1.14 Query:

Accounting of post-retirement medical facilities

and leave encashment benefits.

1. A public sector company under the administrative control of Ministry of Mines, has the following retirement benefits:

(i)            Provident Fund.

(ii)            Gratuity.

            (iii)            Post-retirement medical facilities.

2. Post-Retirement Medical Facilities Scheme is framed with a view to provide medical benefits to employees of the company and their spouses subsequent to their retirement on contributory basis. The benefit covers treatment facilities including supply of medicines in the company’s hospital on a monthly contribution of Rs. 15/- per member. Where the company’s hospital is not available, reimbursement of medical expenses is allowed limited to one month’s pay, on a monthly contribution of Rs. 20/-. The retired employee who intends to avail such benefit has to apply in advance along with the contribution and submit his claim as and when incurred. This indicates that all employees may not opt for such a scheme and even after giving the option, may not avail the facility regularly. Also, the cost of treatment in the company’s hospital cannot be determined accurately.  Further, it is difficult to anticipate and determine the cost of post-retirement benefits in advance when the employee is still in service.

3. The company also has a leave encashment facility which is under “Leave Rules” and not under “Retirement Benefits”. Under the leave rules, the entitlement of various kinds of leave to employees is furnished below:

Entitlement of various kinds of leave

4. Encashment of earned leave is allowed once in a calendar year to executive employees subject to having a 30 days balance at his/her credit after availing the encashment. In case of non-executive employees, encashment of earned leave is allowed only out of encashable portion. In addition, executive employees are allowed to encash half pay leave up to 100 days on completion of every 5 years of continuous service subject to having 30 days balance at their credit after availing encashment. In case of superannuation, retirement or death of an employee, the entire earned leave can be encashed. Also, in case of retirement, executive employees are allowed to encash half pay leave up to 480 days. Thus, the leave rules confirm that encashment of leave is not exclusively a retirement benefit. (Emphasis supplied by the querist)

5. Accounting Standard (AS) 15 deals with accounting for retirement benefits, which includes “leave encashment benefit on retirement”. It is explained in the introduction para of AS 15 that the Standard applies to retirement benefits, if the predominant characteristics of these benefits are in the nature of either a defined contribution scheme or a defined benefit scheme. According to the querist, the Standard does not apply to those retirement benefits for which the employer’s obligation cannot be reasonably estimated. The company has no exclusive scheme for leave encashment on retirement and the existing leave encashment facility is composite in nature for in-service as well as retiring employees. The computation of value of leave outstanding on a year to year basis, while the employees are still in service, is not feasible on an accurate basis since it depends upon several factors listed above. The company does not feel it mandatory to account for such benefits even on actuarial basis (emphasis supplied by the querist). As regards to post-retirement medical facilities, as already explained in para 2, the cost of such benefit is not determinable in advance, while the employees are in service as well as after retirement.

6. The company has, therefore, opted to account for leave encashment and post retirement medical facilities on “Pay as you go” basis as mentioned in AS 15 and declared the accounting policy on retirement benefits as follows:

“Retirement Benefits

1.         Contribution to provident fund is recognised in Profit & Loss Account on the basis of actual liability.

2.         Liability on account of service gratuity is covered under Group Gratuity Life Assurance of Life Insurance Corporation of India. Contributions to the scheme are charged to Profit & Loss Account.

3.         Other retirement benefits like leave encashment and post retirement medical facilities are recognised only at the time of payment made to employees on or after their retirement.”

7.  The accounting policy stated under para 6 above was questioned by CAG during the audit of accounts for the year 1995-96. Being not satisfied with the reply of the company, they have commented as mentioned below:

            “Profit after Period Adjustment Rs. 53526.37 lakhs.

Reference is invited to Notes on Accounts-Item No. 2.5 (ii) and Statutory Auditor’s Report Item No. 4 (j). The company has not provided for the liability towards leave encashment benefits and post retirement health scheme on actuarial basis in contravention of Accounting Standard 15.”

8. The querist has sought the opinion of the Expert Advisory Committee on the following points:

(i)         Is the accounting policy on retirement benefits like leave encashment and normal retirement medical facilities followed by the company in order, based on the scheme, facts and circumstances explained above?

(ii)        If it is not considered proper, what should be the correct method of accounting, rationale therefore and method of determination thereof?

                                                                           Opinion                                       May 20, 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 matter 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 further notes that ‘accrual’ is one of the fundamental accounting assumptions underlying the preparation and presentation of financial statements as per Accounting Standard (AS) 1 on ‘Disclosure of Accounting Policies’, issued by the Institute of Chartered Accountants of India. The term ‘accrual’ has been defined in the Standard as below:

“Revenue and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this statement).”

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.  The Committee further notes that the Guidance Note on Accrual Basis of Accounting, issued by the Institute of Chartered Accountants of India, deals with ‘Authoritative pronouncements of the Institute vis-a-vis accrual accounting’. Para 8.1 in this regard, inter alia, states as below:

“ The Council of the ICAI and its various committees have issued various Guidance Notes, Statements and Accounting Standards. The accounting treatments contained in these documents are primarily based on accrual accounting. Thus, adoption of accounting treatments recommended in these documents would ensure that a company has followed accrual basis of accounting.”

5. In view of the above, the Committee notes that the principles of accounting for costs of retirement benefits laid down 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, are in consonance with the accrual basis of accounting, which is the requirement under the Companies Act, 1956. Accordingly, even though the benefits such as leave encashment benefit which are not exclusively payable at the time of retirement or superannuation but also are available during the tenure of employment of the concerned employee, the principles laid down in AS 15 would still be relevant in view of the accrual basis of accounting, in case the predominant features of the benefits are similar to those dealt with in AS 15.

6. With regard to the leave encashment benefits available to the employees of the company in question, the Committee notes from the Human Resource Management Manual of the company (separately submitted by the querist), the following facts, apart from those included in the query given above:

“For the purpose of leave encashment, an amount equal to total of following elements as on the date of application will be payable on the basis of 30 days a month.

Basic pay including special pay, personal pay and non-practising allowance etc.

Dearness Allowance.”

7. On the basis of the above, the Committee is of the view that the leave encashment benefit available to the employees of the company in question is of the nature of a Defined Benefits Scheme as defined in AS 15 as below since the benefit is determinable by reference to employee’s earnings and years of service:

“Defined benefits 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.”  

8. The Committee also notes para 12 of AS 15 as below:

“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.”

9. On the basis of the above, the Committee is of the view that even though the leave encashment benefits is not exclusively available on retirement of the concerned employee, but is available during the course of service, the provision in this regard should be made in the period in which the services are rendered by the employee keeping in view the accrual basis of accounting.

10. With regard to the Post Retirement Medical Facilities Scheme of the company, the Committee notes the further facts given in the Scheme (submitted separately by the querist) as below:

“ The retired employees residing at places where the company has its own hospitals/full-fledged dispensaries would be allowed medical treatment facilities, including medicines as available in such hospitals/dispensaries only:

In respect of such retired employees who reside at places where the company does not have its own hospital/full-fledged dispensaries, reimbursement of medical expenses incurred shall be regulated as under:

Indoor Treatment

Reimbursement of medical expenses incurred for indoor treatment will be allowed subject to the condition that the treatment is obtained in Government hospitals or other hospitals notified by the company.

Outdoor Treatment

For out patient/domicillary treatment, reimbursement of medical expenses shall be allowed as per Company’s Medical Attendance Rules. The reimbursement will however be subject to annual ceiling as mentioned below:

11. The Committee is of the view that the post-retirement medical benefits, the facts of which have been given in the query and in the above paragraph, does not appear to be of the nature of a Defined Benefit Scheme as defined in AS 15, particularly, in respect of the cost of medical facilities provided in the company’s own hospitals, since the cost of the benefits under the said scheme is not with reference to the earnings/years of service of the employee exclusively. However, keeping in view the underlying consideration of accrual basis of accounting that an obligation exists towards such a benefit during the period the service is rendered by an employee, it would be necessary to make a provision in this regard on reasonable basis, say actuarial, past experience etc., if the amounts involved are material.

12. On the basis of the above, the opinion of the Committee in respect of issues raised in para 8 of the query is as below:

(i)         The accounting policy for leave encashment benefit and post retirement medical facilities is not in order. The Committee has not gone into the accounting policies related to other retirement benefits of the company as the query has been raised in the context of the leave encashment benefit and the post retirement medical facilities.

(ii)        Provision for leave encashment liability, whether to be discharged during the course of employment or on retirement or death, and post-retirement medical facilities, should be accrued in the period in which the relevant service is rendered by the employee. The amount of liability to be accrued in this regard should be estimated on a rational basis keeping in view the factors like actuary’s evaluation, the past experience about the benefits actually availed of, possibility of availing the past leave in future etc. The rationale of accounting has been discussed in above paragraphs.

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