Have you ever wondered what the difference is between a cost of living allowance and an Index?

They are ultimately intimately connected, with the one affecting the outcome of the other.

The cost of living itself is defined as the cost of maintaining your standard of living, in other words the standard that you have maintained over a period of time. Changes in the cost of living are used to determine a cost of living index. These calculations are used to compare the cost of maintaining a specific standard of living in different locations, which are then used to measure the cost of living in terms of purchasing power, which was discussed in a previous article.

When you compare the cost of living between two locations, you are in effect comparing the difference in the aggregate cost of the same selected basket groups in each location. This is done by using the average reported price in each location for the same quantity of each item within each basket, e.g. a cup of coffee in a 5 star hotel or the cost of one litre of the highest octane petrol. The cost of living is therefore the relative differential in the local cost of the selected baskets, at the ruling exchange rate, between two selected locations.

We tend to refer to the two locations as home and host locations. The home location is the location you are moving from, and the host location is the location you are moving to.

When you compare the cost of living between two different locations, the objective is to calculate the difference as an index. This is done by dividing the cost of the selected baskets in the home location by the cost of the selected baskets in the host location. The result is multiplied by 100 to enable the host location index to be expressed relative to the home location, with an index of 100. If the calculated host index is 130, then the host location is 30 percent more expensive than the home location, which would have an index of 100. This means that such an individual would need to earn 30 percent more in the host location than what they are currently earning in the home location in order to maintain the same standard of living and retain the same level of purchasing power that they are accustomed to in the home location.

What are basket groups (Baskets)?

Basket groups are in effect a collection of similar related items within a specific category such as transport or housing related items. The cost of all items in each basket group are gathered according to specified quantities (e.g. 1 litre of milk in the case of the groceries basket), reported, examined and aggregated in each location to create a cost of living index per basket group. Basket groups include Housing, Education, Recreation and Culture, Household Goods, Alcohol and Tobacco, Clothing, Communication, Furniture and Appliances, Groceries, Healthcare, Personal Care, Transport, all of which would affect the household budget of the typical expat.

A Cost of Living Allowance (COLA) is an adjustment in salary based on a relevant Cost of Living Index (COLI). When an employee relocates, they may require an adjustment to their earnings in the form of an allowance to compensate for the cost of living difference indicated by the COLI. Put simply, this allowance is referred to as a Cost of Living Allowance or alternatively a Cost of Living Adjustment. A COLA is necessary to ensure that employees are compensated for the change in cost of living for the duration of their assignment.

As an international assignee / expatriate it is vital to regularly check your salary to ensure that you are being compensated and are being adjusted accordingly. As the COLI changes, so should your COLA or alternatively your host salary.

A reliable cost of living report should calculate a COLI for the host and home locations you select and it should allow you to specify which basket groups you want to include or exclude. You should exclude basket groups that you will not be required to spend your salary on. For example if the host location employer provides housing, then housing should not form part of the COLI as the salary will not be affected by differences in the cost of housing.

A COLA report calculates how much additional allowance (over and above your current salary) you need to earn in another location to compensate for a higher cost of living, hardship and the exchange rate, in order to have the same relative spending power and as a result have a similar standard of living as you have in your current location.

Why would you want to use this type of information when moving around the world?

If you are offered a job in another country or location, it is imperative to know whether the salary offer is realistic in maintaining the standard of living you are accustomed to.

Take for example an offer for X US dollars a year in Dubai, UAE including relocation and transport, but excluding Education and Housing. Initially the offer seems great, you are ready to pack your bags and move to your new adventure. Then on further research you find that Education and Housing will take 75 percent of your salary leaving you with only 25 percent to cover all the other basket group costs. Perhaps this would not be an issue for a single person, but the standard of living would be compromised for a married expatriate with two school going children and you would need to renegotiate your package. It is obviously better to make use of a reliable cost of living report before you accept an offer rather than find out when you start working in the host location.

We recommend that you run a reliable cost of living report to calculate your required Cost of Living Allowance adjustment ensuring that you get the correct data for you move.

Steven McManus runs the most comprehensive international cost of living website Xpatulator.com, with free global COL reviews and rankings. Three content calculators include COL Index, COL Allowance and Salary Purchasing Power Parity.

Steven McManus runs the most comprehensive international cost of living website http://www.xpatulator.com, with free global COL reviews and rankings. Three content calculators include COL Index, COL Allowance and Salary Purchasing Power Parity.

Author Bio: Steven McManus runs the most comprehensive international cost of living website Xpatulator.com, with free global COL reviews and rankings. Three content calculators include COL Index, COL Allowance and Salary Purchasing Power Parity.

Category: Career
Keywords: Cost of living allowance, cost of living review, international cost of living, cost of living index