Human Resources Accounting and Audit | Management Optional Notes for UPSC PDF Download

Introduction

• Human resource accounting is a process aimed at recognizing and reporting the investments made in an organization's human resources, which are not traditionally accounted for in standard accounting practices. It extends the principles of accounting to match costs and revenues and organizes data to communicate valuable information. 
• Human resource accounting treats both management and employees as human capital, considering them as assets that will yield future benefits for the organization. In this approach, expenditures associated with human resources are recorded as assets on the balance sheet, diverging from the conventional accounting method that treats such costs as expenses on the income statement, reducing overall profit.

Concept and historical review of Human Resource Accounting

• In the 1960s, researchers began developing methods for accounting for an organization's human resource assets. Initially, the prevailing notion considered all expenditures on human capital formation as charges against the revenue for the period, as it was believed not to create any physical asset. However, this perspective has evolved, and the current understanding is that costs incurred on assets, such as human resources, should be capitalized since they yield benefits that can be quantified in financial terms. Human Resource Accounting involves treating people as organizational resources and quantifying their cost and value to the organization. 
• This encompasses measuring the costs associated with recruiting, selecting, employing, training, and developing employees in both private firms and public sectors, assessing their economic value to the organization. Essentially, Human Resource Accounting is a complex method that aims to determine, in financial terms, the effectiveness of personnel management activities and the utilization of people within an organization. It involves accounting for people as organizational assets, valuing them as assets rather than expenses. This approach highlights the organization's investment in its people and tracks how the value of these individuals changes over time, comparing their worth with substitute costs periodically.
• As per the American Accounting Association Committee, Human Resource Accounting is the process of identifying, measuring data about human resources, and communicating this information to relevant stakeholders. Likert (1971) outlined that Human Resource Accounting serves various purposes within an organization. It provides cost/value information to facilitate management decisions regarding the acquisition, allocation, development, and maintenance of human resources, ultimately aiming for cost-effectiveness. Additionally, it enables management and employees to effectively analyze the utilization of human resources. Jasrotia (2004) stressed the importance of human resource accounting in India, emphasizing the significant shift from manufacturing to service-oriented industries in the Indian economy. The researcher highlighted that the success of organizations in this context depends on the knowledge and intellectual capabilities of personnel. The research suggested that the Indian government should mandate the accounting and reporting of human resources for every organization, similar to the approach adopted in Denmark since 2015.
• Human Resource Accounting (HRA) serves as an effective basis for managing human assets, allowing organizations to assess whether these assets are appreciating, depleting, or being conserved. The main goals of HRA include providing cost-value information about acquiring, developing, allocating, and maintaining human resources, enabling management to monitor their use effectively, determining whether human assets are appreciating or depreciating over time, supporting the development of effective management practices, motivating individuals within the organization, enhancing their value through training, and aiding in the planning of physical resources.
• Human Resource Accounting is crucial for making informed and effective management decisions related to human resources, ultimately contributing to cost-effective organizational objectives. Leading management scholar Flamholtz (1979) describes the HRA model as a "psycho-technical systems" (PTS) approach to organizational measurement. This approach emphasizes that measurement involves both process functions and numerical information, highlighting the importance of presenting numerical measures in HRA. The measurement process in HRA plays a significant role in increasing awareness of the vital role of human capital in the organization's short and long-term productivity and growth.

Uses of Human Resource Accounting

Grojer and Johansson's perspective on human resource accounting suggests that it serves as a political tool, aiming to highlight potential mismanagement of human resources within an organization. They view it as a pedagogical instrument, meaning it plays a role in teaching and learning about the organization's human resources, facilitating analysis and structuring of information. Additionally, human resource accounting is seen as a decision-making aid, helping ensure that decisions related to human resources are more rational and align with the management's perspective.

Benefits of Human Resource Accounting

• Anticipating Changes: Human resource accounting helps in anticipating changes related to the workforce, allowing organizations to prepare for future challenges.
• Providing Various Testing Methods: It offers different methods for testing and evaluating the effectiveness and value of human resources within an organization.
• Increasing Productivity: By recognizing and valuing human assets, human resource accounting can contribute to increased productivity as it emphasizes the importance of investing in people.
• Ensuring High Returns: Properly managed human resources, as indicated by human resource accounting, can lead to high returns for the organization.
• Individual Employee Aspiration: It helps individual employees aspire to grow within the organization by recognizing and valuing their contributions.
• Providing Scope for Advancement: Human resource accounting provides insights into the skills and capabilities of employees, offering a basis for career advancement and development.
• Highlighting Strengths and Weaknesses: It sheds light on the strengths and weaknesses of the existing workforce, enabling organizations to make informed decisions for improvement.
• Assisting Potential Investors: For potential investors, human resource accounting provides valuable information to assess and judge a company's human capital, contributing to investment decisions.

Human Resources Accounting and Audit

Limitations of Human Resource Accounting

• Human resource accounting faces challenges in valuing human assets and is criticized for potentially dehumanizing the workforce. There is a lack of empirical evidence supporting its effectiveness, and the measurement of human resources is considered problematic. Employees and labor unions may not appreciate this approach.
• In India, human resource accounting has not gained widespread acceptance, and companies often do not prioritize issues related to it. The Companies Act in India does not mandate the disclosure of worker costs in annual reports. While awareness about measuring and reporting human assets has increased in the last decade, the concept is still struggling for recognition and has not been established as a systematic practice.
• Notably, Bharat Heavy Electrical Ltd (BHEL) was among the first organizations in India to use human resource accounting in the financial year 1972-73, primarily in the public sector. Subsequently, both public and private organizations, including Infosys, Steel Authority of India, Southern Petrochemicals, Industries Corporation of India Ltd, Mineral and Metals Trading Corporation of India, Hindustan Zinc Ltd, Associated Cement Companies Ltd, Madras Refineries Ltd, Oil India Ltd, Oil and Natural Gas Commission, and Cement Corporation of India, have started providing information related to human resources in their annual reports.

Conclusion

In Conclusion, Human Resource Accounting (HRA) is a method that assesses employees' performance by considering their costs and contributions to the organization. Its primary objective is to address challenges related to the valuation of intangible assets. HRA provides valuable insights into employees as assets, enhancing the organization's reputation. The approach aims to manage human capital effectively, treating human resources on par with other organizational assets that require investment over time for productivity. This includes costs related to recruitment, training, and development, which are capitalized and amortized over the assumed productive life of the human resource, accounting for attrition and potential decline. The HRA system endeavors to systematically evaluate and record the value of human resources in an organization's financial statements, reflecting their worth over time.

Human Resource Audit

Auditing is a common practice in the financial domain, driven by legal obligations. However, in the context of Human Resources, there is no legal mandate for conducting audits. Despite this, some companies find value in performing Human Resource audits. A Human Resource audit serves as a tool to assess the effectiveness of an organization's human resource functions.

Concept and Scope of Human Resource Audit

• The Human Resource Audit is a systematic and formalized process designed to examine an organization's human resource management strategies, policies, procedures, documentation, structure, systems, and practices. 
• It aims to evaluate the strengths, limitations, and developmental needs of the current human resources in order to enhance organizational performance. The underlying principle is that human resource processes are dynamic and need continuous review and adjustment to align with changing needs. 
• Human Resource Audits go beyond mere problem-solving; instead, they provide insights into the underlying causes of existing and potential issues.

Scope of Human Resource Audit

• Human Resource Audit is a formal process to check if an organization follows rules, improves HR practices, trains company managers, gets ready for government checks or legal issues, understands the department's environment, and shows effort to do things right and fix mistakes. Basic audit principles include defining what to check, creating a questionnaire, collecting data, comparing results, giving feedback, making action plans, and encouraging continuous improvement.
• The main purpose of HR audits is to clarify how HR work and roles should be done in the organization, set a starting point for future improvements, assess current effectiveness, make practices consistent across different locations, check the knowledge and skills needed by HR staff, and improve performance for key customers within the organization.
• There are two types of audits: internal and external.
  • Internal Audit: Done by the company's own staff as part of their control activities.
  • External Audit: Done by external experts hired specifically for this purpose, offering an unbiased evaluation of how the company manages its workforce.

Preparation for an Audit

• Auditor Engagement:
  • If using internal resources, formalize their engagement with clarity on scope.
  • Select individuals who are non-political and not high in hierarchy.
  • Provide training for internal auditors.
• Data Gathering:
  • Complete a self-assessment questionnaire for better audit planning.
• On-site Access:
  • On-site audit is crucial for the process.

Human Resource Audit Process

• Determine Scope and Type:
  • Identify areas for the audit based on organizational needs.
  • Conduct a comprehensive review or focus on specific concerns.
• Develop Audit Questionnaire:
  • Spend time creating a detailed document covering all audit subjects.
• Collect Data:
  • Assess specific areas using the questionnaire to gather relevant data.
• Benchmark Findings:
  • Compare audit results with benchmarks for insights.
  • Benchmark against similar-sized firms on various HR metrics.
• Provide Feedback:
  • Review data and offer feedback to HR experts and senior management.
  • Present findings and recommendations in a written report.
• Create Action Plans:
  • Analyze audit information to generate action plans.
  • Prioritize changes based on importance: high, medium, and low.
• Foster a Climate of Continuous Improvement:
  • Regularly monitor and enhance policies, procedures, and practices.
  • Keep HR systems updated with the latest information.
  • Track audit findings, turnover, complaints, and employee survey results.
  • Identify trends for informed decision-making and preventive measures.

Approaches to Human Resource Audit

• Comparative Approach:
  • Description: Auditors use a Competitor Company as a model.
  • Process: Compare the organization's results with the selected company or industry.
• Outside Authority Approach:
  • Description: Auditors use standards set by an external consultant.
  • Process: Benchmark the organization's results against the criteria provided by the outside authority.
• Statistical Approach:
  • Description: Develop statistical measures of performance.
  • Process: Utilize the company's existing information to create statistical performance measures.
• Compliance Approach:
  • Description: Review past actions for compliance with legal requirements and industry policies.
  • Process: Assess whether activities align with established legal standards and industry procedures.
• Management by Objectives (MBO) Approach:
  • Description: Establish specific goals for performance measurement.
  • Process: Set objectives and measure the organization's actual performance against these goals to make final decisions.

Main Steps of the Audit

• Define Desired HR Practices: Clearly outline the HR practices desired for the organization.
• Assess Current Practices: Evaluate existing practices against the established criteria.
• Analyze Results: Examine the results of the assessment.
• Establish Improvement Goals and Take Action: Set improvement goals based on the analysis and initiate necessary actions.

Conclusion

In essence, Human Resource Audit evaluates the effectiveness of people and processes within an organization. It serves multiple purposes, including ensuring legal compliance, maintaining or improving competitiveness, establishing efficient documentation practices, and identifying strengths and weaknesses in various employment processes. Conducted regularly, similar to financial audits, it provides an overview of personnel management, covering aspects from recruitment to termination. Human Resource Audit aids senior management in ensuring legal compliance, evaluating HR policies and practices, and aligning them with strategic planning. By identifying and correcting inefficiencies, it saves costs and helps plan for the future. Ultimately, it allows companies to assess their investment in employees and anticipate the returns from this valuable asset.