Leave encashment provision: when a simple accrual is enough and when you need an actuary

Every March, the auditor asks the same question: how did you arrive at the leave encashment number? And every March, a fair number of companies answer with a spreadsheet: balance days times daily rate. For some entities that is fine. For most companies, including small ones, it is not the final figure. The leave encashment provision has to come from an actuary, and the rule that decides this is not where most people look.

Short-term or long-term: the first test

Start with your leave policy, not your size.

• Short-term: leave that must be used or encashed within 12 months after the year end. Book it at the expected cost, undiscounted. Any entity can do this.
• Long-term: leave that can be carried forward and used or encashed later. Under AS 15 and Ind AS 19 this is an "other long-term employee benefit", and the standards ask for an actuarial value using the projected unit credit method.

If your policy lapses all unused leave at year end, or forces encashment of everything every March, you may not have a long-term benefit at all. Most Indian policies carry earned leave forward, so most have one.

Leave carry forward 30 days: the OSH Code changes the shape

The OSH Code, in force since 21 November 2025, sets the rules for annual leave with wages for workers. Two parts matter here:

• earned leave can be carried forward up to 30 days, and the excess at year end has to be encashed, not lapsed;
• leave the worker applied for and was refused carries forward without that limit.

So for workers covered by the Code, part of the balance turns into a payment every year, which is short-term, and part sits on, which is long-term. State Shops and Establishments Acts have their own carry-forward limits for shop staff. Your provision should follow the policy you actually run.

Who needs an actuarial valuation of leave encashment

Here is the part people get wrong. The relief for smaller entities depends on whether you are a company.

Companies. A small and medium-sized company (SMC) under the Companies (Accounting Standards) Rules gets relief from some paragraphs of AS 15: certain disclosures and discounting rules. But ICAI's text still asks an SMC to "actuarially determine and provide for the accrued liability" using the projected unit credit method. There is no size or headcount below which a company can skip the actuary for long-term leave. Ind AS companies apply Ind AS 19 in full.

For reference, an SMC is a company that is not listed, not a bank, financial institution or insurer, had turnover up to ₹250 crore and borrowings up to ₹50 crore, and is not part of a group with a larger company. The status is tested at the year end and applies after two consecutive years.

Non-company entities (firms, LLPs, trusts, proprietors) follow ICAI's levels:

The rational method ICAI gives as an example is exactly the spreadsheet: assume all leave is payable to all employees at the end of the year.

A worked example

A pump maker in Coimbatore is a private company with 140 employees and ₹80 crore turnover, so it is an SMC. At 31 March its employees hold 4,200 days of encashable earned leave, and the average daily rate is ₹1,200.

• The simple accrual gives 4,200 × ₹1,200 = ₹50,40,000.
• Because it is a company and the leave carries forward, that number is only an interim estimate. The year-end figure comes from an actuary, who considers salary growth, attrition, how much leave is actually encashed versus availed, and discounting.
• The actuary's figure might be higher or lower. The difference is booked as a true-up in March.

Now a partnership firm in the same town, ₹8 crore turnover, 30 people. It is Level IV. The ₹50 lakh style accrual is an accepted final figure for it.

Leave encashment tax exemption, and the deduction

Two separate tax questions often get mixed up.

For the company. A leave encashment provision is not deductible when booked. It is deductible only when actually paid, the rule that used to be section 43B(f) and is section 37 of the Income-tax Act, 2025. The Supreme Court upheld the old rule in 2020. So each year's provision is added back in the tax computation, and the payments are claimed instead. Keep the provision in a clearly named account so this is easy.

For the employee. Encashment while in service is fully taxable. Encashment on leaving is exempt up to the least of: the amount received, ten months' average salary, 30 days of leave for each completed year, and ₹25 lakh over a lifetime across employers.

Setting up the leave encashment provision

1. Classify your leave types. Which lapse or are encashed within 12 months, which carry forward.
2. Know your entity type and, for non-companies, your ICAI level and headcount.
3. Run a monthly accrual if you like steady numbers in your management accounts.
4. Book the actuary's figure at year end if you are a company, or a larger non-company, and true up the difference.
5. Mark the provision as not deductible until paid.

On exit, the encashed leave, gratuity and final wages each have their own timeline. The gratuity post covers the biggest of those, and the full and final settlement post covers PF on the final salary.

Vatsin Payroll can post a monthly leave provision journal, off by default. It is a simple accrual and says so on screen; for companies, treat it as the interim number and book the actuary's figure in March.