bba sem 4 accounts

8/19/2019 Bba Sem 4 Accounts

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Meaning of Fund Flow Statement:

A fund flow statement is a statement in summary form that indicates changes in terms of financial

position between two different balance sheet dates showing clearly the different sources from which

funds are obtained and uses to which funds are put.

It summarizes the financing and investing activities of the enterprise during an accounting period.

By depicting all inflows and outflows of fund, the statement shows their net impact on workingcapital of the firm.

If the total of inflows is greater than the outflows, the excess goes to increase in working capital. If

there is deficit of funds during a particular accounting period, the working capital is impaired. So

fund flow statement is an important tool for working capital management.

Some definitions of financial experts are given for the clear conception of fund flow

statement:

According to R. N. Anthony:

“The funds flow statement describes the sources from which additional funds were derived and the

uses to which these funds were put.”

Roy A. Fouke defines fund flow statement as“a statement of sources and application of funds is

a technical device designed to analyse the changes in the financial condition of a business

enterprise between two dates.”

Thus, the fund flow statement reveals the volume of financial transactions and explains the flow of

funds taking place within a business during a particular period of time and its effect on the net

working capital. It is not a substitute for either the Profit and Loss Account or the Balance Sheet,

but it is an useful supplement to them.

It describes the sources from which funds are obtained and the uses of these funds, in a condensed

form.

Objectives of Fund Flow Statement:

Some of the important objectives of preparing fund flow statement are:

1. Fund flow statement reveals clearly the changes in items of financial position between two

different balance sheet dates showing clearly the different sources and applications of funds. Thus,

it summarizes the financing and investing activities of the enterprise.

2. It also reveals how much of the total funds is being collected by disposing of fixed assets, howmuch from issuing shares or debentures, how much from long-term or short-term loans, and how

much from normal operational activities of the business.

3. It also provides information about the specific utilisation of such funds i.e., how much has been

used for acquiring fixed assets, how much for redemption of preference shares, debentures or short-

term loans as well as payment of tax, dividend etc.

4. It helps the management in depicting all inflows and outflows of funds which cause a change in

working capital of a business organisation.


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5. The projected fund flow statement helps management to exercise budgetary control and capital

expenditure control in the enterprise.

Management uses fund flow statement for judging the financial and operating performance of the

business.

Importance of Fund Flow Statement:

The importance of fund flow statement may be summarised:1. Analyses Financial Statements:

Balance Sheet and Profit and Loss Account do not reveal the changes in the financial position of an

enterprise. Fund flow analysis shows the changes in the financial position between two balance

sheet dates. It provides details of inflow and outflow of funds i.e., sources and application of funds

during a particular period.

Hence it is a significant tool in the hands of the management for analysing the past, and for

planning the future. They can infer the reasons for imbalances in the uses of funds in the past and

take corrective measures for the future.

2. Answers Various Financial Questions:

Fund flow statement helps us to answers various financial questions such as:

(a) How much fund flowed into the business?

(b) How much of these funds were provided by the operations?

(c) What are the other sources of funds?

(d) How were these funds used?

(e) Why was there less/more amount of net working capital at the end of the period than at the beginning?

(f) Why were the dividends not larger?

(g) How was the purchase of fixed assets financed?

(h) Where have the net profits gone?

(i) How were the loans repaid?

3. Rational Dividend Policy:

Sometimes it may happen that a firm, instead of having sufficient profit, cannot pay dividend due to

inadequate working capital. In such circumstances, fund flow statement shows the working capital

position of a firm and helps the management to take policy decisions on dividend etc.

4. Proper Allocation of Resources:

Financial resources are always limited. So it is the duty of the management to make its proper use.

A projected fund flow statement enables the management to take proper decision regarding

allocation of limited financial resources among different projects on priority basis.


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5. Guide to Future Course of Action:

The future needs of the fund for various purposes can be known well in advance from the projected

fund flow statement. Accordingly, timely action may be taken to explore various avenues of fund.

6. Proper Managing of Working Capital:

It helps the management to know whether working capital has been effectively used to the

maximum extent in business operations or not. It depicts the surplus or deficit in working capital

than required. This helps the management to use the surplus working capital profitably or to locatethe resources of additional working capital in case of scarcity.

7. Guide to Investors:

It helps the investors to know whether the funds have been used properly by the company. The

lenders can make an idea regarding the creditworthiness of the company and decide whether to

lend money to the company or not.

8. Evaluation of Performance:

Fund flow statement helps the management in judging the financial and operating performance of

the company.

Limitations of Fund Flow Statement:

Despite its various advantages, the fund flow statement suffers from certain limitations:

1. Historical Nature:

The information used for the preparation of the fund flow statement is essentially historical in

nature. It does not estimate the sources and application of funds for the near future.

2. Structural Changes Not Disclosed:

The fund flow statement does not disclose the structural changes in financial relationship in a firm.

In other words, it does not reveal shifts among items making up the current assets and current

liabilities. It does not tell us whether any loss of working capital has unduly weakened the financial

position or not.

3. Not Foolproof:

The fund flow statement is prepared from the data provided in the balance sheet and profit and loss

account. Hence, the defects in financial statements will be carried over to the fund flow statement

also.

4. Ignores Non-Fund Items:

As fund flow statement ignores non-fund items, it becomes a crude device compared to income

statement and balance sheet.

5. Not Relevant:

A study of changes in cash (i.e., cash flow statement) is more relevant than a study of changes in

funds for the purpose of managerial decision-making.

General Rules:

We know, working capital (WC) = Current Assets (CA) – Current Liabilities (CL) or, WC = CA – CL

From the above equation, we may deduce


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(i) An increase in CA or a decrease in CL – Causes an increase in WC

(ii) A decrease in CA or an increase in CL – Causes a decrease in WC

(iii) A simultaneous increase in CA and CL or a simultaneous decrease in CA and CL— will have no

effect on WC.

A flow of funds takes place only if a transaction involves one current account (CA or CL) and one

Non-current account (NCA or NCL).

From above the following general rules can be formed:

(i) Transactions which involve only current accounts (CA or CL) do not result in a flow of funds.

(ii) Transactions which involve only Non-current accounts (NCA or NCL) do not result in a flow of

funds.

(iii) Transactions which involve one current account (CA or CL) and one Non-current account (NCA

or NCL) results in a flow of funds.

Preparation of Fund Flow Statement:

Generally, two comparative balance sheets—one at the beginning and the other at the end of the

period—are used for preparing a fund flow statement. In addition, a summarised income statement

comprising non-fund or ‘non-operating’ items and a statement of retained earnings or at least

material information from these statements are required in order to find out fund from operations.

Additional information regarding change in non-current accounts like plant and machinery,

building, share capital, debentures etc., if available, will sharpen the firms financial profile as

revealed by the fund flow statement.

The fund flow analysis involves the preparation of two statements:

(a) Statement or Schedule of Changes in Working Capital and

(b) Statement of Sources and Application of funds.

1. Statement or Schedule of Changes in Working Capital:

The primary purpose of a fund flow statement is to explain the net change in working capital, it will

be better to prepare first the schedule of changes in working capital before preparing a fund flow

statement.

The Schedule or Statement of changes in working capital is a statement that compares the change

in the amount of current assets and current liabilities on two balance sheet dates and highlights its

impact on working capital.

The format of this statement is:


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2. Fund Flow Statement:

After preparing the schedule of changes in working capital, the next step is to prepare the FundFlow Statement to find out the different sources and applications of funds. While preparing this

statement the emphasis is given on the changes in the fixed assets and fixed liabilities. The

statement may be prepared either in ‘T form’ or in ‘Vertical form’.

A proforma of each of them is given:


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Notes:

(1) Either of the two will appear in the Fund Flow Statement.


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(2) Either of the two will appear in the Fund Flow Statement.

(3) Payment of dividend and tax will appear as an application of funds only when these items are

appropriation of profits and not current liabilities

Meaning of Cash Flow Statement:

A cash flow statement is a statement of changes in the financial position of a firm on cash basis.

It reveals the net effects of all business transactions of a firm during a period on cash and explains

the reasons of changes in cash position between two balance sheet dates.

It shows the various sources (i.e., inflows) and applications (i.e., outflows) of cash during a

particular period and their net impact on the cash balance.

According to Khan and Jain:

“Cash Flow statements are statements of changes in financial position prepared on the basis offunds defined as cash or cash equivalents.”

The Institute of Cost and Works Accountants of India defines Cash Flow statement as“a statement

setting out the flow of cash under distinct heads of sources of funds and their utilisation to

determine the requirements of cash during the given period and to prepare for its adequate

provision.”

Thus, a cash flow statement is a statement which provides a detailed explanation for the changes in

a firm’s cash balance during a particular period by indicating the firm’s sources and uses of cash

and, ultimately, net impact on cash balance during that period.

Features of Cash Flow Statement:

The features or characteristics of Cash Flow Statement may be summarised in the following

way:

1. It is a periodical statement as it covers a particular period of time, say, month or year.

2. It shows movement of cash in between two balance sheet dates.

3. It establishes the relationship between net profit and changes in cash position of the firm.

4. It does not involve matching of cost against revenue.

5. It shows the sources and application of funds during a particular period of time.

6. It records the changes in fixed assets as well as current assets.

7. A projected cash flow statement is referred to as cash budget.

8. It is an indicator of cash earning capacity of the firm.

9. It reflects clearly how financial position of a firm changes over a period of time due to its

operating activities, investing activities and financing activities.


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Objectives of Cash Flow Statement:

Cash Flow Statement is prepared to fulfill some objectives.

Some of the main objectives of Cash Flow Statement are:

1. It shows the cash earning capacity of the firm.

2. It indicates different sources from which cash been collected and various purposes for which

cash has been utilised during the year.

3. It classifies cash flows during the period from operating, investing and financing activities.

4. It gives answers to various perplexing questions often encountered by management, such as why

the firm is unable to pay dividend instead of making enough profit? Why is there huge idle cash

balance in spite of loss suffered? Where have the proceeds of sale of fixed assets gone? etc.

5. It helps the management in cash planning and control so that there are no shortage or surplus of

cash at any point of time.

6. It evaluates the ability of the firm to meet obligations such as loan repayment, dividends, taxes

etc.

7. A prospective investor consults the cash flow statement to ensure that his investment gets regular

returns in future.

8. It discloses the reasons for differences among net income, cash receipts and cash payments.

9. It helps the management in taking capital budgeting decisions more scientifically. 10. It ensures

optimum use of funds for the maximum benefit of the enterprise.

Utility or Importance of Cash Flow Statement:

Cash Flow Statement is useful for short-term planning and control of cash. A business entity needs

sufficient amount of cash to meet its various obligations in the near future such as payment forpurchase of fixed assets, payment of debts, operating expenses of the business etc.

It helps the financial manager to make a cash flow projection for the immediate future taking the

data relating to cash inflows and cash outflows from past records. As such, it becomes easy for him

to know the cash position which may either result in a surplus or a deficit one. Thus, cash flow

statement is another important tool of financial analysis for the management.

Its main advantages are:

1. Evaluation of Cash Position:

It is very helpful in understanding the cash position of a firm. Since cash is the basis for carryingon business operations smoothly, the cash flow statement is very useful in evaluating the current

cash position of the business.

2. Planning and Control:

A projected cash flow statement enables the management to plan and coordinate the financial

operations properly. The financial manager can know how much cash is needed, from where it will

be derived, how much can be generated internally, and how much could be obtained from outside.

3. Performance Evaluation:


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A comparison of actual cash flow statement with the projected cash flow statement will disclose the

failure or success of the management in managing cash resources. Deviations will indicate the need

for corrective actions.

4. Framing Long-term Planning:

The projected cash flow statement helps financial manager in exploring the possibility of repayment

of long-term debts which depends upon the availability of cash.

5. Capital Budgeting Decision:

A projected cash flow statement also helps the management in taking capital budgeting decisions.

6. Liquidity Position:

Liquidity position of a firm refers to its ability to meet short-term obligations such as payment of

wages and other operating expenses etc. From cash flow statement the financial manager is able to

understand how well the firm is meeting these obligations.

At the same time the ability of the firm in cash earning can be known from cash flow statement. As

a matter of fact, a firm’s profitability is ultimately dependent upon its cash earning capacity.

7. Answers to Different Questions:

Cash flow statement is able to explain some questions often encountered by the financial manager

such as, why is the firm not able to pay dividend in spite of making huge profit? Why there is huge

cash balance in spite of loss etc.

Limitations of Cash Flow Statement:

Cash Flow Statement is, no doubt, an important tool of financial analysis which discloses the

complete story of cash management. The increase in—or decrease of—cash and reasons thereof, can

be known, However, it has its own limitation.

These limitations are:

1. Since cash flow statement does not consider non-cash items, it cannot reveal the actual net

income of the business.

2. Cash flow statement cannot replace fund flow statement or income statement. Each of them has

a separate function to perform which cannot be done by the cash flow statement.

3. The cash balance as disclosed by the projected cash flow statement may not represent the real

liquid position of the business since it can be easily influenced by the managerial decisions, by

making certain payments in advance or by post ponding payments.

4. It cannot be used for the purpose of comparison over a period of time. A company is not better off

in the current year than the previous year because its cash flow has increased.

5. It is not helpful in measuring the economic efficiency in certain cases e.g., public utility service

where generally heavy capital expenditure is involved

Meaning of Ratio Analysis:


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Ratio analysis refers to the analysis and interpretation of the figures appearing in the financial

statements (i.e., Profit and Loss Account, Balance Sheet and Fund Flow statement etc.).

It is a process of comparison of one figure against another. It enables the users like shareholders,

investors, creditors, Government, and analysts etc. to get better understanding of financial

statements.

Khan and Jain define the term ratio analysis as“the systematic use of ratios to interpret the

financial statements so that the strengths and weaknesses of a firm as well as its historicalperformance and current financial conditions can be determined.”

Ratio analysis is a very powerful analytical tool useful for measuring performance of an

organisation. Accounting ratios may just be used as symptom like blood pressure, pulse rate, body

temperature etc. The physician analyses these information to know the causes of illness. Similarly,

the financial analyst should also analyse the accounting ratios to diagnose the financial health of

an enterprise.

Generally, ratio analysis involves four steps:

(i) Collection of relevant accounting data from financial statements.

(ii) Constructing ratios of related accounting figures.

(iii) Comparing the ratios thus constructed with the standard ratios which may be the

corresponding past ratios of the firm or industry average ratios of the firm or ratios of competitors.

(iv) Interpretation of ratios to arrive at valid conclusions.

Advantages of Ratio Analysis:

Ratio analysis is widely used as a powerful tool of financial statement analysis. It establishes the

numerical or quantitative relationship between two figures of a financial statement to ascertain

strengths and weaknesses of a firm as well as its current financial position and historicalperformance. It helps various interested parties to make an evaluation of certain aspect of a firm’s

performance.

The following are the principal advantages of ratio analysis:

1. Forecasting and Planning:

The trend in costs, sales, profits and other facts can be known by computing ratios of relevant

accounting figures of last few years. This trend analysis with the help of ratios may be useful for

forecasting and planning future business activities.

2. Budgeting:

Budget is an estimate of future activities on the basis of past experience. Accounting ratios help to

estimate budgeted figures. For example, sales budget may be prepared with the help of analysis of

past sales.

3. Measurement of Operating Efficiency:

Ratio analysis indicates the degree of efficiency in the management and utilisation of its assets.

Different activity ratios indicate the operational efficiency. In fact, solvency of a firm depends upon

the sales revenues generated by utilizing its assets.


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4. Communication:

Ratios are effective means of communication and play a vital role in informing the position of and

progress made by the business concern to the owners or other parties.

5. Control of Performance and Cost:

Ratios may also be used for control of performances of the different divisions or departments of an

undertaking as well as control of costs.

6. Inter-firm Comparison:

Comparison of performance of two or more firms reveals efficient and inefficient firms, thereby

enabling the inefficient firms to adopt suitable measures for improving their efficiency. The best way

of inter-firm comparison is to compare the relevant ratios of the organisation with the average ratios

of the industry.

7. Indication of Liquidity Position:

Ratio analysis helps to assess the liquidity position i.e., short-term debt paying ability of a firm.

Liquidity ratios indicate the ability of the firm to pay and help in credit analysis by banks, creditors

and other suppliers of short-term loans.

8. Indication of Long-term Solvency Position:

Ratio analysis is also used to assess the long-term debt-paying capacity of a firm. Long-term

solvency position of a borrower is a prime concern to the long-term creditors, security analysts and

the present and potential owners of a business. It is measured by the leverage/capital structure and

profitability ratios which indicate the earning power and operating efficiency. Ratio analysis shows

the strength and weakness of a firm in this respect.

9. Indication of Overall Profitability:

The management is always concerned with the overall profitability of the firm. They want to know

whether the firm has the ability to meet its short-term as well as long-term obligations to its

creditors, to ensure a reasonable return to its owners and secure optimum utilisation of the assets

of the firm. This is possible if all the ratios are considered together.

10. Signal of Corporate Sickness:

A company is sick when it fails to generate profit on a continuous basis and suffers a severe

liquidity crisis. Proper ratio analysis can give signal of corporate sickness in advance so that timely

measures can be taken to prevent the occurrence of such sickness.

11. Aid to Decision-making:

Ratio analysis helps to take decisions like whether to supply goods on credit to a firm, whether

bank loans will be made available etc.

12. Simplification of Financial Statements:

Ratio analysis makes it easy to grasp the relationship between various items and helps in

understanding the financial statements.

Limitations of Ratio Analysis:


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The technique of ratio analysis is a very useful device for making a study of the financial health of a

firm. But it has some limitations which must not be lost sight of before undertaking such analysis.

Some of these limitations are:

1. Limitations of Financial Statements:

Ratios are calculated from the information recorded in the financial statements. But financial

statements suffer from a number of limitations and may, therefore, affect the quality of ratio

analysis.

2. Historical Information:

Financial statements provide historical information. They do not reflect current conditions. Hence, it

is not useful in predicting the future.

3. Different Accounting Policies:

Different accounting policies regarding valuation of inventories, charging depreciation etc. make the

accounting data and accounting ratios of two firms non-comparable.

4. Lack of Standard of Comparison:

No fixed standards can be laid down for ideal ratios. For example, current ratio is said to be ideal if

current assets are twice the current liabilities. But this conclusion may not be justifiable in case of

those concerns which have adequate arrangements with their bankers for providing funds when

they require, it may be perfectly ideal if current assets are equal to or slightly more than current

liabilities.

5. Quantitative Analysis:

Ratios are tools of quantitative analysis only and qualitative factors are ignored while computing the

ratios. For example, a high current ratio may not necessarily mean sound liquid position when

current assets include a large inventory consisting of mostly obsolete items.

6. Window-Dressing:

The term ‘window-dressing’ means presenting the financial statements in such a way to show a

better position than what it actually is. If, for instance, low rate of depreciation is charged, an item

of revenue expense is treated as capital expenditure etc. the position of the concern may be made to

appear in the balance sheet much better than what it is. Ratios computed from such balance sheet

cannot be used for scanning the financial position of the business.

7. Changes in Price Level:

Fixed assets show the position statement at cost only. Hence, it does not reflect the changes in price

level. Thus, it makes comparison difficult.

8. Causal Relationship Must:

Proper care should be taken to study only such figures as have a cause-and-effect relationship;

otherwise ratios will only be misleading.

9. Ratios Account for one Variable:


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Since ratios account for only one variable, they cannot always give correct picture since several

other variables such Government policy, economic conditions, availability of resources etc. should

be kept in mind while interpreting ratios.

10. Seasonal Factors Affect Financial Data:

Proper care must be taken when interpreting accounting ratios calculated for seasonal business.

For example, an umbrella company maintains high inventory during rainy season and for the rest of

year its inventory level becomes 25% of the seasonal inventory level. Hence, liquidity ratios andinventory turnover ratio will give biased picture

Classification of Ratios:

The use of ratio analysis is not confined to financial manager only. There are different parties

interested in the ratio analysis for knowing the financial position of a firm for different purposes. In

view of various users of ratios, there are many types of ratios which can be calculated from the

information given in the financial statements. The particular purpose of the user determines the particular ratios that might be used for financial

analysis. For example, a supplier of goods of a firm on credit or a banker advancing a short-term

loan to a firm, is interested primarily in the short-term paying capacity of the firm, or say in its

liquidity.

On the other hand, a financial institution advancing a long term credit to a firm will be primarily

interested in the solvency or long- term financial position of the concern. Similarly, the interests of

the owners (shareholders) and the management also differ. The shareholders are generally

interested in the profitability or dividend position of a firm while management requires information

on almost all the financial aspects of the firm to enable it to protect the interests of all the parties.

(A) Traditional Classification or Statement Ratios:

Traditional classification or classification according to the statement, from which these

ratios are calculated, is as follows:


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(a) Balance Sheet or Position Statement Ratios:

Balance Sheet ratios deal with the relationship between two balance sheet items, e.g. the ratio of

current assets to current liabilities, or the ratio of proprietors’ funds to fixed-assets. Both the items

must, however, pertain to the same balance sheet. The various balance sheet ratios have been

named in the chart classifying statement ratios.

(b) Profit and Loss Account or Revenue/Income Statements Ratios:

These ratios deal with the relationship between two profit and loss account items, e.g., the ratio of

gross profit to sales, or the ratio of net profit to sales. Both the items must, however, belong to the

same profit and loss account. The various profit and loss account ratios, commonly used, are

named in the chart classifying statement ratios.

(c) Composite/Mixed Ratios or Inter Statement Ratios:

These ratios exhibit the relation between a profit and loss account or income statement item and a

balance sheet item, e.g., stock turnover ratio, or the ratio of total assets to sales. The most

commonly used inter-statement ratios are given in the chart exhibiting traditional classification or

statement ratios.

(B) Functional Classification or Classification According to Tests:

In view of the financial management or according to the tests satisfied, various ratios have

been classified as below:

(a) Liquidity Ratios:

These are the ratios which measure the short-term solvency or financial position of a firm. These

ratios are calculated to comment upon the short-term paying capacity of a concern or the firm’s

ability to meet its current obligations. The various liquidity ratios are: current ratio, liquid ratio and

absolute liquid ratio. Further to see the efficiency with which the liquid resources have been

employed by a firm, debtors turnover and creditors turnover ratios are calculated.

(b) Long-term Solvency and Leverage Ratios:


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Long-term solvency ratios convey a firm’s ability to meet the interest costs and repayments

schedules of its long-term obligations e.g. Debt Equity Ratio and Interest Coverage Ratio. Leverage

Ratios show the proportions of debt and equity in financing of the firm. These ratios measure the

contribution of financing by owners as compared to financing by outsiders.

The leverage ratios can further be classified as:

(i) Financial Leverage,

(ii) Operating Leverage,

(iii) Composite Leverage.

(c) Activity Ratios:

Activity ratios are calculated to measure the efficiency with which the resources of a firm have been

employed. These ratios are also called turnover ratios because they indicate the speed with which

assets are being turned over into sales, e.g., debtors turnover ratio. The various activity or turnover

ratios have been named in the chart classifying the ratios.

(d) Profitability Ratios:

These ratios measure the results of business operations or overall performance and effectiveness of

the firm, e.g., gross profit ratio, operating ratio or return on capital employed. The various

profitability ratios have been given in the chart exhibiting the classification of ratios according to

test. Generally, two types of profitability ratios are calculated

(i) In relation to sales, and

(ii) In relation to investments.

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


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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’.

2. Flamhoitz defines HRA as ‘accounting for people as an organizational resource. It involves mea-

suring 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 organiza-

tional 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:

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 beingtreated 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 valu-

ation 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.

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.


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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.

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 valu-

able 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 consid-

ered 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.


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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

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