Human Resource Accounting
The process of identifying and reporting investments that are made on the human resources by a company that is currently unaccounted for in the conventional accounting practice is known as Human Resource Accounting (HRA). In simpler terms, it is referred to as that type of accounting under which various expenses and cost related to the employees of a company and their salary and wages, recruitment, selection, development, training, hiring, etc. is recognized and calculated. The company can document its assets accurately by assessing, budgeting, and reporting the true value of the human resource that the company has.
Objectives of Human Resource Accounting
Various objectives of human resource accounting are as follows:
- It is used to measure the cost related to the human resource of the company.
- Helping the management in preparing proper plans and budgets for training and other services that are provided to the employees.
- To ensure whether the organization is doing the proper utilization of human resources.
- Increasing awareness and value about human resources and treating them as an important asset of the company.
- For making efficient and better planning for human resources.
- For doing the proper accounting of retirement benefits that are enjoyed by the employees and other benefits over their service period given by the organization.
- To aid top management in human resource analysis.
- For calculating the actual cost incurred by the organization on its manpower.
- To figure out the returns that the organization is getting from its inputs over the human resources, their training, recruitment, and other facilities given to them.
Process of Human Resource Accounting
To execute the human resource accounting effectively and efficiently, it is required for the management to follow a particular procedure. The various steps of this procedure are explained below:
1. HRA Objectives
There are certain goals that every company has to accomplish and work on. In the first step, the company determines these goals and requirements to set a foundation for the objectives of the human resource accounting system.
2. Developing HRA Measurements
The second step in this process is to develop HRA measurements. For this purpose, the companies can use any of the two methods that are available, i.e., Monetary and Non-monetary Methods. These methods are helpful in calculating the cost and/or value of human resources. The management can use any one or both of these methods for the measurements. But it is a must to check the validity and consistency of any method before applying or implementing it.
3. Developing HRA Database
Certain factors work as the basis for human resource accounting. Such factors are time management sheet, the cost of each employee working in the company, different psychological factors, etc. These factors form a database for human resource accounting.
4. Pilot Testing the System
This is the fourth step in the process of human resource accounting. At this step, the management conducts a pilot test of the system. A pilot test is a type of sample test which is done on a selected number of people before conducting the main test. This test aims to pre-check the working system before finalizing it as part of the organization or the main research work. Also, pilot testing helps in finding the flaws in the database which can be corrected before the final implementation. But pilot testing can only be successful if there is coordination and cooperation in the management throughout the process.
5. Implementing the Human Resource Accounting
This is the fifth and final step in the process of human resource accounting. Now, the management will implement the human resource accounting in the organization and will introduce the entire workforce and staff to a new system of accounting. But the implementing the system is not enough. The management has to explain the importance and different methods of HRA to the employees so that they can adapt to the new concept and remain satisfied with the organization.
Methods of Human Resource Accounting
There are various methods that can be used under the human resource accounting system. Generally, these methods are divided into the following two categories:
1. Cost Approach Method
It calculates the various cost that the company is expected to spend on its employees. It is a type of monetary model (the model which deals with the monetary aspects).
The cost approach method is further divided into the following two categories:
- Acquisition Cost Method
Under this method, organizations capitalize on all costs which are related to their human resources such as welfare, training, etc., and amortize them in the P&L Account throughout their working period in the company, i.e., from appointment to retirement.
- Replacement Cost Method
Under this approach, the cost of replacing the employees is measured. The replacement costs include recruitment, selection, compensation, and training cost. The collected data helps in deciding whether the company should dismiss or replace the staff or not.
- The assumption made by this method is false because the value of the currency can't be stable.
- Only the costs to the organization are measured under this method but the value of the employees is completely ignored.
- Gathering the information regarding human values is highly tedious.
- There can be difficulty in calculating CTC in the acquisition model when the employees are already fully trained and there is no need to incur any development, training, or recruitment costs over them.
- The replacement cost method may lead to an upwardly biased estimate because there can be a greater cost of replacing an employee with an inefficient firm.
2. Value Approach Method
It is also a type of monetary model. This method calculates the value of the employees on the basis of the future service that is expected from him/her till the retirement.
Under this approach, three methods are included:
- Present Value Method
Under this method, the management calculates the present value of all future benefits to employees so that it can be determined whether the company can bear the cost. It also helps in knowing the gains that the business may get in the future from the cost incurred on the employees.
- Value to the Organization Method
This method determines the most valuable employee of the organization and measures whether the company is enjoying premium profits from the services given by that employee. This all is helpful in understanding the value of the selected employee.
- Expense Model Method
The expense model attaches the money to the behavioral outcomes produced by working in the organization. The method focuses on the criteria of absenteeism, turnover, and job performance. Here, the management determines the cost for each criterion separately by using the traditional organizational tools.
- The present value method is an objective measure because it uses too much statistical data such as census income return and mortality tables. Other than this, it focuses more on the average numbers instead of the value of any specific group or individual.
- Under the value to the organization method, the soundness of the valuation is completely based on the judgment, information, and impartiality of the bidder.
- The process of calculation is lengthy and cumbersome in the expense model method.
Models of Human Resource Accounting
1. Lev and Schwartz Model
Under this model, the company determines the present value of future benefits to employees on the basis of the given assumption:
- The classification of the employees is done based on their age, skill, and experience.
- The average annual income of each age group is calculated.
- After it, earnings till the retirement of the employees are calculated.
- Later, the calculated value of each group is discounted with the rate of cost of capital.
- Only the salary and wages of the employees will be considered in this method. All other benefits and perks are excluded from it.
- Employees' termination, resignation, or other possibilities are ignored in this method.
2. The Eric Flamholtz Model
Under this model, the company also includes the factor of employees leaving the job earlier, voluntary retirement, retrenchment or death of the employee, etc. to calculate the present value of the future benefits. There are some assumptions and facts that the company considers under this model:
- The company, first of all, determines the period of the employees' working for the organization.
- Then, determine a period after which an employee may leave the job willingly or due to any other reason.
- After it, the company will estimate the value of employees for the organization and their contribution to the business' success.
- At last, the company will apply the present value method and consider all the facts and assumptions that are described above under the Lev and Schwartz Method.
3. Morse Model
Under this model, the company determines the services that are rendered by the employees to the business. Morse model determines all other monetary benefits that are enjoyed by the human resource of the company such as retirement benefits, gratuity, leave encashment or paid leave, perks, bonuses, etc. This calculation is done on proper assumptions and then these values are discounted to calculate the present value of future benefits.
4. Linkert Model
This model is different from the other models. Here, the company focuses on the non-monetary benefits given to the employees instead of the monetary benefits. The organization considers the benefits such as employees' job satisfaction, productivity, safety, health benefits, etc. to figure out the present value and benefits to the organization.
5. Organ's Model
Under this model, the company calculates the net benefits from each employee and then multiplies it with an estimated period for which the employee may work for the organization. In short, this method calculates the individual contribution of the employees toward the business during a certain period.
Benefits of Human Resource Accounting
Various benefits of the human resource accounting are as follows:
- This accounting is helpful in improving the decisions taken by the management of the company.
- Other than this, it also helps the management in implementing the best methods of salary, wages, and overtime administration.
- This system of accounting discloses the actual value of the human resource and the contribution given by them to the success of the business.
- This accounting is also beneficial for the organization for having a proper and efficient utilization of manpower resources.
- Employees are the most valuable assets of a company. If they are satisfied with the organization and the organization is also successful in utilizing them effectively and efficiently then it will increase the productivity of the business which can further cause an increase in the profit.
Limitations of Human Resource Accounting
Other than the above-given benefits, human resource accounting has certain limitations also. These are as follows:
- There is not any standard procedure given by the accounting to calculate the value of human resources.
- The methods which are given above are based on various assumptions which reduce their validity.
- During the valuation process, the turnover of the employees is ignored.
- There are some factors that are out of the control of the organization due to which the life of working can't be adequately estimated. Hence, the final valuation is turn out to be unrealistic.
- It is very difficult to make a comparison between the valuations done by two different companies. This is because these companies may use different methods of value calculation as per their suitability and due to the absence of a standard method.
- Human resource is a very valuable and important aspect of the business but in spite of it, tax laws do not recognize them as assets.