Chapter 27

Human Resources Accounting

After reading this chapter, you should be able to:

List the objectives of human resource accounting.

Enumerate the methods that evaluate human resources.

Explain the strengths and weaknesses of human resources accounting.

Human resource accounting: meaning

Human resource accounting is a process of estimating the cost benefit of investments on human resources with a view to assessing their value to the organization.

Objectives of human resource accounting

To provide quantitative information about the cost and value of human resources available within the organization for decisions concerning the human resources of the organization.

To facilitate the preparation of human cost or budget for performing human resource functions.

Objectives of human resource accounting (contd.)

To provide methods and standards for evaluating the worth of people to the organization effectively.

To help the management in monitoring the utility of human resources constantly.

Objectives of human resource accounting (contd.)

To carry out planned and measured changes in the value of the human resources of an organization.

To provide early warning to the management about the impending changes in the value of the human resources.

Objectives of human resource accounting (contd.)

To enable the organization to reward the employees on the basis of the assessment of their values within the organization.

To permit all the stakeholders of the business to have a fair knowledge of the value of the existing human resources.

Historical cost approach

This approach was developed by Lee Brummet, Eric Flamholtz and William C. Pyle.

As per the historical cost approach, the value of human resources is the cumulative cost incurred on recruiting, training and developing the employees.

Historical cost approach (contd.)

According to this approach, the cost incurred for recruiting, training and developing the employees should first be capitalized and the amount so capitalized should then be amortized (written off) over the estimated useful life of the human resources.

Replacement cost approach

The major contributors to this approach are Rensis Likert and Eric G. Flamholtz.

The aim of this approach is to offer a more realistic accounting treatment to value the cost of an asset.

Replacement cost approach (contd.)

This approach considers the aggregate cost of recruiting, training and developing persons as suitable replacements for the existing levels of expertise and experience available with the organization.

The replacement approach can be classified further into personal replacement and positional replacement.

Types of replacement cost approach

Personal replacement When the cost of replacing an incumbent

(job holder) in a specific position of the organization is considered, it is known as personal replacement.

Types of replacement cost approach (contd.)

Positional replacement In this type, only the exact skills and

knowledge required for job performance is considered. It does not consider other skills and abilities possessed by the position holder.

Opportunity cost approach

This method was introduced by Hekimian and Jones.

According to this approach, any decision that involves a choice from more than one alternative has an opportunity cost. This can be better explained through an example.

Opportunity cost approach (contd.)

When an employee decides to resign his or her present job to pursue higher studies, he or she should consider not only the expenses (like fees) for the higher studies but also the salary loss due to leaving the present job.

Clearly, the sacrifices made for choosing a decision (pursuing higher studies) are called opportunity cost.

Standard costing approach

This approach was advocated by David Watson.

According to this approach, the value of human resource is the standard cost fixed for various HR functions like hiring and training. The steps involved in this approach are

Employees of an organization are first classified into different groups/grades based on their hierarchical position.

Standard costing approach (contd.)

The standard cost is then fixed for each grade of employees and their value ascertained.

Aggregate standard cost computed for the entire workforce is regarded as the human resources value of the whole organization.

Value-based approach

According to the value-based approach, the value of human resources depends primarily on its ability to generate revenues.

Value-based approach does not make much reference to the historic cost but emphasises more on the future earning capacity of the human assets.

Value-based approach (contd.)

Since the valuation approach is based more on the conceptual proposals, it is difficult to practise it in real circumstances due to the complexities involved.

Present value of future earnings model

This model was advocated by Brauch Lev and Aba Schwartz.

According to this model, the value of human resources depends on the present value of the future earnings to be made from a person’s employment.

Present value of future earnings model (contd.)

This model aggregates the estimated present value of the future income of an employee from his or her remaining service after adjusting for the possibility of premature death or permanent disability.

In this model, the remaining years of service of an employee is critical in determining his or her value in the organization.

Certainty equivalent model

The proponent of this method is Pekin Ogan.

The two major components of this model are

Net benefit Certainty factor

Which provide the means for determining the net present value of the human resources.

Certainty equivalent model (contd.)

According to this model, the net benefit is the difference between the total investment made by the organization in acquiring, training, developing, integrating and maintaining the employees and the total benefits received out of the skills, ability and knowledge of those employees.

Certainty equivalent model (contd.)

Certainty factor is finally applied to compute the current equivalent of net benefits.

Stochastic reward valuation model (SRVM)

This model was originally developed by Eric Flamholtz.

According to this model, the process of fixing the value of an employee depends upon the variability of that person from four different perspectives and potentialities. These are

Productivity Promotability

Stochastic reward valuation model (SRVM) (contd.)

Transferability Retainability This model perceives that the value of

an employee depends upon the value of each of four factors/ positions connected with that person. However, the chances of the employee being in any of these positions (service states) depend on the law of probability.

Human asset multiplier model

This method was advocated by W. J. Giles and D. F. Robinson.

In this approach, the valuation of human resources is made in the same way as other business assets are valued on a “going concern concept” basis. The steps in this model are

A human asset multiplier is first applied on the gross remuneration of an employee.

Human asset multiplier model (contd.)

These multipliers are then weighted for different grades of employees to know the gross value of each employee.

The gross value of the human resources of an organization can be computed by just totalling all the individual values calculated separately.

Unpurchased goodwill model

The proponent of this method is Hermanson.

In this model, the capitalized value of the super profit of the organisation is treated as the value of human resources. The steps in this model are

The organization must first ascertain its actual earnings and average it for the past few years.

Unpurchased goodwill model (contd.)

It should then identify the normal rate of return of the industry to which the organization belongs.

Then, the organization must make a comparison between its actual average earnings and the normal earnings of the industry.

Unpurchased goodwill model (contd.)

In case the actual earnings are more than the normal earnings of the industry, the difference is known as super profit.

When this super profit is capitalized with the help of the normal rate of return of the industry, the capitalized amount is treated as the value of the human resources.

Causal, intervening and end-result model

This model was introduced by Rensis Likert and David G. Bowers.

As per this approach, the purpose of human resource accounting is to measure the causal and intervening variables in some way so as to measure the value of the human resources.

Causal, intervening and end-result model (contd.)

In this method, the introduction of changes in the organizational structure and management style are known as causal variables.

According to this approach, the result of the changes in the causal variables would be increased earnings of the organisation called end-result variables.

Causal, intervening and end-result model (contd.)

This approach also assumes that there are a few critical variables that function in between the causal and end-result variables called intervening variables. These intervening variables may be employees’ attitude, motivation, perceptions, job satisfaction and goals-oriented behaviour.

Five-dimensional model

This model was advocated by Myers and Flowers.

According to this approach, five dimensions of workforce determine the value of human resources critically and collectively. These are

Knowledge Skills

Five-dimensional model (contd.)

Health Availability Attitude This approach assumes that the value

of human resources is the collective outcome of all these factors. As such, if one factor is not performing effectively, the other factors would also become proportionately ineffective.

Five-dimensional model (contd.)

This method suggests that all aspects of an employee must be taken care of adequately by the organization for enhancing the value of the employees.

Aggregate payment model

This model was developed by S. K. Chakraborty.

This method suggests that the capital base of an organisation should include the value of human asset.

According to this method, the value of human resources is the function of the average salary of the employees and their average employment tenure in the organization.

Aggregate payment model (contd.)

This model suggests that the ideal mode of identifying the value of human resources is group valuation and not individual valuation.

Uses of human resource accounting

Human resource accounting helps the organization in identifying the changes occurring in human resources over a period of time.

It provides useful information to the management for determining HR activities in a cost-effective way.

Uses of human resource accounting (contd.)

It enables the organization to evaluate the returns earned from the investment made on the individual employees.

It helps the organization identify and retain the high-value employees by offering them better facilities and emoluments.

Uses of human resource accounting (contd.)

It enables the employees to possess the feeling of self-worth whey they become aware of their value to the organization.

Weaknesses of human resource accounting

The weaknesses of human resource accounting are

Lack of real ownership Lack of guiding principles, concepts,

conventions and regulatory body

Weaknesses of human resource accounting (contd.)

Lack of recognition by tax authorities Possible opposition from employees

and their union The absence of adequate awareness

and research