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The spirit of conservatism has been ingrained into accountants and followed by accounting policies with the diktat to anticipate no profits, but provide for all known losses. State Bank of India (SBI) created a flutter when its annual results nosedived due to a liberal provision for bad debts and a monstrous provision for pension payments.
Reading the 146 paragraphs in Accounting Standard- 15 on Employee Benefits issued by the Institute of Chartered Accountants of India (ICAI) can be a cumbersome task. But the impact these have on the financial statements of an entity can make one sit up and take notice.
The standard details that the ultimate cost of a defined benefit plan may be influenced by many variables such as final salaries, employee turnover and mortality, medical cost trends and, for a funded plan, the investment earnings on the plan assets.
In order to measure the present value of the post-employment benefit obligations and the related current service cost, it is necessary to make actuarial assumptions and get an actuarial valuation and attribute benefits to period of service.
AS-15 insists on the projected credit unit (PCU) method as the basis for actuarial valuation. To the layman, the PCU method would mean arriving at the liability by pro-rating the years of service with the benefits payable. Actuarial gains and losses hit the profit and loss account while the liability keeps aggregating every year.
Impact on SBI
SBI applied AS-15 after the Ninth Bipartite Settlement increased the wages of bank employees and triggered an amendment to the SBI Pension Fund Rules. The Actuary valued the pension liability at Rs 11,707 crore. The provision existing was a miniscule Rs 1306.70 crore.
The additional pension cost of Rs 7927.41 crore in respect of past service cost and Rs 2,473 crore for the period 2010-11 should have hit the profit and loss account. But the Reserve Bank of India dispensed with this requirement in a letter DBOD/BP/No./16165/21.04.018/2010-11 dated April 18, 2011 as a result of which SBI set off Rs 7927.41 crorewith its Statutory Reserves. This policy has been mentioned by the Auditors in their report with the preface that the remark is not a qualification.
The significance and materiality of this can be gauged from the statistic that the provision for past service cost equalled almost 96 per cent of the net profits of SBI. The Ninth Bipartite Settlement also reopened the pension option to employees of public sector banks. The Payment of Gratuity Act increased their limits.
These twin provisions resulted in higher provisions as per AS-15. Circular No DBOD.No. BP.BC.80/ 21.04.018/2010-11 dated February 9, 2011 of the RBI permitted banks to amortise this burden over a period of five years. Utilising this concession, SBI did not charge Rs 400 crore to profits. Other banks too have had to take similar hits, though the impact has not been so intense.
Applying Accounting standards
Concerns have been raised whether there was an under-provisioning in earlier years since the impact of a wage revision cannot create so much havoc in a single year. The Bipartite Settlement was inked in early 2010 and hence SBI had enough time to announce the impact during the year. Since the advent of Ind-AS/ IFRS and its acceptance of sudden-death hits to the financial statements, the concept of slow poison or amortising unexpectedly huge costs over a period of time is virtually non-existent.
The SBI saga shows that the RBI would certainly announce standards where alternative treatments from Ind-AS/IFRS would be permitted.
A glimpse of what is to come is evident in the Circular of February 9, 2011 in which the RBI states that consequent upon the introduction of International Financial Reporting Standards (IFRS) from April 1, 2013 (though this date is yet to be formalised) for the banking industry as scheduled, the opening balance of reserves of banks will be reduced to the extent of the unamortised carry forward expenditure.
One can expect similar announcements on fair value, providing for sticky debts and income recognition and asset classification (ICAR) norms. Banks are already debating the possibility of creating a monthly provision for employee benefits to prevent running into a storm at the year-end.
(The author is a Bangalore-based chartered accountant.)
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