How to Handle Vacation Pay

Vacation pay is a mandatory entitlement for employees under Canadian employment standards law. Getting it wrong — underpaying, not accruing it, or mishandling terminations — can create liability. This article explains the rules and how to track it correctly.

The Basics

Every province sets minimum vacation entitlements. The most common rules:

Vacation pay = a percentage of gross earnings (including overtime, commissions, and bonuses — not just base salary). It accrues throughout the year on every dollar earned.

Check the employment standards for the province where the employee works — rates and entitlements vary, and some provinces have updated their rules recently.

Two Ways to Pay Vacation Pay

Option 1: Accrued and paid out when vacation is taken

Vacation pay builds up throughout the year. When the employee takes time off, they receive their regular pay plus the accrued vacation pay draws down. This is the most common approach.

In QBO Payroll, set the vacation pay rate for each employee. The software accrues it automatically and tracks the outstanding balance.

Option 2: Paid out each pay period ("vacation pay in lieu")

Some employers (particularly for part-time or temporary workers) add the vacation pay percentage directly to each paycheque — 4% or 6% extra on every pay. The employee receives it continuously rather than as a lump sum when they take time off.

Note: This option is not available in all provinces and may not be permitted depending on the employment arrangement. Confirm with your Mesa CPA advisor.

Normal Procedure

Setting up vacation pay in QBO Payroll

1. In QBO Payroll, go to the employee's profile.
2. Under Pay types, find Vacation pay.
3. Set the accrual rate (4% or 6% depending on entitlement and province).
4. Select whether vacation pay accrues on all earnings or specific pay types.
5. Save.

QBO will calculate the vacation pay accrual automatically on every payroll run and track the outstanding balance.

Processing vacation pay when time is taken

1. When running payroll for the period, enter the vacation hours in the Time Off section.
2. QBO calculates the payout from the accrued balance.
3. Review and approve.

Abnormal Procedures

An employee is terminated and has unused vacation.

All accrued, unused vacation pay must be paid out on termination — this is a legal requirement in every province. QBO Payroll will show the outstanding vacation balance. Include it in the final paycheque.

You have been running payroll without tracking vacation pay.

You may have an outstanding liability. Work with your Mesa CPA team to calculate what should have accrued and determine how to bring it current. Depending on the situation, you may need to issue retroactive payments to affected employees.

An employee wants to take more vacation than they have accrued.

You can allow this (unpaid leave or an advance on future accrual), but it is your discretion — it is not required. Whatever you decide, document it and apply consistently.

FAQ

Does vacation pay apply to contractors?

No. Vacation pay is an employment standards entitlement for employees only. This is one of the factors that distinguishes employees from contractors.

Is vacation pay subject to source deductions?

Yes. Vacation pay is treated as employment income — CPP, EI, and income tax are withheld, same as regular wages.

What if I give employees more than the minimum vacation?

That is fine and common — provincial standards are the floor, not the ceiling. Document your vacation policy clearly in an employee handbook or offer letter so everyone's expectations are aligned.

Do part-time and seasonal employees get vacation pay?

Yes. Vacation pay accrues on all earnings regardless of employment status. Part-time and seasonal employees earn it proportionally.