1.8       Query

Whether termination benefits paid to workers on account of

 automation of plant be treated as deferred revenue expenditure

1 A composite textile unit manufacturing fine/super-fine blended cloth was manufacturing 100% cotton cloth till 1978-79. During the year 1978-79, the company devised a renovation/automation/modernization programme of its spinning, weaving and processing departments in phased manner. It also devised new production patterns and rationalisation of old patterns. As a part of the automation scheme, the company installed 24 shuttle less fully automatic looms in the year 1982-83 and 1983-84 and stopped working of 96 ordinary and semiautomatic looms so as to manufacture high quality blended cloth. Consequently, the company is in a position to reduce its workers strength by 175 without affecting production schedules.

2.  For terminating services of 175 workers, the company entered into an agreement with the concerned labour union according to which it agreed to pay all benefits to the workers which are legally available to them in the form of “Terminal Benefits”. The total amount to be distributed among the workers works out to Rs. 53 lacs against which the company would be in a position to reduce its salaries/ wages bill by Rs. 1.05 lacs every month. Considering the present average wage level for textile workers in the city in which the mill is located, the payback period to the company for terminal benefit payments works out to 5 years.

3. The company has adopted cash system of accounting for the normal payment of gratuity. Accordingly, it is debiting the gratuity payment to profit and loss account in the year of its payment.

4. On the basis of the above facts and figures, the querist has sought the opinion of the Expert Advisory Committee in respect of the following:

(i)         Whether ‘Terminal Benefits’ payment to workers on their termination of services from the company can be considered as deferred revenue expenditure since the company would be receiving fruits of this payment over a period of years in the form of savings in salaries/wages bill?

(ii)        Considering ‘Terminal Benefits’ payment as deferred revenue expenditure, whether it can be spread over a period of 5 years including the year of payment?

(iii)       What will be the treatment of ‘Terminal Benefits’ payment in the computation of taxable income of the company?    

                                                  Opinion                                                                  January 10, 1986

1.The Committee notes that the Institute of Chartered Accountants of India, in its Guidance Note on Terms Used in Financial Statements, 1has defined the term ‘Deferred Revenue Expenditure’ as the “Expenditure for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods”.

2.The Committee also notes that the ‘Statement on Auditing Practices’ (1983) issued by the Research Committee of the Institute of Chartered Accountants of India, has stated in para 10.1 at page 52 that “If a future period will receive benefit from the outlay, the proper portion of the deferred charge should appear on the balance sheet. Unless some value can be determined as flowing into the future, there is no justification for not writing-off the item immediately”.

3.In offering its opinion on the query, the Committee presumes that the amounts involved in the payment of various types of termination benefits are material.

4. The Committee is of the view that the termination benefits which had to be paid irrespective of automation of plant (e.g., gratuity) cannot be treated as deferred revenue expenditure since necessary provisions in respect of such payments should have been made in the accounts in accordance with the accepted principles of accounting. Thus, termination benefits to that extent should be expensed in the profit and loss account of the year in which they are paid with a separate disclosure therein as an extra-ordinary item “in a manner that their relative significance and effect on the current operating results of the period can be perceived.2” However, termination benefits which had to be paid as a direct consequence of automation (e.g., retrenchment benefits) can be treated as a deferred revenue expenditure since it is expected to benefit, in the form of savings in salaries and wages, the subsequent periods.

5.With regard to the period of write-off of deferred revenue expenditure, the Committee notes that the ‘Statement on Auditing Practices’ (1983), issued by the Research Committee of the Institute of Chartered Accountants of India, has recommended in para 10.6 at page 54 that where the expenditure is of deferred revenue nature, the basis of write off in subsequent years should be reasonable…..” The Committee also notes that para 10.1 of the said Statement states that “In some cases the time involved will be related directly to some other account, as in the case of debenture  discounts and debenture issue expenses. In other cases, it may be influenced by tax laws, e.g., preliminary expenses can be written off over 10 years for income tax purposes (Section 35D of the Income tax Act, 1961). In many instances, such as deferred advertising, plant rearrangement, research and development, cost etc., the period has to be arbitrarily decided by the management, and the auditor should satisfy himself that it is not unreasonable.”

6.The Committee notes that it is not possible to relate expenditure on termination benefits incurred on automation of plant with some other account as in the case of debenture discounts and debenture issue expenses. There is no specific provision in the tax laws regarding amortisation of the deferred revenue expenditure arising on account of payment of termination benefits on automation of plant. The Committee is therefore of the view that the period of write-off has to be decided by the management on reasonable basis such as the period expected to benefit from such expenditure, which may be computed on the pay-back period of such expenditure. However, the Committee is of the view that in view of the prudence concept of accounting, such an expenditure should be written-off as early as possible, say a period of 3 to 5 years.

7.On the basis of the above, the opinion of the Committee on the various issues raised by the querist is as follows:

(i)         Termination benefits arising as a direct consequence of automation, e.g., retrenchment benefits, the benefits of which flow into the future periods in the form of savings in salaries and wages can be treated as a deferred revenue expenditure. However, termination benefits which had to be paid irrespective of automation, e.g., gratuity, cannot be treated as a deferred revenue expenditure, but should be expensed in the year in which they are paid and disclosed in the profit loss account as an extraordinary item as suggested in para 4 above.

(ii)        Termination benefits treated as deferred revenue expenditure as per 7 (i) above can be spread over a period of 5 years. However, from the prudence point of view, it may be written-off in a period of less than five years.   

(iii)       Since there is no specific provision regarding the amortisation of the said expenditure, it is possible to claim it as a deduction from business income of the year in which it is incurred for the propose of computation of taxable income.

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1  Para 4.5, page 13.

2   Accounting Standard 5 on “Prior Period and Extraordinary items and changes in Accounting Polices” issued by th Institute of Chartered Accountants of India.