CHAPTER -2 MEASUREMENT OF HUMAN RESOURCES COST 2.1
Introduction In present growth of accounting system is very speedy and concept
of HRA is modern. Human is lifeless assets compare to other productive equipment means human is not only productive equipment but valuable assets of organization, so there is require of valuation
presentation of human in account.
The first attempt to value the human being in monetary terms was made by Sir William petty as early as 1691. Petty was of the opinion that labour was "The father of wealth" and it must be included in any estimate of national wealth. Further efforts, in this connection, were made by William Far in 1853, Earnest Engle IN 1883.
However, the real and attractive work done in this field from 1960 when
accounting practice of not valuing the human resources along with other material resources. As a result,) accountants and economists all over the world became conscious of the fact that appropriate methodology and procedures have to be developed for finding the cost and value of the people to the organization. Over a period of three decades, a number of experts have worked on it and produced certain models for evaluating
human resources. The notable among them are Shultz (1960), William C.pyle(1967), Flam holtz (1971,1972 and 1975), Morese (1973), Lav and Schwartz (1971), Jaggi & Lav (1974), Kenneth Sinclare (1978), etc.
Very first in 1691 sir William petty had attempted to evaluate a man in monetary manner. As opinion of Mr. petty workers are father of assets. They (workers) should be evaluating in national assets. Afterwards, Mr.william far in 1853, Mr. Earnest Engel in 1883 had done efforts in this field.
But attentive work did in this field from 1960. When human evaluanists erudite had strongly criticized the exclusion of human resource by orthodox accounting method. Consequently, accountants and economists of world, started thinking over to proper process and method of cost and evaluation of employees (human resource) of the organization. Out of them Mr. Shultz 1960, Mr. William Pyle 1967, Mr. Erik Flam Holtz 1971 Mr. Morese 1973, Mr. Jaggi & Lau's 1974, Mr. Kenneth Sinclare 1978 remarkable contribution in this field.
Obviously it is not an easy task to evaluate the human resource and its presentation in accounts as physical assets. There are different opinions seen for its calculation and method of inclusion. Though it is well accepted the valuation and inclusion of human resources.
The present chapter deals with some of the important models evolved during the last decades for valuation of human resources. The chapter has been divided into two parts. Part I discuss the approaches suggested for the computation of human resource cost
Organization. In part II, different methods for the measuring human resource value have been Included.
TYPES OF EXPENSES: The main purpose of accounting is to ascertain the true results of
the business in terms of profit and loss during a particular accounting period. The profit or loss of a business can be ascertained by matching business revenues against the cost of the same period. The emphasis is clearly on the same period. Therefore, a clear understanding between capital and revenue (expenditures and receipts) is necessary for the correct ascertainment of profit or loss. It may be noted that revenue items are included only in income statement or profit or loss account and capital items from part of balance sheet figures. Let us examine the features of capital and revenue items in the accounting parlance.
In the determination of profit or loss of a business during a year, it is very necessary to distinguish between capital and revenue expenditure or receipt. Before the preparation of final accounts, it is essential to understand clearly the distinction between them.
2.2.1 Capital expenditure: Capital expenditure is that expenditure which results in acquisition of an asset (Tangible or intangible) or which results in an increase in the earning capacity of a business .another test of a capital expenditure is that the benefit of such expenditure are likely to accrues for a long period .Obvious
examples of capital expenditure are money paid for land &
building, plant & machinery, furniture & fixture, goodwill, patents, copyright etc.
2.2.2 Revenue expenditure: It is an expenditure which is incurred on consumable items or goods and services acquired for resale. Revenue expenditure helps in maintaining the earning capacity of business. The benefit of revenue expenditure is exhausted in the accounting period it self or within one year. Thus expenses whose benefit expires within the year of expenditure and which are incurred to maintain the earning capacity of existing assets are termed as revenue expenditure. Examples of revenue expenditure are: 1)
Cost of goods purchased for resale.
Expense incurred in connection with production of goods or service.
Administrative, selling and distribution expenses.
Interest on business loan, depreciation etc.
Any expenses to maintain fixed assets in working order. 33
The following are the points of distinction between capital expenditure and revenue expenditure;
capital expenditure is incurred in acquiring or improving permanent Assets which are not meant for resale. But revenue expenditure is a
Routine expenditure incurred in the normal course of business
and Includes Cost of sales as also the upkeep of fixed assets etc.
Capital expenditure seeks to improve the earning Capacity of the business where as revenue Expenditure purposes to maintain the earning capacity of the business.
Capital expenditure is normally a non recurring outlay but revenue Expenditure is usually a recurring item.
Capital expenditure produces benefits over several Years. Hence only a small part is charged to income statement as depreciation and the rest appear in the balance sheet. But Revenue expenditure is consumed within an accounting yea and the entire amount is charged to the (current years) Income Statement. Hence it does not appear in the balance Sheet.
2.2.3 Deferred revenue expenditure: There are certain expenses which may be in the nature of revenue but their benefit may not be consumed in the year in which such expenditure has incurred; rather the benefit may extend over a number of
years. All such expenditures which are basically in the nature of revenue expenditure, e.g. heavy advertising expenditure incurred in introducing a new line or developing a new market. Charges of these expenses are deferred because such expenses benefit more than one accounting period. Moreover the profit of a particular year should not be unduly affected. The matching principle demands this basis of charges should usually be proportionate to the benefit consumed/reaped.
The practice which varies considerably in detail is to write off the amount over the period of years in which the benefit is expected to accrue say 3 to 5 years. If the expenditure can be ear-marked as being in respect of a specified object, the expenditure should be written off during the life of that object, e.g. heavy accidental losses, such as loss arising from a fire or an earthquake; the loss may be spread over a few years. The deferred revenue expenditure not yet written is shown on the assets side of the balance sheet. Thus, deferred revenue expenditure is revenue in character but -
the benefit of which is not exhausted in the same year, Or
is applicable either wholly or in part of the future years, Or
is accidental with heavy amount and it is not prudent to Charge against the profit of one year.
The deferred revenue expenditure may be classified into the following four categories: (I)
Expenditure wholly paid in advance, where no service has yet been performed, necessitating it being carried forward, e.g. office rent, and telephone rent etc. paid in advance.
Expenditure partly paid in advance, where a portion of the benefit has been derived within the accounting period , the balance yet being unused and therefore, shown in the balance sheet as an asset e.g. special advertising expenditure for a new product.
Expenditure in respect of service rendered which for any sound reason is considered as an asset or more properly not considered to be allocable to the accounting period e.g. cost of experiments, discount on issue of share, debenture etc.
Amount s representing loss of an exceptional nature e.g. property confiscated in a foreign country, loss on uninsured assets etc.
COMPARISON BETWEEN CAPITAL EXPENDITURE AND DEFERRED REVENUE EXPENDITURE: The main feature of capital expenditure is that results in a benefit which will accrue to the business enterprise for a long time, say 10 to 15 years. Deferred revenue expenditure also results in a benefit which will accrue in future period but generally for 3 to 5 years.
The capital expenditure or the resulting asset is usually capable of being reconverted into cash through may be at a loss. This is not possible in the case of deferred revenue expenditure. At times, heavy loss such as loss due to earthquake is treated as deferred revenue expenditure in the sense that they are written off over a period pf 3 to 5 years. Such a loss cannot be treated as capital expenditure.
IS EXPENSE OF HUMAN RESOURCE CAPITAL OR REVENUE? Traditionally, evolution of the human resources is not being done in
most of the institution. The expenses of recruitments, training, and development of employees of institute are debited at profit and loss account as revenue expense. It is also not noted in balance sheet. If we think according to principle of accounting the rules of double entry accounting system are being violated. Because institute gets advantage for a long period of expenditure on employees so it should be indicate in balance sheet as capital expenditure or deferred expenditure, but instead of them total amount indicating on profit - loss accounting the profit of institution will decrease and the evaluation of human resource will denounced.
Another argument among this theory is that the expense on employee should be indicate in profit - loss account as revenue expenses because, is there surety that employee will stay for a long period in the
institution? If given more incentives or for other some reason purpose he will take up job elsewhere. But re -argument among this argument that by which proof you can say that the employees will relive from institute? Majority of cases where the employees remains loyal to their job or institution till retirement. As per Indian culture they marriages with institute at life time, in rare case they divorce from institute.
The auditor certified in their report of audited traditional account of institute that the profit -loss account of institute shows real and reasonable profit/loss and the balance sheet fumish real and reasonable situation. Here too the value of the human resource is devalued.
Thus, the situation that arises for not taking human resource expenditure into account as revenue expenses shows as follows: (I)
It is not reasonable that expense of human resource debited profit loss account as revenue expense and reduce the profit or shows loss in profit and loss account in current accounting year. For this purpose the share holder of company gets less dividend so, value of the company reduce in share market.
The balance sheet of the institute will not exhibit the economic condition when the human resource expenses will be indicate in profit and loss account as revenue expense, because assets are less if value of human is not shown in assets side.
The human resources are valuable assets than other physical property in an institute. The institute depreciates on physical assets. Even the provisions of company act are formulated accordingly, but human resource is not exhibited in the balance sheet, so the depreciation is neglected. Actually, value of human resource is shown in the balance sheet, the depreciation should be made, so by seriously thought of efficiency of employees the solution of its maintain and develop can be taken.
We can't find the true rate on retum on capital employed of those institutions that is not valued human resource which is dependable success of institution on individual skill and expertness position. For example, if the production firm invests 10 lacs and profit is Rs. 2 lacs so the return on investment is 20%. Now, if in a tax consultant firm, 2 tax consultants invest Rs. 1 lacs and earn Rs. 2 lacs, then the return on investment is 200%. But if the human resource value for the both the firms are 20 lacs, than the return on investment will be 10%. So to get the true rate on capital employed. Thus the human resource evaluation should be considered in the balance sheet for getting true rate on capital employed.
If the human resource is not considered in the balance sheet the creditors-debtors or investors can't know true and reasonable economic situation if institution, so the decision taken are incorrect. Suppose out of both company X Ltd and Y Ltd, X Ltd incurred more expense on appointment. Training and welfare
activities and all expenses are shows in the profit -loss account as revenue expense so it is naturally its profit of that year is reduced but y co. is not incurred expenses on employees so its profit of that year is rises. By seeing this results any investor agree to invest in y co. or purchase the y co. in beginning the profit will show as rises but than day - to day profit will reduced or may be rise loss by dissatisfaction, disloyalty, worried and turnover of employees and no bar of worried for wrong decision. While if the value of human resource indicated and any invest or purchase the company x, day -to day high results will get and his decision is proper.
METHODS OF VALUATION OF HUMAN RESOURCE ACCOUNTING. This chapter presents the measurement approaches developed so
far to account for the human resources. A number of studies designed to compute the cost and value of human resources have been conducted in United States. The studies reviewed here are those conducted by Harmanson (1964), William C. Pyle (1967), Rensis Likert (1967), Hekimian and jones (1967), lev and Schwartz (1971), Flamhotz (1971, 1972) Jaggi and Lau (1974) ) Friedman and Lev
(1974), Myer's and
Flower's (1974), and chakraboty's (1976 ). The purpose of this review in two-
measurement of cost and value of the human resources and to know their
short-comings and secondly, as a corollary, several of the studies have been a valuable guide in designing of the present study.
The chapter has been divided into two parts. Part I discuss the methods/ approaches suggested for computation of human resource cost to the organization. In part II, different models for measuring human resource value have been included.
PART I MEASUREMENT OF HUMAN RESOURCES COST These approaches/methods involve computation of costs of human resources to the organization. Such cost may be calculated by any of the following methods.
2.4.1 HISTORICAL COST METHOD. This approach was developed by Brummet, Flamholtz and pale. According to this approach, the actual cost incurred on recruiting. Selecting, hiring. Training and developing the human resources of the organization are capitalized and written off over the expected useful life of the human resources the historical cost of human resources in case of this method is thus treated in the same manner as the cost of any other physical asset. Any expenditure incurred for trading or development of the human resources increases the value of human asset like any other physical asset and therefore, capitalized in a similar manner. Amortization
of a human asset is also done in a similar manner. In case of human asset expires before the end of the expected service life period, the whole of the amount not written off is charged against the revenue of the year in which such event takes place. In case the useful life is recognized to be longer than the original expected, amortization is appropriately rescheduled.
The method has the following merits, 1.
The method is simple to understand and easy to work out.
The method follows the traditional accounting concept of matching cost With revenue.
The method can provide a basis for valuing a firm's returns on its Investments on human resources.
The methods suffers from the following demerits, (1)
The method takes into account only a part of acquisition cost of Employee. It dose not consider the aggregate value of their potential Services.
It is difficult to estimate the period over which the human resource will provide service to the organization. It thus creates problems in determining the amount to be amortized over the year.
The value of human assets according to this method goes on Decreasing every year due to amortization. However, in reality, the Value of human Asset increases over time on account of people Gaining experience.
2.4.2 REPLACEMENT COST METHOD. This approach was developed by Rensis likert and Eric G. Flamholtz. This approach values the human resources at their present replacement cost. In other words, human resources of an organization are to be valued on the basis of the assumption what would cost the firm if the existing human resources are required to be replaced with others of equivalent talents and experience.
The approach is similar to the historical cost approach mentioned above except that it allows for changes in the cost for acquiring, training and developing the employees in place of taking their historical cost for capitalization.
The method has the following merits, (1)
The approach incorporates the current value of the firm's human Resources. Thus, the financial statements prepare according to this Approach are more realistic as compared to those prepare under Historical Cost approach.
The method is more representative and logical.
The method has the following demerits, (1)
The method is at variance with conventional accounting practice of Valuing Assets at historical costs.
It is almost impossible to ascertain correct replacement cost of existing Human resources since there can be no complete replacement for them.
There is no objective way for determination of replacement cost. Personal Prejudices do works. Moreover, there is no foolproof method for Verification of replacement cost.
2.4.3 OPPORTUNITY COST METHOD This approach has been suggested by Hekimian and Jones. According to this approach, the value of an employee is determined according to his altemative use. In case an employee has no altemative use, no value will be placed on him. This approach specifically excludes those types of employees who can be hired readily from outside. The suggests competitive bidding process for the scarce employees in an organization. It means that the opportunity cost is linked with scarcity. The opportunity cost of an employee or group of employees in one department is calculated on the basis of the offers (bids) by other departments for those employees. This will be clear from the following example:-
A company has two departments X and Y. the amount of capital employed (In physical assets) in department X and Y is RS.10 lacks and Rs. 5 lacks respectively. The required rate of return on total capital employed (physical as well as human) is 15%. It is expected that with the employment of a specific group of technocrats, department X can make a profit of Rs. 3 lakhs while department Y can make a profit of Rs. 2.5 lakhs.
The capitalized value of profit with the technocrats at the rate of 15% comes to Rs. 20 lakhs in case of department X and Rs. 16.67 lakhs for department Y. in case the value of physical assets is deducted from this figures, the value of human resources comes to Rs. 10 lakhs in case of department X and Rs. 11.67 lakhs in case of department Y. Hence, department Y can offer a higher bid for the technocrats as compared to department X.
In terms of salary, department X can offer a salary is Rs. 1.50 lakhs (Rs.10 lakhs * 15%) while department Y unto RS. 1.75 lakhs (Rs. 11.67 • 15%). Department Y can thus offer a high salary. Department Y will have the technocrats on account of a higher bid and it will include Rs.11.67 lakhs as its investment in human resources.
According to the authors of this approach, a bidding process, such as this, is a promising approach towards,
More optimal allocation of personnel and
A quantitative base for planning, evaluating and developing human assets of the firm.
This approach has several demerits, (1)
It has narrowed down the concept of opportunity cost by restricting it to the next best use of the employee within the same organization.
It has specifically excluded from its purview those employees who are not scarce or are not being bid by other department. This is likely to result in lowering morale and productivity of the employees, who are not covered by the competitive bidding process.
The total valuation of human resources based on this method may be misleading and inaccurate. This is because a person may be an expert in a particular area and there for may be useful for one department but useless, for another department. Thus, he may be a valuable person for the department he is working and command a high value. However, he may have a lower price in a bid by the other department where his services are not at all required.
2.4.4 STANDARD COST METHOD. This approach has been suggested by David Watson. According to this approach, standard cost 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 a organization is the value of human resources for accounting purposes.
MERITS AND DEMERITS:
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 process.
2.4.5 AGGREGATE PAYMENT APPROACH This approach has been suggested by prof. SKchakraborty (1976). As matter of fact, he is the first Indian to suggest a model for valuation of human resources of an organization. According to his model the human resources are to be valued as a group and not on individual basis. Prof. Chakraboty's model for valuation of human resources involves the following steps: (1)
All the employees of an organization are divided in two groups, managerial and non managerial. The average tenure of the employment of the employees in the group is estimated on the basis of past experience.
The average salary of the group is determined on the basis of the salary wage structure prevalent in the organization.
The value of human resources is now determined by multiplying the average salary of the group with the average tenure of the employees in the group.
The value determined under 4th above, is discounted at the expected average after tax return on capital employed over the average tenure period to ascertain the present value of the estimated future payment.
Dr.chakraborty suggests that the adoption of such a long term rate will avoid fluctuations in the value of "human asset" from year to year simply due to changing annual rates of return.
Prof. chakraborty has also suggested that the recruitment, hiring, selection, development and training cost of each employee should be recorded separately. This should be treated as deferred revenue expenditure and may be written off over the expected average stay of the employee in the organization. The deferred portion not written off should be shown in the balance sheet of the organization. If there is pre-mature exit of an employee on account of death, retirement, etc., the balance of the deferred revenue expenditure attributable to the person should be written off against the income of the year of exit itself.
MERITS AND DEMERITS:
As regards disclosure of accounting information relating to human resources, prof. chakraboty's has suggested that "human assets" should be shown under the heading "investments" in the balance sheet of the organization. He has not favored its inclusion under the heading fixed assets since it would cause problem of depreciation, capital gains and losses, in the event of their exit. Similarly, he has not favored there inclusion in current asset on the ground that this will not be conformity with the general meaning of the term.
2.4.6 TOTAL COST METHOD: This approach has been suggested by prof. N.Dasgupta (1978). According to him the various approaches suggested in the previous basis take into account only those persons who are employed and ignore those who are unemployed. In case the value of human resources of the nation is to be determined, it should be done in a manner that it brings in its purview both employed and unemployed persons. The system should be such that it fits in preparation of the balance sheet showing the human resources not only of a firm but also of the whole nation.
According to prof. Dasgupta, the total cost incurred by the individual, the state and the organization in bringing the individual up to that position in the organization(in case of a nation making him fit for
appropriate employment) should bra taken as the value of person on the
day he starts serving the organization or becomes fit for appropriate employment. It will include his education, training expenses which he and the state have incurred. The value should be further adjusted by the amount of intelligence (higher or lower which he has). The amount spent by the organization on recruitment, training, familiarizing and developing human beings employed in the organization should be considered separately. However, it should also be treated as a cost increasing the value of human beings. In case the number is large, the valuation can be done group-wise.
The value determine on the aforesaid manner should be adjusted at the end of each year by the organization on the basis of his age, seniority,
capabilities, etc.. The measurement can be done with the help of psychologists and other concerned experts. The revised value would be the value of the employee at the end of the year.
MERITS AND DEMERITS:
Prof.Dasgupta's approach seems to be sound theoretically. However, its practical application may be difficult since it will involve a number of abstract factors which may not be capable of being expressed in monetary terms precisely and objective
2.4.7 CAPITALIZATION OF SALARY METHOD: The value of the human resource can find by method of capitalization of salary as find
present value of future income of average
salary of a common class of employees. But it is thoughtful that which discount rate has been taken for the calculation of present value. Generally that rate is use which discount rate is use for
2.4.8 RETURN ON EFFORT EMPLOYED METHOD: According to this method there is calculation of how and what effort of each employee of institute doing in various work of institute. The measure determines effort of employee in various work of institute as like purchase, production, sales, administration etc.
There are marks
considered for measure of quality, work efficiency, result etc. of effort of each individual - employee of institute. Measure of individual effort by calculation of marks of each effort. The simple example is given below-
Calculation of marks for types of work
(1) For managerial work
(2) For work of sales/production manager
(3) For work of salesman /store keeper
Calculation of marks for experience of work (1) For experience of 1 to 3 years
(2) For experience of 4 to 7 years
(3) For experience of 8 to 10 years
(4) For experience of more than 10 years
Calculation of marks for quality of work (1)
For simple work
For satisfaction work
For best work
Now, if valuation of satisfied work of 9 years experienced clerk can evaluate by multiply of each marks as follows:
Measure of efforts of clerk = Marks of type of work x Marks of Experience of works x Marks of quality of Work
Valuation of best and 5 years experienced manager Measure of efforts of manager
10 x 3 x 4
Thus, determining measure of effort of each person- employee and addition of it can evaluate the efforts of all employees of institute. The base of it found total effort of each type of work and its profit and also
determines retum on effort of employee. So maximize distribution of employee between various works of institute.
BEHAVIOURIAL VARIABLES METHOD According to this method indicate measure of effect of managerial
policy on employee's behavior. There should be measure of work efficiency, royalty to institute, power of endurance, trust, discipline of employee for measure of quality of employee
If the managerial policy autocrat, exploited, take work by presser, in beginning the productivity - production increase so profit is rise and return on capital employed also rise but then after some time in the employee royalty to institute, trust are decrease, shirking, opposition of employees increase and turn over of employee also increase so results are negative in long time. Reducing the productivity and production the profit and return on capital employed also reduced.
But if the
policy is democrat,
encouragible, beneficial, well, there is no good result in beginning but day - to day increase of love, royalty, work efficiency, moral, and discipline of employees towards institute, so productivity, profitability, return on capital employed will be rises.
There are rules of personnel management that if management care employee, employee will care management (institute). So it is unavoidable to maintain of value of human resource.
PRESENT ECONOMIC VALUE METHOD
According to this method the value of human resource of the institute is evaluate by what is present value of human resource /employee? For this purpose estimate how much contribution of employee in future earning of institute and evaluate its present value. There is also considered rate of discount for evaluation of present value.
The use of this method is very hard task because it is very hard work to decide the contribution of employee in future earning of institute, and it is also hard that at which rate of discount the present value evaluate, and it is also unfixed that how much time employees will do effective work? When they retired? All these purpose estimations should be used.
Various authors has furnished some models for determine how much time employee will work in the institute means how much time they stay in the institute? These models as like Lev and Schwartz model, Erik Flam Holtz Model, Jaggi Lau's Model etc.
2.4.11INCREASING GOODWILL VALUE METHOD It is generally observed than an old and established firm is in a position to earn a higher amount of profit as compared to a new firm inspire of all other things (such as investment, location, quality of goods etc.) remaining the same. This is because over a period of time a firm establishes its reputation on account of which not only the old customers
Continue to patronize the firm but they also bring new customers. This enables the firm to earn excess profits as compared to a new firm. Goodwill has therefore been defined as "the present value of firm's anticipated excess earnings."
It is very difficult to define the term goodwill. It is variously defined as "the attractive force which brings in custom" and another stating it as meaning the old customers resorting to the old place. From this it follows that there can be goodwill only for established business. The need for valuing goodwill arises only when circumstances warrant such as the admission of a partner, sale of business, etc. however, valuation of goodwill is a complicated task. As observed by kerala high court in C.I.T vs. Jacob (1973) "Goodwill is normally built up by the personal efforts spread over a number of years of the assessed. Therefore, it is impossible to estimate in monetary terms the cost of building up the reputation which is treated as goodwill." According to the institute of charted accountants of India, goodwill is "an intangible asset arising from business connections or trade name or reputation of an enterprise."
From the above it can be concluded that goodwill is the estimated value of the reputation of a firm.
How does goodwill arise? Goodwill is the reputation enjoyed by the business which is reflected in the business having large number of customers resulting in
high turnover and high profit. As all customers are not alike, they have been zoologically classified as dogs, rats' cats and rabbits. (Whiteman smith motor co. vs. Chaplin). Dog is attached to a person rather than to a place. So customers of that bent of mind follow the outgoing owner if he does not go too far. The rat has no attachment and is purely casual. In the case of cats it is attached to particular house not to the persons living therein. So it represents customers attached to the old shop. Rabbit's sole consideration is proximity. "these categories serve as a reminder that the goodwill of a business is a composite thing referable in part to its locality, in part to the way in which it is conducted and the personality f those who conduct it and in part to the likelihood of competition, many customers no doubt being actuated by mixed motives in conferring their custom."
Need for valuation of Goodwill The need for valuation of goodwill in the business arises in the following circumstances: 1.
When the private ownership business sold their business to another.
In partnership firm (A)
When admission, retired or death of current partner,
When on dissolution the business sold to another person Firm or Company
When changes of profit sharing ratio
When amalgamation of two or more firm
In the joint stock company (A)
When the business of a company is taken over by another Company, e.g. in case of amalgamation or absorption.
When the company's shares are not quoted on the stock Exchange and their value is be determined for the purposes of Estate duty and wealth tax, etc
When a person wants to purchase a large block of the
Company's Shares with a view to acquire control over
the management of the Company. (D)
When the business of the company is being over by the Government.
When the management wants to write back goodwill which it wrote Off earlier to reduce or eliminate the debit balance in the profit and Loss account.
Valuation of commercial goodwill The various methods for the treatment of goodwill in the business may be laid down as follows:
Memorandum revaluation method
Simple profit method
Capitalization of profit method
Super profit method
The valuation of human resource indirectly valued when the valuation of goodwill of the business. But the valuation of goodwill is not valued each year, so valuation of human resource is seeing as indirectly at the value of goodwill. The traditional proprietors choose the write of goodwill after some time, so profit is reduce when goodwill reduce each year and hidden reserve rises. Generally in these period value of human resources should be rises, but here value of human resource is reduced by reduce of goodwill. Therefore directly valuation of goodwill is batter instead of indirect valuation. For this purpose changes traditional method of valuation of goodwill, so give more weight age to factors affected to human resources out of various factors affected to valuation of goodwill. For this purpose human resources classified in two part(1)
Internal human resources- which includes employees, managers and Experts.
External human resources - which includes customers, creditors and Investors. There perfectly indicate the ratio of internal and external human
resources in the valuation of goodwill. If valuation of goodwill increase or decrease by changes the value of human resources it should be indicate in the balance sheet as human capital. So value of human resources included in the valuation of goodwill. Thus, valuation of goodwill should be done directly and periodical instead of at the time of sale of business or changes of ownership
PART II. 2.5
MEASUREMENT OF HUMAN RESOURCE VALUE The value of human resources of an organization can be assessed
in two Different ways:
By discounting the future salaries and other capital costs (such as cost
employees) by a certain rate of discount, and
By discounting the future earnings of the organization at a certain date by a suitable rate and allocating a part of the present value of earnings to human resources.
In consonance with the above two premises, a number of valuation models have been suggested in the literature. These are:
2.5.1 PRESENT VALUE OF FUTURE EARNINGS MODEL The model of measurement of human capital suggested by Brauch Lev and Aba Schwartz is based on the economic concept of human capital. Capital is defined as a source of income over a period of time and its worth is the present value of future incomes discounted by a certain rate. Irving Fisher, one of the originators of human capital theory, states that "the value of capital must be computed from the value of its estimated future net income not vice-versa." However, a close look at the definition of capital and its valuation shows that Fisher does not talk of human or
non -human capital separately. However, the valuation of human capital is as important as that of non-human capital because human beings have the productive capacity and are one from in which wealth can be held. According to this model, the value of human resources is ascertained as follows:
All employees are classified in specific group according to their age and skill.
Average annual earnings are determined for various ranges of age.
The total earnings which each group will get up to retirement age are calculated.
The total earnings calculated as above are discounted at the rate of Cost of capital. The Value thus arrived at will be the value of human Resources/assets.
The following formula has been suggested for calculating the value of an employee.
According to this model.
w I (t)
the value of an individual r years old
the individual's annual earnings up to the retirement.
present age of the employee
Lev and Schwartz are of the opinion that "the determination of the total value of a firm's labor force is a straight forward extension" of the measurement procedure of an individual to the organization. They have divided the whole labor force into certain homogenous groups such as unskilled, semi-skilled technical staff, managerial staff etc., and in accordance with different age groups.
Average earnings profiles for differ rent classes and age - groups are prepared for each group of personnel separately and present value of human capital is calculated in accordance with the above formula. The aggregate present value of the different groups of personnel will represent the capitalized future earnings of the firm as a whole. They have advocated the use of 'cost of capital' rate for the purpose of discounting the future earnings of the employees for arriving at their present value.
From the following details compute the value of human resources of an employee group with an average age of 57 year. (i) Annual Average Earning of an employee till the Retirement age
(ii) Age of retirement years
(iii) Cost of capital
(iv)No. of employees in the group
2:1 (t) (1+ R) (T-r)
80000 80000 80000 + ------- + -------- + -----1.10(62-58) 1.10(62-59) 1.10(62-60) 1.10(62-61)
80000 80000 + ------- + ------(1.10)5 (1.10)4 (1.10)3 80000 1.61
80000 80000 + ------- + - - 1.46 1.33
80000 + ---1.21
49689 + 54794 + 60150 + 66115 + 72727
Alternatively the value of an employee can be computed with the help of Annuity Table. The present value of an annuity of Re. 1 for five years at 10% is 3.791. Hence, the present value of Rs. 80000 for five
years comes to 80000· 3.791 =303280. This is almost the same as calculated above.
Since the total number of employees in the group are 80, hence the total value of human resources of this group comes to 3, 05,898· 80 = Rs. 2, 44, 71,840
Thus, in brief, the model identifies an individual's expected economic value to the organization to his future earnings for his remaining active service life. His future expected income stream is discounted by an appropriate rate to arrive at the present value of his services. However, the model suffers from the following deficiencies:
A person's value to an organization is not determined entirely by the person's Inherent qualities, traits and skills but also by the organization role in which the individual in placed. Moreover, the individual's
organization in the abstract from. They are valuable only when such qualities serve as a means to achieve the organizational goals.
The model also does not take into account the possibility and probability of an Individual leaving the organization for reasons other than death or retirement. It may be stated here that people quit organizations for a variety of reasons.
The assumption of the model that people will not make role changes during their Career with the organization also seems to be unrealistic.
In the organizations, employees are quite often
transferred to other Departments and their role also changes when they are transferred
The model also ignores other considerations such as seniority, Bargaining capacity, skill experience, etc., which may result in? Payment of higher or lower salaries to employees. Thus the salaries Paid
may not really
employee's real Worth to the organization.
2.5.2 REWARD VALUATION MODEL: This model has been suggested by Flamhotz (1971). This is an improvement on 'present value of future earnings model' since it takes into consideration the possibility or probability or an employee's movement from one role to another in his career and also of his leaving the firm earlier than his death or retirement. According to this model, the ultimate measure of an individual's value to an organization is his expected realizable value. The realizable value is estimated on the basis of the present worth of the set of future services he is expected to provide during the period he is likely to remain with the organization. The model suggests a five step approach for this purpose.
Determination of the period for which a person is expected to serve the organization.
Identification of 'services states' (i.e. roles or posts) that the employee might occupy during his service career including the possibility of his quitting the organization.
Estimation of the probable period for which a person will occupy each possible 'services states' (posts or roles) in future in the organization.
Estimation of the value derived by the organization when a person occupies a particular position, i.e. a service state for the specific time period. Such value can be determined either by multiplying the price of the services (articles) with the quantity of the services (articles) to be rendered (produced) or the income expected to be derived from the services to be rendered.
The total value of the services derived by the organization by different employee's
group of employees is determined. The
value thus arrived is discounted at a pre-determined rate to get the present value of human resources.
The model suffers from nearly all the drawbacks from which the present value of future earnings model suffers. Moreover, it is difficult to obtain reliable data for determining the value derived by an organization during the period a person occupies a particular position. The model also
ignores the fact the individuals operating the group may have a higher value
This model identifies the major variables that determine an individual's value to an organization. According to this model, the ultimate measure of an individual's value to an organization is his expected realizable value. There is a dual aspect to an individual's value (I) the amount an organization could potentially realize from his service if he remains an employee of the organization during the period of his productive service life and (ii) the amount actually expected to be derived, taking into account the person's likelihood tum over. The former is the person's expected conditional value while the latter in his expected realizable value.
The model is based on the notion that a person's value to an organization depends upon the position to be occupied by him in the organization. An individual generates values for an organization as he occupies and moves to different roles and renders services to the organization. The movement of people from one organizational role to another is a stochastic process. As people move and occupy different organizational roles (i.e., service states), they render services (i.e., rewards) to the organization. However, the roles they will occupy in future will have to be determined probabilistically for each individual.
According to Prof. Flamholtz, an individual's expected realizable value is determined by two factors (i) the individual conditional value and (ii) the probability that the individual will maintain his expected service life. The product of those two variables is the present worth the services actually expected to be derived by an organization. An individual's conditional value may be defined as the present worth of the potential services that are expected to be rendered to the organization. This value, in turn, consists of three factors: productivity, transferability and promo ability. Productivity refers to the services an individual provides while occupying his present position. Transferability is a set of services an individual is expected to provide if he is transferred to a same position level in a different department of the organization. Promo ability is a set of services an individual is expected to provide at higher level position.
Further, an individual conditional value is determined by two factors (i) his skill; and (ii) his activation level. Individual's skill may be defined as the currently developed potential to provide service to an organization. Activation level of a person is the extent to which that person is affected by motivation.
Besides, the personal factors determining the conditional value of an individual, there are organizational factors as well. These are (i) the role occupied/performed by the individual within the organization and (ii) the organizational rewards. A role may be defined as a set of behaviors expected of all persons occupying a specific position in an organization.
On the other hand, organizational rewards are the benefits which people expect from the organization during their tenure with it.
Thus, a person's expected realizable value is the product of conditional value and the probability that the person will maintain organizational membership. The probabilities (P) in the formula are determined on the basis of the firm's past experience.
The validity of the above determinants of an individual's value to an organization was empirically tested by Prof. Flamholtz in an international firm of Certified Public Accountants (CPA) in United States. In this field study, it was observed that, besides the above determinants of an individual's value to an organization, four other variables attitudes, abilities, traits and the individual's manager - were also identified. Thus, keeping in view the above findings of the field study, Prof. Flamhollz has presented the following model of the determinants of an individual's value of an organization.
2.5.3 NET BENEFIT MODEL This approach has been suggested by Morse (1973). According to the approach, the value of human resources is equivalent to the present value of the net benefits derived by the organization from the service of its employees. The method involves the following steps.
The gross value of services to be rendered in future by the employees in their individuals as well as their collective capacity is determined.
The value of future payments (both direct and indirect) to the employees is determined.
The excess of the value of future human resources (as per 1 above) over the value of future payments (as per 2 above) is ascertained. This, as a matter of fact, represents the net benefit to the organization on account of human resources.
The present value of the net benefit is determined by applying a pre-determined discount rate (generally the cost capital). This amount
2.5.4 CERTAINLY EQUIVALENT NET BENEFIT MODEL This approach has been suggested by Pekin Ogan (1976). This, as a matter of fact, is an extension of "net benefit approach" as suggested by Morse. According to this approach, the certainty with which the net benefits in future will accrue should also be taken into account while determining the value of human resources. The approach requires determination of the following: (1)
Net benefit from each employee as explained under 'net benefit approach' above.
Certainty factor at which the benefit will be available.
The net benefit from all employees multiplied by their certainty factor will give certainty-equivalent net benefits. This will be the value of human resources of the organization.
2.5.5EMPLOYEE TURN OVER RATE MODEL The model is based on valuation of groups rather than individuals. The 'group' in an organization refers to a homogenous group of employees who may be working I different departments. The information generated by 'group valuation' will provide a basis for predicting, with greater accuracy, the career movements of the employees within the organization and the chances of their quitting the firm at any time. It maybe started here that it is really difficult to predict the stay of an employee on an individual basis, but on a group basis, it becomes easy to ascertain the percentage of a particular group of employees likely to remain with or leave the organization or to be promoted to the higher ranks during each of the forthcoming periods.
In their model, Jaggi and Lau have suggested the use of Markov Chain
to consider the career movements of the
employees within the organization and the chances of their retirement or death. The proposed model requires the determination of the Rank Transitional Matrix and the expected quantities of services for each rank of service. The Matrix is prepared from the historical personnel records
usually available in an organization. For the purposes of measurement of expected qualities of service or performance criteria is needed.
The model includes data on the historical movement of groups of employees within an organization into a Rank Transitional Matrix (i.e., an estimate of the probabilities of group's career movements). The value of the services an organization's current employees render in a future period is calculated by multiplying the estimated number of current employees that will be in each services state in that period is calculated by multiplying the estimated number of current employees that will be in each services state in that period by the value of the services an employees in each state (i.e., rank) renders to the organization. The components the model is presented in the equation as follows.
(TV) = (N).Ir". (T)". (V) Where TV = column vector indicating the current value of all current employees in Each rank. N
column vector indicating the number of employees currently in each Rank.
rank transitional matrix indicating the probability that an employee will be in each rank with the organization or terminated in the next period given his current rank.
column vector including the economic value of an employee of rank 'I' During each period. Although Jaggi and Lau's study has improved the reliability of the
probability measure (P) in the Flamholtz model, the study has not suggested any specific guidelines to improve the validity of the expected services measurement, as propounded earlier.
2.5.6 ADJUSTED DISCOUNT FUTURE WAGES MODEL In his pioneering work at Michigan State University (USA), Hermanson8 suggests the discounting of a stream of wage payments to people as a measure of a person's value to an organization. However, he suggests the adjustment of this discounted future wage stream by an efficiency factor.9 He advocates use of this factor on the ground that differential earnings of a firm are attributable to human resources only. To calculate efficiency ratio, he makes use of weighted average of the firm's net income during the past five years. The current year is given a weight of 5; the preceding year receives a weight of 4 and so on. This efficiency ratio is then used for adjusting the present value of expected future wage payments over a five year period to arrive at the human resource value.
This approach also suffers from certain drawbacks. The selection of five years period for giving weights has no justification. Moreover, it is difficult to apply the efficiency factor concept in real world situations. There also no theoretical or empirical justification for giving weights.
2.5.7 SOCIO-PSYCHOLOGICAL MODEL In
Management and Value', Likert developed a conception model that incorporates a number of variables to be measured to arrive at productive capability of an organization. Likert and Pyle define net worth of an organization as "the present value of contributions employees make over their life less costs incurred in acquiring, developing, maintaining and utilizing these services".
Likert has identified three classes of variables which are important to the profitability of a firm-casual variables, intervening variables and endresult variables. These variables are defined as under:
The casual variables are independent variables which determine the course of developments within an organization and the result achieved by the organization. These casual variables include only those independent variables which can be altered or changed by the organization and its management.
The intervening variables reflect the internal state and health of the organization e.g., the loyalties, attitudes, motivations, performance goals, and perceptions of all members and their collective capacity for effective interaction, communication and decision making.
The end - result variables are the dependent variables which reflect the achievements of the organization, such as productivity, costs, scrap loss and earnings.
It is clear that Likert's approach is based on inter play of three variables defined above. He suggests the use of a questionnaire to arrive at values for these factors. According to Likert, a certain pattern of casual variables yield certain levels of intervening variables which, in turn, lead to certain levels of end-result variables. The end-result variables (i.e., productivity and earnings of the organization) are converted into present value by using a certain discount rate. He asserts that casual and intervening variables should be periodically measured and any favorable or unfavorable shifts described in each production or financial report. The accumulated data on casual and intervening variables may be used to establish mathematical relationships between the independent variables (i.e., casual and intervening) and such end - result variables (i.e., productivity and earnings).
The socio - psychological model developed by Likert attempts to provide useful information, though non - monetary, about the present and the expected future attitudes, behavior and satisfactions of a firm's human resources. However, doubts have been expressed regarding the validity of Likert's assumption that performance is a function of satisfaction. The research conducted later by Likert and Bowers suggested opposite relationship indicating that satisfaction is a function of performance and not vice - versa.
According to W. Carper, "Problems, however, exist here. The variables can be difficult to categorize. The correlation and co - variance of the independent factors involve complex analysis. Also, continued tests are needed to generate sufficient data from which to develop conclusions about the impact of management decisions".
2.5.8 FIRMS INVESTMENT IN HUMAN RESOURCE MODEL Friedman and Lev rely on the economic theory of human capital for measuring the firm's investment in human resources. Their model is based on firm vs. market wage relationships. The differences between a given firm's actual wage structure and the average wages prevailing in the relevant labor markets are assumed to be mainly caused by the firm's personnel policies. The value of human resources investment is determined by discounting the series of wage differentials over the expected service life (to the firm) of current employees.
Thus, the measure suggested by Friedman and Lev provides information on how investment differs from industry averages. However, like the Lev and Schwartz Model (discussed earlier), it has the typical problems of discounting the differential wages flows.
2.5.9 FIVE DIMENSIONAL MODEL Myers and Flowers' suggest use of five dimensions in valuing human resources of an organization. These are: knowledge skills, health, availability and attitude. The individual's knowledge enables him to direct
his skills and his health enables him to apply them. The five dimensions are factorial rather than additive --- if anyone is lacking, the others are rendered correspondingly ineffective. In this model, the performance of an employee represents his value to the enterprise and is a function of such variables as his knowledge, skills, health, availability and attitude, which are mutually inter - related. Among these dimensions, the attitude is the most important variable yielding the end - result. The model suggests the use of attitude score and their respective weights to arrive at an attitude index for a group of employees. The product of the attitude index and annual salary is the value of the employee and the difference between this value and the annual salary is regarded as the gain or loss arising out of the individual's continued employment with the organization. However, a major shortcoming of the model is that the managers and
the accountants are not familiar with
the area of attitude
measurement. The complexities involved in the use of the model in real world situations make it not only expensive, but also impracticable. Besides, the information generated by the model may not be as useful to the external users as it is to the management for internal purposes. Rose Dicarlo, who commenting on the model, observed "the relationship between attitude measures and subsequent firm profitability must be established to enable the model to be useful for investment decisions".
2.5.10. PROFESSIONAL SERVICE ORGANIZATION MODEL Pekin Ogan's model extends some of the concepts advanced by Flamholtz and Lev and Schwartz and also specific certain variables which have not been stated in the earlier studies. In the proposed model, the researcher has incorporated and highlighted the effects of costs and benefits. According to his approach, which he calls as 'value - oriented quantification approach', the total adjusted net present human resource value of a professional service organization is equal to the aggregate discounted certainty equivalent net benefits of the employees in the organization. He gives the following formula for quantifying an individual's economic value:
Pekin Ogan's model presents a new concept of determination of certainty - equivalent net benefits stream for such employee in an organization, which consists of two elements (a) his or her net benefit which are a function of the employee's expected benefits and total costs; and (b) a certainty factor which is comprised of the employees probability of continued employment and probability of survival. He has presented his model of human resource valuation in the following figure:
Certainty Equivalent Net Benefits
Adjusted total net present value of Human Resources for the organization.
Sources: Pekin Ogan-A Human Resource Value model for Professional Service Organizations Accounting Review Apri11976. P. 306.
The model presented by Pekin Ogan is certainly an improvement over other models presented earlier in this chapter. This model takes with Accounts the 'costs' generated by the employees for the organization, which the other models have ignored. It also makes use of the 'certainty factor' designed to measure the probability of continued employment and probability of survival. However, a major shortcoming of the model is that it can be applied only in those organizations where 'costs' and 'benefits' of employees can be traced fairly objectively.
In view of the growing importance of human resource accounting, many corporate enterprises in India are voluntarily giving information about their human resources. They number about 15 in all and include many important public sector enterprises viz. Bharat Heavy Electrical Ltd. (BHEL, Steel Authority of India Ltd. (SAIL), Minerals and Metal Trading Corporation of India. (MMTC), National Thermal power Corporation (NTPC), Oil and Natural Gas Commission (ONGC) and Engineers India Ltd. (ElL). Among all these enterprises BHEL is the pioneer in the field of human resource accounting since mid 1970. Most of the Indian companies and corporations have followed basically Lev and Schwartz model for valuation of human resources. 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. In each category 10 to 15 salary grades have been identified the valuation of human resources. The model adopted by BHEL is given below
P x 12 x N x E x I HRV
Where, HRV =
human resource value of the group of employees in the Particular salary grade.
annual compensation per employee in the given salary grade. This includes various items basic pay, DA, eeA, PF contribution by employers etc.
total number of employees in the grade.
Efficiency Factor. The factor varies with the amount of experience.
decreases at About 5% for each accounting period of five or six years. =
Incremental factor. It is 5 % for a five year period. The period of 5 Years has been taken as the basis in the assumption that people With five years experience are normally promoted to the next higher Grade.
it has been taken at 12 % per annum which is the weighted Average cost of capital to the company
To sum up, the researches reported above are a significant contribution to the knowledge in the area of measurement of human resource cost and value in an organization. Nonetheless, the approaches suggested suffer from certain limitations. As such, there is no consensus in the accounting world in respect of any of the approaches suggested. Each approach has its own advantages and limitations. However, data relating to the cost and value of human resources generated under each of the method can serve us a useful tool for managing the human resources more effectively.
STATEMENTS In the preceding pages, we have explained the various models dealing with the model of valuation of human resources as assets. The "present value of future earnings "model, as suggested by Lev and Schwartz, has been found to be most popular model on account of convenience and objectivity. The exponents of human resource valuation models in most cases have not dealt with the mode of recording and disclosure of the accounting information relating to human resources in the books of accounts or financial statements of the organization. This has been left to the discretion of the accounting bodies that have yet to develop a generally accepted basis for valuation, recording and disclosure of human resource accounting information in the financial statements of an organization.
In most cases,
information is given in the form of supplementary information attached to the financial statements.
Prof. N. Dasgupta has suggested in his total cost approach (explained earlier) the following mode for disclosure of human resource in the balance sheet of an organization.
According to him, the human resources valued as per his model should shown both on the "assets" as well as "liabilities" side, it should be shown after the fixed assets as human assets classified into two parts -( 1) value of individual, (2) value of firm's investment. On the "liabilities" side it should be shown after the capital as human assets capital by that amount at which it has been shown on the assets side against 'value of individual'. He has given the following example to clarify his point
A firm has started its business with a capital of Rs. 100000. It has purchased fixed assets worth Rs. 50000 in cash. It has kept Rs. 26000 as working capital and incurred Rs. 24000 on recruitment training and developing the engineers and a few workers. The value of engineers and workers is assessed at Rs. 80000. The items will be shown in the balance sheet as follows:
BALANCE SHEET (INCLUDING HUMAN RESOURCES) I
Capital Human assets capital
Human Assets: (I) individuals' value
(ii) value of firm's
investment Current Assets 180000
Sources: Corporate Accounting (S N Maheshwari P-3.230)
Now, we see that both selected fertilizer companies how can show human assets in the balance sheet. The balance sheet of KRIBHCO as on 31- 3 -2008 Liabilities
Share capital 34795 equity
Shares of Rs.1 lacs each (includes 26991 shares of Indian govet.
(Rs. In lacs) Amount Amount
shares of Rs.
value (as per annexure 7 & 12 g )
co- op. edu.& training fund investment
178.11 14042 equity
shares of Rs. 10000 each
39650.20 Less: share
Add: share forfeited
surplus Secured loan:
Bank loan Tax balance
liabilities & Provi. Human assets capital indu. val ue (as per annexure 7 & 12 g) co- op. edu.&
The balance sheet of IFFCO as on 31-3-2008 Am!.
Liabilities Equity share capital
(Rs. In corers)
Reserve & surplus
Long term Unsecured loan Short term
Human assets 4850.68
Deferred trade tax
Co- op. edu. & training
Human asset capital Individual value Co-op. edu. & training
HUMAN RESOURCE ACCOUNTING IN INDIA In India, the financial statements of companies have to be
presented as per the provisions of the companies act, 1956. The act does not provide for disclosure of any significant information about human resources employed in a company except that the companies have to give by way of a note to the profit and loss account, particulars of employees
getting remuneration of Rs. 144000 per annum or more. However, there is nothing in the act which presents a company from giving details about its human resources by way of supplementary information attached with its financial statements.
In view of the growing importance of human resource accounting, many corporate enterprises in India are voluntarily giving information about their human resources. They number about 15 in all and include many important public sector enterprises viz. Bharat Heavy Electrical Ltd. (BHEL, Steel Authority of India Ltd. (SAIL), Minerals and Metal Trading Corporation of India. (MMTC), National Thermal power Corporation (NTPC), Oil and Natural Gas Commission, (ONGC) and Engineers India Ltd. (ElL). Among all these enterprises BHEL is the pioneer in the field of human resource accounting since mid 1970. Most of the Indian companies and corporations have followed basically Lev and Schwartz model for valuation of human resources.