hr accounting and its methods

7/28/2019 HR Accounting and its methods

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Human Resource Accounting


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CONTENTS Introduction Of Human Resources Accounting

Various Definitions of Human Resources Accounting

Methods of Human Resources Accounting

Summary

Conclusion

Bibliography

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2BY: VAGHELA MANISHA


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IntroductionTwo types of resources are used in every business

enterprise:1. Physical and financial resources

2. Human resources.

One asset is omitted and its worth I want to know,

That asset is the value of men who run the show

These lines are clearly indicate

that the value of men (human-resources) is not

measured and reflected in the accounts of

business enterprise. Although the success of the

business to a greater extent depends upon the

abilities, efficiencies and power of these people

who actually run the business.3


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Human resource accounting may

be considered as such an accounting system

which recognizes the human resources as an assetand 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 informationrelating 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 ofHRA:-

Human Resource accounting is an

attempt to identify and report investments made in

human resource of an organization. Basically it is aninformation system that tells the management what

changes over time are occurring to human resources

of the business.

- R. L. Woodruff5


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Human resource is the

measurement and quantification of organizational

inputs such as recruiting, training experience and

commitment.

- Stephen Knauf

HRA is the process of identifyingand measuring data about human resources and

communicating this information to interested

parties.

-American Accounting Association

Human Resource accounting is the measurement

of costs and value of the people for the

organization.

- Flamholtz

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Methods of HRA:- Historical cost method

Replacement cost method

Opportunity cost method Capitalization of salary method

Economic valuation method

Return on efforts employed method

Adjusted discounted future wages method Reward valuation method

Standard Cost Method

Current Purchasing Power Method7


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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,

placing and developing the human

resources of an enterprise are

capitalized and written off over the

expected useful life of human

resources.

The procedure followed for

human resource asset is the same

as that of other physical asset.8


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Any amount spent on training and developing

human resources increase its efficiency, hencecapitalized.

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 towork out.

The traditional accounting concept of matching cost

with revenue is followed in this method.

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

resource investment.

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Limitation

It is very difficult to estimate the number of years an

employee will be with the firm.

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

effect of investment on employees will be realized. The extent to

which the employee will utilize the knowledge acquired is also

subjectively estimated.

It is also difficult to fix a rate of amortization. A number of

methods have been derived to write-off depreciation on fixed

assets but in the case of human asset it will generally be on a

constant basis.

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

human resources the situations just the reverse. With the

acquisition of experience and training in the course of time the

utility of employees increases rather than decreasing.11


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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

companys human resources. The human resources of a

company are to be valued on the assumptions as to what

it will cost the concern if existing human resources are

required to be replaced with other persons of equivalent

experience and talent.12


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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 historicalcost. In this method the cost of recruiting, selecting,

training etc. of new employees to reach the level of

competence of existing employees are measured.

AdvantagesThis 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 measurefor 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 humanresources and different persons may arrive at different

estimates.

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In order to overcome

the limitations of replacement

cost method, Hekimian and Jones

suggested the use of opportunity

cost method which determinesthe value of human resource on

the basis of an employees value

in alternative uses. Accordingly

the value of an employee is based

on his opportunity cost-the riceother divisions are willing to pay

for the services of an employee

working in another division of an

organization.

3) Opportunity cost method Hekimian andJones Competitive Biding Method :-

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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 theopportunity cost is linked with scarcity. This method

determines the value of human resources by

establishing competitive bidding within an organization.

AdvantagesThis method ensures optional allocation of human

resources.

It provides a quantitative base for planning,evaluating and developing human resources of an

organization. Development in human resource can

easily be made on the basis of the information of

this method.vaghela_manisha13@y

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Limitation

This method fails to accommodate the possibility ofhiring of employees of similar efficiency, experience

and skill.

It excludes from its purview those members of the

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

organization.

The application of this method is doubtful unless

the alternative uses of an employees service

available in an organization are traced out.

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4) Capitalization of salary methodBaruch Lev and Aba Schwartz :-The advocates of this methodBaruch 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 staywith the organization may be used as a

replacement for the value of human

resources, in view of the close co-relation

between employees compensation and

their value to the organization.

Thus the value of human resources

is the present value of future earnings of

homogeneous group of employees.18


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The authors of the model recommend the following

formula to :-

Where,

V = The human capital value of a person r years old,

T = The persons retirement age,l (t) = The persons annual earnings upto retirement,

r = A discount rate specific to the person.

Tvr = l(t)

___________________________________

t=r (1+r)t-r

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Advantages

This model has introduced economic value concept of

HRA.

Human capital value is found out after considering the

remaining period of service of the employees, thus due

weightage is given to working life span of the employees.

Limitation

The basic assumption of the model that an employee

will stay with an organization until he retires does not

generally hold true.

The selection of discount rate is subjective.

The change in employees behavior as a result of

promotion, transfer etc. is not considered true.

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5) Economic valuation method:-

Economic valuation method considers the

present worth of the employees future service expected

to be derived during their stay with the organization as

the value of firms human resource. Although there aresome 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. 22


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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 theirassociation with the organization. Under this method, the

valuation of human resources involves the following

steps:

Estimation of employees future services;

Multiply step I) by the employees rate of pay;

Multiply step II) by the rate of return on investment.

This would give the present worth of employees

services.

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Advantages

This model takes into consideration the employeescareer movements.

If employees leave enterprise on account of the

reasons other than death and retirement, then such

possibilities are also considered in this model.

This model is regarded better than Lev and Schwartz

model due to above two types of inclusion in this

model.

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Limitation

Estimation of the probabilities for each employees

occupying various positions and valuation of

contribution of services from all these positions is not

an easy task.

To estimate exit probabilities and changes from oneposition to another is an expensive process.

It is difficult to estimate an employees expected

tenure of service.

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

of expected to be rendered service by an employee.

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6) Return on efforts employed method:-

This method measures the value of the

firms human resources on the basis of efforts made by

the individual for the organizational benefits. These

efforts are evaluated in the light of the following factors :

Positions an employee holds;

Degree of excellence employee achieves;

Experience profile of the employee.26


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Advantages

It makes possible inter-divisional comparison whichensures 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 valuationmethod.

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 wagesmethod:-

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 earnsover 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. 29


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Estimation of wages and salaries to different levels of

employees for succeeding five years.

Calculation of the present value of the wage and salarypayments at the rate of return which is considered

normal in the industry.

Determination of an average efficiency ratio for a

specific period, usually the previous five years.

Calculation of the present value of future services of

the firms human resources. This is worked out by

multiplying the firms efficiency ratio.

It is with this argument Hermanson

suggested to measure the value of the human

resources on the capitalized value of the excess future

profits realized by the firm. Accordingly, the valuation of

a firms human-resources involves the following step:

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The calculation of efficiency ratio is as follows:

Efficiency Ratio= Actual Average Earnings of the firmNormal 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 valueof 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 ofefficiency which is not true.

The discounting factor is subjective in nature.

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8) Reward valuation method:-

As an improvement over thecapitalization of salary method, Flamholtz developed a

model commonly known as Stochastic Rewards

Valuation Method. The method seeks to measure the

value of human resources on the basis of an employees

value to an organization at various services states (roles)that he is expected to occupy during the span of his

working life with the organization. The author has

identified the major variables which determine the value

of an individual to a firm. 33


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Estimation ofemployees 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;

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.

In the context of his model the assessment of

employees value involves the following steps:

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Advantages

It is the most scientific model as it demonstrates the

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

It is matured model as it takes into consideration the

employees withdrawal from the organization earlier

than death or retirement.

Limitation

This method does not indicate the method of estimating

the future compensation flows of the employees.

It is practically difficult to determine the probability of

employees career movement within the organization

and of his exit from the organization.

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10) CurrEnt Purchasing Power Method :-

Under it, instead of taking the

replacement cost to capitalized, the capitalized historic

cost of investment in human resources is converted into

current purchasing power of money with help of indexnumbers. Its great advantage is its simplicity even

though it might produce only approximate answers and

approximately correct data.37


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SummaryHuman resource accounting provides quantitative

information about the value of human assets, whichhelps 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 negativeeffects of certain programmes, which are aimed at

improving profits in the short run. If not recognized on

time, these programmes could lead to a fall in

productivity levels, high turnover rate and low morale of

existing employees.

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