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TMI BlogProvision for gratuity not shown in balance-sheet and extent of company’s liability on account of gratuity also not disclosedX X X X Extracts X X X X X X X X Extracts X X X X ..... mmended by the Institute of Chartered Accountants of India in paras 4.1 to 4.1-3 (para 2.2 of the Revised Statement) of "Statement on Treatment of Retirement Gratuity in Accounts" (Annex 1) issued by it, and if a suitable provision is not made in the accounts, or there is an under provision, the amount of gratuity liability so estimated or left unprovided, as the case may be, should be indicated by way of a note to the accounts. In case the company does not provide for the "gratuity liability" or does not state the quantum of "gratuity liability" by way of a note, the balance-sheet and profit and loss account cannot be regarded as disclosing a true and fair view of the state of affairs. It is hence the duty of the auditors to qualify their reports to this effect and specifically state that the requirements of Schedule VI have not been complied with properly. This has also been made clear in paras 8.7 and 8.8 (paras 9.12 and 9.13 of the new edition) of the "Statement on Auditing Practices" issued by the Institute of Chartered Accountants of India. ANNEX 1 STATEMENT ON THE TREATMENT OF RETIREMENT GRATUITY IN ACCOUNTS 1. Introduction 1.1 The Council of the Institute of Chartered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear to the trustees and charged to the revenue account. The rules relating to the recognition of a gratuity fund for income-tax purposes are given in Part C of the Fourth Schedule to the Income-tax Act, 1961. Often the trustees do not administer the fund themselves but arrive at an arrangement with the Life Insurance Corporation of India through a Group Gratuity Insurance Policy to administer the fund. 2.2 The need to provide for accruing gratuity liability is based on sound accounting considerations and exists regardless of whether in the computation of taxable profit, it is or is not allowed as a deduction. At the same time it is appreciated that when deciding whether or not to make provision for accruing gratuity liability, management may find that special circumstances exist which provide a valid justification for not making a provision. The Council is of the opinion that in all such cases, when provision for accruing gratuity is not made, or if made is inadequate, the matter should be referred to by way of a note in the accounts indicating the total accrued liability, appropriately calculated or the shortfall in the provision, as the case may be. 2.3 When an enterprise decid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t also becomes necessary to make assumptions regarding investment returns likely to be earned in future. Accordingly, determination of the cost of accruing gratuity benefits can, only be made on the basis of assumptions regarding the future course of a variety of events. As a consequence, it is not possible to ascertain with certainty, either the present value of accruing gratuity liability or the financial provisions required to meet such liability as it emerges. Techniques of making estimates of this nature are developed in actuarial science and the problems of estimating the liability in respect of accruing gratuity benefits and devising appropriate financial arrangements to meet such liability fall within the province of the actuary. As the actuarial estimates are based on forecasts regarding future course of events, it becomes necessary for the actuary to keep the changing experience in respect of such events under constant review and to re-examine the working of financial arrangements in the light of such review. Thus arises the need for periodical actuarial valuations. 3.2 Provisions for gratuity liability are sometimes based on estimates of gratuity liability made on the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in consultation with the actuary. Some of the factors which will determine the interval between the two actuarial investigations are: (a) the purpose of the investigation, i.e., whether to determine the rate of contributions to the Gratuity Fund, and to determine periodically the adequacy of the fund, or to make provisions in the annual accounts for accruing gratuity liability or to state in note to the balance-sheet the amount of total accrued gratuity liability not provided for in the accounts; (b) the method of costing valuation to be adopted by the actuary; (c) the employee strength, its age/service profile, rate of employee turnover and frequency of changes in dearness allowance amounts. (if the accruing liability from year to year is unlikely to fluctuate widely, it may be possible to carry out the actuarial investigations at less frequent intervals); (d) changes in gratuity benefit rules; (e) provisions in the gratuity trust fund rules regarding frequency of actuarial valuation. In the opinion of the Council, an actuarial valuation should be carried out at least once every three years except in situations where the consulting actuary advises valuations at more ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... service. Even after provisions are started, owing to special circumstances, it may be found that increase in the liability during a particular year is too large to be observed by the provisions normally expected in respect of that year. Such sudden large increases in liability may arise as a result of improvements of benefits under a gratuity scheme, sizeable increases in the level of salaries as a result of revision of scales of basic salary or dearness allowance as well as from the need for a change in actuarial assumptions. When such an event occurs, it may be permissible to spread the provisions to cover a part of such increase over a period of years provided that the amount charged in the profit and loss account of the year is not less than the amount properly chargeable to that year and the amount for which the provision is deferred does not exceed the increase in the liability pertaining to the past services of the employees. The tax implications of such a procedure, both regarding the allowance in the year in which the provision is deferred and in subsequent years will have to be carefully considered. During the period over which the total provisions are spread, the accumu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the above calculations, a question arises as to whether the liability under the Companies (Profits) Surtax Act, 1964, should also be taken into account in determining the likely reduction in the amount of tax to be deducted from the gross amount of gratuity. Two approaches are possible. On the one hand, as surtax now forms a more or less permanent feature of the tax assessment in the country, it may appear reasonable to take surtax into account in calculating the net-of-tax liability. On the other hand, as the calculation of surtax depends on a number of factors and there can be no easy way of ascertaining whether there would be a liability for surtax in the future year in which gratuity is paid, or the precise magnitude of the profits chargeable to surtax (the incidence and rate of surtax depending on the amount of the capital base), it can be argued that surtax should not be taken into account when calculating the net-of-tax rate. In the event of an enterprise adopting the first approach, namely, taking into account surtax, it is suggested that some estimate may be made of the likely surtax liability based on the average ratio which surtax bears to the total profit of the comp ..... X X X X Extracts X X X X X X X X Extracts X X X X
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