The Different Forms of Compensation

Human Resources Management / By David J Hoare MSA / 01/21/2013

There are two different forms of compensation provided to employees; direct and indirect. Direct forms
of compensation have a multitude of types or methods, from salaries to bonuses. Indirect compensation is
primarily the various types of benefits and long term incentives. This article is an introduction to
the terminology of compensation.
One of the forms of compensation is direct remuneration for services rendered by the employee. The
term used for this is wages. It consists of four different groups of payment from the employer to the
employee. They are salary, hourly, commission and bonus types of wages.
Contents [hide]
 1 Direct Forms of Compensation
o 1.1 Salary
o 1.2 Hourly
o 1.3 Commission
o 1.4 Bonuses
 2 Indirect Forms of Compensation
o 2.1 Benefits
o 2.2 Equity Based Programs
 3 Summary – The Different Forms of Compensation

Direct Forms of Compensation

Salary
This type of wage is customarily a set sum of remuneration over a defined period of time. The most
traditional form is a dollar amount over a period of one year. The frequency of payment is another part of
the compensation and is based on industry standards. Most businesses pay for services twice a month.
Salaries are the most commonly used tool to pay professional or licensed employees. In general there is
an expectation from the employer of a longer term commitment from the employee for providing a
regular uninterrupted compensation stream via a salary.
Hourly
This is a dollar amount per hour of service to the employer, more commonly used to compensate
unskilled and skilled laborers in the workforce. This form of compensation comes with an implied
understanding that during times of slow or minimal workloads, the employee may not be used to provide
services. In effect, there is no guarantee of a regular cycle of pay.
Commission
When compensation is based on volume or some form of performance, this is known as commission
based remuneration. Other terms used include piecework or piecemeal. Many industries used this type of
remuneration to get a minimum standard of production in exchange for compensation. It is used to shift
risk from the employer to the employee. There are two methods to calculate commission. One is based
on volume of services and the other is based on sales.
An example of an industry that uses volume remuneration extensively is the fishing industry. The men
that work on the boats have a risk that the captain will not find fish. In exchange, the captain may hit
upon some nice fishing grounds and bring in a large catch. Once the fish is offloaded, the processors use
commission to compensate the production workers. These workers are paid by piecemeal, that is, how
much final product they can generate from the catch. Typically their cuts of the meat are weighed and
they are compensated based on that measurement for services rendered.
An example of an industry that uses sales based commissions is the auto retail dealerships. Here the
salesman is enticed to get the buyer to purchase the vehicle so that he may receive compensation for his
services. Other commission based industries include, brokers, real estate agents, door to door salesmen,
internet website owners and some folks in the cleaning services.
Bonuses
Bonuses are used to increase performance from the employee. This is a variable type of remuneration
and is more commonly found with salaried staff to incentivize them for a particular goal whether time or
volume based. Other reasons used for bonuses are to increase or maintain retention of certain skills or the
pool of skill-sets needed in the company. Sometimes bonuses are paid when a company meets certain
financial standards or goals over an extended period of time.
Bonuses are not commonly used with hourly or commission based employees due to the nature of the
type of compensation already established. However, in small businesses it is used as a tool to incentivize
these two types of remuneration to meet certain goals.The other form of compensation is indirect in
value. This includes benefits and equity based programs. In general, these two types of indirect
compensation provide value to an employee over a longer period of time.
For a more detailed and informative analysis and comparison of direct compensation, I have written an article
describing these and their respective IRS compliance requirements. In addition I explain the connection
to Exempt and Non-Exempt status and connection with the owner’s profit. Read: Four Types of Direct
Compensation for a more in-depth understanding of direct compensation.
If interested in my help as an accountant or consultant, contact me through the ‘My
Services’ page in the footer.

Indirect Forms of Compensation

Benefits
This particular group is traditionally thought of in the form of insurances (health, dental, life, disability
and vision) andretirement. Very few small businesses provide benefits to their employees due to the cost
involved. When small businesses begin providing benefits, they customarily start out with retirement
because of simplicity and low cost. As they grow, they add health insurance (mandated by law for
employers with 50 or more employees) and continue to expand the benefit package as the number of
employees increase and the risk of business performance decreases. Benefits allow for retention and
recruitment.
Other benefits can include transportation, paid time off, vacation time, and customized incentives
(lodging, meals, phones, etc.).
Equity Based Programs
Rarely found in the small business world for several reasons. These types of indirect compensation tie
the employee to the company via ownership. Due to the complexity and the legal issues involved, very
few small businesses use this tool. This is a sophisticated method to retain key employees and is
discussed in another article.

Summary – The Different Forms

of Compensation
This article introduced the reader to the terms of compensation. There are two forms of compensation,
direct and indirect. Each form of compensation has types of remuneration (pay). As a small business
owner, you need to understand the basic forms of compensation and the types used to pay
employees. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol)
businessecon.org. I would love to hear from you. If interested in my help as an accountant or
consultant, contact me through the ‘My Services’ page in the footer.