Human Resource Accounting

CONTENTS
Introduction Of Human Resources Accounting

Various Definitions of Human Resources Accounting

Methods of Human Resources Accounting

Summary
Conclusion

Bibliography
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Introduction
Two types of resources are used in every business enterprise: 1. Physical and financial resources 2. Human resources. One asset is omitted and its worth I want to know, That asset is the value of men who run the show These lines are clearly indicate that the value of men (human-resources) is not measured and reflected in the accounts of business enterprise. Although the success of the business to a greater extent depends upon the abilities, efficiencies and power of these people who actually run the business. 3

Human resource accounting may be considered as such an accounting system which recognizes the human resources as an asset and records it in the books of account after measuring its value in the same way as other physical resources. Such accounting may generate and present valuable and significant information relating to human resources. Employees are the greatest assets of an organization and its success or failure depends on the quality and performance of the employees. But traditional accounting systems fail to indicate the value of the most valuable asset.
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Definitions of HRA:-

Human Resource accounting is an attempt to identify and report investments made in human resource of an organization. Basically it is an information system that tells the management what changes over time are occurring to human resources of the business. - R. L. Woodruff 5

Human Resource accounting is the measurement of costs and value of the people for the organization. - Flamholtz Human resource is the measurement and quantification of organizational inputs such as recruiting, training experience and commitment. - Stephen Knauf

HRA is the process of identifying and measuring data about human resources and communicating this information to interested parties. vaghela_manisha13@y BY: VAGHELA MANISHA -American Accounting Association6
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Methods of HRA:
Historical cost method Replacement cost method Opportunity cost method Capitalization of salary method Economic valuation method Return on efforts employed method Adjusted discounted future wages method Reward valuation method Standard Cost Method Current Purchasing Power Method 7

1)Historical cost method:This method developed by Brummet, Flamholtz and Pyle. According to this method, the actual cost incurred on recruiting, selecting, training, placing and developing the human resources of an enterprise are capitalized and written off over the expected useful life of human resources.

The procedure followed for human resource asset is the same as that of other physical asset.
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Any amount spent on training and developing human resources increase its efficiency, hence capitalized. The amortization of human resource asset is also done in the same way as that of other physical asset. The asset is written off over its useful life. If the asset is liquidated prematurely then it is underwritten off amount is charged to revenue account. On the other hand, if it has a longer life then expected, its amortization is reschedule.
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Advantages

This method is simple to understand and easy to

work out.

The traditional accounting concept of matching cost

with revenue is followed in this method.

It can help a firm in finding out a return on human

resource investment.

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Limitation
It
is very difficult to estimate the number of years an employee will be with the firm.

It is difficult to determine the number of years over which the

effect of investment on employees will be realized. The extent to which the employee will utilize the knowledge acquired is also subjectively estimated.

It

is also difficult to fix a rate of amortization. A number of methods have been derived to write-off depreciation on fixed assets but in the case of human asset it will generally be on a constant basis.

The value of an asset decreases with amortization. In case of

human resources the situations just the reverse. With the acquisition of experience and training in the course of time the utility of employees increases rather than decreasing. 11

2) Replacement cost method:-

This method was developed by Rensis Likert and Eric G. Flamholtz. The cost of replacing employees is used as the measure of companys human resources. The human resources of a company are to be valued on the assumptions as to what it will cost the concern if existing human resources are required to be replaced with other persons of equivalent experience and talent.
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This method corresponds to the historical cost method mentioned earlier except that it allows for changes in the cost of acquiring and developing employees in place of taking their historical cost. In this method the cost of recruiting, selecting, training etc. of new employees to reach the level of competence of existing employees are measured.

Advantages
This method has the advantage of adjusting the
human value of price trends in the economy and thereby provides more realistic value in inflationary times.

It has the advantage of present-oriented.

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Limitation

It may not always be possible to obtain such a measure

for a particular employee.

It is not always possible to find out the exact

replacement of an employee.

This method does not reflect the knowledge,

competence and loyalties concerning an organization that an individual can build over time.

It is difficult to find out the cost of replacing human

resources and different persons may arrive at different estimates.
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3) Opportunity cost method Hekimian and

Jones Competitive Biding Method :In order to overcome the limitations of replacement cost method, Hekimian and Jones suggested the use of opportunity cost method which determines the value of human resource on the basis of an employees value in alternative uses. Accordingly the value of an employee is based on his opportunity cost-the rice other divisions are willing to pay for the services of an employee working in another division of an organization.

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Thus, the value of an employee would be high if he has several alternative uses for employment in the various division of an enterprise. This brings to light an important fact that the opportunity cost is linked with scarcity. This method determines the value of human resources by establishing competitive bidding within an organization.

Advantages
This method ensures optional allocation of human
resources.

It provides a quantitative base for planning,

evaluating and developing human resources of an organization. Development in human resource can easily be made on the basis of the information of this method. vaghela_manisha13@y
ahoo.com

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Limitation

This method fails to accommodate the possibility of

hiring of employees of similar efficiency, experience and skill.

It excludes from its purview those members of the

firms human resources who are not scarce and, therefore, are not being bid by other divisions of the organization.

The application of this method is doubtful unless

the alternative uses of an employees service available in an organization are traced out.

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4) Capitalization of salary method

Baruch Lev and Aba Schwartz :The advocates of this method Baruch Lev and Aba Schwartz have used the concept of human resources in terms of economic value in this model. According to them the salaries payable to employees during their stay with the organization may be used as a replacement for the value of human resources, in view of the close co-relation between employees compensation and their value to the organization. Thus the value of human resources is the present value of future earnings of homogeneous group of employees.

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The application of this method involves the following steps:

Division of employees into homogeneous groups. The

basis of employees division include their age, designation, skill and task;

Determination of the average annual earnings for

each group of employees;

Calculation of the present value of the total earnings

of each class of employees with the help of an appropriate discount rate.

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The authors of the model recommend the following formula to :-

T vr = t=r

l(t)
___________________________________

(1+r)t-r

Where, V = The human capital value of a person r years old, T = The persons retirement age, l (t) = The persons annual earnings upto retirement, r = A discount rate specific to the person.
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Advantages

This model has introduced economic value concept of

HRA.

Human capital value is found out after considering the

remaining period of service of the employees, thus due weightage is given to working life span of the employees. Limitation

The basic assumption of the model that an employee

will stay with an organization until he retires does not generally hold true.

The selection of discount rate is subjective. The change in employees behavior as a result of
promotion, transfer etc. is not considered true.
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5) Economic valuation method:-

Economic valuation method considers the present worth of the employees future service expected to be derived during their stay with the organization as the value of firms human resource. Although there are some resemblances between earlier model i.e., capitalization of salary method and this model, yet they differ with each other. The economic valuation model 22 recommends the capitalization.

According to economic valuation method, the value of human resources is determine on the basis of the expected services of the employees in each service state that they may occupy during their association with the organization. Under this method, the valuation of human resources involves the following steps:

Estimation of employees future services; Multiply step I) by the employees rate of pay; Multiply step II) by the rate of return on investment.
This would give the present worth of employees services.
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Advantages

This model takes into consideration the employees

career movements.

If employees leave enterprise on account of the

reasons other than death and retirement, then such possibilities are also considered in this model.

This model is regarded better than Lev and Schwartz

model due to above two types of inclusion in this model.

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Limitation

Estimation of the probabilities for each employees

occupying various positions and valuation of contribution of services from all these positions is not an easy task.

To estimate exit probabilities and changes from one

position to another is an expensive process.

It is difficult to estimate an employees expected

tenure of service.

It is also difficult to find out valid data about the value

of expected to be rendered service by an employee.
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6) Return on efforts employed method:-

This method measures the value of the firms human resources on the basis of efforts made by the individual for the organizational benefits. These efforts are evaluated in the light of the following factors :

Positions an employee holds; Degree of excellence employee achieves; Experience profile of the employee.
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Advantages
It makes possible inter-divisional comparison which
ensures effective competition.

It helps the management in human resources

allocation among various divisions of the organization.

It assists the management in regulating the various

functions of an organization.

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Limitation

It is more an index of efficiency rather than a valuation

method.

Management finds it difficult to measure and express

the individual efforts in monetary value.

The measurement procedure of individual efforts differs

from firm to firm and, therefore, there is no uniform and widely accepted procedure for it.

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7)Adjusted discounted future wages

method:-

Roger H. Hermanson developed this model wherein he recommends measuring the value of human resources on the basis of relative efficiency of an organization in the industry. This model relates the value of human resources with the extra profit the firm earns over and above the industry expectations. In fact, this model attributes the difference in profitability rates between firms of an industry to the varying efficiency of 29 their human resources.

It is with this argument Hermanson suggested to measure the value of the human resources on the capitalized value of the excess future profits realized by the firm. Accordingly, the valuation of a firms human-resources involves the following step: Estimation of wages and salaries to different levels of employees for succeeding five years.

Calculation of the present value of the wage and salary

payments at the rate of return which is considered normal in the industry.

Determination of an average efficiency ratio for a

specific period, usually the previous five years.

Calculation of the present value of future services of

the firms human resources. This is worked out by multiplying the firms efficiency ratio.
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The calculation of efficiency ratio is as follows: Efficiency Ratio= Actual Average Earnings of the firm Normal Earnings of all firms If Efficiency Ratio = 1: The firms average rate of return equals the rate of return of the economy. It means that the value of human resource is at par with the industry. If Efficiency Ratio > 1: The firms return is higher than the normal earnings. The value of the human resource is more than the industrial average.
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If Efficiency Ratio < 1: The firms return is lower than the normal earnings. The value of the human resource is less than the industrial average.

Advantages

It considers the relative efficiency of the firm.

It recognizes the time value of money. Limitation

It considers every employee a like in terms of
efficiency which is not true.

The discounting factor is subjective in nature.

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8) Reward valuation method:-

As an improvement over the capitalization of salary method, Flamholtz developed a model commonly known as Stochastic Rewards Valuation Method. The method seeks to measure the value of human resources on the basis of an employees value to an organization at various services states (roles) that he is expected to occupy during the span of his working life with the organization. The author has identified the major variables which determine the value of an individual to a firm. 33

In the context of his model the assessment of employees value involves the following steps:

Estimation of employees expected service life;

Identification Estimation

of set of service states (roles) that an employee may occupy during his service life; of the value derived by the organization at a particular service state of a person for the specified time period;

Estimating

the probability that a person will occupy at possible mutually exclusive service state at specified future times;

Determining Discounting

the total value of the services derived by the organization from its all employees; the total value to its present value at a pre34 determined rate.

Advantages

It is the most scientific model as it demonstrates the

impact of the concept of human asset upon the management of human resources.

It is matured model

as it takes into consideration the employees withdrawal from the organization earlier than death or retirement.

Limitation

This method does not indicate the method of estimating

the future compensation flows of the employees.

It is practically difficult to determine the probability of

employees career movement within the organization and of his exit from the organization.
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9) Standard Cost Method :-

This method envisages establishment of a standard cost per grade of employee, updated every year. Variances produced should be analyzed and would form a useful basis for control. Replacement costs can be used to develop standard costs of recruitment, training and developing individuals, such standards can be used to compare actual results with those planned. 36

10) CurrEnt Purchasing Power Method :-

Under it, instead of taking the replacement cost to capitalized, the capitalized historic cost of investment in human resources is converted into current purchasing power of money with help of index numbers. Its great advantage is its simplicity even though it might produce only approximate answers and approximately correct data.
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Summary
Human resource accounting provides quantitative information about the value of human assets, which helps the top management to take decisions regarding the adequacy of human resources. Based on these insights, further steps for recruitment and selection of personnel are taken. Outside the organization, quantitative data on the most valuable asset has an impact on the decisions of the investors, clients, and potential staff of the company. When proper valuation and accounting of the human resources is not done then the management may not be able to recognize the negative effects of certain programmes, which are aimed at improving profits in the short run. If not recognized on time, these programmes could lead to a fall in productivity levels, high turnover rate and low morale of 38 existing employees.

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