Valuation of Human Resources Business Valuation 11.
Need for Human resources accounting
In the case of an IT firm, the value of its physical assets is negligible when compared with the value of the
knowledge, experience, development and application skills of its personnel. Similarly, in hospitals, academic
institutions, consulting firms, etc., the total worth of the organisation depends mainly on the skills of its employees
and the services they render. Hence, the success of these organizations is contingent on the quality of their Human
Resource – its knowledge, skills, competence, motivation and understanding of the organisational culture.
Definition of Human Resources Accounting
Human Resource Accounting (HRA) denotes just this process of quantification/measurement of the Human
Resource. In other words, it is the process of identifying and measuring data about human resources and
communicating this information to interested parties. (June 2009, June 2010, June 2016)
Statutory provisions for HRA in India
In India, the Companies Act, 2013 does not mandate furnishing of HRA related information in the financial
statements of the companies. The Institute of Chartered Accountants of India too, has not brought out any
definitive standard or measurement in the reporting of human resources costs. However, some organizations in
India such as Infosys, BHEL and ACC have furnished the value of their human resources and related information
in their annual reports
Benefits of HRA
Although there is no statutory requirement of furnishing of HRA related information in the financial statements of
the companies in India, HRA serves the following purposes in an organisation:
a. It furnishes cost/value information for making management decisions about acquiring, allocating,
developing, and maintaining human resources in order to attain cost-effectiveness;
b. It allows management personnel to monitor the use of human resources effectively;
c. It provides a sound and effective basis of human asset control, that is, whether the asset is appreciated,
depleted or conserved;
d. It helps in the development of management principles by classifying the financial consequences of various
practices.
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Valuation of Human Resources Business Valuation 11.2
HRA
Cost based Value based
model model
Replacement Stochastic
Historical Cost Economic Value
Cost Reward valuation
Opportunity Cost Group basis
valuation
Cost based models – Under this model, the valuation is based on expected Cost incurred on the employees of the
organization.
Name of the Name of the Remarks
Model inventor (Year
of invention)
Historical R. Likert (1967) Under this model, the actual cost of recruiting, selecting, hiring, placing and
Cost Model developing the employees of an organisation are capitalized and amortized over
the expected useful life of the asset concerned, which represents the total value
of human resources.
Benefits:
a) Easy to understand; and
b) easy to compute
Shortcomings:
a) It only capitalizes recruiting training, development, placement and inducting
cost but ignores the future expected costs to incurred for their maintenance;
b) In case minimal cost is incurred for the initial training and development of
employee (as he was already a skilled / trained employee), this model will value
such employee at a nominal cost, which may not be correct
b) estimation of the number of years over which the capitalized expenditure is to
be taken and the rate of amortization is subjective; and
c) value of human resource increases, but through this treatment capital cost
decrease through amortization
The Eric G Value of the HR to an organisation is reflected by the amount that the
Replacement Flamholtz organisation would have to pay to replace these individuals. It consists of
Cost model estimating the costs of recruiting, selecting, hiring, training, placing etc of the
existing employee.
Benefit: It takes into account fluctuation of the job market and general rise in
price level.
Shortcomings: It is difficult to find the exact replacement of the existing human
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Valuation of Human Resources Business Valuation 11.3
resources in actual practice.
Opportunity J.S. Hekimian This method is used to value employees possessing certain skills who are rare
Cost model / and C.H. Jones (scarce) in availability. The opportunity cost of on employee is determined by
Competitive (1967) using comparative bidding method. The idea is to ascertain the next best activity
Bidding which can be performed by the employees had they not been recruited in their
model current function. That activity is the opportunity cost which a Company is
loosing and, hence, the employees are valued on that basis.
Benefit: provides for more optimal allocation of human resource and sets a
quantitative base for planning, developing and evaluation human resources of
the organization.
Shortcoming:
a) It is difficult to compute the opportunity cost of an employee in any
organization
b) This approach adopts discriminating attitude, since it takes into account
only skilled (scarce) HRs. Other employees are not included in the
human asset base of the organisation.
c) There is no criteria on which the bids are based. Rather, the managers
rely only on their judgement.
Value based approach – Under this model, the valuation is based on expected benefits accrued from the
employees of the organization.
Name of the Name of the Remarks
Model inventor (Year
of invention)
Economic Baruch Lev and Under this method, valuation of HR can be done by aggregating the present
Value / PV Schwartz (1971) values of wages and salary payable to individual employees during the stay
of future with the organization. The idea is to take the salary figures as the basis of
earnings / ascertaining the benefits which have been accrued to the company from its
Lev and employees.
Schwarz
model This method involves the following steps:
(a) division of employee according to their age, grade of pay and
designation
(b) determination of average per year
(c) calculating of total earnings based on the remaining tenure of the
service life
(d) discounted total earning on the basis of average rate of return.
Benefit: This method is basically oriented towards measuring changes in the
employees’ value earnings rather than employers’ gains from the employees.
Shortcoming: Estimating the annual earnings and tenure of each and every
employee is a difficult task
Stochastic Eric G The movement or progress of people through organizational ‘states’ or roles
Rewards Flamholtz is called a stochastic process. The Stochastic Rewards Model is a direct way
valuation (1971) of measuring a person’s expected conditional value and expected realizable
model value. It is based on the assumption that an individual generates value as he
occupies and moves along organizational roles, and renders service to the
organisation.
Benefit: It measures the progress of the individual through the organizational
ladder.
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Valuation of Human Resources Business Valuation 11.4
Shortcoming: The extent of information required to make the necessary
estimates of the expected tenure and the probability that the individual will
occupy the state for the specified period of time is difficult to obtain.
Group basis Jaggi and Lau This model recognised the fact that proper valuation of human resource is not
valuation (1974) possible unless the contributions of individuals as a group are taken into
model view. It might be difficult to predict an individual’s expected service tenure
in the organisation or at a particular level or position but on a group basis, it
is easier to ascertain the percentage of people in a particular group likely
either to leave the firm during each of the fourth-coming period or to be
promoted to higher leaves.
Benefit: From an organizational perspective, this approach captures the value
of an individual more objectively through connecting him with the group in
which he/she works
Shortcoming: This method dilutes the individual contribution to the
organization and focuses on the group contribution. In a group, there might
be individuals of different caliber. This method averages out each one of
them.
Illustration 1: Aftech Ltd is a firm that specializes in offering technical consulting services. Aftech reported
operating income (EBIT) of Rs. 51.5 Lakh in the most recent year. In the most recent year, the firm had Rs. 14
lakhs training and recruitment expenses. A consultant who joins Aftech stays with the firm on average, 4 years.
Training and recruitment expenses are amortizable over 4 years, and over the past 4 years they are:
Year Training and recruitment expenses (Rs. In Lakhs)
0 14
1 12
2 10.40
3 9.10
4 8.30
Assuming a linear amortization schedule (over 4 years) you are required to estimate:
i) The value of human capital
ii) The adjustment to income (June 2005)
Illustration 2: From the following distribution of employees of Jalan Limited, calculate the total value of human
capital by Lev and Schwartz model.
Age Unskilled Semi-Skilled Skilled
No. Avr annual earning No. Avr annual earning No. Avg. annual earning
30-39 100 18,000 60 36,000 40 84,000
40-49 50 30,000 30 48,000 20 120,000
50-54 30 36,000 20 60,000 10 180,000
Retirement age is 55 years. Apply discount factor of 10%. In calculations of total value of human factor lowest
value of each class should be taken.
Illustration 3: A company has a capital base of Rs. 3 crore and has earned profits of Rs. 33 Lakhs. Return on
investment of the particular industry to which the company belongs is 12.5%. If the services of a particular
executive are acquired by the company, it is expected that the profits will increase by Rs. 7.5 lakhs over and above
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Valuation of Human Resources Business Valuation 11.5
the target profit. Determine the amount of maximum bid price for that particular executive and the maximum salary
that could be offered to him. (June 2017 & similar question in December 2017)
Practice Questions
Q 1: ABC Consulting Ltd. is a firm that specializes in offering management consulting services to software
companies. ABC Ltd. reported operating income (EBIT) of Rs. 102 Lakhs in the most recent year. However the
firms expenses include the cost of recruiting new consultants and the cost of training which amounts to Rs. 20
Lakh. A consultant who joins ABC Consulting Ltd. stays with the firm, on an average, for 4 years. Recruitment
and training expenses are amortizable over 4 years. Over the past 4 years they are:
Year Training and recruitment expenses (Rs. In Lakhs)
0 20
1 16
2 15
3 12
4 10
Assuming a linear amortization schedule (over 4 years) you are required to estimate:
i) The value of human capital asset and the amount of training and recruitment expenses amortization
this year
ii) The adjustment to net income (December 2006)
Solution: (Rs. In Lakhs)
Year Training and recruitment expenses Unamortised portion Amortisation this year
0 20 20 (100%) -
1 16 12 (75%) 4
2 15 7.5 (50%) 3.75
3 12 3 (25%) 3
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Valuation of Human Resources Business Valuation 11.6
4 10 0 2.5
Total 42.50 13.25
i. The value of human capital asset is Rs. 42.5 Lakhs and the amount of training and recruitment expenses
amortization this year is Rs. 13.25 Lakhs
ii. Adjusted operating income = Operating income – training and recruitment expenses – amortization expenses
this year
= Rs. 102 Lakhs + Rs. 20 Lakhs – Rs. 13.25 Lakhs = Rs. 108.75 Lakhs
Q2: DKB Consulting Ltd. is a firm that specializes in offering management services to software companies. DKB
Consulting Ltd. reported operating income (EBIT) Rs. 204 Lakhs in the most recent years. However the firm’s
expenses include the cost of recruiting new consultants and cost of training which amounts to Rs. 40 Lakhs. A
consultant who joins DKB consulting Ltd. stays with the firm on an average for 4 years. Recruitment and training
expenses are amortizable over 4 years immediately following the year in which they are incurred. Over the past 4
years the expenses are:
Year Training and recruitment expenses (Rs. In Lakhs)
0 40
1 32
2 30
3 24
4 20
Assuming a linear amortization schedule (over 4 years) you are required to estimate:
i) The value of human capital asset and the amount of training and recruitment expenses amortization this year
ii) The adjustment to income (June 2011)
Solution : (Rs. In Lakhs)
Year Training and recruitment expenses Unamortised portion Amortisation this year
0 40 40 (100%) -
1 32 24 (75%) 8
2 30 15 (50%) 7.5
3 24 6 (25%) 6
4 20 0 5
Total 85 26.5
i. The value of human capital asset is Rs. 85 Lakhs and the amount of training and recruitment expenses
amortization this year is Rs. 26. 50 Lakhs
ii. Adjusted operating income = Operating income – training and recruitment expenses – amortization expenses
this year
= Rs. 204 Lakhs + Rs. 40 Lakhs – Rs. 26.50 Lakhs = Rs. 217. 50 Lakhs
Q 3: From the following data in respect of Manas Ltd., compute the value of employees of the organization by
using Lev and Schwartz model.
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Valuation of Human Resources Business Valuation 11.7
Age House Keeping Staff Administrative Staff Professional Staff
No. Avg. annual earning No. Avg. annual earning No. Avg. annual earning
30-39 100 300,000 60 350,000 40 500,000
40-49 50 400,000 30 500,000 20 600,000
50-59 30 500,000 20 600,000 10 750,000
Retirement age is 60 years. Apply discount factor of 10%. In calculations of total value of human factor lowest
value of each class should be taken. (December 2012)
Solution : The PV of earnings of each category of employees is:
House Keeping Staff:
Age group 30-39, assume that all 100 employees are just 30 years old.
Present Value (Rs.)
Rs. 300,000 p.a. for next 10 years (300,000 X 6.144) 18,43,200
Rs. 400,000 p.a. for years 11-20 (400,000 X 2.37) 948,000
Rs. 500,000 p.a. for years 21-30 (500,000 X 0.913) 456,500
3,247,700
Age group 40-49, assume that all 50 employees are just 40 years old
Rs. 400,000 p.a. for next 10 years (400,000 X 6.144) 2,457,600
Rs. 500,000 p.a. for years 11-20 (500,000 X 2.37) 1,185,000
3,642,600
Age group 50-59, assume that all 30 employees are just 50 years old
Rs. 36,000 p.a. for next 10 years (500,000 X 6.145) 3,072,000
Administrative Staff:
Age group 30-39, assume that all 60 employees are just 30 years old
Present Value (Rs.)
Rs. 350,000 p.a. for next 10 years (350,000 X 6.144) 2,150,400
Rs. 500,000 p.a. for years 11-20 (500,000 X 2.37) 1,185,000
Rs. 600,000 p.a. for years 21-30 (600,000 X 0.913) 547,800
3,883,200
Age group 40-49, assume that all 30 employees are just 40 years old
Rs. 500,000 p.a. for next 10 years (500,000 X 6.144) 3,072,000
Rs. 600,000 p.a. for years 11-20 (600,000 X 2.37) 1,422,000
4,494,000
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Valuation of Human Resources Business Valuation 11.8
Age group 50-59, assume that all 20 employees are just 50 years old
Rs. 600,000 p.a. for next 10 years (600,000 X 6.144) 3,686,400
Professional Staff:
Age group 30-39, assume that all 40 employees are just 30 years old.
Present Value (Rs.)
Rs. 500,000 p.a. for next 10 years (500,000 X 6.144) 3,072,000
Rs. 600,000 p.a. for years 11-20 (600,000 X 2.37) 1,422,000
Rs. 750,000 p.a. for years 21-30 (750,000 X 0.913) 684,750
5,178,750
Age group 40-49, assume that all 20 employees are just 40 years old
Rs. 600,000 p.a. for next 10 years (600,000 X 6.144) 3,686,400
Rs. 750,000 p.a. for years 11-20 (750,000 X 2.37) 1,777,500
5,463,900
Age group 50-59, assume that all 10 employees are just 50 years old
Rs. 750,000 p.a. for next 10 years (750,000 X 6.144) 4,608,000
Total Value of Human Capital
Age House Keeping Administrative Professional Total
No. Total No. Total No. Total No. Total Earnings
Earnings Earnings Earnings
30-39 100 324,770,000 60 232,992,000 40 207,150,000 200 764,912,000
40-49 50 182,130,000 30 134,820,000 20 109,278,000 100 426,228,000
50-59 30 92,160,000 20 73,728,120 10 46,080,000 50 211,968,120
599,060,000 441,540,120 362,508,000 1,403,108,120
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