RREVISED AS15: EMPLOYEE BENEFITS Effect of Amendment on Gratuity Ceiling with effective from 24 th May 2010 Revised Accounting Standard 15 : Employee Benefits is applicable to all Level I entities in entirely and some relaxation in terms of Disclosures are given to Level II & Level III entities. This standard largely talks about the reorganization and measurement principles, and the disclosures are required. As per revised AS 15 all the employee Benefits are grouped into Four major types; Short term Employee Benefits Post Employment Benefits Other Long term Employee Benefits Termination Benefits The recognition and measurement principle for each major four types of benefits is different. This paper uses the reference as per Revised AS 15 issued by the Institute of Chartered Accountant of India & latest amendment on gratuity ceiling. Revised AS15 becomes effective from 07 th December, 2006 which is revised by the announcements and the limited revisions due difficulties in easy application and is mandatory in nature. This implies, that while discharging the attest the function, the members of ICAI would have to examine whether this Accounting Standard is compiled with in the presentation of financial statements covered by their audit. In the event of any deviations from AS, it will be their duty to make adequate disclosures in their audit reports, so that the users of financial statements may be aware of such deviations. However this paper makes effort only to bring about the recognition and measurement principles along with the disclosure table requirement pertaining to gratuity benefit and latest amendment on gratuity ceiling from Rs. 350,000 to Rs. 1,000,000 with effective from date 24 th May, 2010.This paper analyze the standard in a very detailed way with the help of certain important notes & tabular or diagrammatic approach to understand and analyzing the intricacies involved. The standard recognizes that it will be responsibility of the reporting enterprise to measure the obligations under the defined benefit plans. It also recognizes that for doing so enterprise to measure the obligations under the defined benefit plans. It is also recognize that for doing so the enterprise would normally use the service of a qualified Actuary. This is where the role of actuary enhances and becomes all the more important. M/s. K A Pandit Consultants & Actuaries 1
Objective of AS15: Employee Benefits Recognize a liability when employee has provided service in exchange for benefits to be paid in future An expense when the enterprise consumes the economic benefit arising from service provided by an employee in exchange for employee benefits. Payment of Gratuity Act, 2010 Amendment in Payment of Gratuity Act, 1972 with increase in gratuity maximum ceiling from Rs. 350,000 to Rs. 1,000,000 with effective from 24th May, 2010 as per official Gazette issued by Central Government of India. Updated Benefit Scheme: 15 days salary for each year of continuous service with maximum of Rs. 1,000,000. M/s. K A Pandit Consultants & Actuaries 2
Profit & Loss Account Current Service Cost It is the increase in the present value of the defined benefit obligation resulting from employee service in the current period. Interest Cost it is the increase during a period in the present value of a defined benefit obligation which arises because the benefits are one period closer to settlement i.e. Increase in PBO purely because of time value of money. Expected Return on Plan Assets Is interest, dividends and other revenue derived from the plan assets, together with realized and unrealized gains or losses on the plan assets, less any costs of administering the plan and less any tax payable by the plan itself. Past Service Cost Is the change in the present value of the defined benefit obligation for employee service in prior periods, resulting in the current period from the introduction of, or changes to, post-employment benefits or other long-term employee benefits. Past service cost may be either positive (where benefits are introduced or improved) or negative (where existing benefits are reduced). Recognition of Transition Liability Where an enterprise first adopts this Statement for employee benefits, the difference (as adjusted by any related tax expense) between the liability in respect of employee benefits other than defined benefit plans and termination benefits, as per this Statement, existing on the date of adopting this Statement and the liability that would have been recognized at the same date, as per the pre-revised AS 15, should be adjusted against opening balance of revenue reserves and surplus. Actuarial (Gain) or Loss It comprise of experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred)and the effects of changes in actuarial assumptions. Profit & Loss For Current Period Current Service Cost + Interest Cost + (Expected Return on Plan Assets) + Past Service Cost + Transition Liability + Actuarial (Gain)/loss for the period. M/s. K A Pandit Consultants & Actuaries 3
Balance Sheet Reconciliation Opening Net Liability Difference in the present value of defined benefit obligation and fair value of plan assets at the start of the period. Expense as per P & L Statement The total expense recognised in the statement of profit and loss for each of the following, and the line item(s) of the statement of profit and loss in which they are included: Current Service Cost + Interest Cost + (Expected Return on Plan Assets) + Past Service Cost + Transition Liability + Actuarial (Gain)/loss for the period. Net Transfer Liability From Other Company Difference in present value of defined benefit obligation & Assets transfer in from other company. Net Transfer Liability to Other Company Difference in present value of defined benefit obligation & Assets transfer out to other company. Employers Contribution Contribution made towards the gratuity trust fund by an employer during the specified period or full & final settlement made by an employer during the specified period. Closing Net Liability Difference in the present value of defined benefit obligation and fair value of plan assets at the end of the period. Closing Net Liability Opening Net Liability + Expense as per P & L Statement+ (Employers Contribution) + Net Transfer Liability from other Company + (Net Transfer Liability to other Company). M/s. K A Pandit Consultants & Actuaries 4
Recent developments The Government has notified the Payment of Gratuity (Amendment) Act 2010 in May 2010. This bill to this amendment was approved by the Cabinet before 31 March 2010. The amendment raises the ceiling on gratuity payable to employees from the existing Rs. 350,000 to Rs. 1,000,000. Financial reporting impact The enactment of this amendment will require entities, which have fixed their maximum gratuity liability at the ceiling laid down in the act, to pay higher gratuity to their employees. We believe that the proposed amendment will give rise to the timing issue as to in which period the provision is required. Given below is our perspective on this issue. Should the proposed change in the limit be considered in determining gratuity liability as at 31 March 2010? Gratuity liability is covered under scope of AS 15 Employee Benefits and is treated as a defined benefit plan. According to AS 15, the provision for a defined benefit plan is calculated using the projected unit credit method (PUCM) of actuarial valuation. The application of PUCM requires an entity to make various financial assumptions such as future salary increases and changes in benefit levels. Consequently, the proposed change in the gratuity limit should also be considered for determining defined benefit liability as at 31 March 2010. It does not matter if the bill was an act at the reporting period date, as long as there is reasonable certainty that the law would be passed. Appropriate disclosures should be made with regards to the above in the notes to the financial statements. How would it affect the Financial statement of Companies? Companies which provide Gratuity as per the payment of Gratuity Act, 1972 will have to make higher provisions in their balance sheets for gratuity. This increase in the limit will require companies to increase provision not just for employees who have already reached the threshold limit of Rs 3.5 lacs but also for those who will exceed the limit in future due to expected salary rise. This in turn will lead to an increase in the charge to profit and loss (P&L). M/s. K A Pandit Consultants & Actuaries 5
What would be the effects on the AS-15 Disclosures? This increase in Gratuity liability should be accounted for with reference to AS 15 : accounting for past service cost in the AS-15 Disclosure. it needs to be measured and recognized as per paragraph 94 of AS 15 which is as follows: 94. In measuring its defined benefit liability, an enterprise should recognise past service cost as an expense on a straightline basis over the average period until the benefits become vested. To the extent that the benefits are already vested immediately following the introduction of, or changes to, a defined benefit plan, an enterprise should recognise past service cost immediately. Best advice for Companies that wish to avoid a huge rise in Actuarial liability next year can opt for a mid term valuation so that they can prepare in advance for the increased provision required. M/s. K A Pandit Consultants & Actuaries 6
Steps involved in Actuarial valuation Accounting by an enterprise for defined benefit plans involves the following steps: (a) using actuarial techniques to make a reliable estimate of the amount of benefit that employees have earned in return for their service in the current and prior periods and to make estimates (actuarial assumptions) about demographic variables (such as employee turnover and mortality) and financial variables (such as future increases in salaries and medical costs) that will influence the cost of the benefit. (b) discounting that benefit using the Projected Unit Credit Method in order to determine the present value of the defined benefit obligation and the current service cost (c) determining the fair value of any plan assets (d) determining the total amount of actuarial gains and losses (e) where a plan has been introduced or changed, determining the resulting past service cost (f) where a plan has been curtailed or settled, determining the resulting gain or loss M/s. K A Pandit Consultants & Actuaries 7
Actuarial Assumptions Actuarial assumptions comprising demographic assumptions and financial assumptions should be unbiased and mutually compatible. Financial assumptions should be based on market expectations, at the balance sheet date, for the period over which the obligations are to be settled. Actuarial assumptions are an enterprise s best estimates of the variables that will determine the ultimate cost of providing post-employment benefits. Actuarial assumptions comprise: (a) demographic assumptions about the future characteristics of current and former employees (and their dependants) who are eligible for benefits. Demographic assumptions deal with matters such as: (i) mortality, both during and after employment; (ii) rates of employee turnover, disability and early retirement; (iii) the proportion of plan members with dependants who will be eligible for benefits; and (iv) claim rates under medical plans; and (b) financial assumptions, dealing with items such as: (i) the discount rate (ii) future salary and benefit levels (iii) In the case of medical benefits, future medical costs, including, where material, the cost of Administering claims and benefit payments and (iv) the expected rate of return on plan assets Actuarial assumptions are unbiased if they are neither imprudent nor excessively conservative. M/s. K A Pandit Consultants & Actuaries 8
Actuarial assumptions are mutually compatible if they reflect the economic relationships between factors such as inflation, rates of salary increase, the return on plan assets and discount rates. For example, all assumptions which depend on a particular inflation level (such as assumptions about interest rates and salary and benefit increases) in any given future period assume the same inflation level in that period. An enterprise determines the discount rate and other financial assumptions in nominal (stated) terms, unless estimates in real (inflationadjusted) terms are more reliable, for example, where the benefit is indexlinked and there is a deep market in index-linked bonds of the same currency and term. Actuarial Gains and Losses Actuarial gains and losses should be recognised immediately in the statement of profit and loss as income or expense Actuarial gains and losses may result from increases or decreases in either the present value of a defined benefit obligation or the fair value of any related plan assets. Causes of actuarial gains and losses include, for example: (a) unexpectedly high or low rates of employee turnover, early retirement or mortality or of increases in salaries, benefits (if the terms of a plan provide for inflationary benefit increases) or medical costs; (b) the effect of changes in estimates of future employee turnover, early retirement or mortality or of increases in salaries, benefits (if the terms of a plan provide for inflationary benefit increases) or medical costs; (c) the effect of changes in the discount rate; and (c) differences between the actual return on plan assets and the expected return on plan assets M/s. K A Pandit Consultants & Actuaries 9
The following chart depicts the assumption of discount rates used by various listed companies in the study for the period 2009 2010. 60 50 40 30 20 10 0 7-7.5 7.5-8 8-8.5 8.5-9 The following chart depicts the assumption of rate of future salary increase used by various listed companies in the study during 2009 2010. Rate of future salary increase M/s. K A Pandit Consultants & Actuaries 10