According to The Harvard Business Review's February magazine article How Financial Accounting Screws Up HR, accounting rules and practices mistakenly favor using nonemployee labor instead of employees.
The main reason is the treatment of employees as a fixed cost. Key quote:
"...a number of rules have been prompting a major effort by companies to move work to nonemployees. One involves treating wages and salaries as fixed costs. Such costs are a big worry for investors because if business and revenue decline and those costs can't be cut, the profitability and value of the business collapse in a hurry ...
Why wages and salaries are ever considered fixed costs in the United States is a puzzle given that virtually all employment there is "at will," which allows companies to end it unilaterally for any business-related reason.
The other accounting rules favoring the use of nonemployee labor the article points to are:
- Using per-employee statistics as key performance metrics: Using nonemployer labor reduces the number of employees, which improves per-employee metrics like sales per employee, profitability per employee, etc.
- The use of nonemployee labor can increase a firm's reported gross margins: Direct labor costs are included in a firm's cost of goods sold. This reduces a firm's gross margin, a metric investors closely scrutinize. Nonemployee labor is much easier to categorize so it's not included in the gross margin calculation than employee labor costs are.
- It's generally harder to get approval to hire an employee than it is a contractor: This is not an accounting rule, but a common financial practice at most corporations.
Based on our corporate consulting work, our work with investors, and our experiences working at corporations, we agree that accounting rules and practices are tilted towards the use of nonemployee labor.
And many corporate decision-makers do not fully understand the impacts of these rules and practices on resource allocation and hiring decisions.
So shining a light on these issues is important.
But even if the accounting rules and practices are changed - and we think they should - the use of freelancers and nonemployee labor by corporations will likely continue to grow.
The reason is simple.
The main trends driving the use of nonemployer labor - the need for greater business agility and flexibility, the challenges of hiring in-demand labor, the greater productivity and efficiency of nonemployee labor in some instances, and the desire by many skilled workers to be independent - significantly outweigh the accounting impacts.
