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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stand withdrawn from the aforesaid date.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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