What is Gratuity?

Gratuity is an employee benefit that may become payable when an employee's employment ends, subject to the applicable statutory requirements and employment terms. Gratuity is generally linked to an employee's eligible service and the salary considered under the applicable rules. It may become payable on events such as retirement, resignation, death or other qualifying circumstances.

For financial reporting, however, gratuity is not simply the amount that would be payable if an employee left today. An employer may have an obligation for benefits earned by employees over their period of service, with the eventual amount affected by factors such as future salary increases, employee turnover and the timing of payment.

Gratuity generally depends on an employee’s length of service, applicable wages, and the circumstances of exit. In India, gratuity is currently governed by the Code on Social Security, 2020, effective from November 2025, which replaced the earlier Payment of Gratuity Act, 1972. The Code also introduced changes to eligibility and wage-related provisions, including specific rules for fixed-term employees.

The statutory benefit may also be supplemented by an employer’s policy or employment terms. However, the amount payable to an employee is different from the employer’s accounting liability, which may require actuarial valuation.

If an employer has a gratuity obligation that falls within an applicable accounting framework, such as AS 15, Ind AS 19 or IAS 19, an actuarial valuation is generally needed to measure and report the obligation. Whether a valuation is required depends on the relevant labour laws, the accounting framework and the nature of the benefit, not simply on the size of the organisation.

Gratuity is a future benefit, and the amount ultimately payable cannot always be determined from today's salary and service alone. The eventual payment depends on assumptions about how long employees stay, how salary grows, and when payment falls due, not only today's salary and service record. The accounting liability represents the present value of this expected obligation, which is why it is measured through valuation rather than a simple current-date calculation.

Gratuity actuarial valuation is typically performed annually, usually at the company’s financial year-end, to support financial reporting.

Companies preparing interim financial statements may also need the obligation assessed or updated at interim reporting dates, depending on their reporting requirements and materiality.

An out-of-cycle valuation may also be required when there is a material change in employee data, salary structure, benefit terms, workforce composition or other assumptions that could significantly affect the gratuity obligation.

The process begins with employee data: age, salary, service and relevant plan terms. An actuary selects appropriate assumptions, projects the gratuity each employee is expected to earn, and attributes that benefit to periods of service already rendered. The attributed benefit is then discounted to present value, with results documented in a report supporting the financial statements.

The Projected Unit Credit Method (PUCM) is an actuarial method used to measure an employee benefit obligation. Under this method, each period of an employee’s service is treated as giving rise to an additional unit of benefit.

For gratuity valuation, the method estimates the benefit that an employee is expected to receive in the future, taking into account factors such as future salary, expected length of service, employee turnover and the timing of payment. The expected future benefit is then allocated to the periods of service and discounted to its value as of the reporting date.