Under U.S. GAAP, employers must accrue a liability for compensated absences — paid vacation, sick leave, sabbaticals, and similar employer-paid time off — when all four conditions in ASC 710-10-25-1 are met. The accounting for compensated absences puts the expense in the period the employee earns the time, not the period they take it, and the liability sits on the balance sheet until the hours are used or paid out at separation.
The Four Conditions That Trigger Accrual
ASC 710-10-25-1 requires all four of the following before an employer must record a compensated absence liability. If any one fails, accrual is not mandatory.
- Services already rendered. The employee’s right to the paid time off must come from work already performed, not from future service still owed.
- Rights vest or accumulate. The benefit either carries forward to future periods, or the employee is entitled to a cash payout at separation. Time that simply expires each period with no payout fails this test.
- Payment is probable. It must be likely the employer will actually pay out the benefit. Vested vacation almost always clears this bar; nonvesting sick leave often does not.
- The amount can be reasonably estimated. The employer must be able to produce a reliable dollar figure. Without adequate history or data, accrual is deferred until an estimate becomes feasible.
The vesting-versus-accumulating distinction does most of the work here. A benefit vests when the employee has a right to cash for unused time even after leaving. It accumulates when unused hours roll forward instead of expiring. Many vacation policies do both.
The fourth condition is where most deferrals actually land. A company that just rolled out a new PTO plan may lack the turnover and usage history to estimate the liability with any confidence. When the data catches up, the accrual kicks in for all earned-but-unused time.
Measuring the Liability
Once the four conditions are met, the liability equals what the employer expects to pay when the time is used or cashed out, measured at the pay rate expected to be in effect at payment. Most companies use current pay rates as the best available estimate and adjust when known raises or contractual increases are already scheduled.
Payroll Taxes Belong in the Estimate
Base wages are not the whole liability. Employer-side payroll taxes that will be triggered by the eventual payout have to be included. Social Security runs 6.2% on wages up to $184,500 for 2026, and Medicare adds 1.45% with no cap.1Social Security Administration. Contribution and Benefit Base FUTA applies at 6.0% on the first $7,000 of each employee’s annual wages, though most employers get a credit that brings the effective rate to 0.6%.2Internal Revenue Service. Topic No. 759, Form 940, Employers Annual Federal Unemployment Tax Return State unemployment tax rates vary. If the policy continues health insurance or other fringe benefits during the absence, those costs go in too.
Turnover and Timing
Not every accrued hour will be paid the same way or at the same time. Departing employees get a lump-sum payout (when the benefit vests), while those who stay draw down gradually. Historical turnover data refines the estimate and also drives the split between current and noncurrent portions of the liability.
Journal Entries
The mechanics are simple. When employees earn the time, debit compensation expense and credit a liability account (commonly “Accrued Compensated Absences” or “Accrued PTO”). The expense hits the income statement in the earning period, not the taking period. When the employee later uses the time or is paid out, reverse the liability: debit the accrued liability and credit cash or payroll payable. If the pay rate has risen since the original accrual, book the difference as additional compensation expense in the settlement period.
How Different Leave Types Are Treated
Vacation and General PTO
Vacation is the textbook case. Most policies make vacation both accumulating and vesting, so all four conditions are typically met and the full balance of earned-but-unused time must be accrued. Policies with rollover caps still require accrual, up to the cap.
Sick Leave
Sick leave gets a specific carve-out under ASC 710-10-25-7. Even when it accumulates from year to year, nonvesting sick leave does not require accrual. The expense is recorded when the employee actually calls in sick.
That treatment flips when sick leave vests. If your policy pays out unused sick time at retirement or termination, accrue it the same way as vacation. The same is true if employees are routinely allowed to use sick days for reasons unrelated to illness; at that point the benefit functions as general PTO regardless of what the policy calls it.
Sabbaticals
Sabbaticals turn on the purpose of the leave. When a sabbatical rewards past service with unrestricted time off — for example, three months of paid leave after ten years — accrue the cost ratably over the service period the employee works to earn it. One-tenth of the expected cost hits expense each year.
When the sabbatical exists to benefit the employer instead, as with a research sabbatical where the employee is expected to return and apply what they learned, the leave is tied to future service. The cost is generally expensed during the leave itself or over the required post-leave service period, not accrued against past service.
Paid Holidays
Holidays are the simplest category. They don’t accumulate and they don’t vest. The second condition fails, so no advance liability is recorded. The cost is expensed in the pay period the holiday falls in.
Unlimited PTO
Unlimited PTO produces an unusual accounting result. With no defined bank of hours, there is nothing to accumulate and nothing to vest. The second condition fails and no liability goes on the balance sheet. This is part of the reason some employers adopt these plans: it removes an accrual that can grow substantial for companies with generous rollover policies and long-tenured employees. State paid sick leave mandates still require tracking specific hour balances regardless of the broader label, so multi-state employers can’t rely on the unlimited framing to eliminate all tracking obligations.
State Payout Laws Can Force Vesting
Whether vacation vests isn’t always up to the employer. Roughly 20 states require payout of unused vacation or PTO at separation even when the written policy is silent or tries to say otherwise. California, Colorado, Massachusetts, and Nebraska all mandate full payout by law. In those jurisdictions, accrued vacation is legally vested regardless of the handbook, and the second accrual condition is automatically satisfied.
Elsewhere, payout obligations depend on the written policy or employment contract. No policy promising payout, no obligation. But an established written policy or past practice of paying out unused time is often enforceable in these states as well.
The practical point for accounting: companies operating in mandatory-payout states can’t avoid the vacation accrual by drafting the policy differently. State law overrides. Multi-state employers need to track accruals by jurisdiction, because the same PTO policy can create a vested liability in one state and a non-vested benefit in another.
Balance Sheet Presentation and Disclosures
Split the total liability between current and noncurrent portions. Current covers the amount expected to be used or paid out within twelve months (or the operating cycle, whichever is longer). The rest is noncurrent. The split affects current ratio and working capital, which lenders and investors watch.
Financial statement notes must describe the compensated absence policy, including how benefits accumulate, vest, and are forfeited. If the liability can’t be reasonably estimated and has therefore been deferred, disclose that as well.
USERRA and FMLA Interactions
Two federal leave statutes affect how accrued time moves. Returning service members are not automatically entitled to vacation accrual for their period of military service, but if the employer provides accrual to employees on comparable leaves of absence, the same benefit must extend to those on military leave.3eCFR. 20 CFR 1002.150 Employers must let service members use vacation credits earned before deploying if the employee requests it, but generally cannot force the employee to burn vacation during military leave; the narrow exception is a company-wide mandatory shutdown where all employees take vacation together.4U.S. Department of Labor. USERRA Advisor
FMLA leave is unpaid by default, but employers can require, and employees can elect, that accrued paid leave run concurrently with the FMLA period.5U.S. Department of Labor. FMLA Frequently Asked Questions When that happens, the accrued liability draws down faster than historical usage patterns would predict, which can shift the current-versus-noncurrent split and warrant a look back at the estimate.