Education

PPF schemes: convenient or not?

DOLPHY D?SOUZA | Updated on November 20, 2011

A company operating a private PF scheme needs to ensure that the annual return credited to the balance of each employee is not less than that on the Government-operated scheme.

Some Indian companies prefer operating provident fund (PF) schemes on their own rather than using the Government fund for reasons of administrative and other convenience. One key eligibility condition for a private trust is that the benefit provided to an employee should not be lower than that offered under the Government-operated scheme.

The Government declares the return payable on its PF scheme annually. A company operating a private PF scheme needs to ensure that the annual return credited to the balance of each employee is not less than that on the Government-operated scheme.

If the PF trust earns a low return on its investments, the company needs to compensate the fund for the deficit. If the funds of the trust are embezzled, the employer will have an obligation to make good the loss. If the trust earns a high return on the investment, the excess can either be added to the employees' PF balance or carried forward to compensate for future deficits.

If a company opts for the Government-operated scheme to provide PF benefit to its employees, it treats this as a defined contribution scheme because its obligation under the scheme is limited to the amount contributed to the fund. Thereafter, it is the responsibility of the Government to manage the fund and pay the accumulated amount to the employees.

Two options

In the case of a private PF scheme, the company operating such a scheme is responsible for providing the principal along with a specified rate of return. Hence, the actuarial and investment risk of the scheme fall, in substance, on the company.

Therefore, such a scheme is a defined benefit plan, which, under Indian GAAP, needs to be accounted for according to an actuarial valuation using the projected unit credit method (PUCM).

PUCM involves projecting future salaries and straight-lining the PF impact thereof to determine the current service charge to the P&L for each year. As future salaries will be high, the PUCM will entail a substantially higher charge to the P&L account compared to the annual contribution charge in the case of a defined contribution plan.

PUCM also requires the company to project forward the benefit payable at the expected rate of return on the Government-operated scheme and discount this to the present value. To project forward the benefit payable, a company needs to estimate the interest rate likely to be declared by the Government on the Government-operated scheme. In practice, this rate is generally not available for periods exceeding one year and may not be possible to estimate.

Lack of clarity

While a privately managed PF scheme is a defined benefit scheme, neither the standard setters nor the actuarial society/institute has provided any guidance on application of the PUCM to private PF schemes.

Because of the lack of guidance and the issues involved in doing a PUCM, barring very few exceptions, all companies account for PF funds as a defined contribution scheme. Further, a note is added in justification that the actuary cannot determine the fair value. Many companies, however, do create a provision for any current shortfall in the return on the fund. For example, if the return on the fund is 8 per cent and the Government requires 9 per cent to be credited to the employee's account, a provision of 1 per cent is generally made.

Accounting for a private PF scheme is a complex issue under Indian GAAP. The standard setters should provide appropriate guidance on accounting for private PF schemes. A temporary but operational solution may be to make a provision for the full deficit in the fund (without considering future shortfalls that may arise because the fund's earnings are less than the Government declared rate) rather than applying the PUCM method.

For example, if the fair value of the fund is Rs 10 crore and the total obligation to employees, along with interest accumulation for all the past years as well as the current year is Rs 12 crore (based on Government declared rates), a provision for the deficit of Rs 2 crore should be made, preferably accompanied by a funding of that amount.

This issue has gained considerable importance because the Government has declared an interest rate of 9.5 to be credited to employees' accounts whereas many private PF trusts could be earning considerably lower, resulting in a significant deficit amount.

(The author is Partner Assurance, Ernst & Young.)

Published on November 20, 2011

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