Employee benefits refer to all forms of perks or compensation paid by an employer to an employee apart from the salary or wages for the services provided by the employee. Actuarial valuation of employee benefits may include sick days, medical insurance, overtime, profit sharing, retirement benefits etc. In simple words, actuarial valuation deals with the computation of the present value of payments that would be made to employees in future as part of an employee benefits scheme. The first step in actuarial valuation is to calculate the benefit available to the employee. The AS 15 and Ind AS 19 provide the accounting treatment and disclosure to be made with respect to employee benefits. What is Actuarial Valuation of Employee Benefits? Actuarial valuation of employee benefits may be with respect to leave, gratuity, provident fund, pension, deferred benefit schemes, long service awards, etc. To calculate actuarial valuation, actuaries will make assumptions and determine how likely an employee is to resign or die before the retirement age, increase in employees salary etc. In order to arrive at these assumptions, actuaries use probabilities for various events which are termed as actuaries assumptions. Actuarial assumptions cover both financial and demographic assumptions. Financial assumptions include: Discount Rate.Employee salary increase rate.Medical cost escalation. Demographic assumptions include: Probable Mortality Rate.Employee Turnover Rate.Probable disability. What is the Need of Actuarial Valuation of Employee Benefits? An organization may need services of actuarial valuation of employee benefits for the following probable reasons: To prepare year-end financial statements which depict accurate results and financial positionTo ensure that compliance with Indian GAAP is metTo ensure proper accounting of employee benefits in the books of accountsTo ensure that liabilities are recorded in the financial statements in respect of employee benefit schemes in accordance with AS 15 or Ind AS 19, as may be applicable to an organizationTo estimate the liability accurately and to make adequate disclosures as required by the accounting standardsFor employee benefits of an India based subsidiary of an international parent company, one would need to report under the GAAP applicable to the parent company whether US GAAP, IAS 19, etcTo assess whether the company holds the required level of assets to match the employee benefits’ liabilityTo assess the amount of contribution needed by the organization to make up for gratuity funds or trustsTo ascertain the cost to be paid with reference to the liability of employee benefits in a merger or acquisitionTo determine the amount of settlement of liabilities in case of winding up, liquidation or discontinuance of operationsTo precisely determine the level of provisions to be recorded in the year-end financial statements Which Employee Benefits Require Actual Valuation? AS 15 and Ind AS 19 both deal with the valuation of all employee benefits except on share-based payments. Sometimes, it is not clear as to which benefits require an actuarial valuation. The general principle is that the actuarial valuation of employee benefits needs to be valued actuarially only in the following conditions: The benefit is collected in the past.The benefit is earned for services rendered in the past.The benefit will be paid in future maybe after retirement or post-death whatever is decided before.There should be a certain reasonable amount of benefit. The following are the few types of employee benefits where actuarial valuation can be required: How Is An Actuarial Valuation of Employee Benefits Done? The basic purpose of an actuarial valuation of employee benefits is to calculate the ‘present value’ of payments that would be made to the employees in future as part of the employee benefit plan.Actuaries start their work by making assumptions about future salary increment rates, employment attrition and also the mortality rates. The assumptions are then used to calculate the benefit payments that will be made from the employer to its employees, as per the rules of the plan.Actuaries also choose another assumption method called the discount rate, to convert the future payments into a present value. This liability is to be disclosed in the financial statements.Actuarial valuation generally includes not just an estimate of liability, but also extended disclosures in the form of an actuarial report. The disclosures are different for different accounting standards. In the context of Indian GAAP, there are differences between AS 15 and Ind AS 19 as far as the disclosures are concerned. Regulatory Framework Governing Actuarial Valuation of Employee Benefits AS 15, Ind AS 19, US GAAP and other International Accounting Standards provide a regulatory framework for actuarial valuation of employee benefits. The main aim of AS 15 and Ind AS 19 is to ensure that: A liability is mentioned in the balance sheet that represents the actuarial value of the benefits that have been accrued till the balance sheet and are expected to be paid in future.An expense is recognized in the statement of profit or loss, representing the cost of running these benefits schemes over the reporting period.From the reporting company’s benefit, the liability is the excess of Defined Benefit Obligation (DBO).In the absence of these accounting standards, the true financial position of the companies will not be disclosed.Ind AS 19 requires additional disclosures to set out the significant risks to post-employment plans. How are various employee benefits treated under AS 15 and Ind AS 19? AS 15 and Ind AS 19 applies to all types of employee benefits, except those that are linked to shares. The benefits are categorized as follows: Short Term Benefits Short term benefits such as bonuses, salaries etc. do not require the actuarial valuation. Long Term Benefits Long term benefits are further categorized as: Post employment benefits:- such as gratuity and pension, and Other Long Term benefits:- such as jubilee awards, which are paid during the service of the employee. Leave benefits can be categorized as either post employment or other long term benefits, depending on the scheme rules and assumptions whether a FirstIn First Out (FIFO) or a Last In First Out (LIFO) method is used for actuarial valuation of employee benefits. See Our Recommendation: All you need to know about EPF Form 10C. How to Set Actuarial Assumptions for Actuarial Valuation of Employee Benefits? In case the actuarial assumptions are wrong, it can lead to wrong liability estimates. Hence there must be a thorough understanding of the accounting standards applicable in the company. Most of the accounting standards like AS 15, Ind AS 19, IAS 19, ASC 715 and FRS 17, places the responsibility for all actuarial assumptions on the Board of Directors of the reporting organization. The actuarial valuation of employee benefits requires the following process: Discount rate It is the most important assumption. This set is based on yields on the central government bonds. Actuaries generally have access to the financial data on G-secs to set the assumption. It is the responsibility of the companies to request a full explanation regarding the actuarial valuation report. Salary Escalation and Attrition Rates These are the best estimates for the reporting enterprise regarding the future increments and attrition of the employee. Other assumptions include the mortality rate, leave availment, disability, etc., which are relevant and important for the specific schemes. How to interpret the results regarding Actuarial Valuation of Employee Benefits? The company’s official after getting the report should assess the information contained in these reports. In order to understand the results of actuarial valuation of employee benefits the companies need to focus on the settlement of closing and opening DBO or Defined Benefit Obligation, which is a required disclosure under both AS 15 and Ind AS 19. This is a critical piece of information to understand why the obligation has increased or decreased during the reporting period. The various elements for interpreting are as follows: DBO at the opening and closing dates come from the results of actuarial valuation of employee benefits.Service cost is an increase in obligation due to an additional year of service by employees, an employee who had rendered at least four years of service.Interest Cost is an increase in obligation because the benefit payment date is now a year closure.Benefit payments are the number of benefits that have been paid during the reporting period to employees who have left the company.Actuarial loss is assessed when a full actuarial valuation of employees has been carried out to assess the closing DBO. Conclusion Reducing investment risk exposure and pro-actively managing scheme funding are the key priorities of the sponsors of defined benefit plans. This requires having an in-depth knowledge of how assets and liabilities perform under a range of market conditions and also identifying different risk drivers to establish the basic checkpoints to ensure the continued relevance of the asset-liability management strategy. Actuarial Gains and Losses comprise the difference between the previous and actual actuarial assumptions or the changes in the assumptions. Actuarial Gains or Losses should be determined by profit or loss immediately as an income or an expense. Also, Read: Various Reasons Why Provident Fund is Important to the Salaried Class.