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Governance framework to set actuarial assumptions

Posted by Nasrat Kamal on 16-May-2017 09:15:00

Setting the right actuarial assumptions is central to the accuracy of any actuarial valuation. However, there is a general lack of understanding among the stakeholders about how the assumptions should be set.

No matter how much care is taken in doing an actuarial valuation, the results could still be useless if assumptions are not set correctly. For certain companies, choosing the wrong assumptions could mean that he liability in the books of accounts could be understated or overstated by as much as 50% or even more. From our own experience, accountants and auditors, irrespective of the size or reputation of their firms, have misconceptions about several key aspects.

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Topics: Actuarial valuation, AS 15, Ind AS 19, Actuarial assumptions

5 issues to consider for Gratuity scheme funding

Posted by Nasrat Kamal on 25-Apr-2017 10:10:00

Under the right circumstances, a decision to set aside funds to back a gratuity scheme could deliver significant benefits to the companies.

Gratuity is a statutory benefit - employers are required to pay a lumpsum benefit to their employees who have served for at least five years. The lumpsum is generally calculated as 15 days of eligible salary for each year of service.

Unlike certain other benefits like salaries, bonuses and life insurance, an employee receives gratuity only at the exit from the company and not while in service.

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Topics: Employee benefits, Actuarial valuation, Gratuity valuation, Funding

4 issues to understand about actuarial valuation of leave benefits

Posted by Nasrat Kamal on 04-Apr-2017 08:45:00

Treatment of leave schemes under AS 15 and Ind AS 19 is widely misunderstood. Companies end up spending resources on actuarial valuation on schemes that may not require any, while fail to identify schemes that may require one.

Background

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?

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.

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Topics: Actuarial valuation, AS 15, Ind AS 19, Compensation and benefits, Leave valuation, Compensated absences

4 ways in which Ind AS 102 can affect your company

Posted by Megha Agarwal on 27-Mar-2017 10:15:00

Ind AS 102 will bring much needed uniformity in valuation and accounting of share-based benefits. However, the cost for the affected companies is likely to increase significantly. 

 

What Ind AS 102 is all about?

Ind AS 102 prescribes financial reporting in respect of share-based benefits and is relevant for companies which remunerate their employees by share-based (or stock option) schemes, such as Employee Stock Options (ESOP), Share Appreciation Rights (SAR), Phantom Equity, Share Purchase Plans (SPP) etc. A brief introduction of these schemes is provided in the white paper at the end of this post.

How are share-based benefits accounted currently?

Currently, there is no accounting standard that deals specifically in the accounting of share-based benefit schemes. Guidance Note No 18 (GN 18) issued by the Institute of Chartered Accountants of India (ICAI) provides 'guidance' on how these schemes should be treated, but it does not have the force of an accounting standard. Consequently, many companies that run material stock option schemes do not make any disclosure or allowance in respect of these schemes.

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Topics: Compensation and benefits, Share-based schemes, SAR, Ind AS 102, GN 18, ESOP

Increase in gratuity limit and the impact on gratuity valuation

Posted by Nasrat Kamal on 13-Mar-2017 09:45:00

The Government of India is all set to increase the maximum limit of gratuity to ₹20 lakhs. Companies reporting under Ind AS 19 will be affected more than those reporting under AS 15.

But first, we need to be clear about what is actually going to change. A formal notification on the matter is yet to be released. However, the media reports suggest that the 'gratuity limit' on gratuity for private sector employees to ₹20 lakhs.


The increase in gratuity limit as reported by the media can have two possible interpretations:

1. The amount of maximum gratuity payable under the Payment of Gratuity (PG) Act, which is currently capped at ₹10 lakhs will increase to ₹20 lakhs. This would lead to an increase in the liability and P&L expense of the affected companies.

2. The second interpretation is that the amount of gratuity that can be taken 'tax-free' by employees, which is also capped at ₹10 lakhs, will increase to ₹20 lakhs. Many media reports are referring to this 'tax-free' limit, but this interpretation seems less likely. If we go by this interpretation, there will be no impact on the gratuity liability.

Rest of this post is based on the first interpretation.


Payment of Gratuity Act 1972

Currently, the Payment of Gratuity Act 1972 ('PG Act') prescribes that a lump sum gratuity be provided to any employee who resigns, dies or retires from the company after completing about five (5) years of continuous service. 

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Topics: Employee benefits, Actuarial valuation, Compensation and benefits, Gratuity valuation, Regulatory update

How to select discount rate for actuarial valuation

Posted by Megha Agarwal on 06-Mar-2017 11:00:00

There is more to selection of discount rate than simply looking up the interest rates on internet. Many companies don't realise the complexities involved and need to do more than they are doing currently.

Any actuarial valuation involves the use of a 'discount rate', which is used to calculate the present value of future benefits promised by an employee benefit scheme.


This post only covers the selection of discount rate. Details on other topics related to actuarial valuation of employee benefits can be found here.


Accounting standards, such as AS 15, Ind AS 19, IAS 19 and US GAAP have prescribed rules on how the discount rate should be selected.
 
The significance of discount rate in any actuarial valuation cannot be over-estimated. It has a significant direct impact on the liability. T his is one assumption that can be validated by looking at publicly available information and therefore undergoes the maximum scrutiny of the auditors and external analysts. 
 

whose responsibility is it?

Many companies have a perception that it is alright to leave the decision to set the discount rate to their actuaries. In the past, such an approach has led companies into severe problems. If an error or discrepancy in choosing the discount rate is revealed, companies cannot pass on the consequences to the actuary.
 
Discount rate, as with all other actuarial assumptions, remains the responsibility of the Board of the reporting enterprise. It is their responsibility to ensure that they have done enough to ensure the actuarial assumptions were set correctly with due attention to the work done by the actuary. Of course, this responsibility can be delegated by the Board to the managers in the company. In case of any issues, the Board and the delegated personnel will be held accountable. In most cases, the consequences on the actuary would be a disciplinary action by the Institute of Actuaries of India, which is unlikely to be of any significant benefit to the company.
 

WHAT IS PRESCRIBED UNDER the ACCOUNTING STANDARDS?

Most accounting standards prescribe that the discount rate should be set equal to the yield to maturity on Government bonds (Government securities, or GSecs) having term consistent with the term of liabilities, as at the date of valuation.

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Topics: Employee benefits, Actuarial valuation, AS 15, Ind AS 19, Discount rate, Actuarial assumptions

3 ways in which IND AS 19 is different from AS 15

Posted by Nasrat Kamal on 27-Feb-2017 06:48:57

Ind AS 19 should be a welcome news for most companies, as the P&L statement will become very stable and the actuarial losses will flow through the OCI.

For companies coming under the ambit of Indian Accounting Standards (Ind AS), the transition from the previous AS-framework is expected to be challenging and the impact could be significant.

From an employee benefits perspective, the reporting requirements will change from AS 15 to Ind AS 19.  Ind AS 102 will be applicable for share based benefits, but that is not covered in this post.

Ind AS 19 will bring about many changes in how employee benefits reporting is carried out. This post sets out three most important differences between AS 15 and Ind AS 19, and how companies will be affected by them. It is worth noting at this point that these changes only affect 'post-employment benefits' such as gratuity and pension, whereas 'other long-term benefits' (OLTB) will not be affected by Ind AS 19. Most leave benefit schemes fall within the OLTB category.

1. Introduction of Other Comprehensive Income or OCI

A part of what was P&L expense will be reported as OCI under Ind AS 19. Overall, the sum of P&L expense and OCI under Ind AS 19 will remain the same as P&L under AS 15.

The concept of OCI did not exist under AS 15. To consider the impact this will have on a reporting company, let's first understand how P&L expense is calculated under AS 15.

AS 15 P&L statement consists of several elements, such as current service cost, interest cost, expected return on assets and actuarial losses. Ind AS 19 separates these elements into P&L statement and OCI. Generally speaking, for unfunded schemes, actuarial losses will be reported under OCI, and all other elements would continue to be part of the P&L statement. For funded schemes, an additional amount could be attributed to OCI from P&L statement, as explained in the next section. Note that the actuarial gains and losses are referred to as 'remeasurements' under Ind AS 19.

Impact on reporting companies:

The introduction of OCI will make the P&L statement significantly more stable.

2. Introduction of Net INTEREST COST

Expected return on assets (ERA) and interest cost will be comined into one measure 'net interest cost'. It will be calculated as interest on opening deficit, where 'interest rate' will be the beginning of year discount rate.

Net interest cost is a new concept under Ind AS 19. However, as with OCI, this measure can be matched and compared with other measures of AS 15 to understand the impact on the financial position of a company.

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Topics: Employee benefits, AS 15, Ind AS 19

Why we don't need actuarial valuation of future salaries

Posted by Nasrat Kamal on 02-Feb-2017 21:37:41

Why don't we just calculate the present value of future salaries and hold that as a liability, just like we do for future gratuities that we are going to pay?

Though AS 15 and Ind AS 19, both deal with the treatment of all employee benefits (except share based payments), it is sometimes not too clear which benefits require an actuarial
valuation. For example, certain benefits, such as salaries, no liability is recorded in the balance sheet for future salaries.  For other benefits, such as gratuity or pension, an actuarial liability is required to be held on the balance sheet.


The general principle is that a benefit needs to be valued actuarially only when:

1. The benefit has been accrued in the past,
2. The benefit is earned exchange for service rendered in the past,
3. The benefit will be paid in future, dependent on predefined triggers (such as retirement)
4. The amount of benefit should be reasonably certain


With this principle in hindsight, let's look at a few types of employee benefits and understand
whether an actuarial valuation is required:

Salaries: Salaries are earned over a month, in exchange for service rendered
by employees that month and paid out at the end of the month. The amount of salary is certain. Since the benefits are paid out immediately and not withheld to be paid in future, no liability exists and an actuarial valuation is not needed.

Annual bonus: Under usual circumstances, bonuses are earned over the year, in
exchange for service rendered during that year and paid out at the end of the year. It
can be argued that the bonus earned in the initial part of a year is withheld to be paid
at the end of the year and therefore the annual bonus could require an actuarial
valuation. However, to be valued actuarially, a benefit needs to be 'long-term'
and a general agreement is that means that benefit should be withheld for more than 12
months. Further, the amount of annual bonus is usually contingent on a number of
other factors, such as individual and company performance, which implies that the
amount of bonus is highly uncertain. Therefore an actuarial valuation of annual bonus
is not necessary.

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Topics: Employee benefits, Actuarial valuation, AS 15, Ind AS 19

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