HR Accounting 6 Important for Organizations

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HR Accounting: A Comprehensive Overview

Unlock the secrets of HR (Human Resource) accounting. Learn actionable strategies to integrate systems, reduce errors, and boost your team’s efficiency and bottom line.

Introduction

Human Resource Accounting (HRA) is a relatively new concept adopted by some corporations, reflecting the realization that human resources are their most valuable assets. HRA aims not only to measure the investment made in developing human capital but also to accelerate its value.

Definition of HR Accounting:

The American Accounting Association’s Committee on Human Resource Accounting defines it as:

“The process of identifying and measuring data about human resources and communicating this information to interested parties.”

Essentially, HRA extends conventional accounting principles to match the costs and revenues associated with human resources and to communicate this relevant information in financial terms.

Core Concepts and Meaning of HR Accounting

HRA is a vital information system that tracks the changes occurring over time to an organization’s human capital. It acknowledges that human resources are a capital resource, making their valuation and disclosure in financial statements crucial for investors, management, and other stakeholders.

As human beings are the active agents driving economic growth, HRA involves:

1. Valuing human resources.
2. Recording this valuation in the books of accounts.
3. Presenting this information in the financial statements.

HRA’s primary role is to provide management with information essential for performing functions related to acquiring, developing, allocating, conserving, utilizing, evaluating, and rewarding human resources.

Objectives of HR Accounting

The main objectives of HR Accounting are:

• To facilitate the management of people as a key organizational resource.
• To assist management in decision-making regarding the acquisition, allocation, development, and maintenance of human resources, thereby controlling HR costs.
• To provide information on human resource cost and value to management.
• To assess the effective utilization of human resources.
• To determine if human resources are generating a return on investment for interested parties.
• To furnish human resource accounting details to external stakeholders like bankers and financial institutions.

Historical Perspective

The recognition of human resources as actual assets, with skills, ability, and creativity that machines cannot replace, marked a new era in the last four decades. Key contributors and studies include:

• Schulz (1960) and William Pyle (1967): Recognized the actual value of human resources.
• Flamholtz (1973) and Kenneth Sinclare (1978): Contributed methodologies for valuing employees.

The Need for HR Accounting

The necessity for HRA arose from behavioral scientists pointing out the serious handicap caused by the failure of conventional accounting to value human resources.

1. Inaccurate Performance Reflection: Conventional financial statements often fail to accurately reflect business performance because expenses on human resources (like training) are charged to current revenue instead of being treated as long-term investments.
2. Distorted Valuation and ROI: The conventional balance sheet does not reflect the value of human assets, leading to a distortion in the total valuation of the organization and the rate of return on investment (ROI).
3. Inadequate Information for Decision-Making: Conventional accounting lacks sufficient information about human resources, making careful use of all resources difficult for managers.
4. Risk of Eroding Investor Interest: Treating investments in human resources as mere expenses can lead to management decisions that harm the long-term success of the organization and investor equity.
5. Differential Treatment of Capital: Conventional accounting treats human and non-human capital differently, ignoring the fact that productivity and profitability depend heavily on human assets.

Costs Involved in HR Accounting

The primary costs involved in HR Accounting are:

1. Acquisition Cost

Costs incurred to secure the right person for the right job, including those who are not selected:

• Recruitment Cost: Advertising, agency fees, recruiter salaries, and administrative expenses.
• Selection Cost: Costs of application processing, tests, interviews, medical examinations, and consulting fees.
• Placement Cost: Costs associated with determining the best fit based on an individual’s ability, attitude, and interest.

2. Training and Development Cost

Costs incurred to enhance an individual’s skill and productivity potential:

• Formal Training Cost: Remuneration to training staff, fixed cost of training schools, and orientation costs.
• On-the-Job Training Cost: Costs from mistakes, and payments exceeding an employee’s initial contribution.
• Special Training Cost: Costs of specific programs designed to achieve performance standards.
• Development Programme Cost: Expenses for lectures, conferences, seminars (delegate fees, travel, loss of output).

3. Welfare Cost

Expenses incurred to provide a healthy and congenial working environment to boost morale and civic life:

• Welfare and Amenities within the Organization: Creches, canteens, washing facilities, rest shelters, safety measures.
• Welfare outside the Organization: Social insurance, medical and education facilities, housing, and recreational facilities.

Models of HR Accounting

HR Accounting models are broadly classified into two categories:

A. Cost Based Models

Model	Description	Limitations
1. Historical Cost Approach (Pyle)	Capitalizes all costs (Recruitment, Training, etc.) related to human resources. This value is amortized over the expected service life.	Historical costs are sunk costs and irrelevant for decision-making. Ignores future maintenance costs. Distorts the value of highly skilled employees who require less training.
2. Replacement Cost Approach (Likert & Flamholth)	Values human resources based on the cost required to replace existing employees with others of equivalent talent and experience (Individual or Positional Replacement Costs).	Highly subjective and often impossible to determine, especially for top management.
3. Opportunity Cost Model (Hekimian & Jones)	Values human assets based on their alternative best use (opportunity cost), usually established by competitive bidding within the firm. Only applies to scarce employees.	Excludes employees who can be readily hired from outside the firm. Focuses only on a segment of the firm’s human resources.

B. Economic Value Models

Model	Description	Limitations
1. Present Value of Future Earnings Model (Lev & Schwartz)	Determines the value of human resources as the present value of estimated future earnings, discounted by the rate of return on investment.	Ignores the probability of an employee leaving for reasons other than death or retirement. Ignores the probability of employees changing roles (promotions/transfers).
2. Reward Valuation Model (Flamholtz Model)	Determines an individual’s value by the expected services they will render, accounting for the probability of movement through a set of organizational roles over time.	Difficult and costly to estimate the probabilities of likely service states for each employee and determine their monetary equivalent. Ignores the value added by individuals working as a group.
3. Valuation on Group Basis	Calculates the present value of all employees in a specific rank, based on the probability of them remaining with the organization and their economic value during each time period.	Ignores the exceptional qualities of skilled individuals. The exit of one key individual can severely affect the group’s performance.

Significance and Advantages of HR Accounting

HR Accounting offers numerous benefits to the organization:

• Manpower Planning: Provides essential information for right-sizing and strategic decision-making regarding human resources.
• Personnel Policies: Offers data for formulating effective policies on promotion, working environment, and job satisfaction.
• Resource Utilization: Helps in achieving the optimal utilization of human resources.
• Proper Placements: Ensures the right person is placed in the right job based on skills and abilities.
• Morale and Motivation: Increases employee morale and motivation by demonstrating the organization’s commitment to their value and welfare.
• Attracting Talent: Reputable organizations that conduct HRA attract highly competent employees.
• Training Design: Assists in creating appropriate training and development programs.
• Investor Information: Provides valuable data to current and prospective investors for making long-term investment decisions.

Major Limitations of HR Accounting

Despite its benefits, HR Accounting faces several limitations:

• Legal Hurdles: Indian company law, income tax law, and other legal frameworks do not yet provide rules for showing human resource assets in the balance sheet.
• Uncertainty of Value: The value of human assets is uncertain due to high employee mobility and the unpredictable nature of human life.
• Dehumanization Risk: If not implemented correctly, HRA can lead to the dehumanization of employees if valuation is misused.
• Lack of Uniform Standards: Unlike financial accounting, HRA lacks specified, uniform accounting standards, making inter-firm comparison difficult.
• Difficulty in Quantification: It is challenging to accurately quantify the value of human qualities like honesty, morality, and generosity.
• Jealousy and Reduced Efficiency: Disclosing high or low valuations can negatively affect employee morale and efficiency.