Meaning and Definition of HR Accounting
Human resource accounting is described as an accounting system that treats human resources as an asset and records all financial expenditures on them, such as wages, salaries, training, and so on, in the books of accounts. Human resources, like other physical assets, have a value that is documented in the books of accounts.
Human resource cost assessment, planning, and reporting assists the organisation in correctly recording its assets and is thus an important aspect of every business association. Any organization’s financial report is entirely dependent on the cost of labour employed by that organisation.
“Human resource accounting is the measuring of expenses and value of people for the organisation,” says Flamholtz.
“Human resource accounting is the assessment and quantification of human organisational inputs such as recruiting, training experience, and commitment,” according to Stephen Knauf.
According to the Committee of the American Accounting Association, “Human resource accounting is defined as “the process of identifying, measuring, and presenting data on human resources to interested parties.”
“Human resource accounting is an attempt to identify and report investments made in an organization’s human resource that are currently not accounted for in traditional accounting practise,” writes R. L. Woodruff.
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Objectives of HR Accounting
1) Human resource accounting is one of the most effective methods for determining an organization’s human resource expenditures and the actual worth of these resources. The HRA is the foundation for all choices about the people employed by a company.
2) It enables the organisation to create an expected budget for human resource expenses, such as acquisition costs, training costs, costs for expanding human assets, salaries and wages, and so on, well in advance.
3) To determine the worth of human resources, an organisation must adhere to particular rules and procedures established by the human resource department.
4) It assists the administration in determining if existing human resources are being used to their full potential, i.e., the workforce should be utilised to its full potential. There should be no labour exploitation in the company.
5) In the event that the value of the human assets working in an organisation is about to change, HRA notifies the authorities ahead of time so that suitable actions may be made to safeguard the organization’s most valuable human assets.
6) The HRA system assists any organization’s management in evaluating employees based on their performance and standards and providing appropriate incentives.
7) Once management obtains complete quantitative knowledge on the organization’s human assets, they begin to consider it in all of their choices. As the organisation becomes more aware of the economic implications of human resources, the management philosophy improves even more.
Process of HR Accounting
Step 1: HR Accounting Objectives: Every organisation must achieve a set of objectives. The foundation for determining the objectives of the human resource accounting system is these aims and organisational needs. The HRA system’s goals include a problem-free budgeting system that defines the cost of human resources and provides precise information about their worth to management for optimal use.
This data is gathered from many divisions inside the company. All departments involved with human resource management are responsible for clearly describing the responsibilities they perform, the numerous judgments they make, and the reason for these decisions. It becomes easier to establish the HRA system’s objectives after this information is provided by various departments inside the organisation.
Step 2: HRA Measurement Development: Human resource accounting measures can be done using one of two ways. The following are the details:
1) Management can choose one measuring technique or a combination of methodologies for the measurements, and
2) Monetary or non-monetary approaches can be used to determine the cost or value of human resources, or both.Any of these methods’ validity and consistency must be validated before they are implemented.
Step 3: Create an HR Accounting Database: The human resource accounting system is based on a number of criteria, including time management sheets, the cost of each person working for the company, and numerous psychological aspects. These variables make up the HRA system’s database.
In some cases, reorganising the whole organization’s accounting system to categorise human resources costs separately becomes necessary; otherwise, the costs will be classified under administration and general expenditures. This classification should be based on monetary factors including staffing, training, and development, among others.
In this method, the costs associated with the various tasks listed above may be determined independently, making the HRA’s operation considerably easier. Aside from looking after the monetary issues, the accounting department must also keep an eye on non-monetary components such as employee behaviour and assess the worth and character of employees in order to determine how helpful they may be to the organisation.
Step 4: System Pilot Testing: The next phase is the pilot testing of the accounting process when the preceding three steps have been completed in a systematic manner, i.e., the objectives have been established, dimensions have been designed, and a sufficient database for the HRA system has been established.
Pilot testing referred to the process of pre-testing a system before incorporating it into an organisation. The effectiveness of pilon testing depends on management’s coordination and collaboration throughout the procedure.
Step 5: Putting the Human Resource Accounting System into Practice: This is the final phase in the HRA process, in which the organisation exposes the new accounting system to the whole workforce and employees. Employees are educated on the importance of HRA and the many techniques for achieving it so that they are familiar with the notion and enthusiastically welcome it.
It should be stated plainly how this HRA would benefit them. Deserving applicants are assigned the responsibility of managing the HRA system. HRA may simply carry out any type of alteration by making a few tweaks and enhancements in the system. For the HRA system to run smoothly, periodic reviewing is necessary, as it will prepare the system to adapt to the changing needs of the organisation.
Methods of HR Accounting
A variety of strategies contribute to the human resource accounting system. These techniques may be divided into two groups.
1. Monetary Measurement Methods: Monetary measurement methods are used to determine the monetary worth of individuals as organisational resources. Employee performance, the number of promotions and transfers, worker productivity, and profits generated by an employee for the company are some of the ways in which an employee’s worth may be quantified in monetary terms.
2. Non-Monetary Measurement Approaches: These methods encompass those aspects of human resource that cannot be measured monetarily yet have a financial impact on the organisation. For example, employee behaviour, performance, attendance, growth, devotion, and capacity to achieve organisational goals are all factors to consider.
All of these characteristics are significant in determining the worth of personnel, and they can also be used to predict the monetary advantages that the company will get in the future.
Monetary Measurement Methods
1) Historical Cost Technique: The historical cost method was created by Brummet, Flamholtz, and Pyle. Historical cost refers to the costs incurred through time in the purchase and development of human resources, which are then integrated to determine the real cost of HR as an asset and estimate depreciated cost of human resources.
Human resources are regarded similarly to physical resources in this manner. When any component of a physical property expires, the value of that physical asset is lowered by the cost of that expired element. Similarly, every year, a portion of the worth of an employee is depreciated as an expenditure against the profits earned.
The costs of recruiting, training, development, promotion, and other HR activities are considered an investment in HR and are lowered every year until the person leaves the company.
2) Replacement Cost Approach: This method was developed by Rensis Likert and Eric G. Flamholtz to calculate the worth of workers working in an organisation by analysing the cost of replacing current employees with new employees.
If present employees are to be replaced by another suitable and competent person, management predetermines the expenditures expended using this strategy. Aside from that, the costs of recruiting, training, selection, and development are all calculated. It is based on the workers’ development expenditures rather than their past worth, unlike the historical cost method.
3) Opportunity Cost Strategy: Hekimian and Jones came up with this method after seeing various managerial workers’ willingness to hire a big number of individuals and bring their worth to the investment base.
Because it is founded on the opportunity un idea of economics, the opportunity cost method prioritises human resources. The opportunity cost and the scarcity of human resources are inextricably linked. There is no opportunity cost for excess personnel or top-level staff. The method of opportunity cost may not apply to all human resources.
4) Lev and Schwartz’s Capitalization of Salary Approach: This method was created in 1971 by Lev and Schwartz.The present value of the future earning model is also known as 11. According to them, there was a strong link between an employee’s wage and his or her value to the organisation.
This strategy is based on two assumptions: the first is that an employee’s future earnings may be used as a substitute for his current worth, and the second is that the person will stay with the company until he retires. The steps in this approach are as follows:
1) Employees are divided into groups based on their age, experience, and talents.
ii) After that, each group of employees’ annual income is determined, and
iii) Finally, the present value of each group over future income is calculated using the appropriate discount rate.
5) Economic Valuation Way: Another method for determining the cost of human treenkees operating in an organisation is the economic valuation method. Future revenues that can be earned by the employees in his service are calculated using this strategy.
This cost is deducted from the current cost of different functions such as recruiting, selection, training, and so on. The economic cost of the employees is calculated as a result of this computation.
6) Return on Investment Employed Method: The benefit or return of an organisation is entirely dependent on the work of its employees. The gains delivered by employees to the organisation in terms of profitability, productivity, and other factors are measured using this technique. Designation, experience, talents, and other characteristics are taken into account during this type of appraisal.
7) Method of Adjusted Discounted Future Wages: Hermanson proposed a technique in which an employee’s remuneration is adjusted to the worth of that individual inside the organisation.
An efficiency factor is used to the discounted future earnings to measure the relative efficacy of the organization’s human resources. The stages involved in determining the value of human resources using this technique are as follows:
i) First, over the next five years, all employees’ earnings and salaries at various hierarchical levels are determined.
ii) The present value of the wage and salary payments is then determined at the rate of return.
iii) The average efficiency ratio for a certain period is calculated. The time span is usually greater than five years.
iv) Finally, the present value of the organization’s human capital’s future services is computed. This is accomplished by multiplying the discount amount (step ii) by the efficiency ratio of the organisation (step iii).
The following formula may be used to compute the efficiency ratio:
Efficiency data = ACTUAL AVERAGE EARNINGS OF THE ORGANISATIONS / NORMAL EARNING OF ALL ORGANISATIONSIf Efficiency Ratio = 1: the organization’s average rate of return is the same as the economy’s rate of return. It signifies that the value of HR is the same as the value of the industry.
If Efficiency Ratio > 1: The profits of the company are higher than the average earnings of the company. This indicates that the human resource is worth more than the industry average.
If Efficiency Ratio < 1:The organization’s profit margin is lower than average. Human resource is worth less than the average in the industry.
8) Reward Valuation Method: Flamholtz introduced the reward valuation approach, which is an improved version of the salary capitalization method. This strategy takes into account the fact that an employee may leave his or her employment before retirement or death, and that his or her role may vary throughout his or her professional lifetime.
The expected realisable value of an employee, according to this method, is the sum of the present and actual value of the employee. The assumption underpinning this predicted realisable value is that there is no relationship between an employee’s overall cost and his value in the organisation at any given time.
The current value of the services that an employee can supply in the future throughout his employment in the organisation can be used to determine an employee’s worth.
Non-Monetary Measurement Methods
The following are examples of non-monetary measurement methods:
1) Skills Inventory: A skill inventory is a list of a person’s talents. It categorises employees based on their abilities. Employees’ behaviour and skills are the most straightforward ways to assess them.
Employees’ qualifications, training, experience, and other supplementary talents are used to evaluate these abilities. The estimate of how much longer their services can be optimally utilised is done based on their potentiality.
2) Performance Evaluation Methods: Human resources can also be evaluated based on their performance. The following are the two ways of performance evaluation that can be used:
i) Rating: In this method, a scale is used to evaluate a worker’s performance. Employees are rated based on their level of intelligence, professional knowledge and interpersonal skills, capacity to judge situations, and so on.
ii) Ranking: In this strategy, people are ranked according to one or more factors. Rankings are seen as a different type of rating. When an assessor is required to rate workers based on their leadership skills, for example, ranking can be done.
There are several different types of ranking procedures that can be used.
a) Simple Ranking: This is the most basic technique, in which the evaluator evaluates the employees based on specified parameters and ranks them from higher to lower. In the case of punctuality, for example, the person who is the most punctual is given the highest rank, while the person who is late the most is given the lowest rank.
b) Alternative Ranking: In this technique, the person with the highest value is chosen, and the person with the lowest value is chosen. For the rest of the people, the method is the same. As a result, the ranking mechanism is easy and trustworthy.
c) Paired Comparison: In this procedure, each employee is ranked after being compared to other employees. As a result, the best one may be easily distinguished from the others.
3) Potential Assessment: As the name implies, potential assessment is the examination of an organization’s human resource capability for the future. The trait approach is the most common method for evaluating potential.
This technique focuses on finding the attributes that workers possess that are essential for a specific job role, as well as determining the degree to which they are present in the workers. Because an individual’s development is determined by his potential, potential evaluation is crucial in determining the non-monetary value of human resources.
4) Attitude Assessment: An individual’s attitude is a reflection of their personality. Organizations that use attitude measuring techniques may readily grasp their employees’ perspectives, such as whether they are satisfied with their job, the working circumstances, whether they desire a raise in their compensation, or whether they are satisfied with the organisation as a whole, and so on.
These are some questions that can be simply answered by assessing the employees’ attitudes. Management can learn about the feelings of the employees who work for them by studying their attitudes. The questionnaire approach, in which numerous questions are presented and the employee responds from a list of answers, is one of the most prevalent ways to determine an employee’s perspective.For example, i) Excellent ii) Good (iii) Average iv) Below Average
5) Subjective Expected Utility: The term “subjective expected utility” refers to a combination of the terms “utility” and “subjectivity.” To begin, utility refers to the worth or usefulness of a resource to its user. Second, subjectivity refers to an individual’s personal viewpoint on the potential of any given event. Utility and subjective probability can be calculated using a variety of psychophysical approaches.
Paired comparison, ranking methods, and magnitude estimation are some of these methods. The magnitude estimation method deals with allocating numbers to represent the magnitude of an attribute. If a property is given a zero value, it means that it has no value, but if the number allocated is large, it means that the property has a lot of value.
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Importance of HR Accounting
HRA has become increasingly important in almost all organisations as time has passed. Its significance is explained below:
1) Facilitates Scheduling and Implementing HR Policies: An organization’s HR rules cover things like training, promotions, demotions, and transfers, among other things. Every organization’s seamless operation depends on the proper scheduling and implementation of these policies. An organization’s HRA system is in charge of this function.
2) Helps in Calculating ROI: HRA is an accounting system that records an organization’s human resource expenditures. An organisation may simply determine the actual Return on Investment (ROI) by computing the profits earned by the organisation once the investment has been computed.
3) Motivates Employees: When employees see their true worth in the eyes of the organization’s HRA system, they are driven to develop themselves. The amount of money spent on them will motivate them to boost their output in proportion to the amount of money spent on them by the company.
4) Sign of Good Health of the Organisation: HRA is a reliable indication of an organization’s health. The amount of money spent on a company’s human resources can be used to estimate how much money it will make in the future.
5) Improves Process of Decision-Making: HRA serves as a clearinghouse for data on the actual worth of human resources employed by a company. This information aids management in making informed decisions on organisational issues.
6) Helps in Determining the Need of Recruitment: HRA reports on the likelihood of obtaining returns and the amount of money that should be spent on the organization’s manpower. When profits are high, demand for new staff rises, and when profits are low, no additional recruitment takes place. The HRA’s information is totally used to make these decisions.
7) Ascertains Negative Effects of the Programmes: The HRA system also aids management in determining the negative effects of various programmes in operation.
Issues / Problems / Limitations of HR Accounting
HRA has a lot of benefits, but it also has some drawbacks.Some of them are as follows:
1. Non-Availability of Standards: The organization’s fundamental issue is the lack of appropriate standards for evaluating the cost of human resources. The Institute of Chartered Accountants of India (ICAI) must develop guidelines for determining the value of human capital.
2. Trade Union Resistance: Estimating the value of human resources may lead to labour unrest and pushback from union leaders. The biases of management when measuring the worth of human assets could be the source of this opposition. As a result, before implementing HRA in a company, all employees and management must be educated on the value of HRA and how it might benefit them.
3) Expensive: When implementing HRA in an organisation, the first thing to keep in mind is that it must be cost effective. This system is worthless if its adoption has a negative impact on the organization’s profits. As a result, the investment in this system should be prudent; otherwise, the organisation may pay additional costs.
4) Variety of Methods Create Confusion: There are a variety of ways that can be used to calculate the cost of human resources. This leads to misunderstandings, so management should use a specific method to assess HR costs in order to avoid any uncertainty.
5) If the human asset assessment is not done appropriately, the employees may be exploited. The HRA’s evaluation should be beneficial to the organisation, but not at the expense of employee impartiality.
6)Uncertainty about Continuance of Employees: Unlike machinery, it is unrealistic to expect employees to stay with a company for the rest of their lives. Employees may be forced to leave their jobs due to unforeseen circumstances. As a result, an employee’s stability in any organisation cannot be guaranteed. However, this uncertainty increases the number of vacancies in the organisation, making it difficult to estimate human resource accounting, which further disrupts the organization’s operations.
7) Lack of Perfect Knowledge about Future Receiving of HR: The future is unpredictably unpredictable and full of unknowns. Nobody knows whether or not a particular venture will be profitable. As a result, occasionally evaluating on a hypothetical basis causes a major challenge for the HRA system. As a result, one could argue that perfect knowledge of an organization’s future earnings is lacking.
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