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Calculation of loss of pay – Part II

May 25, 2010 2 comments

In the previous post, we talked about how some organizations make the mistake of presenting loss of pay as a deduction in payroll instead of reduction in pay. Let us examine some more issues pertaining to loss of pay in this post.

Loss of pay when pay calculation is on the basis of the calendar day logic

If your organization follows the calendar day logic, ensure that you record dates pertaining to the days for which loss of pay should be applied for an employee. For example, let us assume that the payroll manager wishes to apply 1 day loss of pay for an employee in July payroll. It is important for the payroll manager to know to which month the loss of pay pertains. Depending on the month, the loss of pay value would change. If the employee has a monthly salary of Rs. 31,000 on which loss of pay has to be applied, the value of one-day salary in July is Rs. 1,000 (Rs. 31,000/31 days) while the value of one-day salary in June is Rs. 1033 (Rs. 31,000/30).

In case the loss of pay pertains to a day in June, and if the payroll manager applies a 1 day loss of pay in July and reduces pay by Rs 1,033 instead of Rs. 1,000, he would be committing a mistake.

Hence, in the above example, the payroll software should have the capability to take the loss of pay input by way of dates, calculate the correct loss of pay amount and reduce pay accordingly. It may be noted that many of the payroll software applications in India simply take the loss of pay input by way of days without taking cognizance of the month in which the loss of pay days fall.

Taking cognizance of dates is important not only for calculation but also for reversal of loss of pay. There are occasions when loss of pay, applied in the previous month’s payroll, may be reversed in a subsequent month on account of loss of pay having been applied by mistake earlier. Again, if the dates pertaining to the loss of pay are not considered, the reversal of loss of pay may be done incorrectly and the employee may be credited with a loss of pay reversal amount which may be different from the actual loss of pay amount deducted earlier.

Impact of loss of pay on pay arrears

Whenever pay structure changes happen with retrospective effect, payroll managers should remember to make adjustments for loss of pay, if applicable, while calculating arrear pay. Here again, unless dates pertaining to loss of pay days are recorded, the payroll manager may be calculating arrear pay incorrectly.

For example, let us assume that an employee has 1 day loss of pay in June. If the organization hikes pay by revising the pay structure of the employee in August with effect from June 1, the payroll manager should ensure that the arrear pay is calculated after taking into the impact of the one-day loss of pay in June.

Clarity in loss of pay rules for non-statutory deductions in payroll

We find that in many organizations there is no clear-cut policy pertaining to application of loss of pay on deductions, particularly with reference to fixed deductions such as loan recovery and those on account of benefits such as accommodation, recreation club facility, and transport provided by the organization.

The organization’s policy should specify if there is a hierarchy among deductions with regard to applying loss of pay. For example, a loan recovery may come first and a deduction for recreation club may come later.

In case an employee has loss of pay for the whole month, the policy should specify if fixed deductions should be carried out, given the possibility of a negative net salary on account of 100% loss of pay. If deductions such as loan recoveries are deferred to subsequent months on account of 100% loss pay, the payroll manager should re-work perquisite valuation, if applicable, on loan deductions and re-calculate the income tax liability for the year.

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Categories: Payroll

Calculation of loss of pay – Part I

May 21, 2010 7 comments

The basis of calculation of loss of pay for employees is fairly well established, yet, we come across many instances of incorrect calculation of loss of pay in organizations. The mistakes we are talking about here are not calculation errors but those on account of organizations adopting an incorrect basis for calculation of loss of pay.

Let us look at a common mistake committed by payroll managers while calculating loss of pay on employee salary.

Loss of pay amount as a deduction in payroll

Some payroll managers view loss of pay as a deduction in payroll instead of a reduction in pay. For example, an employee receives a monthly Basic salary of Rs. 10,000 in April and is entitled to no other head of pay. The Provident Fund (PF) contribution is Rs.  1,200 per month (12% of Rs. 10,000). The company in which the employee works follows the calendar day basis for pay calculation. If the employee has no loss of pay in April, his salary statement will read as follows.

Earning
Basic Salary : Rs. 10,000
Deduction
Provident Fund : Rs. 1,200
Net Pay : Rs. 8,800

If the employee has 15 days loss of pay for April, the company calculates the loss of pay to be Rs. 5,000 for April, shows this as a deduction, and calculates the net pay as follows.

Earning
Basic Salary : Rs. 10,000
Deduction
Provident Fund : Rs. 1,200
Loss of Pay Deduction : Rs. 5,000
Net Pay : Rs. 3,800

The above method is wrong since PF is calculated on “fixed” Basic instead of “earned” Basic for the month. Instead of presenting the loss of pay amount as a deduction, the company should reduce the pay to arrive at the net pay. For the above example, the net pay should be calculated as follows.

Earning
Basic Salary : Rs. 5,000
Deduction
Provident Fund : Rs. 600
Net Pay : Rs. 4,400

In the above example, the company ends up paying a lower net salary — Rs. 3,800 instead of Rs. 4,400 for the month — on account of incorrect loss of pay calculation.

Specifying loss of pay as a deduction in payroll leads to incorrect income tax, PF, and Employee State Insurance (ESI) deduction calculation.

When loss of pay is stated as a deduction, the income tax, if the employee has taxable income,  is calculated on full pay and hence the employee ends up paying income tax on salary he doesn’t receive. While for PF and ESI, both employer contribution and employee deduction are overstated.

Presenting loss of pay as a deduction (instead of reduction in pay) may look like a silly mistake. But you would be surprised to know that there are many companies that commit this silly mistake while processing payroll each month.

We will examine some more issues pertaining to loss of pay calculation in the next post.

Enhancement of wage limit for ESI coverage

May 2, 2010 Leave a comment

The Ministry of Labour and Employment, Government of India, has notified that the wage-limit for coverage of employees under the Employee State Insurance (ESI) scheme will be Rs 15,000 per month effective May 1, 2010, as against Rs 10,000 earlier.

Click here to read the government notification.

The new rule could bring in more employees under ESI in your organization from May 2010. If your organization is still to come under ESI, check if the number of additional employees that would be eligible for ESI on account of the wage-limit enhancement will require your organization to go for mandatory ESI registration.

In addition, keep in mind to apply the new wage-limit while including employees for ESI calculation from May 2010 payroll onwards.

Categories: ESI