Gratuity is an employee benefit scheme, which is classified as a Defined Benefits Obligation (DBO) Plan. The term 'gratuity' comes from the word gratitude - in the context, it is meant as a thank you expressed by the company to its employees. Under a gratuity plan, an employee earns gratuity for every year of service rendered by him/her, and this benefit accrues for every further year during which the employee renders service to the company. When the employee leaves the company, this gratuity payment becomes due. The gratuity obligations of a company are valued according to actuarial valuation principles and presented in the gratuity report, which is required for the financial audit of the company. 


Accounting of Gratuity Report

Under Accounting Standards that are used in India, such as Ind AS 19 and As 15(R), gratuity has to be accounted as a liability when the employee has rendered service to the company, and is recognised as an expense when the company consumes benefit arising out of the services rendered by the employee. Since the obligation has to be accounted for future years, an actuarial valuation is required to estimate the gratuity obligations of the company. While performing the gratuity valuation, the actuary makes use of assumptions such as mortality rate, salary growth rate, expected future salary, attrition rate of the company etc. The valuation is performed using Projected Unit Credit (PUC) method, and under this method a unit of benefit is accrued to the employee for each additional year of service rendered by him. 

We will now look at the recognition of key figures in the gratuity valuation report, and how the amounts are accounted in the financial statements of the company. For reference, you can view the Model Ind AS 19 Gratuity Report.  

Profit And Loss Account Treatment

In the P&L Account, the following components are recognised by the company under two main heads - Service Costs and Net Interest Costs:

Head: Service Costs
Head: Interest Costs
Current Service Cost
Interest Cost on DBO
Past Service Cost
Interest on Plan Assets
Curtailment Cost
Interest due to effect of ceiling
Settlement Cost

Additionally any administrative expenses and taxes are charged to P&L Account, and the final DBO Cost included in the P&L. Figure 1 shows the amounts recognised in the Profit and Loss account. 

Figure 1: P&L Reporting of Gratuity Scheme

Balance Sheet

In the Balance Sheet, the net defined benefit liability (asset) shall be recognised. When an entity has a surplus in the DBO, it shall measure it at the lower of surplus in the DBO or the asset ceiling. 

Recognised in the Balance Sheet
Present Value of Obligations
(Less) Fair Value on Plan Assets
(Less): Unrecognised Past Service Costs
Amount Not Recognised as an Asset 

Figure 2 shows the amounts recognised in the Balance Sheet. 

Figure 2: Amounts recognised in Balance Sheet

Actuarial Gains / Losses

Another key component to be recognised is the actuarial gains or losses. These arise due to changes in assumptions, and based on the accounting standard, they are classified either into the P&L account or into a separate account known as OCI - Other Comprehensive Income. In Ind AS 19 reporting, the actuarial gains and loss are shown in OCI, whereas in AS 15(R) they are shown in the profit and loss account. Since these figures depend on the assumptions and can vary significantly, the recognition in OCI mitigates the volatility in the P&L account due to the actuarial gains and losses. Figure 3 shows the actuarial gains/losses recognised under IND AS 19 in the OCI. 

Figure 3: Actuarial Gains/Losses recognised in OCI under Ind AS 19

Related Articles:

Sample of Actuarial Valuation Gratuity Report under Ind AS 19 Accounting Standards 

Sample of Actuarial Valuation Gratuity Report under AS 15(R) Accounting Standards 

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