Human Capital as Intangible Asset - Essay Example

Sporting Glory – The Great Intangible: A Case Study Submitted by: [Client’s Name] Submitted to: [Professor’s Name] [Date] Accounting intangible assets in today’s business organizations are becoming more complex since there have been various changes to the traditional manner by which business operates. More and more of today’s business organizations link their competitive advantage to processes and resources not necessarily related to fixed or liquid assets where GAAP applies. Some argues that the inclusion of the estimated value of all the intangible assets in the financial statement provides accuracy to the accounting statement and accounting report (Rose 1993); others believe that valuing intangible assets and including them on the financial statement can be irrelevant on some context (King 1999). In the case of human resource accounting where the competitive advantage of a business is its people, is the human resources’ expected value to the company necessary in the balance sheet? Can its presentation provide more accurate assessment of the company’s book value? Or is the relevance of this financial information constrained in the internal decision-making process of the company? In order to determine how intangible assets such as the human resource affect the presentation of the balance sheet, it is necessary to understand what intangible assets are and how they affect the financial presentation. Intangible Asset: Definition The International Accounting Standard Board (IASB) defined an intangible asset in IAS 38 as “an identifiable non-monetary asset without physical substance…controlled by the entity as a result of past event and from which economic benefits are expected”. There are three elements to this definition namely the identifiability of the asset, the ability of the entity to control (or measure) the asset, and the derivation of economic benefits of the entity in the future because of these assets (IAS 1998). GAAP allows the measurement of only one intangible asset which is the goodwill by measuring two financial events which are the book value and the fair value of the entity. (Goodwill is defined as the excess between these two financial events). Discussions occur when other intangible assets like the human capital (skills, techniques, potential contributions) need to be considered in the financial report. Human Capital as Intangible Asset An intangible asset is thus an asset that is identifiable, measureable, and beneficial (in the long run) to a business entity. By definition, the development of the human resource as well as the knowledge and skills acquired over the period of stay which can translate to a measurable competence and potential is an intangible asset of the organization. The competencies of its workforce are not something physical but are something that is identifiable and adds value to the business in the short and the long run (Moore, 2007). However, current accounting standards do not consider the relevance of investments made by the business organization in the acquisition, management, and development of its human resource for financial reporting. GAAP requires that financial reporting should be accurate and reliable. However, the lack of provisions of GAAP on human resource accounting makes it difficult to give an accurate value of a business whose main revenue driver is its human resource, particularly in the service industry. The existing financial reporting standards do not consider the costs allotted for human resource activity as an asset or equity but considers the liabilities associated in keeping such the workforce such as deferred compensations and retirement plans (Schwarz & Murphy, 2008). There is nothing on the asset category in the balance sheet that would reflect the benefits presented to the company of a well-trained, content, or highly educated workforce. On the other hand, the expenses associated with recruitment and training of new employees and the development programs of existing ones are meshed in the payroll expense that there is no way to measure the expense against the satisfaction level of employees (Sackman et al, 1989). GAAP and Human Capital A content and satisfied workforce clearly adds value to the business through productivity and (some degrees of) efficiency. Traditional accounting systems treats costs associated with the development of human resource as an expense in the income statements which reduces the profits of the organization (Grojer, 1997). A rift between the book and fair values of the human capital and the accounting system employed is clear. Using the traditional accounting system in accounting human capital does not yield an accurate representation of what really is taking place. On the other hand, the inability of the traditional accounting system to address the appropriate classification of the undeniable asset presented by the human capital to the business requires a more accurate accounting system that would take this issue in its proper context. GAAP dictates that the valuation of an intangible asset, like goodwill, to be based on the past event in keeping with its framework of conservatism. However, measuring intangible assets does not depend on historical cost. Because GAAP only sees the liability of the human capital, it could not provide important information in the management decision-making process related to the human resource. In a case where important decisions are to be made in a layoff, a deeper knowledge and relevant understanding on the value of the human assets is important in coming up with the decision. By looking only at the liabilities incurred in maintaining such a workforce, the business might lose sight of the investments it has made in developing the workforce for future productivity (King, 1999). When the business experiences budget constraints, the very first financial category that is cut is the overhead (or administrative) cost. It is in this category where programs related to recruitment and workforce development belong. Cutting this expense category translates to an underdeveloped workforce which also implies professional underperformance in the long run (Ng, 2004). With the lack of proper presentation or categorization of human assets in the balance sheet, business organizations are bound to make serious errors in the decision-making process. In order to account for the disparity in the financial reporting of the human resource as an intangible asset, human resource accounting was established. Human Resource Accounting With the growing involvement of human capital in the valuation of a business, the need to accurately represent them in the balance sheet as an asset becomes very important. By including the value of its human resource in its books, the company will be able to show how profitable it is not only in terms of its fixed and liquid assets but also in its human capital. For businesses whose biggest driver for revenue is its human assets, like in professional sports, the need to employ an accounting system that reflects the profitability presented by these human assets would give a fair and accurate valuation of the business, compared to when the traditional accounting method is employed. Human resource accounting is not yet an internationally established and accepted financial accounting practice (Moore, 2007) but it is getting more and more popular in many countries around the world because of its ability to represent the best approximate value of the human asset (Grojer, 1997). Human Capital on the Balance Sheet Since GAAP requires accuracy and reliability in the financial reporting, it is just logical to place the book value and the fair value of the human resource in the balance sheet. While this accounting practice is not yet generally accepted, more and more companies, particularly those that buy out other companies, look at the book value of the human capital as an asset. An efficient, self-directed, and highly productive workforce in a target organization means that lesser resources are required to optimize their skills and talents to contribute to the business organization (Patrick et al, 1999). This workforce (or human capita) is undeniably an asset to the business. By reflecting the value of the human asset on the balance sheet, all stakeholders will have a good idea on what to expect from a business’ human assets. Hence, it is just logical to devote a category for the human asset in the balance sheet. Disadvantages of Human Resource Accounting But since Human Resource Accounting is not a generally accepted accounting practice, it suggests that there are issues in this practice that needs to be carefully considered. One of these issues is the potential misrepresentation of the company’s actual value because of the value associated with the human assets. A company’s worth will dramatically increase when the value of the human asset is taken into account. This translates to the reported profitability or financial stability of a business that is actually unprofitable and economically worthless simply because smart and highly skilled employees are associated with the business. This simple example defeats the very purpose of the need to establish a new accounting system that would provide more accurate financial report of the business (Rose, 1993). Human resource accounting is very applicable in internal decision making process. Management will be able to trace and justify the expenses incurred related to the development of its human assets and from then be able to determine whether to increase or decrease development costs by investigating the output. The ability of the management to sift through the information offered by integrating the human assets in the organization will determine future profitability or loss of the company. Moreover, the applicability of human resource accounting is limited to business organizations whose main source of value is derived from its workforce, like in the professional sports industry. In typical cases like in a manufacturing firm, the value of majority of its human resource is insignificant compared to the value of the fixed and liquid assets of the firm which means that human resource accounting method is inapplicable in the industry. Conclusion Human resource accounting offers a better way of reporting financial figures accurately. By introducing and taking into account the approximate value of the human assets, a concept that has never been done and was never accepted in the generally accepted accounting principle, the financial statement would reflect the best approximate value of the business’ worth. In the case of professional sports, accounting its human assets and placing the accounted value in the balance sheet offers a lot of opportunities for the business because the accounted value would show a significant increase of the business’ worth. Similarly, the introduction of human resource accounting will provide the organization a better sense of direction in terms of human management. With the availability of the information on the income statement and the balance sheet categorized for the development of human capital, management can easily determine whether the expense associated with human development has corresponding increase in the value of the organization as a whole. But human resource accounting is a non-standard accounting practice (Grojer, 1997). It has a lot of inherent flaws and it could potentially ruin the stringent requirements of GAAP and IASB when it comes to accurate and reliable financial reporting. As was mentioned earlier, the increase in the net worth of a business due to the value of its human resource may offer an inaccurate picture of the financial performance and capabilities of the business. Hence, it is highly unlikely that the practice of human resource accounting be acceptable, if at all. To answer Whitting and Chapman’s question of whether the value of rugby players, being a team’s most valuable asset, should be placed on the balance sheet, I think, based on the previous discussion, that it should not be placed on the balance sheet for use and evaluation of external clients. Placing the value of rugby players in the balance sheet may inflate the actual value of the business which can be misleading and unethical. However, I would highly recommend the use of human resource accounting for internal decision making process because of the undeniable benefit that can be derived by the business from such accounting process. References Grojer, J.E. (1997). Editorial. Journal of Human Resource Costing and Accounting, 2 (2), 7-8 International Accounting Standard. (1998). IAS 38: Intangible Asset. Retrieved online from http://www.iasplus.com/standard/ias38.htm King, A., Henry, J. (1999). 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