Retirement liabilities- Instead of providing in profit and loss account, companies can create separate reserve

The country’s apex body on accounting standard has cleared way for a change in the way Indian companies account for their employee’s post-retirement benefits like gratuity. Instead of providing for these in profit and loss account, companies can create a separate reserve.

As against the proposed norm in India under the international financial reporting standards (IFRS) requiring companies to show the financial effect of employee benefit schemes in a company’s profit and loss account, the government will now allow firms not to show the effect directly in their books of accounts but reflect them separately in a reserve account, said an official in the government.

The change follows demands from the industry which said that taking the burden of actuarial valuations of long-term employee benefit schemes could take a toll on their bottom line.

“The change will enable corporate India to smoothen the charge for retirement benefits over the service period, and importantly protect the profit and loss from external fluctuations (such as discount rates), which are outside the control of individual companies,” said Jamil Khatri, executive director , KPMG .

The change, which was cleared by the National Advisory Committee on Accounting Standards – an expert body under the ministry of corporate affairs, will require companies to show the entire amount of actuarial gains or losses immediately under a separate head, rather than taking them to the P&L account.

Actuarial gains and losses are used when accounting for pension plans because of the need to make assumptions about the future rate of salary increases, the length of employee tenure, an appropriate discount rate for the plan obligations and the expected rate of return on plan assets.

Unexpected rates of employee turnover, early retirement, and increase in salaries, or medical costs count among reasons that can lead to market volatility in accounting for retirement-related benefits.

The change in accounting treatment will augur well to Indian companies having a strong presence abroad. “The impact of this change will be significant for Indian companies with overseas subsidiaries where such subsidiaries have significant post-retirement benefit plans and also have significant investment of plan assets in market price sensitive instruments (for example, equity shares),” said Mr Khatri.

The proposed new accounting treatment could, however, increase the tax burden of companies. Says Dolphy D’souza, IFRS leader , Ernst & Young: “if income tax were to be based on IFRS numbers, then minimum alternate tax (MAT) liability would be higher as the actuarial losses are debited to reserves rather than income statement.”

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