Wage Expense

It is the compensation employers pay for their none-fixed workers

Author: Adin Lykken
Adin Lykken
Adin Lykken
Consulting | Private Equity

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The Boston Consulting Group as an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

Reviewed By: Andy Yan
Andy Yan
Andy Yan
Investment Banking | Corporate Development

Before deciding to pursue his MBA, Andy previously spent two years at Credit Suisse in Investment Banking, primarily working on M&A and IPO transactions. Prior to joining Credit Suisse, Andy was a Business Analyst Intern for Capital One and worked as an associate for Cambridge Realty Capital Companies.

Andy graduated from University of Chicago with a Bachelor of Arts in Economics and Statistics and is currently an MBA candidate at The University of Chicago Booth School of Business with a concentration in Analytical Finance.

Last Updated:October 31, 2023

What Is a Wage Expense?

Firms may rely on external workers to perform some tasks. Such workers are compensated based on short-term contracts or work hours. The wage firms pay for these workers is called wage expense.

Wage expense is a variable cost since firms' needs for external workers varies from one period to another. Even the amount of the wage may vary depending on some variables.

For instance, during holidays, many organizations require extra workers. Also, wages during such periods would be higher than usual since there would be a high demand for labor and a low supply.

Key Takeaways

  • Wage expense is the cost of external workers who are compensated based on the number of hours they work, the number of units they produce, or the short-term contract they are assigned.
  • It can be reported based on whether a firm uses accrual or cash accounting.
  • It can be listed under a separate line if it’s a period cost or within COGS if it’s a product cost.
  • Wages payable is the liability of firms towards their workers who were not compensated.

Types of Wage Expenses

There are different types of wages depending on firms' needs:

  1. Contract-based wages: in this case, external workers get paid based on a short-term contract signed with a firm. For instance, an agreement signed with an external management consultant can exemplify a contract-based wage.
  2. Item-based wage: Workers get paid based on the number of items they produce. One example can be a journalist who is compensated depending on the number of articles they write.
  3. Hourly-based wages: In this case, workers are paid based on the number of hours they work. One example is the hourly wage a restaurant pays external servers during Christmas.

Wage Expense vs. Salary Expense

The main difference between wage and salary expense is that wage expense is the cost of extra workers paid by firms, whereas salary expense is the cost of salaries paid to employees.

To better identify the difference, it is crucial to note that employees are fixed workers who are compensated based on long-term contracts. Such Contracts range from three months reaching a couple of years. 

Thus, employees abide by the salary stated in their contracts. Therefore, the number of extra work hours or produced units doesn't affect their fixed salaries. On the other hand, workers' wage is variable depending on their working hours or made units.

It is also important to note that usually, employees enjoy more benefits than workers. These benefits may include health care insurance, bonuses, or scholarships, whereas workers only earn their deserved wages. 

The type of departments hourly-based workers operate in also usually differs from contract-based employees. Hourly compensated workers mostly work in departments that require simple tasks and talents. Examples may include store cashiers, industrial workers, servers, or janitors.

On the other hand, most firms would prefer to keep their administrative employees and supervisors close to the firm by offering them long-term contracts.

The reason behind this behavior is that such employees are assigned tasks that require intelligence and experience. Accountants, managers, salespeople, and engineers can be examples of such employees.

Summary of differences between employees and workers:

Employees Workers
Fixed long-term workers Short contract-based workers
Enjoy benefits offered by employers Only get compensated their deserved wages
Operate in sophisticated departments Mainly operate in facilities and factories

Accounting for Wage Expenses

The way wage expense is recorded on income statements depends on the accounting method used by a firm. The main two considered accounting methods are accrual accounting and cash accounting:

1. Cash accounting: It is an accounting method in which businesses record expenses when they are paid and revenues when they are received.

2. Accrual accounting: It is an accounting method stating that revenues and expenses must be recorded when they are incurred regardless of whether the expenses are paid or the revenues are received. 

Example of accrual accounting: Suppose a farmer received an order from a restaurant. The farmer delivered the order, but the payment was scheduled one week ahead. 

In this case, as per accrual accounting, the farmer must record revenues on order the second it was delivered even though he was not paid for it. Also, the restaurant must record the cost of the order since the cost is incurred even if it is not paid. 

On the other hand, if the farmer and the restaurant use cash accounting, they would both wait for a week till the cash transaction takes place to record the order's revenue or expense.

Building on the previous notes, wages are recorded according to the accounting method used. If it's cash accounting, they will be recorded when wages are paid. If it's accrual accounting, they will be recorded when incurred by a firm regardless of whether they are paid. 

It is important to note that not all wage expenses are listed under the wage expense line in the income statement. For example, it will depend on whether a wage expense is a period or product cost.

If it's a product cost, it will be recorded under COGS. It will be recorded separately under wage expenses if it's a period cost.

To better understand accounts and entries involved in both situations, refer to the example below:

Wage Expenses example

You are the owner and co-founder of BasketCo, a manufacturer that produces local Lebanese baskets. Ten workers work per unit, earning $2 on each basket they make. You use accrual accounting in your bookkeeping standards.

You pay your workers for what they produce each Friday. On average, each worker can make 25 baskets a week.

Total cost to prepare baskets= $2 x 25 x 10= $500

On a typical Friday, you will record the wage expense of your workers accordingly:

Journal Entry
Db. Wage Expense $500
Cr. Cash $500

Last week, you were short on cash and promised your workers to compensate them the week after. In this case, you will record the entries as follows:

Journal Entry
Db. Wage Expense $500
Cr. Wages Payable $500

Wages payable: A liability account is recorded when your workers owe you their wages.

Next Friday, you will close the unpaid wages as follows:

Journal Entry
Db. Wages Payable $500
Cr. Cash $500
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Researched & authored by Mohamad El Hayek | LinkedIn

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