Mastering Gratuity Valuation: Key Insights from the Payment of Gratuity Act, 1972
Have you ever thought about what happens when an employee retires after years of loyal service?
They deserve more than just a farewell cake. They deserve gratitude in the form of gratuity. But here’s the catch - calculating it isn’t as straightforward as it seems.
In India, gratuity payments are guided by a law known as the Payment of Gratuity Act, 1972. If you run a business or manage HR or finance, this is something you cannot ignore.
So let’s dive into it - what is gratuity valuation, why it matters, and how it works under this law.
What is Gratuity and Why Should You Care?
Gratuity is a financial “thank you” from employers to employees. It is paid when employees leave after at least five years of service.
This payment reflects appreciation. It supports employees in their life after work. It’s also a legal obligation.
If you run a company with more than 10 employees, the law says - gratuity is not optional.
What Does the Payment of Gratuity Act, 1972 Say?
This law lays down who is eligible for gratuity, how much to pay, and when to pay it. Here’s what it says in simple terms:
Employees must complete five years of continuous service.
Payment is triggered by retirement, resignation, death, or disability.
The gratuity amount is based on salary and tenure.
But there’s more to it. Calculating gratuity isn’t a random guess. It involves proper gratuity valuation.
What Is Gratuity Valuation?
Gratuity valuation is the process of estimating how much a company owes in gratuity - today and in the future.
This is not just about cutting a cheque when someone leaves. You must account for gratuity as a liability in your books.
This valuation helps you stay compliant and plan your finances better.
How Is Gratuity Calculated Under the Act?
The formula used is quite straightforward:
Gratuity = (15/26) × Last Drawn Salary × Years of Service
Here, salary includes basic pay and dearness allowance. The number 26 represents working days in a month.
If someone has worked for 7 years and their last drawn salary is ₹50,000, then:
Gratuity = (15/26) × 50,000 × 7 = ₹2,01,923 (rounded off)
Seems simple? But this is just the surface.
Why Do You Need a Gratuity Valuation?
Imagine this - you have 50 employees. Some are close to retirement. Others just joined.
Can you guess how much you’ll owe in gratuity next year? Or five years later? That’s where gratuity valuation helps.
It gives you a clear picture of your financial liability. It helps you set aside funds.
It also keeps you compliant with accounting standards like Ind AS 19 or AS 15.
What to Consider for Gratuity Valuation?
Here’s the tricky part. The amount you pay depends on many variables:
Employee age
Salary structure
Years of service
Attrition rate
Discount rate (based on government bond yields)
Future salary growth
Actuaries study all these factors. They estimate the total gratuity liability based on statistical models. That’s why you need experts. One wrong assumption can cause big errors in your balance sheet.
Why Following Accounting Standards is Important?
Companies must follow Ind AS 19 (for listed companies) or AS 15 (for others). These standards require full disclosure of gratuity liability.
They also ask for actuarial valuation to measure this liability accurately. If you’re not doing it yet, now’s the time to get started.
What Happens If You Don’t Do the Gratuity Valuation Properly?
Let’s be honest - ignoring this can cost you big time. You could:
Face audit red flags
Show incorrect liabilities
Risk employee disputes
Struggle with cash flow issues when large payments are due
That’s not a situation any responsible employer wants.
How Often Should You Do Gratuity Valuation?
At the very least, you must do a gratuity valuation annually.
But if your workforce is growing or changing rapidly, do it more often. It helps you stay ahead and be better prepared.
Small Business? This Still Matters
Many SMEs feel gratuity isn’t a concern. But if your team is more than 10 people, this law applies. It’s not just about compliance. It’s about showing employees you care. It’s about building trust and goodwill.
How Gratuity Valuation Helps Employees
Put yourself in their shoes. Wouldn’t you want your employer to be prepared for your retirement benefits?
Employees value transparency. A well-planned gratuity policy gives them peace of mind. It also improves retention. People stay where they feel valued.
So, What Should You Do Next?
Review your employee records.
Work with an actuary for accurate gratuity valuation.
Ensure your HR and finance teams are aligned.
Communicate your gratuity policy clearly to employees.
Stay updated on the law and accounting norms.
The best way to handle this is to partner with experts.
Conclusion
Mithras Consultants is an independent actuarial and insurance consultancy firm providing qualitative financial and insurance solutions to its clients.
Our goal is to provide business solutions customised to client‘s needs to help our clients make the best possible decisions on their financial, insurance and risk management programs.
We help you stay compliant. We help you plan better. And we help you protect what matters most - your people.
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