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Since COVID-19 landed on New Zealand shores, many businesses have been impacted by lockdowns or a downturn in customer demand, which has resulted in employees either working less hours or accepting a reduction in remuneration.

Where it is possible for businesses to return employees to increased hours of work, it may be assumed that the impact of pay reductions is complete. However, the application of Annual Leave may create some confusion and also impact a business’ cashflow.

How is leave accrued?

According to the Holidays Act 2003, when an employee takes annual leave, they are paid the greater of either their ordinary weekly pay as at the beginning of their leave period, or their average weekly earnings for the 12 months immediately before their leave period.

This means that whilst an employee will have accrued Annual Leave during a 20% reduction in their salary, if they have returned to normal hours, any future annual leave will be paid out at the full, normal salary rate.

Importance of accruing for annual leave

At $60,000 gross salary per annum, the cost of one week’s Annual Leave is equivalent to $1,154 gross (rounded). This is in comparison to the cost of one week’s Annual Leave whilst a 20% pay deduction is applied, where the cost of 1 week’s Annual Leave would be equivalent to $923 gross (rounded).

Larger companies tend to accrue 8% of an employee’s earnings to allow for these payments, which means they may have a shortfall in their accruals versus actual payments. Smaller organisations tend to pay Annual Leave as it is taken.

Richard Matson, Director of K3 Accounting agrees that it is important for businesses to be aware of their annual leave liability. He says “for those small and medium businesses who do not accrue their Annual Leave liability it is also an important cost to consider when proposing any redundancies, as again it could significantly impact short-term cashflow”.

“An employee who is confirmed as disestablished after a consultation process, is entitled to any redundancy provisions, annual leave and notice periods outlined in their employment agreement. This could catch some businesses out”.

For any termination of employment payments, an employee will receive payment for both their Annual Leave Entitlement and Annual Leave Accrual.

Annual leave entitlement and accrual

Annual Leave Entitlement relates to any days annual leave from their previous anniversary years, not taken over the course of their employment. When terminating an employee, this is paid out. If a pay cut had been applied at any point, the amount the employee receives for any days owing could be greater than the average of their pay for those days over their last 12 months.

Annual Leave Accrual relates to any days of Annual Leave from the employee’s current anniversary year. When terminating an employee, this is paid at 8% of the employee’s gross earnings for this anniversary year, less any leave already taken.

So, an employee earning $60,000 gross salary, who has worked for 6 months since their last anniversary date would be entitled to approx. $2,400 gross. Note, if an employee has also received other earnings such as regular commission, this would also form part of their total gross earning on which the 8% must be calculated. A full list of what is included or excluded from the calculation of gross earnings, can be found on the IRD website, or through an HR expert.

Employers must also pay any outstanding Alternative Holiday earned for working a Public Holiday, and not yet taken; and any other agreed Days in Lieu or similar arrangements.

These calculations can become complex, and for sound financial and employee management it is important to get it right the first time.  We recommend seeking clarity on your accounting process and obligations from your Accountant or Payroll Provider given the potential unplanned costs you could be facing.

Lastly, from an employer’s perspective, the company’s HR contact (whether that be a leader or a dedicated expert) may be fielding queries from nervous employees who are planning ahead to try and predict their financial security. Employers should ensure they have a consistent, clear message to communicate to prevent any unnecessary stress or miscommunication during a potentially difficult time.

Please feel free to contact us for a chat on your approach.