Treatment of Human Assets in the Balance Sheet
Introduction
Human capital has over the past few decades gained extensive recognition as an intangible asset that is capable of enhancing an organisation’s success (Rajaekharan 2001). Dean, McKenna and Krishnan (2012) affirm that human capital ‘is often regarding as one of the most valuable assets of corporation’ (p. 61). However, Mukhopadhyay (1992) affirms that despite the fact that human assets are considered valuable in businesses quest to earn income; the balance sheet does not recognise the value of human capital. Another major shift with reference to the importance of human capital is underlined by emergence of a trend whereby human capital is currently being considered as an asset that should be entrenched in the balance sheet. Scarbrough and Elias (2002) assert that there is need for businesses to adjust their approach to financial accounting by ensuring that they not only take into account hard financial measurements but also appreciate the importance of entrenching the people-related or soft assets. This paper evaluates whether humans should be treated as assets by examining whether human capital meet the conventional definition of an asset for inclusion on the balance sheet.
Analysis
The purpose of the balance sheet as one of the financial statements is to depict a firm’s actual financial position. Therefore, elimination of human asset in the balance sheet leads to misrepresentation of the balance sheet (Flamholtz 1999). Thus, the figure denoted as ‘total assets’ in the balance sheet does not actually comprise of the organisation’s human assets. Subsequently, the balance sheet does not indicate its actual investment of its human capital.
An asset refers to a business resource that is expected to generate future economic benefit out of a particular event or past transaction. The business must also have the capacity to control the economic benefit to be generated. In addition to the above aspects, the asset should be capable of being measured and reliably expressed in monetary terms (Whittington & Delaney 2011). In line with the above definition, the human asset successfully meets the definition of an asset and hence should be incorporated in balance sheet. Under the conventional accounting approach, the cost incurred in hiring and training human capital is usually categorised as an expense in the income statement, despite the fact that the cost incurred in developing human capital is expected to generate some benefits in the future beyond the current accounting period (Flamholtz 1999). Dean, McKenna and Krishnan (2012) affirm that ‘the stock of human capital embodied in people produces value for a company’s final products or service that contributes to the company’s earning power’ (p.62).
Failure to include human capital in the balance sheet is one of the major limitations of the conventional accounting method. To deal with this limitation, businesses should entrench the human resource accounting approach. The human resource accounting approach accentuates emphasises that it is possible to assign value to human capital as an organisational asset by measuring the cost incurred by firm in the recruitment, selection, hiring, training and developing its human capital (Aquinas 2010). Inclusion of human asset in the balance sheet is also possible by determining the economic value of its human capital (Aquinas 2010). Flamholtz (1999) illustrates the how human capital can be incorporated in the balance sheet in his case of South-western Electronics Company. Flamholtz (1999) asserts that the company expects to undergo substantial growth over the next decade and has thus invested $150,000 in recruiting and selecting 100 employees and an additional $350,000 in training and developing the selected employees. The hired employees are expected to generate substantial value to the organisation over the next 10 years. Under the human resource accounting approach, South-western Electronics Company can capitalize and amortize the expenditure incurred in developing its human capital over the expected useful life of the hired employees. Therefore, the firm’s balance sheet should comprise human asset as one of the elements, which should amount to the net amortization value of $450,000 (Flamholtz 1999). This shows that it is possible to assign value to human asset hence including it in the balance sheet.
Conclusion
Human capital satisfactorily meets the conventional definition of an asset. Thus, it is important for organisations to consider integrating human asset in the financial accounting process. The value of human capital should specifically be integrated in the balance sheet. Therefore, organisations should shift from the traditional accounting approach and integrate the human resource accounting approach. On the basis of human resource accounting, it is possible to successfully assign value to human capital by amortizing the cost incurred in employee recruitment, selection, hiring and training and development over the expected useful life of the employee. Through this approach a firm can truly represent the value of human capital in its balance sheet.
References
Aquinas, P 2010, Human resource management, Vikas Publishing House, New Delhi.
Dean, P, McKenna, K & Krishnan, V 2012, ‘Accounting for human capital; is the balance sheet missing something’, International Journal of Business and Social Science, vol. 3, no. 12.
Flamholtz, E 1999, Human resource accounting; advances in concepts, methods and applications, Springer US, Boston, MA.
Mukhopadhyay, A 1992, Limitation of balance sheet, Northern Book Centre, New Delhi.
Rajaskharan, N 2001, Competency web; the corporate DNA, Universities Press, Hyderabad.
Scarbrough, H & Elias, J 2002, Evaluating human capital, CIPD Publishing, London.
Whittington, R & Delany, P 2011, Wiley CPA exam review 2011-2012. Volume 1, outlines and study guides, Wiley, Hoboken, NJ.
