New Paradigms in Accounting – Human Resource Accounting

1. New Paradigms in Accounting – Human Resource Accounting Background Human Resource – An Asset ? Definitions Objectives of HRA Valuation Approaches

2. Background • The most valuable asset of an entity which is not reported in the Balance Sheet due to conventional accounting practices • Behavioral scientists like Maslow, Elton Mayo emphasized the value of Human Resource Management to increase output • Currently, expenses of Selection, Training and Retirement are considered as Revenue Expenditure • Writers such as Kaplan, Landekich are of the view that the Traditional Framework of Accounting is expanding

3. Human Resource – An Asset ? IASC Definition of an Asset: “ Is a resource controlled by the enterprise, as a result of past event and from which future benefits are expected to flow to the enterprise” Theoretical Questions: • Are Humans resources? • Are they controlled by the enterprise? • Do they result from past events? • Do they bring future economic benefits? • If “Yes” for all it is an “asset”

4. Human Resource – An Asset ? Opponents’ View (Against View) Generally, to recognize an asset in the B/S two tests have to be satisfied. • Verifiability test • Measurability test Since, the second test is not being satisfied HR is not recognized as an asset

5. Human Resource – An Asset ? Proponents’ View (For View) Not recognizing HR in Balance Sheet leads to; • Discarding the matching principle (Cash Basis ?) • Violating the accrual principle • Violating the principle of adequate disclosure • Under rates the firm’s net worth • Does not reflect the “True and Fair” view of the entity

6. Definitions: Human Resource Accounting Definitions • AAA Definition: “ The process of identifying and measuring data about human resources and communicating this information to the interested parties ” • Stephen Knauf (1983): “ The measurement and quantification of human organizational inputs such as recruiting, training, experience and commitment ” • Eric Flamholtz “ Accounting for people as organizational resources. It is the measurement of the cost and value of people for the organization ”

7. Objectives and Purposes of Human Resource Accounting Objectives • Recognition of value of all resources controlled/ used by the entity (Primary Objective) • Improvement of Human Resource Management (Quality and Quantity of Goods can be Increased) • Effective and Efficient management of people Purposes • Internal Decision Making • External Decision Making

8. Objectives and Purposes of Human Resource Accounting Purposes • Internal Decision Making - on alternative investment decisions E.g. Direct Recruitment Vs Internal Promotion Retirement Vs Retention • External Decision Making - To evaluate the true worth of the firm for investor decision making, To compute ratios as ROCE more accurately

9. Valuation Approaches of Human Resource Measurement is arbitrary and there are mainly 2 approaches; - Cost based approaches - Earnings based approaches Cost Based Approaches 1. Historical Cost Approach 2. Replacement Cost Approach 3. Opportunity Cost Approach 1. Historical Cost Approach The cost of recruitment, selection, development are all capitalized and amortized over the useful life time of the employee. This amortization may be dealt according to the situation.

10. Valuation Approaches of Human Resource 1. Historical Cost Approach Benefits: Easy to operate, Conforms with the matching principle, Similar to the treatment of other fixed assets Shortcomings: Estimation of the useful life time may not be easy, The value of humans are generally increasing over time - but this method gives a declining picture, This method doesn’t actually measure the value but undermines it

11. Valuation Approaches of Human Resource 2. Replacement Cost Approach - The cost to replace the existing human resources are estimated. All costs incurred to attain the current level of competence of an existing employee. Created from scratch Benefits: Is present/ future oriented Disadvantage: Not always possible to obtain such a measure (identical replacement), It is hence subjective

12. Valuation Approaches of Human Resource 3. Opportunity Cost Approach – Is based on economic concept which overcomes the deficiency in replacement cost app. Measured through a competitive bidding process within the entity. Steps: 1. The entity is divided in to investment centers 2. The investment centre managers bid for scarce employees they need within the entity 3. The maximum bid price may obtained by the capitalization of the excess profits generated by the employee

13. Valuation Approaches of Human Resource • Example: The capital base of the company = Rs. 200,000/- The current net profit = Rs. 20,000/-The ROI of Assets = 12% Excess profits generated by emp = Rs. 6,000/- Calculate the capitalized vale (O/C) of this employee Weaknesses: • Restricted to the next best alternative of the same organization • Subjective – Only being bid employees • Discriminatory

14. Valuation Approaches of Human Resource Earnings Based Approaches • Harmon Son’s Approach: Present value of future 5 years’ earnings Weaknesses: Discount Rate?, Efficiency Ratio ?, Highly complex calculations • Lev and Schwartz Model PV of future earnings until retirement. Weaknesses: Only retirement/death for termination, the promotions not considered etc