Gratuity Provision: How to Accrue It Every Month
Gratuity is a real monthly liability from year one, not a bill on exit. How to accrue half a month's salary per year and post the journal entries.
On this page
- Why the liability is real even before five years
- The simple accrual method
- The actuarial method and when it is required
- Journal entries for the provision and the payout
- Is the provision tax deductible?
- Worked example: 12 employees, mixed service lengths
- Reviewing the provision at year end
- Frequently asked questions
- Do I need to provision for staff with less than 5 years of service?
- What if an employee leaves before 5 years?
- Does a pay rise change the provision for past years, not just the current one?
- Is gratuity itself taxable to the employee?
- Should the provision include ETF or EPF?
Provision for gratuity every month. Do not wait until someone resigns. The rule: half a month’s wage or salary, at the rate last drawn, for each completed year of service, restated every time salaries change. Ignoring it until an employee leaves does not remove the liability (the money you owe). It just means the whole bill lands on one month’s accounts instead of being spread across the years it was earned.
Why the liability is real even before five years
Under the Payment of Gratuity Act No. 12 of 1983, a qualifying employee (5 or more completed years, and an employer with 15 or more workmen on any day in the 12 months before the employee left) is entitled to a gratuity. That is half a month’s wage or salary, at the rate last drawn, per completed year of service (s.6(2)(a)). By law, nothing is payable before the 5-year mark. But that does not matter for your accounts. An employee who has worked 3 years has already earned 3 years of that gratuity. It becomes payable the moment they cross into year 5. Wait until 5 years, or until someone resigns, and your accounts have understated money you really owe for years. This is the idea behind LKAS 19 Employee Benefits: gratuity is a defined benefit (a future payment based on service and salary). The cost is recognised as the employee works, not when it is paid.
The simple accrual method
Most small businesses use a simple monthly accrual, not a full actuarial valuation (a calculation done by a specialist called an actuary):
- Take each employee’s current monthly basic pay (or the parts the Act treats as “wage or salary” for gratuity), at the rate last drawn.
- Divide by 2 to get “half a month’s salary”.
- Multiply by completed years of service. The Act itself only pays out on completed years. But accruing part of the current year monthly, by policy, keeps the provision closer to the true position.
- Add up the total across all employees. That is the provision balance your accounts should carry.
- Each month, adjust for a year added, a salary increase, new joiners, and leavers who were paid out. A salary increase changes the value of all past years, not just the new one.
A bookkeeper can run this simple method in a spreadsheet or payroll system. Its main limit: it assumes every employee reaches their gratuity date, and ignores staff who leave before 5 years. It also ignores the time value of money: money paid years from now is worth less than money today.
The actuarial method and when it is required
LKAS 19 requires the defined benefit obligation to be measured using the Projected Unit Credit method. An actuary calculates this from assumptions about staff turnover, discount rates, salary growth and how long staff live. Many small and medium Sri Lankan firms use the simple accrual instead. Their auditors accept it where the difference from an actuarial valuation is not material (not big enough to change a reader’s view of the accounts). Whether your simple method still holds, or your provision now needs a full valuation, is a materiality judgement your own auditor makes. Ask them directly, rather than assume last year’s approach still applies.
Journal entries for the provision and the payout
A typical monthly entry, using example account names:
| Entry | Debit | Credit |
|---|---|---|
| Monthly gratuity provision (the increase in the balance for the month) | Gratuity expense (profit and loss) | Provision for gratuity (balance sheet liability) |
| Gratuity actually paid to a leaver | Provision for gratuity (balance sheet liability) | Bank |
| If the leaver’s entitlement is more than what was provisioned for them (for example a late salary increase not yet reflected) | Gratuity expense (P&L), for the shortfall | Bank, for the shortfall |
The provision stays a liability (money you owe) the whole time the employee is owed it. Only the payment reduces cash and clears it. The most common mistake: posting the full payout to expense in the exit month, with nothing provisioned. This understates profit in the years the liability was earned and overstates the expense in the exit year. For the wider set of monthly payroll postings, see Payroll Journal Entries for Sri Lankan Employers.
Is the provision tax deductible?
Tax deductions under the Inland Revenue Act No. 24 of 2017 generally follow expenses actually incurred in producing income for the year. That is not always the same as an accounting book provision under LKAS 19. Contributions paid into a gratuity fund or trust approved by the Commissioner-General of Inland Revenue are dealt with apart. Such a fund is itself taxed at a concessionary rate (a lower rate). That suggests the tax system treats a funded, approved setup differently from an unfunded book entry. Your own year-end provision is not the same as an actual payment, and not the same as a contribution to an approved fund. Ask your accountant or tax adviser whether it is deductible when charged or only when paid. Get that confirmed before relying on it for a tax return.
Worked example: 12 employees, mixed service lengths
| Employee | Monthly salary (LKR) | Completed years | Provision at half a month × years (LKR) |
|---|---|---|---|
| A | 150,000 | 8 | 600,000 |
| B | 95,000 | 3 | 142,500 |
| C | 220,000 | 12 | 1,320,000 |
| D | 80,000 | 1 | 40,000 |
| E–L (8 staff, average) | 90,000 average | 4 average | 1,440,000 (combined) |
| Total provision | 3,542,500 |
This is the provision balance for these 12 employees, based on current salaries and completed years, not the amount paid out this year, since most have not left. Check any figure against the gratuity calculator, and confirm start dates. See Length of Service: Counting Years for Gratuity for what counts as continuous service.
Reviewing the provision at year end
- Redo every employee’s provision using the year-end salary and completed years. Do not use a mid-year average.
- Check the account: opening balance, plus the year’s charge, less payouts to leavers, should equal the closing balance.
- Flag anyone who has crossed, or is close to crossing, the 5-year mark.
- Confirm with your auditor whether the simple accrual is still right for you as headcount or average tenure grows.
- Keep the working papers. The Act gives the Commissioner of Labour power to inspect gratuity records.
Non-payment of a gratuity that has fallen due carries its own surcharge and recovery rules. See surcharge and recovery. But that only bites once the 30-day deadline has passed on a termination. Provisioning properly stops that deadline becoming a cash-flow crisis. For eligibility and calculation rules, see 6 things to know about gratuity in Sri Lanka.
Do this automatically in Humanised. Payroll software for accountants calculates EPF, ETF and APIT for every client each month. It keeps each client’s full payroll history in one login.
This is general payroll guidance. Every case is different. For your own case, speak to a payroll practitioner or a lawyer.
Frequently asked questions
Do I need to provision for staff with less than 5 years of service?
Yes, good accounting practice says so. The cost accrues from the first year, even though it is not payable until 5 years. Whether to accrue fractional years is a policy choice. Not provisioning at all for under-5-year staff understates the liability.
What if an employee leaves before 5 years?
No gratuity is payable under the Act, unless they die or retire due to ill health before then, which the Act treats separately. So you reverse their provision balance out of the accounts rather than pay it.
Does a pay rise change the provision for past years, not just the current one?
Yes. Gratuity is calculated on the salary last drawn. So a salary increase raises the value of every completed year already accrued. It is not just the year the increase took effect. Redo the full provision, not just the new year, whenever salaries move.
Is gratuity itself taxable to the employee?
Retiring gratuity is a terminal benefit, subject to Inland Revenue Department withholding rules above certain combined thresholds. Whether a payment qualifies for a lower rate or an exemption depends on your circumstances. Check with a tax adviser.
Should the provision include ETF or EPF?
No. EPF and ETF are separate contributions required by law, worked out monthly on ongoing earnings. Gratuity is a distinct exit benefit under its own Act, with its own separate provision.
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