Defining 'Salary' and how is it calculated

As in all my articles, my mantra is to “ keep it simple” in payroll, as that is what works in payroll. I have written before on issues with how salary has been provided and applied to employees in payroll. Still, it’s one of the annoying questions (other than the Holidays Act) I regularly get where if the powers that be in a business focused on the mantra “ keep it simple”, there would not be the issues I see with how an employee’s salary is paid.

In very basic terms, the salary is an all-inclusive rate, so an employee gets a set payment for set hours worked in a pay period. The great thing for a business is that it can then budget on this labour cost as it is a fixed amount. Yes, there are some factors to consider. There may be additional payments, such as an annual bonus or an annual salary review that may involve a base salary increase, but all in all, a salary is one of the easier types of payments we process in payroll.

In this article, I will talk about salaries by answering the following questions to explain the issues I frequently see in how salary is used and applied in payroll. The questions are:

How is salary defined and paid each pay?
What about overtime when getting paid a salary?
How does this work with leave taken under the Holidays Act?

How is salary defined and paid each pay?

I get this question often as a salary could be stated as a per annum figure (salary will be $80,000 per annum), a pay period figure (monthly, fortnightly, 4 weekly or weekly). The issue with payroll is when salary is paid monthly there is not the same number of days each month, so what should payroll pay the employee: the same amount each month or based on actual days worked? Well, to start with, what and how salary is paid is by agreement (unless based on the minimum wage, we will talk about this later). So firstly, payroll needs to look at what the employee’s employment agreement says about their salary and how it is paid.

Another factor here is the payroll system. You will need to understand if the software system allows you to enter the salary as was agreed in the employment agreement or does the system have its own method of determining how an annual salary is defined in a pay period. This rears its head, especially when payroll moves to a new payroll system and salary is paid at a different rate from one system to another. It’s one of the many questions that should be asked when moving to a new payroll system.

If there is no direction or agreement on how salary is paid (what is paid each pay period) in the employee’s employment agreement, then how salary has been paid in the past should be followed as this is the precedent. If you have a valid reason to change from how salary was paid previously, it is important before the change is made that you fully consult with the employee or employees affected, as what has been previously paid or agreed cannot just be changed by the business or payroll without their agreement.

What is the difference between salary defined by pay period or actual days? I would state between the two options determining salary based on the pay period is the better option (of the 2 in this context). It provides certainty for the business with a fixed amount for budgeting. In payroll, it aids in processing and flows on for leave. And it helps the employee as they know that they will get the same payment each pay period. The use of actual days is usually raised as a question because someone in the business believes it is unfair or non-compliant for an employee not to be paid for the actual days they have worked in a month for monthly paid employees, as there can be more than four weeks in a month and those weeks do not clearly fit within a defined month (partial weeks).

The only time actual days need to be paid is when the employee is paid a monthly minimum wage salary, as the employee must be paid for the actual hours worked in the pay period. I have seen minimum wage salaried employees paid monthly, and this is just messy because paying an actual monthly salary usually means a manual workaround to ensure the minimum wage is paid correctly. So, take the hint – a monthly minimum wage salary is not a good way to go.

I will give you two examples below, but this can be done in other ways. The key is what was agreed or what is or has been done in payroll and what the payroll system software does in how salary is calculated.

Salary defined by pay period

Using the pay period to define salary, the previous example of $80,000 is stated as the per annum figure (and nothing more is paid). All that is needed is to use the agreed pay period to determine the salary payment for each period.

Monthly paid:$80,000/12 = $6666.67*
Fortnightly paid:$80,000/26 = $3076.92*
Weekly paid:$80,000/52 = $1534.46*

*This is the gross figure.

To break the salary down to a day in a week and hours in a day is quite simple as long as days and hours can be defined. And for a salaried employee, their week and day should easily be defined (as they are fixed hours and do not vary).

Example:

The employee gets paid an annual salary of $76,000 paid weekly. The employee works 7.5 hours per day, Monday to Friday.

Salary paid weekly: $76,000/52 = $1461.54 (per week)
Salary per day: $1461.54/5 = $292.31 (per day)
Salary per hour: $292.31/7.5 = $38.97 (per hour)

Salary is defined by actual days worked

If the employee’s employment agreement or how it has been calculated in payroll is based on actual days, this becomes a little more complicated.

Payroll still needs to define a week and a day, using the daily salary rate multiplied by the number of days in the month.

What about overtime when getting paid a salary?

Paying overtime to an employee on a salary defeats the purpose of paying a salary. Overtime is typically a variable pay component, and this can mean that if it becomes a regular part of an employee’s pay (but still variable), they are just a waged employee. It also means that the standard calculations used to determine leave will need to change to the secondary leave calculations under the Holidays Act. The employee is now a variable hour’s employee and is not paid the same each period (more on this in the next section).

Going back to a salary being an all-inclusive rate, how overtime can still be worked and included in salary but not undermining it is through incorporating overtime in the salary that is paid. Here is an example of how this could be done:

Salary is paid based on a 42-hour week, 37.5 is the employee’s standard work week, and 4.5 hours is to cover any additional hours worked (overtime). In some weeks, the employee could work overtime (less or more than the 4.5 hours), other weeks, none, but over a year, it balances out. The key to this is working out the balance.

One point is that you cannot do this if the employee is paid the minimum wage, as they must be paid for hours worked at the minimum wage.

How does this work with leave taken under the Holidays Act?

Annual holidays under the Holidays Act are based on a week. The other types of leave are based on a day. When defining a salary, it is important that it can be applied to the requirements of the Holidays Act. Now, salary and leave paid are based on two different rates as the leave rate is based on the calculations used under the Holidays Act, and salary is about what was agreed. Here are just two examples: one for an employee getting paid salary only and one with a salary that includes variable overtime:

Example 1 (salary paid only):

Salaried employee (annual salary $85,000 paid based on pay period, gets no other payment), weekly paid: $85,000/52 = $1634.62

An employee takes a week of annual holidays:

Average weekly earnings (AWE) gross (12 months)/52 = $1634.62
Ordinary weekly pay (OWP), Section 8(1) = $1634.62

AWE and OWP are the same, so $1634.62 is paid to the employee.

Example 2 (salary + overtime):

Salaried employee (annual salary $85,000 paid based on pay period, gets $18,500 overtime (variable hours worked) over the last 12 months and $1575 in the previous four weeks.

An employee takes a week of annual holidays:

Average weekly earnings (AWE) gross (12 months)/52 = ($85,000 + $18,500) = $103,500/52 = $1990.38
Ordinary weekly pay (OWP), Section 8(2), four weeks average = ($6538.48 (4 weeks base salary) + $1575 (Overtime worked in last four weeks))/4 = $2028.37

OWP is the higher of the two, so the employee will be paid $2028.37.

There is a major issue if the salary is paid monthly and using OWP Section 8(2), the four-week average. If the employee is paid monthly and the week cannot be defined under OWP Section 8(1) because they work variable overtime, then OWP Section 8(2) the four-week average must be used. The issue here is that if monthly paid, there are not four weeks in a month, and the divisor for OWP Section 8(2) is 4, payroll cannot use 4.33 as a divisor. It means it will inflate OWP.

The effect on FBAPS leave if overtime is variable on top of salary will mean that instead of relevant daily pay (RDP), what the employee “would have received had the employee worked on the day concerned”, that average daily pay (ADP) must be used which is a 52-week gross that will pick other payments like overtime, agreed bonuses etc. to inflate the rate again. This should not happen if the salary is treated as a true salary and not a waged employee.

Just one extra thing, as it gets asked regularly, does an employee just get paid their salary on a public holiday? If an employee is paid a salary and works on a public holiday, they still get 1.5 for actual hours worked on the public holiday (being paid a salary does not stop this). And if the day is an otherwise working day, they will also get an alternative holiday.

In conclusion, how salary is paid to an employee is not up to payroll to decide. It is what has been agreed, as it is not stated in the legislation. If it’s not defined by the agreement, then the business should consult with employees and get an agreement on how salary will be paid. Payroll needs to be involved in this as what is agreed needs to be workable in payroll and the payroll system used. Otherwise, it could create major additional work and undermine the true benefits of paying a salary to the business, processing it in payroll and, of course, giving the employee certainty.

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