Methods of Human Resource Accounting

The purpose of human resource (HR) accounting is to assign a dollar value to either individual employees at a company or the company’s workforce as a whole.

Because trained and productive employees are valuable to an organization, they are sometimes referred to as human capital. There is no definitive way to calculate the value of an employee, HR accounting uses several different methods. Each of the methods has its own merits and limitations.

Methods of Human Resource Accounting

  1. Capitalization of Historical Costs Method.
  2. Replacement Cost Method.
  3. Opportunity Cost Method.
  4. Economic Value Method.
  5. Standard Cost.
  6. Cost-Benefit Method.
  7. Noin-Monetary Methods for HRA(Human Resource Accounting).

Here we try to discuss these methods briefly, as below:

Capitalization of Historical Costs Method

This approach was developed by William C. Pyle and assisted by R. Lee Brummet & Eric G. Flamholtz in 1967. In this approach, the actual cost incurred in recruiting, hiring, training, and developing the human resources of the organization is capitalized and amortized over the expected useful life of 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 recognized to be longer than originally expected, revisions are effected in the amortization 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 are also capitalized and is amortized over the remaining life. The unexpired value is an investment in human assets.

This method is simple to understand and easy to work out. It meets the traditional accounting concept of matching costs with revenue. It can provide a basis for evaluating a company’s return on its investment in human resources.

But it suffers from the following limitations:

  • The valuation method is based on false assumptions.
  • It takes into account a part of the employees’ acquisition costs and thus ignores the aggregate value of their potential services.
  • It is difficult to estimate the number of years over which the capitalized expenditure is to be amortized.
  • It is difficult to determine the rate of amortization. Should it be increasing, constant, or decreasing one?
  • The economic value of human resources increases over time as people gain experience. But in this approach, the capital cost decreases through amortization.
  • The assets cannot be sold.
  • This method measures only the cost of the organization but ignores completely any measure of the value of the employee to the organization.

Replacement Cost Method

Rensis Likert first developed this approach based on the concept of the replacement cost. This method measures the cost to replace an organization’s existing human resources. It indicates what it would cost the concern to recruit, hire, and train, and develop human resources to match the present level of efficiency.

It is more realistic as it incorporates the current value of firms’ human resources in its financial statements prepared at the end of the year.

But it suffers from the following limitations;

  • This method is at variance with the conventional accounting practice of valuing assets.
  • There may be no similar replacement for a similar certain existing asset. It is really difficult to find an identical replacement of the existing human resource in actual practice.
  • The determination of replacement value is affected by subjective considerations to a marked extent, and therefore, the value is likely to differ from man to man.
  • Consider more subjectivity into the measure.
  • This method may also lead to an upwardly biased estimate because an inefficient firm may incur a greater cost to replace an employee.

Opportunity Cost Method

This method was first advocated by 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 to 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.

The value of a human resource is determined based on the value of an individual employee in alternative use. If an employee is hired from an external source, there is no opportunity cost to him. But this approach suffers from the following limitations:

  • 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.
  • The total valuation of human resources for 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 a valuable person for the department in which he is working and thus commands a high value but may have a lower price in the bid by the other department.
  • Under this method, valuation based on opportunity cost is restricted to alternative use within the organization. In real life, such alternative use may not be identifiable on account of the constraints in an organizational environment.

Economic Value Method

The value of a human resource is measured based on the contribution they are likely to make to the organizations during the period of their employment.

The soundness of the valuation depends wholly on the information, judgment, and impartiality of the bidder. The economic value model of human resource accounting involves estimating the total inflow of cash that will be produced by an employee throughout his service to the company.

Subtracting the total cost of hiring, training, developing, and paying an employee from the estimate of the cash he will generate for the company, and you have arrived at his net worth according to the economic value method of HR accounting.

Standard Cost

The standard cost method of human resource accounting involves determining the total cost of recruiting and hiring each employee, as well as the cost of any training or development.

According to the standard cost method, the economic value of an employee is the total of these expenditures, and the annual economic value of the entire workforce is equal to the total amount of money spent on recruiting, hiring, training and developing all employees during the year.

Cost-Benefit Method

Under this method, we can calculate the total estimated benefit which is given by the employee to an organization. Then we calculate the total value of the benefits which is given by a company to employees and its difference is a surplus which is a real value of the human resource asset.

Noin-Monetary Methods for HRA(Human Resource Accounting)

The non-monetary methods for assessing the economic value of human resources also measure the Human Resource but not in dollar or money terms.

Rather, they rely on various indices or ratings and rankings. These methods may be used as surrogates of monetary methods and also have a predictive value.

He non-monetary methods may refer to a simple inventory of skills and capabilities of people within an organization or to the application of some behavioral measurement technique to assess the benefits gained from the Human resource of an organization.

Rao (1986) identified the main elements of the non-monetary method of Human Resource Accounting. The main elements are as follows:

  1. The skills or capability inventory is a simple listing of the education, knowledge, experience, and skills of the firm’s human resources.
  2. Performance evaluation measures used in HRA (Human Resource Accounting) include ratings and rankings. Ratings reflect a person’s performance about a set of scales. They are scores assigned to characteristics possessed by the individual. These characteristics include skills, judgment, knowledge, interpersonal skills, intelligence, etc. The ranking is an ordinal form of rating in which the superiors rank their subordinates on one or more dimensions, mentioned above.
  3. Assessment of potential determines a person’s capacity for promotion and development. It usually employs a trait approach in which the traits essential for a position are identified. The extent to which the person possesses these traits is then assessed.
  4. Attitude measurements are used to assess employees’ attitudes towards their job, pay, working conditions, etc., to determine their job satisfaction and dissatisfaction.

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