1. A company is a 50:50 joint venture of an Indian company and a foreign company since 1st April, 2000. The company is in the field of manufacturing lube additive systems for automotive and industrial lubricants and for the treatment of fuels in India. Some of these are also being exported.

2. The company has a separate gratuity trust with independent trustees operating the trust. To meet the gratuity liability payable to the employees, the said trust has taken a policy from Life Insurance Corporation (LIC) under the ‘Group Gratuity-cum-Life Assurance Scheme’, for which the premium paid to LIC is debited to the ‘Gratuity Expense Account’ in the books of the company. As and when gratuity claims arise under the said policy on account of resignation, retirement, VRS, etc., claims are lodged with LIC by the trust and the said claims are settled by LIC. The cheque received from LIC is deposited in the savings bank account of the gratuity trust. The trust settles the claim by issuing its own cheques to the concerned employees.

3. The querist has stated that at the end of each accounting year, the company approaches LIC for actuarial valuation of the gratuity liability of the company. While giving the certificate of actuarial valuation, LIC considers the data given by the company, besides the parameters considered by it. In arriving at the amount of actuarial liability computations, retirement age, rate of interest credited by LIC to the Fund account of the company, mortality experience table, salary growth and the withdrawal rate, etc., are considered. On the basis of the aforesaid, LIC provides the following data:

(a) The actuarial valuation as on the date.

 

(b) The Fund Balance with LIC – It is learnt that LIC credits the premium paid by the trust, interest at the rate decided by LIC management on the balance in the Fund Account and deducts the gratuity claims settled by it based on the claims received from the trust.

 

(c) Based on (a) and (b) above, LIC determines the premium payable by the company.

 

The querist has stated that the company provides gratuity liability in its books of account based on the difference between (a) and (b) above to comply with the requirements of Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India.

4. As per the querist, while preparing the accounts for the year ended on 31.3.2002, the company had declared the following accounting policy in respect of gratuity liability:

"A separate trust has been established covering gratuity liability of staff. The Trust has taken a policy under Group Gratuity Insurance Scheme of LIC. Liability for gratuity is determined based on actuarial certificate obtained from LIC."

The following accounting data is also available in respect of gratuity provision in the books of account of the company for the year ended on 31.03.2002:

 

(a) The premium paid to LIC for the gratuity policy taken by the gratuity trust for the year 2001-02 is Rs. 43.30 lakh and the same

is debited to, ‘Gratuity Expense Account’ in the books of the company.

 

(b) The provision for gratuity in the books of account of the company as on 1.4.2001 is Rs. 168.09 lakh.          

(c) The actuarial gratuity liability as indicated by LIC as on 31.3.2002 is Rs. 402.15 lakh.                                    

(d) The Fund balance as indicated by LIC to the credit of the trust as on 31.3.2002 is Rs. 72.66 lakh.

(e) The provision for gratuity made in the books of account of the company for the year 2001-02 is Rs. 161.40 lakh (Rs. 402.15 lakh minus Rs. 72.66 lakh minus Rs. 168.09 lakh).

5. During inspection of the accounts by the auditor of one of the joint venture partners, it has been commented that gratuity liability provided by the company in the books of account for the year 2001-02 is not in line with the provisions of AS 15. The observation of the audit team is as follows:

"For gratuity payable to employees, the company has taken insurance policy under Group Gratuity Insurance Scheme from Life Insurance Corporation of India Ltd. The company had paid the annual premium of Rs. 43.30 lakh to LIC during the year 2001-02 and the same was charged to the Profit & Loss Account in 2001-02. In addition, the company has also provided a liability for gratuity amounting to Rs.161.40 lakh, which is not correct as the premium is paid regularly and no premium was due/outstanding as on 31.3.2002. As per Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, issued by the Institute of Chartered Accountants of India, in case the liability for gratuity is funded through a scheme administered by an insurer, it is usually considered necessary to obtain an actuarial certificate or a confirmation from the insurer that the contribution payable to the insurer is the appropriate accrual of the liability for the year which shall only be charged to the statement of profit and loss. Therefore, only premium payable/paid during the year should be accounted for, hence additional liability of Rs. 329.49 lakh is wrongly created, thereby reducing the profit of the company to that extent."

B . Query

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

(a). Whether the observation made by the audit team of the joint venture partner is correct, i.e., whether in a defined benefit scheme like gratuity, when policy is taken from LIC, the company would be required to account for/provide in the books of account only to the extent of the premium paid/payable under the policy to be in line with AS 15.

 

(b) In the above case, what should be the accounting treatment of the accrued amount on account of gratuity to the employees, in case actuarial valuation is determined by LIC for accrued liability of gratuity. Whether any treatment in the books of account is to be given or not.

 

(c) Since the certificate issued by LIC stipulates that the Fund balance to the credit of the trust under the policy taken for covering the gratuity liability would be the base for settlement of claims under the policy, i.e., claims under the policy would be settled subject to availability of Fund balance indicated by them, whether the company is required to provide in its books of account the difference between accrued liability calculated according to the actuarial valuation and the Fund balance indicated by LIC as is being done by the company.

 

(d) Whether the accounting policy declared by the company as cited above needs any change to clarify the factual position in the books of account to be understood by the shareholders.

C. Points considered by the Committee

7. The Committee notes that there is some discrepancy between the amounts of balances of certain items stated by the querist in paragraph 4 above, the amounts mentioned by the auditor as per paragraph 5 above, and the amounts stated in the certificate issued by LIC supplied separately by the querist. The opinion of the Committee contained hereinafter is based on the principles of accounting and does not reflect the accuracy or otherwise of the amounts of various balances. The Committee also notes that the total premium payable as per the certificate issued by LIC includes the amount of life cover premium which does not add to the Fund balance.

8. The Committee notes paragraphs 13, 14 and 15 of Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’, which state as below:

"13. When there is a separate retirement benefit fund, it is sometimes assumed that the amount paid by an employer to the fund during an accounting period provides an appropriate charge to the statement of profit and loss. While, in many cases, the amount funded may provide a reasonable approximation of the amount to be charged to the statement of profit and loss, there is a vital distinction between the periodic funding of retirement benefits and the allocation of the cost of providing these benefits.

 

 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.

9. From the above, the Committee notes that the profit and loss account should be debited by the amount of accrued liability for the year on account of gratuity for an amount as may be determined by actuarial valuation. A company may, in order to provide sufficient funds for meeting the gratuity liability when it actually arises, contribute similar amount to a separate fund. Thus, whereas the purpose of a charge to the profit and loss account is to account for the accrued liability, the purpose of contributions to a fund is the availability of enough funds to meet the liability when it actually arises. As a result, depending upon the amount of contributions made to the fund, the balance of the fund account and the accumulated debit to the profit and loss account may not be the same.

10. In respect of accounting for retirement benefits funded through a scheme administered by an insurer, paragraph 17(iii) of AS 15 states as below:

"(iii) In case the liability for retirement benefits is funded through a scheme administered by an insurer, it is usually considered necessary to obtain an actuarial certificate or a confirmation from the insurer that the contribution payable to the insurer is the appropriate accrual of the liability for the year. Where the contribution paid during a year is lower than the amount required to be contributed during the year to meet the accrued liability as certified by the actuary or confirmed by the insurer, as the case may be, the shortfall is charged to the statement of profit and loss for the year. Where the contribution paid during a year is in excess of the amount required to be contributed during the year to meet the accrued liability as certified by the actuary or confirmed by the insurer, as the case may be, the excess is treated as a pre-payment."

11. The Committee notes from the facts of the case that on the transfer of funds by the company to the gratuity trust for payment of premium by the trust to the LIC for Group Gratuity-cum-Life Assurance Scheme, the same is treated by the company as gratuity expense which is charged off to the profit and loss account. The Committee also notes that the company has been making a provision for gratuity liability to the extent of the difference between the gratuity liability as per the actuarial valuation and the balance of the accumulated Fund (as stated in paragraph 3(b) above) with LIC after considering the contribution to the Fund for the year. The Committee presumes that the amount of life cover premium paid by the company to LIC is excluded from the contribution made to the Fund every year for the purpose of determining the amount of provision required to be made, since the amount of life cover premium does not add to the Fund balance.

12. The Committee also notes from the facts of the case that the LIC has undertaken to meet the gratuity liability of the company only to the extent of the availability of the Fund. The Committee further notes from the facts of the case that the Fund balance available with the LIC is less than the accrued liability determined on actuarial basis. Thus, in the event of there being insufficient balance in the Fund, the company will be required to meet its obligations towards gratuity liability from its own resources. In other words, the Fund balance represents only a part of the accrued liability of the company. Therefore, the company should have an accumulated provision equivalent to the amount of the difference between the accrued gratuity liability and the Fund balance. Accordingly, additional provision should be made in the current year to meet any shortfall in the accumulated provision for gratuity. The Committee notes that this is being done by the company.

D. Opinion

13. On the basis of the above, the Committee is of the following opinion on the issues raised by the querist in paragraph 6 above:

(a) In a normal situation, the observation made by the audit team of the joint venture partner would be correct, i.e., the premium payable under the policy should normally be treated as provision since in a normal situation the premium would be the difference between the accrued actuarial liability and the existing balance of the Fund. However, in the present case, the company should make a provision for gratuity liability by way of a charge to the profit and loss account as explained in paragraph 12 read with paragraph 11 above.

 

(b) The accounting treatment of the accrued amount of liability on account of gratuity as per actuarial valuation should be as explained in paragraph 12 read with paragraph 11 above.

(c) Yes, under the circumstances of the company, the company is required to make a provision for the difference between the accrued liability as per actuarial valuation and the Fund balance indicated by LIC, as is being done by the company.

(d) Yes, it would be appropriate to word the accounting policy in a manner to clarify that the Group Gratuity-cum-Life Assurance Scheme of LIC covers gratuity liability of the company only to the extent of the availability of the Fund, and that the company is making a provision in its books of account for the balance amount of gratuity liability.

1Opinion finalised by the Committee on 16.7.2003.