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How To Correctly Record and Pay Out Annual Leave in Xero

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Make sure you avoid these 3 common errors:

  1. Incorrect Annual Leave Balance
  2. Annual Leave not paid out at the correct rate
  3. Annual Leave in Advance being confused with Holiday Pay

Annual Leave Balances

The most common Annual Leave error I find in Xero is incorrect balances. This generally happens when the employees’ standard hours change or they are working irregular hours. For these situations a Manual Adjustment will generally be required to keep the Annual Leave Balance correct. There is no warning about this so it’s often missed.

Annual Leave by NZ law is accrued in Days/Weeks, whereas Xero Payroll keeps Annual Leave balances in Hours. So when standard hours change, the number of hours Xero Payroll is using to represent a Day/Week, changes. Here’s an example.

Your employee used to work 20 hours a week – represented in Xero Payroll as 5 hours, 4 days a week. Therefore 1 week Annual Leave will be represented by 20 hours. If the employee then changes to 30 hours a week standard hours, then now Xero Payroll is representing a week as 30 hours, not 20. So the Annual Leave 4 week accrual will change from 80 to 120 hours.

Annual Leave balances in Days/Weeks should be based on the current work patterns, not past ones. So if an employee had an Annual Leave balance of 80 hours (based on working 20 hours a week), and then they change to 30 hours a week, you would need to adjust the Annual Leave balance up to 120 hours, as that is the new representation of 4 weeks for that employee.

Check the “Leave Transactions” report (Reports / Payroll Reports) to see the complete history and if there are any errors or mysteries that don’t make sense such as:

  • A different number of Annual Leave hours accrued in different years
  • Random Annual Leave or other Leave accruals
  • Holiday Pay Balances continuing to accrue for more than one year
  • Annual Leave Cash Up balances that have not been reversed out

I’ve given a fuller explanation in my earlier blog https://livingbusiness.co.nz/blog/xero-part-time-flexible-employee-annual-leave/

Once you have confirmed what the Annual Leave balance should be, it can easily be fixed with an Unscheduled Pay run, which can also be backdated if required.

Annual Leave not paid out at the correct rate

Paying out Annual Leave at the correct rate is an entirely different issue from ensuring the Annual Leave balance is correct. Paying out Annual leave concerns the $ rate to pay at the time Annual Leave is taken.

Problems generally arise when employees are working irregular hours, or their standard hours have changed. In these situations, it may well be incorrect to be paying out at the standard hourly rate. This is because Annual Leave is required to be paid out at the higher of the normal rate or an average rate. The best explanation of this in detail is on the government website https://www.employment.govt.nz/leave-and-holidays/

If Annual Leave has been paid at a standard rate in error, then it can be fixed a couple of ways – might be a good idea to consult with the employee as to their preference. You can adjust the Annual Leave Balance to compensate for any underpayments, or you could recalculate what the payments should have been and pay the shortfall to the employee.

I’ve explained how to do this in my earlier blog. https://livingbusiness.co.nz/blog/xero-part-time-flexible-employee-annual-leave/#adjustments

Annual Leave in Advance being confused with Holiday Pay

There is generally never a situation where Holiday Pay is paid out unless the employee is being terminated. This can happen at the end of employment, or if an employee is changing from Casual to Permanent so is being “terminated” and then reloaded as a new employee in Xero Payroll, under a new employment contract. Find out more about the difference between Annual Leave and Holiday Pay and recording them in Xero.