What Is Actuarial Valuation Of Gratuity?

In today’s constantly changing business world, companies need to take into account its future liabilities that would arise because of the services provided by its current employees. They need to evaluate the amount payable to its employees sometime in the future in the form of employee benefit schemes.

Some of these employee benefit schemes include:

• Salary and bonus: This is a mandatory form of benefit provided to the employees of the organisation for working in the organisation.
• Recognition awards: In order to encourage the committed and diligent employees, companies need to conduct recognition awards.
• Medical Insurance: This is a kind of unforeseen payment that the company may be required to pay anytime in the future.
• Pensions and gratuity: These are a form of employment benefits paid after retirement. Hence, these can be considered as an obligation of the company to be paid later on in the future.

This is where actuarial valuation of gratuity comes into picture. Its sole purpose is to estimate the present value of its expected future cash flows associated with these employee benefit plans. By evaluating these current and future liabilities, companies eliminate the risk of not being able to compensate their present employees as well as those who have retired.

In simple words, we can say that actuarial valuation includes evaluating how much amount to set aside today in order to compensate and fulfil their obligations towards the employees of the organisation in future.

Equating Assets and Liabilities

To evaluate the actuarial valuation of gratuity report, we equate the assets enjoyed by the company that are brought in by the employees to the liabilities suffered by the company due to the employee benefit schemes. For the asset side, we take the contributions made by the employees towards the growth of the organization in the form of the current financial resources available. On the other hand, liabilities would include the payout made to the employees for their services rendered. By comparing these two, the company gets an idea about the current situation of their funds and whether or not it can cover future employee benefits. While estimating the assets and liabilities, actuary should consider the following:

1. Discounting rate: It is used to calculate the present value of the future payments, i.e. future amount payable as employee plans are discounted back on today for accurate estimation of required funds.
2. Salary growth rate: The increase in salaries of employees also need to be considered for better evaluation and handling of resources.
3. Inflation rate: With time, inflation may occur and needs to be adjusted in accordance with employee benefit plans.
4. Employee contribution rate: Employers’ and employees’ contribution towards the growth of the company needs to be analyzed too according to which their future benefits are estimated and hence amount to be set aside today are decided.
5. Mortality Rates: Due to unpredictable characteristics of life, it is better to evaluate mortality rates in advance and take them into account in the actuarial valuation report.

Reasons of Evaluating Actuarial Valuation of Gratuity Report

The company, in general should know about its present funds and whether or not they are sufficient to cover present as well as future labilities. Hence, actuarial valuation of gratuity gives an idea about the monetary state of the company and thus, is necessary for any type of company, big or small. This is one of the major reasons for estimating future liabilities and working on the actuarial valuation.

Since employees in the organization need to be compensated for the hard work they put in, actuarial valuation of gratuity is required to avoid last minute hassle or to manage funds more wisely. The company needs to set aside the amount payable to employees to not land in a situation where it faces shortage of funds to pay their due employee benefit payments to retiring or present employees.

Another major reason for evaluating the actuarial valuation of gratuity report is the accounting standards set so as to ensure companies handle their finances in a better way. Under these accounting standards, actuaries are required to estimate their company’s future liability and make provisions for that beforehand. Hence, the balance sheet of the company would include provisions such as employee benefit schemes like pensions, sick or paid leaves, gratuity, etc. These are then included in the financial statements of the company and play a major role while estimating future obligations.

Various accounting standards include:

1. AS-15(R): Accounting standard 15 came into effect on April 1,2006. It deals with the consideration given to the employees in exchange of the services rendered by them. This excludes inventory compensation and is limited to short term and long-term benefits provided, post-employment and termination benefits, etc. One key aspect of this accounting standard is that the gain enjoyed or loss suffered by the company due to these employees’ contribution is accounted in the profit and loss account. Under this, expected return is calculated by taking the sum of each individual return of the investment multiplied by its probability of occurring.
2. IND AS 19: This accounting standard is the updated version of AS-15(R) introduced by the Ministry of Corporate Affairs as AS-15(R) demanded upgradation to match IAS 19 that is being followed internationally by companies. A key difference between these two is that in the updated version, actuarial gains or losses with be included in OCI, i.e. Other 

Comprehensive Income rather than P/L account.

In the OCI account, actuarial gains and losses are divided into 3 parts) Actuarial Gain or Loss due to Demographic Assumption

1. b) Actuarial Gain or Loss due to Financial Assumption
2. c) Actuarial Gain or Loss due to Experience

Additionally, under IND AS 19, discount rates are used to evaluate the expected return from the investment.

Apart from these two, US GAAP which stands for Generally Accepted Accounting Principles, are the accounting standards followed in the U.S. Also, IFRS is another accounting standard rule that stands for International Financial Reporting Standards.

Conclusion

To sum up, actuarial valuation is required to be done not only by being binded by the accounting standards but also by moral obligation of compensating the employees of the organization for the services rendered by them and managing the company’s funds to provide them employment benefit schemes

Frequently Asked Questions 

1) How is actuarial valuation of gratuity calculated? 

Actuarial valuation of a gratuity calculated by using the formula - 

Gratuity = (Last Drawn Salary × Tenure × Gratuity Rate) ÷ 26, adjusted to account for actuarial assumptions such as mortality, discount rate, and withdrawal rates.

2) How to audit Actuarial Valuation?

Verifying data accuracy, examining assumptions, recalculating samples, evaluating technique compliance, assuring legal conformity, testing sensitivity, enlisting actuaries, and recording findings to validate outcomes are all part of auditing actuarial valuation. 

3) What is the significance of the discount rate in the valuation process? 

The discount rate has a substantial influence on valuation results and aligns the computation with market interest rate developments by reflecting the time value of money and decreasing future gratuity liabilities to their present value.

4) What is the purpose of an actuarial valuation for gratuity? 

Estimating an organization's gratuity liability through actuarial valuation serves the dual purposes of guaranteeing accurate financial reporting, adherence to accounting standards, and efficient provisioning for employee benefits.