Treatment of payments made under voluntary retirement

scheme.

1.A public limited company is having surplus manpower to the tune of thirty thousand. In the industry to which the company belongs, presently the EMS (Earnings per Man-shift) is Rs. 135.00. The infructuous expenditure on account of unproductive wages and perquisites the company has to bear year after year is considerably high. To avoid this peculiar phenomenon, a voluntary retirement scheme has been introduced in the industry. Under this scheme, an employee, in addition to the normal superannuation benefits, i.e., gratuity, leave encashment, travelling and transportation expenses to native place and balance standing at the credit of provident fund, gets notice period pay and ex-gratia payment equivalent to 1-1/2 months salary for every completed year of service or equivalent to the salary of the balance months of service, whichever is lower.

2. The querist has further stated that since this scheme is being accepted by the employees, the company will benefit by getting some of these employees out of the wage list although at a substantially high cost. In the normal course the company would be paying the wages and perquisites to the employees even at a higher scale for the rest of the period of their service. By paying them for the balance period at the current rate of salary, the company is getting the benefit of non-payment of the same at high rate in future years. In other words, the expenditure incurred in the current year is on account of relief of expenditure in future years.

3.The querist has sought the opinion of Expert Advisory Committee as to whether the unusual expenses of notice pay and ex-gratia payment at the rate of 1-1/2 months emoluments for each completed year of service or emoluments for the balance period of service, whichever is lower, can be deferred for the period of service left to the credit of the employee, instead of charging the same in the current year’s profit and loss account together with the normal benefits.

Opinion November 10, 1989

1.The Committee notes paragraph 4.05 of the ‘Guidance Note on Terms Used in Financial Statements’, issued by the Accounting Standards Board of Institute of Chartered Accountants of India, which is reproduced below:

“4.05 Deferred Expenditure

Expenditure for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods. This is also referred to as deferred revenue expenditure.”

2.The Committee also notes paragraph 10.1 and 10.6 of the ‘Statement on Auditing Practices’, issued by the Research Committee of the Institute of Chartered Accountants of India, which states, inter alia:

“10.1…… If a future period will receive benefit from the outlay, the proper portion of the deferred charge should appear on the balance sheet. Unless some value can be determined as flowing into future, there is no justification for not writing off the item immediately. The fact that the amount spent is large, should not by itself affect the decision.

In some cases the time involved will be related directly to some other account, as in the case of debenture discounts and debenture issue expenses. In other cases, it may be influenced by tax laws, e.g., preliminary expenses can be written off over 10 years for income tax purposes (section 35D of the Income-tax Act, 1961). In many instances, such as deferred advertising, plant rearrangement, research and development costs, etc., the period has to be arbitrarily decided by the management, and the auditor should satisfy himself that it is not unreasonable.

10.6 Where any expenditure shown under the head “Miscellaneous Expenditure” is of a revenue nature but has not been written off by the company on the grounds that the company is likely to derive benefit of such expenditure in future, proper inquiry must be made to ensure that there are bona fide reasons for such carry forward and that the amounts are not being carried forward merely with a view to increasing the profits of the year. Where the expenditure is of a deferred revenue nature, the basis of write-off in subsequent years should be reasonable; and the amount written-off must be treated as a charge against the profits and not as an appropriation”.

3.The Committee notes that the terminal benefits payable by the company on voluntary retirement can be classified as under:

(a) Termination benefits to be paid irrespective of the voluntary retirement scheme, i.e.,

(i) Balance in the provident fund.

(ii) Cash equivalent of accumulated earned leave.

(iii) Gratuity.

(iv) Travel expenses.

(b) Termination benefits which are payable on account of voluntary retirement scheme, i.e.,

(i) Monetary terminal payment (1-1/2 months wages for each completed year of service or wages for the balance period of service, whichever is less).

(ii) Notice Pay.

4.The Committee is of the opinion that termination benefits mentioned in para 3(b) above, i.e., the monetary terminal payment and notice pay, are directly related to the voluntary retirement scheme which has been introduced to reduce the expenditure on unproductive wages and perquisites in future. Therefore, in the opinion of the Committee, termination benefits mentioned in para 3(b) can be treated as deferred revenue expenditure since the company is expected to benefit, in the form of saving in salaries and wages, in the subsequent periods.

5.With regard to the period of write-off of the deferred revenue expenditure, the Committee notes that it is not possible to relate expenditure on termination benefits with some other account as in the case of debenture discounts and debenture issue expenses. Further, there is no provision in tax laws regarding amortisation of expenditure on termination benefits as in the case of preliminary expenses. The Committee is, therefore, of the opinion that the period of write-off has to be decided by the management on a rational basis such as the pay back period of such expenditure. The pay back period should be computed taking into account factors like present scale of salary, future increment, tax benefits, saving on account of other terminal benefits such as gratuity, cash equivalent of accumulated earned leave, employers’ contribution to provident fund, etc. arising because of early retirement and such other related factors. However, the Committee is of the opinion that keeping in view the prudence concept of accounting, such an expenditure should be written off as early as possible, say a period of 3 to 5 years.

6.The Committee is also of the view that the terminal benefits referred to in para 3(a) above and the terminal benefits referred to in para 3(b) above to the extent they are not deferred, should be expensed in the profit and loss account with a separate disclosure therein as an extra-ordinary item as required in para 10 of Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Council of the Institute of Chartered Accountants of India, which is reproduced below:

“Extra-ordinary items of the enterprise during the period should be disclosed in the statement of profit and loss as part of net income. The nature and amount of each such item should be separately disclosed in a manner that their relative significance and effect on the current operating results of the period can be perceived”.

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