CHAPTER 3

HUMAN RESOURCE VALUATION MODELS

SR. NO. TITLE PAGE NO.

3.1 INTRODUCTION 63

3.2 MODELS OF HUMAN RESOURCE VALUATION 64

3.2.1 MONETARY MODELS 64

3.2.1.1 COST BASED MODELS 64

3.2.1.2 VALUE BASED MODELS 66

3.2.2 NON-MONETARY MODELS 74

3.3 CONCLUSION 76

3.4 REFERENCES 77

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 CHAPTER 3
HUMAN RESOURCE VALUATION MODELS

3.1 Introduction:
The people are the most important assets of an organization but the value of this asset is
yet to appear in financial statements. Valuation of Human Resource in monetary terms,
not only facilitates its presentation in balance sheet but also helps in strategic planning
and the achievement of these plans (Gupta, N. & Singh, A. K.).

Human capital may find its place on the assets side on a balance sheet only if it is
expressed in terms of value. A proper method for measuring Human Resource Value is
needed to disclose human capital among balance sheet items (Milost, F., 2014).

Sir William Petty around 1961 made the first attempt to estimate the money value of
human beings. According to Petty, labour is the "father of wealth" and thus considered
labour as one of the important factors in estimation of national wealth. This, one of the
first attempts made towards the valuation of human asset, estimated the value of the stock
of human capital by capitalizing the wage bill in perpetuity at the market interest rate; the
wage bill being determined by deducting property income from national income (Kiker,
B. F., 1966).

Human Resource Accounting is important for managers and other professionals.

Accountants need a system which is capable of providing accurate and reliable
information about human resource of the organization (Jaggi, B., & Lau, H. S., 1974). It
is evident from the past literature that there is enormous/significant work done in the past
two to three decades on valuation of human resource. There were several attempts made
to overcome this problem. As a result of these attempts, many research scholars have
developed different models of Human Resource Valuation. Thus, researcher, in this study
made an attempt to understand these different models of Human Resource Valuation
which is one of the important objectives of this research work.

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3.2 Models of Human Resource Valuation:
The major objective of Human Resource Accounting is to develop a valid and reliable
method of valuing the human resources in an organization. Both monetary and non-
monetary measures are required to make decision in different areas of acquisition,
development, allocation of human resources and for monitoring and evaluating the
effectiveness and efficiency of utilized human resources by management (Flamholtz, E.
G. , 1999).

3.2.1 Monetary Models:

A small group of economists came together to develop certain techniques to measure the
worth of human capital. They came up with two ways of estimating the value of humans
which were: 1) Cost of Production and 2) Capitalized Earnings procedures. In the cost of
production method, an estimate was made of all the costs incurred towards “producing” a
human asset, whereas in the capitalized earnings approach an estimate was made of an
individual’s present value of future income stream (Spiceland, J. D., & Zaunbrecher, H.
C., 1976).

3.2.1.1 Cost Based Models:

I. Acquisition Cost Model /Historical Cost model:

This method was applied in 1969 by R.G. Barry Corporation which was a footwear
Company in USA, Columbus. As per this method, a calculation of cost incurred on
recruiting, hiring, training and development of human resource is made. The costs so
determine were capitalized as human asset and then, were amortized over the period
employee would remain with the organization. This method meets the accounting
principle of matching cost with revenue. This method is simple and information required
to calculate Human Resource Value can be easily ascertained (Sarkar, D., 2012; Ganesha,
K. S., 2015). There are some limitations however, as the economic value of an active
human does not always correspond to its historical cost. It is difficult to estimate the
number of year’s employee will remain with the organization resulting in difficulty of
writing off the capitalized expenditure over a period of stay of employee with the

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organization. Also any appreciation or depreciation can be subjective as it may not relate
to the increase or decrease in the productivity of human asset. Also, the costs related to an
employee in an organization may differ from one employee to another, thus making the
historical cost method not comparable for values of human resources. The Historical Cost
Method was highly criticized as it only takes into account the sunk costs which are
irrelevant for decision making (Parijan, K. K. & Naderian, A., 2014).

II. Replacement Cost Model, Flamholtz, 1973:

Replacement cost takes into account today’s sacrifice that will have to be incurred to
replace an employee currently employed. For example, when an employee leaves an
organization, the organization has to incur additional cost with respect to recruiting,
selecting and training the replacement. As direct and indirect costs are involved,
management includes such components of opportunity cost and expenses. This method
suggests dual notion of replacement cost i.e. positional and personal. Positional
replacement cost talks about the sacrifice that is incurred today to replace an existing
employee with a new employee with the same caliber to provide the existing services for
the same position. There are three elements to the positional cost i.e. hiring, training and
severance costs. Severance cost deals with the cost that organization bears when an
employee leaves a particular post in the company (Andrade, P., & Sotomayor, A. M.,
2011, p. 80).

Replacement cost of an employee has been found to be not only highly subjective but
often impossible too. At the management level, finding an exact replacement may be not
only be difficult but also impossible. The exit of a top management level employee may
substantially change the value of human assets (Sarkar, D., 2012).

III. Opportunity Cost Model, Hekimian and Jones, 1967:

This method was given by Hekimian and Jones in 1967 who recommended “competing
bidding price” which meant that opportunity cost of an employee or group of employees
in a department was calculated on the basis of the bids/offers offered by other

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departments for them. This meant that the value of an employee was calculated on the
basis of his alternate use in an organization.

The disadvantage of this method was that it did not take into account the fact that some
employees were not scarce and also the fact that a person with specialized knowledge in
one field would have zero valuation for alternate work (Shawai, A. S., 2015; Rao, P. M.,
p. 11).

IV. Standard Cost Model:

This method of valuation has been given by David Watson. Under this method, an
accumulation is to be done every year for each grade of employees with respect to the
standard costs of recruiting, hiring, training and development (Rao, P. M., p. 12);
Ramudu, V. B., 2014).

3.2.1.2 Value Based Models:

“The first truly scientific procedure for finding the money value of human beings was
devised in 1853 by Farr. He advocated the substitution of a property tax for the existing
English income tax system. The former would include property consisting of the
capitalized value of earning capacity. His procedure for estimating capitalized earning
capacity was to calculate the present value of an individual's net future earnings”,
(Spiceland, J. D., & Zaunbrecher, H. C., 1976).

According to Monetary Value Based Models, promotional policies, annual increments,

periodical agreements etc., should be taken into consideration in order to make the
estimation of future salaries and wages and the present value of such estimated salaries
and wages are to be calculated to get the value of human resource in monetary terms.
There are different methods which employ different formulae to calculate Human
Resource Value (Salati, A. Y., 2015).

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 I. Hermanson’s Models:
Hermanson (1964: 4) defines an asset as follows: "The assets are scarce resources
(defined as services but grouped by and relating to agents) operating within the entity,
capable of being transferred by the forces in the economy, and expressed in monetary
terms that can be acquired as a result of current or past, which apparently has the ability
to provide future economic benefits" (Andrade, P., & Sotomayor, A. M., 2011, p. 90).
Hermanson suggested two models of Human Resource Valuation. These are un-
purchased goodwill method and Adjusted discount future wages model.

a) Hermanson’s Un-Purchased Goodwill Method (1964):

Hermanson, R. H., (1964), according to this model, every asset provides income to the
organization through its use. Thus, the value of asset should be equivalent to the net
income received from the use of such asset. The basis of this method was that every
business earns normal rate of return with the use of its resources. If any business earns
return over and above normal return, it is un-purchased goodwill of the business which is
mainly due to human resources which are not considered in balance sheet. This method
was also subject to criticism. This method considered the role of human resource in
earning return in excess of normal return and thus it ignores the role of human resources
in carrying normal operation or to earn normal returns. Thus, this results in
underestimation of value of human resources (Inekwe, Murumba, 2014).

b) Hermanson’s Adjusted Discount Future Wages Model (1964):

Hermanson, R. H., (1964) identifies the human value as the total present value of future
salaries and wages multiplied by the average efficiency rate. An efficiency ratio is the
weighted average ratio of the return on investment of the given firm to all the firms in the
economy for a specified period basically current year and preceding four years are
considered for the valuation purpose. Highest weight is given to the current year and in a
diminishing manner to the remaining years

Symbolically;
Efficiency Ratio = 5RFO / REO + 4RF1 / RE1 + 3RF2 / RE2 + 2RF3 / RE3 + RF4 /
RE4

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Where:

RFO = Return on firm’s assets for current year.

REO = Return on assets of the economy for current year.

RF1 = Return on firm’s assets for second year.

RE1 = Return on assets of the economy for second year, and so on.

The model is subject to following criticism:

a. The efficiency ratio is subjective.

b. The weighting scheme is purely arbitrary.

c. The valuation period of five years is also without justification.

II. Brummet, Flamholtz and Pyle’s Economic Value Method of Group

Valuation (1968):
Brummet, R. L., Flamholtz, E. G., & Pyle, W. C., (1968) suggested valuation of human
resource employed in organization on group basis. According to this method, the
valuation of employees should be done on group basis by estimating their contribution to
the total economic value of the firm. Under this method, firm’s present value is
determined by forecasting its future earning and discounting it with the discounting
factor. This portion of its present value is allocated to human resource based upon their
relevant contribution. This method is used in insurance industry at the time of merger or
sale of the firm, to value the sales forces (Flamholtz, E. G, 1999, p. 193).

III. Lev and Schwartz’s Present Value of Future Earnings Model (1971):
Lev, B., & Schwartz, A, (1971) propounded a Human Resource Valuation model based
on economic approach of Human Resource Valuation. In this model, Lev and Schwartz
measured the value of human resource by applying present value approach. Total value of
human resource of the firm was represented as present value of total future earning of all
the employees of the firm. Company spends money on knowledge and motivation of
employees but all such expenditures do not result in creation of asset. An asset is created

68
only when the increased productivity of an employee exceeds the cost. Such increased
productivity of an employee is result of expenditure incurred on employee’s knowledge
and motivation. According to this model, the value of human resource is present value of
his future earning till retirement from the employment. This method is explained in detail
in chapter one under selected parameter for present study.

IV. Flamholtz’s Stochastic Reward Valuation Model (1971):

According to Flamholtz, E., (1971), Human Resource Value is based on expected
quantities of service of each employee in each service state, that is, person’s value to an
organization depends on the positions to be occupied by him in the organization. The
movement of people from one organizational role to another is a stochastic process with
rewards. According to this model, the value of human resource is arrived at by
multiplying the expected quantities of service of employees in each state with
corresponding probabilities of an individual occupying these service states in
forthcoming period of time. A "service state" is the organizational role or a position in
which an individual is expected to render a specified quantity of services to the
organization during a specified time period. The movement of people from one position
to another position is a stochastic process with rewards.

There were four steps in the valuation of human assets:

i. Describing the different service or institutional posts that a person could

hold in the establishment.
ii. Determination of the number of years of tenure in each service post.
iii. Deciding the monetary worth of every post to the establishment. This can
be done either by price quantity approach or income approach.
iv. Estimation of the Human Resource Value.

This model was criticized on different fronts such as difficulties in obtaining valid data
regarding the value of a service state, a person’s expected tenure and probabilities of
occupying various service states at specified times.

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 V. Robinson’s Human Asset Multiplier Method (1972):
Giles and Robinson (1972) hypothesized that the goodwill of a firm in terms of
supernormal earnings is attributable to its Human Resource. As such, the total value of its
human resource is nothing else other than the value of the goodwill of the firm as
assessed by the relative price earnings ratio of an organization as compared to the
industry average. From the total value of the human resource of an organization, to reflect
the value of an individual or of the different groups, the concept of multipliers has been
advocated in the model.

An employee multiplier factor is designed to reflect the qualification and technical

expertise, experience required to perform the job, personal qualities and attitude,
promotional capabilities, replacement scarcity, loyalty and expectations of future service.
The multiplier so designed, is proposed to be used as a means of relating to the cost of
wages and salaries to the asset value of employees. The method proposes to divide the
employees into different categories such as senior management, middle level
management, supervisors, clerical and operative grades. The salaries and wages for each
of these groups which when multiplied with appropriate multipliers and aggregate, reflect
the value of the organizational human resource. The multipliers are then proposed to be
adjusted, either scale up or down, so that the total value of human resource so assessed
should be equal to the value of the goodwill as hypothesized earlier.

VI. Morse’s Net Benefit Method (1973):

This approach is developed by Morse J. W. (1973). According to Morse, there are two
components of Human Resource Accounting viz. Human Asset Accounting and Human
Capital Accounting. Both these components deal with two different aspects of total
human resource employed in an organization. Morse made an attempt to establish
relation between value of human asset and value of human capital employed in an
organization. The value of human asset is the net present value of services rendered by
the employees to an organization both at individual level and services rendered
collectively in team. Whereas the value of human capital employed is present value of
future earning of the employees presently working in an organization. Net benefit arises

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to the organization only if value of human asset exceeds the value of human capital, that
is, the gross value of the services he renders exceeds the value of the expenditures the
organization makes to obtain these services. It means employee’s skill and knowledge are
valuable to an organization.

This method involves the following steps:

a) Determining the gross value of services to be provided by employees in the
future, based on their individual and collective capabilities.
b) Determining the value of future payments (direct and indirect) for employees.
c) Determining the excess of the future value of human resources on the value of
future payments. This represents the net benefit to the organization's account of
human resources.
d) The present value of net benefit is determined by applying a discount rate pre-
determined usually the cost of capital. This amount represents the value of human
resources for the organization.

VII. Jaggi and Lau’s Human Valuation Model (1974):

Flamholtz’s model considered the probability of career movement from one service state
to another service state and also probability of employee's leaving the organization before
retirement or death, unlike the Lev and Schwartz model. But, Flamholtz’s model was
also criticized stating the difficulty of estimating probability of career movement or exit
of each employee before retirement or death. Jaggi and Lau developed a model using
Markov chain technique. One of the interesting features of this model was that it
considered probability of career movement within the organization on group basis that is
homogenous group of employees working in a firm. One of the serious barriers of earlier
model of Flamholtz, was difficulty in estimating the probability of career movement of
each individual employee, which was taken care in this model of Jaggi and Lau by
considering the career movement on group basis (Jaggi, B., & Lau, H. S., 1974, pp. 321-
329).

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VIII. Friedman and Lev’s Human Resource Valuation model (1974):
Friedman, A., & Lev, B., (1974) suggested this model. According to them, wage and
salary structure of different firms in homogenous industry vary. In other words,
employees with same qualification get different salary in different firm. The investment
in human resource is the result of difference between the external and internal Human
Resource Values. An external Human Resource Value is calculated as the discounted
value of the hypothetical wage bills based on the average wages prevailing in the relevant
labour market. Internal Human Resource Value is calculated as the discounted value of
actual wages to be paid to current employees over their expected service life. This
difference in wages and salaries can be attributed to different personnel policies of these
firms. The major factors identified for wage differentiation were employees training and
indirect compensation.

A positive difference will indicate the discounted value of the stream of wage savings
resulting from the firm's personnel policies. The firm spends on extensive training of
employees and thus employees are paid below market average wages. While firms
providing little training, due to lack of special economies or training expertise, acquires
trained employees and pay them above-average wages. Such firms may experience
negative difference between external and internal Human Resource Value indicating
discounted value of the stream of wage dis-savings resulting from below-average
compensation, training, etc. Thus, the wage scale of the firm is determined by its specific
policies in hiring, developing, and maintaining the work force.

IX. Chakraborty’s Human Resource Valuation Model (1976):

Sk. Chakraborty of Indian Institute of Management, Calcutta, was the first Indian to make
an attempt at valuation of resources. Chakraborty was of the view that human resource
should be considered as an asset and should be included in investments. According to this
model, employees are divided into two groups that are, managerial group and non
managerial group. Average salaries and average tenure of the employees of the two
groups are ascertained. Average tenure of the employees in the group is estimated on the
basis of past experience and average salary is determined on the basis of salary wage

72
structure prevalent in the organization. The average salary of the group is multiplied with
average tenure of the employees in the group. The value obtained is discounted at the
expected average after tax return on capital employed over the average tenure period to
ascertain the present value of the estimated future payment. Chakraborty also considered
the recruitment, selection, training and development, cost of the employees as deferred
revenue expenditure. This deferred revenue expenditure can be written off over expected
average stay of the employee in the organization and the deferred revenue expenditure
not written off can be shown in the balance sheet as asset. Death or any such incidence
may result in premature exit of an employee from the organization. In such case, the
balance deferred revenue expenditure of such employee can be written off against the
income of the same year of exit (Rao, P. M., 2001, pp. 341).

X. Ogan’s Certainty Equivalent Net Benefits Method (1976):

Certainty Equivalent Net Benefit Model of Ogan is an improvement over the Net Benefit
Model. According to this model, the certainty with which the net benefits will accrue in
future should also be taken into account while calculating the value of human resources.
Certainty equivalent net benefit of an employee is combination of two elements: (1) his
or her net benefits, (2) a certainty factor which is comprised of the employee's probability
of continued employment and probability of survival.

Net benefits are the result of the difference between expected benefits and total costs.
The expected benefit of an individual employee is arrived at by multiplying his or her
monetary value benefit potential with his or her individual performance index. The
Monetary Value Benefit Potential benefit is the maximum benefit that an employee is
expected to generate. The capability of an employee to generate maximum benefit is
determined by his education, benefit rate and estimated useful life to the organization.
The individual performance index is a measurement that indicates the degree of
management's judgments and expectations about the individual's performance. The total
cost comprises of total maintenance cost which includes future salaries and wages, start-
up costs, recruiting and initial training cost at their historical value and future training and
development costs. Thus, the certainty equivalent net benefit is the product of the net

73
benefits from all the employees and their certainty factor. This represents the value of
human resource of the organization (Ogan, P., 1976).

XI. Watson’s Return on Effort Employed Method:

This method is developed by David Watson. Under this method, the efforts used in
various functions such as buying, manufacturing and selling are measured. Factors that
determine the quantity and quality of efforts dispensed are used to measure the
contribution made by an employee to perform various functions. These factors include
level of grade of work done, effectiveness in performing the job, the experience and
efficiency of an individual while the job etc. Total effort of each individual is determined
by multiplying these factors together. The aggregate score of all the individuals thus
obtained represent the total efforts employed in the organization. This method facilitates
the allocation of human resources among the different functions of an organization such
as buying, manufacturing and selling as per the ratio of profit to efforts (Watson, D.,
1978).

3.2.2 Non-Monetary Models:

Non-monetary methods assess the economic value of human resource by applying
various indices or ratings and rankings. The non-monetary methods may refer to a simple
inventory of skills and capabilities of people within an organization or to the application
of some behavioral measurement techniques to assess the benefits gained from the human
resource of an organization (Bhagat, M., Dutta, B. K., & Dutta, M., 2011).

I. Likert’s Causal, Intervening and End Result Variable Model:

This model was suggested by Likert. According to this model, the trend in organizational
earning can be estimated if meaningful relation is established among three variables,
these are causal, intervening and end – result variables. This estimated earning if further
multiplied by discounting rate, results in the present value of the firm and human
resource. Causal variables include behavior and organizational capabilities such as the
structure of the organization and management's leadership strategies, skills, behavior,
policies, and decisions. These are independent variables and these can be controlled or

74
altered by organization and its management. The intervening variables are the result of
the internal state, health, and performance capabilities of the organization such as
motivations, attitudes, loyalties, satisfactions, performance goals, and perceptions of all
members and their collective capability for communication, decision making, and
effective action. End result variables of the organization are determined by causal and
intervening variables. These end result variables include financial and performance data
of the organization such as productivity, costs, scrap loss, growth, share of the market,
and earnings (Likert, R., & Pyle, W. C., 1971; Akintoye, I. R., 2012).

II. Statistical Based Method:

The descriptive information containing statistics about human resources are collected,
used and presented using statistical method as per the requirement of management (Salati
A. Y., 2015).

III. Skill Inventory:

Under this method, individual’s capabilities and skills are identified and enumerated.
Employees are classified according to their skills. This is one of the basic techniques of
evaluating employees of an organization (Flamholtz, E. G, 1999, p. 220) (33).

IV. Performance Evaluation Techniques:

Performance evaluation is a key factor in enhancing the quality of work input there by
upgrading the development of an organization. These include rating method, ranking
method, attitude measurement and assessment of potential. Some of the modern
techniques used to evaluate the performance of an individual are Management by
Objectives, Psychological Appraisals, Assessment Centers, 360-Degree Feedback, 720
Degree etc. (Shaout, A., & Yousif, M. K., 2014; Khanna, M., & Sharma, R. K., 2014).

75
3.3 Conclusion:
The aim of bringing human resource in the category of asset of the organization resulted
in series of efforts made in the field of Human Resource Accounting. Many researchers
developed different methods of measuring Human Resource Values. While others
worked on operationalization of such methods in corporate sector. In broader sense, these
methods are divided in two parts viz. Monetary Models and Non-Monetary Models.
Methods grouped under Monetary Model calculate Human Resource Value in monetary
terms. Monetary Model is further divided into Cost Based Methods and Value Based
Methods.

The cost based methods consider the total capitalized cost incurred on employees as
Human Resource Value. The popular methods based on cost are Historical Cost Methods,
Replacement Cost Model, Opportunity Cost Model, and Standard Cost Model.

Value based methods consider the present value of future projected salaries and wages as
the values of human resources. The methods of calculation and duration of valuation are
different in different models. Methods based on values are Lev and Schwartz Present
value of future earnings model, Flamholtz Stochastic reward valuation model, Jaggi and
Lau’s Human Valuation Model, Morse’s Net Benefit Method etc.

Non-monetary methods assess the economic value of human resource by applying

various indices or ratings and rankings. These are Likert’s Causal, Intervening and End
Result Variable model; Statistical based method and other performance evaluation
techniques.

Different researchers in their research study and different companies in valuation of their
employees adopted different methods of Human Resource Valuation. In context of
Indian corporate sector, Lev and Schwartz model of Human Resource Valuation gained
advantage over other models. Many companies in India adopted this model to value their
human resource.

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