Query No. 32
Subject: Accounting treatment of unencashable portion of sick leave.[1] A. Facts of the Case
1. A consultancy and engineering company provides different types of leave to its employees, one of which is sick leave. Every employee is entitled to 12 days’ of sick leave for an year. Sick leave can be accumulated upto 180 days during the service period, out of which leave upto 120 days is encashable at the time of retirement or death.
2. According to the querist, the company follows an integrated cost and financial accounting system. Leave accrued per employee is credited to a provision for leave account every month. The company observes 5 working days in a week, i.e., 40 hours per week. These 40 hours are allocated to jobs/leave (depending upon whether the employee has worked on job or has availed leave) and booked to respective job/provision for leave account. Such allocation and accounting are also done on a monthly basis. The company considers that every employee will avail of the leave due to him before his retirement. Accordingly, the company makes leave provision at the end of the year for the unavailed leave upto the ceiling of 180 days. For this purpose, at the end of the year (in March), the leave appearing in the individual’s account is valued at March payroll. The value so arrived represents the year-end provision for leave and the provision for leave account is adjusted by debit or credit to the payroll cost.
3. The government auditors are of the view that the provision for sick leave should be restricted to the extent of encashable ceiling of 120 days. The government auditors’ observations on the subject, as stated by the querist, are as below:
“Current Liabilities & Provisions (Schedule F), Provision - Rs. 34,651.19 lakh
Provision for Leave Salary – Rs. 6,711.56 lakh.
The above is overstated by Rs. 95.20 lakh due to provision of sick leave in excess of 120 days, which is encashable at the time of retirement, in contravention of Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’.
This has resulted into overstatement of Provision for Leave Salary encashment and understatement of profit by Rs. 95.20 lakh.” 4. As per the querist, if the company follows the government auditors’ observations, it may tantamount to under-provisioning to the extent of 60 days (i.e., 180 days - 120 days), which would not be in line with the requirement of section 209(3) of the Companies Act, 1956 to maintain books of account on accrual basis.
B. Queries
5. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
C. Points Considered by the Committee
6. The Committee notes that AS 15 deals with accounting for retirement benefits in the financial statements of employers. ‘Retirement benefit schemes’ have been defined in AS 15 as below:
“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 dependants.”
Since the unencashable part of the sick leave can be availed of at any time during the period of service and not necessarily on retirement, the Committee is of the view that it is not a retirement benefit and is, accordingly, not covered by AS 15.
7. The Committee notes paragraph 12 of AS 15, which states as under:
“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.”
The Committee is of the view that though the above paragraph deals with retirement benefits only, the principle underlying this paragraph is equally applicable to other employee benefits. Thus, the cost of providing benefits to employees in return for the services rendered by them in an accounting period should be accounted for in that period.
8. Sick leave being granted to employees is in consideration for services rendered by them. An employee is entitled to twelve days of sick leave for one year of service. Based on the observations made in paragraph 7 above, the Committee is of the view that from the view point of the employer, the cost of receiving an employee’s services for a year comprises not only the salaries and wages payable for the year but also the estimated cost of sick leave to which the employee is entitled.
9. The Committee is of the view that from an accounting angle, the nature of unencashable portion of sick leave is similar to that of the encashable portion, insofar as both entitle an employee to receive salary or wages for a period during which he does not render any services to the employer. However, in the case of unencashable sick leave, there may often be a significant uncertainty as to whether it would be actually availed of or not. In such a situation, it may not be possible to make a reasonable estimate of the employer’s obligation in respect of accumulated unencashable sick leave.
10. Based on the considerations set forth in paragraphs 8 and 9 above, the Committee is of the view that it is appropriate to make a provision in respect of accumulated unencashable sick leave if a reasonable estimate of the employer’s obligation in this behalf can be made (subject, of course, to consideration of materiality). The provision so created should be adjusted at the time the employee actually avails the leave.
11. According to the querist, the company considers that every employee will avail of the leave due to him before his retirement. The Committee presumes that this estimate is reasonable under the facts and circumstances of the case.
12. The Committee notes that the method followed by the company for creating provision in respect of accumulated unencashable sick-leave and its adjustment are in line with what has been stated in paragraph 10 above.
13. Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, requires that “all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed” (paragraph 24). The manner of treatment of unencashable sick leave constitutes an accounting policy and would therefore need to be disclosed in accordance with AS 1, if significant.
D. Opinion
14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5:
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[1]Opinion finalised by the Committee on 23.10.1999. |