Incentive Staff Compensation
by Tom Davis, CPA (September 20, 2004)

Current State of CPA Firm Staffing
One of the most critical problems in accounting firms, as perceived by firm owners and management, is the difficulty in hiring and retaining qualified staff.  The improving national and world economy, combined with increased requirements for entering the CPA profession, as well as changes in population age and growth has reduced the candidates for accounting firm positions.  This has resulted in substantially increased staff costs.

This trend will continue indefinitely and will in fact get much worse than it is.  Salaries paid for staff will increase dramatically in the next three years.  If firms want to recruit and retain a work force that is skilled, has an “entrepreneurial” focus that will aid the firm in getting new work, and is productive, attention must be paid to motivating staff in this direction. 

Motivating Staff
There are many things that effect staff motivation.  Compensation, other benefits, flexible working hours, and general working conditions all play a part.  Also, each staff’s “motivational buttons” will differ from someone else’s.  There is typically no single motivational factor that controls a staff’s performance. 

Many of these motivational factors must be determined by common sense and by conferring with individual firm members to “customize” them to meet their needs.  However, a staff’s compensation package is a key motivational factor and should be handled in a manner that will promote a firm culture of high fee generation and promotion of client services.

 In most firms, the salary component of a staff’s compensation package is set at “market.”  This level of compensation is designed to cover a staff’s services within some expected range of effort and productivity.  Typically, there are other compensation components such as profit sharing plans, 401K savings plans, and other “bonuses.”  In many cases, these other compensation components are based on a small percentage of a staff’s salary and on a staff’s longevity to the firm.  In most instances, neither the salary nor other compensation component has a direct tie to a quantifiable measure of production. 

Not tying compensation to production in some manner diminishes compensation’s effectiveness as a tool for improving performance and firm profits.  It also “confuses” staff who believe that the firm is looking at their production to determine the compensation level. 

Another issue is “what is production?”  In most firms, production is chargeable hours.  In some instances, production is related to some realization percentage (bill production).  These measures of production can lend themselves to misstatements as staff charge more time (if the main emphasis is on chargeable hours) or not enough time (if emphasis is placed on a high realization level). 

A more appropriate measure of a firm member’s production is billings.  This information is easily available from a firm’s time and billing system.  Also, firm members seem to readily understand the concepts involved. 

Billing-based Compensation
The concept of a billing-based compensation plan is that staff will be compensated at market for a certain level of production (billings).  If this billing budget is exceeded, the staff person will receive a “bonus” of a percentage of the excess.  Staff are motivated to produce more, since they will make more. 

A staff’s base compensation is established at market for the level of staff employed, for an “average” level of production and realization.

A staff’s billing budget is set at historical and achievable levels.  The budget should not be “optimistic” or otherwise unobtainable.  If the staff has previous work history with the firm, the budget might just be the last year’s billings for that staff.  If the staff is new to the firm, an estimate of the expected billing must be made.

For example, a new staff’s billing budget can be calculated by dividing compensation by the annual expected hours (2,080 hours for a 52-week, 40 hours per week schedule).  Then multiply the result by expected chargeable hours (let’s say 1,700 chargeable hours), and then multiply the result by some multiple factor (typically between 3 and 4) and by a realization factor (the more experienced the staff, the higher the factor).  If the Staff’s salary was $55,000 and the multiple was 3.5, and the realization percentage is 90%, the billing budget would calculate to $141,600
($55,000 / 2,080 * 1,700 * 3.5 * .9).

The billing budget is then compared to the actual billings and any excess of billings over the budgeted amounts is available for the bonus.  If the bonus percentage is 35% and the staff in the previous year had $151,600 in billings ($10,000 over the billing budget), the bonus would be $3,500.

The bonus should be paid at least once a quarter to motivate in a maximum fashion. 

Billing-based Compensation Issues
It is important to make sure staff have input in all areas of the billing-based compensation.  Without this ability to have an impact on the components, they will feel that they are being asked to take an inordinate amount of “risk.”

The base salary must be perceived as being “market” level.  About the only way this can be done is to reach agreement with the staff to this effect.  Even though the bonus is paid quarterly, the bonus calculation is based on an annual calculation.  A billing budget excess in one period would be offset in another period. 

The billing budget, along with its distribution over an annual period should be “negotiated”.  If this billing budget is primarily arrived at based on historical information, this should be an easy item.  The budget for a new staff member will be more difficult. 

Realistically, it may be that an entry-level firm member or a person filling a position that has not existed before is a poor candidate for this billing-based compensation approach.  However, it is important that they are apprised of this compensation method at the time of hire, and they are made aware that they will be compensated in this manner in the future.

The bonus percentage should be large enough to excite staff with the prospect of a “material” dollar pay out.  A bonus of 10% is too low and one of more than 50% is excessive.  A bonus of 30% to 35% is realistic.  Remember that the firm is striving to achieve a “no-lose” position.  If staff exceed their budget significantly, they make money and the firm makes money.  If the percentage is too low, there is no incentive.  If it is too high, the firm will not increase owner profitability.

To make billing-based compensation work, staff must also be empowered in the proposal and billing aspects of the process.  If fee proposals are not planned with staff participation, they will not feel they have any control over the amount at which their time will be billed. 

Basically, the proposal process should set forth the services to be provided by the firm (staff), the information to be provided by the client, and the price of these services.  Any “planned” discount or premium will be determined so that it does not impact on staff in an inappropriate manner.

Letting staff start the billing process will provide the opportunity to bill for “change orders” that relate to services performed outside the scope of the proposal.  When a bill is prepared, any adjustment should be allocated to the staff or to the firm.  If there was no “planned” firm adjustment in the proposal stage and if there was no extraordinary events that occurred during the engagement, any adjustment should be allocated to the staff.

The allocation of adjustment to staff is an area that, at first glance, appears to be difficult.  It is easy to feel that this could potentially be an opportunity to abuse staff with an unfair allocation.  In actual practice this is not a problem.

If the firm has adopted a project approach to practice and is billing on a completed project basis, there is less opportunity to be mixing services in a single invoice.  This limits the staff whose time is billed to those involved with the project, thus reducing the opportunity to distort adjustment allocation. 

Another potential problem area with adjustments is the unfair allocation among the staff that actually performed the service.  This can be resolved by letting the firm’s practice management system handle all allocations based on the dollars of production being billed.  This approach averages any adjustment among all the staff being billed.

This billing-based compensation model will not work for all staff.  Some firm members, such as administrative staff, will not have billable time.  This will not be an issue if reasonable billing budgets are established.  Billing budgets should also take into consideration changes in a staff’s responsibilities.  If someone moves from a high production capacity to a position that has substantially more non-billable time, the billing budget should be adjusted accordingly.

A problem can arise when a budget surplus turns into a budget deficit in a subsequent period.  This would result in a payback from the staff, which will cause much pain.  To reduce the possibility of this occurring, use a “hold back” on budget payouts.  A 25% rate is a reasonable safety net.  The hold back will be paid at the end of the year when the final calculations are made.  For example, if the bonus payment in any period except for the final one were $2,000, the amount actually paid would be $1,500.

Another issue is the payment of the bonus if a staff person leaves the firm before the year-end.  One approach is to pay the bonus to staff that are employed at the end of the calculation period.  This will work best if the billing budget is reasonably allocated among the calculation periods.  Billing budgets can also be “prorated” to the date the staff leaves the firm.  If the “rules” are communicated at the inception of the billing-based compensation plan, these types of problems will be avoided.

Tom Davis CPA is owner of TC Davis, CPA and president of Knowledge Concepts, Inc., the developers of the FirmWorks practice information application.  Contact him at tdavis@knowledge.org and at 888.832.4823.

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