Introduction

A gratuity is a fundamental employee benefit that the organisation who work in India have to provide to their employees or workforce. The gratuity scheme is governed by the Payment of Gratuity Act, 1972. It is basically a reward given by companies to its employees as an honour for their long-term association with the organization. Managing gratuity obligations is not just about compliance it also ensures that we have sufficient assets when these liabilities are to be paid. An Actuarial Valuation plays a critical role in managing assets with liabilities to achieve a balance. In this blog, we shall learn about the concept of Actuarial Valuation of Gratuity schemes and its benefits.

Let's dive deeper into this topic under two main headings.

1. Applicability of Payment of Gratuity Act, 1972
2. Applicability of relevant accounting standards

1.The Payment of Gratuity Act, 1972

The Gratuity Act 1972 regulates gratuity benefits for employees in India. An overview of enforcement is as follows:

Protected entities

• Establishments employing 10 or more people: This Act applies to all establishments with a limited number of workers.
• Employee Qualifications: An employee working for more than 5 years is eligible. Except in the case of death or disability.

Gratuity calculation

The amount of the gratuity is calculated as follows:

Gratuity = Last Month Salary (Basic + DA) * Years of Service * 15 /26

The Act makes it an obligation for employers to give gratuities. However, the actuarial valuation is not expressly specified. However, accounting standards require the agency to perform an actuarial valuation in order to accurately estimate this liability.

2a. Applicability of Actuarial Valuation to Corporate Entities

For organizations, accounting standards such as IND AS 19, AS 15 (Revised) and IFRS require actuarial valuation of gratuity schemes. The main causes include:

1. Compliance: Accurate estimation of pension liability is essential for financial journalists.
2. Stakeholder Assurance: Transparent financial disclosure increases stakeholder confidence.
3. Financial planning: Understanding future debt supports cash flow planning and management.

2b. Applicability of Actuarial Valuation to Non-Corporate Entities

Organizations which are not corporate are not entitled to accounting standards. However, they may conduct valuation in cases such as:

• Look for investments or loans that require detailed financial disclosures.
• Voluntarily adopt corporate guidelines to ensure better financial governance.
• Gain clarity on long-term responsibilities or operational planning.

2c. Applicability of IND AS 19 to Companies

Here's a deeper integration of how it applies to companies:

1. Applicability Criteria

IAS 19 applies to companies following International Financial Reporting Standards (IFRS), including:

• Listed Companies: Listed entities (whose shares can be bought and sold by the general public) to prepare financial disclosures in accordance with IFRS.
• Large corporations and multinationals: These companies often use IFRS voluntarily to ensure consistency across jurisdictions.
• Companies in countries that have adopted IFRS: In countries where IFRS is applicable, IAS 19 will automatically apply to covered entities in scope.

For companies in India, IND AS 19 applies to:

• Companies listed on recognized stock exchanges in India
• Companies that meets the threshold described by the Ministry of Corporate Affairs (MCA).
• Parent and subsidiary companies that use IND AS for aggregated disclosures.

Why Do These Accounting Standards Need Actuarial Valuation?

Accounting standards require actuarial valuations for gratuity schemes to:

• Ensure Accurate Liabilities: Actuarial assumptions consider factors like employee turnover, mortality, and salary escalation, ensuring precise liability estimation.
• Facilitate Audit and Compliance: Financial disclosures in line with standards like IND AS 19 or AS 15 foster transparency and audit readiness.
• Manage Financial Risk: Insight into liabilities allows organizations to allocate resources effectively, mitigating financial risks.

How frequently do we need Actuarial Valuation of Gratuity Scheme?

It depends on:

• Regulatory Requirements
• Financial Reporting Requirements
• Organizational practices.

For companies that follow accounting standards such as IND AS 19 or IAS 19, an actuarial valuation is usually needed in the following situations:

1. Financial Reporting at the year-end
   • Annual financial performance:

   Companies should conduct an actuarial valuation at the end of each financial year to accurately recognize their gratuity responsibilities in the annual financial statements.

   • Objective:

   To meet the accounting standards as per IND AS 19 or AS 15 (revised) Make satisfactory financial statements for shareholders, investors, and regulators.

2. Interim financial report
   • Quarterly or semi-annual Financial Statement:

   Companies that prepare interim financial statements (as determined by regulatory agencies or stakeholders) may require updated actuarial valuations.

   • Objective:

   Reflects significant changes in gratuity liabilities due to demographic changes, market conditions, or assumptions such as discount rates. It helps ensure compliance with standards such as IND AS 34 (Intermediate financial reporting), which requires consistent and up-to-date reporting practices.

Why are actuaries required for Actuarial valuation of gratuity schemes?

There is involvement of technical expertise in calculation of gratuity schemes in which actuaries can help by applying statistical models to predict these types of uncertainties more accurately.

Accounting standards such as IND AS 19, AS 15 compliances must be duly met which requires Actuaries to conduct these valuations.

Actuaries help in setting assumptions for discount rates, salary escalation rates etc. which is an essential part of the fund calculation for a gratuity scheme.

Conclusion

Actuarial Valuation is not only about compliance requirements; it is an essential tool for financial planning as well as risk management. By giving more focus on a well-defined approach the organisation can manage their gratuity obligations effectively while making sure legal compliances are fulfilled.

Frequently Asked Questions