ASC 710 and 712: Accruing Compensated Absences, Bonuses and Severance

Payroll-related accruals are a favorite place for small clients to be wrong in the same direction every year. Vacation is expensed when taken. The annual bonus is booked when the checks are cut in March. Severance is booked when the last paycheck goes out. Each of those timings is usually a year-end understatement of liabilities.

This guide covers the three accruals that most often appear in audit files: compensated absences, bonuses and termination benefits.

When must compensated absences be accrued?

An employer accrues a liability for future compensated absences when all four conditions of ASC 710-10-25-1 are met (KPMG):

1. The obligation is attributable to services already rendered.
2. The rights vest or accumulate.
3. Payment is probable.
4. The amount can be reasonably estimated.

The liability is accrued in the year the absence is earned, allowing for anticipated forfeitures from turnover (ASC 710-10-25-2). The rights need not have vested or accumulated yet: the cost is accrued as it is earned, which can be before vesting or accumulation (KPMG).

The words vest and accumulate carry the analysis. Vested rights must be paid even if the employee leaves. Accumulating rights are earned but unused time that can be carried forward, even if the carryforward has a cap. If accumulating rights carry forward, benefits paid later are earned by services already rendered, so a liability is recognized to the extent payment is probable and reasonably estimable (KPMG).

Three situations come up often:

• Use it or lose it. Rights that lapse at year end and are not paid on termination neither accumulate nor vest, so no accrual is needed when the entity's fiscal year and the employee's benefit year coincide, unless past practice creates a constructive obligation. If the benefit year differs, for example it runs from an anniversary date, vacation earned but unused at the reporting date needs to be assessed and is generally accrued (KPMG).
• Sick pay. An employer is not required to accrue nonvesting accumulating sick pay (ASC 710-10-25-7), but may do so if the four conditions are met (ASC 710-10-25-8). Actual practice governs over the label: if employees are customarily paid sick pay when they are not ill, or can take paid terminal leave for unused sick days, the benefit is accounted for as a compensated absence under ASC 710-10-25-1 (ASC 710-10-25-6, KPMG).
• Sabbaticals. If the leave is granted only to perform research or public service that benefits the employer, nothing is accrued in advance. If it is unrestricted paid time off for past service, accrue over the service period needed to earn it, assuming the other conditions are met (ASC 710-10-25-4 and 25-5, KPMG).

An illustration. At December 31, ten employees each hold five unused vacation days that carry forward. The daily pay rate is $200, and no forfeitures are expected.

When is a bonus accrued?

A cash bonus plan is a deferred compensation arrangement under ASC 710, while stock compensation plans are covered by ASC 718 (KPMG). Where the terms attribute the benefit to a single year of service, the cost is recognized in that year. Where they attribute it to a period longer than one year, the cost is accrued over that period in a systematic and rational manner, and only the portion applicable to current service is accrued (ASC 710-10-25-9 and 25-10, KPMG). An annual bonus earned for the fiscal year is therefore generally accrued during that year when payment is probable and reasonably estimable, even if the checks are cut after year end.

Other points:

• Signing bonuses. KPMG says a signing bonus is generally expensed when paid. An advance subject to a clawback is recognized as an asset only if the clawback is enforceable and the entity intends and is able to enforce it, which is uncommon.
• Multi-year arrangements. Accrue over the service period in a systematic and rational manner. KPMG's example of a three-year retention award accrues cost either graded or straight-line, applied consistently, with cumulative expense never below the vested amount.
• Bonuses tied to share price. These fall under ASC 718, not ASC 710 (KPMG).

An illustration. A company's year-end estimate of the annual bonus pool is $120,000, to be paid on March 15.

How is severance accounted for?

Termination benefits fall into four groups, and the group sets the timing.

A history of paying similar termination benefits can indicate a substantive plan, which puts the benefit under ASC 712 rather than ASC 420 (KPMG).

One-time benefits are recognized when management with authority commits to the plan, the plan identifies the number of employees, their functions, locations and expected completion date, the benefit terms are specific enough for each employee to calculate the amount, and significant changes are unlikely. The plan must also be communicated to the affected employees. If employees do not have enough detail to calculate their benefit, no accrual is recorded.

Timing then depends on required service. Employees who need not work, or who stay only through the minimum retention period, produce a liability recognized in full at the communication date. The minimum retention period cannot exceed the legal notification period or, if none applies, 60 days (ASC 420-10-25-7, KPMG). If employees must work beyond that period, the cost is accrued ratably over the service period.

An illustration. On December 10 management approves and communicates a plan to terminate 8 employees on December 31 with $5,000 each and no further service required.

If the same one-time plan were first communicated to employees in January, no liability would exist at December 31 even though management decided in December, because the ASC 420 plan must be communicated.

Audit angle

1. Read the policies. Obtain the employee handbook, bonus plan documents, employment agreements and any severance plan. Classify each vacation and sick plan as vesting, accumulating or use-it-or-lose-it.
2. Recompute the vacation accrual. Agree unused days from the payroll or time system to the policy, multiply by the pay rate, and compare to the ledger. Test the rate used for officers separately.
3. Test the bonus. Agree the pool to board or compensation committee approval, compare it to payments made after year end, and test performance conditions to results.
4. Search for severance. Read board minutes, scan post year-end disbursements and ask about workforce reductions. Check the date of communication to employees against year end.
5. Test completeness with subsequent payments. Payroll disbursements in the weeks after year end are the quickest test for unrecorded bonuses and severance. See /us/blog/accrued-expenses-journal-entries-audit.
6. Judge the estimates. Management's estimates of forfeitures and bonus achievement are accounting estimates. See /us/blog/auditing-accounting-estimates-au-c-540-sas-143.

Common misstatements: vacation expensed when taken, a bonus booked only when paid, a signing bonus deferred as an asset with no enforceable clawback, severance accrued before the plan is communicated, and ongoing and one-time severance blended under the wrong standard.

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

Sources

• KPMG, Employee benefits Handbook, September 2026 (compensated absences, sick pay, sabbaticals, deferred compensation and bonuses, signing bonuses, special termination benefits, ASC 420 one-time benefits, 60 day retention period): https://kpmg.com/kpmg-us/content/dam/kpmg/frv/pdf/2026/employee-benefits.pdf
• PwC Viewpoint, Pensions and employee benefits guide, 6.4 Compensated absences: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/pensions-and-employee-benefitspeb/peb_guide/Chapter-6-PEB/64_Compensated_absences_8.html
• PwC Viewpoint, Pensions and employee benefits guide, 6.3 Cash bonus plans and cash bonuses: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/pensions-and-employee-benefitspeb/peb_guide/Chapter-6-PEB/63_Cash_bonus_plans_and_cash_bonuses_3.html
• PwC Viewpoint, Pensions and employee benefits guide, 8.1 Termination and other postemployment benefits overview: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/pensions-and-employee-benefitspeb/peb_guide/Chapter-8-PEB/81_Termination_and_other_postemployment_benefits_overview_1.html
• PwC Viewpoint, Pensions and employee benefits guide, 8.5 Restructurings and one-time termination benefits: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/pensions-and-employee-benefitspeb/peb_guide/Chapter-8-PEB/85_Restructurings_and_onetime_termination_benefits_20.html

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error