CONCEPT OF HUMAN RESOURCE ACCOUNTING

Human Resource Accounting (HRA) is a new branch of accounting. It is based on the traditional concept that all expenditure of human capital formation is treated as a charge against the revenue of the period as it does not create any physical asset. But now a day this concept has changed and the cost incurred on any asset (as human resources) should be capitalised as it yields benefits measurable in monetary terms. Human Resource Accounting means accounting for people as the organisational resources. It is the measurement of the cost and value of people to organisations. It involves measuring costs incurred by private firms and public sectors to recruit, select, hire, train and develop employees and judge their economic value to the organisation.

MEANING
Human resource accounting is an attempt to identify and report investments made in the human resources of an organisation that are not presently accounted for under conventional accounting practice. Basically, it is an information system that tells the management what changes overtime are occurring to the human resources of the business, and of the cost and value of the human factor to the organisation. The system may serve both the internal and external users, providing management (internal users) with relevant data on which to base recruiting, training and other development decisions and supplying investors, lenders and other external users of financial statement with information concerning the investment in and utilisation of human resources in the organisation. Accounting is a man-made art and its principles and procedures have been evolved over a long period to aid business in reporting for the management and public. Of the four factors of production, viz., man, money, material and land, the last three of them are amenable to conventional accounting, but the first one, i.e., the human resource has not been subject to such accounting. Over the last two decades the idea of accounting for human resources is gaining active consideration. Much of the work on accounting for human resources focused primarily on development or validation of HRA concepts. The traditional practice of treating all expenditure on human capital formation as an immediate charge against income is not consistent with the treatment accorded to comparable outlays in physical capital. The American Accounting Association strongly critised the practice of assigning a Zero value to an asset and stated that Costs should be capitalised when they are incurred in order to yield future benefits and when such benefits can be measured. Management of any concern continuously strives hard for obtaining maximum efficiency. In order to measure the effectiveness of any firm the normal method is to examine financial statements. These statements include balance sheets in which physical assets such as cash accounts receivables, inventory and plant are recorded. These statements normally do not mention the productive capacity of the workers or goodwill of the company. The following variables do make a firm superior to other firms. (i) Level of intelligence and aptitude of the personnel. (ii) Level of training of employees. (iii) Level of performance targets and motivation to achieve success for the organisation.

Quality of leadership. Capability to use differences for purpose of innovation and improvement. Quality of communication within the organisation. Effectiveness of decision-making. Ability to achieve cooperative teamwork. Quality of control processes. Capacity to achieve effective coordination. Ability to use experience and measurements to guide decisions, improve operations and innovations. These factors are not accounted for in the balance sheet. Human resources accounting has developed in an attempt to overcome this deficiency. HRA is the art of valuing, recording and presenting systematically the work of human resources in the books of accounts of an organisation. Thus, it is primarily an information system, which informs the management about the changes that are taking place in the human resource of an organisation.

(iv) (v) (vi) (vii) (viii) (ix) (x) (xi)

DEFINITIONS
Human Resource Accounting is the process of identifying and measuring data about human resources and communicating this information to interested parties. - American Accounting Society Committee on HRA Human Resource Accounting is an attempt to identify and report investments made in human resources of an organisation that are presently not accounted for in conventional accounting practice. Basically it is an information system that tells the management what changes over time are occurring to the human resource in the business. - Woodruff 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 measurement of the cost and value of the people for the organisation. - Eric Flamholtz of university of California, Los Angeles

COST BASED HRA

The important approaches for cost based HRA are given below: 1) Historical Cost Approach This approach was developed by William C. Pyle (and assisted by R. Lee Brummet & Eric G. Flamholtz) and R.G. Barry corporation, a leisure footwear manufacturer based on Columbus, Ohio (USA) in 1967. In this approach, actual cost incurred on recruiting, hiring, training and development the human resources of the organisation are capitalised and amortised over the expected useful life of the human resources. Thus a proper

recording of the expenditure made on hiring, selecting, training and developing the employees is maintained and 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 recongnised to be longer than originally expected, revisions are effected in the amortisation schedule. The historical cost of human resources is very similar to the book value of the other physical assets. When an employee is recruited by a firm, 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 developing is also capitalised and are amortised over the remaining life. The unexpired value is investment in human assets. This method is simple to understand and easy to work out. It meets the traditional accounting concept of matching cost with revenue. It can provide a basis of evaluating a companys return on its investment in human resources. But it suffers from the following limitations: a) It takes into account a part of the employees acquisition costs and thus ignores the aggregate value of their potential services. b) It is difficult to estimate the number of years over which the capitalised expenditure is to be amortised. c) It is difficult to determine the rate of amortisation. Should it be increasing, constant or decreasing one? d) The economic value of human resources increases over time as the people gain experience. But in this approach, the capital cost decreases through amortisation. 2) Replacement Cost Approach This approach was first suggested by Rensis Likert, and was developed by Eric G. Flamholtz on the basis of concept of replacement cost. Human resources of an organisation are to be valued on the assumption that a new similar organisation has to be created from scratch and what would be the cost to the firm if the existing resources were required to be replaced with other persons of equivalent talents and experience. It takes into consideration all cost involved in recruiting, hiring, training and developing the replacement to the present level of proficiency and familiarity with the organisation. This approach is more realistic as it incorporates the current value of companys human resources in its financial statements prepared at the end of the year. It is more representative and logical. But it suffers from the following limitations: a) This method is at variance with the conventional accounting practice of valuing assets. b) There may be no similar replacement for a similar certain existing asset. It is really difficult to find identical replacement of the existing human resource in actual practice.

c) The determination of a replacement value is affected by the subjective considerations to a marked extent and therefore, the value is likely to differ from man to man. 3) Opportunity Cost This method was first advocated by Hc 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 for 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. This method can work for some of the people at shop floor and middle order management. Moreover, the authors of this approach believe that a bidding process such as this is a promising approach towards more optional allocation or personnel and a quantitative base for planning, evaluating and developing human assets of the firm. But this approach suffers from the following limitations: a) It has specifically excluded from its preview the employees scarce or not being bid by the other departments. This is likely to result in lowering the morale and productivity of the employees who are not covered by the competitive process. b) The total valuation of human resources on the competitive bid price may be misleading or inaccurate. It may be due to the reason that a person may be an expert for one department and not so for the other department. He may be valuable person for the department in which he is working and thus command a high value but may have a lower price in the bid by the other department. c) Under this method, valuation on the basis of opportunity cost is restricted to alternative use within the organisation. In real life such alternative use may not be identifiable on account of the constraints in an organisational environment.

HUMAN RESOURCE VALUATION MODELS

There are five human resource valuation models. The following are the valuation models of Human Resource Accounting: I. Hermansons Un-Purchased Goodwill Model II. Lev and Schwartz Present Value of Future Earnings Model The model of measurement of human capital suggested by Brauch Lev and Aba Schwartz is based on the economic concept of human capital. Capital is defined as the source of income over a period of time and its worth is the present value of future incomes discounted by a certain rate. Irving Fisher, one of the originators of human capital theory states that the value of capital must be computed from the value of its estimated future net income, not vice-versa. According to Lev and Schwartz, the value of human capital represented by a person of age r is the present value of his remaining future earnings from his employment. The following formula is given by them for calculating the value of an individual:

Vr. =

I (t) t=r (1+R) t-r

Where Vr = the value of an individual are years old I (t) = the individuals annual earnings upto the retirement T = retirement age R = a discount rate Lev and Schwartz are of the opinion that the determination of the total value of a firms labour force is a straightforward extension of the measurement procedure of an individual value to the organization. The model identifies an individuals expected economic value to the organization to his future earnings for his remaining active service life. His future expected income stream is discounted by an appropriate rate to arrive at the present value of his service. The value of total human resources of an organisation is found out by aggregating the present value of all employees. The model suffers from following deficiencies: a) A persons value to an organisation is not determined entirely by the persons inherent qualities, traits and skills but also by the organisational role in which the individual is placed. b) The model also does not take into account the possibility and probability of an individual leaving the organisation for reasons other than death or retirement. c) The assumption of the model that people will not make role changes during their career with the organisation also is unrealistic. d) Earnings (salary) are an expense. How can the capitalised value of expenses to be incurred in future be an asset? It is the value of the benefit expected to accrue that should be capitalised and not the amount to be spent for the use of the asset. The neglect of these variables reduces the usefulness of the model considerably yet it considers the economic value of the human beings.