Ind AS Accounting Impact: New Labour Codes Drive Higher Gratuity & Leave Liabilities and Squeeze Corporate Profits in India

Ind AS Accounting Impact: New Labour Codes Drive Higher Gratuity & Leave Liabilities and Squeeze Corporate Profits in India.

How new Indian Labour Codes change gratuity and leave encashment accounting under Ind AS 19 and AS 15, impact corporate profitability, and mandate immediate expense recognition.

India’s New Labour Codes, which came into force on 21 November 2025, represent a watershed moment in labour law reform, consolidating multiple outdated statutes into four unified codes covering wages, social security, industrial relations and workplace conditions.

While aimed at worker welfare and regulatory clarity, these reforms have profound implications for corporate accounting , especially gratuity and leave liabilities.

Most notably, under Indian Accounting Standards (Ind AS), companies must recognise increased employee benefit obligations immediately in profit & loss, potentially weighing on corporate profits in the near term.

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What the New Labour Codes Change

1. Redefined Wage Base
The new Codes reset the statutory definition of “wages”. Employers must treat at least 50% of total remuneration as wages, including basic pay, dearness allowance and retaining allowance. Where an employee’s wages historically fell below this threshold, they are now deemed to be 50% of total pay. This directly increases statutory benefit calculations , including gratuity, provident fund, leave encashment and overtime.

2. Wider Gratuity Eligibility:
Under the legacy Payment of Gratuity Act, 1972, gratuity was payable only after five years of continuous service. The New Labour Codes maintain this for permanent staff but also extend gratuity rights to fixed-term and contractual employees after just one year of service.

3. Leave Benefits and Encashment:
The Codes also revise annual leave access by reducing the minimum days threshold, making paid leave more accessible. As leave encashment hinges on wage definitions, this expands corporate leave liabilities.

Ind AS and AS Accounting-Key Differences.

Corporate Accounting Impact: Ind AS 19
Under Ind AS 19 – Employee Benefits, any change in defined benefit obligations caused by amendments to the plan , such as expanded gratuity eligibility or higher wage bases is classified as past service cost and must be immediately expensed in the Statement of Profit & Loss. This is a stricter treatment than under traditional Indian GAAP.

Indian GAAP Perspective (AS 15):
For entities reporting under AS 15, the vesting status of the benefit matters:
Vested past service cost (i.e., for employees already eligible under prior service conditions) is recognised immediately as an expense.
Unvested past service cost (i.e., future eligibility) may be amortised over the vesting period and recognised gradually.

The result is that Ind AS reporting tends to show a larger upfront expense, with more immediate profit impact compared to AS 15.

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Immediate Profit & Loss Impact
Recognition Timing.

The Institute of Chartered Accountants of India (ICAI) has clarified that *any increase in gratuity and leave liability due to New Labour Codes must be included in interim financial results for the quarter ending 31 December 2025. This is true even though supporting rules for the Codes are still pending notification.

Importantly:
Prior financial statements (before 21 November 2025) are not restated but must disclose the nature and expected impact.
Entities with March year-end must recognise these obligations in Q3 FY26 results.

Expense vs Deferral:

Under Ind AS 19, all past service costs , arising from increased benefits because of plan amendments are expensed immediately, with no deferral or smoothing. This increases expenses in current reporting periods, lowering profits compared to legacy accounting.

Why This Matters for Corporate Financials:

1. Impact on Earnings
Immediate recognition of past service cost means that borderline profitable companies may show sharp profit drops in Q3 FY26. This influences investor sentiment, equity valuations, and performance metrics for executive compensation.

2. Balance Sheet Effects
Higher gratuity and leave accruals increase employee benefit obligations under non-current liabilities and current provisions. While not affecting cash flow immediately, they tighten net worth and financial ratios.

3. Tax Considerations
No special tax deductions apply solely due to New Labour Codes. However, if increased gratuity or leave liabilities will only be deducted for tax upon actual payment, companies may recognise deferred tax assets, subject to prudence testing under Ind AS 12.

Practical Implications for Businesses
Payroll Revision.

Many companies will need to reassess and restructure remuneration components to ensure compliance with the new “wages” definition. For instance, basic pay may need adjustment to meet the 50% threshold influencing provident fund, gratuity computations, and employee take-home pay dynamics.

Financial Planning & Forecasting

Finance teams must revise projections to incorporate the immediate hit to P&L. Sensitivity testing and scenario planning are critical to anticipate varied outcomes based on employee mix, service tenure, and salary structures.

Communication to Stakeholders

Clear disclosures are essential in financial statements and investor communications, especially for listed companies reporting under Ind AS. Transparent explanation of quantification methods, assumptions and estimated impacts builds investor trust.

Sectoral & Workforce Impact:

Fixed-Term Workforce:

The shift enabling gratuity after one year for fixed-term staff particularly affects sectors reliant on contract labour including retail, hospitality, logistics, IT services and manufacturing. Companies with large non-permanent workforces will see proportionately higher liabilities.

Employee Welfare Outcomes:

From an employee perspective, the reforms are widely regarded as progressive:
Earlier access to gratuity benefits improves workplace financial security.
A broader wage definition ensures enhanced provident fund and social security payouts.

Challenges & Uncertainties:

While ICAI’s FAQs have provided guidance on accounting treatment, questions remain on how certain atypical elements such as inclusion of variable pay, ESOPs in gratuity calculation or transition rules pending official Code Rules will be resolved. Companies must track subsequent notifications and regulatory clarifications.

Conclusion:

The New Labour Codes of 2025 mark a significant shift in statutory benefit entitlements in India but their impact is no longer solely legal or HR-centric..

Accounting under Ind AS now places immediate profit consequences on expanded gratuity and leave obligations, requiring companies to revise earnings forecasts and financial disclosures. A combination of compliance readiness, strategic payroll design, and clear communication will be essential for organizations navigating this transition.