John Lewis, the department store group whose slogan is 'never knowingly undersold' is to pay out £40m to compensate staff for incorrect holiday payments made as a result of an accounting error.

The mistake came to light when a call handler, who had recently joined, queried why holiday pay did not take account of allowances, such as Sunday and bank holiday pay, which John Lewis pays at a higher rate.

The group, which also owns Waitrose, is run as a partnership with 85,500 partners. Around 69,000 workers, as well as pensioners and ex-employees, are now in line for an average payment of £350, with some due to receive considerably more.

John Lewis said it had a review under way that would have ensured the payout before the employee raised the issue, while an independent review had confirmed there were no additional problems.

The payments, which were made in monthly staff pay cheques yesterday, have been dated back to 2006, when the business began using a digital payment system. The error in calculating holiday pay followed the introduction of Working Time Regulations in 1998.

This legislation states that holiday pay should be based on the average hours and pay collected by staff in the last three months. As John Lewis staff who work Sundays or Bank Holidays receive double pay, this should have been reflected in the holiday payments.

Tracy Killen, director of personnel for the John Lewis Partnership, said: 'As soon as we established that we were not implementing the working time regulations correctly, we worked quickly to make the repayments to our partners in a way that is both fair and responsible.'

The £40m one-off payment will be recognised as an exceptional item in the retailer's interim results next month. Updating pay systems to ensure all future holiday payments are correct is expected to add around 0.5% to annual pay costs.