Human Resource Accounting(HRA): Benefits, Methods, Models

Human Resources Accounting is involved in identifying, measuring, capturing, tracking, and analyzing the potential of a company’s human resources and communicating the resultant information to the company’s stakeholders.

Human resources (HR) is one of the organization’s valuable assets; there is no statutory regulation to report it in its annual report.

But sometimes, the HR value of an organization can exceed its’ tangible asset value, but traditional accounting systems provide little chance to record and recognize these HR values.

For instance, when Bill Gates declared to retire from the Microsoft Corporation a few years back, the company’s share price fell significantly.

But traditional accounting suggests no impact on the company’s financial condition, but the actual scenario is different.

It was a method by which a cost was assigned to every employee when recruited and the employee’s value in the future. Human resource accounting reflects the potential of an organization’s human resources in monetary terms in its financial statements.

Definition of Human Resource Accounting

Ravindra Tiwari (2012) has pointed out, “Human resource accounting is an attempt to identify, quantify and report investment made in Human resources of an organization that is not presently accounted for under conventional accounting practice.”

“Human resource accounting (HRA)refers to the measurement and quantification of human organizational inputs such as recruiting, training, experience, and commitment.” – Stephen Knauf (1983).

“Human resource accounting is accounting for people as organizational resources. It is the measurement of the cost and value of people for the organization” – Eric Flamholtz (1974).

“A term used to describe a variety of proposals that seek to report and emphasize the importance of human resources – knowledgeable, trained and loyal employees in a company earning process and total assets.” – Davidson and Roman L Weel.

“Human resource accounting is the process of identifying and measuring data about human resources and communicating this information to interested parties.” – American Accounting Association (1973).

“Human resource accounting is an attempt to identify and report investments made in human resources of an organization that the presently not accounted for in a conventional system that tells the management what changes over time are occurring to the business’s human resources.” – Woodruff (1970).

“Human resource accounting involves measuring the costs incurred by business firms and other organizations to recruit, select, hire, train, and develop human assets. It also involves measuring the economic value of people to the organization”. – Palanivelu, R.P (2007)

It is evident from the above definitions that human resource accounting is the process of identifying and reporting the investment made in an organization’s human resources that are presently not accounted for in conventional accounting practices.

Human resource accounting is the art of valuing, recording, and presenting the work of all human resources in an organization’s accounts. It can help management make vital decisions about selection, layoff, transfer, training, and promotion.

The modern view is that cost incurred on any asset as human resources need to be capitalized as it provides benefits measurable in monetary terms.

Measurement of cost and value of the people in organizations is essential; costs incurred in recruitment, selection, hiring, training, and development of employees, along with their economic values, are very much relevant for human resource accounting.

Therefore, human resource accounting can be defined as the process of identifying, recording, measuring human resources, and communicating related financial information associated with the human resource to interested users.

Advantages / Benefits of Human Resource Accounting

The main purpose of human resource accounting is to help human resource professionals and senior managers use an organization’s human resources efficiently and effectively.

Human resource accounting is intended to provide users with information to acquire, develop, allocate, conserve, reward, and utilize human resources.

Human resource accounting measures the cost and the value of people in an organization for use in various management decisions.

Human resource accounting provides information about the total cost of human assets, which can use for calculating their benefits for business by comparing it with the benefits provided by employees.

Human capital becomes the most important asset in the corporation to extract value. The present accounting system ignores the importance of human resource value. Managers lack information about the effectiveness and efficiency of human resource investment.

Experts identified that human resource accounting produces a variety of benefits for management, employees, and stockholders, which are listed below:

Human resource accounting provides useful information about the cost and the value of human resources. It shows the strengths and weaknesses of human resources. All this information helps managers plan and make the right human resources decisions.
Investors would like to know the value of a firm’s human assets. Moreover, they want to know about an organization’s investment in human resources. This information would assist them in deciding to acquire, retain and dispose of the stock.
Human resource accounting provides useful information for making suitable personnel policies about promotion, favorable working environment, employee job satisfaction, etc.
It allows management personnel to monitor the use of human resources effectively.
It provides a sound and effective basis for human asset control, whether the asset is appreciated, depleted, or conserved.
It helps develop management principles by classifying the financial consequences of various practices.
Only reputed organizations conduct human resource accounting. So, competent people want to join these organizations. Therefore, it attracts the best employees and managers to the organization.
It provides cost/value information for making management decisions about acquiring, allocating, developing, and maintaining human resources to attain cost-effectiveness.
It offsets uncertainty and change, enabling the organization to have the right person for the right job at the right time and place.
It provides scope for the advancement and development of employees through effective training and development.
It helps the individual employee to aspire for promotion and better benefits.
It aims to see that human involvement in the organization is not wasted and brings high returns to the organization.
It can foresee the change in value, aptitude, and attitude of human resources and accordingly change the techniques of interpersonal management.

Limitations or Disadvantages of HRA (Human Resource Accounting)

Many difficulties are involved in the implementation of human resource accounting.

A few important limitations or demerits are mentioned below:

There is no specific guideline for measuring the cost and value of human resources.
While valuing human assets, the demand for rewards and compensation might be higher.
The nature of amortization to be followed is yet to be fixed up.
Tax laws do not recognize human assets; in that sense, they might only be theoretical.
Several methods are available for valuing human resources, but there is a lack of wider acceptance.
It is a difficult task to value human assets.
Human resource accounting is full of measurement problems.
Employees and unions may not like the ideas.
The life of a human being is uncertain. So its value is also uncertain.
All the accounting methods 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 until retirement, far from possible.
It may lead to jealousy among the employees when they find differences in their relative value. One can think that its price is very high and the other’s price is very low may destroy team solidarity.
It lacks empirical evidence.
There is no universally accepted method of the valuation of human resources.

Methods of Human Resource Accounting

The purpose of human resource (HR) accounting is to assign a dollar value to either individual employees at a company or the company’s workforce as a whole.

Because trained and productive employees are valuable to an organization, they are sometimes referred to as human capital.

There is no definitive way to calculate the value of an employee, and HR accounting uses several different methods. Each of the methods has its own merits and limitations.

Here we try to discuss these methods briefly, as below:

Capitalization of Historical Costs Method

This approach was developed by William C. Pyle and assisted by R. Lee Brummet & Eric G. Flamholtz in 1967. In this approach, the actual cost incurred in recruiting, hiring, training, and developing the organization’s human resources is capitalized and amortized over the expected useful life of human resources.

Thus a proper recording of the expenditure made on hiring, selecting, training, and developing the employees is maintained. 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.

The historical cost of human resources is very similar to the book value of the other physical assets.

When a firm recruits an employee, 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 development are also capitalized and is amortized over the remaining life. The unexpired value is an investment in human assets.

This method is simple to understand and easy to work out. It meets the traditional accounting concept of matching costs with revenue. It can provide a basis for evaluating a company’s return on its investment in human resources.

But it suffers from the following limitations:

The valuation method is based on false assumptions.
It considers 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 an increasing, constant, or decreasing one?
The economic value of human resources increases over time as people gain experience. But in this approach, the capital cost decreases through amortization.
The assets cannot be sold.
This method measures only the organization’s cost but completely ignores any measure of the value of the employee to the organization.

Replacement Cost Method

Rensis Likert first developed this approach based on the concept of replacement cost. This method measures the cost to replace an organization’s existing human resources.

It indicates what it would cost the concern to recruit, hire, and train, and develop human resources to match the present level of efficiency.

It is more realistic as it incorporates the current value of firms’ human resources in its financial statements prepared at the end of the year.

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 isn’t easy to find an identical replacement of the existing human resource in actual practice.
The determination of replacement value is affected by subjective considerations to a marked extent, and therefore, the value is likely to differ from man to man.
Consider more subjectivity into the measure.
This method may also lead to an upwardly biased estimate because an inefficient firm may incur a greater cost to replace an employee.

Opportunity Cost Method

Opportunity cost method was first advocated by 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 to 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.

The value of a human resource is determined based on the value of an individual employee in alternative use.

If an employee is hired from an external source, there is no opportunity cost to him. 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 lower the morale and productivity of the employees who are not covered by the competitive process.
The total valuation of human resources for the competitive bid price may be misleading or inaccurate. It may be because a person may be an expert for one department and not so for the other department. He may be a valuable person for the department in which he is working and thus commands a high value but may have a lower price in the bid by the other department.
Under this method, valuation based on opportunity cost is restricted to alternative use within the organization. In real life, such alternative use may not be identified because of the constraints in an organizational environment.

Economic Value Method

The value of a human resource is measured based on the contribution they are likely to make to the organizations during their employment.

The soundness of the valuation depends wholly on the information, judgment, and impartiality of the bidder. The economic value model of human resource accounting involves estimating the total inflow of cash produced by an employee throughout his service to the company.

Subtracting the total cost of hiring, training, developing, and paying an employee from the estimate of the cash he will generate for the company. You have arrived at his net worth according to the economic value method of HR accounting.

Standard Cost

The standard cost method of human resource accounting involves determining the total cost of recruiting and hiring each employee and the cost of any training or development.

According to the standard cost method, the economic value of an employee is the total of these expenditures, and the annual economic value of the entire workforce is equal to the total amount of money spent on recruiting, hiring, training, and developing all employees during the year.

Cost-Benefit Method

Under this method, we can calculate the total estimated benefit which the employee gives to an organization.

Then we calculate the total value of the benefits which a company gives to employees, and its difference is a surplus which is a real value of the human resource asset.

Noin-Monetary Methods for HRA(Human Resource Accounting)

The non-monetary methods for assessing the economic value of human resources also measure the Human Resource but not in dollar or money terms.

Rather, they rely on various indices or ratings and rankings. These methods may be used as surrogates of monetary methods and also have a predictive value.

The non-monetary methods may refer to a simple inventory of skills and capabilities of people within an organization or to the application of some behavioral measurement technique to assess the benefits gained from the Human resource of an organization.

Rao (1986) identified the main elements of the non-monetary method of Human Resource Accounting. The main elements are as follows:

The skills or capability inventory is a simple listing of the firm’s human resources’ education, knowledge, experience, and skills.
Performance evaluation measures used in HRA (Human Resource Accounting) include ratings and rankings. Ratings reflect a person’s performance on a set of scales. They are scores assigned to characteristics possessed by the individual. These characteristics include skills, judgment, knowledge, interpersonal skills, intelligence, etc. The ranking is an ordinal form of rating in which the superiors rank their subordinates on one or more dimensions mentioned above.
Assessment of potential determines a person’s capacity for promotion and development. It usually employs a trait approach in which the traits essential for a position are identified. The extent to which the person possesses these traits is then assessed.
Attitude measurements assess employees’ attitudes towards their job, pay, working conditions, etc., to determine their job satisfaction and dissatisfaction.

Models of Human Resource Accounting

5 Human Resource Accounting five models are;

The Lev and Schwartz Model

Lev & Schwartz advocated the estimation of future earnings during the remaining service life of the employee and then arriving at the present value by discounting the estimated earnings at the cost of capital. The assumptions in this method are realistic and scientific.

The method has practical applicability when the availability of quantifiable and analyzable data is concerned.

Still, this model cannot give any method to record the value of human resources in the Books of Accounts. According to this model, the value of human resources is ascertained in the following ways:

All employees are classified into specific groups according to age, experience, and skill.
Average annual earnings are determined for various ranges of age.
The total earnings each group will get up to retirement age are calculated.
The total earnings calculated as above are discounted at the rate of the cost of capital.
The value thus arrived at will be the value of human resources/assets.

This method has some limitations, which are as follows:

This method does not indicate the accounting treatment of human resources.
This method only considers wages and salaries, but wages and salaries are not only the costs associated with the employees. Other costs are associated with the employees.
The model ignores the possibility and probability that an individual may leave an organization for reasons other than death or retirement. The model’s expected value of human capital measures a person’s human capital’s expected ‘conditional value.’ The implicit condition is that the person will remain in an organization until death or retirement. This assumption is not practical.

The Eric Flamholtz Model

Flamholtz (1996) developed this model.

This is an improvement on the present value of the future earnings model since it considers the possibility or probability of an employee’s movement from one role to another in his career and of leaving the firm earlier, that is, death or retirement.

The model suggests a five-step approach for assessing the value of an individual to the organization:

Forecasting the period will remain in the organization, i.e., his expected service life;
Identifying the services states, i.e., the roles that they might occupy, including, of course, the time at which he will leave the organization;
Estimating the value derived by the organization when a person occupies a particular position for a specified period;
Estimating the probability of occupying each possible mutually exclusive state at specified future times; and
Discounting the value at a predetermined rate to get the present value of human resources.

Morse Model

Under this model, the value of human resources is equivalent to the present value of the enterprise’s net benefits from its employees’ service. The following steps are involved in this approach:

The gross value of the services to be rendered by the employees in their individual and collective capacity.
The value of direct and indirect future payments to the employees is determined.
The excess of the value of future human resources over the value of future payments is ascertained. This represents the net benefit to the enterprise because of human resources.

Likert Model

Rensis Likert, in the 1960s, was the first to research HRA(Human Resource Accounting) and emphasized the importance of strong pressures on HR’s qualitative variables and its benefits in the long run.

The Likert Model is a non-monetary value-based model. According to Likert’s model, the human variable can be divided into three categories:

Causal variables;
Intervening variables; and
End-result variables.

The interaction between the causal and intervening variables affects the end-result variables through job satisfaction, costs, productivity, and earnings.

Ogan’s Model

Pekin Ogan (1976) was the pioneer of the Net benefit model. This is an extension of the “net benefit approach,” as suggested by Morse.

According to this approach, the certainty with which the net benefits in the future will accrue should also be considered while determining the value of human resources.

The approach requires the determination of the following:

Net benefit from each employee.
Certain factors at which the benefits will be available.
The net benefits from all employees multiplied by their certainty factor will give certainty-equivalent net benefits.

Conclusion

The traditional accounting practices ignored the value of human factors in the organization and preferred treating them as expense and expendable. This fundamentally lopsided attitude towards human resources decisively goes against the employees’ interests.

For instance, the cost of training incurred to update the skills and knowledge of the employees were treated only as an expense and not as an investment.

Although human resource accounting is still in its infancy as far as its development is concerned, a few approaches are available to study human resource accounting.

However, none of these approaches has found universal acceptance because they have inbuilt contradictions, incompleteness, or inability. Thus far, these approaches have failed to fulfill the basic requirements of traditional accounting concepts and practices like the double-entry concept.

It is still challenging to determine the value of the organization’s human resources through different methods, and accounting techniques have already been opposed to human resource accounting.