The Balance Sheet

The standard approach to expatriate compensation for the past 30 years has been the Balance Sheet (or buildup system). An estimated 83 percent of companies use this method for their long-term expatriate compensation. It is designed to or ensure an employee is "no worse off" during the assignment than they were at home. The employee should retain the same amount of purchasing power and savings of the same capacity as his country of origin. The expatriate neither gains nor loses from a financial perspective.

Establishing Home Spendable Income

A balance sheet starts by establishing how families spend their money at home. This is done by using statistical averages based on each national government's consumer expenditure survey.

Home spending is calculated by:
• Establishing taxes by income and family size
• Apportioning the remaining disposable income between savings and consumption
• Using a consumption model of Goods and Services and Housing and Utilities

Home country spendable income includes twelve categories: food at home, household supplies and services, personal care, clothing, medical care, telephone and communications, household furnishings and equipment, domestic help, transportation, recreation and entertainment, food away from home, and alcohol and tobacco. Individual items can be weighted for each nationality, like German nationals might proportionately spend more pork and potatoes and Asian nationals may purchase more rice and fish.

Compare Prices

The next step is to compare prices collected at the host location and compare the cost of that lifestyle in the last location. Of course, a family's lifestyle will never be exactly the same and elements like international telephone calls, domestic help, etc. should be calculated. This is more than establishing simple price differences and takes a bit of art as well as science.

Cost of Living Index

The "cost of living index" represents the difference in the cost between comparable goods and services at the home and host location at a particular exchange rate. A cost of living index above 100 indicates the host location is more expensive, whereas an index below 100 indicates it is less expensive. To determine the amount paid to the employee, the cost of living index is applied to the home spendable income with the resulting "cost of living allowance" (COLA) determining what supplement is required to make the employee "whole". The package should provide enough for both the home spendable income, plus the COLA.

Pay Increases

Changes to pay over time are necessary to keep up with inflation and changes in exchange rate. Calculations are usually based on studies like Mercer's cost of living. Most companies change the COLA every six months to reflect these economic changes.
The COLA will go up when there is higher inflation in the host location than in the home country and/or devaluation of the home country currency requiring a greater amount of home country currency to purchase the same amount of host currency.
The COLA will go down when there is lower inflation in the host location than in the home country and/or devaluation of host currency requiring a smaller amount of home country to purchase the same amount of host currency.

Alternative Approaches

Localization

The localization approach involves basing the expatriate's salary on the local (host country's) salaries. While less confusing to implement, this can be a difficult position for the employee. The same position in different countries can have vastly different salaries. This approach also provides for cost-of-living allowances, which can be applied to taxes, housing, and dependents and which is similar to the balance sheet method.

An advantage to the localization approach include ease of administration and equity with local nationals. Some disadvantages include the usual need for negotiated supplements and pay based on host country economics versus performance and job responsibilities.

Lump Sum

The lump sum approach uses the home country's system for determining base salary. In addition to this salary, the expatriate is offered a lump sum of money to apply to items that he or she values versus a specific amount for taxes, housing, etc. This approach is typically used in shorter assignments of 1 to 3 years.

This approach is advantageous because allows the employee to determine where they want to spend their money. A disadvantage is that the calculation can be complex and involve time-consuming analysis.

Cafeteria Approach

Most popular for senior-level expatriates, this approach can be more cost-effective than other methods. Similar to the lump sum plan, this approach provides a single sum of money and the expatriate is offered a selection of options. These may include such benefits as a company car, company-paid tuition, or a range of other assets.

The benefits of this plan is that is provides the expatriate exactly what is needed. The disadvantage is that it is not commonly available, and only to some employees.