Different valuation models are available for measuring human assets in an organization. The current approaches are divided into two categories:
- Monetary measures
- Non-monetary measures
1. Replacement Costs
This method estimates the value of an employee relative to the cost that the organization incurs if they are replaced with someone of equal ability.
Flamholtz, who used this model, cited two different concepts of replacement costs:
- Individual replacement cost
- Positional replacement cost
Therefore, the potential future positions and positional replacement costs should be identified for all employees.
An estimation of the probability of employees occupying their respective positions at the expected time should also occur. The positional replacement cost represents the cost of replacing the services expected of an individual in their current and future roles.
2. Opportunity Cost
The opportunity cost method determines the value of human assets based on the value of individual employees in an alternate role.
The guiding criteria here posits that human assets have value only when they have another use. Only scarce personnel represent the value of human assets.
Thus, no opportunity cost exists for easily hirable employees. Hekiman and Jones use the opportunity cost method to calculate the worth of employees, which involves a competitive bidding process by the investment center managers for the scarce employees they desire.
The bid price reflects the perceived value of the individual employee, and only scarce employees form the asset base of the investment center.
One argument suggests that evaluating human assets on this basis encourages managers to select employees more optimally, which results in the most efficient use of employee time.
3. Historical Costs
This method involves capitalizing the cost of maintaining the individual to produce the service state rewards to the organization (i.e., all costs related to recruitment, training, and development of the employees).
Training costs tend to amortize over a shorter period than recruitment costs since training becomes outdated and employees must develop new skills to meet technological change.
An organization writes off the value annually over an individual employee’s expected tenure. The unexpired value constitutes an investment in human resources.
4. Economic Value
This method measures the value of human assets on the assumption that an individual generates value by occupying and moving among roles and rendering services to the organization.
The occupied roles depend probabilistically upon the positions previously occupied. Thus, the valuation process involves probabilities of the employees’ change of position and the derived service.
A person’s expected service value may be expressed as follows:
(S) = (n / t=1) Si P (Si)
(S) represents the expected total service, Si represents the expected derived service from each state occupied by the employee, and P(S) represents the estimated probability of the expected derived service.
Determining the total value of expected future service involves multiplying the physical equivalent of services by their price. The next step discounts the total value at the appropriate rate of return to obtain the present value of the service.
The current value so obtained represents the value of human assets.
5. Discounted Present Value of Future Wages and Salaries
The value of human resources equals the present value of employees’ future earnings until retirement. This approach may classify employees into homogeneous groups according to the type of assignment, nature of work, age, level of skill, and so forth.
An appropriate rate of discount like the cost of capital can compute the present value of future earnings.
1. Discounted Net Present Value of Future Earnings
The discounted net present value of future earnings is based on managerial behavior, style, policies, and the employees’ attitudes, performance, and collective capabilities.
Under this method, measuring the value of human resources involves predicting the future earnings of the employing firm, discounting the same to net present value, and allocating a portion of this value to human assets.
Predictions of the firm’s future earnings consider two types of variables:
- Causal variables
- Intervening variables
The former category comprises elements such as management behavior, style, and organizational structure, while the latter category refers to the employees’ loyalties, motivation, goals, and attitudes.
2. Attitude Scores
The value of employees can also be determined based on attitude scores derived from their knowledge, skills, and annual income. The next step is to multiple these attitude scores by the employees’ annual salary.
The difference between the resulting value and the employee’s annual earnings reflects the gain or loss that the firm incurs by retaining the employee.
3. Flamholtz Model
According to Flamholtz, measuring an individual’s value to an organization involves personnel evaluation methods such as ranking. Evaluations can be undertaken by the following staff:
- Independent experts
Measuring the economic value of an individual to the organization can involve their net contribution, that is, their gross value, less the compensation and other costs associated with their employment.
Methods of Human Resource Accounting FAQs
The primary purpose of such accounting is for managerial decision-making. This accounting helps managers to make decisions about human resources and how they can be used most efficiently. Such decisions include: employment, performance appraisal and reward systems, training and development programs and policies, transfers and promotions among others (mello, 2010).
No, the information provided in the financial reports from outside sources is not sufficient to make decisions related to human resources. For example, one does not find labor costs reported in the income statements of general corporations which totals less than 1 percent of total sales revenue. The labor cost presents in the income statement is net of deferred compensation.
One such limitation among others includes that it can be used only when an organization's human resources are specialized and well defined. It also works best when there is a rigorous market for managerial talent where employees earn different salaries for performing similar job positions.
One such key performance indicator in a human resource information system is the accuracy of personnel data. The other one includes the completeness and timeliness in reporting.
An organization should update its human resource accounting system at least every fiscal year. This will include update the data and reports and reconciling any errors that may exist in the system.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.