Jamnalal Bajaj Institute of Management Studies, Mumbai.

Human Resource Accounting

Group Number : 14
Team Members: Gaurav Jaiswal (122) Vishal Yadav (124) Saiprasad Sale (123) Vivek Nambiar (119) Huma Sheikh (121) Sunil Waghmode (120) Rohan Todkar (118)

Human Resource Accounting

What is Human Resource Accounting :

Human Resource Accounting (HRA) involves accounting for expenditures related to human resources as assets as opposed to traditional accounting which treats these costs as expenses that reduce profit. It is a recording of transactions related to the value of human resources.

It is the measurement and reporting of the costs incurred to acquire and develop people as organizational resourcesObjectives of HRA systems It's basically adopted to treat human resources as assets, to generate human data about names, to assign value to human assets in the balance sheet.

Objectives of HRA:
The objectives include:

Provide information for making management decisions about acquiring, allocating, developing and maintaining human resources in order to attain cost effective organization objective. To develop methods of ensuring human resources cost and value and to allow management personnel to monitor effectively the use of human resources. Provide a system of asset control i.e. whether assets are conserved, deflated, or appreciated (Boedker et al 2008). Aid in the development of management principals by classifying the financial consequences of various practices. Develop a theory that will explain the nature and determinants of the value of people to enterprises.

Significance of human resource accounting

A well defined human resource accounting can help the management to become more efficient, in addition it is useful in internal reporting and to external users of financial statement. Usefulness in internal reporting 1. Helps in planning - Human resource cost acting provides cost information required in human resource planning process thereby facilitating preparation of future forecasts and budget (booth 1998). 2. Help in decision making - human resource accounting provides data in areas where alternative option exist e.g. whether to acquire a trained employee or develop one
J.B.I.M.S. Page 2

Human Resource Accounting

from within, or whether to retrench or retain an employee. Instead of applying nonmonetary measures of potential ability, the economic value of recruits will be better criteria for selection and optimization of the expected value of the organization human resource and subsequent valuation of adequacy of return on investment in human resource. Helps in capital budgeting - the present technique used in capital budgeting decision consider the human dimension as a qualitative factor. This is not realistic in the present scenario where huge investment is being made in development of employees and therefore human resource accounting system would justly assess the impact of capital budgeting on human and non-human asset. Helps in control - human resource accounting help to ensure that human resource objective are attained objectively and efficiently as it provide information necessary to implement the control function. The standard cost of acquisition and development is compared with actual cost incurred and the variance if any is analyzed to identify the possible lapses in personnel management function (Scarpello and Theeke, 1989). Helps in performance evaluation - the present convention of measurement of return on investment ignores the changes in human resources and this encourages mangers to use their human resource to include their short term objective. Inclusion of human resource input would be a good performance measure as it would reveal the return on human asset. It helps in activity analysis - measurement of human resource value would provide top management with new set of financial ratio for effective organization activities analysis e.g. ratio of human and non-human resources indicate the degree of labor intensity. Higher labor intensity could be used as a result of outdated technology requiring the utilization of high proportion of labor or employment of unwarranted existing labor (Tang, 2005).

3.

4.

5.

6.

Methods of Measuring HRA:

Human Resource Cost Accounting (HRCA) Human Resource Value Accounting (HRVA)

HRCA:
1) Historical Cost Approach The actual cost incurred on recruiting, selecting, training, placing and developing the human resources of an enterprise are capitalized and written off over the expected useful life of human resources

J.B.I.M.S.

Page 3

Human Resource Accounting

2) Replacement Cost Approach The cost of replacing employees is used as the measure of companys human resources. The HR of a company are to be valued on the assumption as to what it will cost he concern if existing human resources are required to be replaced with other persons of equivalent experience and talent.

3) Opportunity Cost Approach It is based on economic concept of opportunity cost which removes the deficiency in replacement cost approach. Measured through a competitive bidding process within the entity.

J.B.I.M.S.

Page 4

Human Resource Accounting

HRVA:
MODELS USED IN HUMAN RESOURCE VALUE ACCOUNTING

1.

The Lev and Schwartz Model Flamholtz Model Morse Model The Lev and Schwartz Model:-

This model was developed in 1971.It determines the value of human capital embodied in a person of age t is the present value of his remaining future earning from employment in the form of salaries, wages, etc. Under this model: a. All employees are classified in specific groups according to their age and skill. b. Average annual earnings are determined. c. The total earnings where each group will get up to retirement age are calculated. d. The total earnings calculated as above are discounted at the rate of cost of capital. The value thus arrived at will be the value of human resources/assets. The following formula has suggested for calculating the value of an employee according to this model-

V=r*l(t) / (1+R)*t-r

J.B.I.M.S.

Page 5

Human Resource Accounting

V= value of an individual l(t)= the individuals annual earnings upto the retirement t= retirement age r=present age of the employee R=discount rate

2.

Flamholtz Model:-

This method determined an individuals value to an organisation by the services he is expected to render to the organisation during the period he is likely to remain with the organisation in various position or services states. The present value of human resource maybe derived by discounting the realisable value of expected future services at a specified rate. The model suggests a five step approach for assessing the value of an individual to the organisation: a. Forecasting the period that is remained in the organisation i.e. his expected service life. b. Identifying his roles and the tasks. c. Estimating the value derived by the organisation when a person occupies a particular position for a specified period of time. d. Discounting the value at a predetermined rate to get the present value of human resources. 3. Morse Model:-

The value of human resources is equivalent to the present value of the net benefits derived by the enterprise from the service of its employees. The following steps are involved under this approach:a. The gross value of the services to be rendered in future by employees is calculated in their individual and collective capacity. b. The value of direct and indirect future payments to the employees is determined. c. The difference between the points (i) and (ii) represents the net benefit to the enterprise.

J.B.I.M.S.

Page 6

Human Resource Accounting

HRA in INDIA:
It is a popular phenomenon among the Indian corporate world is to disclose information relating to human resource in annual statements. In this context, it is necessary to conduct a study to assess the disclosure pattern of HRA information in Indian corporate World.

It first promulgated by BHEL (Bharat Heavy Electrical Ltd), a leading public enterprise, during the financial year 1972-73. Later it was also adopted by other leading public and private sector Organization in the subsequent years. Some of them are Hindustan Machine Tools Ltd.(HMTL). Oil and Natural Gas Corporation Ltd.(ONGC), NTPC, Cochin Refineries Ltd. (CRL), Madras Refineries Ltd.,(MRL), Associated Cement Company Ltd.(ACC) and Infosys Technologies Ltd.(ITL). However, adaptability of various model (mainly Lev and Schwartz model, Flamholtz model and Jaggi and Lev model) and discount rate fixation and disclosure pattern i.e. either age wise, skill wise etc in BHEL, SAIL, MMTC (Minerals & Metals Trading Corporation Of India Ltd.) HMTL, NTP make it clear, that there has been no uniformity among Indian enterprises regarding HRA disclosure. Example: BHEL

P x 12 x N x E x I HRV= F
grade etc. HRV P 12 Human Resources Value of the group of employees in the particular salary Annual compensation per, DA, CCA, HRA, PF contribution by employers

N Total number of employees in the grade. E Efficiency Factor. I Incremental Factor. It is 5% for five years period. F 12% per annum weighted average cost of capital

Research paper AN ANALYTICALSTUDY OF HUMAN RESOURCE ACCOUNTING PRACTICES AN INDIAN EXPERIENCE .....Mamta Ratti Integral Review - A Journal of Management
J.B.I.M.S. Page 7

Human Resource Accounting

Objectives: To study the value of human resources at different levels of organization. To study hierarchical per capita HR. Findings : Table indicates the value of employees vis--vis total no. of employees as per Lev and Schwartz model. The total value of employees of sampled organizations is about 15crores.According to this table, TCS indicates the highest value of employees i.e. 87.09%and it also have highest percentage among total number of employees 53.9%(17,000 employees).The second company which have highest value is Gillette India Ltd. i.e. 4.22%value. But the table shows that there are some companies in sample that have higher number of employees but value of their human resources is not higher like as Guru Gobind Singh Thermal Power Plant that has employed 11.46% (3,620 employees) but their human worth is only 2.3%that is too much less than number of employees. Thus, inspite of large number of employees, value of human capital is not high. The lowest value of human capital is represented by Sagar Electricals which employed 0.063% employees and their human worth is only 0.004%.
No of Human emoloyees 1,568 (4.96) 3,620(11.46) 53(0.167) 190(0.60) 900(2.85) 32(0.10) 26.0(0.82) 60(0.190) 300(0.95) 40(0.12) 915(2.89) 200(0.63) 20(0.063) 17,000(53.9) 122(0.38) Value of HR ( in crore) 664.6(4.22) 373.6(2.37) 6.69(0.04) 14.71(0.09) 90.85(0.57) 2.98(0.018) 41.8(0.26) 25.61(0.162) 33.03(0.20) 14.27(0.090) 31.58(0.20) 92.86(0.59) 0.69(0.004) 13,700.55(87.09) 18.32(0.11) Value per employee ( Rs in lakh) 42.3 10.3 12.6 7.7 10 9.3 16 42.6 11 35.5 3.4 46.4 0.3 80 15

Sr. No.

Company Name

1 Gillette India Ltd. 2 GGS, Thermal Power Plant 3 HNT International 4 Haryana Milk Foods Ltd. 5 Ind Chenial Health Spl(P) Ltd. 6 Keniforn Chemicals Pvt. Ltd. 7 Mahaan Proteins Ltd. 8 Nibson India Ltd. 9 OST Electronics Ltd. 10 Poorva Consultants 11 Ranbaxy 12 M/s Saint Gobain Diamat Winter Ltd. 13 Sagar Electricals 14 Tata Consultancy Services 15 Vedilal Chemicals Ltd.

It can be inferred that the value of human resources does not depend upon the number of human beings employed or in other words, it can be said that if the number of employees are higher than the value will be higher. The situation may be that value of human resources may be higher in spite of less number of human capitals. So, another factor that increases the value of human capital is amount paid by organizations to their employees. If companies pay higher amount on salaries to their human resources then value will be higher, and if companies will pay less, human capital will be low. This is why, companies have higher
J.B.I.M.S. Page 8

Human Resource Accounting

number of human resources but their value is less than the companies which employed less number of employees. If companies paid higher salaries to their employees, human capital worth is higher. On the other hand, the manufacturing companies are paying less amount to their employees so their value of human resources is less inspite they employed large number of work force. The second reason is IT Companies employed most of the workforce at higher and middle level and salaries at both levels are higher in comparison to lower level. The manufacturing companies paid employed larger workforce at lower level and salaries at lower level is also less. That is why; human capital worth is less in manufacturing than in the IT Company
Value of Value of Value of employees at employees at employees at higher level Middle level Lower level 143.9 79.4 2.92 27.4 19.5 8.7 37.5 31.7 5.6 44.9 17.5 3.3 25 9.74 7.8 15 12.2 8.2 43 0.23 10 23.7 46 17.7 14.3 12.1 7.7 94.4 30.1 9.4 22.2 10.1 4.5 36.4 167 0.5 5 5 2 110.5 87.4 17 22.6 19.2 13.6

Sr. No.

Company Name

1 Gillette India Ltd. 2 GGS, Thermal Power Plant 3 HNT International 4 Haryana Milk Foods Ltd. 5 Ind Chenial Health Spl(P) Ltd. 6 Keniforn Chemicals Pvt. Ltd. 7 Mahaan Proteins Ltd. 8 Nibson India Ltd. 9 OST Electronics Ltd. 10 Poorva Consultants 11 Ranbaxy 12 M/s Saint Gobain Diamat Winter Ltd. 13 Sagar Electricals 14 Tata Consultancy Services 15 Vedilal Chemicals Ltd.

Per Capita Value of Human Resources: High performing organizations in order to keep performing on a continuous basis must treat their human capital as the most important and valuable asset. They should treat them as adults, as partners and with dignity and respect. As we all know that People who feel good about themselves produce good results and People who produce good results feel good about themselves. Such a healthy and virtuous cycle goes on and on, satisfying the individual goals and organizational goals too at the same time, in that the individual drives the job satisfaction, which in turn induces him to reach out for excellence, culminating in the all round development of the performing organizations. In recent years, India has evolved from an inward looking economy to one with a global orientation. Today, the company exports large number of products to various destinations than ever before. Sound human resources not only facilitate to improve a firms long run responsiveness and flexibility also thereby competitiveness. Organizational structure strategy, technology and physical assets cannot guarantee sustainable competitive advantage for an organization in the era of globally competitive business environment in which not only companies but
J.B.I.M.S. Page 9

Human Resource Accounting

entire product categories can disappear over-night. This is because of the fact that competitors can done all of the traditional benchmarks of success. Human resources provide an organization a sustainable competitive advantage through the creation of superior quality intellectual assets. Table indicates the value per employee and number of employees working in organization.TCS have the highest number of employees i.e. 17,000 and value per employee is also very high i.e. 80 lakh. The table shows that this is one of the biggest IT Company. After TCS,M/s Saint Gobain have the highest value 46.4 lakh of each employee that is very high in comparison to the number of employees i.e only 200 but the value shows that human resources are very important for these organizations. After that comes Nibson India Ltd. and Gillette India Ltd. which have approximately same value of human resources but there is very much difference among the number of employees. On the other hand, there are many companies in which number of employees are very high but their value is very low like as Guru Gobind Singh Thermal Power Plant with 3620 employees and per employee value is only Rs.10.3

Case Study : Infosys company ltd :

The company recorded an increase in income from Rs 15,648 crore in 2008 to Rs 20,264 crore in 2009. In 2009 the company reported a profit before tax of Rs 5,819 crore compared to Rs 4,470 in 2008. The earnings per share increased from 78.25 to 101.65. There was also a growth in book value and profit before interest and tax. However market capitalization dropped from Rs 82,362 in 2008 to Rs 75,387 crore in 2009. Infosys was the first company to value it employees in India. The software company did the first valuation in fiscal year 1995-96 using Lev & Schwartz model. The value of it 1,172 employees was Rs 1.86 billion. The company has always considered employee as critical to organization success and therefore the introduction of human resource accounting will further help the organization to focus on it workers. Murphy, the managing director of Infosys has supported HRA saying that "Comparing this figure over the years will tell us whether the value of our human resources is appreciating or not. For a knowledge intensive company like ours, that is vital information." As stated earlier Infosys technologies limited use Lev and Schwartz to value the company's human resources. The value of employee is taken as the present value of the future earning of workers. In computing the present value of employees the following assumption are made. Employee compensation comprises of indirect and direct benefit and includes income earned in India and abroad.
J.B.I.M.S. Page 10

Human Resource Accounting

Incremental earning based on age or group Discount rate/cost of capital of 12.18% and 13.32% the previous year. As indicated above the total value of human resource increased in 2009 compared to 2008. However the value of human resource per employee decreased from 1.08 in 2008 to 0.97 in 2009. Numerical: Valuation of Employees: 50 employees in all who need to be valued The employees are grouped based on their level/grade Assume the organization structure of the company has three levels- L1,L2, L3 50 employees are occupying these levels as: 20 (Level 1), 20 (Level 2), 10 (Level 3)

Demonstrate the Valuation for Level 1 employees Solution: Step 1: Carry out Age level analysis of 20 employees of Level 1

Step 2: Calculate the expected tenure of each group The mean age of each group is 23,33,43,53 Consider the retirement age as 58 Expected tenure of the groups is 35,25,15 and 5 years respectively For ease of computation let the expected tenure be 5,4,3 and 2 respectively

J.B.I.M.S.

Page 11

Human Resource Accounting

Step 3 : Salary/wage is assumed to be Rs. 100 per year This includes both direct and indirect component

Step 4 : To project the annual salary, 10% growth is considered annually

Step 5: Discount the projected salary/wage of an employee at 5%

Step 6: Total Present Value of Level 1 Employees

J.B.I.M.S.

Page 12

Human Resource Accounting

Deterrents to HRA:
Human Resource Accounting (HRA) is relatively a new concept & not much followed in the industry, reason being the objections raised against it. The main deterrents to HRA are as follows: HRA is based on assumptions: The organizations which follow HRA do not have common methods of HR accounting. The assumptions made for accounting vary from organization to organization. The methods are based upon various assumptions. HRA is not recognized by tax laws: Being a new concept, it has not yet received recognition from tax laws worldwide. As there is no rigid base for the assumptions made in the HRA, no tax law recognizes it either as an obligatory or voluntary method of accounting. This results in HRA being considered as a theoretical concept only. Difference in valuation of assets & that of HR: The traditional methods of accounting take into consideration different valuation methods for valuation of assets. These methods cannot be applied to HR valuations as it is not a tangible asset. Factors included for valuing not measurable in monetary terms: As HRA considers the intangible benefits like efficiency, quality, and intellectual properties associated with the human resources of the organization, it cannot be measured in monetary terms. Use of different models makes it difficult for comparison: The methods used for HRA vary from organization to organization which makes it difficult for them to compare the results of the same. The parameters taken into consideration are different for every organization. This makes it difficult for comparison. Not credible: As only numeric figures associated with the human resources cannot depict the true value of the individual, we cannot only rely on HRA for the evaluation of the Human Resource of the organization.

J.B.I.M.S.

Page 13

Human Resource Accounting

Future Outlook of HRA:

Though much progress has been made in accounting for human resource in India, comparison can only be made within the same (inter-period) firm but not between firms because of different modification made in computation techniques and lot of objectivity while making estimates. All the company's that have introduced human resource accounting have used the Lev and Schwartz economic model. The human resource accounting presentation in India can be summarized in the table below All the companies that furnished information about human resource value included such report as a separate report from the main financial statement i.e. the income statement and the balance sheet. This means that human resource accounting is not still considered as part of financial statement but additional materials for use by users of annual report. Thus human resource accounting is in need of further development in order for human resource data to receive equal weight like other items in the balance sheet and income statement. In order for human resource accounting to have significance and to be part of financial statement the value of human resource as computed by various company should be incorporated in the balance sheet. This will make the balance sheet complete and lead to better analysis than traditional balance sheet. For instance considering the case of Infosys, return on asset before considering value of human resource is computed as follows This illustrate that omitting the value of human resource from the balance sheet can give misleading information about the company's performance. Before incorporating the value of human resource the ROA in 2009 was 27% but after incorporating the value of human asset ROA drop to 4.8% which is the actual return on asset. In addition the earlier calculation indicated a growth in return on asset by 1% while calculation incorporating human resource value indicates a growth in ROA by 0.8% between 2009 and 2009. This example indicates that human resource accounting can lead to better analysis of financial performance of a company. Investors can use human resource ratios to analyze the performance of the company over the period and thus understanding whether the performance of the company is improving or deteriorating. For instance in the case of Infosys total income/human resource ratio was 0.21 in 2009 compared with 0.17 in 2008. This indicates an improvement in performance of the company. Other human resource ratios which illustrated improvement in performance include value added to human resource which increased from 0.15 to 0.19 and return on human resource value which increased from 4.7 to 5.9. Based on human resource ratios the company performed better in 2009 compared to 2008 and investor can use this information to make an investment decision. However other ratios of profitability, liquidity, efficiency and leverage need to be included while analyzing the financial health of a company otherwise the use of a single category of ratio can mislead users of accounting information. Management can also use the information provided by human resource accounting. Breakdown of the workforce in term of professionalism can help managers to decide whether they have right mix of workforce to drive organization growth. Change in the mix can be necessitated by change of business or acquisition and merger. For a technology firm
J.B.I.M.S. Page 14

Human Resource Accounting

like Infosys, a large portion of the workforce is expected to be professionals with less unskilled workers but for a manufacturing firm the number of semi skilled worker is expected to be higher. Comparison of the level of professionalism between firms in the same industry can pinpoint weaknesses or competitive advantage that one firm have over the other (Harrell and Klick, 1980). In technology industry if the managers find that the number of semi-skilled and unskilled worker is high than technical staff and other professionals, it is an indication that the organization has insufficient skills to sustain growth in a highly competitive market. For instance in 2009 Infosys had 97,349 software professionals compared to 7,501 support staff. This indicate that the firm has the right mix of workforce and it is expected that in future the growth in both categories of workforce will be proportional but in a situation where the number of supporting staff grow at a higher rate than software professionals it may be a sign that the organization is not maintaining the correct proportion of workforce. The increased use of the balanced score card will make human resource accounting to be more useful for making strategic decision in India. The balanced score card is a performance measure system that consider both financial measures and non-financial measures of performance such as business process perspective, customer perspective, and learning and growth perspective (Kaplan and Norton, 1996). The balance score card just like human resource accounting is more useful than traditional financial reporting system which indicate how a company has performed in the past but offer little information on future performance of the company. For instance a firm may reduce training cost to boost current earnings but the future earnings might be adversely affected due to reduced productivity. The balance score card balance between external and internal measures, subjective and objective measures, and performance results and the drivers of future results. During the current information age the firm value is embedded in customer relations, innovative processes and human resource unlike in industrial age when the firm value depended on property, plant and equipment. Though financial accounting system was good at valuing asset in industrial age, in information age it is ineffective which calls for adoption of the balanced score card and human resource costing and accounting. As stated earlier balanced score card goes beyond financial measure to include internal process perspective, customer perspective and learning and growth perspective. 1. Financial perspective - this indicate financial measures e.g. return on asset, return on equity, value added, net profit margin etc 2. Customer - this indicate measures such as customer retention, customer satisfaction and market share. 3. Business process perspective - this indicate the following measures; quality, cost and throughput associated with business processes e.g. production, procurement and order fulfillment. 4. Learning and growth perspective - this indicate measure such as skill sets, employee retention, employee satisfaction etc. The future of human resource accounting in India and the rest of the nations may be linked to the balanced score card. In today business application human resource accounting suffer
J.B.I.M.S. Page 15

Human Resource Accounting

due to the fact that it is not grounded in business strategy. When balance score card is linked to human resource accounting this problem would be solved (Kaplan & Roll, 1972). In addition the measures developed within human resource accounting will be utilized by the balanced score card particularly in the area of learning and growth perspective which deal with measures such as skill sets, employees satisfaction, employees retention etc. One of the shortcomings from use of balance score card is the missing link between nonfinancial indicators and financial measures such as cash flow and earnings. The use of human resource accounting will help to transform non-financial measures to financial ones thus linking them to financial reporting system. To make human resource accounting more meaningful and to facilitate it inclusion in financial statement, personnel cost should be classified into two categories namely capital expenditure and revenue expenditure. Capital expenditure will include costs such as acquisition, retention, development, up-gradation or update and hiring cost (recruitment and training). Revenue expenditure will include salaries, wages, commission, bonus, allowance, efficiency maintenance cost and short term motivation (Cascio, 1998). Capital expenditures should be capitalized and recorded in the balance sheet as intangible assets and amortized over the useful life of human asset. This armotisation should be recorded as expenses in the income statement. Revenue expenditure should be charged against revenue in the income statement. This will be the only way that human resource cost is represented in the financial statements i.e. the income statement and the balance sheet rather than a separate report in the annual statement.

Conclusion:
Human resource accounting provides quantitative information about the value of human resource, which helps the top management to take decisions regarding the adequacy of human resources. Based on these insights, further steps for recruitment and selection of personnel are taken. Outside the organization, quantitative data on the most valuable asset has an impact on the decision of investors, clients, and potential staff of the company. When proper valuation and accounting of human resources is not done then management may not be able to recognize the negative effects of certain programs, which are aimed at improving profit in the short run. If not recognized on time this programs could lead to fall in productivity levels, high turnover rate and low morale of existing employees. Just as Likert and Bowes (1968) conclusion that whilst it is true that accounting has a myopic focus on monetary data it is also this focus which is impending the flow of accounting information, particularly to external users about economic resources and activities which cannot effectively be expressed in monetary terms. There are several areas in which nonmonetary measurements may be evolved in accounting and human resource accounting is probably one of these. To make valuation of human resource objective and comparable there must be a universally acceptable method of valuation.

J.B.I.M.S.

Page 16