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Gratuity Valuation

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In India, Gratuity benefits are payable as per Payment of Gratuity Act, 1972. The Act defines the level of benefits payable to an employee.

As per Payment of Gratuity Act, 1972, Gratuity payment is payable to an employee only after completion of 5 years of continuous service at the time of termination, resignation, or retirement.

Gratuity is payable to an employee before completing 5 years only in case of death or permanent disablement.
Gratuity amount is Non-taxable up to INR 20,00,000. Any amount above INR 20,00,000 is taxable under Section 10(10) of the Income Tax Act.
The purpose of the Gratuity valuation is to keep appropriate liability in the Balance sheet of the Company and expense can be booked in the Profit & Loss account. Large organisations get the valuation done on quarterly/monthly basis. Small and medium size entities get the gratuity valuation done at least once in a year as per AS 15 R or IND AS 19 accounting standard.
Gratuity valuation is critical and important to ensure that the employer keep sufficient fund to pay off the liabilities. This is also a way to boost employees’ confidence.

Following are the 4 pillars to do actuarial valuation of gratuity benefits:

The goal is to transform the data into information and information into insight. The data needed for actuarial valuation is mostly Employee data related to salaries, Date of Joining, Date of Birth and benefit structure. There are some basic checks we always perform to ensure whether the data we use is reliable or not.

Actuarial Assumptions:
Results obtained from an Actuarial Valuation are nothing but a proper blend of assumptions. More valid the assumptions, more reliable the results. The assumptions we use for calculating the liability is based on the past experiences and future expectations by the company (Attrition rate and Salary Growth rate). When there is less evidence of past and future experiences an industry average can be used for ascertaining liabilities.

Number Analysis:
Once the inputs to the model are set (Data and Assumptions), the nect task is to analysis of the obtained results. The figures we need to analyse are the liability and expense numbers. They should be consistent with the accrued liability as well as with previous year’s results.

Disclosures in the report:
The best way to make someone believe in our work is to make it presentable and easy to understand numbers as per prescribed disclosure formats as mentioned in Actuarial practice standard or accounting standard.

In India, the standard formula to calculate gratuity is:
Monthly Salary × Number of years of employment (rounded to nearest year) × 15/26
Generally, Monthly Basic + D.A. salary is considered for gratuity valuation.