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Opportunity cost, standard cost, current purchase cost, and power and economic cost method

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  • 1. 1OPPORTUNITY COST, STANDARD COST,CURRENT PURCHASE COST, ANDPOWER AND ECONOMIC COSTMETHODBYMANISHA VAGHELAvaghela_manish a13@yahoo.co m
  • 2. Flow of presentation2 Meaning of Human Recourse Accounting (HRA) Definition Of HRA Importance of HRA Objectives of HRA Opportunity cost method • Advantages • Disadvantages Standard cost method • Advantages vaghela_manisha13@yahoo.c • Disadvantages om
  • 3.  Current purchase power method3 • Advantages • Disadvantages  Economic Value method • Advantages • Disadvantages  Conclusion vaghela_manisha13@yahoo.c om
  • 4. Meaning of HRA 4 Human Resource Accounting (HRA) means to measure the cost and value of the people (i.e. of employees and managers) in the organization. It measures the cost incurred to recruit, hire, train and develop employees and managers. HRA also finds out the present economic value of its employees and managers. After measuring the cost and value of its employees and managers, the organization prepares a report.vaghela_manish a13@yahoo.co m
  • 5. 5 This report is called HRA Report. It is shown to the top level management. It can also be shown to the employees, managers and outside investors. vaghela_manisha13@yahoo.c om
  • 6. Definition Of HRA6  The American Accounting Association has defined HRA as ‘the process of identifying and measuring data about human resources and communicating information to interested parties.’  According to Woodruff Jr., VP of R.G. Barry Corporation U.S.A, “HRA is an attempt to identify and report investment made in human resources of an organization that are not accounted for under conventional accounting practice. Its an information system that tells the management what changes over time are occurring to vaghela_manisha13@yahoo.c om
  • 7.  Human resource Accounting is the process of7 identifying and reporting the Investments made in the Human Resources of an Organization that are presently not accounted for in the conventional accounting practices. In simple terms, it is an extension of the Accounting Principles of matching the costs and revenues and of organizing data to communicate relevant information in financial terms. vaghela_manisha13@yahoo.c om
  • 8. Position of HRA in India8 In India, very few companies use HRA. HRA is not compulsory in India. Infosys Technologies and BPL are the leading companies in India, which use HRA. HRA reports give useful information to the company management, employees and investors. vaghela_manisha13@yahoo.c om
  • 9. Importance of HRA9 Human Resource Accounting provides useful information to the management, financial analysts and employees as stated below:-  Human Resource Accounting helps the management in Employment and utilization of Human Resources.  It helps in deciding transfers, promotion, training and retrenchment of human resources  It provides a basis for the planning of physical assets vis- a-vis human resources vaghela_manisha13@yahoo.c om
  • 10.  It helps in evaluating the expenditure incurred for10 imparting further education and training of employees in terms of the benefits derived by the firm.  It helps to identify the causes of high labour turnover at various levels and taking preventive measures to contain it.  It helps in locating the real cause for low return on investment, like improper or under-utilization of physical assets or human resources or both.  It provides valuable information for persons interested in vaghela_manisha13@yahoo.c om making long term investments in the firm.
  • 11. Objectives of HRA11  Provide cost value information about acquiring, developing, allocating and maintaining human resources so as to meet organizational goals.  Enable management to effectively monitor the use of human resources.  Find whether human assets are appreciating or depreciating over a period of time.  Assist in the development of effective management practices by classifying the financial consequences of vaghela_manisha13@yahoo.c om various practices.
  • 12. 12 vaghela_manisha13@yahoo.c om
  • 13. 13  In order to overcome the limitations of replacement cost method, Hekimian and Jones suggested the use of opportunity cost method.  It determines the value of human resource on the basis of an employee’s value in alternative uses.  Accordingly the value of an employee is based on his opportunity cost – the price other divisions are willing to pay for the services of an employee working in another division of an organization. vaghela_manisha13@yahoo.c om
  • 14. 14  This brings to light an important fact that the opportunity cost is liked with scarcity.  This method determines the value of human resources by establishing competitive bidding within an organization.  This model envisages the computation of monetary value and the allocation of people to the most promising activity. vaghela_manisha13@yahoo.c om
  • 15. 15  For example: The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages.  If a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.). vaghela_manisha13@yahoo.c om
  • 16. 16 In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost. vaghela_manisha13@yahoo.c om
  • 17. Opportunity cost is expressed in relative price, i.e., the17 price of one choice relative to the price of another.  Example: if milk costs $4 per gallon and bread costs $2 per loaf, then the relative price of milk is 2loaves of bread. If a consumer goes to the grocery store with only $4 and buys a gallon milk with it, then one can say that the opportunity cost of that gallon of milk was 2 loaves of bread (assuming that bread was next best alternative ) vaghela_manisha13@yahoo.c om
  • 18. Advantages18  This method ensures optional allocation of human resources.  It provides a quantitative base for planning, evaluating and developing human resources of an organization. Development in human resource can easily be made on the basis of the information of this method. vaghela_manisha13@yahoo.c om
  • 19. Limitation19  This method fails to accommodate the possibility of hiring of employees of similar efficiency, experience and skill.  It excludes from its purview those members of the firm’s human resources who are not scare and , therefore, are not being bid by other divisions of the organization.  The application of this method is doubtful the alternative uses of an employee’s service available vaghela_manisha13@yahoo.c om
  • 20. 20 vaghela_manisha13@yahoo.c om
  • 21.  This method envisages establishment of a standard cost21 per grade of employee, updated every year.  Variances produced should be analyzed and would form a useful basis for control.  Replacement costs can be used to develop standard costs of recruitment, training and developing individuals, such standards can be used to compare actual results with those planned. vaghela_manisha13@yahoo.c om
  • 22.  A standard cost has two components: a standard and a22 cost. A standard is like a norm and whatever is considered normal can generally be accepted as standard.  For example, if a score of 72 is the standard for a golf course, a golfers score is judged on the basis of this standard. In industry, the standards for making a desk, assembling a radio, refining crude oil, or manufacturing railway cars are based on carefully determined quantitative and qualitative measurements and vaghela_manisha13@yahoo.c om engineering methods.
  • 23.  A standard must be though of as a norm in terms of specific items, such as pounds of materials, hours of23 labor required, and percentage of plant capacity to be used.  In many firms, a standard can be operative for a long time. A change is needed only when production or the products themselves have become obsolete or undesirable. vaghela_manisha13@yahoo.c om
  • 24. Advantages24  The use of standard costs is a key element in a management by exception approach. If costs remain within the standards, Managers can focus on other issues. When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention. This approach helps managers focus on important issues.  Standards that are viewed as reasonable by employees can promote economy and efficiency. They provide benchmarks that individuals can use to judge their own vaghela_manisha13@yahoo.c om performance.
  • 25. 25  Standard costs can greatly simplify bookkeeping. Instead of recording actual co0sts for each job, the standard costs for materials, labor, and overhead can be charged to jobs.  Standard costs fit naturally in an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control. vaghela_manisha13@yahoo.c om
  • 26. Disadvantages26  Standard costing system may be tedious, expensive and time consuming to install and keep up to date.  The standard costing system controls the operating part of an organization only as it ignores the other items like quality, lead-time, service, customer satisfaction and so on.  The standard costing system will become less useful in vaghela_manisha13@yahoo.c om modern factories where the just in time principles are
  • 27. 27  The standard costing system may not be applicable in case of small firms as it requires high degree of skill.  The standard costing may not be very effective in those organizations where non-standardized products are manufactured and services are rendered. vaghela_manisha13@yahoo.c om
  • 28. 28 vaghela_manisha13@yahoo.c om
  • 29.  Under it, instead of taking the replacement cost to29 capitalized, the capitalized historic cost of investment in human resources is converted into purchasing power of money with help of index numbers.  Its great advantage is its simplicity even though it might produce only approximate answers and approximately correct data.  To evaluate an investment which has cash inflows and/or outflows spread over several years it is necessary to take account of the time value of money. vaghela_manisha13@yahoo.c om
  • 30. That is because a sum to be received in the future is worth less than the same amount received now because30 the amount received now can be invested immediately. Thus it will grow through earning interest to be a bigger amount at the date when the future amount is received.  To equate the cash flows in such an investment they must all be adjusted to their current purchasing power. This is called discounting and can be done with present value tables which supply discount factors for all likely rates of interest over a range of years. vaghela_manisha13@yahoo.c om
  • 31. Advantages 31 CPP method adopts the same unit of measurement by taking into account the price changes.  Under CPP method, historical accounts continue to be maintained. CPP statements are prepared on supplementary basis.  CPP method facilitates the calculation of gain or loss in purchasing power due to the holding of monetary items.  CPP method uses common purchasing power as measuring unit. So, the comparative study is easy. vaghela_manisha13@yahoo.c om
  • 32. Disadvantages32  CPP method considers only the changes in general purchasing power. It does not consider the changes in the value of individual items.  CPP method is based on statistical index number which can not be used in an individual firm.  It is very difficult to choose a suitable price index.  CPP method fails to remove all the defects of historical cost accounting system. vaghela_manisha13@yahoo.c om
  • 33. 33 vaghela_manisha13@yahoo.c om
  • 34.  Economic valuation method considers the present worth34 of the employee’s future service expected to be derived during their stay with the organization as the value of firm’s human resource.  There are some resemblances between earlier model i.e., capitalization of salary method and this model, yet differ with each other. The economic valuation model recommends the capitalization. vaghela_manisha13@yahoo.c om
  • 35.  According to economic valuation method, the value of35 human resources is determine on the basis of the expected services of the employees in each service sate that they may occupy during their association with the organization.  Under this method, the valuation of human resources involves the following steps: 1. Estimation of employees future services; 2. Multiply step 1)by the employee’s rate of pay 3. Multiply step 2) by the rate of return on investment. vaghela_manisha13@yahoo.c This would give the present worth of employee’s om
  • 36. Advantages36  This model takes into consideration the employee’s career movements.  If employees leave enterprise on account of the reasons other than death and retirement, then such possibilities are also considered in this model.  This model is regarded better than Lev and Schwartz model due to above two types of inclusion in this model. vaghela_manisha13@yahoo.c om
  • 37. Disadvantages37  Estimation of the probabilities for each employee’s occupying various positions and valuation of contribution of services from all these positions is not an easy task.  To estimate exit probabilities and changes from one position to another is an expensive process.  It is difficult to estimate an employee’s expected tenure of service.  It is also difficult to find out valid data about the value of expected to be rendered service by an employee. vaghela_manisha13@yahoo.c om
  • 38. Conclusion38 Here by, we end our presentation by concluding that to over the limitations of replacement cost method, opportunity cost came into existence . Standard cost of an employee is mainly decided by recruiting, training and developing individuals. In, Cpp method historic cost of investment in human resources is converted into purchasing power of money. Economic value method is mainly done to know the present worth of the employee’s service vaghela_manisha13@yahoo.c om
  • 39. Questions39 1) Give an example of your own about opportunity cost. 2) What do you understand by standard cost? 3) What is economic value method mainly based upon? 4) Which method is historic cost converted into? 5) Opportunity cost is expressed in which price? vaghela_manisha13@yahoo.c om
  • 40. 40 Thank you vaghela_manisha13@yahoo.c om

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