Applicability of Actuarial Valuation for those companies where Post-Employment Benefits are not in practice

Enquiry:
ICAP Technical Committee’s opinion is requested in respect of below-mentioned scenario: –

AUDITORS’ VERSION

As per Auditors’ report of June 30, 2004 a qualification has been made on our accounts. The exact wording is reproduced below: -Provision for gratuity and leave encashment incorporated in the accounts on the basis of last drawn gross salary is subject to verification through actuarial valuation as required by International Accounting Standard “19”

MANAGEMENT’S VERSION

We have the following employees’ retirement benefits plans: –

1.       Gratuity

The Company has established an approved gratuity fund under defined contribution plan covering all its employees who have completed the minimum qualifying period of six months of the service. The fund operates under a trust administered by the Board of Trustees. The amount of gratuity admissible, shall be a sum equal to last salary drawn immediately preceding the date of his service of the Company, for each completed year of service in the Company.

2.       Leave Encashment

The Company provides a facility to its employees for accumulating their annual earned leave Unutilized earned leave can be used at any time subject to the Company’s approval. Up to 100 days of accumulated leave can be encased on retirement.

The Company management has a different point of view and is of the opinion that:

(i)      Company has defined contribution plan where no actuarial assumptions are involved as per IAS-19

(ii)     Company is not having a policy to pay any sort of Post Employment Benefits i.e.

• Pensions
• Medical Care to employee and their dependents after retirement; and
• Death benefits to the dependents of former employees

Actuarial valuation is required only for Post employment benefits and actuarial assumptions are needed to estimate the size of the future (post-employment) benefits that will be payable under a defined benefits scheme. The main categories of actuarial assumptions are not applicable on our retirement benefits plans, these assumptions are reproduced below for ready reference: –

(a)     Demographic assumptions are about mortality rates before and   after retirement, the rate of employee turnover, early    retirement, claim rates under medical rates.

(b)  Financial assumptions are the discount rate to apply, the expected return on plan assets, future salary levels (allowing for   seniority and promotion as well as inflation) and the future rate of increase in medical costs.

We are readjusting provision of retirement benefits at each balance sheet date as per our accounting policy of “Provisions” which is reproduced here: –

“Provisions are recognized when the Company has a legal or constructive obligation as a result of a past event, and it is probable that outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of obligation. However, provisions are reviewed at each balance sheet date and adjusted to reflect current best estimate.

For your reference we are also enclosing Printed Accounts for the year ended June 30, 2004. Please guide us in this respect whether actuarial valuation is required in our case or not? An early response shall be highly appreciated.

Opinion:

First of all the Committee would like to inform you that IAS 19 ‘Employee Benefits’ is applicable to all employee benefits, be short-term or long-term. For this your attention is drawn towards the following paragraphs of IAS 19:

1        This Standard should be applied by an employer in accounting for employee benefits.

7        Employee benefits are all forms of consideration given by an enterprise in exchange for service rendered by employees.

The Committee would also like to point out that your policy with regard to the gratuity fund does not appear to be very much clear. On the one hand it has been stated that:

“The amount of gratuity admissible, shall be a sum equal to last salary drawn immediately preceding the date of his service of the Company, for each completed year of service in the Company” which gives an impression that gratuity scheme is a defined benefit plan as the Company is liable to pay gratuity on the basis mentioned above irrespective of the availability of funds in the Gratuity Trust Fund. But on the other hand it has been mentioned in your letter under reference that the fund is a defined contribution plan, which does not appear to be in consonance with the earlier statement.

Anyway before reaching any opinion the Committee would like to draw your attention towards the following paragraphs of IAS 19:

Post-employment benefit plans: are formal or informal arrangements under which an enterprise provides post-employment benefits for one or more employees.

Defined contribution plans; are post-employment benefit plans under which an enterprise pays fixed contributions into a separate enterprise (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods.

Defined benefit plans: are post-employment benefit plans other than defined contribution plans.

Further paragraphs 24 to 28 of IAS 19 clearly distinguish between defined contribution plan and defined benefit plan and in the light of them the Committee is of the opinion that if an organization is required to pay either legally or constructively the full amount of promised benefits whether or not sufficient assets are held in the fund or not, in other words if the enterprise is required to make up the deficit of the gratuity fund then that entity will be required to determine the present value of its fund obligations and the related current service cost and where applicable past service cost using the actuarial valuation method i.e. Projected Unit Credit Method.

However with regard to leave encashment the Committee is of the view that this appears to fall under ‘Other long-term employee benefits’ and this is also subject to actuarial valuation. For further details you may refer to paragraphs 126 to 131 of IAS 19.

(November 6, 2004)