Calculating vacation provisions: how it works under German commercial and tax law

What is a vacation provision, exactly?

A vacation provision is calculated when employees carry part of their annual vacation over into the following year. The company is obliged to calculate this so-called “performance arrears” (Erfüllungsrückstand) - the vacation backlog. In practice this means that the employee's remaining vacation is carried over into the following year, but forms a provision on the balance sheet.

Why exactly does this matter? If it is foreseeable for a company that certain payments will or could fall due in the next financial year, it has to set up provisions on its balance sheet. Provisions can also be regarded as debts whose exact amount and due date are not yet known. But because companies have to report all of their assets and liabilities, uncertain obligations that reduce their assets have to be disclosed as well.

What reaches the tax office is therefore the accounting entry “expenses to provisions”. This reduces the profit for the closing year and at the same time transfers the amount into the new financial year.

What exceptions to the vacation provision are possible?

To begin with, every employee is obliged to use up their vacation days in the current financial year. There are a few exceptions in which vacation can be carried over, though: exceptions can be business-related or private events. On the business side this could be a vacation freeze caused by unforeseeable peaks in work, for example. Private events include illness, for instance, during which the employee cannot take the vacation.

Normally these days then have to be used up by 31 March of the following year. In practice, however, there are differing agreements with extended deadlines.

When calculating the vacation provision, a distinction is made between the tax balance sheet (Steuerbilanz) and the commercial balance sheet (Handelsbilanz). Specifically, the commercial balance sheet includes some further costs and expenses in the vacation provision.

Calculating vacation provisions under tax law

Costs and expenses to be taken into account for vacation provisions in the tax balance sheet:

• Annual gross pay
• Employer's social security contributions
• Vacation bonus (Urlaubsgeld)
• Christmas bonus, provided it is a fixed part of the remuneration
• Pay-related ancillary costs such as contributions to the employers' liability insurance association (Berufsgenossenschaft)

Calculating vacation provisions under commercial law

Costs and expenses to be taken into account in addition for the vacation provision in the commercial balance sheet:

• capital-forming benefits (vermögenswirksame Leistungen), provisions for long-service awards
• and additions to pension provisions

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What happens to vacation days when someone changes employer?

If an employee moves to another company and vacation days are still outstanding, a distinction is made between a move at the start of the year and a move during the year:

At the start of the year

If the employee still has vacation entitlement from the previous year at that point, it has to be paid out in cash. Waiving it is not allowed! In this case no vacation provision is necessary.

During the year

There are three different ways of dealing with leftover vacation days when an employee moves on during the year:

1. Carrying vacation days over

In some cases untaken vacation days can be carried over into the new employment relationship, if this is agreed contractually or provided for by law.

2. Paying out untaken vacation days

It is possible for the previous employer to pay the employee for the untaken vacation days. In this case the vacation provision would be used to cover the company's financial obligation.

3. No carry-over and no payout

There are also cases in which untaken vacation is neither carried over nor paid out. This depends on the terms of the employment contract, company rules and statutory provisions.

Exactly how it is handled depends on the individual situation. In any case it is important that the employer is transparent and consistent in applying the vacation rules and that all relevant aspects are clearly set out in the employment contract or in company rules.

How is the vacation provision calculated?

Individual calculation versus average-based calculation

In principle the vacation provision is already a fairly complex and laborious process, because it has to be carried out individually for every employee. But for large companies with many employees, calculating it for each individual employee is very laborious, which is why case law permits vacation provisions to be calculated either as an individual calculation or as an average-based calculation.

The individual calculation

With the individual calculation, the figures are worked out for each single employee. The calculations are exact and so are the results. This process is fairly laborious and time-consuming, but it produces the most accurate data.

So what you need are each employee's individual figures for relevant vacation pay, actual working days and outstanding vacation days .

The most complex of these components is the relevant vacation pay. We will explain the exact process later.

When calculating the vacation provision, a distinction is made between the tax balance sheet and the commercial balance sheet. Specifically, the commercial balance sheet includes some further costs and expenses in the vacation provision.

The average-based calculation

With the average-based calculation, all employees are treated as one group. That reduces the workload considerably. Even so, this method is not advisable where pay structures vary widely, because there is a risk of over- and undervaluation.

We show you the exact average-based calculation below.

What does the vacation provision calculation look like in detail?

To calculate the vacation provision, we first have to establish the components of the equation. As a reminder, this is our formula:

Calculating the relevant vacation pay

The relevant vacation pay is the financial figure for the vacation provision. To get there, the daily rate per vacation day has to be worked out.  

You need the following data for the individual calculation:

• Gross salary of the individual employee
• Costs and expenses to be taken into account

This data is added together to give the relevant vacation pay.

Number of working days per year

Next comes working out the annual working days in order to calculate the daily rate per vacation day. There are two options here. Either the days are determined exactly, or the average value accepted by the tax and commercial balance sheets is used.

• 220 working days under commercial law minus vacation and sick days
• 250 working days under tax law with a 5-day week
• 300 working days under tax law with a 6-day week

These average values may only be chosen for an employment relationship that ran for the whole year.

If you divide the figure you have worked out for the relevant vacation pay by the actual working days, you get the daily rate per vacation day.

Outstanding vacation days

The last factor in our formula is the outstanding vacation days. These are all of the employee's outstanding vacation days as at the balance sheet date, 31 December.

Put these components into our formula and you get the vacation provision for the individual employee.

The average-based calculation method

In principle the formula for the average-based calculation of vacation provisions stays the same as for the individual one. But instead of working with employees' individual figures, the individual values are added together here.

So to carry out the average-based calculation, all salary and wage costs first have to be added up. Next come all working days and public holidays of all employees as a total. Finally, all of the employees' outstanding vacation days have to be added together.

Instead of entering the individual data into our equation, the totals of the values are now used. That means the formula looks like this:

How are vacation provisions released?

Provisions that have been set up have to be released again once a liability no longer exists. Provisions can be released in three ways:

1. If the amount of the provision matches the amount paid out (also called the expense), the release has no effect on profit or loss.
2. If the provision was larger than the payment required, however, the amount exceeding the expense has to be booked as other operating income.
3. If the provision was too small and is not enough for the payment, an additional operating expense has to be booked.

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