The consolidation of 29 labour legislations into four unified Labour Codes marks a watershed moment for Indian businesses. Effective November 21, 2025, these codescomprising the Code on Wages 2019, Code on Social Security 2020, Industrial Relations Code 2020, and Occupational Safety, Health and Working Conditions Code 2020 will pose significant accounting challenges with corresponding implications for auditors. The ICAI has recently issued FAQs dealing with the accounting implications, which will help clarify challenges impacting financial results for periods ending December 31, 2025.
These accounting challenges would primarily be under AS-15 and Ind AS-19 on Employee Benefits.
Potential Increases in Gratuity Liability:
The increase in liability would arise due to two key reasons:
- Wages definition requiring at least 50% of total remuneration: “Wages” (comprising Basic Pay, Dearness Allowance, and Retaining Allowance) must mandatorily constitute at least 50% of total remuneration. Since gratuity is calculated on last drawn wages, this definitional change would substantially increase gratuity obligations for entities whose wages were previously less than 50% of total remuneration. These changes constitute plan amendments requiring past service cost treatment; entities applying AS-15 must expense these on a straight-line basis over the average vesting period and immediately for vested portions (Para 94 of AS-15), while entities applying Ind AS-19 must expense these by the earlier of the plan amendment date or when restructuring costs are recognised (Para 103 of Ind AS-19), resulting in greater immediate impact.
- Covering fixed-term and contracted employees: These employees would become entitled to gratuity after completing just one year of service, compared to the previous five-year threshold for permanent employees, which will continue.
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Distinguishing Plan Amendments from Actuarial Assumptions:
Separating genuine plan amendments from changes in actuarial assumptions involves critical accounting judgment. When entities simultaneously restructure salaries to comply with new codes while granting salary increases, they must bifurcate the impact. Actual salary increases beyond previous estimates represent changes in actuarial assumptions, while structural reallocation to achieve the 50% threshold constitutes plan amendments. Where entities merely restructure salaries without real increases to comply with the codes, the entire increase in gratuity and leave obligations must be attributed to past service cost and treated as discussed earlier.
Interim Reporting Considerations:
Para 39 of Ind AS 34 and para 38 of AS 25 provide that costs incurred unevenly during a financial year shall be anticipated or deferred for interim reporting purposes only if appropriate to do so at year-end. Since gratuity obligations cannot be deferred at year-end, they must be recognised in interim statements for periods ending December 31, 2025.
Events After Reporting Period:
For financial statements covering periods ending before November 21, 2025, but approved thereafter, the increased gratuity liability represents a non-adjusting event. However, para 21 of Ind AS 10 and para 17 of AS-4 require disclosure of the nature of the event and an estimate of the financial effect.
Other Considerations – Leave Encashment, Disclosure of Exceptional Items and Tax Considerations:
Leave encashment obligations classified as long-term employee benefits would require immediate recognition of past service costs under both AS-15 and Ind AS-19. Given the material and non-recurring nature, entities may consider presenting additional expense as an exceptional item under Schedule III of the Companies Act, 2013, read with paras 85, 86, 97 and 98 of Ind AS-1.
For tax purposes, timing of deductibility remains unchanged, creating deductible temporary differences under Ind AS 12 and timing differences under AS 22, potentially generating deferred tax assets subject to prudence considerations.
Mandatory Funding of Gratuity Benefits:
From a future date to be specified, all private entities must obtain insurance for gratuity liability with LIC or approved insurers, except those with approved self-managed funds or employing over 500 individuals establishing such funds. This would transition many entities from book provisions to pre-funded arrangements, potentially impacting working capital.
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The above challenges would require careful actuarial reassessment, robust disclosures and clear communication with stakeholders about the financial impact.
Audit Implications:
The new Labour Codes also present significant audit challenges requiring enhanced professional scepticism and focused procedures under several Standards on Auditing as follows:
- SA 500 – Audit Evidence: Evaluate the competence, capabilities and objectivity of the actuary as a management expert; obtain an understanding of his work and evaluate the appropriateness of his work as audit evidence.
- SA 540 – Auditing Accounting Estimates and Related Disclosures: Critical for evaluating actuarial valuations, gratuity liability estimates, and management’s assumptions in bifurcating plan amendments from actuarial changes.
- SA 560 – Subsequent Events: Applicable for financial statements with year-ends before November 21, 2025, requiring appropriate disclosure of non-adjusting events and their financial impact.
- SA 701 – Communicating Key Audit Matters: Relevant for listed entities, as the Labour Code implications may constitute key audit matters requiring disclosure in the auditor’s report.
- SA 570 – Going Concern: Important where mandatory gratuity funding requirements significantly impact working capital and liquidity positions.
- SA 580 – Written Representations: Necessary for obtaining management representations regarding the completeness and accuracy of employee benefit calculations and disclosures.
- SA 250 – Consideration of Laws and Regulations: Applicable for ensuring compliance with the new Labour Codes and their accounting treatment.
Auditors must ensure that financial statements transparently communicate these material impacts to stakeholders, with robust disclosures that adequately capture both the quantum and nature of these legislative changes, while maintaining strict adherence to applicable accounting and auditing standards throughout the entire audit process.
