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How to correctly set up and pay Annual Leave for part-time flexible employees in Xero Payroll

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The combination of how Xero Payroll is designed, and the complexity of Annual Leave law in New Zealand means we are often fixing up Annual Leave errors in Xero Payroll. Problems can arise with incorrect Annual Leave balances for a number of reasons, but one that we see quite often is where there are part-time staff on flexible hours.

The risk here is that you may be overpaying Annual Leave entitlements, or even worse underpaying them.

What is a week’s Annual Leave?

Annual Leave in New Zealand law is expressed in Weeks/Days.

Perhaps it’s written in the employment agreement, perhaps it’s not. Sometimes it’s a case of sitting down together and deciding what a week’s leave will be. As an example, if the employee works part time on Tues/ Wed/ Thur, then perhaps a week’s leave is those three days. Or if they work different days every week, perhaps it’s “any three days”. There is no definite rule on this – you just have to decide what’s practical. Sometimes, what constitutes a “Week” can only be defined at the time Annual Leave is being taken, as the employee might have moving shifts or changing hours.

It can be useful to think about Annual Leave as 2 components.  Firstly, there is the balance of Annual Leave due to the employee – which is best represented in Weeks – and should reflect whatever the current work pattern is, right now.  This could be a positive balance or even a negative balance if Annual Leave has been taken before it was earned.

Secondly, there is the calculation of how much to pay out at the time Annual Leave is taken.

How does Annual Leave get represented in Xero?

Xero Payroll software has it’s own way of deciding how to record the amount of Annual Leave that an employee is due. All it does is look at what’s in the employment tab as standard hours. That’s it.

It’s not possible to enter in Annual Leave entitlements from the Leave Tab of Xero. You enter this in through the Employment Tab, by putting in standard hours. Then, when it’s time for the Annual Leave to be entered into the employee record (usually after 12 months of employment), Xero just looks at the standard hours, and makes a calculation. Its almost always – Hours Per Day x Days per Week x 4 weeks and it makes the entry automatically.

A very common question we get asked is “but my employee has flexible and changing hours – how many hours / days per week do I put in as Standard Hours?”

If there are no standard hours, then the recommendation to get Xero Payroll working properly is to use minimum hours as a representation of the weeks.  Other payroll software does it differently, but this is the way that works for Xero Payroll.

This doesn’t mean your employee will only get paid Annual Leave based on the Minimum Hours. But it does mean you won’t be overpaying Annual Leave, which would happen if you entered in a higher number of Standard Hours and the employee ended up averaging less than those Standard Hours.

Are you recording and paying out Annual Leave correctly?

So here’s the trick. You are representing the Annual Leave due to your employee by Minimum Hours and Xero will raise the Hourly Rate if the employee has worked on average more than the minimum hours.

Here’s an example:

You have an employee who works part time flexible hours. Some weeks they work 30 hours over 4 days, other weeks they work 10 hours over 2 days, some weeks they don’t work. It just changes every week. You might look at their work history and figure they have worked an average of 15 hours a week and work is increasing so you are confident they will work at least 15 hours a week overall going forward for the foreseeable future.

In the Employment Tab for the employee you could enter in 5 days a week, 3 hours a day as their standard hours. So 1 Week is going to be represented in Xero as 15 hours.

When Xero allocates the Annual Leave, the employee will be allocated 4 weeks, represented in Xero as 15hrs x 4 weeks = 60 hours.

Then, down the track the employee wants to take a weeks’ leave.  Firstly, Xero needs to know how much leave they are taking so that the balance of hours due is correct.  If the employee is taking 1 Week, then that is represented in Xero as 15 hours, so apply for 15 hours.  Keep thinking in terms of Weeks as this is how the legislation is written.

Secondly, Xero needs to work out how much the employee gets paid for the week they are taking.

Firstly – the balance of leave hours

Don’t worry about how many hours or days or any patterns of work the employee has been doing lately. Just record the number of hours of leave taken based on the minimum hours recorded in Xero. So, if the employee wants to be off for a week, then record this as 15 hours – even if they have been working an average of 30 hours in the weeks prior. After the week is taken, the balance will correctly show as 45 hours remaining (3 weeks).

Same process if the employee wants to take 2 days off – record this as 6 hours (2 x 3hrs as per minimum hours) even if they would have worked more or less on those two days. After the two days are taken, the balance will correctly show as 54 hours remaining (4 weeks less 0.4 of a week = 3.6 weeks)

Secondly – how much the employee gets paid for the hours of leave being taken

New Zealand legislation requires that the amount you pay for Annual Leave is based on the higher of their normal pay, or the average of the last 52 weeks. (There are some finer points to this but we won’t worry about those right now). So, when you are paying 1 weeks Annual Leave, it will be the higher of either what they would normally earn in a week, or the average from the last 52 weeks pay – calculated using the dates immediately prior to when the Annual Leave is being taken.

Xero Payroll will work this out for you. If you have recorded the Annual Leave as 15 hours being taken, Xero knows that’s “A Week” according to what’s in the Employment Tab. It will then look back at what’s been paid as an average from last 52 weeks, and this will be the amount it will calculate to pay out. You will see it when the Annual Leave amount appears on the Payslip – there is a blue toggle where you choose to pay either the normal hourly rate (say $25) or the Average rate. If the Average rate is higher, then it’s most likely the correct one.

Xero will increase the $ hourly rate if your employee has worked more than minimum hours. For this example, with the Standard Hours recorded as 15 in Xero, if the employee had actually worked 30 hours a week on average, then their Annual Leave $ rate would double. So instead of being paid 15 hours x say $25 an hour as their normal rate of pay, they would be paid 15 hours x $50 an hour.

You can represent minimum hours with as little as 5 hours a week or even less and as long as you record leave taken based on that proportion, then the balance will be correct. And as long as you toggle to allow Xero Payroll to increase the hourly rate being paid, you will be paying your employees correctly.

Other common errors

There are lots of other situations and questions that arise where a sort out is needed:

  • It’s been more than a year, and no Standard Hours were entered, so there is no Annual Leave allocated, but leave has been taken so there is a negative leave balance
  • It’s been more than a year, but leave has been paid out on every pay
  • Standard Hours entered are higher than the average being worked
  • The Hours being worked have changed, so the Annual Leave balance needs adjusting but unsure how much to adjust
  • Part-time flexible employees have been paid their normal hourly rate when they take leave, instead of a rate based on average earnings
  • Hours are part-time/regular, but have changed at some time and the Annual Leave balance has not been adjusted

How to adjust Annual Leave in Xero Payroll when Part Time hours change

This is an area we are regularly questioned on, and often where errors are made. Here’s an example where adjustments are required:

Your part-time employee works 20 hours a week for 2 years. At the end of 12 months Xero correctly allocates 80 hours Annual Leave  (representing 4 weeks), and then again another 80 hours at the end of 24 months.

Then you get busy and after a few months (2 years, 4 months, 12 days in total), the part-time hours increase to 30. You sign a new employment agreement and the minimum hours are 30 a week.

So now, the hours you previously had in Xero to represent the weeks, is no longer accurate.

There are two changes to make in Xero.

Firstly, update the standard hours in Xero in the Employee Employment tab.  This is all you have to do, so that at the next anniversary Xero will refer to the new standard hours and allocate the updated amount of AL hours to represent 4 weeks.

Secondly, whatever the hourly balance is in Xero at the time of the change – convert this to Weeks because the number of Weeks due to the employee will not change, even when the number of hours worked changes.

Once you have the balance in Weeks, then convert this back into hours based on the new representation  in Xero.

Here’s an example:

Employee has been entered in Xero as 10 hours a week (minimum hours). Over time they were allocated 40 hours Annual Leave (representing 4 weeks), and have taken several days Annual Leave with 2 hours representing each 0.2 of a week.  So they now have a balance of 2.6 weeks Annual Leave, represented in Xero as 26 hours.

Then they change to nearly full time, a new employment agreement is signed and it’s decided to represent their hours in Xero as 35 hours a week.  2.6 weeks Annual Leave will now need to be represented in Xero as 35 hours x 2.6 weeks = 91 hours.  So a manual adjustment of hours will be needed of 91-26 = + 65 hours.

Follow Xero’s instructions on how to do an Annual Leave adjustment (run an unscheduled pay run).

It’s the same principle with an employee decreasing hours. If the Annual Leave is not adjusted in Xero, you will be overpaying.

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