1.17 Query:

Accounting treatment of gratuity paid under

a voluntary retirement  scheme.

1. A Central Public Sector company has incurred continuous losses for past successive years. A voluntary retirement scheme was started in the year 1990-91 to shed off excess labour force. The package payable to the employees being released under the voluntary retirement scheme consists of the following: -

(1)   Cash equivalent of accumulated earned leave.   

            

(2)   Gratuity.

 

(3)  Monetary terminal (compensation) – (1-1/2 months wages for each complete year of service or wages for the balance period of service whichever is less).

 

(4)   Notice pay.

All the aforesaid items including gratuity were amortised for a period of 6 years considering the average balance service period of the employees. It may be mentioned that during 1990-91, 1991-92 and 1992-93 the above package was paid out of non-plan loan received from the Government. Hence, this amount was treated as deferred revenue expenses for writing it off over 6 years, as already stated above.

2. As per the opinion expressed at page 83, Compendium of Opinions, Volume-X, published by the Expert Advisory Committee, The Institute of Chartered Accountants of India, the gratuity is to be charged off fully in the year of payment.  In the Comptroller & Auditor General’s comments on annual accounts of the company for the year 1993-94, the Principal Director of Commercial Audit & Ex-Officio, Director of Commercial Audit, has expressed the opinion that by amortising the gratuity paid under the voluntary retirement scheme, the company’s profit and loss account has understated the loss to that extent. During discussion with the Government Auditors, they cited the opinion of the Expert Advisory Committee in this regard.

3. As far as the company is concerned, it has not gone by the opinion of the Expert Advisory Committee. As per the opinion expressed at page 83 of the Compendium, Volume-X, published by the Expert Advisory Committee, the gratuity is to be charged off fully in the year of payment and is to be disclosed as an extraordinary item. Perhaps this treatment will be valid only in cases where the company makes provision of gratuity in the accounts of every year. But in the case of the company in question, the system is not to provide gratuity in the accounts. The gratuity liability is indicated as per actuarial valuation by way of notes on accounts and the actual cash payment of gratuity is accounted for as expenses of the year. Therefore, the impact of charging off total gratuity payment under the voluntary retirement scheme at one time in full will be substantial and will distort consistency of the profit and loss account for the year. In view of this, the gratuity payment under the scheme has also been treated as deferred revenue expenditure along with the other elements of the packages. CAG’s view to charge off the balance amount now does not appear to be appropriate to the querist since this will only affect the prior period items and will not come under current year’s profit and loss account.

4. The querist has sought the opinion of the Expert Advisory Committee whether the treatment of gratuity paid under the voluntary retirement scheme is to be charged off fully in the year of payment or whether it can be amortised over a period of years according to the benefits to be derived, as in case of the company where annual gratuity liability is not provided in the accounts annually, but paid on cash basis.

1. The Committee notes that the basic question raised by the querist is regarding treatment of gratuity paid under the voluntary retirement scheme. The Committee is, therefore, restricting its opinion only on this issue and is not giving its opinion on other three types of payments, i.e., cash equivalent of accumulated earned leave, monetary terminal compensation, and notice pay, which are covered by the querist under voluntary retirement package.

2. The Committee notes from the ‘Definitions’ given in Accounting Standard (AS) 15 on ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India, that “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.”

3.  The Committee also notes paras 12 and 15 of Accounting Standard (AS) 15 as below:

“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.

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.”

4. The Committee also notes sub-section (3) of section 209, which is reproduced below:

“For the purposes of sub-sections (1) and (2), proper books of account shall not be deemed to be kept with respect to the matters specified therein.

(a)        ………….

(b)        If such books are not kept on accrual basis and according to the double entry system of accounting.”

5.  Based on the above, the Committee is of the opinion that payment of gratuity cannot be treated as deferred revenue expenditure because necessary provisions in respect of such payment should have been made in the accounts in the relevant accounting periods. Since this was not done, the amount paid towards gratuity benefits should be treated as an expense of the period in which the payment is made.

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