November 12, 2012

MU0010 [Manpower Planning and Resourcing] Set1 Q3

Q.3 What is the cost approach of HR ACCOUNTING?


HRA is the art of valuing, recording and presenting systematically the work of human resources in the books of accounts of an organisation. Thus, it is primarily an information system, which informs the management about the changes that are taking place in the human resource of an organisation.

“Human Resource Accounting is the process of identifying and measuring data about human resources and communicating this information to interested parties.”
                                        - American Accounting Society Committee on HRA

“Human Resource Accounting is an attempt to identify and report investments made in human resources of an organisation that are 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 resource in the business.”
-     Woodruff

“A term used to describe a variety of proposals that seek to report and emphasize the importance of human resources – knowledgeable, trained and loyal employees in a company earning process and total assets.”
  - Davidson and Roman L Weel

“Human resource accounting is the measurement of the cost and value of the people for the organisation.”
                          - Eric Flamholtz of university of California, Los Angeles

Objectives of HR Accounting
The objective of HRA is not merely the recognition of the value of all resources used by the organisation, but it also includes the management of human resource which will ultimately enhance the quantity and quality of goods and services. 

The main objectives of HR Accounting system are as follows:
1. To furnish cost value information for making proper and effective management decisions about acquiring, allocating, developing and maintaining human resources in order to achieve cost effective organisational objectives.
2. To monitor effectively the use of human resources by the management. 
3. To have an analysis of the human assets i.e. whether such assets are conserved, depleted or appreciated.
4. To aid in the development of management principles. and proper decision making for the future by classifying financial  consequences of various practices.
5. In all, it facilitates valuation of human resources recording the valuation in the books of account and disclosure of the information in the financial statement.
6. It helps the organisation in decision making in the following areas: 

Direct Recruitment vs. promotion, transfer vs. retention, retrenchment vs. retention, impact on budgetary controls of human relations and organisational behaviour, decision on reallocation of plants closing down existing units and developing overseas subsidiaries etc.

Advantages of HR Accounting
Human Resource Planning anticipates not only the required kind and number of employees but also determines the action plan. 

The major benefits of HR accounting are:
a)     It checks the corporate plan of the organisation. The corporate plan aiming for expansion, diversification, changes in technological growth etc. has to be worked out with the availability of human resources for such placements or key positions. If such manpower is not likely to be available, HR accounting suggests modification of the entire corporate plan.
b)      It offsets uncertainty and change, as it enables the organisation to have the right person for the right job at the right time and place.
c)         It provides scope for advancement and development of employees by effective training and development.
d)         It helps individual employee to aspire for promotion and better benefits.
e)         It aims to see that the human involvement in the organisation is not wasted and brings high returns to the organisation.
f)           it helps to take steps to improve employee contribution in the form of increased  productivity.
g)         It provides different methods of testing to be used, interview techniques to be adopted in the selection process based on the level of skill, qualifications and experience of future human resources.
h)        It can foresee the change in value, aptitude and attitude of human resources and accordingly change the techniques of interpersonal management

Methods of valuation of human resource management
1.  Historical Cost Approach – This approach was developed by William C. Pyle (and assisted by R. Lee Brummet & Eric G. Flamholtz) and R.G. Barry corporation, a leisure footwear manufacturer based on Columbus, Ohio (USA) in 1967. In this approach, actual cost incurred on recruiting, hiring, training and development the human resources of the organisation are capitalised and amortised over the expected useful life of the human resources. Thus a proper recording of the expenditure made on hiring, selecting, training and developing the employees is maintained and a proportion of it is written off to the income of the next few years during which human resources will provide service.

If the human assets are liquidated prematurely the whole of the amount not written off is charged to the income of the year in which such liquidation takes place. If the useful life is recongnised to be longer than originally expected, revisions are effected in the amortisation schedule. The historical cost of human resources is very similar to the book value of the other physical assets. When an employee is recruited by a firm, he is employed with the obvious expectation that the returns from him will far exceed the cost involved in selecting, developing and training in the same manner as the value of fixed assets is increased by making additions to them. Such additional costs incurred in training and developing is also capitalised and are amortised over the remaining life. The unexpired value is investment in human assets.

This method is simple to understand and easy to work out. It meets the traditional   accounting concept of matching cost with revenue. It can provide a basis of evaluating a company’s return on its investment in human resources.
But it suffers from the following limitations:
It takes into account a part of the employees acquisition costs and thus ignores the aggregate value of their potential services.
It is difficult to estimate the number of years over which the capitalised expenditure is to be amortised.
It is difficult to determine the rate of amortisation. Should it be increasing, constant or decreasing one?
The economic value of human resources increases over time as the people gain experience. But in this approach, the capital cost decreases through amortisation.

2. Replacement Cost Approach – This approach was first suggested by Rensis Likert, and was developed by Eric G. Flamholtz on the basis of concept of replacement cost. Human resources of an organisation are to be valued on the assumption that a new similar organisation has to be created from scratch and what would be the cost to the firm if the existing resources were required to be replaced with other persons of equivalent talents and experience. It takes into consideration all cost involved in recruiting, hiring, training and developing the replacement to the present level of proficiency and familiarity with the organisation.

This approach is more realistic as it incorporates the current value of company’s human resources in its financial statements prepared at the end of the year. It is more representative and logical. But it suffers from the following limitations:
a)       This method is at variance with the conventional accounting practice of valuing assets.
b)      There may be no similar replacement for a similar certain existing asset. It is really difficult to find identical replacement of the       existing human resource in actual practice.
c)       The determination of a replacement value is affected by the subjective considerations to a marked extent and therefore, the           value is likely to differ from man to man.

3. Opportunity Cost – This method was first advocated by Hc Kiman and Jones for a company with several divisional heads bidding for the services of various people they need among themselves and then include the bid price in the investment cost. Opportunity cost is the value of an asset when there is an alternative use of it. There is no opportunity cost for those employees that are not scarce and also those at the top will not be available for auction. As such, only scarce people should comprise the value of human resources.

This method can work for some of the people at shop floor and middle order management. Moreover, the authors of this approach believe that a bidding process such as this is a promising approach towards more optional allocation or personnel and a quantitative base for planning, evaluating and developing human assets of the firm. But this approach suffers from the following limitations:

a)       It has specifically excluded from its preview the employees scarce or not being ‘bid’ by the other departments. This is likely to result in lowering the morale and productivity of the employees who are not covered by the competitive process.
b)      The total valuation of human resources on the competitive bid price may be misleading or inaccurate. It may be due to the reason that a person may be an expert for one department and not so for the other department. He may be valuable person for the department in which he is working and thus command a high value but may have a lower price in the bid by the other department.
c)       Under this method, valuation on the basis of opportunity cost is restricted to alternative use within the organisation. In real life such alternative use may not be identifiable on account of the constraints in an organisational environment. 

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