Provision for untaken leave

What it means

A provision for untaken leave is a provision that a company keeping double-entry books creates at the end of the accounting period for annual leave that employees became entitled to in the current year but have not yet taken. It includes pay for the untaken days and the statutory contributions the employer will pay when the leave is taken.

The reason is the principle that costs belong to the period in which they arise. Employees earned their leave entitlement in the current year, so the company's obligation already exists even though it will be paid later. Without the provision the current year's result would look better and the following year would carry costs that do not belong to it.

The provision is kept as a short-term provision. In the following year it is released as employees take their leave, or used against pay in lieu of untaken leave when employment ends. At the end of the next year a new provision is created based on the current balance.

How it works in practice

The calculation is based on attendance records: for each employee the number of untaken days at 31 December is multiplied by average daily earnings, and employer contributions are added. Payroll software can generate the basis automatically, but leave balances need checking.

Creating the provision is not tax-deductible. In the tax return it is therefore added back to the accounting result as a non-deductible adjustment, and its release in the following year is deducted. Only the leave pay actually paid becomes deductible. The difference between the accounting and tax views gives rise to deferred tax if the company records it.

In the financial statements the provision is one of the items auditors routinely check. They compare it with attendance records and with movements in the following year. High leave balances can also signal an HR problem, such as an overloaded team that cannot find time to take leave.

What to watch out for

A common mistake is leaving out contributions, which can make up more than a third of the provision. Leave carried over from the previous year is also often forgotten, although it belongs in the provision too. Both errors understate the provision and overstate profit.

Companies using single-entry bookkeeping do not create provisions. When switching to double-entry, this must be remembered and the provision introduced from the first financial statements. Micro entities have some simplifications, but as a rule they should still create a provision for untaken leave if it is material.