Accounting of Gratuity LiabilityFor a long time no provision was made for gratuity liability and gratuity payments were accounted on cash basis as and when incurred. Auditors merely noted that gratuity is accounted on cash basis and not on accrual basis.Even in tax laws there, was no special provision for allowance of contributions paid to the Gratuity Fund as an expense.

It was only in 1995 that old AS 15 was issued in terms of which it became obligatory to provide for gratuity liability on actuarial basis.Now Revised Accounting Standard AS (15) is prescribed by the Institute of Chartered Accountants of India which was mandatory from 1-4-2006 but date of implementation was relaxed and now it is mandatory with effect from accounting periods commencing on or after 7th December 2006.Before we deal with provisions of the new standard, let us clearly understand difference between Provisioning & Funding

Accounting provision is only an entry in the books of accounts and gratuity when paid is allowed as an expense before arriving at Profit or Loss for the year.Accounting provision is not allowed as deductible expenditure in computation of tax liability.However if you set up an Approved Gratuity Fund recognized under Part of the Fourth Schedule to the Income Tax Act, 1961, the contribution to the Trust Fund is allowed as deductible expenditure in terms of Section 36 (I) (v) of the Income Tax Act, 1961.

ContinuedTax Treatment follows EET patternContribution exemptEInterest Income tax-freeE(build-up of the Fund)Gratuity Benefit in excess of months salary for each year of service or 15 months salary (which is lower) subject to maximum of Rs. 3,50,000/- is taxable.TFunding is not compulsoryPartial Funding is allowed.

You can fund part of the liability and for the balance portion you may make only accounting provision.You may not Fund the liability and keep the Entire liability is unfundedMany employers are under the impression that if gratuity is funded with LIC or any other insurers, there is no need for actuarial valuation.This is not correct. The Accounting Standards Board of Institute of Chartered Accountants of India has clarified as under:Q 12:In case of defined benefit schemes covered under a Group Gratuity or other defined benefit scheme with an insurance company, where the actuarial risk and investment risk have not been transferred from the enterprise, where an enterprise can rely upon actuarial valuation certificate provided by the insurance company or a separate certificate from a qualified actuary is required to be obtained for determination of actuarial liability

In the case of defined benefit schemes covered under Group Gratuity or other defined benefit scheme with an insurance company where the actuarial risk and investment risk have not been transferred from the enterprise, the actuarial valuation certificate provided by the insurance company can be relied upon by the enterprise. However, the enterprise should ensure that such actuarial valuation has been carried out by a qualified actuary in accordance with AS 15 (revised 2005), the underlying data is accurate, the assumptions are appropriate and the information required for compliance with the disclosure requirements of the Standard have been provided by the insurance company. A separate certificate from another qualified actuary is not necessary.

Let us look at alternative scenarios when the company has to adopt Revised Accounting Standard AS (15).Scenario I: Company was not making any provision towards Gratuity Liability

Scenario II: Company was making provision according to old standard AS (15) of 1995

Scenario III: company was having a Group Gratuity Policy of LIC but the Fund accumulated with LIC was not adequate compared to amount of actuarial provision required by Revised Accounting Standard AS (15).

Scenario IThe liability arising on implementation of Revised AS (15) is clearly prior period item which should be debited to Profit & Loss AccountScenario IIUnder old Accounting Standard Actuarial Method was prescribed and as such incremental liability arising on account of switch-over from old standard to new standard will be adjusted against Revenue Reserves / Surplus as provided in the Accounting Standard.

However many employers do not include employees for computation of liability if they have not completed five years of service. This interpretation was always wrong since gratuity liability is incurred for every year of service and not merely on vesting of liability after five years. Any incremental liability arising on account of inclusion of such employees will be treated as prior year charge and debited to Profit & Loss Account.

Scenario IIILIC calculates contribution payable on actuarial basis but does not follow Projected Unit Credit Method as laid down by Revised AS (15); in fact it follows Aggregate Method which results in lower contribution and lower level of funding. On adoption of Revised AS (15) incremental liability will have to be adjusted against Revenue Reserves / Surplus since old AS (15) did not lay down Projected Unit Credit Method.