What is Human Resource Accounting?
As you pick through the 500 million pages or so that Google throws up during a search into Human Resource Accounting, you’ll find the definition laid out by the American Accounting Association’s Committee crops up quite regularly:
“The process of identifying and measuring data about human resources and communicating this information to interested parties.”
Remind me never to get stuck in the kitchen at a party with them.
However, this process’s growing popularity that provides organizations and managers with real data on one of our most valuable resources—their people—shows that it holds real value in many key areas.
So, let’s try and put it in a better way.
Human Resource Accounting is a way to measure the cost to the company of its people against the income they create.
In the most basic accounting formula:
Generated income – employee cost = profit
But, as we all know, life just isn’t that simple. People aren’t like machines and equipment. Yes, they may both wear out over time, but people grow in experience, education, and skills, often increasing in value over time, but that’s only if their costs remain the same, which they don’t. And not all of our people advance in value. Some slide right off the scale.
Enter Human Resource Accounting—doing its best to make sense of human value. A method (or multiple methods) or measuring financial value, tangible costs, and personable value inform those who need to know precisely what type of return they’re achieving on their investment.
What are the objectives of Human Resource Accounting?
Objectives vary from business to business, but as a rule of thumb, they include:
- Providing the cost of acquiring, developing, and maintaining the people in your business.
- Delivering accurate financial monitoring of employees for managers.
- Locating any areas of depreciation and appreciation amongst a business’s staff.
- Helping to develop more effective management operations.
- Creating a deeper awareness of the value of a team.
- To create a more streamlined and effective human resource system.
- Becoming accurately informed about the people and their roles in the business, to make better-informed decisions where required.
- Creating an efficient utilization of the company’s manpower.
As you read down the list, it all seems very much a matter of common (business) sense. The more data we’re armed with, the better equipped we are to make those big decisions.
When it comes to measuring the numbers, though, HRA has to dig deep into a lot more areas than you’d initially think. The most obvious measure is to believe that the cost of your staff is their wages. When you look at these models and the impact of everyone working within a business, you soon start to see the effect runs far deeper than you’d ever imagined.
- Acquisition – marketing, advertising, interview, agency costs, and recruitment fees
- Education – training, development of a role, implementing new technologies, learning new systems and software
- Remuneration – salaries, bonuses, incentives, benefits, holiday pay, and other paid time off
- Managing – the cost of organizing and maintaining a happy staff, meeting needs, managing issues, and creating a satisfactory environment
This is only a small selection of the total possible variables involved. Allocating how an income stream relates to each employee in the organization also takes a great deal of understanding to monitor accurately. Different roles will have varying levels of impact on sales; every business’s complexities make it difficult to create a system to monetize and measure.
What is the importance of Human Resource Accounting?
Every manager will have plenty of long and short-term goals for their business. How they get there and achieve the results they set out to is down to meticulous planning, making the right decisions, and understanding the data.
Monitoring costs versus income is the simplest way of measuring profit, but that doesn’t always give us the true value of the way a business is being run or its staff’s effectiveness.
What are the advantages of Human Resource Accounting?
Utilizing any data instead of a hit and hope mentality gives all of us the ability to make better-formed decisions. When it comes to accounting costs and running a business, the advantages are almost endless.
Understanding what your staff cost and the financial input and effect they have on your business allows you to better plan and organize your operation.
Suppose you’re considering expansion, diversifying, investing in new technology, or moving operations. In that case, it all depends on cost, and that includes the cost of the people you’re going to move into those roles.
Providing business and financial stability
Monitoring patterns and the awareness of costs, especially of our people, deliver the ability to invest sensibly and maintain the strongest players in their relevant roles, avoiding uncertainty and poor performance.
Creating forward movement and development
Monitoring the returns or losses of specific training and development avenues gives managers an understanding of how beneficial—or not—they are for growth.
Improving employee aspirations
Promotions, benefits, and further investment into employees create a desire for improvement, loyalty, and personal development.
The benefits and bonuses to drive harder-working employees to achieve greater results can be monetized and measured, anticipated, and enhanced.
It’s a superb avenue for testing
Such testing isn’t limited to any part of the business. From interviewing techniques to training and bonus delivery—each test can be monetized and measured to define best practices, improve systems, and create growth.
What are the limitations of Human Resource Accounting?
There are, of course, limitations with such difficult commodities to measure. People aren’t as black and white as machines are, and measuring such a diverse range of assets is incredibly complex.
Without some sort of standardized procedure, HRA isn’t as quantifiable as general accounting.
Let’s consider a few of the elements that undoubtedly add anomalies to the process and its figures.
We’ve made the assumption earlier that we grow with experience, creating an employee’s appreciation as a resource. But, if we’re stuck in old methods in a changing and advancing market, such value depreciates.
The lifespan of the resource can’t be guaranteed either. People leave jobs to chase better opportunities all the time. Measuring the return on the massive investment in acquiring staff that may stick with a company for six months or six years creates issues.
No two people are ever the same. Consider a sales team with the same opportunities and equipment, yet, each month, their performances will differ from their colleagues’ performance and to that of their performance over previous months.
Neither can you guarantee stability in your industry market, unforeseeable events that change the way your sector operates, or world events that impact not only the operation of your business as a machine but of your staff as emotional beings. They can all create anomalies in an HRA system.
Human Resource Accounting methods/models of Human Resource Accounting
When it comes to the models of HRA, they fall into two camps: cost-based models and value-based models.
Historical cost model
This approach measured the actual costs in recruiting, hiring, training and developing their human resources over the hire’s expected lifespan. This way, the expense can be written off against the income attained over the same time or expected life of the company’s operative.
However, where new hires leave the company early, for whatever reason (a liquidated asset no less), the account’s impact would be obvious. With less time and return to write-off against, the value of the hire is low.
It’s a similar way to measuring physical assets, creating some kind of ‘book value.’ Sadly, unlike physical equipment and resources, people aren’t quite so easy to estimate.
Replacement cost models
This model considers the costs of replacing its human resources from scratch. Suppose the business were to lose a key player (or any player). In that case, the costs a replacement cost model considers are those required to find another suitable, equally qualified, and proficient team member.
This approach feels fairly realistic, as it measures against the current financial health of the business. However, its limitations include issues with finding an identical replacement to balance the figures.
No two people will have exactly the same qualities and performance levels, showing the model can’t truly value people as physical assets as conventional accounting methods would.
Opportunity cost models
Opportunity cost is the value of an asset when considering its investment against an alternative use. Applying this to human resources, the creators perceived that an employee who could be moved within the business’s roles held additional value.
However, this system’s limitations include misleading or unrealistic bidding wars between departments, creating low or high-cost value, without too much input into carrying out the role itself and performance.
Also, the value is restricted to use within the business, where the assigned value might be inaccurate when it came to other outside environments.
Value of future earnings models
This value-based model compares the investment into human resources against their estimated future earnings.
As you can imagine, a model working on an estimated future anything leaves itself open to issues. Over time, roles may change, employees will leave, and their performance itself could shift.
Reward valuation models
Reward valuation models improve on the previous values of future earnings models by including the probability of employees moving through organizational roles over time.
The limitations here are with those employees who fail to follow a typically expected path. Assigning monetary values to the change of positions over time is also problematic.
Valuation as a group model
One of the issues of the reward valuation model was that it failed to include individuals’ impact within groups and teams.
Estimating the percentage loss of employees from a group was easier than estimating any single employee or worker’s working lifespan.
The probabilities worked with were estimates, determining the economic value of single employees on group results. The model fails to incorporate that the strongest players can carry a weak team, and the weakest players will hold just the same economic value.
A group could suffer far more dramatically than anticipated at the loss of their strongest acquisition than one of the weaker employees.
Understanding what our employees, managers, and staff are worth in monetary terms can help guide managers and business owners to make truly important decisions, especially when it comes to staff acquisition, company development, and, of course, in finance and budgeting.
Determining the best model for each business has to be considered a course of action; the figures delivered have to offer real value to its managers.
It does uncover that understanding the value of our teams goes a lot deeper than the numbers they represent. Yet, those numbers provide an equal amount of valuable business data for so many future all-important big-business decisions.