HUMAN RESOURCE ACCOUNTING

The Non accounting of human resources and the change occurring therein, of an organization
may provide a poor picture of the profits and profitability of the organization.
Objectives of the Study:
This unit aims to provide a basis for the conceptual framework of Human Resource Accounting.
An attempt is made to highlight the following aspects.

Development of the Concept of HRA

Meaning and Definition of HRA
Importance
Objectives of Human Resource Accounting
Limitations of Human Resource Accounting
HRA for manager & HR Professionals
Investment in Human Resources
Quality of Work Force and Organizations Performance
Efficient use of Human Resource Enumerating the Assets
Calculating the Market Value of Assets

INTRODUCTION

To ensure growth and development of any organization, the efficiency of people must be
augmented in the right perspective. Without human resources, the other resources cannot be
operationally effective. The original health of the organization is indicated by the human
behaviour variables, like group loyalty, skill, motivation and capacity for effective interaction,
communication and decision making.
Men, materials, machines, money and methods are the resources required for an organization.
These resources are broadly classified into two categories, viz., animate and inanimate (human
and physical) resources. Men, otherwise known as the human resources, are considered to be
animate resources. Others, namely, materials, machines, money and methods are considered to
be inanimate or physical resources.
The success or otherwise of an organization depends on how best the scarce physical resources
are utilized by the human resource. What is important here is that the physical resources are
being activated by the human resources as the physical resources cannot act on their own.
Therefore, the efficient and effective utilization of inanimate resources depends largely on the
quality, caliber, skills, perception and character of the people, that is, the human resources
working in it. The term Human resource at macro level indicates the sum of all the components
such as skills, creative abilities, innovative thinking, intuition, imagination, knowledge and
experience possessed by all the people. An organization possessed with abundant physical
resources may sometimes miserably fail unless it has right people, human resources, to manage
its affairs. Thus, the importance of human resources cannot be ignored. Unfortunately, till now
generally accepted system of accounting this important asset, viz., the human resources has not
been evolved.
For a long period, the importance of human resource was not taken care of seriously by the top
management of organizations. Therefore, at this juncture, it becomes imperative to pay due
attention on the proper development of such an important resource of an organization. Let us
now concentrate our discussion on the conceptual framework of the Human Resource
Accounting.

Meaning and Definition of Human Resource Accounting:

The concept of human resource accounting can be better understood if one goes through some of
the important definitions given by the competent authors in the accounting field.
1. The American Accounting Society Committee on Human Resource Accounting defines it as
follows: Human Resource Accounting is the process of identifying and measuring data about
human resources and communicating this information to interested parties. In simple terms, it is
an extension of the accounting principles of matching costs and revenues and of organizing data
to communicate relevant information in financial terms.
2. Mr. Woodruff Jr. Vice President of R. G. Batty Corporation defines it as follows: Human
Resource Accounting is an attempt to identify and report investments made in human resources
of an organization that are presently not accounted for in conventional accounting practice.
Basically it is an information system that tells the management what changes over time are
occurring to the human resources of the business.
3. M.N. Baker defines Human Resource Accounting as follows: "Human resource accounting is
the term applied by the accountancy profession to quantify the cost and value of employees to
their employing organization"
In short, human resource accounting is the art of valuing, recording and presenting
systematically the worth of human resources in the books of account of an organization. This
definition brings out the following important characteristic features of human resource
accounting:
1. Valuation of human resources
2. Recording the valuation in the books of account
3. Disclosure of the information in the financial statements of the business

Importance of Human Resource Accounting:

Human Resource Accounting provides useful information to the management, financial analysts
and employees as stated below:
1. Human Resource Accounting helps the management in the Employment, locating and
utilization of human resources.
2. It helps in deciding the transfers, promotion, training and retrenchment of human resources.
3. It provides a basis for planning of physical assets vis--vis human resources.
4. It assists in evaluating the expenditure incurred for imparting further education and training in
employees in terms of the benefits derived by the firm.
5. It helps to identify the causes of high labour turnover at various levels and taking preventive
measures to contain it.
6. It helps in locating the real cause for low return on investment, like improper or underutilization of physical assets or human resource or both.
7. It helps in understanding and assessing the inner strength of an organization and helps the
management to steer the company well through most adverse and unfavourable circumstances.
8. It provides valuable information for persons interested in making long term investment in the
firm.
9. It helps employees in improving their performance and bargaining power. It makes each of
them to understand his contribution towards the betterment of the firm vis--vis the expenditure
incurred by the firm on him.

Objectives of Hunan Resources Accounting:

The aim of HRA is to depict the potential of HR in monetary terms, while casting the
organization's financial statements. The concept can be examined from two dimensions: (i) the
investment in HR; and (ii) the value of HR. The expenditure incurred for recruiting, staffing and
training and developing the HR quality is the investment in HR. The fruits of such investments
are increased productivity and profit to the organization. The yield that the investment generates
is considered as the basis for HR value.
Putting in a capsule the main objectives of HRA are to
Improve management by analyzing investment in HR

Consider people as its asset.

Attract and retain qualified people.
Profile the organization in financial terms.

The main objective of human resource accounting is to facilitate the management to get
information on the cost and value of human resources. Human resources accounting brings to
light the quantum of human resources and indicates the right control of conservation, depletion
and appreciation of it in the right perspective. It provides data to the interested persons about the
cost of human resources and correspondingly comparing it with the benefit obtained out of its
utilization. The objective of HRA is not merely the recognition of the value of all resources used
by the organization, but also includes the management of human resource which will enhance the
quantity and quality of goods and services. The basic objective of HRA is to facilitate the
efficiency of human resource. It is basically adopted to treat human resources as assets, to
generate human data about human resources, to assign value to human resources and to present
human assets in the balance sheet.

Limitations of Human Resource Accounting:

Human Resource Accounting is the term used to describe the accounting methods, system and
techniques, which coupled with special knowledge and ability, assist personnel management in
the valuation of personnel in financial terms. It presumes that there is great difference among the
personnel in their knowledge, ability and motivation in the same organization as well as from
organization to organization. It means that some become liability too instead of being human
assets. HRA facilitates decision making about the personnel i.e., either to keep or dispense with
their services or to provide training. There are many limitations which make the management
reluctant to introduce HRA. Some of the attributes are:
i)

There is no proper clear-cut and specific procedure or guidelines for finding cost and
value of human resources of an organization. The systems which are being adopted have

ii)

certain drawbacks.
The period of existence of human resource is uncertain and hence valuing them under

iii)
iv)

uncertainty in future seems to be unrealistic.

There is a fear that HRA may dehumanize and manipulate employees.
For e.g., an employee with a comparatively low value may feel discouraged and develop

v)

a complex which itself will affect his competency to work.

The much needed empirical evidence is yet to be found to support the hypothesis that
HRA as a tool of the management facilitates better and effective management of human

vi)

resources.
In what form and manner, their value to be included in the financial statement is the
question yet to be classified on which there is no consensus in the accounting profession.

Methods of Human Resource Accounting:

a) Cost based approach

1. Historical cost approach

his approach was developed by William C. Pyle (and assisted by R. Lee Brummet & Eric G.
Flamholtz) and R.G. Barry corporation, a leisure footwear manufacturer based on Columbus,
Ohio (USA) in 1967. In this approach, actual cost incurred on recruiting, hiring, training and
development the human resources of the organization are capitalized and amortized over the
expected useful life of the human resources. Thus a proper recording of the expenditure made on
hiring, selecting, training and developing the employees is maintained and a proportion of it is
written off to the income of the next few years during which human resources will provide
service. If the human assets are liquidated prematurely the whole of the amount not written off is
charged to the income of the year in which such liquidation takes place. If the useful life is
recognized to be longer than originally expected, revisions are effected in the amortization
schedule. When an employee is recruited by a firm, he is employed with the obvious expectation
that the returns from him will far exceed the cost involved in selecting, developing and training
in the same manner as the value of fixed assets is increased by making additions to them. Such
additional costs incurred in training and developing is also capitalized and are amortized over the
remaining life. The unexpired value is investment in human assets.
This method is simple to understand and easy to work out. It meets the traditional accounting
concept of matching cost with revenue. It can provide a basis of evaluating a companys return
on its investment in human resources.
But it suffers from the following limitations:

It takes into account a part of the employees acquisition costs and thus ignores the

aggregate value of their potential services.

It is difficult to estimate the number of years over which the capitalized expenditure is to

be amortized.
It is difficult to determine the rate of amortization. Should it be increasing, constant or
decreasing one?

The economic value of human resources increases over time as the people gain
experience. But in this approach, the capital cost decreases through amortization.

2. Replacement Cost Approach

This approach was first suggested by Rensis Likert, and was developed by Eric G. Flamholtz on
the basis of concept of replacement cost. Human resources of an organization are to be valued on

the assumption that a new similar organization has to be created from scratch and what would be
the cost to the firm if the existing resources were required to be replaced with other persons of
equivalent talents and experience. It takes into consideration all cost involved in recruiting,
hiring, training and developing the replacement to the present level of proficiency and familiarity
with the organization.
This approach is more realistic as it incorporates the current value of companys human
resources in its financial statements prepared at the end of the year. It is more representative and
logical. But it suffers from the following limitations:

This method is at variance with the conventional accounting practice of valuing assets.

There may be no similar replacement for a similar certain existing asset. It is really
difficult to find identical replacement of the existing human resource in actual practice.

The determination of a replacement value is affected by the subjective considerations to a

marked extent and therefore, the value is likely to differ from man to man.

3. Opportunity Cost
This method was first advocated by Hc Kiman and Jones for a company with several divisional
heads bidding for the services of various people they need among themselves and then include
the bid price in the investment cost. Opportunity cost is the value of an asset when there is an
alternative use of it. There is no opportunity cost for those employees that are not scarce and also
those at the top will not be available for auction. As such, only scarce people should comprise the
value of human resources.
This method can work for some of the people at shop floor and middle order management.
Moreover, the authors of this approach believe that a bidding process such as this is a promising
approach towards more optional allocation or personnel and a quantitative base for planning,
evaluating and developing human assets of the firm. But this approach suffers from the following
limitations:

It has specifically excluded from its preview the employees scarce or not being bid by
the other departments. This is likely to result in lowering the morale and productivity of
the employees who are not covered by the competitive process.

The total valuation of human resources on the competitive bid price may be misleading or
inaccurate. It may be due to the reason that a person may be an expert for one department
and not so for the other department. He may be valuable person for the department in
which he is working and thus command a high value but may have a lower price in the
bid by the other department.

Under this method, valuation on the basis of opportunity cost is restricted to alternative
use within the organization. In real life such alternative use may not be identifiable on
account of the constraints in an organizational environment.

b) Monetary value based approaches:

According to this approach, the value of human resources of an organization is determined according to
their present value to the organization. For determination of the present value, a number of valuation
models have been developed. Some of the important models are as follows

In this method the future earnings of various groups of employees are estimated up to the age of
their retirement and are discounted at a predetermined rate to obtain the present value of future
earnings used in the case of financial assets. It is the present value of future earnings. To
determine this value, the organization establishes what an employees future contribution is
worth to it today. That contribution can be measured by its cost or by the wages the organization
will pay the employee. The organization does not benefit by monitoring the efficiency of its
investment in employee development because the investment has little or no impact on the
present valuation of future earnings.

1. The Lev and Schwartz Model (Present value of future earnings method)
This model has been developed by Lav and Schwartz (1971). According to this model, the value
of human resources is ascertained as follows

1. All employees are classified in specific groups according to their age and skill.
2. Average annual earnings are determined for various ranges of age.
3. The total earnings which each group will get up to retirement age are calculated
4. The total earnings calculated as above are discounted at the rate of cost of capital. The value
thus arrived at will be the value of human resources/assets.
5. The following formula has been suggested for calculating the value of an employee according
to this model Where, V = the value of an individual r years old. = the individuals annual
earnings upto the retirement
t = retirement age
r = present age of the employee
R = discount rate
Limitations:
1. This model implies that the future work condition of the employee will not change over the
span of his working life, but will remain the same as at present.
2. The approach does not take into account the possibility that the employee will withdraw from
the organization prior to his death or retirement. It is therefore not realistic.
3. It ignores the variable of thee career movement of the employee within the organization. An
engineer will be an engineer throughout his career in the organization.
4. It does not take into account the role changes of employees. A Personnel Manager may
become Chief Legal Officer. However, this method does not give correct value of human assets
as it does not measure their contributions to achieving organizational effectiveness.

2. Flamholtz Model (Reward Valuation method)

This model has been suggested by Flamholtz (1971). This is an improvement on present value
of future earnings model since it takes into consideration the possibility or probability or an
employees movement from one role to another in his career and also of his leaving the firm
earlier, that his death or retirement.
According to this model, the ultimate measure of an individuals value to an organization is his
expected realizable value. Expected realizable value is based on the assumption that there is no
direct relationship between cost incurred on an individual and his value to the organization at a
particular point of time. An individuals value to the organization can be defined as the present
worth of set of future services that the expected to provide during the period he remains in the
organization.
Flamholtz has given the variables affecting an individuals expected value {IERV}: individual
conditional values and his likelihood of remaining in the organization. The former is function of
the individuals abilities and activation level, while the later is a function of such variables as job
satisfaction, commitment, motivation and other factors.
The model suggests a five-step approach for this purpose
1. Determination of the period for which a person is expected to serve the organization.
2. Identification of service states (i.e. roles or posts) that the employee might occupy during his
service career including the possibility of his quitting the organization.
3. Estimation of the value derived by the organization when a person occupies a particular
position. Such value can be determined either by multiplying the price of the services with the
quantity of the services to be rendered or the income expected to be derived from the services to
be rendered.
4. The total value of the services derived by the organization by different employees or group of
employees is determined. The value thus arrived is discounted at a predetermined rate to get the
present value of human resources.

Limitations:

The model suffers from nearly all the drawbacks from which the present value of future earnings
models suffers. Moreover, It is difficult to obtain reliable data for determining the value derived
by an organization during the period a person occupies a particular position. The model also
ignores the fact that individuals operating in a group may have a higher value for the
organization as compared to individuals working independently.
3. Morse Model (Net Benefit Model)
This approach has been suggested by Morse (1973). According to this approach, the value of
human resources is equivalent to the present value of net benefits derived by the organization
from the service of its employees. The method involves the following steps
1. The gross value of services to be rendered in future by the employees in their individual as
well as their collective capacity is determined.
2. The value of future payments (both direct and indirect) to the employees is determined.
3. The excess of the value of future human resources (as per 1 above) over the value of future
payments (as per 2 above) is ascertained. This, as a matter of fact, represents the net benefit to
the organization on account of human resources.
4. The present value of the net benefit is determined by applying a predetermined discount rate
(generally the cost of capital). This amount represents the value of human resources to the
organization.

c) Non- monetary value -based approaches:

1.Pekin Ogan (Certainity Equivalent Net Benefit Model)
This approach has been suggested by Pekin Ogan(1976). This, as a matter of fact, is an ext4nsion
of net benefit approach as suggested by Morse. According to this approach, the certainty with
which the net benefits in future will accrue should also be taken into account, while determining
the value of human resources. The approach requires determination of the following

1. Net benefit from each employee as explained under net benefit approach.
2. Certainty factor at which the benefits will be available

3. The net benefits from all employees multiplied by their certainty factor will give certainty
equivalent net benefits. This will be the value of human resources of the organization.
2. S.K. Chakraborthy Model (Aggregate payment approach)
Indian author Prof. S.K. Chakraborty in 1976 advocated this model. He has valued the human
resources in aggregate and not on an individual basis. He suggested that managerial and non
managerial man power can be evaluated separately. The value of human resource on a collective
or group basis can be is multiplied by the average tenure of employment of the employees in that
group and is the investment in human resource. The average annual salary payments for the next
few years could be found out from the salary grade structure and promotion schemes of the
enterprise. The recruitment, including selection, development and training costs of each
employee could be recorded separately and considered as deferred revenue expenditure to be
written off over the expected average tenure of the employee in the organization. The deferred
portion should be shown in the financial statement of the organization.
In case of permanent exit on account of death, retrenchment etc. then the balance on the deferred
revenue account of that year of that person should be written off against the income in the year of
exit itself. As for disclosure of accounting information on human resources as an asset, he has
suggested to include human assets under investments in the 'financial statement' of the
organization. He is not for taking it as 'fixed assets' as it will cause problems of depreciation,
capital gains or losses upon exit etc.; neither it could be taken as 'current asset' as it will not be in
conformity with the general meaning of the term.

Conclusion

Conclusion Overall, even valuing human resources appear to be important to organizations, most
organizations do not value their human resources and plans to implement valuation of human
resources are at a very early stage. Despite the interest in valuation there will be little or
moderate progress in the area over the next five to ten years. In order to show greater progress,
more needs to be done at both the theoretical and practical level. More search into valuation
methods and models, and the practical implication of these, is needed together with the
engagement of both human resource and accounting professionals in the debate on valuation and
its implementation in practice.

Reference:

1. Human Resource Management and Accounting, R.P. Gupta.

2. Advanced Accountancy, S.N. Maheshwari & S.K. Maheshwari.
3. Human Resource Development-Conceptual Analysis and Strategies, R. Jayagopal.
4. Human Resource Management, S.S. Khanka
5. http://www.pondiuni.edu.in/storage/dde/downloads/hrmiv_hra.pdf