Gaps in GAAP – Compensated absences (such as annual leave) – Whether long-term or short-term under IAS 19s?

In India, employees are entitled to fixed annual leave, say
20 days, per completed year of service. The employees have a right to utilise
the leave at any time after entitlement or alternatively seek cash compensation
on resignation/retirement. Based on past experience, employees generally do not
utilise their leave entitlement immediately. Rather they carry forward a
substantial portion of the unutilised leaves (usually representing the maximum
ceiling imposed by the company — this could range from 180-300 days) up to
retirement/resignation. The carry forward leave is then encashed at the time of
retirement/resignation.

The value of leave liability if determined based on
short-term or long-term classification under IAS 19, may provide materially
different provision amounts. This is because long-term classification involves
discounting and use of the PUC actuarial valuation method.

Before the 2007 annual improvements project, paragraph 7 of
IAS 19 stated that short-term benefits (which include compensated absences) fall
due within twelve months from the end of the reporting period when the employee
has rendered the service. Short-term compensated absences were described in
paragraph 8 as benefits ‘expected to occur’ within twelve months after the end
of the period. Other long-term employee benefits were defined as employee
benefits which are expected to ‘fall due’ more than twelve months from the end
of the period. Therefore, a compensated absence which is due to the employee but
is not expected to occur for more than twelve months, was not an ‘other
long-term employee benefit’ as defined in paragraph 7 of IAS 19, nor was it a
short-term compensated absence as described in paragraph 8 of IAS 19.

The IASB’s intention was to require measurement based on
expected time of settlement. With a view to resolve the above conflict, the IASB
amended the definition of short-term employee benefits and other long-term
employee benefits to replace the terms ‘fall due’ and ‘expected to occur’ with
‘due to be settled.’ It has made a similar amendment in paragraph 8 as well.

Basis for conclusion paragraphs BC4B and BC4C to the amendment provide as below?:

“BC4B?.?.?.?.?the IASB concluded that the critical factor in distinguishing between long-term and short-term benefits is the timing of the expected settlement. Therefore, the IASB clarified that other long-term benefits are those that are not due to be settled within twelve months after the end of the period in which the employees rendered the service.

BC4C?.?.?.?.?The IASB noted that this distinction between short-term and long-term benefits is consistent with the current/ non-current liability distinction in IAS 1 Presentation of Financial Statements. However, the fact that for presentation purposes a long-term benefit may be split into current and non-current portions does not change how the entire long-term benefit would be measured.”

While paragraph BC4B indicates that short-term/ long-term classification should be based on expected settlement, reference to IAS 1 in paragraph BC4C means that a leave may be treated as long-term only if the entity has an unconditional right to defer settlement of liability for at least twelve months after the reporting period.

In other words, whilst the IASB’s intention was to measure such liability based on expected time of settlement, the confusing wordings in IAS 19, both pre and post revision, lend itself to two views.

Position in India?:

In Indian GAAP, the requirements of accounting standard are in line with pre-revised IAS 19. The ICAI has taken a view to treat compensated absences as other long-term employee benefits. Consequently, the practice under Indian GAAP is to treat the leave liability as long-term. In the few IFRS accounts published by Indian companies, it appears that leave liability has been provided based on long-term classification. However, that may not necessarily be what other companies would do, as they start adopting IFRS in 2011.

Further points to consider?:

   i) The IASB has also recognised this issue and has tentatively approved a proposal to amend paragraph BC4C in the basis for conclusion to delete the reference to consistency with IAS 1 and add a sentence to paragraph BC4B to clarify that the definitions of short-term employee benefits and other long-term employee benefits are based on the timing of when the entity expects the benefit to become due to be settled. This indicates that IASB preference is to treat accumulated absences as long-term.

    ii) Globally there appears to be a mixed practice and a mixed view on this issue.

Authors view?:

Under IAS 19?:

The long-term classification for measurement of liability under IAS 19 seems more relevant to India given that this is how it has been accounted for so far, this is the intent of the IASB as well as this is based on ICAI guidance. However, given the confus-ing drafting and reference to IAS 1 in the BC, and the use of the words ‘due to be settled’, the short-term view is also sustainable.

Under IAS 1?:

With regards to presentation under IAS 1 as current or non-current, the same would be current liability because the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.