PROJEK PELAMI /THE.Qf§

BENEFITS AND LIMITATIONS

OF

HUMAN RESOURCE ACCOUNTING

pQTQSTA

A PAPER SUBMITTED TO

MARA INSTITUTE OF TECHNOLOGY

IN PARTIAL FULFILLMENT OF

THE REQUIREMENT FOR

ADVANCED DIPLOMA IN ACCOUNTANCY

BY :

NAME : CHE KARTINA BT. IDRUS

ITM NO : 90002168

DATE : 1 St. AUGUST 1992 ,

« ' •

Page

ACKNOWLEDGEMENT . . . . : . . ". .'. . . . . iv

ABSTRACT . . ... . v

CHAPTER ONE

INTRODUCTION . .' i

l.i TERMINOLOGY ...•..•. ... 2

1.2 OBJECTIVES 8F HRA . . . ": 3 •

1.3 OBJECTIVES OF STUDY 4

1.4 ^HISTORY OF KRA '....,.:. 5

- 1.5 METHODOLOGY .. .... 7

l.'e SCOPE AND LIMITATIONS 8

CHAPTER TWO

LITERATURE REVIEW 10

2.1 DETERMINANTS OF AN INDIVIDUAL VALUE 13

A. Individual Conditional Value .. 15

B. Probability of Maintaining Organizational Membership 23

CHAPTER THREE

DATA COLLECTION 28

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• page

CHAPTER FOUR

ANALYSIS OF DATA

4.1 ACCOUNTING FOR HUMAN RESOURCES

I. Measurement and Recording of HRA 30

A. Cost-based Measurement

a. Historical Cost /ipriT;^ Qs^i^^h 30

' b. Replacement Cost Approach 32

c. Opportunity Cost

Approach 32

B. Value-based Measurement

a. Capitalization of Salary Approach 36

b. Unpurchased Goodwill

Method 37

c. Economic Value Approach .. 39

C. Non-monetory Measurement .... 40 4.2 AN APPLICATION OF STOCHASTIC

REWARDS VALUATION MODEL AT LESTER WITTE & CO ( a CPA FIRM ) 41

4.3 BENEFITS AND LIMITATIONS OF HRA

I . Benefits of HRA 48

II .Limitations of HRA 51

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page

CHAPTER FIVE

CONCLUSION .. . 54

BIBLIOGRAPHY 56

APPENDICES • -

APPENDIX A -

APPENDIX B ,

APPENDIX C .

..APPENDIX D

•APPENDIX E

APPENDIX F

APPENDIX G

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ACKNOWLEDGEMENT

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The author would like to express her gratitude to

Mrs. Jagjit Kaur, the advisor of this project paper for

all the beneficial time and effort that has been

contributed to read and offered many suggestion which

made this a stronger project paper.

In addition, the author appreciate the kindnest of

the librarians of Mara Institute of Technology,

International Islamic University and University of

M'alaya for their help in searching the related articles

and reference books. ^

The special contributions of idea and opinions

from En. Salleh and En. Khairuddin who are currently

working in Islamic Bank and Petronas are gratefully

acknowledged.

Last, but not least, this project paper could not

have been put together without the support,

encouragemen*t and advice from beloved mother . and

supportive friends.

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ABSTRACT

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Human Resource Accounting ( HRA ) is. a new

approach in evaluating human resources that represents

the current status of human resources valuation concept;

which currently is being developed mostly in the

Western countries. By helping management'identify and

evaluate the human resources attributes that can make

the firm more profitable, human resources planning can

also make a significant contribution to a business.

There is a difficulty of measuring Human

Resources, therefore an audit firm has been chosen as a

field of study since it keep tracks of amount of hours

spent on each of the audit staff.

I

A very sophisticated approach to HRA with the

Stochastic rewards valuation model • which has been

applied in Lester Witte & Co, ( a firm in USA ) has been

put forward in this project paper. The model identifies

5 elements that must be defined in determining an

individual's value to the employer . Before that, the

various methods of HRA that have been recommended will

be further elaborated. Benefits and limitations of HRA

is another area to be taken into consideration , before

implementing HRA in the accounting system .

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Finally, It's hoped that this project paper will

contribute to a better understanding of . !. Human

Resource Accounting .

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Moiua^io^im

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In recent yearS;, more -and more organisations are

beginning to extend their information resources by

moving towards systematic research which in essence,

seeks new information about the functioning of the whole

system in relation to its changing environment. One

example is the information gathered about the value of

its :human resources as an organisation moves through a

period of technological and personnel changes.

From an accounting point of view, all assets are

economic values that should be charged to the operations

of • the periods they benefit. This principle applied to

the entire economic life of the assets involved. For

that reason., advocates of human resource accounting

believe that, the often significant costs incurred in

recruiting, hiring, training and developing human

resources for the benefit of more than one period

should, like any other asset of material value be

indentified and charged to the periods in which their

benefit is felt.

The upshot of all this is that such information

can be of vital importance to management for decision

making and measuring the return on their present and

future investment in human resources. More effective

planning and controlling efforts are then assured,

particularly in labour intensive industries, in the

provision of professional services and in the

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relatively new. but- expensive ' specialties, suj h as

systems analysis,and programming.

Of course this holds true only if operating

budgets include all the costs incurred in each

accounting period ' and the amortization of . human

resources over the period benefited. '~

Edwin H. Caplan and Stephen Lendekich in their

-book entitled HRA : Past, present and futuroe, said that:

"There appears to be two major reasons why HRA.has been receiving so much attention in recent years. Firstly, developments in modern organisation theory have made it apparent that there is a genuine need for reliable and complete information which can be used in improving and evaluating the management of human resource. Secondly, the traditional framework of accounting is in the process of being expanded to include a much broader set of measurement than was thought possible or desirable in the past."

1.1 TERMINOLOGY

Human resource Accounting ( HRA ) has been defined

as a method of identifying, measuring and communicating

information about human resources in order to facilitate

effective management within an organisation ( formally

incorporate the value of human contributions into the

.valuation of the firm ).

( Lee Khee Joo, "Human Resource Accounting", Akauntan Wasional, June 1989, p.16 ).

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Stuart Armstrong and Mitchel, James 0 defined HRA

as whatever anybody wants to do to measure the, cost

benefits of managing.human resources and it involves

techniques for estimating the economic impact of the

behavioral outcomes of human resources or marketing

programs. ..

In general, HRA is not only a system of accounting

for an individual's organisation cost and value but also

involves a new way of thihking about managing people who

are the most valuable . and- important asset of^ the

company.

1.2 OBJECTIVES OF HRA

a. To provide cost-value information for making

management decision about acquiring,

allocating, developing and maintaining human

resources in order to attain organizational

objectives.

b. To identify the respective contributions of

capital and labour to overall organizational

performance and to provide a basis for managing

the organization with greater economic

rationality ( through the provision of improved

information for the personnel function).

( Parker L.,D, Terris K.R and Otley P.T, p.150 )

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r;^^;^^^'^^^'^!^^^

c. To provide quantitative information on an

organizations of human resources that

management and investors can , use in their

decision making process.

d. To effectively monitor the use of human

resources in the management's planning and

control function.

e. To aid in the development of other management

objectives' by quantifying the human values to

arrive at better decision making process.

f. ' To provide methods of evaluating management's

utilization of human resources for example

monetary resources for turnover costs.

( Mc.Rae, Thomas W, "Human Resource Accounting As A

Management Tool," The Journal Of Accountancy, August

1974.p.32 )

1.3 OBJECTIVE OF STUDY

a. To be knowledgeable with the concept of Human

Resource Accounting •( HRA ), both theoretically

and practically. This include :

i. the objectives for adopting HRA

ii. the issues and problems concerning the

acceptance of HRA.

iii. the benefits of implementing HRA..

* •

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b. To be exposed to the measurement method and

recording of HRA in the accounting system. HRA'

is still a new approach and with this study it

is hoped that it will give a better

understanding of the subject itself.

c. To establish the determinants of an Individual

Value and the application- of HRA in an

organization. This study would also like to

probe into the extent of how to determine an

individual value since 'individual should also

be considered as an asset to the organization.

The author would study the application of HRA

in an overseas organisation.

1.4 HISTORY OF HRA

Since the 1960's, research, in this subject has

primarily developed based on the human resources school

of personnel management. Flamholtz has specified five

stages in the development of HRA, which are :

a. From 1960 - 1966, this was marked by the

derivation of HRA concepts from the economic

theory of human capital, then the new human

resources school and organizational

psychologists' focus on leadership

effectiveness.

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b. Between 1966-1971, this was identified as a

period of basic academic research, measurement

of models and identification of potential user

as well as some experimental applications in

actual organizations.

c. From 1971-1976, this was a period of growing

interest in HRA, exhibited by. both researchers

and organizations. The applications of HRA were

mostly attempted by small entrepreneural

organizations. Assessments were also made on

the potential impact of HRA information to line

manager and investor decisions.

d. Between 1976-1980, this was identified as a

period of declining interest among accounting

researchers and business organizations.

Flamholtz has attributed that interest in HRA

has waned, possibly because the public

accounting standards- were too stringent to

allow the direct reporting of human asset value

in financial statements, the preoccupation of

business with other concerns and the lack of

organizations preparation to sponsor HRA

applications research and expenditure.

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e. Since 1980 and up to present, there has been

a period of growing interest in HRA. This has

been shown by demonstration of new research

studies and some attempts by major

organizations to apply HRA. In United States,

interest has been accelarated by a focus on

employee productivity. Some of Japanese

Corporates have shown interest in applying a

new approach to their human resources ( as

lifetime a.ssets rather than expenses ). In

Western economies itself, there was a change of

primarily industrial manufacturing to high

technology service economies for which human

capital is a critical source.

1,5 METHODOLOGY

All the information are obtained and compiled

mostly from overseas magazines, accounting journals and

reference books.

The author has conducted an interview with En.

Salleh Yusof, a Personnel Officer in Bank Islam and En.

Khairuddin, a Human Resource Officer in Petronas, to get

some idea and opinion from them regarding the

application of Human Resource Accounting in their

respective organisations. Questionnaires were

distributed to both of them.

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A letter of correspondence was sent to Malaysian

Institute of Accountant ( MIA ) to obtain their

perception on this matter.

1.6 SCOPE AMD LIMITATIOHS

The author feel that the analyzing of data is the

most important area. The technique of "how to measure

and record Human Resource in the accounting system is

important. The author will therefore stress on the

measurement iriethod of Human Resource Acc-ounting. The

various measurement method are comprise of Cost-based

measurement. Value-based measurement and Non-monetary

measurement. Those measurement methods are then

subdivided into different cost approach.

As a result of non implementation of HRA in the

accounting system in any organization in Malaysia, the

author has selected one organization in USA which has

applied this approach in their reporting and management

information system.

Benefits and limitations of HRA is the major scope

that should be covered as it is the main topic of this

study. The author will discuss these benefits and

limitations if applied to any organisation.

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The limitation of this study is that no primary

data has been collected concerning the practicalities of

HRA since, none of the companies in Malaysia has adopted

this approach in their accounting system. All the

information are gathered from articles, accounting

Journals and reference books.

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UTEKATUm REVIEW

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According to Eric Flamholtz, the main criteria for an

asset are :

i. it must possess future service potential

ii. it must be measurable in monetary terms and

iii. it must be subject to the ownership or control

of the accounting entity ( e.g. in the case of

long term lease it would be classified as an

asset).

The investment in people, is expected to poE3es.s

future service potential, they are measurable in

monetary terms and they are subject to the control of

the organisation ( at least on a probabilistic basis )

and thus they should be treated as assets.

( Eric Flamholtz, "Human Resource Accounting,p.293 )

Hermanson argued and classified two types of asset;

the first will be entitled owned assets and the second

category entitled operational assets which will consist

of all scare resources operating in the entity that are

not owned. E.g trained salesforce.

( Lee Khee Joo, "Human Resource Accounting", Akauntan

Masional, June 1989,p. 18 )

F.A Nicholls suggested that HRA advocates were

concerned that the missing of the value of human

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resources in the balance sheet would be a serious

handicap to management and investors in decision making

process. As a matter fact, they appeared as a cost in

the profit and loss statement and some residue may be

found in finished stock or work-in-progress

The anxiety to get into the balance; sheet would

make that statement of resources more -of "mishmash" than

it is at present. He went on to say :

"It seems to be most unlikely that the effectiveness of the net asset value in a balance sheet will be much improved by the inclusion of an estimated capital value of the employees. Adding one more doubtful valuations will stretch the balance sheet beyond its limitations and make it lesSj not more useful. In addition, much of the statistical data generally available relating to employees can be supplied in more detail in published reports. Staff turnover figures, output for man-hour, changes in wages rates, number in. categories of skills, etc..".

( F.A Nicholls, " Human Assets Accounting'" Certified Accountant, June 1975, p. 324 )

During the last decade, several advocates of human

resource accounting, including Hermanson, Likert,

Likert and Pyle and Lev and Schwartz, have suggested

that HRA could benefit external users of financial

statements. External decision makers must know the

changes in human assets in order to evaluate properly

assets and income. If the condition of human assets

changes during the period, conventional accounting

income may be misstated and the asset base distorted.

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The committee on Human Resource Accounting,

summarized the above position :

External users, particularly investors, could benefit from HRA through the provision of information on the extent to which the human assets of the organization have been increased or hav.e diminished during the period ".

( James A.Hendrikcs, " The Impact of H-uman Resource Accounting Information On Stock Investment Decisions", The Accounting Mevie^-51, April 1976, P.292 ).

In his 1971 study, Flamholts proposed.a normative

human resource valuation model which would trace the

movement of an employee through organizational positions

or 'service states' where the individual employee

...is expected to render a specified quantity of

services to the organization during a specified time

period".

( Pekin Ogan, " A Human Resource Value Model For Professional Service Organizations, The Accounting Review, April 1976, p.306 )

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2.1 DETERMIMKTS OF M IHDIYIDUAL'S VALUE

An individual's value to an organisation is

thus multidimensional . It is comprised of two

interacting variables that are :

a. the individual's conditional value and

b. the probability that the individual will maintain membership in the organization^_

( Eric Flamholtz, " Towards A Theory Of Human Resource Value In Formal Organizations ", The Accounting Review. October 1972, p.669 )

An individual's 'conditional value' is the present

worth of the potential services that could be rendered

to the organization, if the individual maintained

organizational membership throughout his expected

service life.

The probability that the individual will maintain

membership in the organization is the complement of the

probability of turnover or exit. It determines the

extent to which the organization will realize the

individual's potential services or conditional value.

The product of these two variables is thus the

individual's 'expected realizable value' that is . the

present worth of services actually expected to derived

during the individual's anticipated tenure in the

organization. This is shown in Figure 1, below.:

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