1.32 Query: Accounting for leave encashment benefit.
1. A public sector company started operations in 1960. The querist has sought the opinion of the Expert Advisory Committee regarding quantification of leave encashment in terms of value and its provision in financial statements of employer in accordance with Accounting Standard (AS) 15 on ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India, as per the facts in this regard stated in the following paragraphs.
2. The company has a scheme to provide earned leave to the extent of 30 days in a year with a bifurcation of 15 days credited to the employee’s account on 1st January and next 15 days on 1st July every year. As such, these credits are given in advance for the period during which an employee can encash or avail. An accumulation of leave upto 240 days is allowed in all cases, in case an employee does not avail/encash leave. Encashment can be availed by an employee upto the maximum of 30 days in a calendar year with the condition that minimum 15 days leave has to be availed, i.e., half of leave being encashed. That would mean that 30 days credit in a year in the employee’s account has a bifurcation of 20 days encashable leave and 10 days non-encashable leave. In case the employee does not encash or avail leave, it gets accumulated, subject to the maximum of 240 days beyond which it lapses. Since the company is in operation from 1960, many employees have an accumulation of 240 days or nearby.
3. Before Accounting Standard 15 came into force, the company was following the practice of accounting for the leave encashment on cash basis, i.e., as and when any employee was encashing the leave, the same was charged to revenue. Now, after Accounting Standard 15 coming into force, the auditors insist that the provision for leave encashment should be made in full which would mean that the company shall have to provide for the entire accumulation which is existing at the credit of the employees and relates to various previous years.
4. The querist has given his views in this regard as below;
(a) Since Accounting Standard 15 deals with the retirement benefits to be provided in the financial statements of the employers under which leave encashment is also one of the items, it is felt that in the situation explained above, encashment of leave under no circumstances has a correlation with the retirement/superannuation of the employee. Anybody is authorised to exhaust his leave on year to year basis before his retirement.
(b) In case liability on account of leave encashment is to be provided for the entire accumulation of leave at the credit of the employee, it will become a huge amount and its loading on one year’s financial statements will distort the picture of profits and it cannot be said to reflect a true and fair view.
5. In view of above, the querist has requested the Expert Advisory Committee to give its opinion on the following issues:
(i) In the circumstances explained above, can the earned leave which is credited to employees’ account at the rate of 30 days per year and is available for encashment or availment as the employees wish, be construed to correlate with the retirement benefits? Is it covered under the provisions of Accounting Standard (AS) 15?
(ii) In case the answer to the above query is in the affirmative, what methodology the company should adopt to satisfy the provisions of Accounting Standard (AS) 15.
(iii) In case the provision for leave encashment is to be quantified, should the actuary calculations be undertaken and provision be made accordingly?
Opinion February 17, 1997
1. 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 .’
2. 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.”
3. Based on the above, the Committee is of the view that since the employer’s obligation relating to employees’ right to receive compensation for earned leave is attributable to employees’ services already rendered, the employer should accrue the liability in respect thereof in the period in which the services are rendered. The Committee is, therefore, of the view that the liability for leave encashment should be accrued whether it is encashable during the tenure of the service or at the time of retirement or death.
4. The amount of liability to be accrued in respect of leave encashment should be 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. Such a provision can also be made on actuarial basis.
5. The Committee also notes para 12 of Accounting Standard (AS) 5, on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, as below:
“12. Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”
6. On the basis of the above, the opinion of the Expert Advisory Committee on the issues raised by the querist in para 5 of the query is as below:
(i) Leave encashment liability, whether to be discharged during the course of employment or on retirement or death, should be accrued in the period in which the relevant service is rendered by the employees as per the accrual basis of accounting prescribed in section 209(3) of the Companies Act, 1956, and AS 15. Thus, even if AS 15 may not be entirely applicable, i.e., in respect of the leave encashment benefit payable during the course of employment, the provision in respect thereof should still be made as per the accrual basis of accounting.
(ii) Since the provision for leave encashment was not made in the relevant past accounting years, the same should be made for the amount accrued so far in the current accounting year. Provision for the entire benefit of leave encashment in the current year is a change in accounting policy and should be disclosed as per para 12 of Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India.
(iii) Please see para 4 above. ___________________________ |