JAMES A. CRAFT AND JACOB G. BIRNBERG"

Human Resource Accounting: Perspective and Prospects

RECENT INTEREST in Human Resource Accounting (HRA) has been stimulated primarily by a growing recognition of employees as basic organizational resources, coupled with dissatisfaction with traditional management control systems which ignore human variables. The purpose of this paper is to evaluate the HRA movement within this context. We begin by examining the movement's development and by noting the two major approaches that have been proposed to measure human assets. We then review alternate uses to which HRA can be put. Finally, we discuss the movement's progress to date and argue for a major redirection of effort away from external reporting and toward the internal use of HRA in man- agement evaluation and decision making.

Development of the HRA Movement Current interest in HRA can be traced directly to the influence

of Rensis Likert, former director of the Institute for Social Research at the University of Michigan. Likert's scheme of organizational analysis dis- tinguishes among causal variables, such as leadership, intervening variables, such as attitudes, morale, loyalty, and motivation, and end-result variables, such as profit and output. He argues that, in evaluating managerial per- formance, most organizations place excessive emphasis on short-run, end- result variables, and, as a consequence, managers become motivated to adopt styles of leadership and develop organizational climates which are

"The authors are, respectively, Associate Professor of Business Administration, University of Pitts- burgh, and Professor of Business Administration, University of Pittsburgh.

'For the foundations on which Likert's concepts are based, see his New Patterns of Management (New York: McCraw-Hill, 1961) and The Human Organization: I t s Management and Value (New York: McCraw-Hill, 1967).

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unfavorable to the development of sound human relationships. According to Likert,

The costs of building and maintaining an effective human organization are usually ignored in the accounting methods of most companies. Similarly, spurious earnings achieved by liquidating some of the company’s investment in the human organiza- tion are not charged against the operation and used in evaluating which system of management works best.*

He concludes that only by improving intervening variables such as employ- ee attitudes, morale, loyalties, and motivation can long-run successful per- formance be obtained. Realistically, however, Likert recognizes that “so long as no quantitative surveillance is maintained over a firm’s human assets.. .” managers would only have limited incentive to devote the time and resources necessary to develop these.3 He proposes a system of account- ing for human resources by estimating the value of a firm’s human assets and monitoring changes in their value. Such a system would involve the rig- orous measures of causal variables (e.g., leadership style, organizational climate) and intervening variables (e.g., attitudes, motivation). These measurements at regular intervals would indicate changes in human organi- zational characteristics, which can influence the organization’s operating efficiency. This, in turn, could result in changes in the organization’s end result variables, profitability, and effectiveness. The socio-psychological measurements of the causal variables could be presented in both internal and external financial reports.4 Such information would be useful to both management and investors in their decision making. Likert avoided specify- ing procedures for measuring or reporting investment in human resources, leaving this task to accountants.

Alternate Measurement Approaches Stimulated by Likert’s ideas, a few accountants began to call

for extending their framework into nontraditional areas. In addition, they suggested that financial accounting reports should include “measurement

Gker t , N e w Patterns.. ., p. 86. “ikert, The Human Organization.. , , p. 103. ‘For additional information and a suggestion that changes in the human organization should be in-

cluded on financial statements to evaluate managers, see Rensis Likert and David G. Bowers, “Improving the Accuracy of P/L Reports by Estimating the Change in Dollar Value of the Human Organization,” Michigan Business Review, XXV (March, 1973), 15-24; Rensis Likert and William C. Pyle, “Human Resource Accounting: A Human Organizational Measurement Approach,” Financial Analysts lournal, XXVII (January/February, 1971), 75-84.

4 / JAMES A. CRAFT AND JACOB 6. BIRNBERG

of turnover, morale, absenteeism, and of other ‘intervening variable^'."^ This increased interest in HRA has led to development of techniques to measure the worth of human assets in organizations. Basically, these methods can be grouped into two general approaches, one “outlay-based’’ and the other “inflow-oriented.’’

Outlay-based approach. Most of the initial work in HRA was directed toward determining organizational investments in people,6 focusing on cash outlays invested in developing human assets, for example, selection and training costs. This approach appears to be generally consistent with both traditional accounting practice7 and the concept of human capital in eco- nomic theory. The estimated investments in the firm’s human assets, for example, would provide a base measure of the organization’s outlays for human resources. The extent to which that outlay is consumed over time through operating activities can be approximated by monitoring the social- psychological measures of intervening variables. The latter are, of course, at best approximations.8

The outlay-based approach most consistent with current accounting re- porting techniques involves historical cost. Using this approach, the out-of- pocket expenditures by the firm in securing and developing its human re- sources (e.g., recruiting, selection, training, etc.) are capitalized for each individual. The other major outlay-based approach involves replacement costs. Through this method, the worth of the organization’s human resources is determined by the current cost to the firm of replacing its existing human

S J a ~ ~ b G. Birnberg and Nicholas Dopuch, “A Conceptual Approach to the Framework for Disclosure,” Iournal of Accountancy, CXV (February, 1963), 59. Also, see Roger H. Hermanson, Accounting JOT Hu- man Assets, Occasional Paper No. 14, Bureau of Business and Economic Research, Graduate School of Business Administration, Michigan State University, 1964; James L. Cullather, “The Missing Asset: Human Capital,” Mississippi Valley Journal of Economics and Business, I1 (Spring, 1967), 70-73; R. Lee Brummet, “Accounting for Human Resources,” Iournal oJAccountancy, CXXX (December, 1970), 62-66; “An Interview with Sidney Davidson,” Forbes, CV (April 1, 1970), 40-42.

5 e e Rensis Likert and Robert L. Woodruff, Jr., “A Brief History of the Development and Implemen- tation of Industry’s First Human Resource Accounting System at the R. G. Barry Corporation,” mimec- graphed, n.d.; also, R. Lee Brummet, et al., eds., Human Resource Accounting: Development and Im- plementation in Industry (Ann Arbor: Foundation for Research on Human Behavior, 1969).

’Of all the available methods to value human resources, the historical cost method is probably the most acceptable to the accounting profession given the tradition of its use, the fact that it can be docu- mented and therefore audited, and due to the added problems that can arise in accounting when the valuation base other than historical cost is used for some of the organization’s assets. See Brummet, “Accounting for Human Resources,” p. 65. For criticisms of the historical cost method, see William A. Paton, “Accounting Today - A Bird’s Eye View,” Michigan Business Review, XXVI (January, 1974),

BR. Lee Brummet, Eric G . Flamholtz, and William C. Pyle, “Human Resource Measurement-A Challenge for Accountants,” The Accounting Review, XLlll (April, 1968), 223-224. Likert’s procedural suggestions for converting intervening variable measurements into dollar terms are presented in Rensis Likert, “Human Resource Accounting: Building and Assessing Productive Organizations,” Personnel, L (Maybune), 8-24.

22-25.

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resources with others capable of rendering equivalent service^.^ The basic unit for valuation here can be the individual, group, profit center, or the entire organization.1°

Inflow-oriented approach. The second major approach focuses on the present economic value of the organization’s human resources in terms of the value of the future benefits to be derived by the organization from the services to be provided by these assets.” One version of this approach involves measuring value indirectly. It begins by forecasting the organiza- tion’s stream of earnings over a specific period of time and then discounting this to determine the organization’s present value. A portion of this value is then allocated to human resources in proportion to those resources’ rela- tive contribution to the firm’s expected incorne.l2 Another inflow-oriented approach is more direct.13 It assumes that an individual’s wage accurately reflects his value to the organization. Under this method, future wage streams are discounted to obtain a surrogate measure of his present human resource value.’*

Alternate Uses for HRA How could HRA be used? At least three uses have been pro-

posed by the literature.

In personnel management. HRA could help the personnel manager make

OFor discussion of some of the advantages of using replacement costs, see William C. Pyle, “Imple- mentation of Human Resource Accounting in Industry,” in Brummet, et al., eds., op. cit., p. 42, and Eric Flamholtz, “A Model for Human Resource Valuation: A Stochastic Process with Service Rewards,” The Accounting Review, XLVI (April, 1971), 264-265. For an attempt to measure positional replacement costs in an organization, see Eric Flamholtz, “Human Resource Accounting: Measuring Positional Re- placement Costs,” Human Resource Management, XI1 (Spring, 1973), 8-16.

‘“For some criticisms of using replacement costs, see Flamholtz, “A Model for Human Resource Valuation.. . ,” p. 42, and also William C. Pyle, “Monitoring Human Resources-On Line,” Michigan Business Review, XXII (July, 1970), 30, and James S. Hekimian and Curtis H. Jones, “Put People on Your Balance Sheet,” Harvard Business Review, XLV (January/February, 1967), 108.

“For theoretical and normative models for the valuation of individuals in organizations, see Eric Flamholtz, “Toward a Theory of Human Resource Value in Formal Organizations,” The Accounting Re- view, XLVII (October, 1972), 666-678, and Flamholtz, “A Model for Human Resource Valuation.. . .” For a concept somewhat different than that elaborated on by Flamholtz, see Hekimian and Jones, op. cit.

”%See Brummet, Flamholtz, and Pyle, op. cit., pp. 222-223. This method has the limitation of leaving the determination of the “relative contribution” of the human resources to a totally subjective estimate.

13For the major exponent of this approach, see Baruch Lev and Aba Schwartz, “On the Use of the Economic Concept of Human Capital in Financial Statements,” The Accounting Review, XLVI (January, 1971), 102-112. For another approach, see Hermanson, op. cit.

“One is left with an uneasy feeling when there is an assumption that a person’s wage is similar to his value to the organization. For some criticisms of this approach, see Eric Flamholtz, “On the Use of the Economic Concept of Human Capital in Financial Statements: A Comment,” The Accounting Review, XLVII (January, 1972), 148-152, and Eric Flamholtz, Human Resource Accounting (Encino, Calif.: Dickenson Publishing Company, 1974), pp. 216-229.

6 / JAMES A. CRAFT AND JACOB G . BIRNBERG

better use of the resources entrusted to him. For example, it may assist him in developing measurements of costs of hiring and training new em- p l o y e e ~ ; ~ ~ such data might then be employed in choosing among alternatives in selection procedures and forms of training. Costs generated in this man- ner, however, would probably never become part of the formal internal cost accounting system and certainly would not become part of the external financial reporting system.

In line management. HRA could also be used to inject additional inputs (e.g. , personnel costs and perhaps social-psychological data) into the organi- zational internal planning and control systems. As such, it could be used both in planning for future activities (decision making) and in evaluation of past performance. This use of human resource data is broader than the personnel cost data in two respects. First, the focus of attention is on mana- gerial activity generally, not on just the personnel department. Secondly, by including human resource data in the performance evaluation process, top management underscores its concern for developing a strong human organization. The firm benefits from this use of HRA through more efficient use of available resources, and the investor profits as a result of greater long-run efficiency.

By investors. HRA could also be integrated into reports designed for external use.16 The form which this external disclosure could take could vary in detail and formality. The data could appear as supplementary notes appended to the financial statements; it could take the form of a set of parallel accounts which would be included alongside more traditional re- ports; or HRA data would be incorporated directly into the firm’s formal audited statements.

The rationale behind this form of disclosure is that these data will aid investors and potential investors in evaluating the economic condition of the firm. Specifically, it should improve their understanding of the true nature of the firm’s stock of resources of ull kinds as well as the prediction of periodic net inflows from operations. (Any argument short of concern for external parties does not require their inclusion in the formal financial statement, either as an integral part thereof or as a supplement to them.

IsJames A. Craft, “Human Resource Accounting and Manpower Management: A Review and Assess- ment o f Current Applicability,” Journal of Economics and Business, X X V I I I (Fall, 1975), 23-30.

’“Perhaps one of the most vocal proponents of external reporting of HRA information is Dean Marvin Weiss. See his articles, “Where ‘Human Resources Accounting’ Stands Today,” Administrative Manage- ment, X X X I I I (November, 1972), 43-48, and “Accounting for Human Resources,” Management Review, LXII (March, 1973), 58. In addition, see Lev and Schwartz, op. cd., and the discussion by Likert and Pyle, op. cit., p. 83.

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The internal audience could be addressed by a system of reports generated solely for internal consumption.)

HRA in Practice R. G. Barry. The best existing examples of HRA external reporting are

the annual reports of the R. G . Barry Corp~ration,’~ which include unaudit- ed HRA reports along with reports in the traditional format. Barry’s report is cost based and utilizes systematic procedures to match consumed human assets with periodic review flows. As such, it might be acceptable to a firm’s auditors because it is consistent with “good” accounting procedures.

Despite the publicity given Barry’s use of the human asset data in its published financial reports, the writing of some of the principals clearly demonstrates that the function of the data is to improve the quality of man- agement, not the quality of investor decisions.18 Were the latter to occur, it would be a by-product of the process.

TIPP. The prototype program developed by Touche, Ross, and Company for the Training Incentive Payments Program (TIPP) provides an example of a formal human assets accounting system, which has been integrated into the internal financial reporting system.lg Here conventional and human resource accounting systems are utilized to measure “the profit improve- ment and cost reduction effects of employee upgrading efforts” in a man- power program. The focus in this case is on the need to communicate with operating managers in language they can understand - monetary units.20

ATGT. American Telephone and Telegraph has developed an outlay (cost) based HRA system which is “used entirely for management planning

”See the AnnualReports of the R. G. Barry Corporation, Columbus, Ohio, for the years 1969, 1970, and 1971. A number of publications discuss the Barry Corporation’s use of HRA. See, for example, R. L. Woodruff, “Human Resource Accounting,” Canadian Chartered Accountant (September, 1970), 156-161; Brummet, et al., eds., op. cit., pp. 67-88; Robert L. Woodruff, Jr., and Robert G. Whitman, “The Behavioral Aspects of Accounting Data for Performance Evaluation at the R. G. Barry Corporation (With Special Reference to Human-Resource Accounting),” in Thomas J. Burns, ed., The Behavioral Aspects of Accounting Data for Performance Evaluation {Columbus, Ohio: Ohio State University, Col- lege of Administrative Science, 1970). p. 14.

L8William Pyle, “Accounting for Your People,” Innovation (November 10, 1970), 46-54. ’OTouche, Ross, and Company, Upgrading Low Income Workers- Costs and Benefits: A Prototype

Information System, 1973 (processed). ”Ibid., p. 30. The report states that, “a private sector manager can not be expected to undertake

or maintain an extensive training program solely out of an expanded sense of social consciousness. The payoff must ultimately be expressed in measures of his own self-interest -measured or estimated in dollar terms.”

8 / JAMES A. CRAFT AND JACOB G. BIRNBERG

and contr01.”~’ The intention here is to improve the evaluation of various personnel procedures and programs by highlighting their impact on employ- ee values and future earnings. The system involves the capitalization of employment and development costs for operators. This “investment” is amortized with adjustments for changes in the expected tenure and in- creased productive capacity of the operator. A calculation is then made regarding recovery or loss on the investment for each employee. The pro- gram has apparently had some effect on management policy, since it is claimed that local offices in the organization are more “cost conscientious because the information is a ~ a i l a b l e . ” ~ ~

Wilte. Perhaps the most sophisticated HRA system proposed to date is that of Lester Witte and Company, certified public accountants. The Witte system, as outlined by Flamholtz and Lundy, is direct, inflow-oriented,23 as compared with the Barry, TIPP, and AT&T approaches which, despite their managerial orientations, are all cost-based, outlay-oriented systems and therefore are not completely satisfactory for management’s purposes.

The Witte system attempts to value human assets by discounting back to the present the sum of future net cash flows generated by the employee. This is assumed to be his “value” to the firm. A simple example of this follows :

Assume that a relatively recent hire to a CPA firm has just passed his CPA exam. The firm is now in the process of valuing its human resources including this staff- man. Management decides that it knows with certainty what his role will be in the firm for the next four years. In years one, two, and three, he will be a senior staffman. In year four, he will be a manager. At the end of year four he will-for convenience of this example-exit the firm.

The firm has estimated that the net service value (billing fees from his services less related salary and fringe benefit costs) of a senior staff accountant is $30,000 per year and a manager’s salary is $50,000 per year. Thus, the potential benefit to the firm of the human resource is the present value of the net service value stream of 830,000 + $30,000 + $30,000 + $50,000. Using a discount rate of twenty percent, the result of the calculation is $87,000.

The purpose of the Witte system is to monitor the development and training of the labor force-in this case, auditors. It is argued here that

“Thomas W. McRae, “Human Rcsource Accounting as a Management Tool,” Journal of Accounfancy (August, 1974), 32-38: and Florence Stone, “Investment in Human Resources at AT&T,” Management Hetiiew, LXI (October, 1972), 23-27.

‘lMcRae, OP. cit. ”Eric G. Flamholtz and Todd S. Lundy, “Human Resource Accounting for CPA’s,” CPA Journal

(forthcoming).

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the change in the value of members of the labor force ought to parallel their growth in skills and in professionalism. Thus, as the junior accountant acquires experience and is enrolled in training programs, he ought to be able to perform a wider array of tasks and/or perform them with greater exper- tise. This change in his skills is paralleled by changes in the auditor’s rank (i.e., from “junior” to “semi-junior” to “senior,” etc.) and the fee charged for his services. The underlying premise of this system is that by placing a dollar value on the development of the labor force’s skills, management gains a better indication of whether it is enhancing the skills of its labor force.

The Witte system, because it is inflow oriented, comes closer than most extant systems to meeting Likert’s goal of valuing the human resource. It is able to do so, however, because of the unique environment for which it was developed-a CPA firm. The CPA firm and a limited number of com- parable organizations permit the human resource evaluator to associate a unique stream of net inflows with each employee. In the case of the auditor, this was billable hours or fees. Comparable streams are ascertainable in a number of service-oriented firms where the client’s charge is the aggregate of the fees charged for the individual professionals. Unfortunately, the Witte technique has applicability to only a small but important subset of interested firms.

It is worth noting that, while the AT&T and Witte systems differ funda- mentally in their approach to measurement, they are concerned with achiev- ing the same goals, i.e., making managers more aware of the impact of their actions on their employees and ultimately on the firm’s economic position. As such, they appear to be following the injunction which says that although people are important to managers, they assume their full significance only when they are measured in units managers understand.

Significantly, methods of measuring human assets other than historical cost which were outlined earlier have not been utilized by any organization for external reports even supplementally. There are good conceptual reasons for users preferring the more traditional cost-based presentation of these data, especially while HRA is still fighting for acceptance. Cost-based data are consistent with the other date reported in the financial statements and, as such, are “objective.” However, to justify the inclusion of a cost-based representation of the value of the organization’s human assets in external reports, there must be some reason to believe it will improve the quality of decision making. As yet, however, there is no clear evidence that this has been the case.

10 / JAMES A . CRAFT AND JACOB G. BIRNBERG

HRA’s Immediate Future The current state of HRA reflects the conflict between trends

in the accounting and personnel professions. While personnel is keenly interested in developing more elaborate measures of the costs and benefits of its activity, accounting is in the process of making its rules more conser- vative, especially in reporting intangible assets. Thus, most recently the Financial Accounting Standards Board, the primary rule-making body in accounting, has set strict guidelines as to when the costs of intangibles, such as Research and Development, may be shown on the balance sheet as assets.

The impetus for accounting’s conservative position is probably two-fold. First, many accountants have always been concerned about capitalizing on the balance sheet excessive amounts of outlays for intangibles. Second, many firms (e.g., Memorex) have had large amounts of these “assets” turn out to be worthless. Always wary and now burned, accountants are likely to be cautious in considering innovation which will increase the intangible assets on the corporate balance sheets. (Indeed, the proliferation of lawsuits against CPA’s for purported instances of subprofessional practice has not alleviated the situation.)

The attempt by personnel managers to include HRA data in the world of external financial reports is untimely. Since accounting practitioners are currently concerned with more fundamental pressing issues, such as inflation accounting, the likelihood of HRA becoming a part of the audited external reports in the short run is slim at best. The parallel accounts mode of disclosure to external parties followed by the Barry Corporation is prob- ably the closest that firms will be permitted to come to disclosing their hu- man assets to external parties in an authoritative form.

It is unfortunate that so many writers are so preoccupied with the use of HRA for external reports. Aside from the aura of respectability that the acceptance of such statements would afford the HRA movement, little of value is gained by inclusion of HRA data in external reports that is not gained by their use just for internal purposes. Since managerial use of HRA seems to hold more value than investor use, any efforts to adopt HRA should be focused on internal rather than external purposes.

SignificantIy , accounting has a strong history of utitizing techniques for internal reports that are not accepted for audited financial statements. The most obvious and analogous of these is direct costing. In the case of direct costing the inventory method is widely used for internal purposes, such as divisional reports for evaluation of performance. However, the direct cost- ing results of operations are then adjusted before the firm-wide reports are

Human Resource Accounting / 11

prepared according to generally accepted accounting procedures. Tech- niques such as this for internal reports are common.

Should HRA be cost-based or inflow-oriented and, if it is outlay-based, should replacement cost or historical cost be used? The preponderence of past experience would suggest that the historical cost-oriented approaches, such as the Barry or TIPP proposals, are most likely to be adopted. Even for internal reports the objectivity of the historical cost data becomes ap- pealing. It means not only that two or more accountants will reach approxi- mately the same answer in measuring the stock and flow of human re- sources, but also the system appears at least slightly less capricious to the manager involved since the accountant did not “conjure up” the number. The manager now can relate the investment in human resources to his activi- ties and the charge for their use to his utilization of these resources.

The significant datum to the contrary is the Witte direct inflow-oriented system. This method exhibits a greater degree of objectivity than many value related methods because of the existence of an ascertainable objective revenue function for each member (or class) making up the labor force. This is not usually the case in an industrial firm.

Overall, the use of the cost-based HRA measures in the internal evalua- tion process is probably more dependent upon the recognition of their value by managers than by accountants. To the accounting department, special internal reports are not unusual. However, it is the manager who must recognize the value of the new information to him in allocating and utilizing the resources for which he is responsible and in measuring economic effi- ciency.

Discussion and Conclusions The HRA movement has probably attempted to go too far

too quickly, given the available methodologies and lack of widespread acceptance within management and the accounting profession. HRA en- thusiasts have tried to get management to do four things at once: (1) pay more attention to personnel variables; (2) place dollar values on human resources and implement human asset depreciation; (3) break with the accountant’s traditional reliance on historical cost data (except for outlay cost methods); (4) develop internal and external reporting procedures using HRA data. Any of these objectives alone would be difficult to achieve, but the attainment of all simultaneously is virtually impossible. The result is that in many cases managers who might be sympathetic to one or more aspects of HRA become skeptical of its value because they can’t accept all

12 / JAMES A. CRAFT AND JACOB 6. BIRNBERG

aspects. And to some managers HRA appears to be a “hastily constructed discipline made up of recycled ‘spare parts’ from other disciplines” rather than a useful, well formulated management

Our review of the current HRA experience convinces us that this new form of accounting will obtain greatest acceptance as an aid in personnel management operations analysis (e.g., turnover cost analysis, training cost analysis, costing out selection procedures, and the like) and in evaluating managerial performance, especially in service-oriented industries. On the other hand, we feel it unlikely that HRA will be recognized by the account- ing profession as having legitimate value in external accounting reporting.

24“Report of the Committee on Human Resource Accounting,” American Accounting Association Com- mittee Reports, The Accounting Review, supplement to XLIX (1974), 122.