Top 4 Methods Used to Measure Human Resource in Your Organisation – Explained!

2. The second question is – How should this asset be amortised?

Some of the methods have been discussed here.

Approaches

(1) Historical or Actual Cost Method:

This approach was developed by Brummet, Flamholtz, and Pyle. Under this method, the amount actually spent on the recruitment, familiarisation and development of employees is capitalised and amortised over the period for which the benefits are expected to flow to the organisation.

Outlays which do not have value beyond the current accounting period are treated as operating expenses.

Costs on recruitment, selection and placement are called acquisition costs while the costs of orientation and training are known as learning costs.

In case the human asset expires before the end of the expected life period or leaves the organisation prematurely, the unamortised cost remaining in the books has to be written-off against the profit and loss account of the particular year.

If the useful life recognised is longer than the original expected life, the amortisation is to be rescheduled.

Merits:

This method has the following merits:

1. This method follows the traditional accounting concept of matching cost with revenue and this is easy to understand.

2. The advantage of this method is that the effect of human resource accounting can be shown on conventional balance sheet and profit and loss account because the information in these statements is also stated on historical cost basis.

3. It can help the firm in finding out the return on human resource investment.

Demerits:

This method suffers from the following difficulties:

1. It is very difficult to estimate the number of years an employee will be with the firm.

2. It is also difficult to fix a rate of amortisation. A number of methods have been devised to write off depreciation on fixed assets but in the case of human assets it will generally be on a constant basis.

3. The extent to which employees will utilise the knowledge acquired is also subjectively estimated.

4. It is difficult to determine the number of years over which the effect of investment on employees will be realised.

5. The value of human resources according to this method goes on decreasing every year due to amortisation but in reality the value of asset increases over the time because of the experience gained by him.

(2) Replacement Cost Approach:

This method was developed by Rensis Likert and Eric G Flamholtz. Under this approach the human resources are to be valued at their replacement cost that is on the basis of the assumption of what cost the firm would incur if the existing human resources are required to be replaced with others of equivalent talent and experience.

This method can assist the process of manpower planning by providing estimates of the costs involved in obtaining employees for different positions.

Decisions about the quality of the personnel to hire and the training programmes to be arranged for them can be taken into account.

Likert has suggested determination of the value of total human organisation on the basis of the assumption that a similar organisation is to be created from scratch. Replacement cost can be of two types:

(a) Positional replacement costs:

Are typical in nature and relate to the position and not to the individual who occupies it. e.g., what will be the replacement cost of the position of an HR manager? All the costs of acquisition, development and separation.

(b) Personal replacement costs:

Are related to a particular person. The substitute must be one capable of the same efficiency as person being replaced.

The replacement cost approach incorporates the current value of the human resource of a firm and hence the financial statements prepared under this method would be more realistic than those prepared under the historical cost approach.

Merits:

1. This approach has the advantage of adjusting the human value of price trends in the economy and thereby provides a more realistic value in inflationary times.

2. It has the advantage of being present-oriented.

Demerits:

1. It is very difficult to ascertain the correct replacement cost of a human being as there can be no complete replacement of a person. The approach gets affected by personal prejudices.

2. The management may be unwilling to replace the human asset because the present value is greater than its scrap value.

3. It is not always possible to find out the exact replacement of an employee.

4. This method is inconsistent with the historical cost of valuing assets. However, the problem could be solved if all the assets are valued at replacement cost.

5. This method does not reflect the knowledge, competence and loyalties for an organisation than an individual can build overtime.

6. It is difficult to find out the cost of replacing human resources and different persons may arrive at different estimates.

(3) Opportunity Cost Approach or Market Value Method:

This approach has been developed by Hekimian and Jones. It suggests competitive bidding process for the scarce employees in an organisation.

The opportunity cost is linked with scarcity. This method is based on the economist’s concept of opportunity cost as “the most profitable alternative use that is foregone by putting it to its present use”. Hekimian and Jones made use of the concept of opportunity cost, in valuing the human resources.

In this method all managers within an organisation will be encouraged to bid for any scarce employee they want and the one who is able to acquire his services puts the bid price as his investment base in respect of that employee.

The bid price is supposedly arrived at by calculating the actual or expected rate for capitalisation of the differential earnings supposed to be earned by the employee.

If an employee can be hired easily externally, there is no opportunity cost for him. A human resource asset has value only when it is scarce.

These “scarce” employees come from within the firm and include only those who are the subject of a recruitment request made by an investment centre manager.

The investment centre with the highest bid would win the human resource and include the price in its investment base.

The competitive bidding process provides an optimal allocation of personnel within the firm and a quantitative base for planning and developing the human assets of a firm. The amount of bid is added to the capital employed of the successful bidder for determining return on investment. This approach is based on the same principle of demand and supply.

Merits:

1. According to the experts, this is a promising approach towards more optimal allocation of personnel.

2. It is a quantitative base for planning, evaluating and developing human assets of the firm.

Demerits:

1. This method suffers from the problem of valuation ie., the adoption of a procedure by which the manager is able to decide the amount of the bid (offer).

2. This method cannot be applied when the employee has no alternative use. This approach specifically excludes those types of employees who can be hired readily from outside.

3. The total valuation of human resources based on this method may be misleading and inaccurate, especially if a person is expert in one department and useless for the other departments.

4. This method may lead to lowering of morale of employees especially of specialists who cannot be used in other divisions.

5. Less profitable divisions may be penalised for their inability to outbid for the recruitment of better employees.

6. The economic and current value approaches using the present value of expected future benefits have a strong theoretical approach. However, from the practical point of view, it is very difficult to quantify future economic benefits.

(4) Economic Value Method:

In this method human resources are valued on the basis of the contribution they are likely to make to the organisation during their continuance in the organisation.

The payments to be made to the person by the employing organisation in the form of pay allowances, benefits etc, are estimated and discounted appropriately to arrive at the present economic value of the individual.

A number of valuation models have been developed for determining the present value of future earnings. Some of the important models have been discussed here:

The Lev and Schwartz Model:

This model has been developed by Lev and Schwartz in 1971. Under this model all the employees are classified into specific groups according to their age and skills. Average annual earning is 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 resource asset.

The Lev and Schwartz model suffers from the following limitations:

1. The model does not consider the possibility of employees leaving the firm.

2. The model ignores the possibilities of promotion of employees.

3. It does not consider the contribution of the firm in developing the value of human capital.

Flamholtz Stochastic Rewards Valuation Model:

According to this model, the ultimate measure of an individual’s value to an organisation is his expected realisable value.

The expected realisable value of an individual is the present worth of the future services expected to be provided during the period he is expected to remain in an organisation.

This is based upon the notion that human beings, like all other assets, are capable of providing future service that has economic value.

The model suggests a five-step approach for assessing the value of an individual to the organisation:

1. Forecast the expected service life of an employee.

2. Identify the roles he (employee) might perform.

3. Estimate the value derived by the organisation when a person occupies a particular position for a specified time period.

4. Estimate the probability of occupying each possible mutually exclusive state at specified future times.

5. Discount (at predetermined rate) the expected service rewards to their present value.

The Flamholtz model is an improvement over the Lev and Schwartz model in the sense that it takes into consideration the possibility of an employee leaving the service as well as the possibilities of promotion of employees.

However, the major drawback of this model is that it is very difficult to estimate the likely service states of each employee.

The model also suffers from the flaw that individuals working in a group have higher value for the organisation as compared to the sum of their individual values.

Morse Net Benefit Model:

According to this model, the value of human capital is determined on the basis of the present value of net benefits derived by the organisation from the expected future services of its employees. It involves the following steps:

1. Determination of the gross value of future services to be rendered by employees in their individual capacities as well as operating in groups.

2. Determination of the cost i.e., the total future payments to be made to the employees.

3. Calculation of “net benefit” to the organisation on account of human resources by subtracting (2) from (1).

4. Calculation of the present value of the net benefits by discounting at predetermined rate of discount.

Chakraborty’s Model or Average Payment Approach:

This approach has been suggested by Prof S.K Chakraborty. He is the first Indian professor to suggest a model for valuation of human resources of an organisation.

In his model, he has valued the human resources on aggregated and not on individual basis. However, managerial and non-managerial manpower can be evaluated separately.

The value of human resource on a group basis can be found out by multiplying the average salary of the group with the average tenure of employment of the employees in that group and shown as Investment in the Position Statement.

The average annual salary payments for next few years could be found out by salary grade structure and promotion schemes of the organisation.

The model consists of the following steps:

1. All the employees of an organisation are divided into two groups, managerial and non-managerial.

2. The average tenure of the employment of the employees in the group is estimated on the basis of past experience.

3. The average salary of the group is determined on the basis of the salary wage structure prevalent in the organisation.

4. The human resources values are determined by multiplying the average salary of the group with the average tenure of the employees in that group.

5. The value determined under (4) 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.

Prof Chakraborty suggested that the recruitment, hiring, selection, development and training cost of each employee should be recorded separately and should be treated as deferred revenue expenditure and may be written-off over the expected average stay of the employee in the organisation.

The deferred portion not written-off should be shown in the balance sheet of the organisation. If there is a premature exit of an employee on account of death, retirement etc., and the balance of the deferred revenue expenditure attributable to that person should be written-off against the income of the year of exit itself.

Prof Chakraborty suggested that “human assets” should be shown under the heading “Investments” in the balance sheet of an organisation to avoid the problem of depreciation of capital gains and losses in the event of their exit. He has not favoured to include the human assets either under fixed assets or current assets.