Balance sheet approach to international compensation advantages and disadvantages

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The Balance Sheet Approach to Expatriate Compensation

The balance sheet approach to expatriate compensation is used to ensure employees are able to maintain their home purchasing power while on a temporary international assignment.

In this approach, employees continue to be paid their home salary, maintain the link to home benefits, and receive a series of allowances to balance host vs. home costs for income taxes, goods and services, and housing. These allowances are specific to home country, income, and family size, and are adjusted over time to take home and host inflation and exchange rate changes into account.

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The balance sheet approach to expatriate compensation is used to ensure employees are able to maintain their home purchasing power while on a temporary international assignment.

These allowances are specific to home country, income, and family size, and are adjusted over time to take home and host inflation and exchange rate changes into account.

According to AIRINC’s 2019 Long Term Assignments Benchmark Report, the balance sheet approach is used by 80% of all global firms sending employees on temporary long-term (three- to four-year) assignments. The key reason is that pay barriers are removed, so the Balance Sheet Approach can be successfully used for any home-to-host combination.

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Over the years, several different compensation methods have been developed to determine the salaries companies offer their employees who are being sent on long-term international assignments. In addition to the host country and the designated position, the compensation package is usually one of the essential aspects for employees. The defined compensation as well as any additional benefits play a decisive role for a potential expatriate whether to accept the proposed mission abroad. Consequently, every employer with the need of international assignments aims to apply an appropriate and attractive compensation method in order to strengthen talent mobility and employee retention.

Originating from an accounting term that describes a calculation where debits and credits must match, the Balance Sheet Calculation is a well-known and widely used way of calculating an expatriate compensation. Several surveys and benchmark reports published in the last years suggest that up to 80% of all global firms are using the Balance Sheet Calculation when sending employees on long-term assignments, which typically last between one and five years. However, due to an increasing need for more flexible assignment types as well as rising administrative and cost pressures, a steady decline of the classical long-term assignments can be observed. As a consequence, global mobility practices including compensation methods have to be adjusted in order to align with these changing business needs. With this development in mind, the following article intends to have a closer look at the current and future relevance of the Balance Sheet Calculation as a useful approach to determine expatriate compensation.

Principle, objectives and advantages of the Balance Sheet Calculation

The main idea of the Balance Sheet Calculation is to ensure that employees maintain the same purchasing power and thus standard of living in the host country that they had in the home country before the time abroad. As a result, the assignees neither suffer a financial loss nor benefit from a financial gain during the duration of the assignment. The approach allows employers to continue to pay employees their home salaries, keeping the link to home benefits and the local salary structure, whilst adding a series of allowances or deductions to balance differences regarding the costs of goods and services, housing, income taxes and social security contributions. These allowances are usually specifically adapted to home and host country, income level and family status. They are typically reviewed and adjusted regularly, e.g. once a year, to take home and host inflation and exchange rate changes into account.

There are four major advantages of using the Balance Sheet Calculation to define an expatriation compensation. First of all, as shortly outlined above, the calculation takes quite a holistic approach to the compensation package, considering a variety of influencing factors to ensure the employees do not experience major financial advantages or disadvantages when moving abroad. Secondly, it helps to align the processes of repatriation or a subsequent assignment. With a Balance Sheet Calculation an employer can prove that a clear approach based on predefined rules is applied, adequately compensating the assignee. In addition, the link to the home country compensation structure is maintained. Thirdly, the approach ensures that all assignees from the same home country are treated equally. Independent of the host country, the structure of the Balance Sheet Calculation is always the same and takes into account the most recent data regarding the cost-of-living differentials between any home and host country combination. Last but not least, the method can be applied no matter if the employee is moving to a higher or lower wage country, as the home country purchase power is protected and a cost-of-living differential can either be added or deducted.

By providing all the different advantages mentioned above, it is no surprise that the Balance Sheet Calculation is one of the most widely used methods of calculating expatriate compensation. However, several limits and disadvantages must be considered as well.

Limits of the Balance Sheet Calculation

First of all, as most Global Mobility responsible will know, the calculations can be time-consuming and complex to administer, especially when managing a high number of expatriates in combination with a high turnover of assignments. Even if they can be automated or outsourced to a certain degree, regular adjustments due to updated cost of living indices, salary increases in the home country or policy changes can considerably increase the necessary time for administration and implementation. The complexity, the amount of required statistical data as well as the necessary social security and tax knowledge grows with the number of country combinations involved.

Secondly, the Balance Sheet Calculation as such does not allow a tie to the local salary structure in the host country, which might lead to considerably different pay levels both between assignees and local staff and between expatriate peers from different home countries. Such disparity may cause tensions in the workplace and negatively influence work atmosphere and employee motivation. In practice, additional host country allowances are used to balance such differentials.

Finally, and often criticized by the assignees themselves, is the fact that the Balance Sheet Calculation relies on many assumptions (cost of living values based on fixed baskets of services and goods, average rental prices, estimates of tax rates, tax deductions and social security contributions) and does not always represent the individual situation adequately. As employers usually can only consider employment income and have no visibility on an employee's personal financial situation, the degree to which the individual factors can be considered is limited.

Considering both the necessary expenditure of time and the limits of a Balance Sheet Calculation, it can be concluded that this approach is most appropriate for mid- and senior-level employees, where the return on investment of the assignment and the efforts on the part of the employer in terms of preparation and administration are at an appropriate rate.

Recent developments regarding assignment compensation

For several years, employment relations have become more and more flexible and international at the same time. There are still the "standard" long-term assignments for several years, especially if directors or other senior staff is sent to set up or manage entities abroad. However, an increase of other employment constellations can be observed: Weekly commuters, frequent and regular business trips, virtual assignments and employment of local staff in a country without an affiliated company. This might be a consequence of the fact that an increasing focus has been on the costs as well as the return on investment of international employee assignments. Depending on the host country, the compensation of an expatriate is between 1.5 and 3 times higher compared to the compensation of employees in the home country. For this reason, employers, regardless of the size of the company and number of assignments, have been searching for cost-saving measures to reduce the costs of assignments on the one hand while maintaining the mobility of employees between different regions or countries on the other hand.

Consequently, the Balance Sheet Calculation was and is subject to constant adjustments in order to align with a more and more cost-conscious environment. In the last few years, companies either completely eliminated or reduced those elements of remuneration that exceed the basic allowances (such as the previously very common "Foreign Service Premium") or greatly reduced individual elements such as housing allowances or additional benefits, e.g. spouse support. This does, however, neither reduce the overall complexity of the approach nor change the limits outlined above.

For some country combinations, the "local-plus-approach" is increasingly interesting. This model, which has become more common in recent years, supplements a local position in the host country with additional, individually negotiated benefits. The salary is the same as that of local colleagues, but certain additional benefits from the classic "expatriate package" are added, for example contributions to school or housing costs. Such additional benefits can be reduced step by step over several years, aiming for a gradual integration of the foreign employee into the local salary structure. This allows the "local-plus-approach" to flexibly take into account the expectations of employees. However, with this model a transfer is only successful if the host country has certain similarities to the country of origin. A Swiss expert is unlikely to move to Dhaka on local Bangladeshi conditions for instance if just a few additional benefits are added. In this regard the "local-plus-approach" has its limitations, as every other compensation method.

Conclusion

The ideal compensation package is one that is considered fair and attractive enough by the expatriate, however, it must also be cost-effective for the organization. Despite its complexity and some other limits, the Balance Sheet Calculation is still the method of choice to determine expatriate compensation efficiently and comprehensibly, especially for long-term assignments of several years with the need of strong ties to the home country and home salary structure. Despite the current developments regarding assignment compensation and the trend towards more flexible, short-term assignment categories, the Balance Sheet Calculation will continue to be an essential element. In particular with regards to the comparability of salaries in relation to different cost of living, tax and social security levels, there is no comparable method at the moment. It is and remains, therefore, an indispensable tool for determining remuneration when employees are deployed across borders.

Originally published by The Global Mobility Journal, February 11, 2021

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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