Human resource accounting

Human Resource Accounting

Prepared By :-

Manisha Vaghela

vaghela_manisha13@y BY: VAGHELA MANISHA
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CONTENTS
 Introduction Of Human Resources Accounting
 Various Definitions of Human Resources Accounting
 Methods of Human Resources Accounting
 Summary
 Conclusion
 Bibliography

vaghela_manisha13@y BY: VAGHELA MANISHA 2
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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.
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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.”
vaghela_manisha13@y
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BY: VAGHELA MANISHA - 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 -American MANISHA
BY: VAGHELA 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
 Currant Purchasing Power Method
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1)Historical cost method:-
This method developed
by Brummet, Flamholtz and Pyle.
According to this method, the
actual cost incurred on
recruiting, selecting, training, placi
ng 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.

Limitation

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

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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
company’s 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:-
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 employee’s 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.
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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
firm’s 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 employee’s service
available in an organization are traced out.

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4) Capitalization of salary method:-
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 groupBY: VAGHELA MANISHA
vaghela_manisha13@y of employees. 18
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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 = ∑ l(t)
___________________________________

t=r (1+r)t-r
Where,
V = The human capital value of a person r years old,
T = The person’s retirement age,
l (t) = The person’s 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.

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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 employee’s future service expected
to be derived during their stay with the organization as
the value of firm’s 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
recommends the capitalization.
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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 employee’s rate of pay;
 Multiply step II) by the rate of return on investment.
This would give the present worth of employee’s
services.

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Advantages

 This model takes into consideration the employee’s
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 employee’s
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 employee’s 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
firm’s 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
their human resources.
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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 firm’s 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 firm’s human resources. This is worked out by
vaghela_manisha13@y the firm’s VAGHELA MANISHA
multiplying BY: efficiency ratio. 31
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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 employee’s
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.
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In the context of his model the assessment of
employee’s value involves the following steps:

 Estimation of employee’s expected service life;
Identification of set of service states (roles) that an
employee may occupy during his service life;

 Estimation 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;

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 Determining the total value of the services derived by
the organization from its all employees;

Discounting the total value to its present value at a
pre-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
employee’s withdrawal from the organization earlier
than death or retirement.
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Limitation
☯This method does not indicate the method of estimating
the future compensation flows of the employee’s.

☯ It is practically difficult to determine the probability of
employee’s 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.
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10) Currant 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, highVAGHELA MANISHA and low morale of
vaghela_manisha13@y BY:
turnover rate 40
existing employees.
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Human resource accounting

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