Human Resource Accounting: Meaning, Definition, Objectives and

Limitations!
Meaning:
Human resources are considered as important assets and are different from
the physical assets. Physical assets do not have feelings and emotions,
whereas human assets are subjected to various types of feelings and
emotions. In the same way, unlike physical assets human assets never gets
depreciated.

Therefore, the valuations of human resources along with other assets are also
required in order to find out the total cost of an organization. In 1960s, Rensis
Likert along with other social researchers made an attempt to define the
concept of human resource accounting (HRA).

Definition:
1. The American Association of Accountants (AAA) defines HRA as follows:
HRA is a process of identifying and measuring data about human resources
and communicating this information to interested parties.

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2. Flamhoitz defines HRA as accounting for people as an organizational

resource. It involves measuring the costs incurred by organizations to recruit,
select, hire, train, and develop human assets. It also involves measuring the
economic value of people to the organization.
3. According to Stephen Knauf, HRA is the measurement and quantification
of human organizational inputs such as recruiting, training, experience and
commitment.

Need for HRA:

The need for human asset valuation arose as a result of growing concern for
human relations management in the industry.

Behavioural scientists concerned with management of organizations

pointed out the following reasons for HRA:
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1. Under conventional accounting, no information is made available about the

human resources employed in an organization, and without people the
financial and physical resources cannot be operationally effective.

2. The expenses related to the human organization are charged to current

revenue instead of being treated as investments, to be amortized over a
period of time, with the result that magnitude of net income is significantly
distorted. This makes the assessment of firm and inter-firm comparison
difficult.

3. The productivity and profitability of a firm largely depends on the

contribution of human assets. Two firms having identical physical assets and
operating in the same market may have different returns due to differences in
human assets. If the value of human assets is ignored, the total valuation of
the firm becomes difficult.
4. If the value of human resources is not duly reported in profit and loss
account and balance sheet, the important act of management on human
assets cannot be perceived.

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5. Expenses on recruitment, training, etc. are treated as expenses and written

off against revenue under conventional accounting. All expenses on human
resources are to be treated as investments, since the benefits are accrued
over a period of time.

Objectives of HRA:
Rensis Likert described the following objectives of HRA:
1. Providing cost value information about acquiring, developing, allocating and
maintaining human resources.

2. Enabling management to monitor the use of human resources.

3. Finding depreciation or appreciation among human resources.

4. Assisting in developing effective management practices.

5. Increasing managerial awareness of the value of human resources.

6. For better human resource planning.

7. For better decisions about people, based on improved information system.

8. Assisting in effective utilization of manpower.

Methods of Valuation of Human Resources:
There are certain methods advocated for valuation of human resources.
These methods include historical method, replacement cost method, present
value method, opportunity cost method and standard cost method. All
methods have certain benefits as well as limitations.

(a)Historical cost method

It suggests capitalizing the expenditure of the firm incurred on recruitment and

selection, training and development of the employees and treats them as the assets of
the organization for the purpose of HR accounting. This method suffers from a
limitation that the capitalization of costs does not reflect its true value. The total
performance has to be judged in relation with the total cost associated with the HR to
reflect its value.

(b) Replacement cost method

The cost of replacement of individual and the re-building cost of organization is

assessed to reflect the HR asset value of the individuals and the organization. However
this method may not reflect either the actual cost or the contribution associated with HR

(c) Opportunity cost method

This model envisages the computation of monetary value and the allocation of people to
the most promising activity and thereby assesses the opportunity cost of main
employees through competitive bidding among the investment centre.

(d) Economic value method

The value of human resource is evaluated on the basis of contribution they are likely to
make in the organization during their stay with the organization. The payments made to
the employees in the form of salary, allowances and benefits are estimated and
discounted appropriately to arrive at the present economic value of the individual.

(2) Non-monetary measures:

(a) Expected realizable value method

The elements of expected realizable value like the productivity, transferability and
promote-ability are measure using personal research, appraisal techniques or other
objective methods. The productivity is measured by objective indices and managerial
assessment. The promote-ability and transferability are measured in terms of potential
using psychometric tests and subjective evaluations.

(b) Discounted present value of future earnings

This method was use by Rencis Likert who proposed three sets of variables-casual,
intermediate, output. These helped in measuring the effectiveness over a period of time.
Casual variable include leadership style and behaviour, the intermediate variable are
morale, motivation, commitment to goals etc. and these in turn affect the output
variables like production, sales, profit etc.

Benefits of HRA:
There are certain benefits for accounting of human resources, which are
explained as follows:
1. The system of HRA discloses the value of human resources, which helps in
proper interpretation of return on capital employed.

2. Managerial decision-making can be improved with the help of HRA.

3. The implementation of human resource accounting clearly identifies human
resources as valuable assets, which helps in preventing misuse of human
resources by the superiors as well as the management.

4. It helps in efficient utilization of human resources and understanding the

evil effects of labour unrest on the quality of human resources.

5. This system can increase productivity because the human talent, devotion,
and skills are considered valuable assets, which can boost the morale of the
employees.

6. It can assist the management for implementing best methods of wages and
salary administration.

Limitations of HRA:
HRA is yet to gain momentum in India due to certain difficulties:
1. The valuation methods have certain disadvantages as well as advantages;
therefore, there is always a bone of contention among the firms that which
method is an ideal one.

2. There are no standardized procedures developed so far. So, firms are

providing only as additional information.

3. Under conventional accounting, certain standards are accepted commonly,

which is not possible under this method.

4. All the methods of accounting for human assets are based on certain
assumptions, which can go wrong at any time. For example, it is assumed that
all workers continue to work with the same organization till retirement, which is
far from possible.
5. It is believed that human resources do not suffer depreciation, and in fact
they always appreciate, which can also prove otherwise in certain firms.

6. The lifespan of human resources cannot be estimated. So, the valuation

seems to be unrealistic.

Methods for Controlling the

Costs of Human Resources
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The four methods used to control the costs of human resources are as
follows: 1. Management by Objectives (MBO) 2. Ratio Analysis 3. Personnel
Productivity 4. Personnel Reports and Budgets.

Human resource costs constitute a significant portion of the total operating

costs in many industrial organisations. An overview of various types of human
resource costs is given in the following Table 30.1. Evidences indicate that
organisation having low costs of human resources as a percentage to the total
cost enjoys competitive advantage. That enables them to emerge as winners
in competitive market. Hence, the need for controlling the costs of human
resources. Accordingly, some of the widely used methods to analyse and
control the costs of human resources are discussed here.

1. Management by Objectives (MBO):

According to Peter F. Drucker, measurement is very important aspect in
management. However, human resource management has been weak in
respect of measurement due to its qualitative variables such as feelings,
attitudes, job satisfaction, etc. Experts have suggested the use of MBO to
measure the qualitative variables of human resources.

For example, K.N. Randeria has prescribed the following procedure for
measuring the qualitative variables of employee:
(a) Employee costs per unit of production/service shall be held (at Base year)
and indexed to as a percentage of fixed and semi-variable costs

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(b) At least two-third of increased cost of improvements in the long-term

agreement with trade unions shall be met through employee productivity.

(c) During the next .years, there shall be reduction of .per cent in down
time of plant and machinery. per cent in the avoidable waste of materials
and. per cent in absenteeism beyond authorised leave.

(d) Ensure that one-third of savings arising out of (c) above will be distributed
to ensure improvement in the individual employees earnings.

(e) An individual employee must move up. grades in his work span of.
years through careful manpower and succession planning.

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(f) At least one-fourth of vacancies in the managerial cadre shall be filled from
amongst the lower job holders through appropriate training and development
programme.

2. Ratio Analysis:
In this approach, the important performance indicators that concern the
personnel function are used. Cost of recruitment training, etc., are the
examples of personnel function.

These indicators are called personnel ratios and cover the following:
(i) Cost of Recruitment:
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This is also called cost per hire. This ratio is used to measure the cost of
recruitment and includes costs such as cost incurred in hiring process; cost of
advertisement; fee paid to the recruitment agency; cost incurred in conducting
tests; group discussion and personal interview; cost of medical examination;
and administrative expenses such as stationery, postage, telephone, etc.

The cost of recruitment, or say, cost per hire is expressed as follows:

Cost of Recruitment

Cost per hire (in Rs.) = Cost of Recruitment/ No. of Recruiters hired/Retained

The knowledge about the cost of hire helps managers rationalize and improve
the efficiency of recruitment process.

(ii) Recruitment Cycle Time:

It means the time taken from commencement to completion of recruitment
process. The main objective of analysing recruitment cycle time is to know the
ideal time needed to initiate and complete the recruitment/hiring process.

An analysis of time taken to complete each stage of hiring will suggest the
need for steps to be taken to minimize the cycle time. Measures like clear job
specification, computerisation of application blanks, standardizing the
screening procedures, etc., help, reduce the cycle time in recruitment process.

(iii) Cost of Turnover:

Employee turnover is expensive as it involves both direct and indirect costs.
Direct costs also called replacement costs include all costs of recruiting an
employee, training, interruption cost, etc. Deterioration in the motivation and
morale of employees are indirect costs.

The cost of turnover can be calculated by using the following formula:

Turnover Rate (%) = Number of Separations/ Average Number of Employees
100

(iv) Cost of Training:

Training is an ongoing activity in organisations to enhance the employee skills
and competence. Though measuring the effectiveness of training in totality is
difficult, yet there are ways to reduce costs involved in conducting training
programmes.

The cost of training is usually expressed in the following ways:

A. Cost of Training Per Trainee = Training Costs/ Number of Employees
Trained
B. Cost of Training Per Employee = Training Cost/ Number of Employees

C. Training Ratio = No. of Trainings/ Number of Employees

3. Personnel Productivity:
Productivity is expressed as the ratio of organisations outputs i.e., goods and
services to its inputs, i.e., physical, financial and human resources. One way
to control the costs of human resource is increasing the productivity of
employees working in the organisation.

Organisations can raise the productivity of their employees through some

techniques like O and M studies, work simplification, quality circles,
productivity-linked rewards and proper utilization of manpower at various
levels.

Thus, when the percentage increase in personnel productivity is higher than

percentage increase in personnel costs, per unit costs of personnel will be
reduced. The same enables companies to continuously increase the
remuneration of their employees with decreasing cost of personnel or keeping
the personnel cost constant.

4. Personnel Reports and Budgets:

Personnel reports provide useful information regarding manpower utilization.
These can be used for controlling human resource costs. Personnel budget is
a personnel programme expressed in monetary terms for key areas such as
employee compensation, facilities, training, development etc. A comparison of
actual costs with budgeted costs helps the manager take corrective measures
to control the personnel costs.