What it means
An employment relationship can end in several ways. The employee may resign, the employer may dismiss for poor performance or misconduct, the role may be eliminated in a redundancy, or a fixed-term contract may simply run out.
Each route has its own financial consequences. A resignation usually requires the employee to work a notice period, while a redundancy may bring a severance payment (money paid in recognition of losing the job), and a dismissal for serious misconduct may bring none.
The final pay calculation normally includes salary up to the last day, any accrued but unused holiday, and any bonus or commission that has been earned. Employers should also check expense claims, loans to the employee and company equipment that must be returned.
For the business, termination has costs beyond the final cheque. There are recruitment and training costs for a replacement, the loss of knowledge, the need to adjust payroll and benefits, and, if handled badly, the risk of a legal claim.
Accountants record the cost in the period when the obligation arises, which can be before the person actually leaves. If a restructuring is announced and employees are told, the cost of severance may need to be recognised at that point as a provision (an estimate of a future payment).
Employees should also look at the effect on benefits such as health cover, pension contributions, share options and bonuses. Many of these have rules about what happens on leaving, and the dates can make a significant difference.
In practice
Real-world examples.
Example
A software company restructures and removes 20 roles. The finance team calculates notice pay, accrued holiday and severance for each person and records a provision in the accounts. The calculation shows a total cost of $380,000, which the board approves before the announcement. Legal advice is taken on the consultation process before any letters are sent.
Example
A senior sales manager resigns to join a competitor. Her contract requires three months of notice and contains a clause on repaying part of a sign-on bonus if she leaves within two years. Payroll calculates the amount to be deducted and agrees it with her in writing. The two sides also agree what the employee may say to clients during the notice period.
Example
A hospitality group ends the contracts of seasonal workers in October. Each worker receives the pay owed for the last shift and the value of untaken holiday. The payroll manager makes sure that the final payments are made on time and that tax documents are issued. Each worker is told in advance what to expect and when.
Formula
Calculation
Total final payment = unpaid salary + accrued holiday pay + severance
An employee earns $1,500 a week (a five-day week, so $300 a day). She has 10 days of unused holiday, has worked 4 years, and is entitled to 2 weeks of severance per year of service. She is owed one final week of salary.
Unpaid salary = $1,500
Accrued holiday pay = 10 x 300 = $3,000
Severance = 4 x 2 x 1,500 = $12,000
Total final payment = 1,500 + 3,000 + 12,000 = $16,500Case study
Seen in the real world.
Brightwell Retail is an illustrative, fictional chain that decided to close three underperforming stores. The human resources director and the finance manager worked together to estimate the cost of ending 45 contracts.
They calculated notice pay, accrued holiday and severance for each person, and added $60,000 for advisers and outplacement support. The total came to $540,000, which was recorded as a provision before the closures began.
Because the figures were prepared early and communicated clearly, staff received accurate payments on their last day and no disputes followed. The illustrative lesson is that careful planning of termination costs protects both the budget and the company's reputation. Brightwell also agreed a simple checklist for every leaver, covering equipment, access passwords, expenses, final pay and benefits, so that nothing was missed in the closing weeks.
Watch out
Common mistakes.
- Forgetting accrued holiday or earned commission in the final payment, which can lead to a claim. Employment law can give employees extra rights, so a quick check with an adviser before the last payroll run is wise.
- Recording severance only when it is paid, instead of when the obligation arises. Under accounting rules the cost is usually recognised once the plan is committed and communicated, which can be before the person actually leaves.
- Treating all terminations alike, when resignation, dismissal and redundancy follow different rules. A resignation, a dismissal for cause and a redundancy differ in notice, pay and the evidence an employer needs, so each needs its own process.
Questions
People also ask.
Is severance pay always required?
No, it depends on the contract, company policy and local law, so many terminations carry no severance at all.
When should the final pay be made?
The deadline is set by local law or the contract, and in some places it is the last day of work.
What happens to company benefits on leaving?
Each benefit has its own rule, so employees should check health cover, pension and share plans before the last day.
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