Human Resource Accounting

for

Training & Development

Shital Jhunjhunwala

Institute of Public Enterprise

Dr. Shital Jhunjhunwala 2

The Importance of Human Capital

Intangible AssetAverage

Rank Top 5

Goodwill 2.48 61.90%

Brands 2.05 57.14%

Intellectual Property Rights (particularly Patents & Trademarks) 1.76 47.62%

Human Capital / Human Resource 1.67 71.43%

Technical Know-how/ Knowledge 1.00 23.81%

Marketing Rights & Distribution Networks 1.00 28.57%

R & D 0.86 28.57%

Processes & Recipe 0.86 28.57%

Software & IT Capabilities 0.62 23.81%

Customer List & Relationships 0.43 23.81%

Experience 0.38 9.52%

Social Responsibility 0.24 9.52%

Business Relationships 0.14 4.76%

Others 0.38 9.52%

3

“most important assets of my company walk out of the door

every night”.

Bill Gates, Microsoft

Dr. Shital Jhunjhunwala 5

The unquestionable Importance of HR …….

Myth “ROI from human capital cannot bemeasured! I am just going to treat it

as ashort term cost, not a long term

investment”

True there is an objective need to build a

credible case for the objective measurement of human capital

But there is a stronger case to build human

capital as an asset and expenditures relating to improved human capital as

a long term investment

Why HRA

• HRA communicates the worth of human resources to the organization and to the public

• Depicting the true value of the organization

• ESTABLISHING INVESTOR CONFIDENCE how efficient their personnel is to deliver returns on investments

The case for HR Valuation

• Monitor effective utilization

• Deciding about transfers, promotion, training and retrenchment

• Evaluating the expenditure incurred for imparting further education and training in employees in terms of the benefits derived by the firm.

It is important to be aware of the fact that HRA is not only about putting figures on human capital;

• It is also about supporting human resource development / management.

• It is about treating employees as assets and knowing whether the asset is appreciated, depleted or conserved;

• It is about acquiring and retaining (good) employees

Value of Training

Companies that scored in the top 20% of a

McKinsey ‘Talent Management Index’ on

average had a 22% higher return to stake

holders than peers in their industry

Echols, Michael E., ROI on Human Capital Investment(Arlington, Texas: Tapestry Press, 2005). pp. 29-30.

Value of Training

In a study by Accenture that measured the overall business impact of investment inlearning found those companies who did hada higher performance and produced higherresults:– Sales per employee = 27% greater– Revenue growth = 40% greater– Income growth = 50% greater

Echols, Michael E., ROI on Human Capital Investment(Arlington, Texas: Tapestry Press, 2005). pp. 29-30.

Value of Training

American Society of Training & Development(ASTD) found that the average 5 year returns instock market value related to the level of a

company training investment:

• Top 50 firms produced 86% returns• Bottom 50 firms produced 19% returns

Echols, Michael E., ROI on Human Capital Investment(Arlington, Texas: Tapestry Press, 2005). pp. 29-30.

Human Capital Matrix

• Revenue per Employee• Cost per Employee• Profit per Employee

- Can easily be calculated as based on financial reports

Training Indicators

Financial Financial & Non Financial

Non – Financial

Training Expenses Training Expense per Employee

Training hours per Employee

Training Exp / Adm Exp (%)

Training Expenses per Employee (Category)

Increase in Output per employee

Training Exp / Total Exp (%)

Increase in Revenue per Employee

Average satisfaction with competence developed by trainee

Training Exp / Employee Exp (%)

Change in Stock Prices per Employee

Average satisfaction with competence developed by immediate head of trainee

Score Card

Indicators

• Goal Setting & Performance Evaluation• Intra Firm Comparison

– Between departments/branches– Across Time periods

• Benchmarking

Can I Determine the Benefit derived from Training ?

Training Evaluation

Performance / Efficiency after training Performance before training

Salesman : Sales after Training

Sales before training

Worker: Output , Defects

IT Personnel : Time / Error

Training Evaluation

Managerial Level

• Increase in Revenue / Reduction in Cost

CFO – reduce cost of capital

- Better reviews from Financial Analysts

• Feedback from those who report to him – Satisfaction of subordinates

• Promotion to next level

Investment not Cost

As human resource is considered as an asset, any expenditure incurred in the acquisition and accumulation of human resource is treated as an investment.

Cost of training and development represents sacrifice that will have to be incurred today to acquire and develop people in future

ROI – Training

ROI = Returns (Net) x 100

Investment

• Investments (Costs)• Returns (Benefits)

Training Investments

• Design & Development - Internal resources , External experts , travelling, etc

• Promotional Cost – brochure, etc

• Administrative Cost – hours

• Faculty Cost - including accommodation & travelling cost

• Material Cost • Facility Cost – Room, Equipment, Lunch, etc

• Trainee Cost - Productive time for which he/she is paid

• Evaluation Cost

Returns from Training

• Productivity & Efficiency • Sales & Profitability • Customers & Markets• Other Saving – Health & Safety, Organizational

Culture

• Other Income

Productivity or Efficiency• Reduction in production costs per unit• Increase in Productivity - hours saved x Rs. Per hour (per worked hour, per shift, per machine, per annum )

– Reduction in Production/completion time per unit (e.g. forms, loans, clients ’ Project)

– Increase in Output

• Reduction in overtime (quantity, cost)

• Less Induction time for new employees• Better Equipment/facility/asset utilisation (e.g. down time due to

machine stoppages, shift changeover time)

• Lower Equipment maintenance or replacement costs• Capacity of staff to solve routine and non-routine problems

(saving of supervision time required)

• Less errors (less time spent on correcting errors)

• Faster access to information

Sales & Profitability• Reduction in overhead costs• Reduction in operating costs• Fall in operating costs as a percentage of total

costs/revenue • Increase in revenue/income/sales (monthly, annually, per

employee, per team, per branch or store)

• Rise in market share (number of customers, unit volume sold)

• Sales to new customers• Enhance Group operating profit• Profit per employee• Stock market performance (i.e. shareholder return)

Customer Satisfaction & Services

• More Sales ( customer satisfaction levels with timeliness, availability, quality and price of goods and services)

• Repeat business (customer retention or loyalty)

• New business resulting from client referrals• New or more customers or markets (e.g. contracts

won, loans processed, funding awarded)

• Less lost business (number of complaints , customers discontinued)

• Reduction in bad debts

Other Saving

• Safety: Reduction in accidents or injuries (number, time lost, compensation costs, premium cost/rating)

• Health : Less Absenteeism• Organizational culture : Less Turnover

(less recruitment and training cost)

Other Income

• Sales from referral of non-sales employee• New Product ideas leading to new product

launches

ROI Example 1

Returns Rs.

Increased Sales 2,40,000

Productivity increases 675,000

Other cost savings 160,000

Other income generation 0

Total Benefits 10,75,000

Investments

Design and development 40,000

Promotion 5,000

Administration 12,000

Faculty 87,000

Materials 15,000

Facilities 40,000

Trainee 550,000

Evaluation 1000

Total cost 750,000

Net Return (Return – Inv) 325,000

ROI ( Net Return/Inv x 100) 43%

ROI Example 2

Each data entry operators cost Rs. 100 per hour.  5 hours are spent on correcting errors per week. After training  20 percent less time is incurred correcting errors. 40 operators were trained at cost of Rs. 50000.

Example 2

Returns : Saving of time : 20% of 5 hours

i.e. 1 hour per week – Rs.100

ROI = 100 x 40 - 50000 x 100

50000

= - 46000/50000 x 100

= - 92%

Example 2

Is the benefit for only 1 week

For a year

ROI = 100 x 40 x 52 - 50000 x 100

50000

= (208000 – 50000)/50000 X 100

= 316%

Example 2

What was the benefit in 3 months

ROI = 100 x 40 x 13 - 50000 x 100

50000

= (52000 – 50000)/50000 X 100

= 4%

Pay Back Period on Training

How long did it take to recover the investment

Example 1

Benefit of 12 months 10,75,000

Benefit in a month 89, 583

Cost 7, 50,000

Pay Pack (cost/ Benefit per month) 8.3 months

Value of Training

Year SavingsPV Factor

(12%)Present Value

1 208000 0.833 1733332 166400 0.744 1238103 133120 0.664 884354 106496 0.593 631685 85197 0.530 45120

Present value of Savings 493866Less: Investment 50000Value of the Program 443866

Merck Model

Gain = Sd x R x P x N

Sd = Shift in performance by average trainee from pre training expressed in standard deviation

R = The Rupee value of the standard deviation of performance shift

P = Percentage of employees impacted

N = Number of employees who underwent training

Valuation of Human Assets

Cost based approaches:i) Historical Costii) Replacement Costiii) Opportunity Costiv) Standard Cost

Economic value based approaches:i) The Lev and Schwartz Modelii) The Eric Flamholtz Modeliii) Morse Model

Historical Costs

Acquisition cost (i) Recruitment Cost

(ii) Selection Cost(iii) Placement Cost(iv) Campus Interview Cost

Learning Cost (i) Formal Training Cost(ii) On the Job Training Cost(iii) Special Training(iv) Development Programmes

Welfare Cost(i) Medical Expenditure

(ii) Canteen Expenditure(iii) Specific and General Allowances(iv) Children Welfare Expenses(v) Other Welfare Expenditure

Other Costs (i) Safety Expenditure(ii) Ex-gratia(iii) Multi-trade incentives(iv) Rewarding Suggestions

Total cost approach

Example: A firm has started its business with a capital of Rs.10,00,000. It has

purchased fixed assets worth Rs.5,00,000 in cash. It has kept Rs.2,60,000 as

working capital and incurred Rs.2,40,000 on recruiting, training and developing

the engineers and few workers. The pay and benefits of engineers and workers is assessed at Rs.8,00,000.

Putting People on the Balance Sheet

Replacement Cost Estimated that the replacement cost of an

executive in middle management level is about 1.5 to 2 times the current salary paid in that position

a) Communication of job abilityb) Pre-employment administrative functionsc) Interviewsd) Testinge) Staff Meetingsf) Travel Costg) Medical Examinationh) Induction i) Pay & Benefits

Opportunity Cost Method

This model envisages computation of monetary value and allocation of people to the most promising activity and thereby to assess the opportunity cost of key employees through competitive bidding among investment centres.

Present Value Of Future Earnings Method

It recognizes an individual’s expected economic value to the enterprise during his remaining service period. An estimate about the future earning is made, for his entire service period till the date of retirement of the employees. Such earnings are discounted by an appropriate range to get the present value.

The Lev and Schwartz Model (Present value of Future Earnings

method)

All employees are classified in specific groups according to their age and skill

Average annual earnings are determined for various ranges of ages

The total earnings which each group will get upto retirement age are calculated

The total earnings calculated as above are discounted at the rate of cost of capital

The value thus arrived at will be the value of human resources/assets

The Lev and Schwartz Formula

Vy =∑t= yPy (t +1) ∑T I (T) /(I + R) t-y

Where, • Vy= expected value of a ‘y’ year old person’s

human capital• T = the person’s retirement age• Py (t) = probability of the person leaving the

organisation• I(t) = expected earnings of the person in period I• r = discount rate

Example: Low Skill Worker

Age (Years ) Annual Earnings per Employee

23-32 40000

33-42 50000

43-52 60000

53-62 70000

Example: Low Skill Worker

Age (Years )

Annual Earnings per Employee

PV Factor (10%) Present Value

23-32 40000 6.145 (1-10 years) 245800

33-42 50000 2.369 (11-20 years) 118450

43-52 60000 0.913 (21-30 years) 54780

53-62 70000 0.352 ( 31-40 Years) 24640

Human Value = Rs. 443670

If they are 100 such workers at the age of 23 then the total value is Rs. 4,43,67,000 . If the attrition rate is 10% the net value is 90% of 4,43,67,000 i.e. Rs. 3,99,30,300

Flamholtz Model (Reward Valuation method)

Measure of an individual’s value to an organization is his expected realizable value. An individual’s value to the organization can be defined as the present worth of set of future services that the expected to provide during the period he remains in the organization.

Flamholtz (1971)model

Flamholtz Model

Employee mapping in service states (Roles &

Positions)

Tenure in each Service State

Estimation of the value derived by the

organization when a person occupies a particular position

Aggregate to get the total value

The Value thus arrived is discounted at a

predetermined rate to get the present value of

human resources

Morse Model (Net Benefit Model)

The value of human resources is equivalent to the present value of net benefits derived by the organization from the service of its employees.

1. The gross value of services to be rendered in future by the employees in their individual as well as their collective capacity is determined.

2. The value of future payments (both direct and indirect) to the employees is determined.

3. The excess of the value of future human resources (as per 1 above) over the value of future payments (as per 2 above) is ascertained. This, as a matter of fact, represents the net benefit to the organization on account of human resources.

4. The present value of the net benefit is determined by applying a predetermined discount rate (generally the cost of capital). This amount represents the value of human resources to the organization.

Morse (1973)

Human Capital Measures An Example

• Revenue = Rs. 10,00,00,000• Expenses = Rs. 8,00, 00,000

• Pay & Benefits = Rs. 2,40,00,000• Absent Cost = Rs. 39,50,000 ( including extra

employees)• Turnover Cost = Rs. 36,00,000• Full time Equivalent (FTE) Employee = 500

HCM Example

• Human capital cost = pay + benefits + absent cost + turnover cost

• HCC = 2,40,00,000 + 39,50,000 +36,00,000 • = 3,15,50,000

31 % more than pay & benefits in financials

Human Capital Value Added

HCVA = Revenue – (Expenses – Employee Expenses)

Or Profit + Employee Expenses

HCVA = Rs.10,00,00,000 - (8,00,00,000 -2,40,00,000)

= 4,40,00,000

HCVA per employee is = HCVA/FTE = 4,40,00,000/500 = 88,000

Human Capital Return on Investment

HCROI = HCVA / Employee Expenses

= 4,40,00,000/2,40,00,000

= 1.83

Return on Talent

Human Economic Value Added

HEVA = EVA / FTE

EVA = Net operating Profit after Tax – Cost of Capital

Dr. Shital Jhunjhunwala 57

Type of Asset

Valuation Value Time Who Focuses on It

Tangible/ Physical

AbsoluteCost

Historical Accountants & Auditors

Monetary/ Financial

Interest/ Return

Present Managers & Analysts/ Investors

Intangible/ Intellectual

Potential Value

Future Boards of Management

How do we measure it ? Who should focus on Intangibles?

Thank You

• Human Resource Costing and Accounting [advocated by Johansson (1996)]: This methodology

• "calculates the hidden impact of Human Resources related costs which reduce a firm's profits.

• Adjustments are made to the P & L. Intellectual Capital is measured by calculation of the contribution of

• human assets held by a company divided by capitalized salary expenditures."

• Human Capital Intelligence [advocated by Jac Fitz‐Enz (1994)]: By use of this methodology, "sets

• of human capital indicators are collected and benchmarked against a database."

• In 1900 = 17% of jobs required knowledge workers.

• In 1997 over 60% of jobs (at least) require an educated workforce

• Today ????