ALTECH'S VACATION DILEMMA

The headline proclaimed, "Why we're letting Virgin staff take as much holiday as they want" (Branson, 2014). Almagoogledthe headlines and found the announcement was getting a lot of pressboth CNN and the BBC covered the story.Some, like the British paperThe Guardian,thought the decision to change wasjust an attention-getting move;othersincludingUSA Today--felt that Branson was adopting an altruistic andprogressiveapproach to employee relations.Asearch of corporate websitesdisclosedother sizeable firms with an unlimited vacation policy for non-hourly workers (andadoptionyear) includingNetflix (2004), Best Buy (2004), Morningstar (2010), Adobe (2012), Lexmark (2013) and MGM Resorts (2013). Alma thought the stories interesting, but she also thought that they missed the point.

As a senior director of human resources for a mid-size technology firm,Altech, Alma had been involved in her firm's switch to an unlimited PTO policy several years earlier. She knew that the decision to change the vacation policy had not been driven by concerns about employee morale. The decision to switch had largely been the result of straightforward business analysis based on dollars and cents, especially management's concerns with the size of the accrued PTO liability.

Firm Background

Altech, a software solutions firm,was established in the1980's in California's Silicon Valley, hometomany computer and technology startups.Altechprospered by combininginvestment in research and development, product engineering andworld-classmanufacturingwithcustomer service.Altech'ssuccess has led to not only increasedassetsandearnings, but an increase in its employee headcount (see Appendices A, B and C).

Accounting for Vacation Pay

Increasingheadcount naturally resulted in increased employee compensation expenses,includingsalaries, health and other insurance costs, and retirement benefits. Vacation pay, or paid time off (PTO), was another component of employee compensation,butitsimpact on compensation expense was neither consistent nor predictable.

BecauseAltechis headquartered in California, it is subject to that state's strict laws concerning vacation policy.In California, a "use it or lose it" policyfor vacation is illegal. Firms mustcompensate employees for up to two weeks of earned but untaken vacation time annually, either by giving time-off or its equivalent in pay (Suastezv. Plastic Dress Up(1982) 31 C3d 774). Since California is home to approximately 20% of U.S. firms, this one state's PTO laws affect many businesses.

Firms spend considerable time and resources trackingvacation days earned, taken, and paid for.Altech'svacation policy provided employees from 14 to 28vacationdays annually, withanaverageof16 days. PTO was earned proportionally throughout the yeareach month 1/12 of the current year's PTO was earned.PTO could be taken as earned,orup to 20 days could berolledforward, or banked, for one year.

Untaken vacation days at the end of the yearbecamea liability on the next year's balance sheetwhoseultimate dispositionwasunknown.If employees usedtheirbankedPTO as days off in the subsequent year, thebankingaccrual was unnecessary--no additionalexpense was incurred by the firm. Whenemployeesdidn't take use their bankeddaysas time off, they were paid for them. Theyreceivedcompensationbeyond their base salaryforforextra time worked,increasingAltech'sexpenses.Depending on employees' behavior,compensation expense (base salary plus paid PTO) could swing widely between years.

Altechactively encouraged employees to take time off,but manyemployeespreferred toreceive cashfor bankedPTO. Departmental managers received memos about the PTO status of their staff throughout the year, reminding them that the behavior of employees regarding PTO would affect both their departments'expensesand cash flow in the current year, and would make budgeting for the next year difficult.Calculating whetherbanked PTO wouldbe used astime off or would require a cash payment was always a guessing game.Alma wasn't sure she understood the problem, but the controller's office said there was adifficulty becausethe contingent liability associated with PTO was created in one year while itseliminationthrough payment or time off--occurredthe next year.

Some had suggested not booking the vacation expense until it was taken as either time off or in pay, but the controller's department said this wasn't possible, saying that the banked PTO met the definitions of both a liability and contingent liability, terms that just left Alma confused. They also said that both the size of the accrued PTO balance and its volatility impacted the firm's financial statements.

Unlimited Vacation

During the time that top management atAltechwas mulling over this issue, a new concept, called "unlimited vacation," or "unlimitedPTO" was catching on in Silicon Valley.Netflix, Zynga, andXobnidangled the policy as they competed for top engineers, hoping toappeal to top talent. Though not appropriate for hourly workers, unlimited vacation time had many benefits for firms whose employees were salaried professionals.Firms involved in newer technologies and the "new economy" typically had a large, unquantifiable asset in employee knowledge.These firms neededto ensure that their most important assettheir employeesremained. Both thecontroller'sdepartment and the human resources department atAltechbelieved that this new policy could be the ideal solution for them.

A popular version of a work environment being cultivated to complement the unlimited vacation policy was calledROWE(Ressler& Thompson, 2008)-- Results Only Work Environment--whereemployeeswere expectedto work as needed in order to achieve a specified goal.Altechmanagement realized that, as a relatively young company with a casual workday approach, it was a prime candidate.Acompany with a more traditional approach to work might find it difficult to measure performance any other way thanbytime spent in the office,butAltechalreadyofferedflex-time, and employees expected to occasionallywork from locationsoutside the office.Much of what was done atAltechwas research and service related,soit was not necessary to have all employees on-site at any particular time.Most projects had beginning and end points and were completed in teams,makingthe company a perfect candidate for the implementation ofROWE. Theswitchwould eliminate costs associated with the tracking ofvacationdays. Management alsoloved that the change would greatly diminish variability in compensation expense and eliminate the contingent liability arising from rolled over PTO.

In an effort to find out how employees felt about the change, and how the companies making the change had been impacted, management scoured many articles on unlimited vacation policies andROWE; they found thatsomeemployeesloved itfeelingthat they had finally achieved a wonderful work-life balance, while others disliked the change,complainingthey could never really take a vacation.Some felt cheated out of the "compensation bonus" for unused vacationdaysthey'd been counting on.What management found regarding company efficacy after the change, however, convinced them to embrace this new policy.Companies, such asTheGap, Evernote, ASC,Chegg,Dynaronixand tens more, had found that once they converted from a traditional work environment toROWE, there was expanded individual and team capacity,increased productivity, higher levels of customer satisfaction, a better ability to attract top talent and a lowered turnover rate!Altech concluded that the change would be a good one for them.

Making the Change

The last year that vacation pay could be "earned andbanked" was 2009; final payments forrolledvacation days were made in 2010.The transformation took time,butoverall, the change proved to be a positive one.After the initial hit to the income statementcaused by recognizing allbanked PTOas an expense,the PTOliabilitydisappearedandcompensationexpense decreased;the bottom line, even without considering the touted addedproductivity, increased.The"triple bottom line" wasup, andthe financial statements and related ratios lookedbetter than ever.Alma, and management, was pleased.

Student Instructions:Answer the following questions. Your responses should be written in essay form;include all appropriate calculations.

1.Explain why the balance for accrued PTO liability is difficult to calculate.You may use an example.

2.A) Explain how this liability and the associated compensation expense impacts the balance sheet and income statement.

B) Which financial ratios may be affected by these balances (list 3)?

C) Why is volatility in these numbers concerning? To whom are they concerning?You may use an example.

3.explaining how the capital markets could react tothe volatility in the financial statements from theunused vacationcontingent liabiliityon its balance sheet.

4.Based on the information in the case provided above, how important is a company's environment in the decision to implement change?

5.What journal entries are needed to reflect the following? Assume the salary is $1,000 per week, s/he earnsfourweeks PTO annually, accruing it at a rate of 1/12 per month, and the employee can take PTO as earned.

a.Each month, record salary and PTO expense.

b.In year 1, employee rolls over two weeks PTO.

c.In year 2, employee elects to take accrued PTO as days off while rolling over two weeks of current PTO to next year.

d.In year 2, employee receives a check for the prior year's unused PTO while rolling over two weeks of current PTO to next year.

e.In year 2, employee takes prior year accrued PTO as time off and uses all of current year's PTO.

6.PTO must be accrued for as earned, creating a liability. How can the characterization of accrued PTO as a contingent liability be correct?