Quiz on establishing a base pay structure, Financial Accounting

I would like you to take the second set of data from session 8 (the one you worked with in the first participation exercise) and do the following:

1.  Determine the number of grades and indicate which jobs are in which grade.  Tell me the point ranges for each of the grade (See step one below).

2.  Determine the midpoint pay rate for each grade (See step two below).

3.  Tell me the midpoint to midpoint percentage progression (See step two below).  Tell me the compa-ratio.

4.  Determine the rate range for each grade (See step three below).

5.  Determine the overlap between grades (See step five below).

In the previous session's exercise, you identified the jobs you would use in setting up a pay structure.  First, recall that in your exercise we said that job L is an outlier, which probably (not definitively) means that it is not a benchmark job.  Thus, drop job L in any further consideration in establishing a base pay structure.  Second, we found that there were two pay structures that emerged: one structure consisted of jobs A through S (excluding job L) and the other structure may be jobs T through W.  For purposes of this exercise, construct only one pay structure with the most jobs (i.e., the pay structure consisting of jobs A through S).

 Session 9:  Continuation of Pay Determinations:  Establishing a Base Pay Structure

We are now ready to construct the base pay system.  Throughout this session we continue to use the first set of data from in the pay structure (without the additional jobs U - X, Q, or T) in Session 8.  Keep in mind there are a number of different "solutions" using the same set of data.


STEP (1) Group common benchmark jobs and bracket them.  In constructing a pay structure, you should be using only benchmark jobs.  You need to group the jobs (at first, tentatively), using points, in order to construct pay grades.  Several things to consider in forming groups: 

A.  Group jobs that are "close" in points.  This ensures that jobs that are similar in points will be compensated similarly.

B.  Point differences (of the benchmark jobs) between groups should be relatively large.  This ensures that the resulting structure differentiates between jobs on points (implying that the jobs are different), and

C.  The point spread within groups should be consistent for all groups.  This is primarily for ease of administration.

For example:

Group One: A (427), B (427), C (418)

Group Two: D (382), E (379), F (362), G (359)

Group Three: H (340), I (338)

Group Four: J (299), K (297), L (295), M (291), N (291), O (283)

Group Five: P (250)

Group Six: R (190), S (188)

Remember I said above that jobs WITHIN a group should be relatively close in points?  Look at the jobs WITHIN each group and note how close they are in points.

I also said that point differences BETWEEN groups should be relatively large. Note, for example, that the difference between job C in group one and job D in group two is 36 points. The difference between job G in group two and job H in group three is 19 points. The difference between job I in group three and job J in group four is 39 points, and so on.

Now that I've grouped them I can try to impose the spread WITHIN groups:  

Group One (hereafter referred to as "Grade 1) point spread will be any jobs with evaluation points greater than 400.

Grade 2: Point spread 351 to 400.

Grade 3: Point spread 301 to 350.

Grade 4: Point spread 251 to 300.

Grade 5: Point spread 201 to 250.

Grade 6: Below 201.

Thus, for this pay structure, I am going to have six grades.  Two IMPORTANT guidelines:

A.   Make sure that ALL the grades - except for the first and last grades - have the same point ranges.  In the above, Grade 2 has a 50 point range, as does Grades 3, 4, and 5.

B.   Make sure that the grades do not overlap in terms of the points. In the above, there are no overlaps.  IF, however, you had said Grade 3's point spread was 305 to 355, it would overlap with Grade 2 who's point spread is 351 to 400.  The reason you don't want an overlap to occur is for the following reason:  Let us say that you want to determine the salary for a non-benchmark job.  You will determine that salary by comparing the non-benchmark job's evaluation point against the pay structure you are constructing (using benchmark jobs).  Let's say that the evaluation point for the non-benchmark job is 353.  With grade overlaps you could slot that non-benchmark job with 353 points into Group 3 OR Group 2. You don't want that confusion.

While we're here, let's point out one other thing. Make sure that you can slot jobs into your structure. For example, let's say you said Grade 3s' point spread is 305 to 355 and that Grade 4 is still 251 to 300.  Let's say you have another non-benchmark job with an evaluation point of 303.  It doesn't fit in either Grade 3 or Grade 4 and is in "limbo" - the twilight zone where you don't know what grade to give the non-benchmark job with 303 evaluation points.  Thus, don't leave unaccounted points between your grades.

STEP (2) Integrate survey data.  To establish a pay structure, one needs to establish the midpoint pay rate for each grade and the rate range for each grade.  To do this, use the survey data to determine the highest and lowest rate of pay for the structure.  The highest rate of pay for the structure can be computed by calculating an average of the pay rates for Grade 1 - the average being either the mean or median.  In the example, the mean rate of pay for Grade 1 is $9.04. The mean rate of pay for Grade 6 is $7.48.  These then are the midpoint pay rates for the highest (Grade 1) and lowest (Grade 6) grades.

Note, that these are the "competitive" midpoint rates of pay.  If you were in an organization that was the industry leader and you wanted to maintain that leadership, you might set the highest rate of pay higher (e.g., by 10%, which would then be $9.04 x 1.10 = $9.94) and keep the lowest grade at the "competitive" midpoint ($7.48).  On the other hand, if you wanted to recruit and attract new college graduates, for example, you might set your lowest rate of pay - Grade 6 - higher.  How you set your rates are not merely based on competitive survey salary data but also on your company's philosophy and policies.

Obviously, you need to also determine the midpoint rates for the grades between the highest and lowest grades (i.e., grades 2 - 5).  There are a number of ways to do this.  There is a formula for what is referred to as the high-low ratio (also referred to as the compa-ratio), which is the ratio:  (midpoint rate for the highest grade/midpoint rate for the lowest rate).  For our example, the h-l ratio is 1.21 ($9.04/$7.48).  If you were to consult a table (if one was available) with a compa-ratio of 1.21, with 6 grades, the mid-point to mid-point percentage progression is approximately 4.0% (It's actually 3.9% but we will round up to 4.0%).  This means that in order to go from $7.48 to $9.04 with six grades, you need to successively multiply each midpoint by 1.04 (4%) starting with $7.48.  So, the midpoints are as follows: 

Grade 6:  $7.48

Grade 5:  ($7.48 x 1.04) = $7.78

Grade 4:  ($7.78 x 1.04) = $8.09

Grade 3:  ($8.09 x 1.04) = $8.41

Grade 2:  ($8.41 x 1.04) = $8.75

Grade 1:  ($8.75 x 1.04) = $9.10 [close enough to $9.04]


Then, do the following:

1. Click that you want to solve for the rate.

2. In the "Input principal":  Put in the midpoint pay rate for the lowest grade.

3. In the "Input years":  Put in the number of grades minus 1 (so if there are 6 grades, it is 6-1 = 5)

4. In the "Input total:  Put in the midpoint rate for the highest grade.

5. Make sure it shows compounded annually.

6. Click calculate.

It will show you a rate.  This is the percentage progression you should use.

Let's try an example.  Here are the facts:  1. The highest grade midpoint is $16.55;  2. The lowest grade midpoint is $7.25;  3. There are 8 grades. The Objective:  Set the midpoints for each of the 8 grades.

First, what is the midpoint-to-midpoint percentage progression I need to set the midpoints?  Go to the link:

Then, do the following:

1. Click that you want to solve for the rate.

2. In the "Input principal":  Put in the midpoint pay rate for the lowest grade:  7.25

3. In the "Input years":  Put in the number of grades minus 1:  8-1 = 7

4. In the "Input total:  Put in the midpoint rate for the highest grade: 16.55

5. Make sure it shows compounded annually.

6. Click calculate.

In the "Rate", it will show you, 12.51%, which represents the mid-point to mid-point percentage progression.

Now, let us apply this 12.51% midpoint-to-midpoint percentage progression to obtain the midpoints for all the other grades:

Grade 1: 7.25

Grade 2: (7.25 x 1.1251) = 8.15

Grade 3: (8.15 x 1.1251) = 9.15

Grade 4: (9.15 x 1.1251) = 10.30

Grade 5: (10.30 x 1.1251) = 11.60

Grade 6: (11.60 x 1.1251) = 13.05

Grade 7: (13.05 x 1.1251) = 14.70

Grade 8: (14.70 x 1.1251) = 16.55

Note, that this procedure yields the "exact" desired midpoint values from the highest to the lowest grade.

EXERCISE ONE FOR THE CONFERENCES:   Here is an exercise I encourage you to complete and post in the Conferences. The facts:  1. The highest grade midpoint is $22.00; 2.  The lowest grade midpoint is $8.50;  3. There are 7 grades. QUESTIONS:  1. What is the mid-point to mid-point percentage progression I need to set the midpoints?  2: What are the midpoints for each of the 7 grades?

Step (3) Set rate ranges for all grades.  Having established the midpoints for all the grades, the next step is to set the rate ranges for all the grades.  If we set the rate range as 10% on each side of the midpoint, we will have the following rate ranges: 

Grade 6:  $6.73 to $8.23 ($7.48 +/- $.75)

Grade 5:  $7.00 to $8.56 (7.78 +/- $.78)

Grade 4:  $7.28 to $8.90

Grade 3:  $7.57 to $9.25

Grade 2:  $7.87 to $9.63

Grade 1:  $8.19 to $10.01

Now we have the minimum, maximum, and midpoint for each pay grade in the structure.  For example, for Grade 2: Minimum = $7.87; Midpoint = $8.75; Maximum = $9.63.

Step (4) Set steps within each grade.  The next step is to set the steps within each grade.  Be aware that how employees receive step and grade increases are policy decisions that are based on the results of the compensation survey (don't forget that compensation surveys also gather information on grade/step increase policies) and an organization's philosophy and past practices/policies.

There are numerous ways to calculate the steps depending on the company's policies (e.g. time in grade, quality step increase based on performance, time to achieve "journey-man" level, how much of a pay distinction there will be between steps, how many steps should be in each grade, etc).

When constructing steps within a grade make sure you use the range of the grade. For example, you can see that the rate range which was calculated for Grade 6 in Step 3 is 6.73 - 8.23. The midpoint (halfway between 6.73 and 8.23 is the midpoint of that range, which is 7.48. You can then construct steps around that grade. A five step grade may look like this:

Grade 6:

Step 1 = 6.73 (the lowest pay rate for grade 6).

Step 2 = 7.10 (halfway between the midpoint and Step 1).

Step 3 = 7.48 (the midpoint of the range 6.73 - 8.23.

Step 4 = 7.85 (halfway between the midpoint and Step 5).

Step 5 = 8.23 (the highest pay rate for grade 6).

Similarly you could construct a 10 step grade with Step 5 being 7.48, the midpoint. The thing you have to keep in mind is that the more steps you have within a grade, the less monetary differences there are between the steps.

Step (5) Calculate grade overlaps.  A final characteristic to consider here is the relationship between grades indicated by the pay overlap between grades (see Milkovich), as a percent.  Theoretically, the overlap in pay between grades represents the similarity of responsibilities, duties, knowledge, skills and other compensable factors that exist among jobs in adjacent pay grades.  To calculate the grade overlap between two adjacent grades, use the following formula:  (Highest pay rate for the lower grade - Lowest pay rate for the higher grade)/(Highest pay rate for the higher grade - Lowest pay rate for the lower grade).  So, the grade overlaps are as follows (In this example, grade 6 is the lowest grade and it progresses up to grade 1):

            Pay Rates                                                    Calculation of Grade Overlap Grade       Overlap (in percent)

Grade 6:  $6.73 to $8.23 ($7.48 +/- $.75)

                                                                              (8.23-7.00) /(8.56-6.73)     =                              .67 or 67%

Grade 5:  $7.00 to $8.56 (7.78 +/- $.78)

                                                                              (8.56-7.28) /(8.90-7.00)     =                              .67 or 67%

Grade 4:  $7.28 to $8.90

                                                                              (8.90-7.57) /(9.25-7.28)     =                              .67 or 67%

Grade 3:  $7.57 to $9.25

Grade 2:  $7.87 to $9.63

Grade 1:  $8.19 to $10.01

Now, for an exercise, calculate the overlaps between Grade 3 and Grade 2,  and the overlap between Grade 2 and Grade 1.  DO THE CALCULATIONS.  You should come up with 67% for both overlaps.

Once you have established this pay structure you should be able to take a (non-benchmark) job and assign a pay rate (or rate range) to it.  For example, let us assume that you have just completed a job analysis and description for a newly created position in your organization.  You should be able to assign job evaluation points for each of the compensable factors in the job by referring to your organization's evaluation guidelines.  Once you have totaled the evaluation points, you should be able to go to the pay guidelines for that class of jobs and look at the corresponding evaluation point ranges to determine the grade, and hence the pay rate range, to assign the job.

Posted Date: 2/23/2013 1:16:59 AM | Location : United States

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