Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 11

Subject: Treatment of settlement allowance paid to employees on retirement.[1]

A.  Facts of the Case

1. A multi-unit, multi-product public sector company has a scheme for payment of ‘settlement allowance’ to retiring employees. Under the scheme, retiring employees are entitled to reimbursement of certain travel-related expenses (to their home town or any other place of their choice) for the class they are entitled to as per company’s travel rules and to a lumpsum payment to cover expenses on food and stay during travel. Alternatively, employees can claim a lumpsum amount equal to one month’s salary. According to the querist, the settlement allowance paid by the company to employees retiring voluntarily is reimbursed by the government.

 

2. The relevant extracts from the scheme for payment of settlement allowance are given below:

 

(i)      The scheme will be applicable to all regular employees in certain grades of the company on superannuation/retirement including voluntary retirement and retirement on medical grounds.

 

(ii)     An employee and eligible members of his family are entitled to the following facilities as admissible on inter-unit transfer in the company’s interest:

 

(a)  travel expenses;

 

(b)  journey incidentals;

 

(c)  freight charges for transportation of personal effects;

 

(d)  transportation of one personal vehicle owned by the employee-either a motor car or scooter/motor cycle/moped; and

 

(e)  packing and forwarding expenses.

 

(iii)    In addition to the above, an employee and eligible member(s) of his family are also entitled to a lumpsum payment to cover the expenses on food and stay in the event of the transit halt, if any, on way to destination to catch connecting train/other mode of public transport, exceeding three hours. This lumpsum payment will be an amount equal to the amount of lumpsum for lodging, boarding and incidentals provided in the TA & DA rules of the company for the employee and each eligible member of his family.

 

(iv)    Lumpsum payment

 

(a)  An employee/the family of a deceased employee, not availing the travelling allowance under clauses (ii) and (iii) above will, at option, be entitled to a lumpsum payment equal to one month’s salary last drawn irrespective of the place of settlement.

 

(b)  Salary for the above purpose includes basic pay, personal pay, dearness allowance, FDA, VDA, ad-hoc relief, interim relief and any other component of wages/salary considered as pay and dearness allowance or part thereof and excludes HRA and CCA.

 

(v)     Where both husband and wife are employees of the company, only one of them, at their option, shall be entitled to the benefits under this scheme, irrespective of the retirement date.

 

(vi)    The claim for reimbursement under clauses (ii) and (iii) above should be supported by necessary documentary evidence as required for a transfer TA claim.

 

3. According to the querist, the government auditors have observed that settlement allowance is a retirement benefit in terms of Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India and provision therefor should be made in the accounts of the company.

 

4. The company’s contention in the matter is as follows:

 

(i)      Settlement allowance does not depend upon the length of service of the employee. It is restricted to the employee’s eligibility under the travel rules of the company, or where the option for lumpsum payment is exercised, to the last salary drawn.

 

(ii)     Since it is not related to the length of service of the employee, it does not accrue in terms of the requirements of section 209(3) of the Companies Act, 1956, and is accounted for on claim basis.

 

(iii)    The amount involved is not significant, as envisaged in AS 15, since it is confined only to employees superannuating. In the case of those leaving service under voluntary retirement scheme, the settlement allowance is reimbursed by the government out of the National Renewal Fund and as such, it has no effect on the profit and loss account.

 

B.  Queries

 

5. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

 

(a)     Whether the settlement allowance is a retirement benefit covered under AS 15.

 

(b)     If so, should a provision be made for the entire liability as at the close of the financial year, on accrual basis as per section 209(3) of the Companies Act, 1956, or is it required to estimate the liability on a rational basis, say, by actuarial valuation and provide for it.

 

C.  Points Considered by the Committee

 

6. The Committee notes that Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, states (paragraph 2) as below:

 

“2.  Retirement benefits usually consist of:

               .......

(f)  other retirement benefits.

 

This Statement applies to retirement benefits in the form of provident fund, superannuation/pension and gratuity provided by an employer to employees, whether in pursuance of requirements of any law or otherwise. 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 described in this Statement(emphasis added). This Statement does not apply to those retirement benefits for which the employer’s obligation cannot be reasonably estimated, e.g., ad hoc ex-gratia payments made to employees on retirement.”

 

7. AS 15 defines ‘defined contribution schemes’ and ‘defined benefit schemes’ as under:

 

“Defined contribution schemes are retirement benefit schemes under which amounts to be paid as retirement benefits are determined by contributions to a fund together with earnings thereon.”

 

“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 years of service.”

 

8. From the above, it can be observed that in a defined benefit scheme, the employer assumes an obligation to provide the agreed benefits to employees. While the amount of retirement benefits under a defined benefit scheme is commonly determined on the basis of (a) the earnings of the employee at or near retirement, and/or (b) length of service, the absence of both these factors in determination of the amount of benefits does not by itself imply that the scheme is not a defined benefit scheme. This is also evident from the use of the term ‘usually’ in the definition of the expression ‘defined benefit scheme’. What is of the essence of a defined benefit scheme is that the employer’s obligation is to provide agreed benefits rather than to make agreed contributions (as in a defined contribution scheme). The Committee is of the view that the scheme of settlement allowance being followed by the company meets this test.

 

9. The Committee further notes that paragraphs 10 and 12 of AS 15 state the following with regard to defined benefit schemes:

 

“10. Defined benefit schemes, especially those that promise benefits related to remuneration at or near retirement, present significant difficulties in the determination of periodic charge to the statement of profit and loss. The extent of an employer’s obligation under such schemes is usually uncertain and requires estimation. In estimating the obligation, assumptions may need to be made regarding future conditions and events which are largely outside the employer’s control.”

 

“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.”

 

10.  Paragraphs 28 and 31 of AS 15 state as under:

 

“28.   In respect of gratuity benefit and other defined benefit schemes, the accounting treatment will depend on the type of arrangement which the employer has chosen to make.

 

(i)      If the employer has chosen to make payment for retirement benefits out of his own funds, an appropriate charge to the statement of profit and loss for the year should be made through a provision for the accruing liability. The accruing liability should be calculated according to actuarial valuation. However, those enterprises which employ only a few persons may calculate the accrued liability by reference to any other rational method e.g. a method based on the assumption that such benefits are payable to all employees at the end of the accounting year.

 

.......”

“31. The financial statements should disclose the method by which retirement benefit costs for the period have been determined. In case the costs related to gratuity and other defined benefit schemes are based on an actuarial valuation, the financial statements should also disclose whether the actuarial valuation was made at the end of the period or at an earlier date. In the latter case, the date of the actuarial valuation should be specified and the method by which the accrual for the period has been determined should also be briefly described, if the same is not based on the report of the actuary.”

 

11. In view of what has been stated in paragraph 8 above and considering the relevant requirements of AS 15 as reproduced above, the Committee is of the view that the company should account for the settlement allowance in accordance with paragraph 28(i) of AS 15 and make the disclosures required by paragraph 31 of AS 15.

 

12. The querist has contended (paragraphs 4(i) and 4(ii) above) that settlement allowance is not related to length of service and, therefore, it does not accrue in terms of requirements of section 209(3) of the Companies Act, 1956. The Committee does not agree with this contention. The Committee is of the view that the settlement allowance is payable in consideration of the services rendered by an employee during the tenure of his employment in the company (though the amount of retirement benefits need not necessarily be proportional to the length of service). As such, an appropriate amount (in respect of the likely amount of settlement allowance) needs to be accrued during such period, as provided in paragraph 12 of AS 15.

 

13. The querist has contended (paragraph 4(iii) above) that the amount involved is not significant as envisaged in AS 15, since it is confined only to employees superannuating (in the case of voluntary retirement, the settlement allowance is reimbursed by the government). Since accounting standards are intended to apply only to material items (paragraph 4.3 of the ‘Preface to the Statements of Accounting Standards’), the Committee is of the view that in case the amount arrived at in accordance with paragraph 28(i) of AS 15 is not material, the requirements of paragraphs 28(i) and 31 of AS 15 would not be applicable. Thus, in such a case, it would be permissible for the company to account for settlement allowance differently, provided the method followed is reasonable having regard to the facts and circumstances of the case and is followed consistently.

 

D.  Opinion

 

14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5:

 

      (a)     Yes, settlement allowance payable by the company is a retirement benefit covered under AS 15.

 

      (b)     (i)   A provision should be made every year in the accounts for the accruing liability on account of settlement allowance. The amount of the provision should be calculated according to actuarial valuation. The disclosures required by paragraph 31 of AS 15 should be made in the financial statements.

 

               (ii)  Where the amount of provision so determined is not material, the company can follow some other method of accounting for settlement allowance, provided such method is reasonable under the facts and circumstances of the case and is followed consistently.

 

[1] 1 Opinion finalised by the Committee on 15.1.1999.