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Valuation of Human Resources

Until recently, the value of an enterprise as measured within traditional balance sheets was viewed as a sufficient reflection of the enterprise's assets. However, with the growing emerge of the knowledge economy, this traditional valuation has been called into question due to the recognition that human capital is an increasingly important part of an enterprise's total value. This has led to two important questions :

1) how to assess the value of human capital in addition to an enterprise's tangible assets and

2) how to improve the development of human capital in enterprises.

The emergence of methods for accounting human resources aimed at measuring, developing and managing the human capital in an enterprise, can thus be said to reflect the need for improving, measuring and accounting practices as well as human resource management. The accounting of human resources can be seen as just as much a question of philosophy as that of technique. This is one of the reasons behind the wide variety of approaches and the broad range of purposes for which human resources are valued.

The four major methods of valuation of human resources are the Historical cost method, multiplier method, replacement cost method and the economic value method.

Historical cost method

This method is similar to the conventional Profit & Loss Account and Balance Sheet, which are also stated on historical cost basis. Here the amount actually spent on an employee for recruitment, induction, training and development is added and capitalized as the opening value of cost of that employee. The capitalized amount is then amortized akin to depreciation of fixed assets over a period of time.

The expenditure incurred in acquiring and integrating new employees are amortised over the period that these employees are expected or estimated to stay in the organization. The expenditure incurred in their training and development would mostly be amortized over a shorter period of time.

The historical cost method presumes that there is a distinct relation between the cost incurred on an employee and his value to the organization at a point of time.

Multiplier Method

In this method, employees are categorized into senior management, middle management, and clerical employees. Multipliers are determined for each of these categories. The largest multipler would undoubtedly apply to the senior management whereas the smallest multiplier would apply to the lower levels in the hierarchy.

The multiplier is then applied to the aggregate of the salaries and wages of each group to arrive at the asset value. The most important element is the multiplier in this method and they must be consistent with the total value of the business.

This method does not assume there is a one to one relation between the cost incurred on an employee and his value to the organization.

Replacement cost Method

Even as the very name suggests, this method values the human resources based on the cost that it would take to replace the organisation's existing human resources. This would therefore not take into account the historical cost but the cost that would be incurred on recruitment, inducting, training and development of a new employee to replace the earlier employee.

There would also be an additional factor involved, which is the opportunity cost of lost revenue during the training and induction period of the new employee.

This method is inconsistent with the historical cost method. However, it would render more meaning and have some substance, if all the assets in the organization were valued on a replacement cost basis instead of only the human resources. This does not happen in contemporary accounting.

Economic value Method

This method presumes that a portion of the future revenues of the organization are directly attributable to the human resources of the organization. Thus the present value of future earnings calculated by applying a suitable discounting factor is taken to be the value of the human resources assets.

The practicality of this method is suspect since the discount rate is highly subjective and the apportionment of future revenues to all the factors resulting in those revenues is also subjective.

From India, Coimbatore
Dear Mr. Peer, is the lev and schwartz method and the other cost based methods (Brummet, Flamholtz and Pyle) included in the four methods you mentioned you mentioned
From India, Mumbai
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