Human resource accounting


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Human resource accounting

  1. 1. Human Resource Accounting Prepared By :- Manisha Vaghelavaghela_manisha13@y BY: VAGHELA 1
  2. 2. CONTENTS Introduction Of Human Resources Accounting Various Definitions of Human Resources Accounting Methods of Human Resources Accounting Summary Conclusion Bibliography vaghela_manisha13@y BY: VAGHELA MANISHA 2
  3. 3. IntroductionTwo types of resources are used in every businessenterprise:1. Physical and financial resources2. Human resources. “One asset is omitted and its worth I want to know, That asset is the value of men who run the show” These lines are clearly indicatethat the value of men (human-resources) is notmeasured and reflected in the accounts ofbusiness enterprise. Although the success of thebusiness to a greater extent depends upon theabilities, efficiencies and power of these peoplewho actually run the business.vaghela_manisha13@y BY: VAGHELA MANISHA
  4. 4. Human resource accounting maybe considered as such an accounting systemwhich recognizes the human resources as an assetand records it in the books of account aftermeasuring its value in the same way as otherphysical resources. Such accounting may generateand present valuable and significant informationrelating to human resources. Employees are the greatest assetsof an organization and its success or failuredepends on the quality and performance of theemployees. But traditional accounting systems failto indicate the value of the most valuable asset.vaghela_manisha13@y BY: VAGHELA MANISHA
  5. 5. Definitions of HRA:-• “Human Resource accounting is anattempt to identify and report investments made inhuman resource of an organization. Basically it is aninformation system that tells the management whatchanges over time are occurring to human resourcesof the business.” vaghela_manisha13@y BY: VAGHELA MANISHA - R. L. Woodruff 5
  6. 6. “Human Resource accounting is the measurementof costs and value of the people for theorganization.” - Flamholtz “Human resource is themeasurement and quantification of organizationalinputs such as recruiting, training experience andcommitment.” - Stephen Knauf “HRA is the process of identifyingand measuring data about human resources andcommunicating this information to interestedparties.”vaghela_manisha13@y -American MANISHA BY: VAGHELA Accounting
  7. 7. Methods of HRA:- Historical cost method Replacement cost method Opportunity cost method Capitalization of salary method Economic valuation method Return on efforts employed method Adjusted discounted future wages method Reward valuation method Standard Cost Method Currant Purchasing Power Methodvaghela_manisha13@y BY: VAGHELA MANISHA
  8. 8. 1)Historical cost method:- This method developedby Brummet, Flamholtz and Pyle.According to this method, theactual cost incurred onrecruiting, selecting, training, placing and developing the humanresources of an enterprise arecapitalized and written off over theexpected useful life of humanresources. The procedure followedfor human resource asset is thesame as that of other physicalasset.vaghela_manisha13@y BY: VAGHELA MANISHA
  9. 9. Any amount spent on training anddeveloping human resources increase its efficiency,hence capitalized. The amortization of human resourceasset is also done in the same way as that of otherphysical asset. The asset is written off over its usefullife. If the asset is liquidated prematurely then it isunderwritten – off amount is charged to revenueaccount. On the other hand, if it has a longer life thenexpected, its amortization is reschedule.vaghela_manisha13@y BY: VAGHELA MANISHA
  10. 10. AdvantagesThis method is simple to understand and easy to work out.The traditional accounting concept of matching cost with revenue is followed in this method.It can help a firm in finding out a return on human resource investment.LimitationIt is very difficult to estimate the number of years an employee will be with the firm.vaghela_manisha13@y BY: VAGHELA MANISHA
  11. 11. It is difficult to determine the number of years over which the effect of investment on employees will be realized. The extent to which the employee will utilize the knowledge acquired is also subjectively estimated.It is also difficult to fix a rate of amortization. A number of methods have been derived to write-off depreciation on fixed assets but in the case of human asset it will generally be on a constant basis. The value of an asset decreases with amortization. In case of human resources the situations just the reverse. With the acquisition of experience and training in the course of time the utility of employees increases rather than decreasing.vaghela_manisha13@y BY: VAGHELA MANISHA
  12. 12. 2) Replacement cost method:- This method was developed byRensis Likert and Eric G. Flamholtz. The cost ofreplacing employees is used as the measure ofcompany’s human resources. The human resources of acompany are to be valued on the assumptions as to whatit will cost the concern if existing human resources arerequired to be replaced with other persons of equivalentexperience and talent.vaghela_manisha13@y BY: VAGHELA MANISHA
  13. 13. This method corresponds to thehistorical cost method mentioned earlier except that itallows for changes in the cost of acquiring anddeveloping employees in place of taking their historicalcost. in this method the cost of recruiting, selecting,training etc. of new employees to reach the level ofcompetence of existing employees are measured.Advantages This method has the advantage of adjusting the human value of price trends in the economy and thereby provides more realistic value in inflationary times. It has the advantage of present-oriented.vaghela_manisha13@y BY: VAGHELA MANISHA
  14. 14. Limitation It may not always be possible to obtain such a measure for a particular employee.It is not always possible to find out the exact replacement of an employee. This method does not reflect the knowledge, competence and loyalties concerning an organization that an individual can build over time. It is difficult to find out the cost of replacing human resources and different persons may arrive at different estimates.vaghela_manisha13@y BY: VAGHELA MANISHA
  15. 15. 3) Opportunity cost method:- In order to overcomethe limitations of replacementcost method, Hekimian and Jonessuggested the use of opportunitycost method which determinesthe value of human resource onthe basis of an employee’s valuein alternative uses. Accordinglythe value of an employee is basedon his opportunity cost-the riceother divisions are willing to payfor the services of an employeeworking in another division of anorganization.vaghela_manisha13@y BY: VAGHELA MANISHA
  16. 16. Thus, the value of an employee wouldbe high if he has several alternative uses foremployment in the various division of an enterprise.This brings to light an important fact that theopportunity cost is linked with scarcity. This methoddetermines the value of human resources byestablishing competitive bidding within an organization.Advantages 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@y BY: VAGHELA MANISHA
  17. 17. Limitation 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 scarce and, therefore, are not being bid by other divisions of the organization. The application of this method is doubtful unless the alternative uses of an employee’s service available in an organization are traced out.vaghela_manisha13@y BY: VAGHELA MANISHA
  18. 18. 4) Capitalization of salary method:- The advocates of thismethod Baruch Lev and AbaSchwartz have used the concept ofhuman resources in terms ofeconomic value in this model.According to them the salariespayable to employees during theirstay with the organization may beused as a replacement for the valueof human resources, in view of theclose co-relation betweenemployees’ compensation and theirvalue to the organization. Thus thevalue of human resources is thepresent value of future earnings ofhomogeneous groupBY: VAGHELA MANISHAvaghela_manisha13@y of employees.
  19. 19. The application of this method involves the followingsteps:Division of employees into homogeneous groups. The basis of employees’ division include their age, designation, skill and task;Determination of the average annual earnings for each group of employees; Calculation of the present value of the total earnings of each class of employees with the help of an appropriate discount rate.vaghela_manisha13@y BY: VAGHELA MANISHA
  20. 20. The authors of the model recommend the followingformula to :- T vr = ∑ l(t) ___________________________________ t=r (1+r)t-r Where, V = The human capital value of a person r years old, T = The person’s retirement age, l (t) = The person’s annual earnings upto retirement, r = A discount rate specific to the person.vaghela_manisha13@y BY: VAGHELA MANISHA
  21. 21. Advantages This model has introduced economic value concept of HRA. Human capital value is found out after considering the remaining period of service of the employees, thus due weightage is given to working life span of the employees.vaghela_manisha13@y BY: VAGHELA MANISHA
  22. 22. Limitation The basic assumption of the model that an employee will stay with an organization until he retires does not generally hold true. The selection of discount rate is subjective.The change in employees’ behavior as a result of promotion, transfer etc. is not considered true.vaghela_manisha13@y BY: VAGHELA MANISHA
  23. 23. 5) Economic valuation method:- Economic valuation method considers thepresent worth of the employee’s future service expectedto be derived during their stay with the organization asthe value of firm’s human resource. Although there aresome resemblances between earlier model i.e.,capitalization of salary method and this model, yet theydiffer with each other. The economic valuation modelrecommends the capitalization. vaghela_manisha13@y BY: VAGHELA MANISHA
  24. 24. According to economic valuation method,the value of human resources is determine on the basisof the expected services of the employees in eachservice state that they may occupy during theirassociation with the organization. Under this method, thevaluation of human resources involves the followingsteps:Estimation of employees future services; Multiply step I) by the employee’s rate of pay; Multiply step II) by the rate of return on investment. This would give the present worth of employee’s services.vaghela_manisha13@y BY: VAGHELA MANISHA
  25. 25. Advantages 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@y BY: VAGHELA MANISHA 25
  26. 26. Limitation 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@y BY: VAGHELA MANISHA
  27. 27. 6) Return on efforts employed method:- This method measures the value of thefirm’s human resources on the basis of efforts made bythe individual for the organizational benefits. These effortsare evaluated in the light of the following factors : Positions an employee holds; Degree of excellence employee achieves; Experience profile of the employee. vaghela_manisha13@y BY: VAGHELA MANISHA 27
  28. 28. Advantages It makes possible inter-divisional comparison which ensures effective competition. It helps the management in human resourcesallocation among various divisions of the organization.It assists the management in regulating the various functions of an organization.vaghela_manisha13@y BY: VAGHELA MANISHA
  29. 29. Limitation It is more an index of efficiency rather than a valuation method. Management finds it difficult to measure and express the individual efforts in monetary value. The measurement procedure of individual efforts differs from firm to firm and, therefore, there is no uniform and widely accepted procedure for it. vaghela_manisha13@y BY: VAGHELA MANISHA 29
  30. 30. 7)Adjusted discounted future wages method:- Roger H. Hermanson developed thismodel wherein he recommends measuring the value ofhuman resources on the basis of relative efficiency of anorganization in the industry. This model relates the valueof human resources with the extra profit the firm earnsover and above the industry expectations. In fact, thismodel attributes the difference in profitability ratesbetween firms of an industry to the varying efficiency oftheir human resources.vaghela_manisha13@y BY: VAGHELA MANISHA
  31. 31. It is with this argument Hermanson suggested to measure the value of the human resources on the capitalized value of the excess future profits realized by the firm. Accordingly, the valuation of a firm’s human-resources involves the following step: Estimation of wages and salaries to different levels of employees for succeeding five years. Calculation of the present value of the wage and salary payments at the rate of return which is considered normal in the industry. Determination of an average efficiency ratio for a specific period, usually the previous five years. Calculation of the present value of future services of the firm’s human resources. This is worked out byvaghela_manisha13@y the firm’s VAGHELA MANISHA multiplying BY: efficiency ratio.
  32. 32. The calculation of efficiency ratio is as follows:Efficiency Ratio= Actual Average Earnings of the firm Normal Earnings of all firmsIf Efficiency Ratio = 1: The firms’ average rate of return equals the rate of return of the economy. It means that the value of human resource is at par with the industry.If Efficiency Ratio > 1: The firms’ return is higher than the normal earnings. The value of the human resource is more than the industrial average.vaghela_manisha13@y BY: VAGHELA MANISHA
  33. 33. If Efficiency Ratio < 1: The firms’ return is lower than the normal earnings. The value of the human resource is less than the industrial average.Advantages☯ It considers the relative efficiency of the firm.☯ It recognizes the time value of money.Limitation☯ It considers every employee a like in terms of efficiency which is not true.☯ The discounting factor is subjective in nature.vaghela_manisha13@y BY: VAGHELA MANISHA
  34. 34. 8) Reward valuation method:- As an improvement over thecapitalization of salary method Flamholtz developed amodel commonly known as Stochastic RewardsValuation Method. The method seeks to measure thevalue of human resources on the basis of an employee’svalue to an organization at various services states (roles)that he is expected to occupy during the span of hisworking life with the organization. The author hasidentified the major variables which determine the valueof an individual to a firm.vaghela_manisha13@y BY: VAGHELA MANISHA
  35. 35. In the context of his model the assessment of employee’s value involves the following steps: Estimation of employee’s expected service life;Identification of set of service states (roles) that an employee may occupy during his service life; Estimation of the value derived by the organization at a particular service state of a person for the specified time period; Estimating the probability that a person will occupy at possible mutually exclusive service state at specified future times;vaghela_manisha13@y BY: VAGHELA MANISHA
  36. 36.  Determining the total value of the services derived by the organization from its all employees;Discounting the total value to its present value at a pre-determined rate.Advantages☯ It is the most scientific model as it demonstrates the impact of the concept of human asset upon the management of human resources.☯ It is matured model as it takes into consideration the employee’s withdrawal from the organization earlier than death or retirement.vaghela_manisha13@y BY: VAGHELA MANISHA
  37. 37. Limitation☯This method does not indicate the method of estimating the future compensation flows of the employee’s.☯ It is practically difficult to determine the probability of employee’s career movement within the organization and of his exit from the organization.vaghela_manisha13@y BY: VAGHELA MANISHA
  38. 38. 9) Standard Cost Method :- This method envisages establishment of astandard cost per grade of employee, updated every year.Variances produced should be analyzed and would form auseful basis for control. Replacement costs can be usedto develop standard costs of recruitment, training anddeveloping individuals, such standards can be used tocompare actual results with those planned. vaghela_manisha13@y BY: VAGHELA MANISHA
  39. 39. 10) Currant Purchasing Power Method :- Under it, instead of taking thereplacement cost to capitalized, the capitalized historiccost of investment in human resources is converted intocurrent purchasing power of money with help of indexnumbers. Its great advantage is its simplicity eventhough it might produce only approximate answers andapproximately correct data.vaghela_manisha13@y BY: VAGHELA MANISHA
  40. 40. Summary Human resource accounting provides quantitativeinformation about the value of human assets, whichhelps the top management to take decisions regardingthe adequacy of human resources. Based on theseinsights, further steps for recruitment and selection ofpersonnel are taken. Outside the organization,quantitative data on the most valuable asset has animpact on the decisions of the investors, clients, andpotential staff of the company. When proper valuation andaccounting of the human resources is not done then themanagement may not be able to recognize the negativeeffects of certain programmes, which are aimed atimproving profits in the short run. If not recognized ontime, these programmes could lead to a fall inproductivity levels, highVAGHELA MANISHA and low morale of vaghela_manisha13@y BY: turnover rate 40existing employees.
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