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Query No. 17
Subject:
Provision
for liabilities towards gratuity/leave encashment
as retirement benefits to
employees.1
A. Facts of the
Case
1. A public
sector company is engaged in passenger/cargo transportation business. The
company has the following accounting policy in respect of
providing for the
liability for gratuity/leave encashment
payable to its employees at retirement:
(a) Gratuity, leave
encashment and pension
liability for staff directly recruited at foreign stations
is calculated as per local laws
prevailing in the
respective countries as at the
balance sheet date; and
(b) Gratuity and leave encashment for staff other than directly recruited at foreign stations are provided on the basis of actuarial valuation as at the balance sheet date.
2. As per the
accounting policy at paragraph 1(b) above, the liabilities
of Rs. 133 crore and Rs. 53 crore towards gratuity and leave
encashment respectively were provided based on actuarial valuation certified by
the actuary as on 31.3.2000 as the net present value of such liability. While
determining the net present value and certifying the above liabilities, the
actuary had assumed
a rate of
return of 10%
despite the fact
that the company had not funded
to meet such liabilities.
3. The auditors
of the company, while expressing their opinion on the accounts for the
financial year ended 31.3.2000, had qualified the accounts for under-provision
of liabilities of Rs. 62 crore to the extent of difference between the gross
liability and net present value of the liability as certified by the actuary.
The quantum of gross liability as determined amounted to Rs. 160 crore and Rs.
88 crore respectively towards gratuity and leave encashment. Further, the
auditors qualified their report for non-compliance with Accounting Standard
(AS) 15, ‘Accounting for Retirement Benefits
in the Financial
Statements of Employers’,
issued by the
Institute of Chartered
Accountants of India, as required under section 211(3C) of the Companies Act,
1956.
B. Queries
4. The querist
has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the
actuary is justified to take assumption of 10% as rate of interest while
arriving at the actuarial liability as at the balance sheet date, despite the
fact that there is no funding of liability.
(b) Whether the auditors are justified in giving qualification in their report towards under-provision of gratuity and leave encashment.
(c) Whether the
auditors are justified in qualifying their report for non-compliance with AS 15
as required under section 211(3C) of the Companies Act, due to the reasons
stated in paragraph 3 above.
C. Points
considered by the Committee
5. The Committee
restricts itself to the specific
issues raised by the
querist and has not touched upon any other issue, e.g., accounting treatment
of gratuity, leave
encashment, etc., for
employees directly recruited
at foreign stations.
6. The
Committee notes paragraphs 14, 15, 17(i), 18, 19 and 20 of AS15, which provide as below:
“14. The objective of
funding is to make available amounts to meet future obligations for the payment
of retirement benefits. Funding is a financing procedure and in determining the periodical
amounts to be funded, the employer may be influenced by such factors as the
availability of money and tax considerations.
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 employees’ services.”
“17. ...........
(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 is made
through a provision for
the accruing liability.
The accruing liability
is calculated according to actuarial valuation. …”
“18. A number of actuarial valuation methods have been
developed by the actuarial profession to estimate employer’s obligations under
defined benefit schemes. While these methods are primarily designed to calculate funding requirements, they are also frequently
used to determine retirement benefit costs for accounting purposes.
19. The actuarial method selected for determining accrual of
liability and the assumptions made can have a significant effect on the expense to be recorded in each accounting period. Therefore, in
carrying out a periodical valuation, an actuary chooses a suitable
valuation method and, in consultation
with the employer,
makes appropriate assumptions about the variable elements affecting the
computations.
20. The assumptions
relate to the
expected inflow from
future contributions and from investments as well as to the expected
outgo for benefits. The uncertainty inherent in projecting future trends in
rates of
inflation, salary levels
and earnings on
investments are taken into
consideration by the actuary in the actuarial valuations by using a
set of compatible
assumptions. Usually, these
projections are extended until the expected date of death of the last
pensioner in case of a superannuation scheme, expected date of death etc. of
the beneficiary in case of family pension, and expected service in case of
gratuity and are, accordingly, long-term.”
7. On the basis
of the above, the Committee is of the view that whether funding is done or not,
is not the determining factor for the amount that should be provided for in the
books of account for the costs related to gratuity and leave encashment. The
Committee is further of the view that the cost of retirement benefits should be
matched with its benefits, i.e., rendering
of the employees’
services and, accordingly,
it should be allocated to accounting periods on a
systematic basis. In arriving at the amount of the provision for the costs of
such retirement benefits in an accounting
period, it is not necessary
that actuarial method
should be used only if the
liabilities are funded. Actuarial method should be used even if an enterprise
is not funding the said retirement liabilities. In using an actuarial method,
an actuary bases his computations on various variables and, accordingly, uses
an appropriate rate of interest for the purpose of discounting. Such a rate may
be based on the enterprise’s reinvestment rate, where the liability for the
retirement benefit is not funded separately.
8. The Committee
notes paragraphs 12 and 14
of the Statement
on Standard Auditing
Practices (SAP) 9,
‘Using the Work
of an Expert’, issued by the Institute of Chartered
Accountants of India, which state as below:
“12. The appropriateness and
reasonableness of assumptions
and methods used and
their application are
the responsibility of the
expert. The auditor does not have the same expertise and, therefore,
cannot always challenge
the expert’s assumptions
and methods. However, the
auditor should obtain
an understanding of
those assumptions and methods to determine that they are reasonable
based on the auditor’s knowledge of the client’s business and on the results of his audit procedures.”
“14. If, ... the
auditor concludes that:
• the work of the expert is inconsistent with the
information in the financial statements, or that
• the work of
the expert does
not constitute sufficient appropriate audit evidence (e.g.,
where the work of the expert involves highly technical matters or where, on grounds of confidentiality, the
expert refuses to make available to the auditor the source data used by him),he should express a qualified opinion, a disclaimer of
opinion or an adverse opinion, as may be appropriate.”
9. From the
above, the Committee is of the view that the auditor’s duty with regard
to actuarial valuation
is to the
extent of obtaining
an understanding of the
assumptions and method
used by the
actuary, to determine that they
are reasonable based on the auditor’s knowledge of the business and on the
results of his audit procedures. Where the auditor
is not satisfied
in this regard
and reaches a
conclusion as stated
in paragraph 14 of SAP 9 reproduced above, he is required to report in
an appropriate manner.
10. The Committee
notes section 227(3) of the Companies Act, 1956, which provides as below:
“The auditors’ report shall also state - ....
(d) whether, in
his opinion, the profit and loss account and balance sheet comply with the
accounting standards referred to in sub-section (3C) of section 211.”
11. From the
above, the Committee is of the view that if the auditor does not agree with the
amount of the provision for the retirement benefits on actuarial basis, he
should qualify his report on true and fair view that although provision has
been made as per the actuarial method as prescribed
in AS 15,
the amount of
the provision is
not adequate. In
this regard, while reporting
under section 227(3)(d), the auditor should state that AS 15 has not been complied with drawing reference to his qualification
in this respect on true and fair view.
D. Opinion
12. On the basis of
the above, the Committee is of the following opinion on the issues raised in
paragraph 4:
(a) Appropriateness
of rate of interest to be used by an
actuary, whether there is
funding or not,
depends upon the
factors specified in paragraph
7 above. Accordingly,
whether the assumption of
10% as rate
of interest is
appropriate or not would depend on those factors.
(b) The
auditor’s duty with regard to actuarial valuation is to the extent of obtaining
an understanding of the assumptions and method used by the actuary, to determine that they are reasonable based on the auditor’s
knowledge of the business and on the results of his audit procedures. Where the
auditor is not satisfied in this regard and concludes as stated in paragraph
14 of SAP 9 reproduced above, he is required to report in an
appropriate manner.
(c) The auditors are not justified in qualifying their report for non-compliance with AS
15 as required under section 211(3C) of the Companies Act, merely because a rate
of interest has been used in the actuarial valuations. As
explained in paragraph
7 above, the use of an appropriate rate of interest is
necessary in making actuarial valuations. However, if the auditor is of the view that the rate of
interest used is inappropriate and he does not agree with the amount of the
provision on actuarial basis, he should qualify his report on true and fair
view that although provision has been made as per the actuarial method as prescribed in AS 15, the amount of the provision is not
adequate. In this regard, while reporting under section
227(3)(d), the auditor should state that AS 15 has not been complied with drawing reference to his qualification in this respect on true and fair view.
1
Opinion
finalised by the Committee on 26.5.2001.
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