: 250 days;
• All 250 unused days lapsed on 31 December 20X1 and were not carried forward to 20X2.
• Average salary cost: VND 1.2 million per day;
• The company had a total of 10,000 paid days in 20X1, comprising actual working days and paid leave days; total salary payable for the year: VND 12,000 million.

Of the 10,000 paid days:

+ 9,000 days were days on which employees actually worked, corresponding to salary of VND 10,800 million.

+ 1,000 days were paid leave days used in 20X1, corresponding to salary of VND 1,200 million.

Tracking of leave days and the accounting obligation

Journal entries (assuming the expense is recognised in profit or loss, with no inventory production or capitalisation involved)

Recording the payroll during 20X1

Dr Salary expense – actual days worked (P/L)                                               10,800
Dr Salary expense – non-accumulating leave used during the year (P/L)  1,200
Cr Payables to employees (B/S)                                                                       12,000

In practice, an entity may not open a separate account for leave-day salary and may instead record the entire VND 12,000 million as salary expense. The separation shown in the example is solely to explain how IAS 19 is applied.

On payment of the salaries

Dr Payables to employees (B/S)     12,000
Cr Cash (B/S)                                    12,000

The payment is the employees’ ordinary salary, comprising both salary for working days and salary for paid leave days.

It does not represent a cash settlement of unused leave entitlements.

Treatment of the 250 unused leave days

At 31 December 20X1, the 250 unused leave days automatically lapsed.

The notional amount calculated using the current daily salary rate is: 250 days × VND 1.2 million = VND 300 million.

However, the entity does not recognise the VND 300 million as an expense or a liability, because:

• employees no longer have the right to use these days in 20X2;
• employees are not entitled to a cash payment in lieu;
• the entity no longer has an obligation to provide the benefit in the future.

No journal entry is made at the lapse date.

Example 3 – Thirteenth-month salary

Also at Joint Stock Company A, the labour contract commits to paying one month’s salary as a thirteenth-month salary, payable in January 20X2. All employees worked the full year of 20X1. One month’s payroll is VND 300 million.

Because this is a legal obligation that accrues progressively with the service employees render during the year, and all staff worked the full year, the entity accrues the entire obligation at 31 December 20X1.

Accrual entry at 31 December 20X1:

Dr Labour cost (thirteenth-month salary) (P/L)     300
Cr Payables to employees (B/S)                             300

Entry on payment in January 20X2 (assuming no personal income tax or payroll deductions, for simplicity):

Dr Payables to employees (B/S)           300
Cr Cash (B/S)                                          300

Common errors and practical difficulties in implementation in Vietnam

Failing to accrue accumulating leave days. This is the most common error. Many entities still recognise leave-pay expense on a cash basis, resulting in understated liabilities and expenses at the end of the reporting period. Auditors typically request a schedule of leave-day balances by employee to review this item.

Confusing accumulating with non-accumulating leave. Classification depends on each entity’s labour rules and leave policy; there is no universal formula. Overlooking a clause that permits a maximum number of days to be carried forward leads to the erroneous conclusion that all leave is non-accumulating and that no obligation need be recognised.

Measuring by the total leave balance rather than the number of days expected to be used. IAS 19.16 requires measurement at the expected additional amount payable, meaning the portion of the entitlement that will actually be used must be estimated. Multiplying the entire leave balance by the unit rate overstates the obligation where the entity has a high turnover rate or a policy under which entitlements expire.

Recognising bonuses on a cash basis rather than on the basis of the obligation. Where a year-end bonus has become an established practice creating a valid expectation among employees, a constructive obligation has arisen at the end of the reporting period even though the formal bonus decision is issued in the following year. Waiting until the decision is issued before recognising the amount is late recognition.

Failing to include employee benefit costs in the cost of inventories. For employees engaged directly in production, the related portion of short-term benefit cost (including accumulating leave) must be included in the cost of inventories under IAS 2, rather than being recognised entirely as an expense in the period. Omitting this step distorts both cost of sales and the closing carrying amount of inventories.

Frequently asked questions

If annual leave is accumulating but the labour rules expressly provide for no cash payment on leaving, must an obligation be recognised?

Yes. IAS 19.15 confirms that an obligation still arises for non-vesting accumulating paid absences, because the accumulated entitlement increases the number of paid leave days the entity must fund in the future. The absence of a cash payment when the employee leaves affects only the estimate of the number of days expected to be used; it does not eliminate the obligation.

Is a bonus expected to be paid more than 12 months later still a short-term benefit?

No. The classification criterion is the expectation of settling the amount in full within twelve months after the end of the annual reporting period in which the employees render the service (IAS 19.8). If a bonus under a long-term plan is expected to be paid after that point, it is classified as an other long-term employee benefit and a different measurement basis applies, including discounting.

How should paid-absence costs for direct production employees be accounted for?

Not recognised entirely as an expense in the period. Under IAS 19.11, where another Standard so requires, the benefit is included in the cost of an asset; for direct workers, the related portion of the benefit cost is capitalised into the cost of inventories under IAS 2 and is recognised in cost of sales only when the goods are sold.

Our entity has never tracked leave balances by individual employee — where do we start?

The first step is to compile data on unused leave days at the end of the reporting period for each employee, classify the leave as accumulating or non-accumulating under the labour rules, and then estimate the proportion of days expected to be used based on turnover data and past leave-usage patterns. This is usually the most labour-intensive part on first application, and also the part auditors review closely.

Classifying benefits, determining constructive obligations and estimating the number of leave days expected to be used require judgement tied to each entity’s human-resources policies. Our IFRS conversion advisory team can help entities review their labour rules, build a model to calculate short-term benefit obligations and develop appropriate accounting policies.

This article has been prepared solely to provide general information and technical guidance, and does not constitute accounting, audit, tax or legal advice for any specific transaction or entity. The figures, assumptions and journal entries in the article are illustrative only and should be adjusted to actual circumstances, professional judgement and the records of each enterprise. We accept no responsibility for any loss arising from the use of the information in this article without appropriate professional advice. For support with a specific situation, please contact our IFRS conversion advisory team.