Page 242 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

228 The Complete Guide to Executive Compensation

numerator and denominator. When such benefits increase (e.g., vacation pay), benefit
costs may show less increase than costs for non-W-2 items. To illustrate, assuming total
benefit costs of $30 million and total payroll of $100 million, we have a benefit rate of
30 percent ($30 million divided by $100 million). If a benefit improvement of $1 million
is implemented for a non-W-2 item, the total benefit cost is 31 percent ($31 million
divided by $100 million). However, for improvements also counted in the denominator,
the final tally is 30.7 percent ($31 million divided by $101 million).
2. Total cost for all benefits (numerator) divided by base pay for time actually
worked (denominator). The numerator is the same as in the earlier definition, but the
denominator consists only of base pay for time actually worked. This is probably the
optimal formula, because all items are accounted for and only once. To illustrate, assume
the $100 million in the previous example consisted of $90 million for base pay and
$10 million for time not worked. The $10 million would be subtracted from the
denominator but not added to the numerator, as it is already included in the $30 million.
The benefit rate, therefore, would be 33.3 percent ($30 million divided by $90 million).
3. Benefit costs excluding time off with pay (numerator) divided by gross pay
(denominator). Of the three, this approach will reflect the lowest benefit percentage,
simply because it has the highest denominator and lowest numerator. It occurs in com-
panies that lack payroll records that record lost time with pay—invariably for those on
the monthly payroll. Based on the previous example, this would result in a benefit rate
of 20 percent ($20 million divided by $100 million). The numerator is only $20 million
because the lost-time pay has not been included.

The variations in these three formulas demonstrate the importance of clearly under-
standing the definition of benefit costs. Using the same data, but changing definitions, we
calculated three different rates: 30 percent, 33.3 percent, and 20 percent.

Accounting, Tax, and SEC Implications
Accounting rules concerning the cost of benefits and perquisites are basically simple and
straightforward. Generally, any costs expensed by the company must be taken as a charge
to earnings (found in the income statement under an item usually identified as “selling,
general, and administrative expenses”). For those items that extend beyond one year,
an accrual is established to retire a liability charge on the balance sheet.
As was discussed in the tax section of Chapter 4 (“The Stakeholders”), the tax effective-
ness varies for both the executive and the company. As Table 6-3 shows, the tax effectiveness
of the employee benefit or perquisite for executives ranges from a “1” (best) to a “5” (worst).
For the company, it ranges from an “A” (best) to a “D” (worst). An additional factor is timing
of taxation and tax deductibility. Tax-qualified pension plans, for example, permit a company
to take a tax deduction when a contribution is made to the plan, whereas employees are not
taxed until they receive the benefit. The taxability and tax-deduction availability will be
reviewed throughout this section.
The SEC disclosure rules typically apply only to those executives named in the proxy. As
these are updated from time to time, it is important to determine what needs to be reported
and in what format. Typically, the requirements deal with perquisites rather than with
employee benefits, although such items as pension size may be a combination of both. This
is discussed more later in the book.