Gratuity

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Gratuity is a lump sum payment given by the employer on resignation or retirement or death. It is a mark of recognition to the employee's service.

In India, as per the Payment of Gratuity Act, 1972, it is mandatory for all companies with employee strength of 10 or more employees to pay Gratuity. The provisions of the Act state that every employee who has completed 5 years of service with an organization is eligible to get the gratuity as per the pre-defined formula as given in the Act. The benefit is non-taxable up-to a ceiling of INR 10 lakhs.

Accounting standard classifies this benefit as a Post Employment Benefit and requires an Actuary to value these benefits for measurement, recognition and disclosures in the Financial Statements

Leave valuation

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During the course of an employment, an employee accrues leave. These leaves are to be exercised in accordance with the prevalent rules and company policy. There are different kinds of leave generally granted by the companies. Some examples are Casual leave, Earned/Privilege leave, Maternity leave, Sick leave and others.

If the leaves can be carried forward to the future years either for the purposes of utilization or for encashment, then the accounting standard categorizes such leaves as "Other Long term benefits". An entity is required to make provision in the books of accounts from a Actuary in respect of these benefits to comply with accounting standards and good corporate governance practices.

Pension valuation

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Most of the government organizations provide pensions to their employees are retirement. Since pension benefits are not mandatory for private companies, only few employers in private sector provide pension to their employees.

Pension is typically given to employees to ensure a stable livelihood post retirement. An actuary is required to value the pension liability for the company based on the pension rules. The measurement, recognition and disclosures in the Financial Statements will be on similar lines to Gratuity/ End of Service Benefit.

Provident Fund valuations

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Provident Fund is a defined contribution scheme where the employer and employee contribute a fixed sum to Employees Provident Fund Organization.

If the provident funds have an exempt status, then the responsibility of provision of benefits rests in the hands of the employer. Employer needs to ensure that fund earns at least equivalent to EPFO rate or better.

An Actuary is required to certify the sufficiency of the funds and provision be made in the books of the employer for any shortfall in the funds.

ESOPs & Retention Bonus Schemes

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In India, many companies have given ESOPs to their employees. ESOPs help ensure alignment of goals of the management and shareholders. We help companies design ESOP and other loyalty bonus schemes and value them for accounting and other purposes.

Design, Re-Design & Drafting of Employee Benefit Schemes

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Employee benefits schemes should be stitched with a lot of care and diligence as they help defining employer-employee relations and have regulatory implications.

Owing to our core expertise in this domain, we provide clients with a 360 degree view of all stakeholders of scheme advantages and disadvantages and budget their current and future costs.

Other related services

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Pricing & Product development

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Reserving & Statutory valuations

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Bonus estimation for 'participating' portfolio

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Experience Analysis

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Investments

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Others

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Pricing & Product development

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Reserving & Statutory valuations

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Experience Analysis

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Investments

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Others

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Frequently Asked Questions

1. What is actuarial valuation and why is it needed?

An actuarial valuation is a type of appraisal which requires making economic and demographic assumptions in order to estimate future liabilities. The assumptions are typically based on a mix of statistical studies and experienced judgment. Since assumptions are often derived from long-term data, unusual short-term conditions or unanticipated trends can occasionally cause problems. Actuarial valuations in India are mostly done for accounting purposes - under AS 15 (revised, 2005), IAS 19 or US GAAP (FAS 87/88/158), as they are mandatory requirements issued by the relevant accounting body. However, actuarial valuations are also done for calculating contribution rate for funded schemes and during mergers & acquisitions.

2. What are employee benefits?

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

3. What are the financial and demographic assumptions?

Given the long term nature of many of the employee benefits, assumptions are required to place a value of the liabilities. No-one can know the future with certainty and hence assumptions are required. Actuarial assumptions fall into two areas; financial and demographic. Financial assumptions will impact the amount of the future expected benefit. Demographic assumptions influence the timing and probability of the benefit amount being paid. One point not to be forgotten is that the ultimate cost of the benefits will only be known when the benefits have been paid and actual experience is known. Assumptions influence the value of the estimated liability at a point in time but do not determine the ultimate cost of the benefit. The financial assumptions are Discount Rate, Salary Growth for salary related benefits, Expected rate of return on plan assets, if a scheme is funded and Medical cost trends for medical plans. The demographic assumptions are Mortality before retirement and after retirement and Attrition Examples of other assumptions that can be made if appropriate are; rates of disability, proportion married for valuing spouse’s benefits, spouse age difference, leave availment rates, retirement age (where early or late retirement is an option).

4. What is Post Employment Term (PET) and how it is calculated?

The Post Employment Term, also known as the term of the obligation, is calculated using the following formula: ∑(Expected future Service duration x actuarial value of liability) ∑ Actuarial value of Liability The expected future service duration is the future service duration of the employees adjusted for the assumed level of attrition and mortality. Since, the calculation of liability takes into account the withdrawal from service and mortality; it will be less the average future service of the employees. The Rate of Interest/Discount Rate used in the valuation is dependent on the Term of the Liability.

5. What are Leave Plan Provisions?

For the actuarial valuation of Leave Benefit Scheme, the following parameters are required: Maximum accumulation: This should be the maximum number of leave days that the employers permit their employees to accumulate; beyond which the leaves are lapsed. Annual Accretion: This is the number of leave days that are credited to the employees either on 1st January or 1st April of every year. Or in some cases, employer’s permit continuous accrual like 1 day’s leave for 11 days service. Leave denominator: It is the number of working days in a month of the company. Leave Benefit is calculated by multiplying employee’s per day salary with the leave balance as at the valuation date. As we consider the monthly salary for valuation, we need the leave denominator for calculating per day salary of the employees.

6. Why CTC is required in actuarial valuation of Leave Benefit Scheme?

The Utilization component in the actuarial valuation of Leave Benefit Scheme is valued on ‘Cost to the Company’ (CTC) of the employees.

7. Applicability of AS-15 compliant valuations?

AS 15 (revised, 2005) is applicable on the following firms: Listed companies on any stock exchange in India Banks/FIs/Insurance companies Companies having turnover of more than 50 crores Companies having borrowings or deposits of more than 10 crores Companies employing more than 50 employees Holding or subsidiary company of any of the above

8. Is funding the liability compulsory?

Gratuity payment is responsibility of employer. Nowhere in act, it is mentioned that employer need to take any sort of insurance policy for gratuity payment. Hence it is up to employer whether they want to take insurance policy to cover its gratuity liability.

9. In case of gratuity, is the provision required from the start of service or after five years?

Yes the provision needs to be made from the start of the service whereas an employee becomes eligible to receive the gratuity benefit only after completing the vesting period of the company.

10. How much gratuity amount is exempted from income tax?

Upto Rs 10 Lacs

11. Can an employee claim Gratuity even before completion of 5 years?

Yes, an employee can claim gratuity even before completion of 5 years in followings cases: > Death (to his nominees) > Disablement

12. Can a company refuse to pay gratuity due to financial Loss to employees?

No, even if company is not doing financial well, company is bound to pay gratuity amount.

13. How to treat number of months for the purpose of gratuity calculation after completion of 5 years?

For example, if an employee has worked for 5 years and 7 months then for the purpose of gratuity payment, 7 months will be rounded off to an year and he will get gratuity for 6 years but in case employee has worked for 5 years and 5 months then he will be eligible for 5 years gratuity payment only.

14. Are contributions to gratuity fund tax exempt?

The contributions made to the gratuity fund are tax-exempt only if they are approved by the Income Tax Act, 1961 upto a limit of 8.33% of the annual salary. In case of a new set up fund, all past contributions are tax-exempt.

15. Are contributions to leave encashment fund tax exempt?

As to our knowledge, contributions to the leave encashment fund are not tax-exempt.

16. What are Gratuity Plan Provisions?

For the actuarial valuation of Gratuity Benefit Scheme, the following parameters are required: a) Salary definition – Basic Salary including Dearness Allowance (if any) b) Benefit formula – 15/26 * (Salary) * (Duration of Service) c) Maximum Limit – INR 10,00,000/- d) Vesting – mostly 5 years of service (not applied in case of death/disability)

17. What are the reasons for actuarial gain or loss?

Actuarial gains and losses may result from increases or decreases in either the present value of the defined benefit obligation or the fair value of any related plan assets. Causes of actuarial gains and losses include, e.g.: a) Unexpectedly high or low rates of employee turnover, early retirement or mortality or of increases in salaries, benefits (if the terms of a plan provide for inflationary benefit increases) or medical costs; b) The effect of changes in estimates of future employee turnover, early retirement or mortality or of increases in salaries, benefits (if the terms of a plan provide for inflationary benefit increases) or medical costs; c) The effect of changes in the discount rate; and d) Differences between the actual return on plan assets and the expected return on plan assets.

18. What is the source of discount rate (i.e. from where do we take the discount rates)?

Discount rate depends on PET. Kindly refer to FAQ 4.

19. Is Leave valuation compulsory? Is sick leave compulsory?

Only if the leave balances are accumulated and carried forward depending on the company rules.

20. When does an employee become eligible for gratuity after completing 5 yrs or 4.5 yrs?

An employee becomes eligible for Gratuity Benefit only after completing continuous service of 4 years and 240 days in the company.

21. How Availment ratio is calculated?

Availment ratio is calculated using LIFO method. It is the ratio of excess leave balances availed from opening balance after deducting the leaves availed from current accrual and the sum of opening leave balance.

22. Criteria for Gratuity benefits

Depends on company rules or POGA whichever is applicable to the employees of the company.

23. What is current & noncurrent Liability?

Current Liability is a company's debts or obligations that are due within one year. A business's long-term financial obligations that are not due within the present accounting year are classified as Non-current Liability.

24. How should the Salary growth rate assumption determined?

This is Management’s estimate of the increases in the salaries of the employees over the long term. Estimated future salary increases should take account of inflation, seniority, promotion and other relevant factors such as supply and demand in the employment market.

25. Impact of Discount rate, salary growth rate on obligation.

In simple terms, discount rate and the defined benefit obligation are inversely related i.e. when the discount rate goes up the DBO decreases and vice versa. Whereas the salary growth rate and DBO are directly related i.e. when the salary growth rate goes up, DBO increases and vice versa.