Month: September 2022

Finance lease:

At commencement of the lease term, leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate).

Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability.

The depreciation policy for depreciable leased assets should be consistent with that for owned assets.

If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the shorter of the lease term and its useful life.

Operating leases:

The lease payments should be recognised as an expense over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit.

The following principles should be applied in the financial statements of lessees:

• At commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate) [IAS 17.20].
• Finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability) [IAS 17.25].
• The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease the asset should be depreciated over the shorter of the lease term or the life of the asset [IAS 17.27].
• For operating leases, the lease payments should be recognised as an expense in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit [IAS 17.33]

The following principles should be applied in the financial statements of lessors:

• at commencement of the lease term, the lessor should record a finance lease in the balance sheet as a receivable, at an amount equal to the net investment in the lease [IAS 17.36]
• the lessor should recognise finance income based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment outstanding in respect of the finance lease [IAS 17.39]
• Assets held for operating leases should be presented in the balance sheet of the lessor according to the nature of the asset. [IAS 17.49] Lease income should be recognised over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern in which use benefit is derived from the leased asset is diminished [IAS 17.50]

Incentives for the agreement of a new or renewed operating lease should be recognised by the lessor as a reduction of the rental income over the lease term, irrespective of the incentive’s nature or form, or the timing of payments. [SIC-15]

Manufacturers or dealer lessors should include selling profit or loss in the same period as they would for an outright sale. If artificially low rates of interest are charged, selling profit should be restricted to that which would apply if a commercial rate of interest were charged. [IAS 17.42]

Under the 2003 revisions to IAS 17, initial direct and incremental costs incurred by lessors in negotiating leases must be recognised over the lease term. They may no longer be charged to expense when incurred. This treatment does not apply to manufacturer or dealer lessors where such cost recognition is as an expense when the selling profit is recognised.

Sale and leaseback transactions

For a sale and leaseback transaction that results in a finance lease, any excess of proceeds over the carrying amount is deferred and amortised over the lease term. [IAS 17.59]

For a transaction that results in an operating lease: [IAS 17.61]

• If the transaction is clearly carried out at fair value: The profit or loss should be recognised immediately.
• If the sale price is below fair value; profit or loss should be recognised immediately, except.
• If a loss is compensated for by future rentals at below market price, the loss should be amortised over the period of use.
• If the sale price is above fair value: The excess over fair value should be deferred and amortised over the period of use.
• If the fair value at the time of the transaction is less than the carrying amount a loss equal to the difference should be recognised immediately [IAS 17.63]

Finance Lease:

At commencement of the lease term, the lessor should record a finance lease in the balance sheet as a receivable, at an amount equal to the net investment in the lease.

The lessor should recognise finance income based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment outstanding in respect of the finance lease

Operating Lease:

Assets should be presented in the balance sheet of the lessor according to the nature of the asset.

Lease income should be recognised over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern in which use benefit is derived from the leased asset is diminished.

• Manufacturer or dealer lessor does not recognise any selling profit on entering into an operating lease because it is not the equivalent of a sale.
• Initial direct costs incurred by lessors in negotiating and arranging an operating lease shall be added to the carrying amount of the leased asset and recognised as an expense over the lease term on the same basis as the lease income.

Any Plan which suggests or mandated by Law to pay employees “agreed benefits” (Determinable by various means). Further Any Actuarial Risk will be borne by Employer.

Employer’s obligation is to provide the agreed benefits to current and former employees and the actuarial and investment risk fall, in substance is on the employer. Examples are pension, gratuity, post-employment medical benefit, etc. Contribution and benefit plans can be varied like State plans, multi-Employer plans or Insured plans and they require separate disclosures in the financial statement.

Recognition of defined benefit cost

Other long-term employee benefits are all employee benefits other than short-term employee benefits, post-employment benefits and termination benefits.

The Standard does not require the measurement of other long -term employee benefits to the same degree of uncertainty as the measurement of post-employment benefits. The Standard requires a simplified method of accounting for other long-term employee benefits. Unlike the accounting required for post-employment benefits, this method does not recognise re- measurements in other comprehensive income.

Accounting treatment for defined benefit plan by an employer

• Make reliable estimate of the employee benefit amount using actuarial techniques.
• Discount such benefit using PUCM* to determine the present value of the benefit obligation and also the current service cost.
• Determine the fair value of any plan assets.
• Determine the total actuarial gain/losses to be recognized in other comprehensive income.
• On introduction or change of a plan, determine the past service cost.
• On curtailment or settlement of a plan, determine the resulting gain/loss.

Under PUCM, each period of employee service gives rise to an additional unit of benefit and such units are measured separately and added to the final obligation. It is applying the present value concept and recognizing a future value as on the balance sheet date. Actuarial gain/losses can result in an increase or decrease in either present value of a defined benefit obligation or the fair value of plan assets. Past service cost is the change in the present value of defined benefit obligations caused by employee service in prior periods.

Actuarial Valuation and Assumptions

Actuarial valuation for employee benefits aims to calculate the present value of benefit payment that will be paid to an employee in future as part of a benefit plan. Calculation of defined benefit obligation is the first step in this valuation. For the above valuation, actuaries will make assumptions to determine how likely an employee is to resign or die prior to the retirement age, how the employee salaries are expected to increase, etc.

In order to arrive at these, actuaries use probabilities for various events which are termed as actuaries’ assumptions. Actuarial assumptions should be unbiased and mutually compatible and cover both financial & demographic assumptions. Financial assumptions should be based on market expectations and also include:

Recognition & Measurement

The net total of the following should be recognized in P&L, except to the extent that another IND AS permits or requires their inclusion in the asset cost:

• Service cost
• Net interest on the net defined benefit liability (asset)
• Re-measurements of the net defined benefit liability (asset)

PUCM is used to actuarially value the other long-term benefits.

The Indian Accounting Standard (Ind AS) 19 aims to prescribe accounting and disclosure for employee benefits. It requires recognition of the liability by an entity when an employee provides services for employee benefits to be paid in the future, and recognition of expenses when the entity utilises the economic benefit arising from service given by an employee in exchange for employee benefits.

For example, when an employee works for a company, the company derives benefit from the effort put in by the employee. Thus, it can be said that the company consumes the services rendered by the employee, and in this case the company will recognise this as an expenditure. And consequently, a liability arises to the employee that is payable by the company which is equivalent to the benefits that are payable by the company.

The liability can be in the form of salaries which are payable every month, or sometimes the liabilities can be carried forward and be payable on retirement, or after completion of a few years. These depend on the nature of the contract between the employer and employee, and all such benefits that are agreed upon to be paid to the employee need to be accounted for. Under Ind AS 19, even constructive obligations need to be accounted for. For example, this may include a festival bonus (like Eid Bonus or Diwali Bonus) which may not be a legal or contractual requirement, but one which the employer voluntarily provides and is followed based on precedence (ie. The company may have paid the same in the previous year, and the employee would expect it).

Accounting for Short Term Employee Benefits

Short term employee benefits are settled within a period of 12 months from the end of the period in which the services were rendered by the employee. Examples include salaries, paid annual leave, rental accommodation, car benefit etc. They are accounted on a undiscounted basis because the settlement is expected to happen within the short term. Short Term Employee Benefits are recognised as

A liability after deducting the amount paid within the year.

As an asset, if the amount paid exceeds the undiscounted amount of the benefits payable.

As an expense in the profit and loss

Example of accounting for Short Term Employee Benefits

Consider an employee with salary of 10,000 Rs per month and 1 month bonus payable every year. If at the end of the year, 2 months salary along with bonus are unpaid, then these are recognised as a liability. However if 2 months extra salary has been paid to the employee, then it is treated as an asset.

For Short term employee benefits, no specific disclosures are required under Ind AS 19.

Post-Employment Benefits: Defined Contribution Plans

Post-Employee benefit schemes where the obligation of an entity is to only contribute to a plan, and no further obligation arises on the entity is known as a Defined Contribution plan.

Defined Contribution Plans are recognised as

• A liability after deducting the amount paid within the year.
• As an asset, if excess amount has been contributed.
• As an expense in the profit and loss

If the contribution is due within 12 months, then no discounting factor is applied. When the contributions do not fall due within 12 months of the end of the reporting period, then it should be discounted using the discount rate.

Example of Defined Contribution Plan Accounting

Lets say a company contributes 10% of every employee’s salary to a employee benefits plan. In this case, the company takes up no further obligation. The Company should account this contribution, amounting to 10% of its salary to the profit and loss account as an expense.

Post-Employment Benefits: Defined Benefits Plan

While Ind AS 19 prescribes accounting for many types of employee benefits such as long term paid absences, long service benefits, profit sharing / bonus schemes and termination benefits, post-employment benefits of a Defined Benefit Plan are accounted with additional complexity under Ind AS 19. The complexity of accounting for post-employment benefits is high, since it requires the use of actuarial assumptions relating to the demographics of the company/industry and also financial assumptions related to the overall economy.

Accrual of Benefits

Post employment benefit schemes with a Defined Benefit Plan are usually structured in a way that the employees gain the benefit for each year of service they have rendered to the company. This benefit is accrued over time, and when the employee leaves the service, the entire benefit is payable to the employee. This is the accrual system of accounting for employee benefits. Under Ind AS 19, the Projected Unit Credit method of accounting is prescribed for calculation of employee benefits, taking into account the accruing nature of these benefits. The basic premise of the PUC method is that each year of service rendered by an employee will give rise to one unit of benefit entitlement to the employee.

PUC Method

Under the PUC method of accounting, a projected accrued benefit is calculated at the begging of the year, and again at the end of the year for all the employees under the plan. The employee’s benefit will depend on years of service and also considers the future salary increase and the plan’s benefit allocation formula. The Benefit attributable to an employee on a future separation date (date of retirement) is the benefit defined under the plan based on credited service as on the valuation date. The “projected accrued benefit” is based on the Scheme’s accrual formula and upon service as of the beginning or end of the year, but using a member’s final compensation, projected to the age at which the employee is assumed to leave active service. The Scheme Liability is the actuarial present value of the “projected accrued benefits” as of the beginning of the year for active members. An individual’s estimated benefit obligation is the present value of the attributed benefit for valuation purposes at the beginning of the year, and the service cost is the present value of the benefit attributed to the year of service in the plan year.

Important Aspects of Defined Benefit Plan Accounting

The present value of a defined benefit obligation is the present day value of post-employment benefits based on the employee’s future salary, resulting from the employee’s service in the current and past periods. The Plan Assets are measured at fair value as on the balance sheet date. The Net obligation is recognised in the profit and loss account as an expenditure, along with a corresponding liability.

Example: In a funded plan having net obligations as 10 crores, and plan assets as 8 crores. In this case, 2 crores is the expense that the company has to make towards the DBO, and this is treated as an expense in the company’s profit and a corresponding liability is accounted.   

Current Service Cost is the cost incurred to the company due to the employee rendering service in the current year. If the employee renders no service, the current service cost is zero. For a Defined benefit obligation, current service cost can be defined as the increase in the present value of defined benefits obligation due to the employee’s service in the current year.

Interest Cost is the increase in defined benefits obligations that arise due to the passage of time. The present value of the DBO increases in a year, because the benefits are one time period closer to settlement. This is captured in interest cost.

Past Service Cost is the changes in present value of DBO due to plan amendments or curtailment. This may arise due to change in the nature of plan. For example, a company may amend the plan to increase the value of its defined benefit payable to its employees. This would result in recognition of the amounts that were not recognised earlier. In the alternative scenario for a plan curtailment, the company may curtail the bonus that is payable to employees who have completed 10 years of service from 6 month’s salary to 3 month’s salary. Thus, the employees will lose some benefits due to curtailment of the plan. These are captured in past service cost.

Plan Assets include the assets held by the Defined Benefit Plan in an employee benefits fund, or any insurance policy that is designed for employee benefit schemes.

Actuarial Gains/Losses are the changes in the DBO due to changes in actuarial assumptions. When accounting for defined benefit plans and post-employment benefits, certain assumptions have to be made on factors such as salary growth rate, attrition rate etc. Changes in these assumptions results in actuarial gain/loss. For example, salary growth rate of a company may fall from 10% to 3% due to economic slowdown. The gain or loss due to this change is known as actuarial gain/loss. These are treated as unrealised gains or losses, and is not debited to the profit and loss account but is captured in the Other Comprehensive Income (OCI).

Accounting for DBO

In the Profit and Loss account, the following components are recognised:

Under the head Service Cost: the current service cost, past service costs, settlements and curtailments (if any);

Under the head Net Interest Cost: Net Interest expense on DBO, Interest on Plan Assets, and interest on the effect of asset ceiling;

Additionally, any administrative expenses and taxes.

Accounting For Other Long Term Employee Benefits

Employee Benefits that are expected to be settled after 12 months from from the end of the period in which the services are rendered, but are not a post-employment benefits or termination/retrenchment benefit are called Other Long Term Employee Benefits . For example, the employee may be entitled to a loyalty bonus after working for 10 years. This is an Other Long Term Employee Benefit. Other examples include long service award or jubilee awards, long term compensated absences, and long term disability benefits.

Other Long Term Employee Benefits are accounted using the Projected Unit Credit Method in a similar method as that of Defined Benefit Plans, however the actuarial gains and losses arising out of Other Long Term Employee Benefit plans are not considered under the OCI but are considered in the profit and loss account. The components charged to the profit and loss account are service cost, net interest on the net defined benefit liability,

Accounting For Termination Benefits

Termination benefits arise when an employee is terminated by the employer or when an employee accepts the employer’s offer of benefits in exchange of termination of employment. This is different to post-employment benefits. Classic example of termination benefits is retrenchment compensation where the employee has no option to accept the termination. Voluntary Retirement Scheme is also an example of termination benefits where the employees are due a compensation and in return accept early retirement.

Termination Benefits are to be recognised on the earlier date of when the company can no longer withdraw the offer of the termination benefits, or when the company recognises costs for restructuring which involves the payment of termination benefits. For instance, a company may face debt restructuring and accordingly, several employees would have to be laid off, and the termination benefits would be recognised.

Measurement of Termination Benefits

Termination Benefits are measured based on the criteria considering if they are an enhancement to post-employment benefits. If they are an enhancement to post-employment benefits (for instance payable after retirement), then they are accounted as per Defined Contribution Plan or Defined Benefit Plan, as the case maybe. If they are not an enhancement to post-employment benefits, based on whether the termination benefits are expected to be settled within 12months they are accounted as either Short Term Employee Benefits (for cases when the settlement is within 12 months) or Other Long Term Employee Benefits (for other cases).

Post-employment benefits are employee benefits (other than termination benefits and short-term employee benefits) that are payable after the completion of employment. Post-employment benefit plans are formal or informal arrangements under which an entity provides post -employment benefits for one or more employees. Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan as derived from its principal terms and conditions.

Post-employment benefits: Defined contribution plans

Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods. Under defined contribution plans the entity’s legal or constructive obligation is limited to the amount that it agrees to contribute to the fund. Thus, the amount of the post-employment benefits received by the employee is determined by the amount of contributions paid by an entity (and perhaps also the employee) to a post-employment benefit plan or to an insurance company, together with investment returns arising from the contributions. In consequence, actuarial risk (that benefits will be less than expected) and investment risk (that assets invested will be insufficient to meet expected benefits) fall, in substance, on the employee.

When an employee has rendered service to an entity during a period, the entity shall recognise the contribution payable to a defined contribution plan in exchange for that service:

• As a liability (accrued expense), after deducting any contribution already paid. If the contribution already paid exceeds the contribution due for service before the end of the reporting period, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash as an expense, unless another Ind AS requires or permits the inclusion of the contribution in the cost of an asset (see, for example, Ind AS 2 and Ind AS 16).

Post-employment benefits: defined benefit plans

Defined benefit plans are post-employment benefit plans other than defined contribution plans. Under defined benefit plans:

• The entity’s obligation is to provide the agreed benefits to current and former employees.
• Actuarial risk (that benefits will cost more than expected) and investment risk fall, in substance, on the entity. If actuarial or investment experience are worse than expected, the entity’s obligation may be increased.

Accounting by an entity for defined benefit plans involves the following steps:

Determining the deficit or This involves:

• Using an actuarial technique, the projected unit credit method, to make a reliable estimate of the ultimate cost to the entity of the benefit that employees have earned in return for their service in the current and prior periods. This requires an entity to determine how much benefit is attributable to the current and prior periods and to make estimates (actuarial assumptions) about demographic variables (such as employee turnover and mortality) and financial variables (such as future increases in salaries and medical costs) that will affect the cost of the
• Discounting that benefits in order to determine the present value of the defined benefit obligation and the current service
• Deducting the fair value of any plan assets from the present value of the defined benefit

Determining the amount of the net defined benefit liability (asset) as   the amount of the deficit or surplus determined in (a), adjusted for any effect of limiting a net defined benefit asset to the asset ceiling. (Asset ceiling is defined as present value of any economic benefit available in the form of refunds from the plan or reduction in future contributions to the plan).

Determining amounts to be recognized in profit or loss:

• Current service
• Any past service cost and gain or loss on
• Net interest on the net defined benefit liability (asset).

Determining the remeasurements of the net defined benefit liability (asset), to be recognised in other comprehensive income, comprising:

• Actuarial gains and losses;
• Return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset).
• Any change in the effect of the asset ceiling (see paragraph 64), excluding amounts included in net interest on the net defined benefit liability (asset).
• Where an entity has more than one defined benefit plan, the entity applies these procedures for each material plan separately.

When an employee has rendered service to an entity during an accounting period, the entity shall recognise the undiscounted amount of short-term employee benefits expected to be paid in exchange for that service:

• As a liability (accrued expense), after deducting any amount already paid. If the amount already paid exceeds the undiscounted amount of the benefits, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash
• As an expense, unless another ind as requires or permits the inclusion of the benefits in the cost of an asset (see, for example, ind as 2, inventories, and ind as 16, property, plant and equipment).

Different employee benefits under AS 19

Short-term employee benefits: There are those which are expected to be fully paid before 12 months after the end of the accounting period in which the employee rendered service.

Other long-term employee benefits: There are those which are not expected to be fully paid within 12 months after the end of the accounting period.

Termination benefits: These are those which are paid to an employee who is terminated from service due to the employer’s decision.

Post Employment benefits: These are those employee benefits which are paid after the completion of employment.

Short-term employee benefit includes the following:

Recognition & Measurement

Once the employee renders service to an employer, the expected amount of short-term employee benefits to be paid for such service has to be recognized as a liability or as an expense. It is considered a revenue expenditure generally except when any other standard requires it to be capitalized.

Types of short-term benefits

Short-term employee benefits are of two types:

• Paid absences
• Profit sharing and bonus plan

Paid Absences

These are compensated absences and can be classified as accumulating paid absences and non-accumulating paid absences. Examples of such absences are holidays, sickness, maternity, etc and their related cost are recognized as follows:

Profit-Sharing and Bonus Plan

‘Profit sharing’ and ‘Bonus Plan’ are benefits such as employee’s annual incentive, managing director’s commission etc. These costs are recognized when the employer:

• Has a present obligation to make such payment on account of past events.
• Has the reliable estimate of expected payment that can be made.

A reporting entity is exempt from the disclosure requirements in relation to related party transactions and outstanding balances, including commitments, with:

(a) a government that has control or joint control of, or significant influence over, the reporting entity;

(b) another entity that is a related party because the same government has control or joint control of, or significant influence over, both the reporting entity and the other entity.

If a reporting entity applies the exemption above, it shall disclose the following about the transactions and related outstanding balances referred to the above:

(a) The name of the government and the nature of its relationship with the reporting entity (ie control, joint control or significant influence);

(b) The following information in sufficient detail to enable users of the entity’s financial statements to understand the effect of related party transactions on its financial statements:

(i) The nature and amount of each individually significant transaction;

(ii) for other transactions that are collectively, but not individually, significant, a qualitative or quantitative indication of their extent.

Transaction with the government-related entity

The Reporting entity is exempt from the disclosures requirement with the government who has control or joint control or significant influence over the reporting entity and another entity that is a related party because the same government has control or joint control of or significant influence over both the reporting and other entity. As a result of such exemption, the entity need not disclose related party transactions and outstanding balances including commitments. If the above exemption applies, an entity must disclose the following:

• Name of the government and nature of its relationship.
• The nature and amount of each individually significant transaction and for other transactions that are collected, but not individually significant a qualitative or quantitative indication of their extent.

Related party transactions are the transfer of services or obligations, resources between a reporting entity, and related party irrespective of the fact that a price is charged.

The Government refers to government, government agencies, and similar bodies whether local, national, or international.

A government-related entity is an entity that is controlled, jointly controlled, or significantly influenced by the government.

Compensation includes all employment benefits such as short-term employment benefits, post-employment benefits, other long-term employer benefits, termination benefits, and share-based payments.