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Statements of Accounting Standards (AS 15)
Accounting for Retirement Benefits in the
Financial Statements of Employers
The following is the text of Accounting Standard
(AS) 15, 'Accounting for Retirement Benefits in the Financial Statements
of Employers', issued by the Council of the Institute of Chartered Accountants
of India.
The Standard will come into effect in respect
of accounting periods commencing on or after 1.4.1995 and will be mandatory
in nature. The 'Statement on the Treatment of Retirement Gratuity in Accounts'
issued by the Institute will stand withdrawn from the aforesaid date.
Introduction
1. This Statement deals with accounting for
retirement benefits in the financial statements of employers.
2. Retirement benefits usually consist of:
(a) Provident fund
(b) Superannuation/pension
(c) Gratuity
(d) Leave encashment benefit on retirement
(e) Post-retirement health and welfare schemes
(f) Other retirement benefits.
This Statement applies to retirement benefits
in the form of provident fund, superannuation/pension and gratuity provided
by an employer to employees, whether in pursuance of requirements of any
law or otherwise. It also applies to retirement benefits in the form of
leave encashment benefit, health and welfare schemes and other retirement
benefits, if the predominant characteristics of these benefits are the
same as those of provident fund, superannuation/pension or gratuity benefit,
i.e. if such a retirement benefit is in the nature of either a defined
contribution scheme or a defined benefit scheme as described in this Statement.
This Statement does not apply to those retirement benefits for which the
employer's obligation cannot be reasonably estimated, e.g., ad hoc ex-gratia
payments made to employees on retirement.
Definitions
3. The following terms are used in this Statement
with the meanings specified:
Retirement benefit schemes are arrangements
to provide provident fund, superannuation or pension, gratuity, or other
benefits to employees on leaving service or retiring or, after an employee's
death, to his or her dependants.
Defined contribution schemes are retirement
benefit schemes under which amounts to be paid as retirement benefits
are determined by contributions to a fund together with earnings thereon.
Defined benefit schemes are retirement
benefit schemes under which amounts to be paid as retirement benefits
are determinable usually by reference to employee's earnings and/or years
of service.
Actuary means an actuary within the
meaning of sub-section (1) of section (2) of the Insurance Act, 1938.
Actuarial valuation is the process
used by an actuary to estimate the present value of benefits to be paid
under a retirement benefit scheme and the present values of the scheme
assets and, sometimes, of future contributions.
Pay-as-you-go is a method of recognising
the cost of retirement benefits only at the time payments are made to
employees on, or after, their retirement.
Explanation
4. Retirement benefit schemes are normally
significant elements of an employer's remuneration package for employees.
It is, therefore, important that retirement benefits are properly accounted
for and that appropriate disclosures in respect thereof are made in the
financial statements of an employer.
5. Provident fund benefit normally involves
either creation of a separate trust to which contributions of both employees
and employer are made periodically or remittance of such contributions
to the employees' provident fund, administered by the Central Government.
6. Superannuation/pension benefit (hereinafter
referred to as 'superannuation benefit') is basically of two types.
(a) The first type of benefit is known as
defined contribution scheme. Under this type of benefit, the employer
makes a contribution once a year (or more frequently in some cases) towards
a separately created trust fund or to a scheme administered by an insurer.
These contributions earn interest and the accumulated balance of contributions
and interest is used to pay the retirement benefit to the employee. Superannuation
available under defined contribution scheme has relevance to only total
of accumulated contributions and interest and bears no relationship, whatsoever,
with the final salary or number of years of service put in by an employee.
The defined contribution scheme for superannuation/pension is, in most
respects, similar to the provident fund, so far as the accounting treatment
is concerned. It also presupposes payment of contributions every year,
either once in a year or more frequently.
(b) The second type of superannuation scheme
is the defined benefit scheme. Under this scheme, the benefit payable
to the employee is determined with reference to factors such as a percentage
of final salary (e.g. the average of one, three or five years' salary),
number of years of service and the grade of the employee. The contribution
required to finance such a scheme is actuarially determined and is generally
expressed as a percentage of salary for the entire group of employees
covered by the scheme. For defined benefit superannuation/pension schemes,
a trust fund can be created or an arrangement can be negotiated with an
insurer so that the annual contributions, calculated actuarially, can
be made each year. In such a case, benefits to employees on entitlement
would be paid by the trust fund or by the insurer. Alternatively, the
superannuation benefit can be paid by the employer as and when an employee
leaves.
7. Gratuity benefit is in the nature of a
defined benefit. Gratuity can be paid by the employer as and when an employee
leaves. Alternatively, a trust fund can be created, or an arrangement
can be negotiated with an insurer so that the annual contributions, calculated
actuarially, can be made each year. Benefits to employees on entitlement
would in such a case be paid by the trust fund or by the insurer.
8. In certain cases, a retirement benefit
scheme may stipulate the basis of contributions on which the benefits
are determined and, because of this, may appear to be a defined contribution
scheme. However, the provisions of the scheme may also result in the employer
being responsible for specified benefits or a specified level of benefits.
In this case, the scheme is, in substance, a defined benefit scheme and
should be accounted for accordingly.
9. While provident fund schemes are generally
contributory schemes from the point of view of employees, gratuity schemes
are non-contributory. The superannuation schemes, on the other hand, can
be contributory or non-contributory.
10. Defined benefit schemes, especially those
that promise benefits related to remuneration at or near retirement, present
significant difficulties in the determination of periodic charge to the
statement of profit and loss. The extent of an employer's obligation under
such schemes is usually uncertain and requires estimation. In estimating
the obligation, assumptions may need to be made regarding future conditions
and events which are largely outside the employer's control.
11. As a result of various factors that frequently
enter into the computation of retirement benefits under defined benefit
schemes and the length of the period over which the benefits are earned,
allocation problems arise in determining how the costs of the retirement
benefits should be recognised in the financial statements of the employer.
Furthermore, long-term uncertainties may give rise to adjustments of estimates
of earlier years that can be very significant in relation to current service
cost.
12. The cost of retirement benefits to an
employer results from receiving services from the employees who are entitled
to receive such benefits. Consequently, the cost of retirement benefits
is accounted for in the period during which these services are rendered.
Accounting for retirement benefit cost only when employees retire or receive
benefit payments (i.e., as per pay-as-you-go method) does not achieve
the objective of allocation of those costs to the periods in which the
services were rendered.
Funding
13. When there is a separate retirement benefit
fund, it is sometimes assumed that the amount paid by an employer to the
fund during an accounting period provides an appropriate charge to the
statement of profit and loss. While, in many case, the amount funded may
provide a reasonable approximation of the amount to be charged to the
statement of profit and loss, there is a vital distinction between the
periodic funding of retirement benefits and the allocation of the cost
of providing these benefits.
14. The objective of funding is to make available
amounts to meet future obligations for the payment of retirement benefits.
Funding is a financing procedure and in determining the periodical amounts
to be funded, the employer may be influenced by such factors as the availability
of money and tax considerations.
15. On the other hand, the objective of accounting
for the cost of a retirement benefit scheme is to ensure that the cost
of benefits is allocated to accounting periods on a systematic basis related
to the receipt of the employees' services.
Accounting
16. In respect of retirement benefits in the
form of provident fund and other defined contribution schemes, the contribution
payable by the employer for a year is charged to the statement of profit
and loss for the year. Thus, besides the amount of contribution paid,
a shortfall of the amount of contribution paid compared to the amount
payable for the year is also charged to the statement of profit and loss
for the year. On the other hand, if contribution paid is in excess of
the amount payable for the year, the excess is treated as a pre-payment.
17. In respect of gratuity benefit and other
defined benefit schemes, the accounting treatment depends on the type
of arrangement which the employer has chosen to make.
(i) If the employer has chosen to make payment
for retirement benefits out of his own funds, an appropriate charge to
the statement of profit and loss for the year is made through a provision
for the accruing liability. The accruing liability is calculated according
to actuarial valuation. However, many enterprises which employ only a
few persons do not calculate the accrued liability by using actuarial
methods. They calculate the accrued liability by reference to some other
rational method e.g. a method based on the assumption that such benefits
are payable to all employees at the end of the accounting year.
(ii) In case the liability for retirement
benefits is funded through creation of a trust, the cost incurred for
the year is determined actuarially. Many employers undertake such valuations
every year while others undertake them less frequently, usually once in
every three years. If actuarial valuations are conducted every year, the
annual accrual of retirement benefit cost can be easily determined. If,
however, the actuarial valuations are not conducted annually, the actuary's
report specifies the contributions to be made by the employer on annual
basis during the inter-valuation period. This annual contribution (which
is in addition to the contribution that may be required to finance unfunded
past service cost) reflects proper accrual of retirement benefit cost
for each of the years during the inter-valuation period and is charged
to the statement of profit and loss for each such year. Where the contribution
paid during a year is lower than the amount required to be contributed
during the year to meet the accrued liability as certified by the actuary,
the shortfall is charged to the statement of profit and loss for the year.
Where the contribution paid during a year is in excess of the amount required
to be contributed during the year to meet the accrued liability as certified
by the actuary, the excess is treated as a pre-payment.
(iii) In case the liability for retirement
benefits is funded through a scheme administered by an insurer, it is
usually considered necessary to obtain an actuarial certificate or a confirmation
from the insurer that the contribution payable to the insurer is the appropriate
accrual of the liability for the year. Where the contribution paid during
a year is lower than the amount required to be contributed during the
year to meet the accrued liability as certified by the actuary or confirmed
by the insurer, as the case may be, the shortfall is charged to the statement
of profit and loss for the year. Where the contribution paid during a
year is in excess of the amount required to be contributed during the
year to meet the accrued liability as certified by the actuary or confirmed
by the insurer, as the case may be, the excess is treated as a pre-payment.
Actuarial Principles
18. A number of actuarial valuation methods
have been developed by the actuarial profession to estimate employer's
obligations under defined benefit schemes. While these methods are primarily
designed to calculate funding requirements, they are also frequently used
to determine retirement benefit costs for accounting purposes.
19. The actuarial method selected for determining
accrual of liability and the assumptions made can have a significant effect
on the expense to be recorded in each accounting period. Therefore, in
carrying out a periodical valuation, an actuary chooses a suitable valuation
method and, in consultation with the employer, makes appropriate assumptions
about the variable elements affecting the computations.
20. The assumptions relate to the expected
inflow from future contributions and from investments as well as to the
expected outgo for benefits. The uncertainty inherent in projecting future
trends in rates of inflation, salary levels and earnings on investments
are taken into consideration by the actuary in the actuarial valuations
by using a set of compatible assumptions. Usually, these projections are
extended until the expected date of death of the last pensioner in case
of a superannuation scheme, expected date of death etc. of the beneficiary
in case of family pension, and expected service in case of gratuity and
are, accordingly, long-term.
Past Service Cost and Review of Actuarial Assumptions
21. An actuarially determined past service
cost arises on the introduction of a retirement benefit scheme for existing
employees or on the making of improvements to an existing scheme, etc.
This cost gives employees credit for benefits for services rendered before
the occurrence of one or more of these events.
22. Views differ as to how to account for
this cost. One view is that this cost should be recognised as soon as
it has been determined. Others believe that the entitlement giving rise
to past service cost is in return for services to be rendered by employees
in future and therefore this cost ought to be allocated over the periods
during which the services are to be rendered.
23. In making an actuarial valuation, the
actuary may sometimes effect a change in the actuarial method used or
in the assumptions adopted for determining the retirement benefit costs.
Any alterations in the retirement benefit costs so arising are charged
or credited to the statement of profit and loss for the year or, alternatively,
spread over a period not more than the expected remaining working lives
of the participating employees. A change in the actuarial method used
for determining the retirement benefit costs constitutes a change in an
accounting policy and is disclosed accordingly.
Retired Employees
24. When a retirement benefit scheme for retired
employees is amended, due to inflation or for other reasons, to provide
additional benefits to retired employees, any additional costs are charged
to the statement of profit and loss of the year.
Disclosures
25. In view of the diversity of practices
used for accounting of retirement benefits costs, adequate disclosure
of method followed in accounting for them is essential for an understanding
of the significance of such costs to an employer.
26. Retirement benefit costs are sometimes
disclosed separately for statutory compliance. In other cases, they are
considered to be an element of employee remuneration and their separate
disclosure is not usually made.
Accounting Standard
(The Accounting Standard comprises paragraphs
27–31 of this Statement. The Standard should be read in the context of
paragraphs 1–26 of this Statement and of the 'Preface to the Statements
of Accounting Standards'.)
27. In respect of retirement benefits in
the form of provident fund and other defined contribution schemes, the
contribution payable by the employer for a year should be charged to the
statement of profit and loss for the year. Thus, besides the amount of
contribution paid, a shortfall of the amount of contribution paid compared
to the amount payable for the year should also be charged to the statement
of profit and loss for the year. On the other hand, if contribution paid
is in excess of the amount payable for the year, the excess should be
treated as a pre-payment.
28. In respect of gratuity benefit and
other defined benefit schemes, the accounting treatment will depend on
the type of arrangement which the employer has chosen to make.
(i) If the employer has chosen to make
payment for retirement benefits out of his own funds, an appropriate charge
to the statement of profit and loss for the year should be made through
a provision for the accruing liability. The accruing liability should
be calculated according to actuarial valuation. However, those enterprises
which employ only a few persons may calculate the accrued liability by
reference to any other rational method e.g. a method based on the assumption
that such benefits are payable to all employees at the end of the accounting
year.
(ii) In case the liability for retirement
benefits is funded through creation of a trust, the cost incurred for
the year should be determined actuarially. Such actuarial valuation should
normally be conducted at least once in every three years. However, where
the actuarial valuations are not conducted annually, the actuary's report
should specify the contributions to be made by the employer on annual
basis during the inter-valuation period. This annual contribution (which
is in addition to the contribution that may be required to finance unfunded
past service cost) reflects proper accrual of retirement benefit cost
for each of the years during the inter-valuation period and should be
charged to the statement of profit and loss for each such year. Where
the contribution paid during a year is lower than the amount required
to be contributed during the year to meet the accrued liability as certified
by the actuary, the shortfall should be charged to the statement of profit
and loss for the year. Where the contribution paid during a year is in
excess of the amount required to be contributed during the year to meet
the accrued liability as certified by the actuary, the excess should be
treated as a pre-payment.
(iii) In case the liability for retirement
benefits is funded through a scheme administered by an insurer, an actuarial
certificate or a confirmation from the insurer should be obtained that
the contribution payable to the insurer is the appropriate accrual of
the liability for the year. Where the contribution paid during a year
is lower than amount required to be contributed during the year to meet
the accrued liability as certified by the actuary or confirmed by the
insurer, as the case may be, the shortfall should be charged to the statement
of profit and loss for the year. Where the contribution paid during a
year is in excess of the amount required to be contributed during the
year to meet the accrued liability as certified by the actuary or confirmed
by the insurer, as the case may be, the excess should be treated as a
pre-payment.
29. Any alterations in the retirement benefit
costs arising from -
(a) introduction of a retirement benefit
scheme for existing employees or making of improvements to an existing
scheme, or
(b) changes in the actuarial method used
or assumptions adopted,
should be charged or credited to the statement
of profit and loss as they arise in accordance with Accounting Standard
(AS) 5, 'Prior Period and Extraordinary Items and Changes in Accounting
Policies'. Additionally, a change in the actuarial method used should
be treated as a change in an accounting policy and disclosed in accordance
with Accounting Standard (AS) 5, 'Prior Period and Extraordinary Items
and Changes in Accounting Policies'.
30. When a retirement benefit scheme is
amended with the result that additional benefits are provided to retired
employees, the cost of the additional benefits should be accounted for
in accordance with paragraph 29.
Disclosures
31. The financial statements should disclose
the method by which retirement benefit costs for the period have been
determined. In case the costs related to gratuity and other defined benefit
schemes are based on an actuarial valuation, the financial statements
should also disclose whether the actuarial valuation was made at the end
of the period or at an earlier date. In the latter case, the date of the
actuarial valuation should be specified and the method by which the accrual
for the period has been determined should also be briefly described, if
the same is not based on the report of the actuary.
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