Question

Alexandra Bay Ltd has five employees. According to their particular employment award, long-service leave can be taken after 12 years, at which time the employee is entitled to 10 weeks’ leave. If an employee were to leave before the completion of 12 years’ service, no entitlement would be paid.

Name of employee	Current salary ($)	Years of service	Years until LSL vests
Mike Black	40 000	2	10
Jan White	40 000	4	8
Noel Brown	50 000	6	6
Peter Green	60 000	8	4
Alvin Purple	70 000	10	2

High-quality corporate bond rates exist with periods to maturity that exactly match the various periods that must still be served by the employees before LSL entitlements vest with them.

Corporate bond period to maturity	Bond rate (%)
10	8.0
8	7.0
6	6.5
4	6.0
2	5.8

The projected inflation rate for the foreseeable future is 2 per cent. The projected probabilities that the employees will stay long enough for the LSL to vest—that is, for a total of 12 years—are as follows:

Name	Probability (%) that LSL will vest
Mike Black	15
Jan White	20
Noel Brown	50
Peter Green	70
Alvin Purple	90

REQUIRED

(a)Calculate Alexandra Bay’s current obligation for long-service leave.

(b)If the opening provision for long-service leave is $12 500, provide the journal entry to record Alexandra Bay’s long-service leave expense

Answer 1

Q.A

Notes

1.The projected salary is determined by the following calculation: Current salary x (1 + inflation rate)n, where n = number of years until the long service leave entitlement vests. In this question it is assumed that the inflation rate proxies for the growth rate for wages and will continue to be 2%. For Black, the calculation is $40,000 x (1.02)10 = $48,760.

2. Accumulated LSL benefit is determined by the following calculation: Accumulated LSL entitlement = (Years of employment) ÷ (Number of years required) x Weeks of LSL entitlement ÷ 52 x Projected salary. For Black the calculation is 2/12 x 10/52 x $48,760 = $1,563.

3. The present value of the long-service leave calculation is determined by the following Formula:

Accumulated long service leave benefit/(1 + appropriate government bond rate)n

where n is the number of years left until long service leave entitlements can be taken. For Black, the calculation is $1,563/(1.08)10 = $724.

4. Probability that long-service leave will be taken: The probability that long service leave will be taken would be determined by reference to prior experience within the organisation and industry. For example, it has been assessed that an employee with 2 years service has a probability of 15% of staying in the firm until long-service leave must be taken. Once an employee reaches the pre-conditional period (in this question, 12 years) the probability is 100% that a payment will be made. For Black, the calculation is $724 x 0.15 = $109. Following on from the above calculations, after considering all five employees, the long service leave provision at the end of the period should total $16,314.

Q.B

If the carrying amount of provision account is $12,500, then it must be raised to $16,314 resulting in a LSL expense for the year of $3,814

Long-service leave expense Dr. $3,814

  Provision for long-service leave Cr. $,3814