Gratuity Provisioning: How Do You Calculate the Right Amount Each Year?

Hi Professionals, how do I determine the quantum of gratuity amount to provision for in the books for each financial year?

Thanks & Regards,
Sreeni

In accordance with the latest provisions of the Income Tax Act, 1961, it is now mandatory for all corporates to make provision for gratuity liability year by year in their books of account. Therefore, you are required to calculate gratuity for all employees who have completed five years of service using the formula provided below and record it as deferred expenditure.

Gratuity Calculation Formula

The formula to calculate the Gratuity Amount for an individual employee is as follows:
Basic Salary of an Individual x 15/26 x Servicing years = Gratuity Amount of that individual employee.

Regards,
R B Yadav
Advocate

Can you please help in explaining further on the same? As per your quote, is it only for the employees who have completed their 5 years that there is a need to show provision in the books, or is it mandatory to show provision for all employees from their date of joining?

Regards,

Just to update on the above, the calculations are as per the Income Tax Act. However, for accounting purposes, the provision in the books, you need to follow the guidelines prescribed under the Accounting Standard AS 15 (Revised).

As per AS 15 Revised, the provision as of March 31 (year-end) needs to be accounted for based on an actuarial valuation done by actuaries. You are required to provide basic information on the salary data required for computing the actuarial valuation.

Based on the actuarial valuation report, you need to account for the provision in the books of accounts.

Gratuity Insurance Requirement under the Payment of Gratuity Act

As per Section 4-A of the Payment of Gratuity Act, every employer, other than an employer of an establishment belonging to or under the control of the Central Government or a State Government, shall obtain insurance in the prescribed manner for their liability for payment towards gratuity under this Act from the Life Insurance Corporation of India established under the Life Insurance Corporation of India Act, 1956 (31 of 1956), or any other insurer as prescribed.

Consequently, the liability for the payment of gratuity naturally shifts to the insurance organization. Therefore, there is no need to provide an additional provision for gratuity. Only in cases where the insurance coverage does not include the full gratuity amount, is there a necessity to make up the difference.