Labour Compliance

Methods of Human Resource Accounting

Human Resource Accounting refers to the process wherein an organisation identifies, assigns and reports the costs incurred on human resource activities such as recruitment, training and development, termination of the employees and other human resource activities. Esteemed scholars develop various methods for the computation of the same. However, most organisations cannot effectively use these methods due to the lack of awareness about such methods.

The article discusses the methods of human resource accounting to help the organisation make an informed decision regarding the right strategy for such accounting.

What Are The Methods Of Human Resource Accounting?

The methods of Human Resource Accounting have been classified into three broad categories, i.e.

• Cost Based Approach
• Monetary Value-Based Approach
• Non-Monetary Value-Based Approach

Cost Based Approach

The Cost based approach focuses on the Cost incurred by the human resource by the organisation. This approach includes the following methods of Human Resource Accounting-

Historical cost approach:

• The Historical Cost Method was introduced by Brumnet, Flamholtz, and Pyle. Here Human Resource Accounting is based on actual Costs incurred on human resources. Such a cost may be of two types- acquisition cost and learning cost.
• Acquisition Cost includes the expenses of the process of recruitment and selection of the employees. It must be noted that this Cost also consists of the expenses incurred by the employees who were not selected.
• Learning Cost – as the name suggests, this is the Cost incurred by the organisation on the training and development of the employees.
• The idea of this method is the capitalization and amortization of the actual Cost incurred for the purpose of recruitment, hiring, training and developing human resources of the organization over the expected life of the human resources wherein a specific part of costs will be written off in proportion to the income of the future years for which those human resources will provide service.
• If the employees are liquidated prematurely, the amount that hasn’t been written off is charged in the year in which the liquation of the employee has taken place.
• In case the useful life of the human resource is considered to be longer than expected originally, there is a need to make revisions with regard to the amortization schedule.
• The historical Cost of human resources is almost like the book value of the other physical assets. The additional costs incurred in training and development are capitalised and amortized over the remaining working life of the employee. The unexpired value acts as an investment in human assets.

Advantages

• The method is simple to understand and quickly worked out.
• Cost is related to revenue.
• It enables to provide a basis for evaluating the company’s ROI 

Replacement cost model

The model was introduced by Likert and Flamholtz. This is to measure the Cost of replacing a firm’s existing human resources. The assumption behind the valuation of human resources is that there shall be a need to create a new organisation from scratch. Hence, the organisation’s cost is calculated keeping in mind the expenses incurred in replacing the current employees and hiring new

employees with similar talent and experience. This includes the cost attributable to the turnover of a present employee, along with the costs of acquiring and developing a replacement for such an employee.

The method is considered more realistic than the historical method as it involves the current value of the firm’s human resources in its financial statements¹, which are prepared at the end of the year.

Opportunity Cost Method

Kim and Jones are considered to be the pioneers of this method, which is also referred to as the Market Value Method. It focuses on measuring the value of human resources based on opportunity cost.

Opportunity cost is an economist concept that can be defined as the asset’s value when there is an alternative opportunity to use it.

 The method is suitable for a company with several divisional heads that are bidding for the services of various people they need among themselves and then including the bid price in the investment cost.

According to this method, the value of the human resources is calculated by establishing competitive bidding within the organisation and based on the value of the employee in alternative uses, wherein the value of an employee is determined by his opportunity cost that is calculated based on efforts made by several organizational units, profit centres or departments.

Advantages

• This method ensures the optional allocation of employees
• It provides a quantitative base for the planning, evaluation and development of human resources of an organisation
• The information received from the method can be effectively used to develop human resources within the organisation.

Monetary Value-Based Method

This method deals with the value addition made by the human resource to the organisation in monetary or quantitative terms. The methods included in the same are explained below.

Capitalization of Salary Method

The method is advocated by Baruch Lev and Aba Schwartz. It states that the salaries payable to the employees during their employment shall be utilized as a replacement, i.e. the value of human resources due to the close correlation between the value of the organisation and the compensation of employees. Hence the value of human resources is the present value of the future earnings of a homogeneous group of employees.

Steps to be followed for the application of the Method 

The organisation must follow the below-mentioned steps to effectively apply his method –

• Division of employees into homogeneous groups based on age, skill, designation and task
• Determining the average annual earnings for every group of employee
• Calculating the present value of total earnings of each class of employees with the help of an appropriate discount rate.

Advantages

• This method led to the introduction of the Economic value method of Human Resource accounting.
• The human capital value is determined after considering the remaining period of service of the employees, thereby providing the required weightage to the working life span of the employees.

Economic Value Method

The value of human resources is measured on the basis of the contribution likely made by them to the organizations during the tenure of their employment.

The accuracy of the valuation is dependent solely on the information, judgment, `as well as impartiality of the bidder. The economic value model of HRA involves estimating the total cash inflow generated by an employee during his service in the organisation.

Upon the subtraction of the total cost of hiring, training, development, and payment of the employee from the estimate of the cash he is expected to generate, the net worth of the employee as per the economic value method of HR accounting can be calculated. 

The model suggests a five-step approach for this purpose.

• Ascertaining the period for which a person is expected to serve the organization.
• Identifying the roles or posts that the employee might occupy during his service career, including the possibility of them leaving the organization.
• Estimating the probable period for which a person would occupy each possible post or role in the organization.
• Evaluating the value derived by the firm when a person occupies a particular position.
• The total value of the services derived by the organization by different employees or groups of employees is determined. The value thus arrived at is discounted at a predetermined rate for getting the present value of human resources.

Advantages

• This method takes into account the career movements of the employees
• The possibility of an employee leaving the organisation due to any other reason than death and retirement is considered under this method of human resource accounting.

Present Value of Net Benefits Method

Morse suggested this method of Human Resource Accounting in the year 1973. Here, the value of human resources is equal to the present value of net benefits derived by the organisation from the service of its employees.

There are specific steps involved in this method, such as

1. The gross value of the services to be rendered in future by the employees in their individual as well as their collective capacity is determined. 
2. The value of future payments (both direct and indirect) to the employees is determined.
3.  The excess of the value of future HR over the value of future payments is ascertained.
4.  The present value of the net benefit is determined by applying a pre-determined discount rate (generally the Cost of capital). This amount represents the value of human resources to the organization.

Standard Cost

The standard cost method of HRA involves ascertaining the total Cost of recruiting and hiring every employee and the training or development of that employee.

Under this method, the value of an employee is the sum of the expenses, and the annual economic value of the entire workforce is equivalent to the total money spent on recruitment, hiring, training, and development of the human resource during the year.

Non-Monetary Approach  

Apart from the monetary methods mentioned above, there are specific other methods of human resource accounting which are used by the organisations, which are elaborated below –

As the name suggests, this method assesses the economic value of human resources in qualitative measures rather than quantitative terms and various indices or ratings and rankings. These methods may be used in addition to monetary methods and have a better predictive value.

This method can be defined as a simple collection of skills and capabilities of people within an organization or as the application of some behavioural measurement technique to analyze the benefits gained from the Human resource of an organization.

The most significant elements of the non-monetary method of Human Resource Accounting were identified by Rao (1986) which are as follows:

• The skills or capability inventory is a simple list of the human resources of the firm’s human resources education, knowledge, experience, and abilities.
• Performance evaluation measures used in Human Resource Accounting involve ratings and rankings. The ratings show a person’s performance on a set of scales, which are the scores assigned to characteristics possessed by the employee. These characteristics include knowledge, judgment, interpersonal skills, intelligence, etc. The ranking is a form of rating provided by superiors to their subordinates on one or more dimensions mentioned above.
• Analysis of potential ascertains a person’s capacity for promotion and development. Here a trait approach is used wherein the traits essential for a position are identified, along with the extent to which the person possesses these traits is assessed by the organisation Attitude measurements assess employees’ attitudes towards their job, pay, working conditions, etc., to determine their job satisfaction and dissatisfaction.

Conclusion

The importance of human resource accounting must not be ignored by organisations, especially in the current times when the paradigms of human resource valuation are shifting drastically owing to the Covid pandemic. Therefore, it becomes essential for organisations to be aware of the various methods of Human Resource Accounting, which can help them to choose the right method for the accurate evaluation of the human resource of their organisation.

FAQs

Read our Article: Meaning and Concept of Human Resource Accounting

1. https://en.wikipedia.org/wiki/Financial_statement