Provision Requirement for MSMEs under New Labour Codes – An Accounting & Compliance Perspective

Provision Requirement for MSMEs under New Labour Codes – An Accounting & Compliance Perspective

Introduction

The introduction of India’s New Labour Codes has brought significant changes to employment regulations, wage structures, and employee benefit calculations. With several large corporates announcing provisions in their Profit & Loss accounts to account for the expected impact of these Codes, many Micro, Small and Medium Enterprises (MSMEs) are uncertain about their own compliance obligations.
A common question faced by MSME promoters, accountants, and auditors is:
“Are MSMEs also required to create provisions in their Profit & Loss accounts for the New Labour Codes?”
The answer lies not in speculation or market trends, but in a careful reading of applicable Accounting Standards and the current legal enforceability of the Labour Codes.
This article explains, in detail, whether provisioning is mandatory for MSMEs, and outlines the correct accounting and disclosure approach under existing standards.

Understanding the New Labour Codes – A Brief Context

The Government of India has consolidated 29 existing labour laws into four Labour Codes:

1. Code on Wages, 2019
2. Code on Social Security, 2020
3. Industrial Relations Code, 2020
4. Occupational Safety, Health and Working Conditions Code, 2020
   One of the most significant changes impacting employers is the uniform definition of “wages”, particularly under the Code on Wages. This definition affects:
   • Provident Fund (PF) contributions
   • Gratuity calculations
   • Leave encashment
   • Bonus eligibility
   Large organisations have already begun evaluating and recognising the expected increase in employee benefit obligations.
   However, the accounting treatment for MSMEs differs substantially from that of large listed companies.

Difference Between Large Corporates and MSMEs

Large corporates (such as listed IT companies) generally:
• Follow Ind AS (Indian Accounting Standards)
• Apply forward-looking estimates
• Recognise liabilities based on probability and management judgement
• Face strict regulatory scrutiny from SEBI and institutional investors

Most MSMEs, on the other hand:
• Follow Accounting Standards (AS) notified under the Companies (Accounting Standards) Rules
• Are governed by AS-29, AS-1, AS-5, and AS-15
• Are required to recognise liabilities only when legally enforceable and reliably measurable
Therefore, the provisioning logic applicable to Ind AS entities cannot be automatically applied to MSMEs.

Accounting Standard Governing Provisions – AS-29

The key Accounting Standard relevant for provisioning is:
AS-29: Provisions, Contingent Liabilities and Contingent Assets
As per AS-29, a provision can be recognised only when ALL the following three conditions are satisfied:

1. A present legal obligation exists as a result of a past event
2. An outflow of economic resources is probable
3. A reliable estimate of the obligation can be made
   If any one of the above conditions is not met, recognition of a provision is not permitted.

Do MSMEs Have a “Present Obligation” under Labour Codes?

This is the most critical test.
Although the Central Labour Codes have been notified, their implementation is dependent on State-specific rules. As of now:
• Many States have not fully notified or enforced the final rules
• No specific directions or demands have been issued to most MSMEs
• Wage restructuring has not been legally mandated yet
Therefore, for most MSMEs:
👉 There is no presently enforceable legal obligation
👉 The obligation is future-oriented and conditional

Under AS-29, a liability becomes a “present obligation” only when the entity cannot avoid settlement.
At present, MSMEs can legally continue with existing wage structures until State Rules are enforced.

Reliability of Measurement – Another Key Constraint

Even if an obligation is expected in the future, AS-29 requires the amount to be reliably measurable.
For MSMEs today:
• The exact wage restructuring mechanism is unclear
• Applicability thresholds may vary
• Employee-wise impact cannot be precisely quantified
• Implementation dates differ from State to State
This lack of certainty makes reliable estimation impossible, thereby failing the second critical condition of AS-29.

Provision vs Contingent Liability – AS-29 Clarification

Provision
• Present obligation
• Payment unavoidable
• Amount reasonably estimable
• Recognised in P&L

Contingent Liability
• Possible obligation
• Depends on future uncertain events
• Not presently enforceable
• Disclosed in Notes to Accounts
AS-29 clearly states that where an obligation is possible but not present, it must not be recognised as a provision, but should instead be disclosed as a contingent liability.
For MSMEs, the Labour Code impact currently falls under this category.

Correct and Audit-Safe Approach for MSMEs

Based on current law and accounting standards, MSMEs should adopt the following approach:
✔ Evaluate Impact
• Review existing wage structures
• Identify potential exposure areas (PF, gratuity, leave)
✔ Maintain Working Papers
• Internal calculations
• Management assessments
• Auditor reference notes
✔ Disclosure in Notes to Accounts
• State that Labour Codes are under evaluation
• Mention non-enforceability at State level
• Clarify that impact is not presently ascertainable
✔ Create Provision Only When:
• State Rules are notified and enforced
• Wage restructuring becomes mandatory
• Liability becomes measurable and unavoidable

Key Takeaway

Provisioning is governed by accounting discipline and legal enforceability — not anticipation or market pressure.
For most MSMEs today:
• Provision in P&L is not mandatory
• Disclosure is sufficient and appropriate
• Premature provisioning is neither required nor advisable
MSMEs should focus on preparedness, documentation, and compliance readiness, rather than fear-driven accounting decisions.