Report on

“Literature Review
of
Human Capital Reporting in the financial statements”
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 Table of Contents
Abstract ........................................................................................................................................... 4
Keywords: ................................................................................................................................... 4
Introduction ..................................................................................................................................... 5
Definition of Human Resource- Finance, Accounting and Economics ...................................... 6
Definition of Capital-Finance and Accounting and Economics ................................................. 6
Definition of Human Capital ...................................................................................................... 6
Key terms used in Human Resource: .......................................................................................... 7
i. Talent Inventory ............................................................................................................... 7
ii. Performance appraisal ...................................................................................................... 7
iii. Training and development................................................................................................ 7
iv. Employee turnover ........................................................................................................... 7
v. Acquisition process of Human Resources ........................................................................ 7
Human Capital: A Cost or an Asset ............................................................................................ 7
Human Capital Accounting and International Financial Reporting Standards:.......................... 8
Measurement Methods of Human Capital: ..................................................................................... 8
Cost Based Approach .................................................................................................................. 8
Limitations: ............................................................................................................................. 9
Replacement Cost approach:....................................................................................................... 9
Limitations: ............................................................................................................................. 9
Present Value of Future Earnings: .............................................................................................. 9
Limitations: ........................................................................................................................... 10
Importance of Human Capital Accounting ............................................................................... 10
Limitations of Human Capital Accounting ........................................................................... 10
Literature review: .......................................................................................................................... 12
Conclusion: ................................................................................................................................... 16
References: .................................................................................................................................... 17

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Abstract
In the contemporary study human capital has become one of the most significant and influential
asset in an organization. Pivot of this study aims at analyzing and presenting the supporting
literature on the presentation of human capital in the financial statements. Under this brief study
several published literatures have been summarized. Human capitals have been ignored in the
financial statements for a longer period of time. Measurement basis identification was one of the
limiting factor and possible options has been presented in the analysis. Human capitals possess
skills and capacity that are critical for any organizational success. Review of the relevant literature
will be guided with key terms and definition of the human resources from different perspectives.
In the age of technological innovation and globalization human resources should not be excluded
from being reported in the financial statements.

Keywords: IC (Intellectual Capital), Human Capital, Talent Inventory, Acquisition, Human

Capital Asset, Measurement.

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Introduction

Under this study various literatures have been studied and presented to evaluate the different
perspectives of human capital for the purpose of presenting in the financial statements. At first
various definition terms has been provided. Secondly, existing standards of accounting has been
considered for the purpose of evaluating the relevance of reporting in the statements. Thirdly,
Measurement methods has been illustrated that can have relevance in the presentation of financial
statements. In the final section the literature review has been provided with a conclusion. This
study is a brief and rigorous in presenting the facts and figures that have been found in the analysis.

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Definition of Human Resource- Finance, Accounting and Economics

Definition under Finance- A Human Resource is a single person or employee within the
organization. Human Resources is also the organizational function that deals with the people and
issues related to people such as compensation, hiring, performance management, and training.

Definition under Accounting- Human resource accounting is the process of identifying and
reporting investments made in the human resources of an organization that are presently
unaccounted for in the conventional accounting practices. It is an extension of standard accounting
principles.

Definition under Economics- Human resource economics covers Labor Economics, Health
Economics, and Human Resource Economics. Labor Economics is concerned with the
determination of wages and hours of work in labor markets. Health Economics is concerned with
the production and demand for health care and how the determinants of demand and supply affect
the costs of various types of health care services. Human Resource Economics studies individual,
family, and market investments in various forms of human capital such as education, on-the-job
training, and health.

Definition of Capital-Finance and Accounting and Economics

Under Accounting and Finance capital refers to financial wealth that is used for the purpose of
starting and maintaining a business.

In classical economics, capital is one of the three factors of production. The others are land, and
labor. Goods with the following features are capital goods as opposed to consumer goods or
durable goods:

Definition of Human Capital

Human Capital is a measure of the skills, education, capacity and attributes of labor which
influence their productive capacity and earning potential. According to the OECD, human capital
is defined as “The knowledge, skills, competencies and other attributes embodied in individuals
or groups of individuals acquired during their life and used to produce goods, services or ideas in
market circumstances”.

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Key terms used in Human Resource:
i. Talent Inventory
Strategic planning involves analyzing the need for and availability of human capital in meeting the
organization's goals and objectives. Creating and maintaining a skills inventory can assist HR in
these efforts. A talent inventory is a compilation of the skills, education and experiences of current
employees.

ii. Performance appraisal

A performance appraisal also referred to as a performance review, performance evaluation,
development discussion or employee appraisal is a method by which the job performance of an
employee is documented and evaluated.

iii. Training and development

Employee training and development is a broad term covering multiple kinds of employee learning.
Training is a program that helps employees learn specific knowledge or skills to improve
performance in their current roles.

iv. Employee turnover

Employee turnover refers to the number or percentage of workers who leave an organization and
are replaced by new employees. Measuring employee turnover can be helpful to employers that
want to examine reasons for turnover or estimate the cost-to-hire for budget purposes.

v. Acquisition process of Human Resources

Human resource management or human resource development, entails planning, implementing,
and managing recruitment, as well as selection, training, career, and organizational development
initiatives within an organization. ... Acquisition entails the hiring of workers most likely to help
a company attain its goals.

Human Capital: A Cost or an Asset

In case of reporting human at cost the assumption undertaken are-

i. People need to be incentivized to work harder.

ii. it is only worth investing in training if there is an immediate need.
iii. removal of people from the organization is primarily a cost decision.
iv. people should be bought in with the highest possible value for the lowest possible cost.

On the other hand, assuming peoples are asset there are implication that-

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 i. People will work better when they have interesting and challenging work to do.
ii. People work harder when they are motivated and committed to their work, experiencing
high levels of satisfaction.
iii. People should be brought into the organization on the basis of their potential to develop
and grow.
iv. Investment in training and skills is worthwhile, if there is likely to be a return on that
investment in the medium to long term.

Human Capital Accounting and International Financial Reporting Standards:

In last decade United States GAAP has been moving toward adoption of more complex
measurement methods in financial reporting compared with the traditional historical cost approach
to asset measurement, including a focus on the measurement of the time value of money and
present value calculations. Certain current assets are now reported at their fair market values at
each balance sheet date, and many items on the balance sheet that are noncurrent are measured at
the present value of the estimated future cash flows. While the IFRS do not currently have
standards requiring HRA, it could be argued that they are moving closer to providing more flexible
approaches to accounting measurements and reporting. For example, the international standards
IAS 38 Intangible Assets and IFRS 3 on Business Combinations allows for the recognition of the
intangible asset goodwill, which indicates a willingness to allow for valuation of assets that are
not traditional tangible assets, such as human resources. Thus, the movement toward fair value
accounting seen in recent years for both U.S. GAAP as well as for international standards indicates
a more sophisticated approach to the measurement of assets, tangible as well as intangible. This
might suggest a willingness to recognize the need for, and consider the measurement and use of
HRA in future external financial reporting.

Measurement Methods of Human Capital:

Cost Based Approach
Cost based approach is referred to as the acquisition model. Under this method organizational
investments in employees are reported using five parameter- recruiting, selecting, formal training,
familiarization, informal training, informal familiarization, experience and development. This
model implies that the costs should not be charged under the profit and loss accounts rather than
capitalized in the balance sheet. The process of giving a status of asset to the expenditure item is
called as capitalization. In case of human resources, it is necessary to amortize the capitalized
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amount over a period of time, so here one will take the age of the employee at the time of
recruitment and at the time of retirement. This method is the only method of human resource
accounting which is based on sound accounting principles and policies Oseni & Igbinosa, (2015).

Limitations:
i. The valuation method is based on false assumption that the naira is stable.
ii. Since the assets cannot be sold there is no independent check of valuation.
iii. This method measures only the costs to the organization but ignores completely any
measure of the value of the employee to the organization (Cascio, 1991).
iv. It is too tedious to gather the related information regarding the human values.

Replacement Cost approach:

This approach measures the cost of replacing an employee. Replacement cost include recruitment,
selection, compensation, and training cost (including the income foregone during the training
period). The data derived from this method could be useful in deciding whether to dismiss or
replace the staff.

Limitations:
i. Substitution of replacement cost method for historical cost method does little more than
update the valuation, at the expense of importing considerably more subjectivity into
the measure.
ii. This method may also lead to an upwardly biased estimate because an inefficient firm
may incur greater cost to replace an employee.

Present Value of Future Earnings:

This is the economic valuation of employees based on the present value of future earnings,

adjusted for the probability of employees’ death, separation, retirement. This method helps in

determining what an employee’s future contribution is worth today Oseni & Igbinosa, (2015).

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Limitations:
i. The measure is an objective one because it uses widely based statistics such as census
income return and mortality tables.
ii. The measure assigns more weight to averages than to the value of any specific group
or individual.

Importance of Human Capital Accounting

Human Capital Accounting provides useful information to the management, financial analysts and
employees as stated below-

i. Human Capital Accounting helps the management in Employment and utilization of

Human Capital.
ii. It helps in deciding transfers, promotion, training and retrenchment of human capital.
iii. It provides a basis for the planning of physical assets vis-a-vis human capital.
iv. It helps in evaluating the expenditure incurred for imparting further education and
training of employees in terms of the benefits derived by the firm.
v. It helps to identify the causes of high labor turnover at various levels and taking
preventive measures to contain it.
vi. It helps in locating the real cause for low return on investment, like improper or
underutilization of physical assets or human capital or both.
vii. It helps in understanding and assessing the inner strength of an organization and helps
the management to steer the company well through the most averse and unfavorable
circumstances.
viii. It provides valuable information for persons interested in making long term investments
in the firm.

Limitations of Human Capital Accounting

Human Capital Accounting is the accounting methods, systems, and techniques, which coupled
with special knowledge and ability, assist personnel management in the valuation of personnel in
their knowledge, ability and motivation in the same organization as well as from organization to
organization. Human capital accounting facilitates decision making about the personnel i.e. either
to keep or to dispense with their services or to provide mega-training.

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There are many limitations which make the management reluctant to introduce HCA. Some of the
limitations are-

i. There is no proper clear cut and specific procedure or guidelines for finding costs and
value of human resources of an organization. The systems which are being adopted
have certain drawbacks.
ii. The period of existence of Human Capital is uncertain and hence valuing them under
uncertainty in future seems to be unrealistic.
iii. As human capital are incapable of being owned, retained, and utilized, unlike the
physical assets, there is a problem for the management to treat them as assets in the
strict sense.
iv. There is a constant fear of opposition from the trade unions as placing a value on
employees would make them claim rewards and compensations based on such
valuations.
v. In spite of all its significance and necessity, the Tax Laws don’t recognize human
beings as assets.
vi. There is no universally accepted method of the valuation of Human Resources.

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Literature review:
Pew Tan, Plowman & Hancock, (2007) have undertaken a study titled-"Intellectual capital and
financial returns of companies". The objective of the paper was to investigate the association
between the firm’s financial performances and the intellectual capital of the firm. The paper used
the public framework of Asian country which pulled on data collected from 150 publicly listed
companies on Singapore exchange. It was an empirical study using partial least squares for
analyzing the data. Under this study four element of IC and company performance were tested.
Major limitation of the study was limiting the research within 150 listed companies of the
Singapore Exchange between the years 2000 to 2002. Findings of the paper are-

i. IC and company performance are positively related,

ii. IC is correlated to future company performance,
iii. The rate of growth of a company's IC is positively related to the company's performance,
iv. The contribution of IC to company performance differs by industry.

IC is a very popular sector to many parties like shareholders, institutional investors, policy makers
and managers. The findings of this paper can attract modern day managers to better harness and
manage IC. The study of IC has undergone a number of stages. First of all, the classification of IC
was determined through sensible awareness of effort. For research perspective appropriate
measure of IC is also important. This paper builds on the current research on IC and provides
empirical evidence on the relevance of IC to the financial performance of companies.

Namasivayam & Denizci, (2006) undertook another study titled- "Human capital in service
organizations: identifying value drivers". The objective of the paper was to draw attention to value‐
creating processes and their impacts on human capital valuation in high‐contact service industries.
The paper was developed on the basis of existing theoretical and empirical research in the field of
intellectual capital, organizational behavior, marketing and economics. Whole study was
conceptual and the approach adopted was analytical. For developing a human capital valuation
model in high contact service industry, this concept has been used. The article shows how to
analyze value addition and transfer in industries. It moves extant research further by outlining a
mechanism to identify relevant drivers of human capital with increased precision. The main
limitation of this paper was that it was conceptual. The article provides a novel conceptualization
of value drivers in industry. Findings of the study was providing a conceptual description of a

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value matrix that can be employed to identify more accurately value drivers of human capital in
various industries. Practical implication of the study is to identify human capital value drivers in
various industries, this paper can be a very useful tool. The value matrix can be helpful for group
industry which is based on these value characteristics making comparisons across and within
industry more readily available.

McGregor, Tweed & Pech, (2004) presented a paper titled- "Human capital in the new economy:
devil's bargain?". The enrichment of human capital and its role in the competitive advantage of
business has been discussed in relation to the changed nature and of the employment relationship.
In particular Drucker's concerns about the threat to business. The paper was also concerned about
relationships between workers and their organizations. Contextual factors such as the- dynamic
nature of labor markets and the centrality of profit making and the definitional difficulties have
been acknowledged. A transitional model of human capital in the new economy was suggested as
a way of modernizing consecutive thinking. The paper concludes that changed employment
relationships do not spell death to people enrichment. Rather it makes managing talent different
and more challenging.

Vidotto, et al. (2017) presented a paper titled- "A human capital measurement scale". Despite the
large number of academic evolution in human capital, there are few instruments to measure it. The
objective of this paper was to develop a holistic scale to measure human capital, considering
aspects related to competence, attitudes, skills, leadership, and organizational memory.
Methodology of the paper was at first reviewing the existing measurement models was carried out.
Second, based on the results the authors developed a scale and a questionnaire that were applied
in a financial institution in Santa Catarina, Brazil, supported by a factor experiment and a reliability
experiment. Findings of the paper was a scale consisting of 13 variables of human capital emerged
that have been grouped into three factors – leadership and motivation; qualifications; and
satisfaction and creativity – which can assist in the organization’s human capital measurement.
From a theoretical view, a more holistic scale was provided, which helped to overcome a unilateral
focus on knowledge (intangibles). This work pointed out that the survey data were collected from
a form of 220 relationship managers of a specific financial institution. The results should be tested
in other banks or organizations from other sectors to check their suitability and to be generalized.
From a practical point of view, it contributed a “tool” that can assist in the measurement of human

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capital and in the knowledge contained, dimensioning the organizational memory and human
repositories. This is the first study that provides a scale to measure organizational human capital
from the Brazilian financial perspective.

Sáenz, (2005) performed a study titled- "Human capital indicators, business performance and
market‐to‐book ratio". For many authors, the difference between the market value of companies'
shares and their book value is the consequence of intellectual capital (IC). To test this, this paper
suggested a methodology to study the relationship between IC indicators and the market‐to‐book
ratio (MBR). In addition, it presents an exploratory application of that methodology in the field of
human capital (HC) and within the Spanish banking industry. In this research, the relationships
between HC, MBR and other business performance indicators were measured. Methodology
mentioned creates a score for each of the three main IC components: human, structural and
relational capital. These scores try to measure the relative position of companies in the same
industry in each of the IC blocks. Then, a global score is set, combining the scores of the previous
blocks. For these calculations to be done, a common set of indicators in the companies studied is
needed. The lack of balance nowadays between showing strategy uniqueness and delivering
comparable information across firms, when preparing external IC reports, has limited the empirical
application of the proposed methodology to HC indicators. The value of this paper lies mainly in
the methodology it provides for external IC benchmarking

Preliminary results showed a clear positive relationship between HC indicators and MBR, and
almost a nonexistent one between HC indicators and banks' efficiency and financial return. In any
case, the highest correlations found were between, on the one hand, banks' efficiency and financial
return and, on the other hand, MBR.

Study undertaken by Ming Chen & Jun Lin, (2004) titled-"The role of human capital cost in
accounting" examined the relationship between human capital and accounting. Purpose of the
research was to deal with the human capital disclosure issue of present accounting systems. Many
companies nowadays derive their competitive advantages mainly from human capital. However,
under generally accepted accounting principles, all human‐related expenditures are treated as
expenses, which are deductions of revenues, thus misleading decision‐makers into inappropriate
judgments. From the paper it has provided an alternative way of measurement and disclosure of
human capital items in financial statements. The paper defined and classified the human capital of

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a company in line with a theoretical framework provided by the authors, sorts out company's
human capital investments according to cost development stages in human resources, isolates
human capital from expenses and finally suggests disclosure in financial statements.

Samudhram, Shanmugam & Low, (2008) presented a paper titled- "Valuing human resources: an
analytical framework". The purpose of this paper was to develop an analytical framework that
links the expenditures on human capital to the resulting long‐term benefits, and thus provide a
model for reporting human capital on balance sheets. The framework identifies different kinds of
accounting treatments for different kinds of human capital related expenses. In the study
expenditures related to human capital was sub-divides into four categories, based on the
expenditure‐long‐term benefits relationships, using a Cartesian axes‐based approach. This is the
first study that breaks down the human capital related expenditures into comprehensive categories
based on the expenditures‐benefits relationships such that positive and negative intangibles are
identified, and examines the financial accounting and strategic managerial accounting implications
of both kinds of intangibles. Findings of the paper showed that a sub‐class of expenditures occur
that are within the control of the organization and provide economic benefits over several periods.
As such, these expenditures can be capitalized. Furthermore, expenditures that do not provide
long‐term benefits or result in lower productivity also exist. These need to be addressed by the
management. Limiting factor of the model was that it required to be formally field‐tested. Real life
implication of the analytical framework was that it may be used in practice by managers for
analyzing the benefits of the different types expenditures on human capital. It can also be used by
researchers to analyses the benefits of the expenditures on different types of intellectual capital
and financial accounting standard setters to standardize the appropriate accounting treatments for
different types of human capital related expenditures.

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Conclusion:
After above discussion it is clear that the vital capital that exists in an organization is its human
capital. Organizations have failed to recognize the capital in the financial statements for a longer
period of time. Various literatures that has been undertaken presents the possibility of measuring
and utilizing the human resources in the financial statements in the long run which will lead to
capacity building and higher profitability for an organization. Identification and reporting the
human resource should be carefully evaluated and lots of studies are necessary to this promising
field as the previous papers have suggested. In the contemporary study it is clear that without
utilizing the methods and processes improvement policies it is impossible to have a clear business
process and work alignment with the organization and employee.

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References:

McGregor, J., Tweed, D., & Pech, R. (2004). Human capital in the new economy: devil's
bargain? Journal of Intellectual Capital, 5(1), 153-164.

Ming Chen, H., & Jun Lin, K. (2004). The role of human capital cost in accounting. Journal of
Intellectual capital, 5(1), 116-130.

Namasivayam, K., & Denizci, B. (2006). Human capital in service organizations: identifying value
drivers. Journal of Intellectual Capital, 7(3), 381-393.

Pew Tan, H., Plowman, D., & Hancock, P. (2007). Intellectual capital and financial returns of
companies. Journal of Intellectual capital, 8(1), 76-95.

Sáenz, J. (2005). Human capital indicators, business performance and market-to-book

ratio. Journal of Intellectual Capital, 6(3), 374-384.

Samudhram, A., Shanmugam, B., & Lock Teng Low, K. (2008). Valuing human resources: an
analytical framework. Journal of Intellectual Capital, 9(4), 655-667.

Vidotto, J. D. F., Ferenhof, H. A., Selig, P. M., & Bastos, R. C. (2017). A human capital
measurement scale. Journal of Intellectual Capital, 18(2), 316-329.

Oseni, A. I., & Igbinosa, P. E. (2015). Accounting for Human Capital: Is the Statement of Financial
Position Missing Something? Journal of educational policy and entrepreneurial research, 2(5),
108-114.

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