Understanding financial human resource in relation

to business

Paper 4Arriffin Mansor

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Contents• What is HR accounting?• What is the value of human?• Why is HR accounting?• The importance of Human Capital Asset• Present accounting ignores the human capital• Return on pay• Human capital architecture.• Costs related to human capital• Human Resources• Future development• Researh and development

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What is human resource accounting? • To record, report and analyze human resource

related figures through the accounting system• The result can be use for planning and

decision making purpose

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What is the value of human?

• Human is priceless.• Human capital can be counted.– How do you calculate the value of an employee in

the company?• Minimum value = The present value of her(his) salary in

the future, by considering the possibility of early absence.

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Why human resource accounting?

• Human capital becomes the most important asset in the corporation to extract value

• Present accounting system ignores the importance of human resource value

• Managers lack information about the effectiveness and efficiency of human resource investment

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Human capital becomes the most important asset in the corporation

• More service(human intelligence) oriented company than before– Higher Tobin’s Q(Price/Equity)– Higher Return on Assets(ROE)

• The importance of capital shifts from financial capital to intellectual capital

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• Intellectual capital including – human capital, – organizational capital• Relation capital(outside)• Customer capital(outside)• Process capital(inside)• Learning and development capital(inside)

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Ku-Jun Lin, Associate Professor, Tam Kang University

Review: Major Balance Sheet Items

Assets• Current assets:– Cash & securities– Receivables– Inventories

• Fixed assets:– Tangible assets– Intangible assets

Liabilities and Equity• Current liabilities:– Payables – Short-term debt

• Long-term liabilities• Shareholders' equity

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Objectives of Ratio Analysis

• Standardize financial information for comparisons

• Evaluate current operations• Compare performance with past

performance• Compare performance against other firms

or industry standards• Study the efficiency of operations• Study the risk of operations

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Rationale Behind Ratio Analysis• A firm has resources• It converts resources into profits through– production of goods and services– sales of goods and services

• Ratios– Measure relationships between resources and financial

flows– Show ways in which firm’s situation deviates from

• Its own past• Other firms• The industry• All firms-

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Types of Ratios• Financial Ratios:– Liquidity Ratios

• Assess ability to cover current obligations– Leverage Ratios

• Assess ability to cover long term debt obligations

• Operational Ratios:– Activity (Turnover) Ratios

• Assess amount of activity relative to amount of resources used

– Profitability Ratios• Assess profits relative to amount of resources used

• Valuation Ratios:• Assess market price relative to assets or earnings

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The DuPont System

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Profi t M argin T ota l A sse t T urnover

RO A E quity M ultip l ie r

RO E

The DuPont System

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Profi t M argin T ota l A sse t T urnover

RO A E quity M ultip l ie r

RO E

EquityCommon

Assets Total

Assets Total

IncomeNet MultiplierEquity ROAROE

The DuPont System

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Profi t M argin T ota l A sse t T urnover

RO A E quity M ultip l ie r

RO E

Assets Total

Sales

Sales

IncomeNet TurnoverAsset TotalMarginProfit ROA

The DuPont System

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Profi t M argin T ota l A sse t T urnover

RO A E quity M ultip l ie r

RO E

EquityCommon

Assets Total

Assets Total

Sales

Sales

IncomeNet MultiplierEquity TurnoverAsset TotalMarginProfit ROE

The DuPont System: Dell

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Multiplier EquityROA

Multiplier EquityTurnover Asset TotalMarginProfit Equity Common

AssetsTotal

AssetsTotal

Sales

Sales

IncomeNet ROE

31.39%

2.16111452.0

2.16112.20250.0659$5,308.00

$11,471.00

$11,471.00

$25,265.00

$25,265.00

$1,666.00ROE

Summary of Financial Ratios

• Ratios help to:– Evaluate performance– Structure analysis– Show the connection between activities and

performance• Benchmark with– Past for the company– Industry

• Ratios adjust for size differences

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Limitations of Ratio Analysis

• A firm’s industry category is often difficult to identify

• Published industry averages are only guidelines

• Accounting practices differ across firms• Sometimes difficult to interpret deviations in

ratios• Industry ratios may not be desirable targets• Seasonality affects ratios

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Ratios and Forecasting• Common stock valuation based on– Expected cashflows to stockholders– ROE and are major determinants of cashflows to

stockholders• Ratios influence expectations by:– Showing where firm is now– Providing context for current performance

• Current information influences expectations by:– Showing developments that will alter future performance

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How Might Ratios Help Me on the IEM?

• Analysis of AAPL, IBM and MSFT, and comparisons to the S&P500 companies can help to:– Assess the (absolute and relative) financial state of each

company– Show each company’s strengths and weaknesses– Predict sustainable growth rate

• Combined with current information, this can help to:– Assess likely future performance– Predict future valuation and earnings growth– Predict returns

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• Characteristics of Human capital– Hard to imitate– Causal ambiguous– Cannot duplicate in a short time

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Present accounting system ignores the importance of human resource value

• Generally Accepted Accounting Principle(GAAP) treats most human capital related costs as expenses, instead of assets

• The more the company invests in human capital, the less the current net income

• Revenue-Expense(including HR)=Net Income

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• Financial ratios, based on financial statements, provide little or bias human capital profitability information, for example– ROA: based on hard asset– Return on Investment(ROI): The “I” represents the

investment on hard assets– Assets Turnover: Sales/Total “hard ”assets

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How about Return on Pay?

• Not all post could be associated with ROA.• Jobs at the lowest level has only Pay to

contend with.• Hence, return on pay could be meaningful in

evaluating the performance of a job holder.

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• Reasons why GAAP does not allow human capital investment becomes assets– Future benefit uncertainty– Conservatism– Ethical issue

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Managers lack information about the effectiveness and efficiency of human

resource investment

• Lay off decisions– Does the lost training cost and future

orientation cost be considered?– Short term, immediate positive impact on

current net income VS effect on long term profit

– Impacts on employee’s feeling which may negatively influence company income

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• Investment in human capital decisions– Where is the beef?– What is the relationship between human capital

investment and operation result?– The communication of company human capital to

investors.

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The Human capital Architecture

• The classification of Human capital – Not all employees are classified as human capital– Value VS Uniqueness(Lepak & Snell, 1999)– High value Employees can be considered as

human capital– Human capital in quadrant 1are most valuable 123

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Accounting in HR

• Is HR expenditure an asset or an expense?• How do you value HR in the Balance Sheet?• How do you justify a worker? ROA or ROP• How do you measure efficiency and profit

contribution by each employee

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Costs related to human capital

• 1. Formation and acquisition costs at the early stage of development, eg. Recruiting cost

• 2. Learning costs in the middle stage of development, eg, Training cost

• 3. Replacement costs at the final stages of development, eg, discharge cost

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Human resource factors that may have influence on operation result

• Financial(human resource accounting, use accounting system to collect data)

• Non financial(use questionnaire)– Personal background, such as age, gender,

education, experiences and licenses. – Personal characteristics, such and personal traits

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Research summary

• If we consider human capital cost as the only variable, usually it does not show significant influence on operation result in most companies.

• However, if we use an intermediate variable, such as customer capital between human capital and operation result, usually human capital would demonstrate significant influence on operating result through the intermediate variable.

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Ku-Jun Lin, Associate Professor, Tam Kang University

• Some personal background and personal characteristic, together with human capital cost, do have significant influences on operating results

• Capitalizing human capital cost may improve the quality of earning.

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The Limitation

• Hard to find specific human resource data• Case study rather than general study

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Future development of HR accounting

• The influence of market value accounting(such as the evaluation of investments) on human resource accounting

• R & D cost also faces the future benefit uncertainty problem, does the accounting treatment for R & D provide any guidance for human resource cost?

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Closing Summary

• Is it an asset or expense? Is training an asset or expense?

• How is HR represented in the Balance Sheet?• How do you evaluate the performance of a

worker? ROA or ROP• How to identify critical performance gaps for

TNA purposes.

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Thank you for listening

Q & A

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