As a generous employer, you may delight in rewarding your staff with a bonus for going the extra mile.

Of course, if your staff are doing well, then your business should also reap the rewards. Viewed that way, the over-performing staff member is sharing in the extra profit that you would not have otherwise enjoyed had they not made the effort.

What you may not realise though, is that the amount of the bonus payment itself does not usually represent the total increase in pay you are giving your staff member.

That is because a bonus payment worked out according to a formula also lifts the amount that the employee gets paid for taking a holiday.

How does that work?

HOW HOLIDAY PAY IS CALCULATED

The Holidays Act 2003 sets out how holiday pay gets calculated.

You must calculate the amount to pay for annual holidays at the time the employee takes their holiday. The calculation is based on the greater of their ordinary weekly pay (ie, what they typically get from week to week) or their average weekly or daily pay.

Average daily pay is calculated like this:

(Last 12 months gross earnings before taking holiday / 52 weeks) / number of working days in a week for that employee = Average daily pay to be paid for each day of holiday

In other words, you work out the “gross earnings” the employee received in the year before their holiday and divide that by 52 weeks. That gives you a weekly average, which you must then divide by the number of their working days to get a daily average.

That daily average amount is what the employee receives for each day of their holiday.

MEANING OF “GROSS EARNINGS”

Employees will have a greater average weekly or daily pay than their ordinary rate of pay if their gross earnings over a year are greater than their base salary or standard wage.

In other words, it’s important to know what “gross earnings” includes because you need to tally this all up at the start.

The Holidays Act says “gross earnings” includes not only salary and wages, but also:

• allowances;
• productivity or incentive payments, including commission;
• payments for leave, such as annual holidays and sick leave;
• payments for overtime;
• the cash value of any board or lodgings where agreed; and
• the first week of ACC compensation, if you have paid that to them.

The Act is clear that you do not have to include discretionary payments. In other words, if your bonus is something that the employee cannot count on receiving because you can choose not to pay it to them, it does not get included in the “gross earnings” sum.

But often what employers call a “bonus” will fall into the category of “productivity or incentive payment”. That is, when you give a formula to your staff, you are in essence saying, “If you do x, I’ll pay you y.” A formula like that leaves no room for any discretion, and if a bonus has resulted from that formula, then it does need to be included in the calculation of “gross earnings”.

AN EXAMPLE

Let’s suppose you pay your employee a salary of $50,000. In addition, you pay them $10,000 as a bonus during the year according to a set formula (i.e. it is not a payment that you are paying them from the goodness of your heart – you are paying them what you promised for reaching a defined goal).

When it comes time for them to take a holiday, you must calculate the amount that you are supposed to pay them before they go on holiday.

Looking back over the previous 12 months, you see that they have earned a gross total of $60,000.

Dividing the $60,000 by 52 weeks gives you an average of $1,153.85 per week, which is $230.77 per day (assuming they work a five-day week). That is what you pay them for each day of holiday they take.

If you had not paid the bonus, you would have divided $50,000 by 52 weeks, which would have been $192.31 per day.

In other words, not only have you paid them $10,000 for the bonus, but you have also increased the payment they receive each day while on holiday by $38.46 per day.

CONCLUSION

The way bonus payments affect holiday pay is a helpful reminder of the way in which holiday pay is supposed to be calculated.

That calculation takes into account gross earnings over the previous 52 weeks, which cover more than just wages or salary, and can mean that the payment they receive while on holiday is higher than their usual rate of pay.

If the calculation remains confusing – don’t think you’re alone. Even government departments can get this wrong.

Have you done this calculation recently? Do you have a process to ensure you capture an employee’s total gross earnings?