New Labour Code: Potential Accounting Implications

Government of India is actively working on reforms of various old laws out of which one is new Labour Code which was cleared by both the houses of parliament in July 2019 and received Presidents assent l on 8th August 2019 and called “The code of Wages 2019”

However, many provisions of the Code of Wages 2019 are still not implemented and are yet to be made effective.` The major challenge in bringing about any labour reforms is to facilitate employment growth while protecting workers’ rights. Further, with the passage of time, labour laws needed an overhaul to ensure simplification and updation, along with provisions which can capture the needs of emerging forms of labour (e.g., migrant workers, contract workers, gig workers etc.).

Although the Code on Wages received the assent of the President of India on 8 August 2019, the other three codes were presented in the monsoon session of the Parliament in September 2020.

The Code of Wages seeks to amend and subsume the laws relating to wages and bonus and matters connected therewith or incidental thereto.

Key changes of the labour code are as follows:

Fixed Term Employment
New definition introduced for “Fixed Term Employment” (FTE) to provide benefits to such employees at par with permanent worker. Termination on completion of tenure of FTE will also not be counted as retrenchment. Completion of five years is not mandatory where termination of employment is due to death or disablement.

Gratuity shall be payable on pro rata basis, in case of an employee employed on fixed-term employment or a decreased employee.

Impact on Gratuity benefits
Permanent employees would be eligible for gratuity after completion of five years as presently exists under the Act, while fixed term employees will have no such criteria, such employees will be paid on the basis of the tenure of their employment with the organization.

Overtime: The Code has introduced a provision stating that overtime of workers is subject to their consent for the work.

Strikes and Lock outs – a. Notice period for strike or lock-out – Within 60 days before strike (as opposed to 6 weeks in current regime) b. Prohibition on strike or lockout within 14 days of notice – applicable to all establishments (Reporting by the employer to the authority within 5 days)

Retrenchment/ Lay off/ Closure
Establishment with 300 or more workers to take prior approval of Central or State Government before lay off or retrenchment or closure. (as opposed to current threshold of 100 workers)

There is a new provision added to provide powers to Central Government to defer or reduce the contribution rates (under PF and ESI) for a period of up to 3 months at a time in the case of a pandemic, endemic, or national disaster. This is obviously coming from the on-going Covid-19 pandemic.

Hours of work: 8 hours of daily work is mandatory for all workers; Period of work including rest interval and spread over to be notified. Prohibition of overlapping shifts is applicable to all establishments except for mines.

Leave with wages: The Code applies provisions relating to annual leave with wages to workers of all establishments (1 day for every 20 days of work performed for establishments other than underground mines and 1 day for every 15 days of work performed underground in mines). The eligibility limit has been changed to 180 days from 240 days of working.

Deductions: Under the Code, an employee’s wages may be deducted on certain grounds including: (i) fines, (ii) absence from duty, (iii) accommodation given by the employer, or (iv) recovery of advances given to the employee, among others. These deductions should not exceed 50% of the employee’s total wage.

Determination of bonus: All employees whose wages do not exceed a specific monthly amount, notified by the central or state government, will be entitled to an annual bonus. The bonus will be at least: (i) 8.33% of his wages, or (ii) Rs 100, whichever is higher. In addition, the employer will distribute a part of the gross profits amongst the employees. This will be distributed in proportion to the annual wages of an employee. An employee can receive a maximum bonus of 20% of his annual wages.

Implications
Overall, the code is expected to benefit the employees across various sectors, especially, those working in the unorganized sectors, gig workers and platform workers. The Code requires employers of gig workers and platform workers to contribute an amount of 2% (maximum 5%) of their turnover for the purpose of funding the schemes aimed at providing social security to the workers. It is expected to increase the cost of companies’ operations. It is uncertain whether these costs would be passed on to the workers by way of deductions in their remunerations.

Gratuity for fixed term contractual employees on a pro-rata basis, even if the contract is for less than 5 years, may result in additional gratuity cost, once the new code is enacted. AS 15 and Ind AS 19 require all post-employment defined benefit scheme to be measured using projected unit credit method.

Changes in the terms or membership of a defined benefit plan might result in a plan amendment or a curtailment or settlement. IAS 19 requires an entity to determine the amount of any past service cost, or gain or loss on settlement, by remeasuring the net defined benefit liability before and after the amendment, using current assumptions and the fair value of plan assets at the time of the amendment. Current service cost and net interest are usually calculated using assumptions determined at the beginning of the period.

However, if the net defined benefit liability is remeasured to determine past service cost or the gain or loss on settlement, current service cost and net interest for the remainder of the period are remeasured using the same assumptions and the same fair value of plan assets. The additional expense is charged to profit or loss in the period after the plan amendment, curtailment or settlement, and it might mean that the net defined benefit liability is remeasured more often. Under AS 15, the additional impact can be deferred and charged to profit and loss over the employment term.

AS 12: Recognition of Duty Credit Entitlement Certificates as government grants

Query
A company Y Ltd. has been granted duty credit entitlement certificates equivalent to 5% of foreign exchange earned in the previous financial year under Served From India Scheme. These credit entitlements shall be valid for three years and can be used for import of any capital goods including spares, office equipment and consumables, etc. The entitlement can be transferred to another entity within the same group in case it remains unutilized. Y Ltd. utilized the above entitlement against the import of capital goods and has not paid any import duty on the said import.

Since Y Ltd. utilized the above entitlement against the import of capital goods, the company has capitalized only net cost of capital goods in the books i.e. net of import duty. Y Ltd. treated the entitlement as government grant under AS 12 Accounting for Government Grant. Whether the accounting treatment adopted by Y Ltd. is correct in respect of above transaction?

Answer
No, the accounting treatment adopted by Y Ltd. is not correct.

As per AS 12, the assistance provided by the government to an entity either in cash or in kind for past or future compliances with certain conditions shall be treated as government grant. It shall exclude those forms of grants which cannot be reasonably valued upon and which cannot be distinguished from normal trading transaction. Further, para 8.1 and 10.1 of AS 12 distinguishes between the capital grant and the grant in nature of promoters’ contribution. Those grants which are related to specific fixed assets shall be accounted under capital grant and grants which are provided with reference to total investment shall be accounted under grant in nature of promoters’ contribution.

Looking into the facts, it can be seen that assistance is provided with reference to foreign exchange earnings during the previous financial year; not with reference to total investment in entity. Thus, it would be appropriate to account the above transaction under AS 12 but it should be treated as grant related to revenue. As per the conditions mentioned for utilization of duty credit entitlement, it can be noted that it is not necessary to utilize the credit entitlement for import of capital goods only but can be used for import of consumables, office equipment.

Further, the credit entitlement can be transferred to another entity within the same group which makes it revenue generating in nature. Therefore, Y Ltd. is not correct in showing the grant as deduction from gross value of capital goods.

References

• EAC opinion Query 21, Volume 33
• Opinion finalized on 3 September 2013
• AS 12

Equipment provided free of cost by the buyer cannot be recognized as an asset in the books of entity

Query
A Company say, B Ltd. is engaged in the business of Warships and Submarines. One of its buyer has entered into a contract for construction and delivery of two ships on a fixed price contract basis along with variable component is respect of certain items of cost. Since the product has to be prepared as per the buyer’s specification, B ltd. has installed certain machineries – Buyer’s Furnished Equipment (BFE) supplied by the buyer for which the installation charges were paid by the buyer and included in the contract price. The buyer has delivered the equipment to B Ltd. free of cost for installation purpose.

B Ltd. accounted the above BFEs as inventory and considered its value (cost price) as a part of sale value in the year of delivery. Whether the accounting treatment adopted by B Ltd. in respect of above transaction is correct?

Answer
No, the accounting treatment adopted by B Ltd. is not correct in respect of above transaction.

As per para 49 (a) of the Framework for the Preparation and Presentation of Financial Statements, any item can be termed as an inventory if it meets the definition of asset – a resource controlled by the entity as a result of its past events from which future economic benefits are expected to arise to the entity.

From the facts provided, it can be noted that the BFEs are directly supplied by the buyer to B Ltd. for installation purpose free of cost for which no cost is incurred by B Ltd. Thus, neither any cost is incurred by B Ltd. nor any amount is recoverable on account of such BFEs except installation charges which are included in the contract price. Further, these BFEs are returned to the buyer as a part of product once the product is complete. Therefore, these BFEs cannot be considered as an asset and cannot be treated as a part of inventory. Also, its value (cost price of BFEs) cannot be considered as a part of sale value or revenue to the entity.

References

• EAC opinion Query 12, Volume 33
• Opinion finalized on 22 May 2013

Relevant Extract

Para 49 of Framework for the Preparation and Presentation of Financial Statements
 (a)An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.