Author: David Jenkins NZPPA,CEO

This is another updated article from way back in 2017, but again, we get asked about this regularly.

The purpose of a salary is to pay an all-inclusive rate that is a fixed, regular payment to an employee for the work they perform. It allows a business to plan and forecast labour costs on an annual basis and can also provide concise data for business planning over the coming years, as the cost of labour is a major factor in any future business decision.

A salary, if constructed correctly and in line with the capabilities of the payroll system used in the business, is a cost-effective way to pay an employee. The same payment is made to an employee in each pay period along with any other special payments, like a bonus paid annually. It is also easier to apply to legislation such as the requirements of the Holidays Act.

Setting a salary can reduce payroll processing time and require fewer payroll resources to administer. Salaries work well in a range of work environments, but not all, so I am not saying that a salary is the way to go to solve all the issues in payroll and the Holidays Act 2003. Salaries are most commonly applied to employees in fixed work environments where the hours are standard, and the job has little in the way of variable work patterns.

One of the issues NZPPA sees regularly, and this impacts payroll, is when employees are on salaries but, for whatever reason, management approves payment of regular overtime in addition to the salary. Paying regular overtime in conjunction with a salary undermines the whole purpose of providing a salary to an employee in the first place.

For example:  Mary is paid a salary of $50,000 per annum and is paid monthly. In her employment agreement, there is nothing about the salary covering additional hours worked and Mary pretty much always works the same hours each week.  The assumption of Mary’s employer is that Mary being on salary means if additional hours are needed to be worked, the salary covers this.  As there is no mention of what hours the salary covers and there is a set pattern of work (a history), if requested to work extra hours Mary could challenge her employer by saying that these additional hours are not covered by the salary provided.

This is usually where management then provides an additional payment to cover these extra hours worked (commonly called overtime) and overtime on top of salary comes into play.

Typically, payroll is not contacted regarding how a salary is constructed or even what it is based on, but it should be. Payroll has access to a wealth of information that can be used in constructing a salary to ensure employees are paid for the work they do, but also to ensure a salary is all inclusive and cost effective for the business.  There are, of course, many other factors to include when constructing an employee’s salary but in general payroll is overlooked.

For payroll when overtime is paid in addition to a salary, it creates a variable pay component that adds to the processing of an employee’s pay because of a range of factors such as:

  • How is this overtime recorded?
  • How is overtime reported to payroll?
  • Is the overtime at a different rate compared to the ordinary rate that is paid to an employee?
  • What additional processing is created and what is the cost in terms of time and money for payroll?

One of the arguments I hear when I raise issues about additional work being applied to payroll is, “It’s payroll’s job to process pay, so what is the problem?”  Yes, it is true that it is payroll’s job, but there are some issues with this, including:

  • Payroll is usually not consulted or involved in any changes (for example, adding overtime on top of a salary).
  • The payroll system may not be able to cater for the new payment and this could create manual processing which is time-consuming and can lead to errors.
  • This additional payment must be factored in regard to processing time and its impact on overall payroll processing.

If overtime is being provided on top of a salary, there are also three other issues to consider and these are:

  1. If overtime is worked and paid on top of salary, it will become part of the employee’s gross earnings that will be applied to their leave rate as part of annual holidays or if part of a day is applied to FBAPS leave as well. This could become a substantial additional cost to the business if it is not clearly defined and budgeted for.
  2. If the overtime becomes regular but variable in nature (worked every week but different days and at different times each week), it means for a salaried employee, it changes what calculation is used under the Holidays Act to be OWP Section 8(2) the 4-week average when the week cannot be determined for annual holidays and ADP when the day cannot be determined for FBAPS leave. Another factor that creates yet another issue is when a salaried employee is paid monthly and is now doing variable overtime; if OWP Section 8(2) is used, what actually means the calculation is the 4-week gross divided by 4 but a monthly paid employee to determine a week would be divided by 4.33. Having to use 4 as the divisor for the 4-week average will result in OWP being set at a higher rate.  This could mean the employer ends up paying more for the leave rate if OWP is higher than AWE.
  3. The other aspect of overtime on top of salary is regarding record keeping. A new requirement came into effect on the 1st of April 2016, which is that any hours worked outside what a salary is based on must be recorded.  It is not about payment, it is about recording these additional hours.  This is concerning minimum wage but does not exclude any other type of salary being paid and the hours worked outside of the agreed hours that a salary is based on.  So, the issue is how and where will these hours be recorded for a period of six years for any employee working additional hours? Have fun asking your CEO for their timesheet and see what reaction you get!

So how do you stop the use of overtime when on a salary?

If overtime is going to be paid on a regular basis, why can’t an analysis be undertaken to factor overtime into the salary rate so it is again part of an all-inclusive rate?

For example:  John is paid a salary based on 45 hours, but in fact his standard week is 37.5 hours and the salary has overtime factored into the salary rate. The overtime hours were identified by doing an average over a period of time (say three months) and then adding that to the standard hours worked for the employee (or whatever pay period is used).   For John, it means no additional payment would be made if extra hours are required to be worked.  Across the whole year, some weeks John works additional hours and others he doesn’t, but the salary based on 45 hours balances out across the year.  This is an effective way to factor overtime into a salary as long as a thorough assessment has been carried out on the additional hours an employee works across a year.

To assist with the above, there should be a clear clause in the employee’s employment agreement that states what hours the salary is based on and that the salary includes any extra hours of work and no additional payment will be made.  This of course does not stop the employer from making an additional payment to an employee such as a bonus if they wish to do so.

In conclusion, use a salary for the purpose it was intended for as a fixed and all-inclusive rate. If any additional payments are to be made such as overtime, they should be assessed and payroll fully consulted to determine whether they are to be regular payments and if so could be included in the salary rather than being a separate pay component, adding to the cost of payroll.

Overall, it’s best to keep payroll as simple and straightforward as possible.

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