Provision for Compensated Absences Under Ind AS 19

1. Question

Innovate Solutions Limited (hereinafter referred to as “the company”) is preparing its financial statements for the year ended 31st March, 2024. The company is assessing its liability for paid leave earned by its employees but not yet taken.

The company’s leave policy and year-end data are as follows:

(a) The company has 200 full-time employees.

(b) Each employee is entitled to 12 days of paid leave per year. Unused leave can be carried forward to the following year.

(c) The leave is accumulating and is classified into two types:

Vesting Leave – 80 employees are entitled to receive a cash payment for any unused leave entitlement if they leave the company.

Non-Vesting Leave – The other 120 employees are not entitled to a cash payment for unused leave upon separation; they can only avail the leave while in service.

(d) As at 31st March, 2024, the average unused leave entitlement across all employees is 6 days.

(e) Historically, 25% of employees with non-vesting leave have forfeited their accumulated leave entitlement without ever taking it. Management expects this trend to continue.

(f) The average daily salary per employee is Rs. 1,500.

State the correct amount of provision for compensated absences that the company should recognise in its books as at 31st March, 2024, in accordance with Ind AS 19, Employee Benefits?

2. Relevant Provisions

Ind AS 19, Employee Benefits

Para 11 – 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:

(a) 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 refund.

(b) 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).

Para 15 – Accumulating paid absences are those that are carried forward and can be used in future periods if the current period’s entitlement is not used in full. Accumulating paid absences may be either vesting (in other words, employees are entitled to a cash payment for unused entitlement on leaving the entity) or non-vesting (when employees are not entitled to a cash payment for unused entitlement on leaving). An obligation arises as employees render service that increases their entitlement to future paid absences. The obligation exists, and is recognised, even if the paid absences are non-vesting, although the possibility that employees may leave before they use an accumulated non-vesting entitlement affects the measurement of that obligation.

Para 16 – An entity shall measure the expected cost of accumulating paid absences as the additional amount that the entity expects to pay as a result of the unused entitlement that has accumulated at the end of the reporting period.

3. Analysis

In this case, to determine the correct provision, the company must calculate the liability for the two distinct groups of employees based on the nature of their leave entitlement, as required by Ind AS 19.

Group 1 – Employees with vesting leave (80 employees)

For employees whose unused leave is “vesting,” the company has an obligation to pay cash upon their departure. This means the company has a present obligation for all unused leave days accumulated by this group, regardless of whether they are expected to take the leave or encash it. The provision must be made for the full accumulated amount.

Calculation – 80 employees × 6 unused days × Rs. 1,500 per day = Rs. 7,20,000

Group 2 – Employees with non-vesting leave (120 employees)

For employees whose leave is “non-vesting,” the obligation arises only if they are expected to utilise the leave in the future. The provision should be measured based on the probability of future usage. The company has historical data indicating that 25% of this group will forfeit their leave. Therefore, the provision should be calculated based on the 75% of employees who are expected to actually take their accumulated leave.

Calculation – 120 employees × 6 unused days × 75% (expected utilization) × Rs. 1,500 per day= Rs. 8,10,000

Total Provision for Compensated Absences

The total liability is the sum of the provisions for both groups.

Total Provision = Provision for Vesting Leave + Provision for Non-Vesting Leave

Total Provision = Rs. 7,20,000 + Rs. 8,10,000 = Rs. 15,30,000

Note – For simplicity, this calculation uses an undiscounted amount. In practice, if the leave is expected to be utilised or encashed beyond one year, the company would determine the liability using an actuarial valuation to arrive at a present value.

4. Conclusion

Based on the relevant provisions and analysis of the case, the company should recognise a total provision for compensated absences of Rs. 15,30,000 as at 31st March, 2024. For employees with vesting leave, the provision is based on their full accumulated balance of Rs. 7,20,000. For employees with non-vesting leave, the provision is adjusted based on the probability of future usage, taking into account historical trends, Rs. 8,10,000.

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