Anonymised, illustrative composite. A target tracked vacation entitlement in a spreadsheet nobody reconciled to payroll — and the buyer found a six-figure liability sitting off every set of financial statements it had been given.
At a glance
A regional retail chain with 58 employees tracked vacation time and vacation pay in a standalone spreadsheet maintained by the office manager, separate from the payroll system that actually issued paycheques. The spreadsheet had not been reconciled against payroll in over three years, and nobody at the company, including the founder-owner, could say with confidence whether the balances in it were accurate.
The buyer's financial diligence team, building the working-capital baseline for the purchase agreement's true-up mechanism, pulled the vacation spreadsheet as a matter of routine and found accrued, unpaid vacation pay totalling $214,000 across the 58 employees — a figure that appeared nowhere on the target's balance sheet as a liability. The company's financial statements had apparently been expensing vacation pay only as it was actually paid out, not accruing it as it was earned, which understated liabilities and correspondingly overstated the equity the seller was claiming credit for.
Ontario's own rule sets the entitlement precisely, and the spreadsheet's methodology matched it correctly even if the accounting treatment did not: under five years of service, vacation pay is “four per cent of the gross wages…earned in the 12-month vacation entitlement year,” rising to “six per cent” at five-plus years. The statute itself, ESA s.35.2, puts it slightly differently and more usefully for a reconciliation: 4 per cent — or 6 per cent at five years or more — “of the wages, excluding vacation pay, that the employee earned during the period for which the vacation is given”. The exclusion matters when checking a spreadsheet against payroll, because vacation pay already paid out is not itself part of the base the next accrual is calculated on. Of the $214,000, roughly $141,000 related to the 34 employees with five or more years of service accruing at the higher rate, and the remainder to shorter-tenured staff at 4%. None of it had been paid out, and none of it had been reserved for on the balance sheet the seller had represented as complete and accurate.
The rule that made this a real, immediate liability rather than a bookkeeping curiosity is the ESA's own payment mechanic: vacation pay is ordinarily required “in a lump sum sometime before they take the vacation time earned,” with narrow exceptions for pay-as-accrued arrangements by written agreement — and critically, on termination, an employee is owed “within seven days of the employment ending or on what would have been the employee's next pay day, whichever is later.” An unreconciled accrual is not a future, contingent cost the way a pension obligation might be; it is money already earned by employees under a statutory formula, payable in full the moment any one of them leaves or the moment their vacation falls due. The buyer's diligence team treated it accordingly — as an already-crystallized liability, not a risk to be modelled.
The $214,000 was built directly into the deal's net working-capital peg as a dollar-for-dollar reduction to the target's working capital at closing, rather than treated as a general representation-and-warranty matter subject to the deal's broader indemnity basket and its associated threshold. That distinction mattered to both sides: a working-capital adjustment is dollar-for-dollar and not subject to a basket's minimum-claim threshold, while an indemnity claim for the same amount might have been partly absorbed by the basket before the seller owed anything. The seller's counsel accepted the working-capital characterization once the underlying calculation was independently verified against the ESA formula and the company's own payroll records for a representative sample of employees.
The signal to check directly, rather than relying on a balance sheet's stated liabilities, is whether vacation pay is tracked in the same system that runs payroll or in a separate, unreconciled record. A vacation liability tracked outside the accounting system is a strong indicator it has never been recognised as a liability at all — and under the ESA's own formula, it is real money owed the moment it is earned, not a policy detail. For a related off-balance-sheet workforce cost that showed up the same way in a different target, see how an unwritten severance exposure sat outside the same seller's reported numbers.
The reason this belongs in financial diligence rather than only an HR checklist is that an under-accrued vacation liability quietly inflates every historical margin figure the seller has ever reported. A business that has not been expensing vacation as it accrues looks more profitable, quarter over quarter, than it actually is — the true cost has simply been deferred onto whoever eventually pays it out, which after closing is the buyer. Reviewing the vacation accrual is therefore as much a check on the reliability of the target's reported EBITDA as it is a check on a single line-item liability.
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