The why and how of 'human asset' valuation

Despite being an important asset for a company, human resource is an asset always ignored by accountants. With regards to assets, there is a fundamental conflict in accounting practices between human and non-human assets. Only non-human assets find a place on a company's balance sheet. Keep in mind that even intangibles like 'goodwill' are accounted for.

An asset is simply something that can generate cash / value in the future. If you go by this definition, human assets should also be accounted for the balance sheet. So why aren't human assets given their due recognition? It is because the formal definition of asset does not recognize people as 'accountable assets' for a company. According to the formal definition, an asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Simply stated, assets are economic resources which represent ownership of value that can be converted into cash.

Human assets do generate cash for a company, but they are not owned by the company. Hence, they cannot be incorporated into the balance sheet. However, the definition and accounting practices do not make human assets any less. They still command the same value and importance for the company. Thus, there are few companies that choose to value their human asset . One example of such companies is the 2nd largest software company in India, Infosys. According to the additional notes filed with regulatory exchanges, Infosys has recently valued each of its employees at over Rs 10 m.

There are many financial models to value human assets. Infosys used the Lev & Schwartz model to calculate the value of their human resources. In the past, companies such as Bharat Heavy Electricals Ltd (BHEL), Steel Authority of India Ltd (SAIL), Minerals and Metals Trading Corporation of India Ltd (MMTC Ltd), Oil and Natural Gas Corporation Limited (ONGC) and National Thermal Power Corporation Ltd (NTPC) have also used the same model. The model uses several factors such as age, annual earnings up to retirement, retirement age of the employees & cost of capital to value the human assets of the company. However, the model ignores productivity of employees, attrition rate and training expenses in its calculation.

Conceptual thinking about valuing human resources is still developing. Accounting bodies all over the world still haven't accepted any model for valuing human resource. Hence, a company does not need to value its human assets for the purpose of external financial reporting. However, people are one of the most valuable assets for any company. No matter how good the company's business is, it is the people who steer it in a particular direction. Therefore, while making internal decisions related to human resource management, a company should consider human asset valuation. The company should look at the parameters such as return on human resource value, ratio of total income to human asset value. All these parameters give a clear picture of efficiency of human resources employed by the company.

Investors could also take human asset valuation into account when they analyze a company for investment purposes. As an investor, you should always give importance to all the 4 Ms (money, machines, materials and men) associated with a company. We believe that you should not ignore the last M which is vital for any company, especially when knowledge is the key element for the future success of any company.