Should a provision be created even in case of non fulfilment of affordability clause?

Fact of the case:

• A Public Sector Undertaking (PSU) was a large steel manufacturing company in India. The Company was guided by the Department of Public Enterprises (DPE) for revising the pay scales of its employees.
• As per DPE Guidelines, the revised pay scales would be implemented subject to the condition that the additional financial impact in the year of implementing the revised pay package should not be more than 20% of the average Profit Before Tax (PBT) of the last three financial years. Also, if the additional financial impact of the revised pay package in the year of implementation is more than 20% of the average PBT of last 3 financial years, the revised pay package should be implemented only partly.

Issue with the company

• The Company informed that the average PBT for the past 3 years was negative. Therefore, benefit of salary revision could not be implemented/ extended to executive employees of the company in terms of the extant guidelines issued by DPE on the subject.
• The company had made an ad hoc provision for salary/wage revision in its accounts for the period. Subsequently, the Company management decided that the provisions created were not in line with the directions of the Government of India, and the Board of Directors decided to write back the provision.
• The Company sought the opinion of the Expert Advisory Committee (EAC) on whether, due to non-fulfilment of the affordability clause, any provision is required to be created for wage revision of employees.

EAC Opinion

• The Committee is of the opinion on the issue raised above that as per the requirements of Ind AS 19, employee benefits which are expected to be paid in exchange for the employee services during a period are required to be provided for as liability
• And a provision for liability is recognised when an entity has a present obligation for which it is probable that an outflow of resources is needed, and can be reliably estimated. An element of judgement is required to determine whether there exists an obligation, and therefore whether a provision needs to be recognised or not.
• The EAC states that the Government guidelines stipulate that since the 3 years PBT is negative there is no obligation on the Company to account for a wage revision.
• The Company will however, need to evaluate legal enforceability of the Government Guidelines, negotiations with the trade unions, any past experience of the Company, any past informal practice, any legal opinion to determine whether it has a present obligation.
• If it is determined that a present obligation exists, and other conditions as per paragraph 14 of Ind AS 37 are met, the provision should be recognised. However, where it is determined that ‘present obligation’ does not exist, or due to any other reason, provision could not be recognised, then the company should also consider whether there is any need for disclosure as a ‘contingent liability’ (unless the possibility of an outflow of resources embodying economic benefits is remote), as per the requirements of Ind AS 37.

Manav Rajgaria, Audit Associate, SW India