Capitalizing Human Resources In Company Management Essay

Since the intellectual capital has gradually transformed into one of the most important assets valued by the companies, the system of the applicable accounting practices that refers to human resource capitalization is subject to thorough research (Guthrie, 2001). In 2003 Ken Lewis, HR Director of Co-operative Financial Services made the following statement:

“We believe that measuring and reporting on the contribution of our people to the business provides a tremendous opportunity to share and enshrine best practice, improving the competitiveness and performance of UK business in both national and global markets” (cited in Accounting for People, 2003, p.21).

The research paper outlines and analyzes the pros and cons of capitalizing human resources (HR) through human resource accounting in company’s financial statements.

The importance of HR capitalization

The rapid development of corporate sector (in particular service-oriented companies) in the well-developed economies of the world within the conditions of the knowledge economy of the 21st century has necessitated the reconsideration of the applicable accounting practices, policies and procedures. In particular, human capital and its intellectual potential are considered as the core assets of the service companies. Many companies owe their successes, profitability and competitive advantages namely to the quality of their HR performance (Brooking, 1996). Thus, to a large extent, the successfulness of most of the service companies in almost every industry directly depends on the quality of staff they hire, retain and develop. Much of the corporate investment therefore is directed to the staff training and empowerment to ensure the high level of both individual and team performance within a company (Robbins, 2001).

Many studies have so far shown that particularly service companies that capitalize their human assets are better valued in terms of return on investment thereon. In particular, the expenditures of quoted service companies on their human resources (including staff selection, recruitment, education, training, welfare, subsistence allowance and pension fund contributions etc) are better accounted for providing they are capitalized. Thus, most of the studies recommend the companies to capitalize their human resources and report all their human resource expenditures which improve the productivity and quality of company’s performance (Edvinsson and Malone, 1997).

Proper HR management and HR capitalization in particular are important within the gradual transformation towards the knowledge-based economy which requires the transparency of inner corporate procedures and processes that relate to the accounting of company’s assets. Since the knowledge-based economies are mainly dominated by the service-oriented companies, their major assets are knowledge, skills, expertise and talented and dedicated workers capable to improve company’s performance. Since HR investment enhance service companies’ competitive advantage, the expenditures on HR account for more than 50% of their revenues (Guthrie, 2001). The accounting of the human capital should therefore be recognized and applied in the financial reports. In accordance with the traditionally applied accounting procedures, all expenditures related to the advancement of HR intellectual development are considered as an expense (Newman, 1999). Such approach erroneously regards HR contributions as unimportant beyond the current period assuming that individual knowledge and skills cannot benefit a company in the future (Steffy and Maurer, 1988).

Human Resource Accounting (HRA) as a relevant approach to HE capitalization

Over the recent years the corporate sector has evidenced the introduction and development of the innovative concept referred to as Human Resource Accounting (HRA). This is largely because companies pay particular attention to their HR and perceive this intangible asset as the core factor that directly impacts their performance, profit-making and competitiveness. HRA has forever transformed the traditional approaches of the financial accounting to the value of human resources. The HR capitalization is therefore made by means of HRA which values and report HR as revenue expenditure charged to the direct costs that are incurred as a capital expenditure. Primarily, HRA identifies and reports the capital invested by companies in their HR that are currently not accounted by the traditional accounting practices. Therefore, non-traditional Human Resource Accounting (HRA) approach has been widely applied within the corporate environment to emphasize on the recognition of human resources and the capitalization of this asset. By and large, HRA stands for the process of attributing monetary (tangible) value to human resources and its recognition as an asset in the corporate financial statements. The application of HRA in the modern corporate practice is mainly driven by the shift of HR management towards the empowerment of employees’ knowledge and skills. In fact, many companies value their human resources more compared to the other assets they possess since they deem that competent and dedicated individual and team performance is the key to company’s success and profitability (Guthrie, 2001). Taking this into account, Kodwani and Tiwari (2007) state that contrary to traditional accounting practice, HRA is the relevant framework that objectively identifies, capitalizes, and reports the expenditure spent on HR.

HRA advantages

As one of the newest accounting techniques, HRA extends the traditionally applied accounting principles that match the revenues and costs to quantify the value of HR and help corporate management achieve the required equilibrium with regard to HR practices. In particular, HRA benefits corporate management, employees and financial analysts by:

(1) Utilizing and planning HR as an asset;

(2) Distributing available resources required for HR transfer, training, retrenchment, and promotion;

(3) Evaluating the costs incurred for the training sessions for HR and the potential benefits they will bring a company;

(4) Enabling low return on investment, including thee improper utilization of HR;

(5) Preventing high levels of absenteeism and turnover at the workplace;

(6) Assisting investors concerned about making long-term investments in company’s business;

(7) Comprehending and assessing the inner working environment and the potential of corporate management;

(8) Improving HR individual and team performance and the bargaining power of HR;

(9) Creating proper background for the effective and relevant management decisions about hiring, maintain and developing HR that would help a company reach its strategic goals;

(10) Making each single employee understand their individual role and contribution in the advancement of expenditure incurred by a company;

(11) Monitoring the process of HR management;

(12) Aiding corporate management and the decision-making processes to further advance company’s financial practices; and

(12) Analyzing the appreciating human capital in a company (Roslender, 2004).

HRA disadvantages

On the other hand, many companies oppose HR capitalization. This is mainly due to the fact that HRA is the system that combines accounting techniques and methods that are aimed to assist personnel management while valuating knowledge, skills and potential of HR as well as their motivation to serve the corporate goals in a dedicated manner. From the financial perspective, this indicates that many companies perceive their employees as liability rather than HR. Indeed, there are various limitations which deter corporate management from introduce HRA in many companies. The apparent disadvantages of HR capitalization through HRA are as follows:

(1) Absence of clear guidelines and procedures that regulate the allocation of costs required to capitalize HR in a company;

(2) Impossibility of adequate HR valuation due to the uncertainty of HR existence within a company (this drawback is explained by high levels of turnover in many companies which makes it impossible to define long-term HR strategies for the future periods of a company’s operation);

(3) Currently applicable HR capitalization systems are featured by numerous drawbacks;

(4) HR are not physical assets and therefore cannot be utilized, owned or retained; therefore corporate management in many companies fails to treat HR as definite asset (for instance, tax legislation does not recognize HR as assets);

(5) Lack of empirical evidence of HRA effectiveness as a management tool applied to facilitate HR management;

(6) Trade unions fear that HR capitalization will make employees demand additional compensation and rewards in line with HRA valuations; and finally

(7) HR capitalization is not a subject to the universally accepted approach, and this fact alone makes its empirical implementation rather complicated.

The abovementioned drawbacks prove that the current practice of accounting cannot place value on knowledge, skills and employee capabilities as they are regarded as intangible assets (Robbins, 2001).

Conclusion

The research has evidenced that the overwhelming majority of competitive service-oriented companies regard HR as their major asset. The nature of HR investment assumes that the core features of human capital require companies to capitalize them. Such a necessity is explained due the impact of the investment on the individual performance of the employees which can potentially benefit a company’s overall success during the future accounting periods (Guthrie, 2001). Overall, service companies are better valued providing that their HR values are recognized through the capitalization of the relevant investments (Edvinsson and Malone, 1997). The spotted drawbacks of HRA, however, evidence that currently there are many procedural complications related to the HR capitalization which make many companies reject this accounting approach. Nonetheless, the findings of the recent empirical studies suggest that the quoted service companies should acquire HR capitalization methods and report their HR expenditures which improve the productivity and quality of their performance. Therefore, HR capitalization is indispensable and important component of corporate competitiveness as it benefits companies’ market capitalization and share prices (Adams and Roberts, 1993).