Human Resource Accounting (HRA)

What is Human Resource Accounting or HRA?

Meaning

Human resource accounting is the process of identifying and measuring the value of the people within a company. This information is crucial for management to navigate changes in the quantity and quality of the workforce. It ensures a balance between the required resources and the available human capital.

HR Accounting is carried out by Human Resources professionals using various tools such as surveys, performance reviews, rewards & benefits, etc. They must also monitor the effectiveness of recruitment, and retention strategies as a part of HRA.

Definitions

Stephen Knauf

“Human Resource Accounting is the measurement & quantification of human organizational inputs such as recruiting, training, experience & commitment.”

 

Mr. Woodruff Jr. Vice President, R.G. Batty Corporation

“Human Resource Accounting is an attempt to identify & report investments made in human resources of an organization that is presently not accounted for in conventional accounting practice. Basically, it is an information system that tells the management what changes over time are occurring to the human resources of the business.”

 

American Association of Accountants

“Human Resource Accounting is a process of identifying & measuring data about human resources & communicating this information to interested parties.”

 

M.N. Baker

“Human resource accounting is the term applied by the accountancy profession to quantify the cost & value of employees to these employing organizations.”

 

A company’s most crucial assets are its people or human resources. The impact of these human assets and their expenses are dealt with by Human Resource Accounting. It delves into understanding and valuing the contributions these individuals make to the organization.

In simple language, HRA is like keeping a score of how much individual team members bring or contribute to the table.

For any organization to grow and succeed, it’s crucial to enhance the effectiveness of its people. Human resources play a key role in making other resources function well. The overall health of an organization is reflected in human behavior factors such as

  • Group loyalty
  • Skills
  • Motivation
  • Communication
  • Making decisions effectively.

All the above factors are contributing elements to human resource accounting.

What are the key objectives of Human Resource Accounting?

The key objective of Human Resource Accounting is to represent the value of human resources in financial terms, which is then reflected in the organization’s financial statements.

The above objective can be broken down into the following aspects:

Cost Information for Management Decisions

Providing cost information to aid effective management decisions related to acquiring, assigning, developing, and sustaining human resources.

Monitoring Human Resource Utilization

Effectively monitoring the management’s utilization of human resources.

Analysis of Human Asset Status

Analyzing the status of human assets – assessing whether they are preserved, depleted, or appreciated.

Development of Management Principles

Assisting in the development of management principles and informed decision-making for the future by categorizing the financial impact of various practices.

Valuation and Disclosure of Human Resources

Facilitating the valuation of human resources, including recording this valuation in the books of account and disclosing the information in financial statements.

Organization Decision-Making Assistance

Assisting the organization in decision-making processes, such as:

(a) Choosing between direct recruitment and promotion
(b) Deciding between employee transfers and retention
(c) Balancing considerations between retrenchment and retention
(d) Evaluating the impact on budgetary controls related to human relations and organizational behavior
(e) Making decisions about reallocating plants, closing existing units, developing overseas subsidiaries, and more.

What are the different methods used in HR Accounting?

Human Resource Accounting employs various methods to manage employee records in an organization. Here are the key eight methods explained:

Cost-Based Method

This method identifies and measures the cost of recruiting, training, developing, and maintaining employees, including the associated benefits.

Present Value of Future Earnings Method

This method values human resources based on their potential future earnings, considering skills, knowledge, and experience. It estimates the company’s future earnings based on employee capabilities.

Historical Cost Method

Historical cost considers the expenses incurred by the organization in recruiting, training, developing, and retaining human capital. It includes employee benefits and compensation.

Replacement Cost Method

The replacement cost is the expense of replacing an employee with a similar one, covering recruitment, training, and other benefits for the new hire.

Recruitment Cost Method

This method incorporates the expenses related to recruiting and selecting new employees. This includes advertising, travel, and HR staff time for reviewing resumes and conducting interviews.

Income-Based Method

Human resources are valued based on their contribution to the organization’s revenue and profits. This method assesses the generated revenue and cost savings resulting from employee work.

Market-Based Method

The cost of human resources is determined by comparing salaries, wages, and benefits with similar positions in other organizations.

Economic Value Method

Employees can generate profits through their skills, knowledge, and experience. The economic value method uses this idea as a contributing factor to the organization’s revenue.

Two common models of Human Resources Accounting

The methods of Human Resource Accounting or HRA are divided into two main branches: Cost-based models and Value-based models, each serving specific objectives. This section discusses both the models in brief.

AspectCost-Based ModelValue-Based Model
FocusQuantifies the expenses incurred for human resources.Assesses the economic worth based on future contributions.
EmphasisAcquisition and maintenance costs over a given period.Future services and potential contributions of employees.
Suitable IndustriesWidely applicable across industries.Particularly popular in the service industry.
PerspectivePast and present costs.Future-oriented, considering the employee’s potential.
ExampleRecruitment costs, and training expenses.Estimating an employee’s value based on future services.

Cost-based model

Cost-based models evaluate the money invested and expenses incurred for an organization’s human resources. Some of these models also measure the value of human capital by considering replacement or opportunity costs.

Notably, cost-based models, when determining the value of an individual or a position, consider both the initial acquisition cost and the ongoing maintenance cost over a specific period.

Example: Recruitment value with cost-based model:

When a company hires a new employee, it involves various expenses beyond the basic salary. The recruitment process incurs costs such as advertising, interviews, assessments, and training. Let’s break down the recruitment costs:

Advertising Cost: $5,000
This includes expenses related to job postings, online platforms, or any promotional activities to attract potential candidates.

Interview and Assessment Cost: $2,000
Encompasses expenses associated with conducting interviews, assessments, and any tools or resources used in the evaluation process.

Training Cost: $3,000
Represents the investment made in training the new employee to align with the company’s processes, culture, and specific job requirements.

Total Recruitment Cost: $10,000

Value-based model

Value-based models determine the economic worth of an employee by considering the potential future contributions they will make. These models are particularly popular in the service industry, where the employees play a central role, steering the organization’s future through their services.

Example: Economic Value of a Software Developer

If the developer is skilled in creating innovative software solutions, the value-based model would estimate the economic value by considering the

  • Revenue generated from future software projects.
  • Potential cost savings through increased efficiency.
  • Overall positive impact on the company’s growth.

What are the features of Human Resource Accounting?

For an HR Accounting strategy to run successfully, there are certain prerequisites or features it must have. Here’s a list:

  • Management Support: Essential support from all levels of management to facilitate the HRA process.
  • Resource Allocation: Adequate time, financial, and human resources are needed for data collection, criteria setting, and ongoing HR valuation.
  • Multi-functional Team: Involvement of a diverse team with various skills to navigate the complex process of measuring HR value.
  • Modern HR Team: Adoption of a contemporary HR team that embraces change and facilitates adaptation.
  • Awareness Campaigns: HR-led campaigns to raise awareness among employees about the valuation process, ensuring understanding and avoiding objectification.
  • Knowledge-Based Methodologies: Development and implementation of knowledge-based methodologies for effective measurement.
  • Strategic Relevance: Measurements designed to align closely with the strategic direction of the company.
  • Economic Consideration: Larger company sizes are favored due to the heavy costs involved; not as economical for small firms.
  • HR Information System: Implementation of a comprehensive Human Resources Information System containing all personnel data for proper administration.

What are the benefits of Human Resource Accounting?

The main benefit of human resources accounting is assessing the investments made by the company in its human assets. It makes planning future finances easier and more streamlined. Here are 10 key benefits of HRA:

  • Reveals Investment Insights: Enables the determination of the company’s investment in employees and expected returns.
  • Quantifies Labor Intensity: Computes the human-to-non-human capital ratio, effectively indicating the organization’s labor intensity.
  • Serves as Asset Planning Basis: Provides a solid foundation for planning physical assets in relation to human resources.
  • Informs Long-Term Investors: Offers valuable information for investors seeking long-term engagements in service sector companies.
  • Facilitates Returns Interpretation: Discloses the value of human resources, facilitating a clearer interpretation of return on capital employed.
  • Enhances Decision-Making: Improves managerial decision-making by providing informed insights from human resource accounting.
  • Identifies Valuable Assets: Recognizes human resources as valuable assets, preventing potential misuse by superiors and management.
  • Optimizes Resource Utilization: Facilitates efficient utilization of human resources and enhances understanding of the impact of labor unrest.
  • Boosts Productivity and Morale: Increases productivity by acknowledging human talent, devotion, and skills as valuable assets, thereby boosting employee morale.
  • Assists in Wage Administration: Provides valuable assistance to management in implementing the best methods of wages and salary administration.

What are the limitations involved in Human Resources -Accounting?

In India, Human Resource Accounting is still a fresh concept. Because of its restricted understanding, there are certain limitations involved with it:

  • Lack of Standardized Procedures: The absence of standardized procedures hinders widespread adoption in the country. Firms currently provide human resource accounting information only as additional data.
  • Uncertain Lifespan and Valuation Realism: The inability to estimate the lifespan of human resources makes valuation appear unrealistic. This includes relying on assumptions that may not hold true, such as the assumption that all workers stay with the same organization until retirement.
  • Legal and Cultural Challenges in India: In India, there is a fear of dehumanization and manipulation of employees through HRA. Example: concerns about employee discouragement, complex development, and potential opposition from trade unions seeking rewards and compensations based on valuation.
  • Lack of Consensus on Inclusion in Financial Statements: The question of how to include the value of human resources in financial statements lacks consensus within the accounting profession.
  • Tax Laws Do Not Recognize Human Beings as Assets: Despite the significance and necessity of HRA, tax laws in India do not recognize human beings as assets. This adds to the complexity of the financial treatment of human resources.
  • Opposition from Trade Unions: Constant fear of opposition from trade unions, as placing a value on employees may lead to claims for rewards and compensations based on such valuations.
  • Uncertain Period of Existence: The uncertain period of existence for human resources raises questions about valuing them under future uncertainty. This makes the process seem unrealistic.
  • Lack of Empirical Evidence Supporting HRA Efficacy: The absence of empirical evidence supporting the hypothesis that HRA facilitates effective management of human resources raises doubts about its practical utility in Indian contexts.
  • Absence of Universal Valuation Method: No universally accepted method of human asset valuation exists, leading to varied approaches and interpretations.
  • Underdeveloped State of HRA in India: As of now, human resources accounting is still in the development stage in India. It requires additional research for effective application and addressing practical challenges.

Summing Up

Human Resource Accounting (HRA) plays a crucial role in recognizing and quantifying the value of human capital within an organization. The objectives, methods, and models discussed shed light on the multifaceted nature of HRA.

Accounting for human resources is a relatively new field, having been in practice worldwide for over 50 years. Despite its global presence, the acceptance of human resources as a vital component in accounting requires the development of future research methodologies.

India, being a developing country with a labor-intensive economy, has traditionally followed standard accounting practices for many decades. However, the adoption of the new system of
Human Resource Accounting (HRA), is still in its early stages in India.

To address both the pros & cons of HRA, there is a need for additional research on valuation methods and models, along with practical implications. Active discussions among HR and accounting professionals are crucial for a more comprehensive understanding and effective application of HRA in practice.

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