What is Compensation?

Compensation is a cash or non-cash payment made in exchange for services rendered. Compensation can include base pay, bonuses, commissions, merit pay, and tip income. It can also include ancillary or deferred payments, such as stock options, vacation pay, pension benefits, free parking, and medical insurance. Compensation levels are based on regional salary surveys; a periodic review of these surveys ensures that an employer sets compensation packages at competitive levels, in order to retain employees. Compensation is also based on performance, so that top-level performers can receive significantly greater pay than mid-range performers.

In a service business, compensation is typically the largest expense incurred by the employer. It is still a significant expense even in businesses that do not require a significant amount of employees.

Compensation Taxes

Compensation is subject to a variety of taxes and withholdings, including Social Security and Medicare. Locally, a municipal government might also impose a head tax, such as $10 per person employed, per month. Technically, a head tax is not a compensation tax, because it does not vary based on the amount of compensation paid out. Instead, a head tax is a fixed amount charged per person employed.

Accounting for Compensation

Compensation is usually charged to expense in the period when the related benefits are incurred - which is to say, in the current period. However, if compensation relates to the production of goods, then the cost of the compensation is instead capitalized into the cost of the resulting inventory. If this inventory is sold, then its cost is charged to the cost of goods sold, along with the cost of the compensation included in it. If the inventory instead remains in stock, then the included compensation cost is also included in this asset, and will remain there until the goods are sold.