How to Calculate a Cost of Living Index

Definition:COLI between any 2 locations. The COLI is the
A Cost Of Living Index (COLI) is a price indexrelative differential in the local cost of the basket
that measures the relative cost of living overgroups and the ruling exchange rate between the
time. It is an index that measures differences in2 selected locations.
the price of goods and services.When comparing the cost of living between
A COLI measures changes over time in thedifferent locations the objective is to calculate the
amount that consumers need to spend to reach adifference in the cost of living expressed as an
certain level or standard of living. COLI is typicallyindex using one of the locations as the Base.
a number, where the Base Index is 100.Typically the home location is referred to as the
A Consumer Price Index (CPI) on the other handBase Location (Index = 100).
is a measure of the average change over time inPractical Example:
the prices paid by consumers. CPI is typically aTake for example a company headquartered in
percentage change compared to the previousLocation A with overseas operations in Location B
period. An increase in CPI is called inflation, while aand C. They send employees on 2 to 3 year
decrease is called deflation. Both the COLI and theassignments from time to time to Location B and
CPI use a market basket of consumer goods andC and need a set of COLI's using Location A as
services.the Base City in order to calculate assignment
A COLI is also used to measure the price of thesalary and cost of living allowances.
same quantities and types of goods and servicesIn our example Location A has an index of 92,
in different geographic locations. The COLI used inLocation B has an index of 129, and Location C
this way shows the difference in living costshas an index of 75.
between different locations.Using our example, you want to know what the
An international COLI measures the differences inCOLI is for Location B and C using Location A as
the local currency price of the same quantitiesthe Base Location:
and types of goods and services in different•Location A COLI = (Location A / Location A)
countries converted to a single currency. ThisX 100 = (92 / 92) X 100 = 100
shows the difference in relative living costs•Location B COLI = (Location B / Location A) X
between international cities. The cost of living100 = (129 / 92) X 100 = 140.2
difference between locations indicates the amount•Location C COLI = (Location C / Location A)
that consumers need to spend to maintain aX 100 = (75 / 92) X 100 = 81.5
certain level or standard of living.The COLI indicates the difference in the cost of
Amongst other uses, COLI's are used byliving between the locations. In the above example
organizations and individuals in the calculation ofthe COLI of 140.2 means that Location B is 1.402
expatriate salary and cost of living allowances intimes more expensive than Location A. In this
order to ensure consistent salary purchasingexample the COLI is positive (higher). This would
power between the home and host country.mean that a person who moves from Location A
Next we will discuss how to calculate a COLIto Location B would need to earn 40.2% more, to
between 2 locations applicable to expatriatehave the same standard of living in Location B as
employees.they have currently in Location A.
Methodology:Location C on the other hand has a COLI of 81.5.
For consistency the goods and services areThis means that Location C is 0.815 times less
grouped into similar/related basket groups.expensive than Location A. In this example the
For accuracy the exact quantity and type of eachCOLI is negative (lower). This would mean that a
of the goods and services within each basket areperson who moves from Location A to Location
defined. Using these definitions, the prices of theC could earn 18.5% less and have the same
same quantities and types of goods and servicesstandard of living in Location C as they have
in each geographic location is obtained from atcurrently in Location A.
least 3 different suppliers representative of thoseApplying a cost of living index to a salary
that would typically be used by expatriates.calculation:
When calculating the cost of living between 2The COLI values are useful in calculating an
locations the difference in the aggregate cost ofappropriate salary in another location. A calculator
all the selected basket groups are examined insuch as a Salary Purchasing Power Parity
each location using the average reported price inCalculator (SPPP) calculates an appropriate salary
each location for the same quantity of each item.using the COLI, exchange rate and hardship
The basket groups are weighted according todifference.
Expatriate expenditure norms.The salary used in the calculator is gross or net
For example the following 13 basket groups havesalary. We advise using net (after tax) salary. This
the following weighting which representswill result in a net salary result in the new location,
expatriate expenditure norms (the 13 basketwhich would then be grossed up for tax and any
groups do not count equally):other statutory deductions in the new location.
•Alcohol & Tobacco (Weight 2.0%)The calculator will then apply the following formula
•Clothing (Weight 2.5%)based on the selections in the calculator:
•Communication (Weight 2.0%)Salary X Cost of living Index Differential X
•Education (Weight 5.0%)Exchange Rate X Hardship Differential =
•Furniture & Appliances (Weight 5.0%)Calculated Salary in new location
•Groceries (Weight 16.5%)Applying the formula to our earlier example with a
•Healthcare (Weight 5.0%)salary of $100,000 in Location A, sent on
•Household (Weight 30.0%)assignment to Location B, with an increase in
•Miscellaneous (Weight 3.0%)hardship of 10% and paid in US Dollars:
•Personal Care (Weight 3.0%)•Location B COLI = 140.2
•Recreation and Culture (Weight 6.0%)•Location C COLI = 81.5
•Restaurants, Meals Out and Hotels (WeightSalary Calculation = $100,000 X 1.402 X 1 X 1.1 =
2.0%)$154,220
•Transport (Weight 18.0%)This means that an employee earning a salary of
Prices for the defined quantities and types of$100,000 in Location A, requires a salary of
goods and services in each location per basket$154,220 in Location B to compensate for a
are gathered on a quarterly basis and the resulting40.2% higher cost of living and a 10% higher level
index is updated for each of the above baskets.of hardship.
These indexes are then used to calculate the