Human Resource Accounting: Key Business Success

Discover Human Resource Accounting (HRA): benefits, methods & importance. Boost HR decisions with valuable insights. Read now!

What is Human Resource Accounting (HRA) and Why is it Important?

Introduction

Human Resource Accounting (HRA) aims to quantify the economic potential of an organization’s employees. It is crucial for organizational growth as human resources are the vital, animate factors (men) that enable other inanimate resources (materials, machines, money, and methods) to be effective.

For a long time, the significance of HR was overlooked by top management, making proper development of this key asset imperative. The organization’s underlying health is reflected in human behavior variables such as group loyalty, skill, motivation, and capacity for effective communication and decision-making.

HRA examines the Human Resource Accounting concept from two main perspectives:

1. Cost of Human Resource: The expenditure related to recruiting, staffing, and training employees.
2. Value of Human Resources: The future return or yield generated by this investment.

Meaning and Definition of Human Resource Accounting (HRA)

Human Resource Accounting (HRA) emerged from research in accounting and finance. It recognizes human resources as valuable assets that appreciate over time if properly managed, placed, and developed.

Traditionally, expenditure on human resources was treated as a revenue charge, as it did not create a physical asset. However, modern HRA treats these expenses as capital expenditure, as they yield benefits over a long period that can be measured financially.

HRA is the measurement of the cost and value of people to the organization. It involves measuring the costs incurred (recruiting, selecting, hiring, training, and development) and judging the economic value of employees to the firm. It extends standard accounting principles to identify and report investments in human resources that conventional practices ignore.

Key Definitions:

• American Association of Accountants (AAA): “Human Resource Accounting is a process of identifying & measuring data about human resources & communicating this information to interested parties.”
• Flamholtz: “Accounting for people as an organizational resource. It involves measuring the costs incurred by organizations to recruit, select, hire, train & develop human assets. It also involves measuring the economic value of people to the organisation.”
• M.N. Baker: “The term applied by the accountancy profession to quantify the cost & value of employees to these employing organisations.”
• Mr. Woodruff Jr.: “An attempt to identify & report investment made in human resource of an organisation that are presently not accounted for in conventional accounting practice.”

In essence, HRA is a process of accounting that identifies and measures human resources to assist management in coping with changes in their quantity and quality, ensuring an optimal balance between required and available human resources.

Objectives of Human Resource Accounting (HRA)

The primary goal of Human Resource Accounting (HRA) is to present the potential of HR in monetary terms within the organization’s financial statements.

The main objectives of an HRA system are:

1. Informed Decision Making: To provide cost-value information for effective management decisions on acquiring, allocating, developing, and maintaining human resources to achieve cost-effective organizational goals.
2. Monitoring Use: To effectively monitor management’s utilization of human resources.
3. Asset Analysis: To analyze whether human assets are being conserved, depleted, or appreciated.
4. Principle Development: To aid in developing management principles by classifying the financial consequences of various practices.
5. Financial Reporting: To facilitate the valuation of human resources, record this valuation, and disclose the information in financial statements.
6. Supporting Specific Decisions: To help in areas such as:
   • Direct Recruitment vs. Promotion
   • Transfer vs. Retention
   • Retrenchment vs. Retention
   • Impact of human relations on budgetary controls
   • Reallocation of plants, closing units, or developing overseas subsidiaries.

Need for Human Resource Accounting (HRA)

The need for Human Resource Accounting (HRA) arises from a growing recognition of the importance of human relations management. Behavioral scientists highlight the following reasons:

1. Operational Effectiveness: Conventional accounting ignores human resources, yet without people, financial and physical resources cannot be operationally effective.
2. Accurate Income Measurement: Expenses on human organization are conventionally charged to current revenue instead of being capitalized and amortized as investments. This distorts net income, making firm and inter-firm comparisons difficult.
3. Total Valuation: Productivity and profitability depend heavily on human assets. Ignoring their value makes the total valuation of the firm incomplete, especially when comparing firms with similar physical assets but different human asset quality.
4. Visibility of Management Actions: If the value of HR is not reported, the impact of management actions on human assets cannot be perceived.
5. Investment View: Expenses like recruitment and training should be treated as investments, as they provide benefits over time, unlike the conventional practice of immediately writing them off.

Importance of Human Resource Accounting (HRA)

Human Resource Accounting (HRA) provides valuable information to management, financial analysts, and employees:

For Management:

1. Aids in the employment, location, and utilization of human resources.
2. Helps decide on transfers, promotions, training, and retrenchment.
3. Provides a basis for planning physical assets alongside human resources.
4. Assesses the benefits derived from expenditure on employee education and training.
5. Helps identify the causes of high labor turnover and implement preventive measures.
6. Locates the real cause of low return on investment (e.g., underutilization of physical or human assets).
7. Assesses the organization’s inner strength, helping the management navigate adverse circumstances.

For External Parties:

1. Provides valuable information for long-term investors.

For Employees:

1. Improves employee performance and bargaining power by making them aware of their contribution relative to the firm’s expenditure on them.

Benefits (Advantages) of Human Resource Accounting (HRA)

The main benefits of Human Resource Accounting (HRA) include:

1. Investment Return: Helps ascertain the total investment made in employees and the expected return.
2. Labor Intensity: The ratio of human capital to non-human capital indicates the organization’s degree of labor intensity.
3. Strategic Planning: Offers a basis for integrated planning of physical assets and human resources.
4. Investor Information: Provides valuable data to investors, particularly in service sector companies.
5. Return on Capital Interpretation: Discloses the value of human resources, enabling a proper interpretation of return on capital employed.
6. Improved Managerial Decision-Making.
7. Preventing Misuse: Clearly identifies human resources as valuable assets, helping to prevent their misuse by superiors or management.
8. Efficient Utilization: Aids in the efficient utilization of HR and understanding the negative effects of labor unrest.
9. Morale and Productivity: By valuing human talent, devotion, and skills, the system boosts employee morale, which can increase productivity.
10. Compensation Systems: Assists management in implementing optimal wage and salary administration methods.

Limitation (Disadvantages) of Human Resource Accounting

Despite its benefits, Human Resource Accounting (HRA) faces several difficulties, limiting its widespread adoption in places like India:

1. Lack of Standardized Procedures: No standardized procedures or commonly accepted standards exist, unlike in conventional accounting. Firms provide HRA data only as additional information.
2. Valuation Method Consensus: There is no universal consensus on the ideal valuation method (cost-based vs. value-based).
3. Uncertain Assumptions: Methods rely on assumptions (e.g., all workers staying until retirement) that may prove incorrect.
4. Depreciation/Appreciation Debate: The assumption that human resources do not depreciate and always appreciate can be challenged in certain cases.
5. Unrealistic Valuation: The lifespan of human resources is uncertain, making their valuation under conditions of future uncertainty unrealistic.
6. Lack of Clear Guidelines: There is an absence of clear, specific guidelines for determining the cost and value of human resources.
7. Dehumanization Fear: A fear exists that HRA may dehumanize and manipulate employees, and a low valuation could discourage an employee.
8. Lack of Empirical Evidence: HRA’s effectiveness as a management tool lacks sufficient empirical support.
9. Financial Statement Disclosure: The exact form and manner of including HRA value in financial statements are unclassified, with no professional consensus.
10. Asset Treatment: Unlike physical assets, human resources cannot be owned, retained, or utilized in the same strict sense, posing a problem for treating them as assets.
11. Trade Union Opposition: There is a constant fear of opposition from trade unions, as placing a value on employees might lead them to demand rewards and compensation based on that valuation.
12. Tax Laws: Tax laws do not recognize human beings as assets.
13. Development Stage: HRA is still in the development stage, requiring significant additional research for effective application.

Approaches to Human Resource Accounting (HRA)

Traditional accounting ignores the human factor, treating it merely as an expense. HRA, despite being in its infancy, offers two main approaches for valuation:

1. Cost-Based Approach: Focuses on the costs incurred in procuring human resources, similar to the historical cost of physical assets.
2. Value-Based Approach: Focuses on the income-earning capacity and future earnings of human resources.

Cost Based Approach (Human Resource Cost Accounting – HRCA)

Human Resource Accounting (HRA) approach assumes the value of a human asset can be reliably estimated through the cost incurred (investment).

Concept	Description	Advantages	Limitations
Historical Cost Approach	Capitalizes actual costs incurred on recruiting, hiring, training, and development. This cost is then amortized over the expected useful life of the employee.	Simple to understand and implement; meets the traditional concept of matching cost with revenue; provides a basis for evaluating the return on HR investment.	Accounts for only a part of acquisition costs; difficult to estimate the amortization period and rate; the capital cost decreases over time due to amortization, while the economic value of an experienced employee often increases.
Replacement Cost Approach	Values human resources based on the cost of replacing existing personnel with new individuals of equivalent talent and experience (including recruitment, hiring, training, and development costs).	More realistic as it reflects the current value of HR in financial statements; more representative and logical.	Varies from conventional accounting practice; difficult to find identical replacements; the determination of replacement value is highly subjective.
Opportunity Cost Approach	Only scarce employees, for whom there is an alternative internal use and who can be ‘bid’ for by different departments, are valued. The bid price is included as the investment cost.	Promising for optimal personnel allocation and a quantitative base for planning and development.	Excludes non-scarce employees, potentially lowering their morale; competitive bid prices may be misleading as a person’s value can vary greatly between departments; restricted to alternative uses within the organization.
Standard Costing Approach	Employees are classified into groups/grades, and a standard cost is fixed for each grade. The aggregate standard cost for the workforce is the human resource value.	Simple to understand and operate.	Lacks objectivity in estimating the standard cost for human resources; determining the standard cost for every grade is complex and time-consuming.

Value Based Approach

Human Resource Accounting (HRA) approach primarily links the value of human resources to their ability to generate future revenues and emphasizes future earning capacity over historic cost.

Model	Proponent(s)	Description	Limitations
Present Value of Future Earnings	Lev & Schwartz (1971)	Calculates the value of human capital as the present value of an employee’s expected future earnings from employment, adjusted for the probability of death/separation/retirement.	Objective, but assigns more weight to averages (e.g., census income, mortality tables) than to the value of a specific individual or group.
Certainty Equivalent Model	Pekin Ogan	The net present value of human resource is determined by two components: Net Benefit (Total Investment – Total Benefits Received) and the Certainty Factor (probability of continued employment, influenced by satisfaction/attitude).	Involves complex and subjective variables.
Stochastic Reward Valuation Model (SRVM)	Eric Flamholtz	The employee’s value depends on their potential for (i) productivity, (ii) promotability, (iii) transferability, and (iv) retainability, and the value of each potential position to the organization.	Difficult to obtain specific, reliable data on the value derived from an employee in a specific, uncertain future position; individual performance may differ from group performance.
Human Asset Multiplier Model	W.J. Cudes & D.F. Robinson	Values human resources on a “going concern concept” by applying a financial multiplier (based on the organization’s market value) to the employees’ gross remuneration.	Relies on the consistency of a financial formula.
Unpurchased Goodwill Model	Roger R. Hermanoon	Value is based on super profit (Actual Average Earnings – Normal Industry Earnings). This super profit is capitalized and treated as the value of human resource.	Based on historical values, affecting future prediction accuracy; fallaciously assumes the entire super profit is earned solely from human resources, ignoring physical assets.
Causal, Intervening and End Result Model	Rensis Likert & David G. Bowers	Focuses on causal variables (organizational structure/management style) leading to intervening variables (increased productivity/performance, decreased cost/scrap), which ultimately result in end-result variables (increased earnings).	Applicable for interactive conditions, not individual capabilities.
Five – Dimensional Model	Myers & Flowers	The value is the collective, factorial outcome of five critical employee dimensions: (i) knowledge, (ii) skills, (iii) health, (iv) availability, and (v) attitudes. If one factor is ineffective, others are proportionately affected.	Requires continuous, comprehensive care for all employee dimensions.
Aggregate Payment Model	S. K. Chakraborty	Focuses on group valuation, where the value of human resources is a function of the group’s average salary and their average employment tenure.	Relies on accurate estimation of average tenure using labor records and turnover rates.

Summary

Human Resource Accounting (HRA) is the process of estimating the cost and benefit of investments in human resources to assess their value to the organization. It uses two main approaches: cost-based and value-based.

Weaknesses of Human Resource Accounting (HRA) include the lack of real ownership over human assets, absence of standardized guiding principles and a regulatory body, non-recognition by tax authorities, potential opposition from employees/unions, and a lack of adequate awareness and research.