Human Resource Accounting and Indian Practice
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Traditional acting practice treat expenses incurred on procurement, development, and maintenance of human resource as revenue expenditure and debit this to profit and loss account but now it is being increasingly realized that this expenses are incurred to get future benefit and as such should be capitalized and reflected in the balance sheet. This can only be achieved through introduction and implementation of human resource accounting.
The study focuses on how human resource accounting has evolved over the period and how human resource accounting is used in today business application particularly in the Indian context. In addition the study also assesses how human resource cost is treated by the accounting standard and try to discuss alternative treatment. Through the study of Indian companies, the paper will propose ways through which human resource accounting can be introduced in India and become more popular than the current application.
The world has witnessed a transition from manufacturing to service based economies. Before 1960s most economies relied on manufacturing sector to sustain growth but the past few decades have witnessed growth in service based economies. The fundamental difference between manufacturing and service sector lies in the nature of their asset. In manufacturing, physical assets like material, plant, equipment and machinery are very important (Johanson and Mabon, 1998). On the other hand for the service sector altitude and knowledge of employee is of utmost significance. For service firm such as information technology (IT), value of physical asset is considered less worth compared to skill and knowledge of its personnel. Similarly, in academic institution, hospital, audit firm, accounting firms etc the strength of the firm depends on skill and services offered rather than physical asset. Therefore the success of service organization depends on the quality of the work force i.e. competence, knowledge, motivation, and skills.
People in the business world today cite human resources as the common greatest asset. However employee value is rarely reported on the financial statements. This may have resulted from capitalist system that tends to glorify capital resources with a lukewarm emphasis on human resources. For this reason management of business enterprises have been rewarded on the basis of their utilization of capital asset without reference to value of workers. In fact business valuation has been a manifestation of this system. The common measurement of return that are used to value business include return on investment, return on asset or return on capital. In these cases there is no reference to the value of human resources.
In service based economies it is important for employee to be recognized as part of the total worth of a firm. In estimating the worth of human capital it is vital to employ some method of quantifying human knowledge, skills, motivation and contribution of human aspect in organization process. Human resource accounting represents this process of measuring or quantifying human resource.
Definition of human resource
Leon. C. Megginson defined human resource as "the total knowledge, skills, creative abilities, talent, altitudes and belief of an organization workforces as well as values, altitude and belief of the individuals involved."
Definition of human resource accounting
One of the definitions of human resource accounting comes from American Accounting Association's Committee on Human Resource Accounting that defines human resource accounting as "the process of identifying and measuring data about human resources and communicating this information to interested parties." Therefore human resource accounting involve measurement of all cost associated with recruitment, selection, induction, training and development of workers as well as the economic value of people in a firm. Flamholtz has a similar definition as he define human resource accounting as "the measurement and reporting of the cost and value of people in organizational resources."
Human resource accounting has also been defined as the system of recording of transactions relating to the value of human resource i.e. the cost of acquisition of their knowledge and utilization of the energy for production of goods and services in the most profitable manner and thereby achieving the organization goals (bassi, et al 1997).
In general human resource accounting may be defined as the process of identifying data about human resource, recording investment made in them and measuring their cost and value. It also involves presenting the information in a significant manner in the financial statement to communicate their worth with changes over the period and result obtained from their utilization to users of financial statement.
There are no statutory requirements which demand companies to furnish human resource accounting related information in their final statement. The company act of 1956 had no provision for HRA. The subsequent accounting bodies such as Institute of Chartered Accountants of India have not yet drafted standard or measurement dealing with accounting and reporting of human resource accounting. While most organization give qualitative pronouncement on importance of human resource very few make effort to give quantitative information about human resource. Currently some organizations are furnishing additional report beyond what is required by statute. One notable statement that has gained wider acceptance among many firms is the corporate social responsibility report. This is due to recognition that the traditional financial reporting does not give sufficient information about organization performance. In India some companies have recognized the value of human resource and include related information in their annual report, they include Infosys, steel authority of India (SAIL), Bharat Heavy Electrical ltd (BHEL), Southern Petrochemicals Industries Corporation of India Ltd, Mineral and Metals Trading Corporation of India, Hindustan Zinc Ltd, Associated cement Companies Ltd, Madras Refineries Ltd, Oil India ltd, Oil and Natural Gas Commission, and the Cement Corporation of India (Punita 2007).
Historical development of human resource accounting
Human resource accounting can be traced back in the medieval European practice of calculating the expected future earning of a prisoner versus the cost of keeping him. At that time a prisoner was considered as the general property of capturing side and therefore after a victory a decision had to be made on whether to capture a prisoner or kill him depending on cost benefit analysis. If expected benefit outweighed the cost the prisoner was capture but if cost were greater than benefit he was killed. For instance in 1964 Sweden and Austria agreed upon the following price list (figures given in taler)
Field marshal 20,000
Cavalry captain 200
Infantry captain 150
Non-commissioned officers 16
Though this was a rough measure, it highlights the fact that human resource has value and such value can be measured using appropriate basis. Development of human resource accounting as a detailed and systematic activity began in 1960 by Rensis Likert. Likert defends long-term planning by strong pressure on human resources' qualitative variable, resulting in greater benefit in the long run. He defined human resource as to include all such assets as a firm's human organization, its customers, loyalty, shareholders loyalty, supplier loyalty, its reputation among the financial community and it reputation in the general society (bowers, 1973).
William potty made the first attempt to value the human beings in monetary terms. He was of the opinion that labor was the source of wealth and must be taken into consideration when making an estimate of wealth. From 1960s the behavioral scientist started a real work of studying about human resource accounting (Flamholtz, 1969).
This development can be dividend into five stages according to Flamholtz.
Stage one (1960 - 1966) - during this era there was increased academic interest in the area of human resource accounting. At this time most people focused on deriving human resource accounting concept from other theories such as psychological theory and economic theory of capital.
Stage two (1966 - 1971) - at this stage the focus shifted to developing different models for human resource accounting. The model developed covered monetary, non-monetary value and cost of human resource. The objective of developing such model was to help the firm in managing their human resource and assessing human resource asset in a realistic manner. The main contributor to the study at this era was Roger Hermanson. During his ph.D studies, he studied the problem of measuring the value of human resource as an element of goodwill. Thereafter researchers who were inspired by his work continued to develop methods and concepts of accounting for human asset.
Stage three (1971 - 1976) - there was rapid growth in research in the area of human resource accounting. The field gain more acceptance and wide spread interest. During this era most researchers tried to evaluate how human resource accounting could be applied in businesses. A notable experiment was that of R.G. Barry which gave substantial contribution to researchers (Boudreau, 1996).
Stage four (1976- 1980) - during this era there was minimal research in the field of human resource accounting. This was due to the fact that there were complex issues that needed further exploration and deeper empirical research than the simple model developed earlier. The other reason for slow growth in human resource accounting at this time was unwillingness among many organizations to offer sponsorship for research in this area.
Stage five (1980 onward) - the shifting from manufacturing to service economies in many developed countries renewed the interest in the area of human resource accounting. In addition the realization of the usefulness of human resource in facilitating growth, profitability and survival of the business contributed to the renewal of interest in the field. Unlike in the previous studies where the main interest was academic with few practical application but since 1990s the focus shifted to application of human resource accounting to business management. Various models which incorporate both tangible and intangible asset have been developed to suit the specific need of the organization. At this time most organization began using human resource accounting as part of financial and managerial accounting practice.
Objectives of HRA systems
It's basically adopted to treat human resources as assets, to generate human data about names, to assign value to human assets in the balance sheet.
The objectives include:
- Provide information for making management decisions about acquiring, allocating, developing and maintaining human resources in order to attain cost effective organization objective.
- To develop methods of ensuring human resources cost and value and to allow management personnel to monitor effectively the use of human resources.
- Provide a system of asset control i.e. whether assets are conserved, deflated, or appreciated (Boedker et al 2008).
- Aid in the development of management principals by classifying the financial consequences of various practices.
- Develop a theory that will explain the nature and determinants of the value of people to enterprises.
Significance of human resource accounting
A well defined human resource accounting can help the management to become more efficient, in addition it is useful in internal reporting and to external users of financial statement.
Usefulness in internal reporting
- Helps in planning - Human resource cost acting provides cost information required in human resource planning process thereby facilitating preparation of future forecasts and budget (booth 1998).
- Help in decision making - human resource accounting provides data in areas where alternative option exist e.g. whether to acquire a trained employee or develop one from within, or whether to retrench or retain an employee. Instead of applying non-monetary measures of potential ability, the economic value of recruits will be better criteria for selection and optimization of the expected value of the organization human resource and subsequent valuation of adequacy of return on investment in human resource.
- Helps in capital budgeting - the present technique used in capital budgeting decision consider the human dimension as a qualitative factor. This is not realistic in the present scenario where huge investment is being made in development of employees and therefore human resource accounting system would justly assess the impact of capital budgeting on human and non-human asset.
- Helps in control - human resource accounting help to ensure that human resource objective are attained objectively and efficiently as it provide information necessary to implement the control function. The standard cost of acquisition and development is compared with actual cost incurred and the variance if any is analyzed to identify the possible lapses in personnel management function (Scarpello and Theeke, 1989).
- Helps in performance evaluation - the present convention of measurement of return on investment ignores the changes in human resources and this encourages mangers to use their human resource to include their short term objective. Inclusion of human resource input would be a good performance measure as it would reveal the return on human asset.
- It helps in activity analysis - measurement of human resource value would provide top management with new set of financial ratio for effective organization activities analysis e.g. ratio of human and non-human resources indicate the degree of labor intensity. Higher labor intensity could be used as a result of outdated technology requiring the utilization of high proportion of labor or employment of unwarranted existing labor (Tang, 2005).
Usefulness in external reporting
In business creditors and other external users of acting information would find data in human resource useful as it would measure change in asset value over period of time thereby reflecting the correct measure of corporate growth. Capitalization of expenses relating to development of human resource also reflects a correct financial position and performance of the organization.
The market value of share may reflect changes in value of human resource thereby enhancing the company's image among the competitors while increasing the confidence of shareholders.
Usefulness in management of human resources
- Acquisition of human resource - human resource accounting provide information for budget preparation for cost involved in recruiting, selecting and hiring human resource. Besides in selection process personnel executive needs data about economic value of a candidate in order to choose the one with the highest economic value.
- Allocation of human resource - human resource accounting provide quantitative information about capabilities, skills and other personal attribute of employee which will help management in attaining a perfect allocation of organization human resources whereby employees are assigned jobs perfectly matching their own abilities in order to fully utilize their skills and capabilities.
- Maintenance of human resource - presently organization use turnover rates to measure the extent of human resource observation. However such parameters are not adequate as they do not fully reflect the impact of turnover. With inclusion in human resource accounting the management may monitor the investment cost through human resource replacement cost which provides the economic magnitude of turnover rate as well (Drake, 1997).
- Evaluation and reward for employees - as human resource accounting can provide management with changes in value of human resources over time both in monetary and non-monetary term, the figures will not only make possible the determination of salary and wages on the basis of employees value but will also provide a criterion to both the management and unions in negotiating any increases in compensation and reward payment.
- Training of human resource - organization invests heavily on human resource development program without evaluating expected payoff of return because this outlay cost is considered as expenses rather than investment. Since human resource accounting involves treating this expense as asset the information about this cot and the benefit of this program would be evaluated on a rational basis.
Case for and against human resource accounting
Argument against human resource accounting
- Incase of high employee turnover rates there may be no basis for capitalization since there is no future benefits to carry asset status.
- If the definition of asset is "future economic benefits the rights of which are owned or controlled by the firm" then one may question whether human resources indeed are assets. Unless one is working in a "slave society" human resource are not owned in the convectional sense of the world, and therefore employees may be opposed to the capitalization because of the connotations that goes with it.
- The development of human resource accounting is necessary to provide a firm with accurate financial reports to guide its decisions. It's also needed to increase the validity of criteria of measurements used in organizations research.
- According to asset recognition criteria, an asset is the future economic benefits the rights of which are owned or controlled by an enterprise. Therefore as long as future benefits are expected to come from these training costs, they can be treated as assets. However, as Cea Garcia observes, this does not hold true in reality;
- "There is a clear absence of correspondence between the real assets in the present firms and those recognized in the balance sheet, in front of a pure economic approach where assets is every instrument or way that can be used in production -distribution of a firm's process or, in general, every category of economic value which can be transformed into goods or services or any instrument at the service of the firm or that the firm uses, regardless its juridical state, and also all those goods and rights that the firm does not own now but used to own or will own later on, by virtue of collateral contracts or agreement which may induce it.
- It may be argued that the rate of amortization and the rate of capitalization may coincide and therefore the net effect on the income statement may be as under convection human resources cost expense treatment.
- The period with which the employee will work for the enterprise is uncertain and therefore the amortization is subjective. Marvin Weiss (1972) discussed the argument for and against Human Resources Accounting argue that there is inability to determine the period of future benefits, the ownership status of such assets and inability to amortize such assets on an objective way.
- As Ebersberger (1981) argues, even where the logic of HRA is a plausible one must confront the issue of measurement. How does one place a value on an individual's head? How can one value commitment to an employer or one's ability to work as a team.
- The management may use human resource accounting to manipulate the workers. The manager may reduce the value of a worker as a way of punishment for perceived or real differences. There is an immense amount of power placed in the hands of the 'valuers' of human resource. Any value placed on an employee may have irreparable damage on employee's attitude. Managers may also transfer some workers near the end of the period to 'clean' up their balance sheet.
- Employee may demand to be paid in accordance to their reported value particularly if they believe this would lead to a higher pay
- HRA may have a disastrous effect on the morale of the employee if his or her value reduces through depreciation. Moreover human beings grow, learn and mature at different rates and therefore a standard depreciation rate is inapplicable.
Case for Human Resource Accounting
- Whereas there may be workers turnover, this may not be justification for expensing the cost of human resources. Failure to capitalize may negate the going concern concept. If an employer were to expect such high turnover then he would not incur expenditure on employee training and development in the first place! On average it is expected that workers will remain long enough for the firm to recoup its investment costs.
- Workers may not be owned as such but the convention of substance over form argues that what matters in transaction is the economic substance not the legal form. Leased assets are recognized in the books despite the fact that they are not owned.
- Human resource expenditure like training and development are incurred for workers who are in the process of learning and therefore they do not benefit the operations of the year in which the costs are incurred. For that reason it is inconsistency for charging such costs in the year of expenditure. Instead they should be capitalized and amortised over the years expected to benefit from the employee's services.
- In pension cost accounting armotisation or accrual of expenditure related to employees is required. Such accrual methods take into consideration length of service and turnover rates.
- Whereas it is agreeable that armotisation rate are subjective, it must be noted that depreciation rates for the tangible assets are mere estimates based on assumptions. It is therefore no justification to prohibit capitalization and armotisation of human resource expenditure.
Measurements in human resource accounting
The main reason why human resource accounting have taken a long period to be incorporated in the company's final report is the difficulty or challenge of assigning monetary value to various human asset cost, investment and employees worth. There are mainly two methods that are used in assigning monetary value to employee cost, investment or worth. This includes:
- the cost approach
- the economic value approach
The cost approach is based on the actual cost incurred by the company in relation with employees. The economic value approach considers human resource as asset and tries to identify the future earning resulting from use of human asset.
The cost approach
Cost is the amount of cash or equivalent given to acquire property or services. If property other than cash is given to acquire property or services the cost is the cash equivalent of property given. When property or the services acquired are sold or consumed the cost are matched with related revenue to determine the amount of net income or net loss. The cost of property or service that are acquired and are still on hand at any particular time represent asset. Such costs are also called unexpired cost. As asset are sold or consumed they become expired cost or expenses. Therefore in accounting cost incurred are recorded in the financial statement as either asset or expenses. Costs which are recorded as expenses in the current period include those which provide benefit during the current accounting period (Schwarz & Murphy, 2008). for instance when machinery is purchased the portion of cost recorded as expenses include depreciation for the year (i.e. the benefit accruing from the use of asset in that particular year) while the portion of cost recorded as asset in the net book value (cost - accumulated depreciation).
Under costing approach various techniques that can be used to value human resource include
Historical cost approach
The actual cost incurred on recruiting, selecting, training and developing the human resources of the organization are capitalized and written off over the expected useful life of the human resource. Under this method the cost of acquisition i.e. recruitment, selection, hiring and training employees are capitalized and written off over the expected useful life of the employees (Flamholtz, 1999). If the employee decide to leave the employment before anticipated period of service then the amortized portion of cost remaining in the company's book is written off against the profit and loss account in that year. If the employee stays beyond the expected term of service then amortization of cost is rescheduled. According to Caplan (1974) the basic theory behind the historical cost method is that human resources value can be determined by accumulating the cost of investment. Human resource accounting in this respect involves a decision to capitalize rather than to expense costs incurred in training and development of employees. When referring to training cost, historical cost means the sacrifice necessary to hire and train people.
The training concept is generally used to define three different issues which are difficult to distinguish in practice; they include capacitating, training, and development. Capacitating is the workers acquisition of knowledge and skills necessary for his job. Training better adapts the worker to the job while development mainly focuses on promotion to higher job levels (Guzman 1996). Once capitalized the resulting balance should be amortized as an expense in the periods when the employee became a productive member of the organization and unamortized balances should be written off when the employee leaves the organization.
- Easy to work and simple to understand.
- It follows the traditional concept of matching cost with revenue. It is favored because it is most similar to convectional accounting
- It can provide a basis of evaluating a company's return on its investment in human resources.
- Suffers from problem of historical costs accounting. The users of accounts may view these values as a measure of the potential usefulness of an employee.
- Difficulty in estimating use of human resources. One cannot tell when an employee may quit a job.
- The economic value of human resources may increase with experience, but armotisation reduces the reported value. It is difficult to reconcile the two.
- Ignores the aggregate value of employee's potential services.
- People may learn things outside the organization which will be useful in their jobs yet these may not be taken in account.
- Training and development cost that are capitalized do not guarantee employee increased performance.
Opportunity cost approach
The value of the human resource is determined according to its alternative use. An estimate of alternative use of the human resource is required. The value of the human resource is the price that the alternative use is ready to pay for it. Opportunity costs are considered as "an asset value when [they are] the target of an alternative use" [Hekimian and Jones, 1967]. The alternative use is the alternative department. As a result, only scarce resources would have an alternative use. This approach suggests competitive bidding for scarce employees in an organization i.e. opportunity costs of employees linked to scarcity. The approach proposes the capitalizing of additional earning potential of each human resource within the company. The opportunity cost approach requires at least two departments or cost centers both desiring the services of the same person or a group of people.
- It cannot value employees who have no alternative use.
- The valuation of employees on alternative use and competitive bid is inaccurate and misleading. One may not have values in the alternative use but perfectly useful in one department. This valuation restricts alternative use within the organization. In real life there is alternative use outside the business and moreover alternative use within the business may not be identifiable because of constraints in an organizational environment.
Standard cost approach
The method was developed by David Watson. The approach advocates for a standard cost per grade of employees updated every year. Replacement cost can be used to develop standard costs of recruiting, training and developing individuals. Such standards can be used to compare results with those planned. Any resource produced should be analyzed and would form a useful basis of control. Under this method, standard cost of recruiting, hiring, training and developing per grade of employees are determined annually. The total standard cost for all personnel of the company is the value of human resources
The problem is that the determination of the standard cost from each grade of employee is a ticklish process (Moore, 2007).
Economic value added approach
This approach utilizes the concept of present value. The value of human resource is considered as the present value of future benefit expected to be received from employees' service (Lev and Schwartz, 1971). Various scholars have suggested a number of valuation techniques under the present value approach. The technique varies in terms of recognition of benefits. Some argue that the benefits to be discounted are the expected stream of payments that the firm will make to the human resource. In either case the human resource in it is seen as a future stream of benefits up to the date of death or retirement, discounted at an appropriate discount rate. This method is perhaps the most appealing because it incorporates the entire stream of benefits. However, present value approach suffers from the following limitations
- It ignores the possibility of a human resource leaving employment in the given organization other than through death or retirement. Having many reasons as to why people may leave an organization.
- Difficult to establish the actual benefits from employment because some of the determining factors like trade unions are out of organization's control.
- Teamwork is a thing more than the sum of the values of individuals. Present value approach does not reflect the contribution of the team as a whole.
- It ignores the organization's effect on the value of a human resource.
The economic value of human resources may be of group, individual or the whole organization. The method for calculating economic value of human resource may be classified as either monetary or non monetary
Monetary measures of human resource value
The Flamholtz model considers the value of human resource as the present worth of services likely to be rendered by an employee in future. When an employee moves from one position to the other at the same level or to different levels the profile of services offered will be different. The value of individual will therefore comprise of the present cumulative value of all possible services to be offered by the employee his career at the organization.
The value of individual cannot be determined with certainty and is considered to have two dimensions.
Conditional value of individual
This is the amount that organization expects to realize from employee service during his productive life in the firm. It is mainly composed of three factors namely
- Productivity - this include various services that employee is expected to undertake in his current position.
- Transferability - this include a number of services that the employee is expected to offer in different position at the same level.
- Promotability - this include a set of service that the employee is expected to offer when in a higher position.
All the three factors mentioned above depend on individual determinant such as energy level and motivation and organizational determinant like reward system and opportunity to use skills.
Expected realizable value of individual
This is a function of expected conditional value and probability that employee will remain in the firm for the whole duration of his productive life. However employees unlike other asset are not owned by the firm and are free to leave. Therefore determining the probability of employee turnover is important. Job satisfaction arises from interaction between organizational determinant and individual determinant. Increased job satisfaction among employee leads to low probability of employee turnover and consequently to higher expected realizable value.
Flamholtz stochastic reward valuation model
Stochastic process represents the movement of employees through organizational role. This model directly measures the expected realizable value and expected conditional value of a person. The stochastic reward valuation model assumes that employee generate value occupies and moves along organizational role while at the same time rendering service to organization. Another assumption in this model is that an employee will move from one state to the other during a specified period of time. The use of the model requires availability of the following information.
- Set of mutually exclusive states that a person is expected to occupy during his productive life with the organization.
- The value attached to each state
- Duration that the employee is expected to stay in the firm
- Probability of occupying each state in future
- The discount rate to be applied to future cash flow.
If it is possible to get the above information, then this model can be the best in determining an individual value. However making the necessary estimate of expected tenure, value of service states, and probability of occupying each state during a specified period of time require more information than is usually available thus making the model less useful in today's business application.
The Lev and Schwartz Model
The Lev and Schwartz Model value human capital as the present value of future earnings from employment. This model is widely used by many Indian firms. The present value of a person who is 'Y' years old can be determined using the following formula
The model determines human resource value by computing the present value of future payment to employee. The future payment includes both direct payment and indirect payment. Most Indian firms that use this model make common assumption i.e. normal career growth, pattern of employments compensation and weightage for efficiency (Sumanta, 2008). Companies make alteration to this model in order to adapt it to their practical requirement e.g. firms use different discount rate in determining the present value of future cash flow. Different companies have different risk based on beta or other measure of risk such as standard deviation of return. This makes the discount rate to differ from one company to the other. Furthermore the cost of capital (discount rate) is determined using weighted average cost of capital (WACC) and since different firms have different capital structure the cost of capital must vary.
The model is basically oriented to measuring changes in employees' value rather than the gains employers derive from employees. Changes in value of employee reflect changes in workers contribution only when payments are directly linked to company performance or employee productivity. Therefore under Lev and Schwartz Model the value of human resource is not directly related to the organization profitability i.e. the value of human asset may be increasing even if the profitability of organization is decreasing (Gröjer, 1997).
Hekimian and Jones competitive bidding model
The value of human resource is based on internal market for labor and the value is determined by manager through the bedding process. Manager bid against each other for workers available in the firm and the highest bidder win the resource. While bedding no specific criteria are used and managers are expected rely on their own judgment.
Non-monetary method for valuing human resource
The non-monetary method does not assess human resource based on money terms or dollars but rather on ratings or indices and rankings. This method can be used as compliment to monetary method. Non-monetary method usually includes simple inventory of capabilities and skill of people in a firm. In assessing the benefit derived from use of human resource, behavioral measurement techniques may be used.
Inventory of capabilities and skill is a simple listing of knowledge, education, skills and experience of the organization human resource. Rankings and ratings are used as performance evaluation measures in human resource accounting. Rating reflects individual performance in relation to set standard i.e. they are score assigned to individual characteristics such as knowledge, skills, intelligence, judgments etc. ranking represent an ordinal form of rating. In assessing an employee capacity for development and promotion an assessment of potential has to be carried out. The specific traits required for a position is first identified and then the extent to which the employee posses this trait is assessed (Boudreau and Ramstad, 1997).
Investment in human resource
The debate on treatment of human resource as asset has been going on for along time. One group argue that investment related to human resource should be treated as expense in the income statement as it is normally done in traditional accounting practice while the other group argue that the investment in human resource is expected to derive benefit for more than one accounting period and as such it should be treated as asset and amortized during the productive life of an employee. To decide on the correct accounting treatment relating to investment in human resource we should first define what is an asset. Asset can be described as anything owned by an entity to derive service in future and should have legally enforceable claim.
Human resources are free to move so there is no guarantee that the organization will derive benefit in future. In addition there is no sales value attached to employee like in other asset and therefore human resource should not be recognized as asset.
On the other hand an organization is considered to have legal ownership of an employee since as long as his contract has not expired he is prevented from joining other firm unless properly relieved. Uncertainty relating to future benefit is common to all assets and not unique to human asset. Asset need maintenance in order to offer for along period of time, similarly human resource need training and development to maintain service potential. This clearly illustrate that human resource is an asset and should be recorded and reported like any other asset.
Recording of human resource cost in financial statement
Currently human resource cost is charged to revenue in the income statement. To assess whether investment in human resource should be recorded as expenses or capital we need to differentiate between capital and revenue expenditure.
Capital expenditure consists of expenditure the benefit of which is not fully consumed in one period but spread over several periods. it include asset acquired for the purpose of earning and not for resale, improving or extending fixed asset, increasing the earning capacity of business and raising capital for business (Toulson & Dewe, 2004). Such expenses are taken to the balance sheet and are determined by the fact whether
- the expenditure made is for purposes of acquiring fixed asset and placing business in a position which it can commence or continue operation
- The expenditure results in some more or less long term benefit to the business.
- The expenditure increases the earning capacity of the business or reduces working expenses.
It must be established whether the expenditure results in acquisition of permanent asset and that the asset is to be used for the purposes of earning revenue.
Revenue expenditure consists of expenditure incurred in one period of account the full benefit of which is consumed in that period. it include purchasing asset required for resale at a profit or for being made into saleable goods, maintaining fixed asset into good working condition, meeting day to day activity of carrying on business etc. revenue expenditure items appear in profit and loss account and are determined by a test as to whether the expenditure made is incurred for the maintenance of earning capacity or for the upkeep of the fixed asset in an efficient condition (Boudreau and Ramstad, 1997).
Based on the above characteristic of capital and revenue expenditure, investment in human resource is made for the purpose of placing business in a position which it can commence or continue operation. In addition investment in human resource yield long term benefit and increases the earning capacity of the business. Therefore costs related to human resource should be treated as capital expenditure and not revenue expenditure. This requires those cost to be capitalized and recorded as asset in the balance sheet.
Due to uncertainty related to duration of human asset in the organization, then investment in human resource can also be treated as deferred revenue expenditure. Deferred revenue expenditure represent the expenditure which would normally be treated as revenue expenditure but it is not written off in one accounting period as its benefit is not completely exhausted in the year in which it is incurred or is of a non-recurring nature and is large in amount (Hanson, 1997). It may be spread over a number of years with a proportionate amount being charged to profit and loss account each year and the balance is carried forward to subsequent years as deferred revenue expenditure and is shown as an asset in the balance sheet. The determining factor is whether the particular expenditure has the element of deriving benefit over some years and the benefit does not exhaust within the particular accounting. For instance an advertising campaign benefit does not exhaust in the year the campaign is made. The expenses made should be spread over the estimated year during which the benefit is to be derived, similarly for investment in human resource such as training increases worker productivity not only in the year of training but also in later years so it is inappropriate to treat all cost as revenue expenditure but rather such cost could be treated as deferred revenue expenditure (Drake, 1997).
The above illustrate that traditional accounting approach of treating investment in human resource as revenue expenditure is not appropriate as such expenditure should be treated as capital expenditure as proposed by human resource accounting and if not as deferred revenue expenditure since the benefit is derived for along period i.e. more than one accounting period.
Cost of human resources
From the above discussion human resource is considered as asset and thus expenditure incurred in acquisition and development of human resource should be treated as investment. The cost of human resource or referred to as historical cost of human asset comprises of both capital (asset) and revenue (expenses). This cost is classified into four main categories namely
- Acquisition cost - this is cost incurred by the firm to acquire the right employee for the job and at the right time and quantity.
- Development (training) cost - training help employee to increase productivity and thus training cost are incurred in order to enrich an employee's skill.
- Welfare cost - this cost are incurred to improve the quality of life i.e. to create a conducive working environment.
- Other cost - for instance employee's safety, ex-gratia, and multi trade incentives.
The acquisition cost includes the recruitment cost, selection cost and placement cost. Training cost comprises of
- formal training cost
- on job training cost
- special training cost
- development programs
Welfare cost comprises of medical expenditure, general and special allowance, canteen expenditure and other welfare expenditure.
The above discussion illustrate that it is possible to report investment in human resource as asset but under the category of intangible assets. Intangible assets have no general accepted definition since the word intangible usually accompanies different concept including investment, asset, resources and other phenomena (Canibano & Sanchez 1998). Other definition of intangible can be derived from statistical, managerial and accounting perspectives.
Accounting definition of intangible
Intangible assets results from deferral of expenditure on service as opposed to expenditure on property (Hendriksen and Van 1992). intangible asset can be categorized as traditional intangibles such as copyright, brand name, patent and licenses while others may be recognized as deferred charges e.g. promotion and advertising, training costs, software development cost etc.
The international accounting standard board has also been actively involved in various project related to accounting for intangible asset. Since the starting of the project in 1989 three revisions have been carried out i.e. the draft statement in1994, E50 in 1995 and E60 in 1997. Finally IAS 38 which deals with accounting for intangible asset was issued in 1998. In developing the standard the following important issues arose (IASC 1998a)
- Whether internally generated assets should be recognized in the balance sheet and incase they are to be recognized, whether the recognition criteria for internally generated intangible asset should differ from recognition criteria for externally acquired asset.
- Whether it is possible to reliably determine the fair value of intangible asset.
- Whether the value of intangible asset should be amortized and over what period.
IAS 38(1998b: 7) defined intangible asset as follows "an intangible asset is an identifiable non-monetary asset without physical substance held for use in production or supply of goods or services, for rental or others or administrative purposes." the same standard define an asset as
- An asset is a resource controlled by a firm as a result of past event.
- An asset is a resource from which future economic benefits are expected to flow to the enterprise.
IAS 38 requires that for an asset to be recognized as intangible asset it should be identifiable in a way that it is possible to distinguish it from good will. In addition the enterprise should have sufficient control of the asset in order to meet the definition of intangible asset. Based on this definition human resource is identifiable and possible to separate it from goodwill thus can be recognized as intangible asset. According to IAS 38 an asset is considered separable if a firm could sell, rent, distribute or exchange the specific future benefit attributed to the asset without also disposing of future economic benefits that flow from other asset in the same revenue activity (IAS 38, 1998a:11). Though it is not possible to sell, rent, exchange or distribute human asset, when an employee is relied his duty it does not require disposing of future economic benefit that flow from other asset thus has some qualities of intangible assets. Furthermore IAS 38 states that for an intangible asset to be recorded at cost the following criteria must be met
- It is probable that future economic benefit attributed to the asset will flow to the firm" (1998a: 19).
- The cost of asset can be measured reliably
Investment in human resource can be measured reliably based on cost incurred for recruitment, selection training and development. Though the worker can leave the organization at his own will unlike other asset it is probable that future economic benefit will be derived from the worker during the duration of his employment. All this definition in IAS 38 indicates that it is possible to treat investment in human resource as asset by capitalizing cost related to human asset and recording it in the balance sheet.
Managerial definition of intangibles
From a managerial perspective intangible resources are considered as 'skills' or 'assets'. Assets comprises of trademarks, patents, contract, databases, trade secret and copyright. Intangible resource considered as competence or skills comprises of expertise of workers, distributors, suppliers and organizational culture (hall 1992). According to lowendahl (1997) resource comprises of human physical and monetary resources as well as information based resources such as technology, management skills, reputation brand name, consumer information and corporate culture. Hanes (1997) has classified intangible resource as either relational resource or competence. Relational resources includes client loyalty, reputation etc while competence is ability to perform a task ans exist both at organizational and individual level. On individual level competence include skills, knowledge, and aptitude while on organizational level it comprises of technology, database, methods, routines, culture and procedures.
Utilization of human resource costing and accounting today
Human resource accounting has not gained wider acceptance in today's business environment. Information generated from human resource accounting is rarely used by management in making decision. Maher (1996) has observed that most mangers in British hotel industry analyze investment in human resource on an ad hoc basis rather than using a more business like approach. In a survey carried out in America, Highhouse $ macan (1994) found that 46% of respondent who presented human resource activity in management report used utility estimates.
Human resource accounting has gained wider application in football business. According to Morrow (1997) 18 British football clubs included players in the balance sheet before the Bosman case. Most clubs used acquisition cost of player on the transfer market as the valuation method. Others valued the entire squad based on the future value. The Bosman case lead to "the adoption of a prudent policy of capitalization and armotisation of players cost of registration over his contract life" (Morrow, 1997, p.69). This presented the best accounting policy to adopt among the football clubs and indicates that HRA will have more application in future. However this required the preparation of two balance sheets one using the traditional accounting principles and the other utilized the future cash flows.
One of the regions where human resource costing and accounting has gained much application is Sweden. Several factors may have contributed to this increased interest
- extensive education in human resource accounting at colleges and universities
- To legitimize the position of human resource director as member of executive board human resource costing and accounting is used (Olsson, 2001).
- Human resource costing and accounting is now used as a new approach to strategic thinking. Previously HRA was interpreted as technical approach to strategic thinking.
- Human resource costing and accounting is used as a change instrument in shifting from regulated economy to amore market oriented economy (Johanson 1998).
Johanson further used human resource cost at one of the department at Volvo to illustrate how human resource cost can be presented in profit and loss account
In 1991 the Swedish government proposed a legislation requiring all firms with more than 100 employees to include personnel cost in their annual report but this proposal was later withdrawn. The other organization which have utilized the data on human resource cost in it report is Stockholm County Council Public Dental Care Services (Subbarao & Zehgal, 1997). The organization assign cost to various personnel activities and present this cost as a percentage of total cost. This information is utilized by manager for strategic decision making. From the P$L account the various personnel cost item as a percentage of the total cost item is presented below.
The two examples from the two firms indicate that human resource cost can be presented in final report and aid users in making an informed decision. For instance in the above example managers can use the above report to control cost related to different personnel cost item. Where the current period cost differs significantly from previous period cost the management should investigate to find the reason for such difference. In addition some standard can be set on different personnel cost item and the actual cost can be compared with standard cost and any variance investigated.
Human resource accounting and the Indian practice
India like the rest of the country has not given much consideration to issues related to human resource accounting. In India this concept is struggling for acceptance and has not been introduced so far as a system. Indian companies act does not require company to furnish information retaliated to personnel cost in their annual report. However in the past decade there has been a growing trend toward measurement and reporting of human asset.
Human resource accounting was first used in public sector by Bharat Heavy Electrical ltd (BHEL) in fiscal year 1972-73. Later other organization both in public and private organization started to furnish information related to human resource in the annual report. These organizations include;
- Steel authority of India (SAIL)
- Southern Petrochemicals Industries Corporation of India Ltd
- Mineral and Metals Trading Corporation of India
- Hindustan Zinc Ltd
- Associated cement Companies Ltd
- Madras Refineries Ltd
- Oil India ltd
- Oil and Natural Gas Commission
- Cement Corporation of India.
Though human resource accounting was introduced back in 1970s it did not gain acceptance and popularity during that time. It was only after the introduction of the concept by Infosys in 1990s that human resource accounting became popular. This was followed by introduction of the concept by leading software industries such as DSQ Software and Saryam computers. The concept has also gained popularity in manufacturing industry with firm such as Reliance Industries furnishing information about human resource in their annual report.
Human resource accounting has gained much acceptance among the various professionals in India such as managers, CEO, accountant and analyst. The chief finance officer at Infosys, Mohandas Pai said in a statement that "Real assets will not appreciate much as businesses get commoditized. Innovation and intellectual power are going to be the key to the future." this illustrate that human resource is key to organization success add should receive equal attention just like other fixed asset. Where organization lacks quality manpower to utilize the fixed asset no value will be derived from such asset which indicate the importance of human asset.
The importance of human resource to organizational success was also evident in a statement by management information system manager at DSQ software ltd, Samrat Gupta who said that "Employees are the most valuable resources of comparison in the service sector. Like all other resources of the company, the employees possess value because of providing future services."
Human resource managers in most Indian companies responded to development in human resource accounting by stating that organizations have now started to realize importance of skilled manpower. Most HR managers shared the opinion that for a company to be successful in a highly competitive environment it requires to continuously improve the level of performance of their workforce. R. Krishnaswamy who is an actuarial accountant, said, "The value can be used internally by an organization to make comparisons from unit to unit, from year to year, as well as within its industry." (Bullen, 2007) Therefore a company which employs human resource accounting will be able to understand whether the value of their human capital was appreciating or depreciating. Human resource accounting data will also aid the comparison of the company over the period and with other firm in the industry thus can be used together with other financial ratios in analyzing the financial performance of the company.
The stock market analysts have also commented to development of human resource accounting. The managing director of Billimoria $ Company said that "In the last few years, people are realizing that their intangible assets are worth much more than their tangible ones. Now an attempt is being made to put a value to these intangibles, and to bring these hidden values to book." The stock market analysts feel that human resource accounting is an investor friendly disclosure as well as assuring the various stakeholders that the business has the right human asset to meet future requirement (Jaggi and Lau 1974).
The above comments from various professionals clearly indicate that human resource accounting is becoming more popular in India. In recent years human resource accounting has gained much acceptance and application in India more than other developing and emerging nation. The government has even set up a ministry dealing with human resource development. This is due to the increased awareness that, it is through the development of human resource that the economy will be able to grow particularly for service based economies.
To assess the growth and use of human resource accounting in India various companies both from private and public sector will be used. An analysis of this company will help in understanding the use of various HRA models discussed earlier and to find out whether information generated by HRA can be uses to influence the decision of various users of accounting information. In addition an analysis of this company will help determine the way through which human resource accounting can be introduced in India.
Infosys company ltd
The company recorded an increase in income from Rs 15,648 crore in 2008 to Rs 20,264 crore in 2009. In 2009 the company reported a profit before tax of Rs 5,819 crore compared to Rs 4,470 in 2008. The earning per share increased from 78.25 to 101.65. There was also a growth in book vale and profit before interest and tax. However market capitalization dropped from Rs 82,362 in 2008 to Rs 75,387 crore in 2009.
Infosys was the first company to value it employees in India. The software company did the first valuation in fiscal year 1995-96 using Lev & Schwartz model. The value of it 1,172 employees was Rs 1.86 billion. The company has always considered employee as critical to organization success and therefore the introduction of human resource accounting will further help the organization to focus on it workers. Murphy, the managing director of Infosys has supported HRA saying that "Comparing this figure over the years will tell us whether the value of our human resources is appreciating or not. For a knowledge intensive company like ours, that is vital information."
As stated earlier Infosys technologies limited use Lev and Schwartz to value the company's human resources. The value of employee is taken as the present value of the future earning of workers. In computing the present value of employees the following assumption are made.
- Employee compensation comprises of indirect and direct benefit and includes income earned in India and abroad.
- Incremental earning based on age or group
- Discount rate/cost of capital of 12.18% and 13.32% the previous year.
As indicated above the total value of human resource increased in 2009 compared to 2008. However the value of human resource per employee decreased from 1.08 in 2008 to 0.97 in 2009.
Bharat Heavy Electrical ltd (BHEL)
The company was the first to report data on human resource in India and has continued to furnish information relating to personnel cost in it annual report. The company use Lev & Schwartz model in valuing it human resource with the following assumption (Patra et al 1987).
- Normal career growth according to present policies. If any vacancy arises it is filled with a level immediately below.
- The present pattern of employee compensation is followed. This includes both direct and indirect benefit as well as the effect of wage revision.
- Weightage for change in efficiency due to skills, experience and age.
- A discount rate of 12% is used in calculating the present value of employees.
The value of human resources from fiscal year 1978-79 to 1990-91 is presented in the table below
Cement Corporation of India
The company produce and market cement and fall under the cement industry. Cement industry plays an important role in the growing Indian economy. India is the second largest producer of cement in the world. The boom in the housing market and infrastructure has boosted cement industry significantly. Cement production rose by 8.13% in year 2007/08 to 168.31 million tones against 155.66 million tones recorded the prior year. As demand for cement increase along with economic growth all cement players are expected to increase their capacity with demand expected to be over 220 million tone by the end of 2009- 10. The industry is expected to record growth of 10% per annum in the coming years.
Human resource in this organization is considered important and constitutes a large portion of the total resource. The organization describe human resource as 'Mother Resources' as it act as the medium through which other resources viz. material, machines and money are organized, coordinated, directed and controlled. Maximum realization of the potentialities of this 'Mother Resources' is of crucial importance for the success of this organization.
The corporation determines the economic value of human asset by discounting the expected future earnings of worker and taking into consideration promotional policies and the salary scale. The valuation in based on principles and guidelines enunciated in the model developed by Lev and Schwartz (1971), Eric Flamholtz (1974), and Taggi and Lau (1974) with appropriate modification done. The value of human resource is illustrated in the following table.
The company also report on it human resource in term of age and professionalism where 49.18% in fiscal year 2008 represent those between 26 -50 years and 15.35% of the total workforce represent technically and professional qualified, degree/diploma holders.
It is the largest private sector player in the upstream oil and gas exploration and production sector. The company was the first in private sector to cross US$ 1 billion mark in net profit and is ranked among the top 150 in profit generation. In financial year 2003/04 the company reported a net profit of US $1,180. During the same year the market capitalization of the company was US $ 17.2 billion (Rs 75,132 crore), making it the most valuable private company in India.
As at 31 March 2004 the company had 11,858 employees. Though the company does not include valuation of employees in their annual report, it has it has furnished report relating to employee professionalism and age as illustrated in the following table
This indicates that engineers comprise the highest number of staff in the organization. Furthermore majority of people in the organization are between 26 -35 years.
Hindustan copper limited
Despite the poor performance of the economy in year 2009 the company was able to report a revenue of Rs 5,680 crore and profit before interest and tax of
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