How Actuarial Valuation Enhances Gratuities: A Comprehensive Guide

Businesses of all types and sizes need to know the rules for actuarial valuation of gratuity. This is especially necessary for the most common benefit in India. They need to understand the regulatory framework for the gratuity scheme. Today, we will explore when actuarial valuation is needed for gratuity.

But before we get into that, let’s first understand which businesses must offer gratuity benefits to their employees. You can look at the aspect in the following ways:

• Applicability of Payment of Gratuity Act, 1972
• Applicability of Relevant accounting standards

What is Actuarial Valuation for Gratuity

Actuarial valuation for gratuity is a process used by companies to determine the amount of money they will need to pay their employees as gratuity in future. It is the sum of money that companies need to set aside for future payments. 

Gratuity is a sum of money paid by an employer to an employee in gratitude for the employee’s service upon retirement, resignation, or death. Companies are required by law in many countries to provide gratuity benefits to employees who have completed a certain number of years in service. 

Actuarial valuation helps companies calculate the present value of these future gratuity payments, taking into account factors such as the employees’ salaries, years of service, and expected future salary increases. This valuation is important for companies to ensure they have enough funds set aside to meet their gratuity obligations and to comply with legal requirements.

The Payment of Gratuity Act, 1972:

The Payment of Gratuity Act, 1972, gives employees a legal right to gratuity if they have worked for 5 years continuously in a company and leave their job due to retirement, resignation, death, or disability.

• This Act establishes a payment scheme for gratuity to employees in workplaces with 10 or more employees at any time in the previous year.
• It applies to all types of businesses, including proprietorships, partnerships, and limited companies.
• Once the Act applies to an organization (when it hires more than 10 employees), it continues to apply even if the number of employees falls below 10.

Applicability of Actuarial Valuation to Corporate Entities:

If your organization is required to run a statutory benefit scheme, you might need an actuarial valuation. According to Chapter IX of the Companies Act, 2013, every company must prepare its accounts following the relevant Accounting Standards. These accounting standards are issued by the Institute of Chartered Accountants of India (ICAI). One such standard, AS 15, requires actuarial valuation for certain employee benefit schemes, including gratuity.

Corporate entities are classified as either Small and Medium Sized Companies (SMCs) or Non-SMCs according to the Companies (Accounting Standards) Rules, 2006. SMCs have some exemptions and relaxations when it comes to complying with AS-15. You can check if you are considered an SMC by referring to the rules.

• SMCs: These are small to medium-sized corporate entities that have some exemptions and relaxations when it comes to complying with AS-15. You can check if you are considered an SMC by referring to the rules.
• Non-SMCs: These are corporate entities that do not fall under the SMC category and must comply with AS-15 for actuarial valuation of their employee benefit schemes, including gratuity.

Understanding whether your organization falls under the SMC or Non-SMC category is important for determining the applicability of actuarial valuation. SMCs have some exemptions and relaxations, while Non-SMCs must comply with AS-15 for actuarial valuation of employee benefit schemes.

Applicability of Actuarial Valuation to Non-Corporate Entities:

Appendix-II of the Accounting Standards addresses the applicability of these standards to non-corporate entities such as Limited Liability Partnerships (LLPs), Partnerships, Proprietorships, etc.

Non-corporate entities are classified into three categories by the Institute of Chartered Accountants of India (ICAI). For Level II and Level III Enterprises, there are some relaxations and exemptions in complying with AS-15, which deals with Employee Benefits.

Applicability of Ind AS 19 to Companies:

Mandatory Adoption:

Since April 1, 2017, Ind AS 19 is compulsory for the following companies:

• All listed companies.
• Unlisted companies with a net worth of Rs. 250 crore or more.
• Holding, subsidiary, joint venture, or associate companies of the listed and unlisted companies mentioned above.

Voluntary Adoption:

Other companies can choose to adopt Ind AS for financial statements since April 1, 2015.

Important Points to Note:

• Once a company starts using Ind AS 19, it must continue to do so for all future financial statements, even if it no longer meets the criteria.
• Once a company adopts Ind AS 19, it doesn’t need to prepare another set of reports under AS 15.

Reasons for Actuarial Valuation in Accounting Standards:

AS 15 and Ind AS 19 require actuarial valuations because they help organizations in the following way:

1. Recognize the liability when an employee has worked for benefits that will be paid later.
2. Recognize the expense when the company uses the economic benefit from an employee’s work for future benefits.

Frequency of Actuarial Valuation for Gratuity Scheme:

1. Year-End Financial Reporting:

Actuarial valuations are needed at the end of each accounting period to prepare financial statements. This applies to all enterprises if AS 15 or Ind AS 19 is applicable, either fully or partially.

2. Interim Financial Reporting:

• Applicability: Enterprises required to present interim financial results per AS 25: Interim Financial Reporting.
• Provisions: Gratuity (and other defined benefit schemes) for interim periods are calculated year-to-date. They use actuarially determined rates from the prior financial year, adjusted for significant market changes and one-time events.
• Mandatory Valuation: Actuarial valuation isn’t mandatory for interim reports. However, Ind AS 19 requires determining the net defined benefit liability or asset regularly to avoid material differences from end-of-period amounts.
• Frequency: Unless expected actuarial gains and losses are immaterial since the last valuation, a valuation should be done. In volatile economies, valuations at each interim balance sheet date may be necessary.

Conclusion

Key Points for Gratuity and Actuarial Valuation:

Payment of Gratuity Act:

Applies if your company has more than 10 employees.

Ind AS 19:

Requires actuarial valuation for both interim and final financial reporting if applicable to your company.

AS 15:

Assess if your entity qualifies for any exemptions or relaxations as a Level II or Level III entity or as a Small and Medium-Sized Company (SMC), and utilize them if eligible.