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Human Resources Accounting Revisited

June 15, 2001
Related Topics: HR Services and Administration, Featured Article
The desire to quantify the benefit of the human resources function has been aconstant theme in the HR literature. Unfortunately, the bewildering variety ofproposals on how to accomplish this has led to confusion and inaction.

    This explanation should help.

    In the late 60s and early 70s, a number of writersproposed that the capital nature of certain human resource costs be recognizedas investments rather than as expenses, which collectively became known as HumanResources Accounting. While the underlying concept was simple andstraightforward, academics observed that capitalization and amortization ofapplicable Human Resources Accounting costs had no measurement of"value" or worth of the HR investment.

    Accordingly, proposals were developed to take the basicinformation and add the dimension of "value" of individuals and thewhole organization. Since accounting measures "cost," not"value" or "worth,” the proposed improvements in Human ResourceAccounting took it out of the realm of acceptable accounting practice.

    Recent literature has focused on a broader measurement,namely that of "intellectual capital." Despite those who considerintellectual capital a new approach, it is really an extension of HR accountingsince without the underlying concept of HR investment there can be nointellectual capital development.

    Advocates of intellectual capital cannot agree on which HRvariables to measure, so they propose letting the user pick and choose.Management consulting firms have picked up on intellectual capital in a big wayand various firms have developed indices that purport to relate specificintellectual capital variables. The end result measures revenue growth andprofit.

    The focus on intellectual capital has resulted in HRaccounting being shifted to the sidelines, even though the HR accounting conceptis far simpler and much easier to implement.

Generally accepted accounting principles and HR accounting
    It is helpful to review how the generally accepted accountingprinciples relate to HR accounting, because the ultimate goal of the HR functionis to have its performance measured "on the books" in the basicaccounting system. This is complete with measures of profit contribution; returnon investment and other measures that conventional accounting produces for theoperating departments.

    While "off the book" indices and statistics havea place, the ability to "show me the money" (to quote a line from arecent movie), ranks far higher in prestige and in determining bonuses andincentive compensation.

    The basic HR accounting model parallels the acquisition oftangible assets. Any acquisition, whether HR related or not, has to be recordedas an asset, an expense, or a loss. An asset is defined as an expenditureproducing future benefit, and recording an asset is known as capitalizing.Expenses and losses expire within the current period.

    As noted above, "value" and "worth"are not measured in generally accepted accounting principles unless there is anactual monetary transaction. So HR measurement based on "value" is notpart of generally accepted accounting principles, at least as now defined.

Capitalizing versus expensing the HR accounting model
    What kinds of HR costs could be considered capital because oftheir incurrence to generate future benefits? The companies that haveimplemented HR measurement either fully or partially have included such costsas:

  1. Recruitment, including agencyfees, headhunters, etc

  2. Hiring and testing

  3. Tuition reimbursement

  4. Seminar costs

  5. Formal training

  6. Informal training

    The same decisions on capitalizing versus expensing applyto both HR and non-HR acquisitions, namely are those costs maintenance,betterment, or improvement. "Maintenance," including normal salarycosts and perhaps such extras as EAP programs and concierge services, areclearly expenses.

    On the other hand, costs such as those listed above, areclearly capital in nature and should be classified as assets or investments.

    Where and how should HR accounting be reported?

    There are three areas to consider:

  1. For taxation, all HR costswould be expensed, as in current treatment. However, there are issues as towhether certain training associated with start up projects has to bedeferred until the projects are operational.

  2. For external reportingpurposes to shareholders, etc, HR accounting must conform to GenerallyAccepted Accounting Principles (GAAP) to be included in external statements.

  3. For internal reporting tomanagement, there are no GAAP restrictions. Companies have implemented HRaccounting systems for portions of their personnel operations as part oftheir budgeting and performance measurement system.

What about the use of HR accounting in external reporting?
    Prior to the release of Accounting Principles Board OpinionNo. 17, there are examples of full or partial HR accounting disclosure inexternal statements. For example, the Atlanta Braves were a publicly held sportsfranchise whose president decided to capitalize the costs of running the team'sfarm club operations and then amortize that cost to expense over five years.

    He justified that treatment as his industry's version ofresearch and development.

    The financial statements also include the costs of playercontracts, which were also being amortized. One could argue that the contractcosts warrant capitalization because of the existence of legal documents tyingthe players to the team. However, with the modern era of free agency andarbitration, even the players are not "owned" in the same way tangibleassets would be.

    Electronic Data Systems (EDS) decided to capitalize thecost of training its computer consultants, and to amortize that cost to expenseover a three-year period. It chose a method of amortization (reverse sum ofyears digits) that would write off larger amounts of training costs as theconsultants became more productive.

    Some air carriers capitalized the cost of flight trainingas new equipment was purchased and put into service, and included those costs insubsequent equipment depreciation.

    The R.G. Barry Corporation issued a comprehensivefinancial statement, but it chose to provide its "total" (conventionaland HR) statement as a supplemental disclosure, not its primary certifiedfinancial statements.

    Even so, the first R.G. Barry statement presented in 1969attracted wide attention in the business press, including the possibilities forincome manipulation. The company included a disclosure notice to remindstatement users that the "total" approach was not acceptable inconventional accounting practice. In retrospect, since Accounting PrinciplesBoard Opinion No. 17 had not yet been released, the decision to capitalizecertain personnel costs was no different than what the Braves did in its primarycertified statements.

    Unfortunately, R.G. Barry included more than actual outlaycosts in its "total approach" so that it could not use the primarystatements for disclosing this information. While an HR accounting system, onceadopted, would have to be applied consistently, the greatest benefit would occurin knowledge or skills-based companies, where employees represent the greatestincome producing asset, and where such abilities are not recognized in currentaccounting principles.

    Again, R.G. Barry was not such a company because it madeladies garments and accessories. It was decidedly "low tech" sewingand assembly operation. In addition, it would be fair to assume that in a"high tech" company, the amount invested in employee training anddevelopment would be a much greater percentage of total assets, so that theroughly $1 million in HR costs reported in 1969 would be much larger in aknowledge based company of equivalent size.

    Whatever the limits of the costs reported in the R.G.Barry financial statements are, the company demonstrated that capitalizingappropriate personnel related costs was feasible, and it also developed a modelfor predicting "expected service life" as the basis for amortizingsuch costs.

    The 1970 "total approach" statements produced alower income than conventional reporting, because the overall investment in HRhad declined faster from amortization of prior costs versus new investments. Thecompany provided such statements through the mid-70s.

    With the release of the accounting board opinion, anyattempts to continue such disclosure in primary statements were eliminated. Itwas ruled that internally generated intangibles, such as employee training, mustbe expensed as incurred.

Accounting board's reasoning:
    The accounting board's reasoning was as follows:

  1. Capitalization of internalintangibles was subjective and did not meet the objectivity standardrequired in generally accepted accounting principles.

  2. Even if objectivity could beachieved, the period of future benefit during which capitalized costs wouldbe amortized was uncertain. Employees were not "owned" liketangible assets, and could leave prematurely.

    As the successor to the Accounting Principles Board, theFinancial Accounting Standards Board (FASB), is aware of the glaring omission ofsuch intangibles in knowledge based companies. For example, a software companywhere the market value of the company equity is many times greater than theunderlying recorded assets. Here, the most important asset, the accumulatedskills of the staff, is not reported at all.

    Not to delve too deeply into the accounting process, butwhen such a company is acquired, and money or securities change hands, thoseunrecorded assets wind up being recorded in a "catch all" accountcalled "goodwill."

    FASB is about to release a new rule on businesscombinations and accounting for goodwill. This is where HR accounting comes intoconsideration. The focus is on identifying as many "hidden assets" aspossible, and recording them in their own right. If the acquired company hadestablished an HR accounting system, that would facilitate the process.

    Aside from the goodwill issue, both FASB and the SEC areconcerned about the lack of information being provided investors inknowledge-based companies that relate to human resource based "intellectualcapital." For example, as an investor, I would surely be interested inknowing that turnover had reached excessive levels and that key engineering andscientific personnel had left the firm. Such information is not now shown infinancial statements, leaving investors in the dark until a news source reportsthe defections.

    Despite the accounting board opinion, which may be revisedas part of the "goodwill" treatment, the underlying reasons fordenying capital status to HR-related costs has no basis in fact.

    If limited to actual outlay costs, and not measurement of"value" or "worth," capitalization of the HR costs listedabove is as objective as recording an invoice for the acquisition of a physicalasset.

    With regard to the amortization period, companies withdefined benefit pension plans base their pension expenses on actuarial estimatesof service life, final compensation, etc. There is no legitimate reason thatthose same estimates could not be used for amortization of deferred HR costs. Ifan employee leaves prematurely, any un-amortized cost is written off as a lossand removed from use prematurely.

    The larger issue is the practical use of generatinginformation that is limited to actual cost and amortization and not to advance "off the book" measures of "value."

Value of an "on the book" system
    An “on the books” system such as that used by R.G. Barry,for all its shortcomings, still provides invaluable information for investorsand management.

  1. First and foremost,capitalization of appropriate HR costs provides meaning to HR expendituresas an investment. Calling it such and then expensing those costs, ascurrently done, surely does not instill confidence that these outlays areindeed intended for long-term benefit.

  2. Second, the rate of increaseand decrease of the HR investment accounts over time (that is, either newinvestment exceeds amortization and write off, or amortization exceeds newinvestment) provides a clear indicator as to the level of personnelresources. It equates such changes to additional income or provides thebasis for an HR bottom line, and for ROI calculations.

  3. Third, even if the accountsare established for internal reporting to management only management canfinally have accurate answers to such questions as to what the costs ofturnover really are. Dumping such costs into current expense makes itimpossible to come up with an "on the books" dollar amount for HRcosts written off when employees depart prematurely. In the same situation,when it comes time to downsize, the amount of "investment" shouldbe one factor in making personnel decisions.

    I recall a presentation to a group of banks in SouthFlorida, whose managers acknowledged a problem with high turnover of part-timetellers, but were assured of a constant supply of replacements. They did notrecognize that while the costs per employee of the three-week new teller programwere about $3000 each. Some 4,000 such turnovers per year led to a heftyexpense.

    Had those costs been capitalized and amortized, apremature departure would cause management (and if included in externalstatements, shareholders) to be more proactive in protecting their investment bydeveloping better retention policies.

    Yes, amortized cost surely does not equate to"value" nor is it supposed to in an “on the book” measure.However, to ignore the benefits of an "on the books" measurement of HRinvestment and consumption for some index seems to me that the creation of an HRfinancial measurement system will never be developed.

    It may very well be that the eventual resolution of theintangible reporting issue by FASB and/or the SEC will set the pace for theimplementation of a workable HR reporting system.


    Since the submission of the above, FASB has finalized the business combinations revised rules, which are due to go into effect on June 30. In addition, FASB has added to its research agenda a stand-aloneproject on reporting of internally generated intangible assets, and is gathering input from the public.

    Readers interested in reading the initial proposals, and submitting their own opinions should go to

    The issues raised do not require a technical knowledge of accounting. The initial comments preclude the possiblerecognition of such costs as training and developmentas assets, on the premise that the organization incurring the costs lacks "control" over such assets.

    (The author believes that this control argument isarchaic and is not in accord with economic reality, in that the employer would not incur such costs if itdid not expect some kind of future benefit.)

    However, the initial comments are also directed to the nature of supplemental disclosures in financial statements (the footnotes) and to the development of a framework for such disclosures. It is in this category that the greatest promise exists for finally giving the HR function an "on the books" presence and a direct way to appraise shareholders of the effectiveness of HR policies and practices.

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