Compensation is any amount paid to employees by the company in regard to pay which is determined by the human resources department of a company. Other than the guaranteed or fixed pay of an employee, the compensation includes variable pay which is paid based on his performance or any other criteria fixed by the company. Other compensation plans include benefits and stock option plans. The fixed or guaranteed pay does not form part of the benefits or compensation. Hence, the compensation and benefits include:
Variable pay: The variable pay is rewarded in cash based on different criteria. The pay can be decided on the performance of the employee, or the based on the results achieved or targets met by the employee. There are various plans in variable pay which include bonus, commission which is usually paid on sales and over time. The three plans are determined based on the performance of the employees. It also includes performance based incentive plans which motivate employees to work harder and increase their efficiency. The advantages of a variable pay are that the company can convert the fixed cost into variable cost if performance declines. It benefits the employees in a way that they can earn additional if their performance improves and gives them an opportunity to have flexible work arrangements. The disadvantage of a variable pay plan is the importance given to quantity as compared to quality, due to this the overall quality of work suffers. It creates competition among the employees and each one performs based only on the achievement of the target. The variable pay is reflected as a variable cost in the accounts. It can be bifurcated as fixed salary and variable salary under the head of salary of the employees.
Stock Option: A stock option plan includes compensation based on equity. It uses the employee’s shares as the employee’s compensation. The compensation via a stock option is usually provided to only a few selected employees at a senior level, otherwise it could create internal issues among the employees. A lot of companies nowadays prefer to provide a stock option plan and reduce the fixed pay. The biggest advantage of a stock option plan for an employee is the benefit to invest in the company for which they work. The stock option can generate wealth for the employees in a long term and the cost of the same could be really high when they plan to sell the stock. A benefit for the company is that they can reduce the cost of human resource payment by paying in stock option. The disadvantage of this option is if the company goes under, the employee is at a huge loss. Also, the prices of shares could drop and the employee would not earn any return. The stock option also leads to no diversification of the portfolio for an employee. Also, if the employee earns money after selling the stock, there will be tax implications for him.
Other Benefits: A large variety of benefits are offered to employees depending on the industry the company is based in. The benefits include pension, insurance policies, access to the company car, access to the company phone, travel and meal allowance, sick leave and many more. Though these are not provided in cash but are included in the total package of an employee. Such additional benefits do form a large part of compensation for the employees. The advantages of providing other benefits to the employees lie in an increase in the efficiency of the employees and their loyalty towards the company. In case of insurance plans, the company can claim a deduction from tax. Employees prefer the benefits provided by the company as compared to a higher salary hence it is beneficial for the company. The cons for the same are a rise in the administrative costs which include maintaining details about each benefit provided. The cost of health insurance is steadily increasing making it difficult for the company to provide to all employees. Many benefits also require the company to follow certain legal laws which increases the cost of legal fees. Thus, additional benefits have pros as well as cons for both, the company as well as the employees.
As far as the accounting treatment of the same is concerned, it is quite different from the above two. In case of additional benefits provided to the employee during a year, the expected amount of compensation to be paid in an accounting year is recorded in that particular accounting year itself. There are plans which include contribution from the employees and well as employer, in such cases; the amount recognized in a period is the contribution of that year. For the amount which is not expected to be settled within a year, it is calculated based on its present value. To determine the current value of any long term plan asset, it is discounted using the net present value. Only the amount which is paid in the current year is recorded and shown as an expense in the current year accounts.
Thus, these are the three main compensation or benefit plans provided by various companies to its employees. Though there are a variety of benefits provided to the employees depending on their position in the company and each one has a different form of reporting. The tax implications also vary based on these benefits. The most popular form of compensation nowadays is the stock option plan which is loved by employees and preferred by employers.
Estrin, M. (2012, Feb 03). The pros and cons of company stock. Retrieved from Bankrate.com: http://www.bankrate.com/finance/investing/pros-cons-company-stock.aspx
Pro and Cons: Offering Employee Benefits. (n.d.). Retrieved from FindLaw: http://smallbusiness.findlaw.com/employment-law-and-human-resources/pro-and-cons-offering-employee-benefits.html