HUMAN RESOURCES ACCOUNTING

What is Human Resource Accounting?

• Human Resource Accounting is the process of identifying and

measuring data about Human Resources and communicating this
information to the interested parties.
• It is an attempt to identify and report the Investments made in Human
Resources of an organization that are currently not accounted for in
the Conventional Accounting Practices.
• Thus, Human Resource Accounting is a term applied by the
Accountancy Profession to quantify the cost and value of employees
of their employing organization
 Objective of Human Resource Accounting
The Aim of HR Accounting is to depict the Potential of the Employees in
Monetary Terms. This concept can be examined from 2 directions i.e.

• Cost of Human Resources i.e. the expenditure incurred for recruiting,

staffing and training the Quality of the Employees and
• Value of Human Resources i.e. the yield which the above investment
can yield in the future.
 Importance of Human Resource Accounting

 The 21st Century has been referred to as the Century of the

Service Sector. All major expansion scope seems to be
happening in the service sector and the scope of expansion of
the manufacturing sector is minimal.
 Butare the Accountants properly able to value this Service
Sector and show this on the Company’s Balance Sheet?
 To be continued…………………
 For any Company operating in the Manufacturing Sector, its core
assets are its Machinery and Fixed Assets but for a Company
operating in the Service Sector, its core assets are its employees
which are Intangible Assets. For a Service Sector Company, the
value of employees gains importance as earnings are based on the
per-employee per hour billing model and profitability is linked to the
value added by the workforce.
 The Concept of Human Resource Accounting was established
primarily for the service sector has now started gaining so much
relevance that now Companies in all Sectors have applying HR
Accounting and a good weightage is given to these reports when
making any Company Analysis.
 Benefits of Human Resource Accounting

The main benefits of Human Resource Accounting are:-

• HR Accounting helps the company ascertain how much Investment it
has made on its Employees and how much return it can expect from
this Investment
• The Ratio of Human Capital to Non-Human Capital computed as per
the HR Accounting Concept indicates the degree of Labour Intensity
of an Organisation.
• HR Accounting provides a basis for planning of physical assets vis-a-
vis Human Resources
• HR Accounting provides valuable information to Investors interested
in making Long Term Investments in Service Sector Companies
 Methods of Human Resource Accounting

A. Cost Based Models

I. Capitalisation of Historical Costs Model
II. Replacement Costs Model
III. Opportunity Cost Model
B. Value Based Models
I. Present Value of Future Earnings Model/ Lev and Schwartz
Model
II. Reward Valuation Model/ Flamholtz Model
 COST BASED MODELS
I. Capitalisation of Historical Costs
 As per this Method of HR Accounting, the sum of all costs related to
Human Resources (i.e. Recruitment, Acquisition, Formal Training,
Informal Training, Informal Familiarisation, experience and
development) is taken together to represent the value of the human
resources.
 The value is amortised annually over the expected length of the
service of individual employees and the unamortised cost is shown as
Investments in the Human Assets.
 If an employee leaves the firm (i.e. Human Assets expire) before the
expected service life period, then the net value to that extent is
charged to the Current Revenue.
Limitations:
This Model of HR Accounting is simple and easy to understand and
satisfies the basic principles of matching the costs and revenues.
• As the historical costs are sunk costs and are irrelevant for
decision making, this model was severely criticised as it failed to
provide a reasonable value to the human resources.
• This method of HR Accounting capitalises only the Training and
Development Costs incurred on the employees and ignores the
future expected costs to be incurred for their maintenance.
• This Model of HR Accounting distorts the value of the highly
skilled human resources as such employees require less training
and therefore, according to this model, they will be valued
at a lesser cost.
 II. Replacement Costs
• The Historical Cost Method was highly criticised as it only takes
into account the Sunk Costs which are irrelevant for Decision
Making. Thus, a new model for Human Resource Accounting was
conceptualised which took into the account, the costs that would
be incurred to replace its existing human resources by an
identical one.
• IndividualReplacement Costs – which refers to the cost that
would have to be incurred to replace an individual by a substitute
who can provide the same set of services as that of the individual
being replaced
TO BE CONTINUED…………..

• PositionalReplacement Costs – which refers to the cost of

replacing the set of services referred by an incumbent in a
defined position
Thus, the Positional Replacement Cost takes into account the
position in the organisation currently held by the employee and also
the future positions expected to be held by him.
 LIMITATIONS:

• As per this method of HR Accounting, the determination of

replacement cost of an employee is highly subjective and often
impossible. Particularly at the management cadre, finding out an
exact replacement is very difficult. The exit of a top management
person may substantially change the human assets value.
 III. Opportunity Cost Model
 This model was advocated by Hekimian and Jones in the year
1967 and is also known as the Market Value Method.
 This method of measuring Human Resources under this Model is
based on the concept of opportunity cost i.e. the value of an
employee in its alternative best use, as a basis of estimating the
value of human resources.
 The opportunity cost value may be established by competitive
bidding within the firm, so that in effect, managers bid for any
scarce employee.
 A human asset therefore, will have a value only if it is a scarce
resource, that is, when its employment in one division denies it
to another division.
 LIMITATIONS:

• One of the serious limitations of this method for Human Resource

Accounting is that it excludes employees of the type which can be
hired readily from outside the firm. Thus, this approach seems to
be concerned with only one section of a firm’s human resources,
having special skills within the firm or in the labour market.
 VALUE BASED MODELS
I.Present Value of Future Earnings Model

 This Model of human resource accounting was developed by Lev

and Schwartz in the year 1971 and involves determining the
value of human resources as per the present value of estimated
future earnings discounted by the rate of return on Investment
(Cost of Capital).
 LIMITATIONS:

• This Model of HR Accounting ignores the possibility and

probability that an Individual may leave an organisation for
reasons other than Death or Retirement. This Model of HR
Accounting also ignores the probability that people may make role
changes during their careers. For example, an Assistant Engineer
will not remain in the same position throughout the expected
service life in the Organisation. Despite the above limitations, this
model is the most commonly used model across the Globe for the
purpose of Human Resource Accounting.
 II. REWARD VALUATION MODEL

 Flamholtz advocated that an Individual’s Value to an organisation

is determined by the services he is expected to render.
 This model of Human Resource Accounting is an improvement
to the “Present Value of Future Earnings Model” as it takes into
account the probability that an individual is expected to move
through a set of mutually exclusive organisational roles or
service states during a time interval. Such movement can be
estimated probabilistically by using the following model
 LIMITATIONS:

• The major drawback of this model of Human Resource

Accounting is that it is difficult to estimate the probabilities of
likely service states of each employee. Determining the monetary
equivalent of service states is also very difficult and costly affair.
Since the analysis is restricted to Individuals, it ignores the value
added element of Individuals working as groups.
 HUMAN RESOURCE ACCOUNTING IN INDIA
• Legally HR accounting is not required but in view of the growing
importance of human resource accounting, many corporate
enterprises in India are voluntarily giving information about their
human resources.
• Bharat Heavy Electricals Ltd (BHEL) and el Authority of India
Ltd (SAIL) initiated HRA in 1974-75.
• Unfortunately, at that time HRA concept was not used widely. It
gained momentum in 1990 and at present companies using HRA
number about 15 in all and include many important public sector
enterprises viz.
 TO BE CONTINUED……………….

• Bharat Heavy Electricals Ltd. (BHEL), Steel Authority of India (SAIL),

Minerals and Metal Trading Corporation of India (MMTC), National
Thermal Power Corporation (NTPC), Oil and Natural Gas Corporation
(ONGC). Among all these enterprises the BHEL is the pioneer in the field of
human resource accounting since mid-1970.
• The model involves valuation of human resources on the basis of the present
value of the estimated future earnings of the employees discounted at the cost
of capital rate.
• BHEL has incorporated certain improvements in this model. The company
has classified its employees into six categories based on skill, type of work,
experience and qualifications.
 References

https://www.charteredcluSb.com/what-is-human-resource-accounting/
BOOKS FOR REFERENCE:
ACCOUNTING FOR MANAGEMENT –S N MAHESHWARI, SUNEEL K
MAHESHWARI, SHARAD K MAHESHWARI