Accrued PTO Liability: 6 Things to Settle Before Year-End

Accrued PTO Liability: 6 Things to Settle Before Year-End

Your employees have unused vacation days, and on December 31 your balance sheet probably says nothing about them. That silence is the problem with accrued PTO liability: the cost of time off is earned a little each pay period, but most small businesses only see it when someone quits and asks to be paid for it.

Six things are worth settling before the books close for the year, and they run in the order you would deal with them. The numbering is a sequence, not a ranking.

One firm to ask about this is System Six, a Seattle bookkeeping and fractional CFO firm for small businesses with a finance function to clean up. Its profile does not say it handles PTO accruals specifically, so ask. System Six is a paid featured member of Sam's List.

1. Decide Whether Accrued PTO Liability Exists in Your Business

The short answer: it depends on your written policy and on your state's law. If employees earn paid time off as they work and can carry it forward or be paid for it, the business generally owes something for the unused balance, and accrual accounting records that cost as employees earn it. If time off is discretionary, granted day by day and never owed, there may be nothing to record.

Two tests help. First, does the time vest, meaning it is earned and yours to keep, or is it granted fresh each year? Second, would you owe cash for it if the employee left tomorrow? A yes to either usually points toward a liability.

The limitation: this is a facts question, not a formula. State law can turn a policy you thought was flexible into a debt, so do not decide from the handbook alone. Ask your CPA and, where the stakes are real, an employment attorney.

2. Write Down a PTO Accrual Policy That Matches How You Run the Business

A PTO accrual policy answers four questions on paper: how fast time is earned, whether there is a cap, what happens to unused time at year-end, and whether it is paid out when someone leaves. The usual models are accrue per pay period, a lump sum at the start of the year, or unlimited time off. Each produces a different number on the balance sheet.

Caps and use-it-or-lose-it rules limit how large the balance can grow. A cap stops the liability from growing without bound. A use-it-or-lose-it rule forfeits unused time at a set date, though some states restrict forfeiture, so check before you adopt one.

The limitation: a policy only helps if you follow it. If the handbook says time expires but managers routinely let it roll over, the practice can matter more than the page. Make the policy and the payroll system say the same thing.

3. Check PTO Payout State Law Before You Promise Anything

Whether unused PTO must be paid when employment ends varies by state. Some states treat earned vacation as wages that must be paid at termination. Others leave it to the employer's policy, and a few fall in between. We are not stating any one state's rule here because the rules differ and change.

What this means for you: your policy and your state's law together set what you owe. A policy that says "no payout" may not hold in a state that treats earned time as wages. If you have employees in more than one state, you may have more than one answer.

The limitation: the PTO payout state law question is a legal one, and an accountant can tell you how to record the balance but not what the law requires. Confirm with an employment attorney or your state labor department before you rely on a policy, and revisit it when you hire in a new state.

4. Calculate the Accrued PTO Liability: Hours, Pay Rate and Burden

The calculation is simple in outline. For each employee, take unused hours, multiply by the current pay rate, and add the employer's share of payroll costs that attach to those wages, often called burden. Add the employees up and you have the balance to record.

An invented example. Suppose an employee has 40 unused hours at $30 an hour. The wages are $1,200. Employer payroll taxes, and sometimes other costs tied to wages, add to that, so the true cost is somewhat higher than $1,200. Ask your CPA which costs belong in the number for your business.

The limitation: the inputs have to be right. Hours need to come from the payroll system, not memory, and pay rates change with raises. Employees who are paid differently, such as hourly versus salaried, or part-time versus full-time, may accrue differently under your policy, so run each group on its own rule.

5. Book the Accrual and True It Up Every Month

Once you have the balance, record it. The usual entry debits a PTO expense account and credits an accrued PTO liability account. Each month, compare the new balance to what the books show and adjust for the difference: time earned adds to it, time used reduces it, and raises or terminations move it.

Monthly beats annual. A single entry at year-end produces a lumpy December and a bookkeeper guessing at balances from months ago. A monthly true-up spreads the expense across the periods in which employees earned the time, which is the point of accrual accounting.

The limitation: cash-basis businesses often record nothing until time off is paid. If your books are on the cash basis, the liability may not appear in them at all, though it still exists as a practical matter. Ask your CPA which method applies to your books and your tax return, since they can differ.

6. Know What the Accrued PTO Liability Does to Your Year-End Balance Sheet

A recorded liability lowers equity and reduces reported profit in the periods where the expense is booked. That can be an uncomfortable surprise the first year you record it, because you are catching up on time earned in prior periods. It is better to see it yourself than to have a lender or buyer find it.

Lenders and buyers read the balance sheet for obligations. In a sale, an unrecorded PTO balance can come up in diligence, and buyers often ask who bears it. A bank reviewing covenants may care about the effect on your working capital or equity.

The limitation: recording the liability does not mean cash leaves the business. It is a promise to pay later, and the timing depends on when employees take time off or leave. Plan for the cash separately from the entry, and ask your CPA how it affects your tax return, since the timing of a deduction can follow different rules from the books.

Where System Six Fits

System Six is a Seattle firm, founded in 2009, that does bookkeeping and fractional CFO work for small businesses. Its live profile says it serves companies generating between $1 million and $10 million in revenue, serves clients nationwide, has about 41 employees, and lists monthly fixed fees from $800 a month. The profile also says the firm was acquired by a searcher in 2021 and helps organizations modernizing a finance function after an acquisition.

A PTO accrual is the kind of recurring entry a monthly close handles: pull the balances, price them, book the change. A bookkeeping firm that closes the books each month can carry it as one of its regular steps.

System Six is early in building a review history on Sam's List, so we describe the firm by its profile and do not cite one. System Six is a paid featured member of Sam's List.

The limitation, plainly: the profile does not say the firm handles PTO accruals or payroll liabilities in particular, so ask whether it will, and who sets up the calculation. The $1 million revenue minimum puts smaller companies outside its range, and the state-law questions in item 3 still need an attorney.

Frequently Asked Questions

Is accrued PTO a liability?

Often, yes, but it depends on your written policy and state law. If employees earn time off as they work and are entitled to use it or be paid for it, accrual accounting records a liability as they earn it. If time off is purely discretionary and never owed, there may be none. Ask your CPA.

Do I have to pay out unused PTO when an employee leaves?

It varies by state. Some states require payment of earned vacation at termination, while others defer to your written policy. Check your state's rules and make your policy say clearly what happens to unused time. An employment attorney or your state labor department can confirm what applies to you.

How do I calculate accrued PTO?

Multiply each employee's unused hours by their current pay rate, then add the employer payroll costs that attach to those wages. Sum the result across employees and record it as a liability. Redo it each month so it reflects time earned, time used and pay changes. Your CPA can confirm which costs to include.

What if my books are on the cash basis?

A cash-basis business usually records PTO only when it is paid, so no liability appears on the books. The obligation can still exist, and a lender or buyer may ask about it. Ask your CPA whether to track the balance off the books, or whether your situation calls for accrual reporting.

If year-end is close, pull every employee's unused hours from payroll this week and price them, then take the total to your CPA. You can compare fractional CFOs on Sam's List, including the firm above.

Disclosure: Some firms named here pay for a Sam's List listing or featured placement. Sam's List takes no referral fee or commission on any engagement.

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About the author: Kimberly Green is cofounder of Sam’s List, a directory and matching platform for financial professionals.