Accounting Implications of the New Labour Codes on Gratuity and Leave Encashment

1. Background

The Government of India has consolidated 29 existing labour laws into four Labour Codes, effective 21 November 2025, including the Code on Wages, 2019 and the Code on Social Security, 2020. One of the most significant changes introduced is the redefinition of “wages” whereby basic pay, dearness allowance and retaining allowance together must constitute at least 50% of the total remuneration.

This statutory change has far-reaching consequences from an ‘accounting’ point of view, particularly for employee benefit obligations such as gratuity and leave encashment, both of which are computed with reference to ‘wages’. The impact is not merely prospective; it alters the measurement of benefits attributable to past employee service, thereby triggering complex accounting considerations.

Recognising these challenges, the Institute of Chartered Accountants of India (ICAI), through its Accounting Standards Board, has issued FAQs on key accounting implications arising from the New Labour Codes. These FAQs provide authoritative guidance on the application of AS 15 – Employee Benefits and Ind AS 19 – Employee Benefits in this context.

2. Accounting Framework: AS 15 vs Ind AS 19

Both AS 15 (Indian GAAP) and Ind AS 19 treat gratuity and long-term leave encashment as employee benefits requiring actuarial valuation. However, the standards differ materially in how incremental obligations arising from plan changes are recognised in the Statement of Profit and Loss.

Before analysing the impact of the Labour Codes, it is essential to clearly understand two foundational concepts under AS 15 and Ind AS 19—actuarial gains and losses and past service cost.

3. Actuarial Gains and Losses – Meaning

As per AS 15 (Revised 2005), actuarial gains and losses comprise:

• Experience adjustments, being the effects of differences between previous actuarial assumptions and what has occurred and
• Effects of changes in actuarial assumptions, such as discount rates, salary escalation, attrition, or mortality.

Actuarial gains and losses therefore arise from re-measurement of estimates used in valuing employee benefit obligations. Importantly, they do not involve any change in the benefit structure itself, but only reflect updated assumptions or actual experience differing from expectations.

4. Past Service Cost – Meaning and Relevance

AS 15 defines past service cost as:

“The change in the present value of the defined benefit obligation for employee service in prior periods, resulting in the current period from the introduction of, or changes to, post-employment benefits or other long-term employee benefits. Past service cost may be either positive (where benefits are introduced or improved) or negative (where existing benefits are reduced).”

Past service cost arises when there is a change in benefit design, either due to:

• Employer policy decisions or
• Statutory amendments, such as those introduced by the New Labour Codes.

Why the Labour Codes Trigger Past Service Cost

The ICAI FAQs clarify that the impact of the New Labour Codes constitutes a plan amendment, not an

actuarial re-measurement.

Specifically:

• Gratuity:
  The increase in liability arises due to:
  • a higher wage base (minimum 50% of total remuneration), and
  • extension of gratuity eligibility to fixed-term employees after one year.
    Both factors alter the benefit formula and eligibility for past service, resulting in past service cost.
• Leave encashment:
  Where accumulated leave is classified as an other long-term employee benefit, any additional obligation arising from revised wage definition or eligibility conditions is also treated as past service cost.

Salary Restructuring vs Assumption Changes

A practical nuance arises where entities simultaneously revise salary budgets:

• Any increase arising from higher expected future salary growth (for example, revising long-term increments from 10% to 12%) represents a change in actuarial assumption and is reflected as actuarial gain or loss.
• The structural reallocation of CTC to comply with the 50% wage rule is a plan amendment, giving rise to past service cost.

Finance function should therefore ensure that actuarial reports clearly bifurcate these two components to ensure accurate classification in profit or loss.

6. Recognition of Past Service Cost

6.1 Treatment under AS 15 (Indian GAAP)

Under AS 15, recognition of past service cost for post-employment benefits such as gratuity depends on vesting:

• Vested past service cost is recognised immediately in the Statement of Profit and Loss.
• Unvested past service cost is amortised on a straight-line basis over the average remaining vesting period.

For other long-term employee benefits, including long-term leave encashment, AS 15 requires immediate recognition, irrespective of vesting.

In practice, given that a large proportion of employees in mature organisations have already completed the minimum service requirement, most of the incremental impact is likely to be front-loaded even under AS 15.

6.2 Treatment under Ind AS 19

Ind AS 19 adopts a more stringent approach:

• All past service cost, whether vested or unvested, must be recognised immediately in the Statement of Profit and Loss at the date of plan amendment.
• There is no concept of amortisation or deferral.

Accordingly, Ind AS entities are likely to experience a sharp one-time increase in employee benefit expense and defined benefit obligation in the period when the Labour Codes are applied.

7. Important Note on Vesting Period for Gratuity

For permanent employees governed by gratuity law, the vesting period is always five years of continuous service. This vesting period does not change with increase in total years of service.

Once an employee completes five years:

• The entire gratuity benefit becomes fully vested.
• Irrespective of whether the employee has completed 6, 10 or 20 years, no portion of gratuity remains unvested.

From an accounting perspective under AS 15:

• For employees who have completed five years, the entire past service cost must be recognised immediately, with no amortisation.
• Amortisation is relevant only for employees who have not yet completed the minimum vesting period (or fixed-term employees with less than one year of service)

8. Leave Encashment – Accounting Treatment

Any increase in leave encashment obligation arising from the New Labour Codes is recognised immediately in the Statement of Profit and Loss under both AS 15 and Ind AS 19. AS 15 does not permit amortisation of past service cost for leave encashment, irrespective of vesting.

9. Timing, Interim Reporting and Events Analysis

For entities with a 31 March year-end, additional gratuity and leave liabilities must be recognised in interim financial statements for the quarter ending 31 December 2025, measured on a year-to-date basis, where legal evaluation indicates enforceability.

For periods ending prior to 21 November 2025, the enactment of the Labour Codes constitutes a non-adjusting event. While no adjustment is made to earlier financial statements, appropriate disclosures regarding the nature and estimated financial impact are required under Ind AS 10 / AS 4.

10. Illustration

Past Service Cost and it’s recognition (AS 15 and AS 19)

Basic facts

Total monthly remuneration per employee: ₹100,000

Wages (basic + DA) before change: ₹35,000 (35% of total)

Wages after change (to meet 50% rule): ₹50,000 (no change in total CTC)

Average past service completed: 10 years

The actuary performs three valuations on the same date:

1. Old plan, old assumptions (wages ₹35,000, salary growth 10%)
   • Defined Benefit Obligation (DBO): ₹200,000
2. Old plan, new assumptions only (wages ₹35,000, salary growth increased to 12%)
   • DBO: ₹210,000
   • Increase of ₹10,000 (₹210,000 – ₹200,000) is due solely to a change in actuarial assumption (higher expected salary growth).
   • This is treated as an actuarial loss, not as past service cost.
3. New plan, new assumptions (wages ₹50,000, salary growth 12%)
   • DBO: ₹290,000
   • Additional increase of ₹80,000 (₹290,000 – ₹210,000) arises because the benefit formula has changed (higher wage base and extended eligibility).
   • This ₹80,000 is past service cost arising from the Labour Codes.

Vested vs Unvested split

Assume the actuary further analyses the ₹80,000 past service cost and concludes:

• 70% (₹56,000) relates to employees who have already completed the minimum 5 years’ service and are vested.
• 30% (₹24,000) relates to employees who have not yet completed 5 years; their average remaining vesting period is 3 years.

Under AS 15

₹56,000 would be recognised immediately in statement of profit and loss in year of plan amendment and ₹24,000 would be recognised on straight line basis over period of 3 years.

Under Ind AS 19

• The entire past service cost of ₹80,000 is recognised immediately in profit or loss in the period of the plan amendment, irrespective of whether the benefits are vested or unvested.

Conclusion

The redefinition of wages under the New Labour Codes represents a fundamental change in employee benefit structure, not a mere actuarial re-measurement. Its financial impact must therefore be accounted for as past service cost, with careful attention to vesting principles under AS 15 and immediate recognition under Ind AS 19. Clear classification, timely actuarial input, and transparent disclosures will be critical as entities transition into the new code.

Author: Shuchi Maitra