It is said that people are the most valuable assets in a company. There are some organizations who prefer not to include them and some other that do. However, there are different options that can either be supportive or be against reporting and measuring human assets in the financial statements. Also, some people may support the fact that by reporting on humans we could manage the improvement of competitiveness and performance in the markets. In this essay, it will be discussed the advantages and disadvantages of reporting human resources in the financial statements. Moreover, I will refer to the intangible assets concept with the relevant definitions, as well as to the intellectual capital within the organization.
Employees in the past decades have been categorized by the accountants as liabilities and not as assets. This phenomenon occurred because of their future pensions or salaries. Also, a large proportion of the company's value of almost 80% was tangible assets. Nowadays, the same proportion of approximately 80% is consisted by intangible assets for instance intellectual property, value of brands, and definitely people. Thus, later where companies offered services, the CEOs started to mention and talk about their employees as their greatest and most valuable asset (Kaye, 2012). Thus, the future drivers of the economy will be the "people", and the capital land and equipment will no longer be the leaders.
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As we understand, the businesses of the 21st century are determined by the elements of Intellectual capital (IC). As Stewart (2002) stated, the IC of a company is the sum of its human capital, structural/organizational capital and customer capital. Firstly, the human capital refers to the skills, brains, training, experience, education, and the dynamics of an organization's workforce and also their motivation and attitudes. Secondly, the structural capital is included of all the trademarks, structures, procedures, information systems, brands and databases which give the permission to organize and diffuse the experiences and knowledge shaped by the human capital. By multiplying the human capital with the structural capital we manage to convert intangible assets and knowledge into wealth. Sveiby (2004) as well as Stewart claimed that IC can be characterized in terms of a tri-partite model. But later Sveiby modified and replaced the customer capital by relational capital. Of the above three IC components, human capital has often being seen as the most important element in the value creation of the organization. Moreover, human capital belongs to employees and is likely to raise challenging management control issues, making its measurement especially important (Coff, 1997; Widener, 2004). According to Sveiby (1997), the management of human capital has been cited as critical for businesses if they are to compete effectively. The reasons to support this idea are that skilled employees must drive innovation; and in addition they must create and recognize the customer's and supplier's benefits.
Moreover, it was observed that a firm's market and book value have a significant difference and this fact is assigned to IC. Book value is the excess of total assets over total liabilities. Market value is the company's shares outstanding times the stock price market of each. Measuring IC is a difficult task to accomplish, although there are various approaches to succeed the measurement. Furthermore, despite the fact that IC importance has improved, there are insufficient disclosures of IC in the company's financial statements. There are two important limitations that the accounting system demands on the measurement and reporting on IC. These weaknesses are responsible for the difference between the book and the market value. The first one is on the classification of the intellectual or intangible assets that are treated as expenses (Abeysekera, 2008). This treatment has an effect on the liquidity of the enterprise and leads to a consecutive under-valuation. Even if the measurements were not accurate enough, it would have been better to measure IC rather than overlooking it. Thus, IC should be included in the financial statements because it will be more helpful to determine the solutions of some problems. In general, in order for the firms to accept the fact of IC in the financial statements, they should attempt to add an additional set of reporting elements to understand the forms of capital. However, with the refusal to include and recognize IC in the financial statements, it leads to the conclusion of presenting unrealistic and unrepresentative financial statements. The second limitation is that in some countries accounting standards approve only the recognition of goodwill to be reported in the financial statements. The goodwill that has been purchased represents only a small part of IC. In Austria and Germany the recognition of any intangible asset is not permitted; this occurs because of the difference of accounting standards in each country (Abeysekera, 2008:12). Some other obstacles of reporting human capital in the company are the following: the information contained could be sensitive to the reporting companies and thus should not be externally exposed or shared. Moreover, there might be some important information available to the competitors through the statements. Furthermore, another obstacle is that measurement of human assets may not be their first priority due to the fact that they face some issues more urgent and critical than the measurement of human assets.
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In order for the stakeholders to be fully informed of the businesses value creation, the measurement and reporting of human capital and IC is an important aspect to achieve this. IC is important if we have good employees, good organizational structure, reputation and competitive advantage over its customers. There have been developed a lot of models for the measurement of IC. The most known framework of Sveiby's (1997) is the Intangible Assets Monitor. This framework is basically based on four intangible asset value creation models - which are growth, renewal and innovation, efficient utilization and stability - and its main focus is the identification of its measures. As I have mentioned, human capital should be reported and measured. Because people are recognized as the most important assets, thus employers should begin their consideration on how to report on people in the financial statements. Sometimes, people are included in the financial statements and more specific in the income statement as an expense. In 1992 Paton noticed that "a well- organized and loyal personnel may be a more important 'asset' than a stock of merchandise" (p.486). But, the major issue was how it could be possible to include them in the balance sheet. Hermanson (1963) rejected the opinion that since businesses did not own employees; they could not be accounted for with the other owned assets. Hence, he designated human assets as operational assets and supported that in relation with the other owned assets; human assets must possess a crucial value to the enterprise and thus should be accounted for together with them. In 1964, Hermansson was concerned of human assets' valuation, and thus with Brymmet et al. (1968) help they first used the term HRA (human resource accounting) in 1968. Flamholtz defines HRA as "the measurement and reporting of the cost and value of people in organizational resources". It involves the measurement of costs related with selection, recruitment and training of workers. HRA has three main objectives: the development of methods to measure human resource cost and value so as to offer a quantitative basis for manager's and investor's decision making; the development of methods to measure human resource cost and value in order to monitor the efficacy of management's exertion; and the development of a theory supporting and explaining the important factors of peoples' value (Flamholtz, 1974). In the 1970s, according to Flamholtz (1985, pp.2-3), an incorrect belief spread indicating that HRA was interested in treating people as objects. Indeed, human resources were part of HRA and they are included in the financial statements. But, this was not the most significant part of the argument above. Thereafter, putting people in the balance sheet was the leading image of HRA. The above argument that Flamholtz mentioned was mainly focused on the properness of human resources valuation on the balance sheet. Nevertheless, many countries in India adopted the concept of HRA like the Bharat Heavy Electrical Limited (BHEL), Infosys and Reliance Industries. These companies were the first in publishing human resources in the annual reports.
HIP Investor CEO Paul Herman (cited in guardian, Leon Kaye) provides three main reasons of why human capital is not included in the Balance Sheet so far. First of all, it is not a requirement to include human capital in the accounting standards of FASB and GAAP. Secondly, companies with base in people are not close to the development or adoption of such a system of people-based accounting. Last but not least, if there was a possibility to include human assets by the CEO, then he/she may be moderated by a chief officer in the financial department who would consider it as risky with increased transparency. Herman's opinions are basically attributed on the idea that companies do not own people, so they should not account for them. This point of view can be perceived as true; however, companies as it is obvious obtain several advantages of their employee's work.
An example of Australia's' companies is going to be discussed in terms of reporting and managing IC (Abeysekera, 2008:12). The example is focused to be aware of the extent in which companies report IC in the financial statements. So, some of the steps they did was to analyze the content in their annual reports. Their results indicated that the IC components were not understood correctly and they were inadequately identified. In fact, the Australian companies do not have a coherent framework for reporting IC. Some other findings are that the IC information reported in the financial statements was incorporated by 40% of external capital and only 30% of human capital.
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The concept of accounting human resources lacks universal acceptability. Nonetheless, intellectual resources and the intelligence of humans are the most valuable and greatest assets of a company. Indeed, assets in general cannot be treated and managed in the same way as people because people are these intangible assets who are the leaders in creating value in an organization. Moreover, the traditional economic factors like raw materials and labor will be less important of those of the global knowledge economy, which includes IC, innovation and skills. Peoples' role in an organization is vital in order to keep their success in high levels.
In conclusion, after analyzing the opinions for and against capitalizing human resources, I will focus on my own viewpoint. I strongly believe that reporting on human could have some beneficial results. Considering the pros and cons of capitalizing human resources I came to the conclusion that the benefits exceed the disadvantages. Those companies who did invest in their employees managed to generate a positive environment for the workforce, and thus perform in a more appropriate financial way than their competitors.