Calculating leave entitlements is surprisingly tricky. They are generally outlined in employment agreements, so it’s easy to assume that staff are being paid correctly. However even the smallest changes to an employee’s role, such as which days they work on, can affect how their leave should be calculated. As your workforce changes, an ongoing review of leave calculation methods is a must.
In this blog, we explore the benefits of undertaking annual leave reviews, the main leave calculations in the Holidays Act 2003, and how to apply these to your leave review process. Let’s dive in!
What is a leave review?
Before you get started, it’s important to understand exactly what a ‘leave review’ is, which is:
A process of regularly checking your employee’s setup in payroll to ensure their leave is being calculated correctly.
We recommend that you carry these out at least once a year to:
- Demonstrate compliance with the Holidays Act 2003.
- Confirm your employees are receiving their correct pay and leave entitlements.
- Minimise risk for you and your business.
- Reduce your potential workload.
How to complete a leave review
So, now you know what a leave review is, let’s discuss how to carry one out. We’ve broken the process down into four main steps.
1. Review your employee’s employment agreements.
It’s important that whoever is responsible for your payroll knows about all of your employee’s entitlements. They can then make sure these are accurately reflected in the payroll set up. If there are contractual bonuses, incentives, or terms around overtime, they need to know.
Tip: Create an approval process that includes your payroll person when making changes to any employment agreements.
2. Review the standard hours that your employees work.
When an employee’s role changes, and their standard hours are affected, it’s easy to forget to update payroll. However, it’s important to check to make sure any changes in hours and days of work are reflected in the payroll setup and that you are still calculating leave correctly. Standard hours can change when someone works regular unscheduled overtime or moves from part-time to full-time hours and vice versa.
Tip: If you think an employee does not have a standard work pattern, review their employment agreement and/or roster to see if core agreed hours can be defined. You may find that they do have an agreed number of contracted hours and days. Just assuming that an employee has no standard hours of work because they work varying hours and days is something that the Ministry of Business Innovation and Employment (MBIE) is critical of.
3. Check that your employee’s payment rates are still correct for all types of leave.
During a leave review, you should also check the payment rates for Family Violence, Bereavement Leave, Alternative Holidays, Public Holidays and Sick Leave.
Defining payment rates can get a little bit tricky. The amount of leave you pay an employee will either be based on their ‘Relevant Daily Pay’, otherwise known as their RDP or their ‘Average Daily Pay’ or ADP.
Relevant Daily Pay (RDP)
If you know what your employee would have earned had they come to work that day, then you’d pay them that amount – known as their RDP.
Most salaried employees are paid RDP because they earn the same amount every day, regardless of their hours worked. Even rostered employees can be paid their RDP if they strictly work their standard rostered hours.
Average Daily Pay (ADP)
If you can’t determine what your employee would have earned had they come to work because their daily hours vary, or they get extra but variable payments for things like commission or unscheduled overtime, you may need to pay their average daily pay instead.
To calculate ADP:
- Work out your employee’s gross earnings over 52 weeks
- Divide this by the number of whole or part days they worked, including any paid leave or holidays during that period.
Staff on ‘casual’ employment agreements are also entitled to sick leave, bereavement leave, and family violence leave after six months if during that time they have worked:
- an average of at least 10 hours a week, and
- at least one hour a week or 40 hours a month.
You should regularly assess your employees against these criteria to determine if they qualify for these leave entitlements.
4. Check payment rates are still correct for annual leave calculations.
According to the Holidays Act, employees must receive four weeks of annual leave each year, based on what a working week is for them. However, not every employee has a standard working week. This is where you can run into a little bit of trouble, so calculating annual leave requires some extra care.
How to calculate annual leave
When calculating annual leave, there are two payment rates that can be used. There is Ordinary Weekly Pay (OWP) and Average Weekly Earnings (AWE). You must use the greater of these two rates to calculate annual leave for your employees. It’s also important to note that the applicable payment rate can vary between staff, so you’ll need to check these are correct for each individual.
Ordinary Weekly Pay (OWP)
Ordinary Weekly Pay is the sum an employee receives for an ordinary working week under their employment agreement. If they work standard hours each week, and you know exactly what they would be paid if they were at work, then you would pay them their OWP. You should include any payments that are a regular part of their pay such as:
- Regular overtime.
- Productivity or incentive-based payments.
Some employees also receive regular but unpredictable payments in addition to their ordinary pay rate. These could be variable overtime payments or incentive payments. This means it isn’t always possible to work out their OWP based on the amount they would normally receive for an ordinary week. If this is the case, you can consider paying their ordinary weekly pay based on the average of their previous four weeks of earnings.
Average Weekly Earnings (AWE)
Average weekly earnings are based on an employee’s average earnings per week over a 52-week period. These include any payments that the employer is required to pay the employee under their employment agreement. This means any contractual bonuses should be included, even though the exact amount of the bonus may depend on performance measures.
Tip: While discretionary payments can be excluded, make sure you check these are truly discretionary and aren’t reflected in some way in the employment agreement.
What about annual leave for casual employees?
Casual employees can be paid annual leave on a “pay as you go” (PAYG) basis. This means you pay them 8% of their gross earnings in lieu of providing four weeks of annual leave. Employees paid like this are usually employed on a fixed-term basis for less than 12-months, or work so randomly that it is impractical to provide them four weeks of annual leave entitlement.
To use PAYG, you must be able to show that you have considered the criteria under section 28 of the Holidays Act 2003 and can justify that your casual employees meet it. Otherwise, you may be required to pay the employee their four weeks of annual leave entitlement, on top of the 8% PAYG already paid.
The easiest way to stay compliant when calculating annual leave
The Holidays Act defines annual leave entitlements in weeks and days, but most payroll systems record annual leave in hours. This makes it difficult to demonstrate and maintain compliance and requires ongoing reviews to ensure leave is being calculated correctly.
SmartPayroll offers the ability to convert and hold annual leave balances in weeks. Using this option will ensure your employees receive their correct entitlements as specified by the Act. You also won’t need to make any manual adjustments to balances because the balance in weeks remains constant, regardless of a change in working patterns. Read more about calculating annual leave in weeks.
As you can see, there are a lot of factors that go into keeping compliant with the Holidays Act 2003 and paying your employees correctly. The Act is complex and involves multiple calculations that apply in different situations. If you feel a little overwhelmed, you’re not alone and we’re here to help. If you have any questions about compliance with the Act or how SmartPayroll can help to support you and your business, get in touch today. We’re committed to making payroll easy and we would love to chat!
Disclaimer: The content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.
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