Query No. 48
Subject: Accounting treatment for leave encashment.1 A. Facts of the
Case
1. A company
was incorporated as a limited company in 1986 under the Companies Act, 1956,
for manufacturing of engineering goods like Tractions and Power
Conditioning Equipments. The company acquired the present business from
its holding company as a going concern in the year 1997.
The company is
having a turnover
of Rs. 38
crore and net worth of Rs. 10 crore. Total capital
employed in the company is Rs. 26 crore and it has 240 employees.
2. A liability
of Rs. 32.81 lakh for leave encashment of the then existing employees, on the
date of transfer of business, was also transferred to the company by its
holding company along with other assets and liabilities.
3. The rules of
leave encashment being followed by the company are described hereunder :
“The leave will be available to an employee after completion
of one year’s service. It can be accumulated upto a maximum of 240 days.
However, if an employee so desires, accumulation of leave over and above 60
days can be encashed by him at any time.” 4. As per the
querist, the company provides for the liability in respect
(i) An employee
has an option
to encash the
earned leave accumulated over and
above 60 days during the employment, i.e., he/she is not required to wait till
retirement for availing leave encashment.
(ii) The present
business/unit was established
by the holding company in the year 1989. 813
employees joined the company between 1989 to 2001, out of which 563 employees
left over the last 11 years. Therefore, average stay of
an employee in the company is less
than 5 years.
(iii) The total
leave encashment liability as on 31.03.2001 was Rs.81.24 lakh. The break-up of the same is given as under: (a) The
liability for leave encashment for 60 days, which is encashable only at the
time of retirement or resignation is Rs. 33.20 lakh.
(b) The
liability for leave encashment over 60 days, which is encashable at any time at
the option of the employee is Rs. 48.04 lakh.
(iv) The liability
for encashment of
leave benefit is
not funded through creation of
trust, i.e., the company is making payment for
leave encashment out of its
own funds. Therefore,
it is necessary to make a
provision for accruing liability on actual basis.
(v) Out of
240 days leave
allowed to be
accumulated by the company,
an employee is
having an option
to encash leaves upto 180 days during employment.
(vi) If the company
provides for leave encashment liability based on actuarial valuation, liability
for leave encashment presently provided
for in the
financial statements would
be grossly understated.
(vii) The objective
of Accounting Standard (AS) 15, ‘Accounting for
Retirement Benefits in
the Financial Statements
of Employers’, is that
proper liability in
respect of retirement benefits is
accounted for and
that appropriate disclosure
in respect thereof is made in the financial statements. The liability
for retirement benefits arises on account of services rendered by employees
to the employer.
Consequently, the cost
of retirement benefits should be accounted for during the period
for which the
services are rendered.
Contrary to the
above, provision for retirement
benefits in the books of account
on cash basis, i.e., when employees are paid retirement benefits, does
not meet the objective of allocation of expenses during the period when the
services are rendered.
B. Query
5. The querist
has sought the opinion of the Expert Advisory Committee
C. Points
considered by the Committee
6. The
Committee notes that AS 15 is
based on the accrual basis of accounting which is also required to
be followed by the Companies Act,1956. This fact is recognised in the Guidance Note on
Accrual Basis of Accounting, issued by
the Institute of
Chartered Accountants of
India, paragraph 8.1 of which, 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.”
7. On the
basis of the above, the
Committee is of the view
that the principles of
measurement laid down
in AS 15 are relevant
even in respect of leave
encashment benefit which is not exclusively payable at the time of retirement
or superannuation but is also available during the tenure of employment of the
employees.
8. The
Committee notes that paragraph 28 of AS 15, inter alia, provides the following:
“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.”
9. On the basis
of paragraphs 7 and 8 above, the Committee is of the view that
since the company
is employing a
fairly large number
of employees, the amount
of the provision
for leave encashment
benefit should be based on actuarial valuation both in case of leave
encashment
10. The Committee is
further of the view that since
the company has not provided for
leave encashment benefit
payable on retirement
on actuarial basis, the auditor should qualify his report both with
regard to section 227(2) and section 227(3)(d) of the Companies Act, 1956,
being not in consonance with AS 15. However, as far as non-provision of leave
encashment benefit payable during the tenure of employment is concerned, the
auditor should qualify his report only with regard to section 227(2) of the
Companies Act, 1956, since AS 15 as such is not applicable in this case.
D. Opinion
11. On the
basis of the
above, the Committee
is of the
opinion that
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