Should Investments in Human Capital Appear on the Balance Sheet?

Should Investments in Human Capital Appear on the Balance Sheet?

🔥 Often we hear that people or employees are claimed as the greatest company assets, even though they don't appear on the balance sheet, unlike other capital investments that are present there.
Under US accounting conventions (US GAAP), human capital is considered as costs rather than benefits. Human capital has no asset value and does not appear in the balance sheet. Improvements in human capital such as by training is recorded as expenses. Such is not the case with machinery, where improvement costs can be capitalized as future benefit.

Rouen (2019) argues that we should find a universally accepted way to track the management of human capital. We need a new way to account for labor so that we can track and reward companies for how they actually treat their employees and invest in them.
The lack of reporting on human capital actually discourages investing in workers. Improvement is needed.
We need improved disclosures to know the effects of such investments. Companies should report their investment in training just like they do their investment in capital.

Detailed information on how much is spent and which types of employees get training provide shareholders with a sense of how the company sees the future while further disaggregating operating costs. A disclosure like this would also encourage firms to invest in their workers and communicate to shareholders that, while the accountants require that training be reported as an expense, managers see it as a long-term bet on their most valuable assets.
Source: Rouen E. 2019. "The Problem with Accounting for Employees as Costs Instead of Assets", HBR, October 2019.

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Tendekai Dzinamarira
Manager, Zimbabwe

Human Capital Accounting

Definition of Human Capital Accounting

According to a study by Smith et al. (2018), human capital accounting is a method used to assess, assign and record value to the contributions made by employees within an organization. This approach involves the measuring of the employees' skills, knowledge, and experience. Therefore, organizations are able to gain an in-depth understanding of the return on investment generated by their employees. This allows them to make well-informed decisions regarding investments in employee development and growth over the long term.

Human Capital accounting versus Traditional Accounting

Human capital accounting differs from traditional accounting in that it considers employees as assets, whereas traditional accounting focuses on tangible assets and treats any investments in training etc. as expenses.

Applying Human Capital Accounting

In order to implement human capital accounting, one should firstly identify the skills, knowledge and experience of the employees through various methods such as surveys or analyzing job descriptions. Then, the gathered information can be quantified using various approaches to assess the impact of the skills on factors such as revenue generation. Some of the methods used to quantify human capital include direct costing, intangible asset measurement methods and the Balanced Scorecard.

Advantages of Implementing Human Capital Accounting. Benefits

Below you find the main positive impacts of accounting for human capital:

The financial performance of firms can be more accurate or understood better when the value of employees is included in the assets' value.
Recognizing the value of human capital accounting and investing in employee development can improve productivity, innovation, and competitiveness.
Providing a detailed overview of assets and liabilities improves the accuracy and transparency of financial reporting.
Giving a priority to employees attracts socially responsible investors and boosts investor confidence.
Identifying and addressing risks associated with employee turnover and skill shortages helps businesses effectively manage human capital-related challenges.

Disadvantages of adopting Human Capital Accounting. Drawbacks

These are the main drawbacks to human capital accounting:

The difficulty to accurately measure and quantify the value of human capital.
Human capital value may be affected by many factors such as employee engagement and motivation. These can be difficult to quantify.
May lead to a focus on reducing labour costs rather than investing in the development of employees.

Please share your practical experiences and challenges with measuring and accounting for the value of investing in your human capital. Thank you.

References:
Bontis, N. (2002). Intellectual Capital: An exploratory study that develops measures and models. Management Decision, 40(3), 316-324.
Smith, J., Johnson, M., & Anderson, L. (2018). Measuring and Valuing Human Capital: Developing a framework for human capital accounting. Journal of Applied Business Research, 34(2), 215-226.
Okeke, R. (2016). Human capital accounting: A literature review. Accounting, 2(1), 1-10.

Jaap de Jonge
Editor, Netherlands

Practical Experiences with Accounting for Human Capital

It's now been 15 or 20 years since I started writing about the need to properly account for investments in and return on human capital / intangible assets. Considering the immense growth in the importance of human capital for modern organizations, it is important and logical to do so. Yet I'm under the impression that little has happened and that we remain in the paradox of the importance and the difficulty of implementing human capital accounting.
It would be very interesting if some of our members could contribute some of their practical challenges and how they dealt with them.

Gandhi Heryanto
Management Consultant, Indonesia

Human Capital Accounting: How to Measure the Value of your Organization's Most Important Asset

Human capital accounting is the process of identifying, measuring, and reporting the value of an organization's human capital. Human capital is the knowledge, skills, and abilities of an organization's employees. It is an intangible asset that can be difficult to measure, but it is essential to an organization's success.
There are three main methods of human capital accounting:

COST-BASED METHODS estimate the value of human capital by taking into account the costs associated with hiring, training, and retaining employees. This method is relatively straightforward to calculate, but it can be difficult to accurately measure the costs of some factors, such as employee turnover.
VALUE-BASED METHODS estimate the value of human capital by taking into account the contribution that employees make to the company's bottom line. This method is more difficult to calculate than cost-based methods, but it can provide a more accurate estimate of the value of human capital.
MARKET-BASED METHODS estimate the value of human capital by comparing the salaries and wages of employees in similar positions to the salaries and wages of employees in the company. This method is relatively easy to calculate, but it can be difficult to find accurate data for comparable positions.

Two companies that have used human capital accounting methods are:
- IBM began using human capital accounting in the 1990s to track the costs and benefits of its employee retention programs.
- Microsoft started using human capital accounting in the 2000s to track the costs and benefits of its employee compensation programs.
ITALISources :
- Okeke, R. C. (2016). Human Capital Accounting: A review of the literature and directions for future research. Management Research Review, 39(12), 1402-1425.
- World Economic Forum and Willis Towers Watson. (2021). Human Capital Accounting: A framework for resetting the value of talent in.TEXT