HUMAN RESOURCE ACCOUNTING

The Non accounting of human resources and the change occurring therein, of an organization may provide a poor picture of the profits and profitability of the organization.

Objectives of the Study: This unit aims to provide a basis for the conceptual framework of Human Resource Accounting. An attempt is made to highlight the following aspects. Development of the Concept of HRA An Historical Score Card Meaning and Definition of HRA Importance Objectives of Human Resource Accounting Limitations of Human Resource Accounting HRA for managers & HR Professionals Investment in Human Resources Quality of Work Force and Organizations Efficient use of Human Resource Enumerating the Assets Calculating the Market Value of Assets Human Capital. Performance

Meaning and Definition of Human Resource Accounting: The American Accounting Society Committee on Human Resource Accounting defines it as follows: Human Resource Accounting is the process of identifying and measuring data about human resources and communicating this information to interested parties. In simple terms, it is an extension of the accounting principles of matching costs and revenues and of organizing data to communicate relevant information in financial terms. Objectives of Hunan Resources Accounting : The aim of HRA is to depict the potential of HR in monetary terms, while casting the organization's financial statements. The concept can be examined from two dimensions: (i) the investment in HR; and (ii) the value of HR. The expenditure incurred for recruiting, staffing and training and developing the HR quality is the investment in HR. The fruits of such investments are increased productivity and profit to the organization. The yield that the investment generates is considered as the basis for HR value. Putting in a capsule the main objectives of HRA are to Improve management by analyzing investment in HR Consider people as its asset Attract and retain qualified people Profile the organization in financial terms. The main objective of human resource accounting is to facilitate the management to get information on the cost and value of human resources. Human resources accounting brings to light the quantum of human resources and indicates the right control of conservation, depletion and appreciation of it in the right perspective. It provides data to the interested persons about the cost of human resources and correspondingly comparing it with the benefit obtained out of its utilization. The objective of HRA is not merely the recognition of the value of all resources used by the organization, but also includes the management of human resource which will enhance the quantity and quality of goods and services. The basic

objective of HRA is to facilitate the efficiency of human resource. It is basically adopted to treat human resources as assets, to generate human data about human resources, to assign value to human resources and to present human assets in the balance sheet. Importance of Human Resource Accounting: Human Resource Accounting provides useful information to the management, financial analysts and employees as stated below: 1. Human Resource Accounting helps the management in the Employment, locating and utilization of human resources. 2. It helps in deciding the transfers, promotion, training and retrenchment of human resources. 3. It provides a basis for planning of physical assets vis--vis human resources. 4. It assists in evaluating the expenditure incurred for imparting further education and training in employees in terms of the benefits derived by the firm. 5. It helps to identify the causes of high Labour turnover at various levels and taking preventive measures to contain it. 6. It helps in locating the real cause for low return on investment, like improper or under-utilization of physical assets or human resource or both. 7. It helps in understanding and assessing the inner strength of an organization and helps the management to steer the company well through most adverse and unfavourable circumstances. 8. It provides valuable information for persons interested in making long term investment in the firm. 9. It helps employees in improving their performance and bargaining power. It makes each of them to understand his contribution towards the betterment of the firm vis--vis the expenditure incurred by the firm on him.

Limitations of Human Resource Accounting: Human Resource Accounting is the term used to describe the accounting methods, system and techniques, which coupled with special knowledge and ability, assist personnel management in the valuation of personnel in financial terms. It presumes that there is great difference among the personnel in their knowledge, ability and motivation in the same organization as well as from organization to organization. It means that some become liability too instead of being human assets. HRA facilitates decision making about the personnel i.e., either to keep or dispense with their services or to provide training. There are many limitations which make the management reluctant to introduce HRA. Some of the attributes are: i) There is no proper clear-cut and specific procedure or guidelines for finding cost and value of human resources of an organization. The systems which are being adopted have certain drawbacks. ii) The period of existence of human resource is uncertain and hence valuing them under uncertainty in future seems to be unrealistic. iii) There is a fear that HRA may dehumanise and manipulate employees. iv) For e.g., an employee with a comparatively low value may feel discouraged and develop a complex which itself will affect his competency to work.

v) The much needed empirical evidence is yet to be found to support the hypothesis that HRA as a tool of the management facilitates better and effective management of human resources. vi) In what form and manner, their value to be included in the financial statement is the question yet to be classified on which there is no consensus in the accounting profession. vii) As human resources are not capable of being owned, retained and utilized, unlike the physical assets, there is problem for the management to treat them as assets in the strict sense. viii) There is constant fear of opposition from the trade unions as placing a value on employees would make them claim rewards and compensations based on such valuation.

ix) Another question is, on value being placed on human resources how should it be amortized. Is the rate of amortization to be decreasing, constant or increasing? Should it be the same or different for different categories of personnel? x) In spite of all its significance and necessity, tax laws do not recognize human beings as assets. xi) There is no universally accepted method of human asset valuation. xii) As far as our country is concerned human resource accounting is still at the developmental stage. Much additional research is necessary for its effective application. Cost of Human Resources: As human resource is considered as an asset, any expenditure incurred in the acquisition and accumulation of human resource will be treated as an investment. Cost of human resources represents sacrifice that will have to be incurred today to acquire and develop people in future. The cost of human resource otherwise called Historical cost of human resources is the investment in human resources which has both Revenue (expense) and Capital (asset) components. This cost may be classified as follows: 1. Acquisition Cost 2. Training (Development) Cost 3. Welfare Cost and The following paragraphs give a detailed enumeration of the various costs involved in the human resources accounting. l. Acquisition Cost: It refers to the costs incurred in acquiring the right man for the right job at the right time and in right quantity. It includes the expenses incurred on recruitment, selection; entire cost is taken into consideration including those who are not selected. a) Recruitment cost: It is the cost incurred to identify sources of human resources both from within and outside the organization. For example, cost of recruiting

materials, administrative expenses, advertising costs, agency fees, recruiter s salary and travel and outstation costs. b) Selection cost: It depends on several factors such as the type of personnel being recruited and the method of recruitment. The cost of selection depends on the position for which a person is being selected. The higher the position, the greater is the selection cost. It includes cost of application blanks, administrative cost of processing applications, conducting tests, interview, medical examination and the Salaries, materials and consulting fees of the selectors. c) Placement cost: In deciding upon the placement, the individual's ability, attitude, interest, temperament and aspirations are taken into consideration with reference to the job requirements. The cost of placement can be collected for the purpose of human resource accounting. 2. Training and Development Cost: It refers to the sacrifice that must be made to train a person either to provide the expected level of performance or to enrich the individual's skill. Training improves the productivity potential of both the individual and the organization. The training cost includes the following: a) Formal training cost: It refers to the cost incurred in conventional training for the orientation of an individual so that he can operate the work. The remuneration to the training staff and the fixed cost of the training schools are essentially Human Resource Investment items. b) On the job training cost: Once the employee is placed on the job, he must be trained to do the job efficiently and effectively and in this regard the employee learns while he is on his job. In the process, the costs of mishandling the job, the payments to the employee more than what he actually contributes are on the job training cost. Thus it is an Investment in Human Resource. c) Special training cost: To achieve the performance standards sometimes specific training programmes may be devised. Such training gets a distinct human resource to the organization. The costs of such training are called special training costs fall under the human resource investment of the organiz d) Development progrornmes cost: Employees may be allowed to participate in a variety of development programmes to enrich their faculties. These programmes may range from ordinary lectures to international conferences and seminars. The participants have an opportunity to interact with other executives on national and international level. Such association involves cost such as delegate fees, the travel cost, loss of output during the development programme etc. which are to be accounted for as a human resource investment.

3. Welfare Cost: Management is after all creation and maintenance of an environment. Therefore, it is a vital function of an employer to provide an atmosphere to the employees to perform their work in healthy, congenial climate conducive to good health and high morale. The expenses incurred for this purpose will facilitate the employee to increase the quality of his civic life. These welfare costs can be classified as follows: i) Welfare and amenities within the organization: Crches, rest shelters and canteens, latrines and urinals, washing and bathing facilities, drinking water and occupational safety etc. are the welfare facilities provided by the employer within the organization. ii) Welfare outside the organization: Social insurance measures, maternity benefit, medical facilities, education facilities, housing, recreational facilities, holiday homes and leave travel facilities are some of the welfare measures provided outside the establishment. Efficient use of Human Resource: The Human Resources of an organization represent one of its largest investments. The term human resources at the macro level indicate the sum of all the components (like skill, creative ability) possessed by all the people. Human resources at the organizational level include all the component resources of all employees from rank and file to top level management. So, it includes the resource, of all people who contribute their services to the attainment of organizational goals. Human resources play a crucial role in the development process of the present economy. It is often felt that though the exploitation of natural resources, availability of physical and financial resources and international aid play prominent roles in the growth of modern economies, none of these factors is more significant than efficient and committed manpower. The following actions will be more fruitful to improve the use human resources: a. Conduct a productivity drive. b. Improve manpower budgeting and control techniques. c. Introduce work measurement. d. Use appropriate payment method by results, bonus and profit-sharing schemes. e. Improve motivation. f. Involve employees in improvement programmes. g. Introduce new technology.

h. Negotiate appropriate productivity programme. i. Introduce training programme based on an analysis of productivity needs. The efficient use of human resources could be successfully planned only when the employees are made to understand the objectives of the organization, plan to develop their own career in the organization which will make them more confident and involve them together as a quality workforce. The efficient use of human resources must result in: - High productivity; - Development of skill and organizational commitment; - Career development; Top management has to ensure that it is not sufficient to merely design the "technological sub-system" which includes work flow, information flow, job roles, job relationships, task force policies, procedures and job feedback. They must also consider "human sub-system" which includes organizational climate, level of motivation, high commitment participation, co-operation, satisfaction with work environment, willingness to accept change, work group factors, human resource development and satisfaction with compensation, company policies and procedures. Valuation of Human Assets : Valuation of human assets are the most important aspect of human resource accounting. A recent trend in today s corporate world is to measure the value of intangible assets of the companies such as goodwill {valuation of goodwill is quite old}, brands, patents, and now human assets. Consultants in HRM emphasize the need for valuation for human assets. Methods of valuation of human assets: There are a number of methods suggested for the valuation of human assets. Many of these methods are based on the valuation of physical and financial assets while others take into account human consideration. Major methods of valuation of human asserts are historical cost, replacement cost, standard cost present value of future earnings and expected realizable value.

The major developments in HRA were started only during l96o's by some of the organizations in USA. Of course, the first attempt to value the human being in monetary terms was made by William Potty who opined that labour was the father of wealth and it must be taken into account while making an estimate of wealth. On scanning through literature, the approaches to HRA can be broadly classified as follows: i) Historical Cost ii) Replacement Cost iii) Opportunity Cost iv) Standard Cost i) Historical cost approach: Brumnet, Flamholtz and Pyle have developed this method. It is on the basis of actual cost incurred on human resources. Such a cost may be of two types- acquisition cost and learning cost. Acquisition cost is the expense incurred on recruitment, selection; entire cost is taken into consideration including those who are not selected. Learning cost involves expenses incurred on training and development. This method is very simple in its application but it does not reflect the true value of human assets. For example, an experienced employee may not require much training and therefore, his value may appear to be low though his real value is much more than what is suggested by historical cost method. Under this approach actual cost incurred towards recruitment, hiring, training and developing human resources of the organization are capitalized and amortized over the future expected useful life of the human resources. Certain part of costs will be written off in proportion to the income of the future years which those human resources will provide service. When these human assets are prematurely liquidated, the amount not written off is charged to income of the year in which such liquidation takes place. When the useful life of the human resource is considered to be longer than originally expected, revisions are to be effected in the amortization schedule. The historical cost of human resource is almost similar to the book value of the other physical assets. The additional costs incurred in training and developing is capitalized and is amortized over the remaining working life of the employee. The unexpired value is investment in human assets.

ADVANTAGES 1. Simple to understand and easily worked out. 2. Cost is related to revenue 3. It enables to provide a basis for evaluating the company s returns on its investment in human resources. DISADVANTAGES 1. It takes into account only acquisition costs and does not take into account his potentiality. 2. It is not clear when or up to how many years the amount should be amortized 3. Amount to be amortized is not fixed. 4. Capital cost decreases with amortization. ii) Replacement cost: Rensis Likert & Eric G.Flamholtz propounded it. This is a measure of cost to replace a firm s existing human resources. Human Resources are to be valued on the assumption that a new similar organization has to be created from scratch and the cost to the firm is calculated if the existing resources were required to be replaced with other persons of equivalent talents and experience. It takes into account all costs involved in recruiting, hiring, training and developing the replacement to the present level of efficiency. As against historical cost methods which take into account the actual cost incurred on employees, replacement cost takes into account the notional cost that may be required to acquire a new employee to replace the present one. Replacement cost is generally much higher than the historical cost. For example, Friedman has estimated that the replacement cost of an executive in middle management level is about 1.5 to 2 times the current salary paid in that position. Replacement cost is much better indicator of value of human assets though it may present certain operational problems. For example, true replacement of a person may not be found easily with whose cost the valuation is done. This approach is more realistic as it incorporates the current value of the organization s human assets in its financial statements prepared at the end of the

year. Costs incurred by an organization in replacing a terminated employee are defined as replacement cost like the following a) Communication of job ability b) Pre-employment administrative functions c) Interviews d) Testing e) Staff Meetings f) Travel Cost g) Employment Medical Examination LIMITATIONS 1. There may be no similar replacement for certain existing assets. 2. The replacement value is affected by subjective considerations and therefore the value is likely to differ from one another. 3. It is against conventional accounting practice. c) Opportunity cost method: Heckiman and Jones first advocated this approach. This is also known as Market Value Method. This method of measuring the value of human resources is based on the economist s concept of opportunity cost . Opportunity cost is the value of an asset when there is an alternative opportunity of using it. In this method there is no opportunity cost for those employees who are not scarce. As such only scarce people should form part of the value of human resources. The employee is considered as scarce only when the employment in one division of an individual or group denies this kind of talent to another division. Thus the opportunity cost of an employee in one department is calculated on the basis of offer made by another department for the employees working in this department in the same organization.

LIMITATIONS 1. The total valuation of human resource on the competitive bid price may be misleading and inaccurate. A person may be a valuable person for the department in which he is working and may have a lower price in the bid by other departments. 2. Only scare employees are included in this method and as a result unscare employees may lose their morale, as they are not counted. 3. It would be difficult to identify the alternative use of an employee in the organization. iv) Standard cost Method: David Watson has suggested this approach. Instead of using historical or replacement cost, many companies use standard cost for the valuation of human assets just as it is used for physical and financial assets. For using standard cost, employees of an organization are categorized into different groups based on their hierarchical positions. Standard cost is fixed for each category of employees and their value is calculated. This method is simple but does not take into account differences in employees put in the same group. In many cases, these differences may be quite vital. According to this approach, standard costs of recruiting, hiring, training and developing per grade of employees are determined year after year. The standard cost so arrived at for all human beings employed in the organization are the value of human resources for accounting purposes. The approach is easy to explain and can work as a suitable basis for control purposes through the technique of variance analysis. However, determination of the standard cost for each grade of employee is a ticklish issue.

HR AUDIT
DEFINITION: Human Resource Audit is a systematic assessment of the strengths, limitations, and developmental needs of its existing human resources in the context of organizational performance . Human Resources Audit is intended to evaluate the efficiency and effectiveness of your HR management function. It will provide important feedback whether the HR function is contributing to the achievement of your organization's business objectives Senior management needs this information in order to make strategic decisions to improve productivity. You can use this feedback to take corrective actions and make decisions on improvement plan. Among various purposes, you can use the Human Resources Audit information:
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To evaluate whether performance of your HR function is as expected To improve contribution of the HR function to the achievement of your business objectives To comply with the country's laws and organizational policies and procedures To develop the professionalism of your HR people To facilitate better hr planning.

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It is clear that this involves examining your current HR policies, practices and strategies and to verify their effectiveness in helping your organization improve its productivity and profitability.

NEED FOR H.R. AUDIT: Top Management saw solutions to their problems, issues and challenges in HRD to face business competition and to achieve organizational goals. PURPOSE OF H.R. AUDIT: 1. To examine and pinpoint strength and weaknesses related to H.R. areas and Skills and Competencies to enable an organization to achieve its long-term and short-term goals. 2. To increase the effectiveness of the design and implementation of human resource policies, planning and programs. 3. To help human resource planners develop and update employment and program plans. SCOPE OF HUMAN RESOURCE AUDIT: Whenever the H.R. Audit it taken up, the scope is decided. Audit need not be exhaustive, but should be focused on particular function of H.R.M. such as Training and Development, Performance Appraisal, Compensation, etc.. However, the objective and approach of H.R. Audit, more or less, remains the same, regardless of scope. APPROACH TO H.R. AUDIT: 1. Self directed surveys. 2. Task Forces within the organisation. 3. Out side Consultants.

AUDITING PROCESS: STEPS IN H.R. AUDIT: Auditing process varies from organizations to organizations. Generally involves following STEPS: STEP ONE: Briefing and Orientation: Key Staff Members meet:

i. To discuss particular issues considered to be important. ii. To chart out audit procedures, and iii. To develop plans and program of audit. STEP TWO: Scanning material information: Scrutiny of all available information pertaining to personnel, personnel handbooks and manuals, guides, appraisal forms, computer capabilities and any other related information. STEP THREE: Surveying employees: a. Interview with key managers, functional executives, Top functionaries in the organisation and employees Representatives, if necessary. b. The purpose is to pinpoint issues of concern, Present strengths, anticipated needs and managerial views on human resources.

STEP FOUR: Conducting interviews: I. What questions to be asked, are developed during scanning of information. II. It is better for H.R. Audit, if clarity about the key factors of H.R.M. selected for audit and the related questions that need to be examined. STEP FIVE: Synthesising: The data gathered is synthesized to present the a. Current Situation. b. Priorities. c. Staff pattern, and d. Issues identified.

STEP SIX; Reporting: 1. The results of the audit are discussed with Managers and Staff Specialists, in several rounds. 2. Important issues are identified for inclusion in the formal Report. The HR Audit Process: The general process of conducting an audit includes seven key steps, each of which is discussed in greater detail below: 1. Determine the scope and type of audit. 2. Develop the audit questionnaire. 3. Collect the data. 4. Benchmark the findings. 5. 6. 7. Provide feedback about the results. Create action plans. Foster a climate of continuous improvement.

Determine the scope and type of the audit To uncover the needed information, it is important to determine exactly what areas should be targeted for review. If the organization has never audited its HR function, or if there have been recent significant organizational or legal changes, the audit team may want to conduct a comprehensive review of all HR practice areas. On the other hand, if concerns are limited to the adequacy of a specific process or policy, the audit focus should be limited to a review of that particular area. Develop the audit questionnaire

Whether conducting a comprehensive audit or an audit of a specific practice, it is important to invest sufficient time in developing a comprehensive document that elicits information on all the subjects of the inquiry. A list of specific questions must be developed to ensure that the questionnaire is complete. Collect the data The next phase includes the actual process of reviewing specific areas to collect the data about the company and its HR practices. Audit team members will use the audit questionnaire as a roadmap to review the specific areas identified within the scope of the audit. Benchmark the findings To fully assess the audit findings, they must be compared with HR benchmarks. This comparison will offer insight into how the audit results compare against other similarly sized firms. Typical information that might be internally benchmarked includes the companys ratio of total employees to HR professionals, general and administrative costs, cost per new employees hired, etc. Benchmarking might include the number of days to fill a position, average cost of annual employee benefits, absenteeism rates, etc. Provide feedback about the results At the conclusion of the audit process, the audit team must summarize the data and provide feedback to the companys HR professionals and senior management team in the form of findings and recommendations. Findings typically are reduced to a written report with recommendations prioritized based on the risk level assigned to each item (e.g., high, medium and low). From this final analysis, a roadmap for action can be developed that will help determine the order in which to address the issues raised. In addition to a formal report, it is critically important to discuss the results of the audit with employees in the HR department, as well as the senior management team, so everyone is aware of necessary changes and approvals can be obtained quickly. Create action plans It is critical actually to do something with the information identified as a result of an audit. The company must create action plans for implementing the changes suggested by the audit, with the findings separated by order of importance: high,

medium and low. It actually increases legal risk to conduct an audit and then fail to act on the results. Foster a climate of continuous improvement At the conclusion of the audit, it is important to engage in constant observation and continuous improvement of the companys policies, procedures and practices so that the organization never ceases to keep improving. This will ensure that the company achieves and retains its competitive advantage. On way to do this is to continuously monitor HR systems to ensure that they are up-to-date and to have follow-up mechanisms built into every one of them. Likewise, it is important to keep track of the audit findings/changes made, turnover, complaints filed, hotline issues, employee survey results, etc. to identify trends in the companys employment-related issues. Identifying problematic issues, growth areas or declining problem spots can help in the decision of where to allocate time, money and preventive training resources in the future. Conclusion: The accounting of human resources can be seen as just as much a question of philosophy as of technique. This is one of the reasons behind the variety of approaches and is further underlined by the broad range of purposes for which accounting human resources can be used, e.g. as an information tool for internal and/or external use (employees, customers, investors, etc.), and as a decisionmaking tool for human resource management (investments in human resources as well as personnel management in gene). HR Audit is very much helpful to face the challenges and to increase the potentiality of the HR personnel in the organization.