1.18  Query:   

Accounting of encashment of earned leave salary at the

time of retirement or death of an employee.

1. A public sector company with more than 20 Units spread all over India is engaged in manufacture, erection and commissioning of various equipments in connection with generation, distribution, transmission of power including non-conventional energy. The turnover in the preceding financial year has been slightly above Rs.4000 crores, with more than 200 crores profit and Rs.400 crores cash surplus.

2. All the Units of the company are profit centres. In order to have better control of cash and to minimise interest burden, Centralised Cash Credit System is followed. The company has a common purchase policy, sales policy, personnel policy, establishment policy and also accounting policy.

3. A point has been raised by one of the branch auditors on the accounts of the company with regard to presentation in annual accounts of non-encashable portion of leave salary. Extract from the personnel manual with regard to Earned Leave (Eligibility and Encashability) has been submitted by the querist for the perusal of the company.

4. The querist has pointed out that from the extract of the personnel manual it can be seen that earned leave is credited to the employees’ account twice in a year, i.e., on 25^th June and 25^th December. 75% of the leave credited is encashable and 25% of leave credited is non-encashable. When an employee avails earned leave, first it is set off against non-encashable portion. An employee is permitted to encash earned leave excluding the advance credit once in a calendar year.

5. The encashable leave at credit of each employee as on 31^st March each year is quantified in terms of rupees with reference to each employee’s basic wages and DA and the same is provided for in accounts as he/she is eligible to encash the same. The non-encashable portion of leave at credit, if any, to individual employees as on 31^st March is not being provided for since as per the company’s personnel manual he/she is not eligible to encash the same while in service. However, in the event of retirement from service or cessation of employment due to death, the entire leave at credit including non-encashable portion is allowed for encashment and is settled and accounted for immediately in that year. The branch auditor is of the view that this non-encashable portion of the earned leave should also be quantified similar to encashable portion and the same should be provided for in the books of account. This, as per the auditor, is needed as per Section 209(iii) (b). It has been argued that since the company’s personnel policy does not permit any employee to encash non-encashable portion while in service and on ‘going concern’ concept, no liability accrues as on 31^st March each year in respect of non-encashable portion of earned leave.

6. The points referred for the opinion of the Expert Advisory Committee are as below:

(i)  Whether non-encashable portion of the leave is a liability as on 31^st March each year and it is to be provided for on going concern concept. If so, what are the reasons?

 

(ii)   If no provision is needed due to there being no legal binding on this non-encashable earned leave as on 31^st March as going concern concept, is it necessary to disclose the same by way of note.

 

1. The Committee notes from the facts of the query that the expression ‘non-encashable’ has been used by the querist in respect of earned leave which is encashable on retirement or death of an employee.

2.The Committee notes sub-section (3) of section 209 of the Companies Act, 1956, which is reproduced below:

“(3)      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.”

3. The Committee also notes paragraph 1.09 of the ‘Guidance Note on Terms Used in Financial Statements’, issued by the Institute of Chartered Accountants of India, which is reproduced below:

                        “1.09   Accrued liability

A developing but not yet enforceable claim by another person which accumulates with the passage of time or the receipt of service or otherwise. It may arise from the purchase of services (including the use of money) which at the date of accounting have been only partly performed and are not yet billable.”  

 

4. Based on the above, the Committee is of the view that since the employer’s obligation relating to employee’s right to receive compensation for earned leave on retirement or death is attributable to employee’s services already rendered, the employer should accrue the liability in respect thereof.

5.  The Committee also notes paras 2 and 3 of Accounting Standard (AS) 15, on ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India, which state as below:

“2.        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 defined in this statement. 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 dependents.”

“3.        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 year of service”

6. Based on the above, it appears to the Committee that the earned leave which is encashable at the time of retirement or death, is predominantly of the nature of a defined benefit scheme.

7.  The Committee further notes paras 12 and 15 of Accounting Standard (AS) 15, on ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India, which state 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 these 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 employee’s service.”

8. Based on the above, the opinion of the Committee on the issues raised by the querist in para 6 of the query is as below:

(i)  Earned leave which is encashable on retirement or death of an employee is a liability which accrues in the year in which the service is being rendered by the employee. Therefore, necessary provision should be made for the liability in that year at an amount estimated on rational basis keeping in view factors like past experience about the benefit actually availed of, possibility of availing the past leave in future etc.

(ii)   In view of (i) above, the question does not arise.

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