Importance Of Human Capital Assets Value example essay topic

The success and failure of an entity will depend on how effectively it utilizes its available resources. Managers must attempt to optimize the acquisition, allocation and development of the assets of the firm. Managers always equate assets to the physical and financial assets of the firm and often ignore the most important and the key element to the success of the organization - it's employees. In service related businesses tangible assets contribute far less to the value of the service than do the intangible assets. These intangible assets are represented by the accumulated and current knowledge of the entity's past and present employees. The abilities of all the employees of an organization at all the levels - management, supervisory and ordinary - to produce value from their knowledge and capabilities of their mind are known as HUMAN CAPITAL ASSETS.

THE IMPORTANCE OF HUMAN CAPITAL ASSETS Value is created when intangible resources are deployed and degrades when they remain unused. Today knowledge or more colloquially, intelligence and brainpower have become the key determinant for the economic and business success. The key success factor of an individual business enterprise is no longer its sheer size or the number of tangible assets it controls - It is it's Human Capital. The importance of the human resources of a company can be illustrated in several ways. The market prices of corporate securities often reflect values substantially different from those indicated by the recorded values of the individual assets.

Obviously, a number of intangible assets including human resources continue to remain unrecorded. Early evidence suggested that the replacement costs of human resources are quite substantial. In a survey, five hundred corporate presidents were asked about the cost of replacing their entire workforce. The estimates ranged from three to five times of the annual payroll of the company. If an organization pays Rs.

500 million payrolls it would have a worth of Rs. 1 billion to Rs. 2.5 billion. Further, in any organization the payrolls exceed the earnings by eight to ten folds, and since the human organization can be regarded as worth three to five times the payroll, the human organization could be valued at twenty five to fifty times a company's annual earnings.

A five percent fluctuation in the firm's human capital would be equal to its reported annual earnings. The growing technical complexity of the modern business and the increasing time required for an individual to gain the experience is making the brainpower a critical resource in many developed countries. In such countries a lot of financial capital is invested in creating the knowledge and intellectual capital. For this reason it is not uncommon to learn of a large corporation purchasing small technologically superior firms - not for their plant and equipment but for their skilled managers, scientists and engineers as evidenced by the "merger mania" experienced in the last 15-20 years. Clearly human capital assets, device creations such as patent able inventions and copyrightable materials, which provide exclusive future benefit potential. Human capital also provides various expert services, consulting and financial planning, which are valuable for free services and are in demand.

In fact, the intellectual assets of a company are often worth three or four times the company's tangible book value. HUMAN RESOURCE ACCOUNTING Human resource accounting historically has been defined as the process of identifying and measuring data about human resources and then communicating this information to interested parties. Human resource accounting, after almost 40 years of extensive research, still continues to be a topic hotly debated by both accounting theoreticians and practitioners. Since initially appearing in the accounting literature, Human Resource Accounting has gone through several stages of development, which are: 1. Development and Validation 2.

Organizational Applications 3. Empirical Research Investigation The potential impact of HRA on economic resource measurement of the firm has always been a source or wonder and astonishment. How exactly do we demonstrate that the little user's guide shipped with a washing machine or the online help embedded in a hotel reservation system make a positive contribution to a company's finances? One of the most recurring topics in technical communication is "proving" the value of our work.

Our current accounting systems and practices have limited means for calculating the financial benefits from the value added services packaged with products and policies and procedures developed for use in-house. When financial capital was scarce and labour was plentiful in the predictable world, the focus of attention was definitely Finance. Financial accounting, planning and control were considered as the key to sustained success for mature organisations. But access to financial capital no longer remains an issue in the global marketplace and human capital is emerging as the new critical factor in this changing environment.

Business valuations, company law and corporate governance are consequently moving away from the conventional considerations of the last century. The accounting methods that were developed and which had become the standard for the Old World now can no longer place a sensible or fair value on a business nor help its stakeholders to assess its capabilities and future prospects. Financial statements cannot tell us how much value is lost in washed out human capital during mergers nor the future cost for developing and redeveloping the competencies lost on account of downsizing. Human Capital Accounting deals with six major issues, which are: 1. Existing methods of reporting on the financial value of Human Capital as an intangible asset. 2.

New reporting standards for the non-financial aspects of Human Capital. 3. The new concepts of Human Capital. 4. Measuring Human Capital. 5.

Analyzing Human Capital (to develop HR strategies that drive organizational performance). 6. Placing Human Capital on the balance sheet. Human Resource Accounting can be tracked through two methods: Cost-based analysis Value-based analysis The cost-based approach focuses on the cost parameters, which may relate to historical cost, replacement cost, or opportunity cost. The value-based approach suggests that the value of human resources depends upon their capacity to generate revenue. This approach can be further sub-divided into two broad categories: non-monetary and monetary.

The nature of resources can also be examined by allocating relative human asset values to different job grades. HRA also helps in examining expenditure on personnel and in re-appraisal of expenditure on services and training. It can also serve as a key factor in case of mergers and take-over decisions, where the human asset value becomes a relevant factor. Another very significant role, which HRA can help in creating, is goodwill for a company. The company can project itself in having best practices with superior policies in place.

Experts believe that this may help the organisation attract more investments. STAND-IN ACCOUNTS FOR HUMAN CAPITAL The various approaches to stand-in or surrogate accounts for human capital also form an important part human capital accounting. Our main focus here is: 1. Goodwill Account 2. Research and Development Expenditure Goodwill Realizing the financial accounting failure, intrinsic in ignoring human capital, capitalizing the asset seems to have become the need of the hour. In certain instances, rather than show it under a separate head, human capital asset is capitalized as "goodwill."Goodwill is the present value of the entity's projected future excess earnings over the average earnings of another entity in the same industry".

There are certain conflicting views regarding goodwill. Some accounting theoreticians argue that goodwill should be written off immediately because it is not transferable, some argue the permissible maximum amortization period should be short because technology changes so swiftly, while others contend goodwill should be viewed as permanent until it has become apparent that it has declined in value. Those who argue that human capital assets should be recognized do not favour immediate write-off or the present amortization requirement for goodwill. Research and Development Research and development costs could be considered substitutes for human capital assets because research improves the knowledge and awareness of employees.

Intellectual capital would be considered to have been increased because of the learning and understanding gained by means of engaging in the research and development. It would be thus expected that the revenues for the firms engaged in research and development would be greater as compared to the firms who have not undertaken research and developmental activities. A number of different methods have been proposed as possible approaches to capitalizing human assets directly. One approach is to capitalize all human resource development expenses and the second approach is to capitalize un purchased goodwill. Capitalizing Un-purchased Goodwill We have previously discussed the goodwill account as a substitute in many instances of human capital.

A very famous method of determining human capital assets is by capitalizing un-purchased goodwill. In this method the excess earning of an entity over the average earnings of all entities in the current year are capitalized. First, the net income after taxes is divided by the average value of owned assets for all business entities. The determined result is the rate of net income on average owned assets. Each entity would determine its own rate of net income on average owned assets.

If an entity's net income were lower than the average for all business entities presumably it had not managed its human resources so effectively that it had capitalizable human assets. If the entity had higher than average rate of net income on average owned assets then the entity had human capital assets that could be capitalized. The excess earnings were presumably due to the application of the intellectual intelligence of the employees. Capitalizing all Human Resource Development Expenses If the outlook that employees are valuable assets and will provide future value to the firms is accepted then the payroll costs that optimise the value of employees in the organisation should be ideally viewed as investments in assets. Those expenditures commonly viewed as expenses but are actually related to the development and progress of human resources of the firm should be capitalized. One approach suggested for the capitalization of assets would be to capitalise the following human resource development expenses.

1. Recruiting - Offering inducement to qualified personnel to accept a particular job or profession 2. Hiring - Engaging personnel services 3. Education and providing schooling and mental development 4. Training 5. Conserving as well as preserving the health and maintaining safety 6.

Utilizing - making use of employee talent 7. Evaluating - Objectively reviewing, examining and judging employee qualifications 8. Rewarding - Giving fair recompense for the valuable contributions of employees In short, one simple approach to capitalization of assets could be capitalizing expenses, such as those in the preceding list, which are related to the development of the entity's human resources. ACTUAL PLACING OF HUMAN CAPITAL ON BALANCE SHEETS A lot has been said about placing the human capital on the balance sheet but there are few who have tried to apply it into practice and one such example is that of the Government of Denmark. The Ministry of Business and Industry has issued a directive that from the trading year 2005, companies registered in Denmark will have to include information on their customers, processes and human capital in their annual reports. The information should have five measures for each parameter and comparison with the previous two years must be shown.

The report should have a narrative for each set of figures. Information for investors about intellectual capital, both current and future, should occupy at least one third of the report. Companies like Infosys, BHEL and Reliance in India have implemented HRA and few are working towards it. Infosys, which started showing human resource as an asset in its balance sheet, has been reaping high market valuations. NIIT has been following a similar method known as Economic Value Added (EVA), which also helps in assessing the real value that an employee can fetch for the company. Experts point out that companies can derive many benefits by going in for HRA.

Not only can they measure the return on capital employed on total organizational assets (including the human assets), but the resources can also be planned accordingly. Once organizations realize the actual benefit of HRA and take it as a growth process, it only helps them in increasing their shareholders' value. When a company is able to assess an individual's worth, it helps in increasing its own worth. THE DETERRENTS While HRA, as a concept has been present in India for more than a decade, with BHEL taking a lead, it is only now that the awareness is being translated into application. Still there are certain deterrents in the way, like, 1. In terms of awareness and acceptance, the level is still low as many companies take little initiative to make the numbers public to shareholders, despite having the data.

2. Another major deterrent is the lack of an industry standard. This means that every company has to evolve its own standard, which can become a tedious process, considering that most of them are still involved in improving their business. Industry bodies like Nass com can help set a standard.

3. Another aspect working against the acceptance of HRA is the need for extensive research that it entails. Many companies do not want to go into the intricacies of finding the value of their human resources. Some industry people feel, while most big companies (with a large manpower) can afford to dwell into such best practices, it is not an economically viable option for small and medium companies. 4. One cannot totally rely on this concept.

Considering the dynamism of the industries, it is very difficult to predict as to what is going to be your future requirements and how technology is going to shape in the near future. 5. Finally, placing a monetary value on intangible assets, like human capital, creates the potential for abuse. CONCLUSION Most of researchers agree that managers, investors, and society in general would benefit from further research in HRA. The adoption of an HR measurement framework is about extending the credibility of HR on the one hand, and on the other placing human capital firmly and strategically on the organization's balance sheet. Measurement represents a powerful tool by which HR can change the way it works and the value the organization perceives it to create.

To know how to measure economic categories related to human beings means that social relations can be better understood and justified. Moreover the economic exchanges between the economic unit and society as well as between persons themselves could be better monitored and deeper recognised..