Treatment of leave schemes under AS 15 and Ind AS 19 is widely misunderstood. Companies end up spending resources on actuarial valuation of leave schemes that may not require any, while fail to identify schemes that may require one.
Companies run several types of leave benefit schemes for their employees. Privilege leaves (also known as earned or annual leaves), sick leaves, casual leaves, maternity leaves, jubilee leave awards etc. may all be available to the employees.
Indian accounting standards, AS 15 and Ind AS 19, both require that a liability should be recognised in the reporting companies’ balance sheets in respect of these leave schemes.
What is the current market practice regarding actuarial valuation of leave schemes?
Unlike gratuity, companies have a high degree of flexibility in designing the terms and rules of their leave benefit schemes. For example, companies can choose:
- how many leaves need to be awarded each year (subject to any regulatory minimum),
- whether these leaves can be carried forward and for how long,
- whether unused leaves can be encashed, and
- whether they can be encashed while in service or only on exit.
Each of these rules have an implication on how the scheme should be treated under AS 15 or Ind AS 19. Therefore, actuarial valuation of leave schemes is a bespoke assignment – each scheme should be carefully studied to ascertain the most appropriate treatment.
Generally, companies get an actuarial valuation done for their primary leave scheme (privilege leaves). Some companies also require actuarial valuation of other schemes, such as sick leaves. Other types of leave schemes do not get much attention from an accounting perspective.
For the leave schemes that do undergo an actuarial valuation, actuaries use a variety of methods for valuation and accounting, depending on their judgement. The methods they use differ in the way the leaves are classified, valued and disclosed.
For more details about actuarial valuation of employee benefits, including leave plans, please refer to the main topic page here.
How to properly account for leave schemes?
The topic of accounting of leave schemes is a complex one. The top four issues to be aware of are listed below:
1. Actuarial valuation is not needed for all leave schemes
There are two types of leave schemes that may require an actuarial valuation:
- Type 1 schemes, where employees have accrued certain leaves during the service rendered till date and unused leaves can be carried forward to future years.
- Type 2 schemes, where employees are entitled to receive a block of leaves upon completing a pre-specified period of service; e.g. jubilee or long-service awards in the form of leaves.
This means that any leaves that cannot be carried forward, such as most types of sick leaves or non-accumulating privilege leaves, do not require an actuarial valuation.
2. Creating a liability for ‘availment’ of leaves is generally not needed
The recommended approach to value leave schemes is LIFO (last-in-first-out). If this method is used, then no liability exists for regular availment of leaves by employees, as the availment is assumed to be first taken from their future leave entitlements.
There is another method currently in use which allows for the possibility that some employees will exceed their annual leave entitlement and therefore they argue that availment should be valued. This logic is not correct because even though some employees will exceed their annual entitlement, all others will not exceed and therefore will see an increase in their leave balances at the next balance sheet date. Therefore, though it can be accepted that over the next 12 months some of the employees’ existing leaves will be utilised over and above their entitlement, this cannot be said for all the future years.
Companies using this method are over-estimating their obligations for unjustified reasons.
We have recently communicated our stand to Institute of Actuaries of India and Institute of Chartered Accountants of India. The Institute of Actuaries of India has published our paper on this topic in the April/May issue of the Actuary India magazine, which can be accessed here.
3. Ask for a reconciliation of opening and closing DBO
Many actuaries classify leave benefits as ‘Other Long-Term Benefit’ (OLTB) and rightly so. For benefits classified as OLTB, the accounting standards do not prescribe any specific disclosures, other than the DBO itself.
Though the actuarial reports for post-employment benefits such as gratuity, contain detailed disclosures, including a reconciliation of opening and closing DBO, the actuarial reports for leave schemes may not contain any information on the reasons for a change in DBO. The problem is exacerbated when companies switch to a different actuary, who may take a completely different view of their leave schemes.
To get a better understanding of what caused the DBO to change, companies should ask their actuaries to provide a reconciliation between opening and closing DBO.
4. Don’t forget your other leave schemes
There are certain leave benefits for which liability should be assessed, but an actuarial valuation may not be needed. These include:
- Non-accumulating privilege leaves, sick leaves, casual leaves etc, which are still outstanding as at the balance sheet date
- Maternity leaves currently being availed
For these schemes, a liability exists as at the balance sheet date for any leaves that are expected to be taken during the next 12 months.
Based on our experience, type 2 leaves (e.g. jubilee leave awards) also miss the attention of employers and auditors from an accounting perspective.
Download our full guide on how to properly account for leave benefit schemes (compensated absences) as per AS 15 and Ind AS 19. Click on the picture below!