Human capital as an essential and measurable asset

TABLE OF CONTENTS

1. Chapter:1 - Aims & Objectives
1.1. Background Context
1.2. Problem Discussion
1.3. Problem Statement (Question)
1.4. Aims
1.5. Objectives
1.6. Summary

2. Chapter:2 - Literature Review
2.1. Human Capital
2.2. Linking Human Capital with Profitability
2.3. Human Capital Measurement: An Evolution
2.4. Why it is Important to Report Human Capital (HC)
2.5. Summary

3. Chapter:3 - Case Studies
3.1. Case-Study 1: (Ichniowski, et al., 1997)
3.2. Case-Study 2: (Huselid, et al., 1997)
3.3. Case-Study 3: (Delery & Doty, 1996)
3.4. Case-Study 4: (Youndt, et al., 1996)
3.5. Summary

4. Chapter:4 - Conclusion & Recommendations
4.1. Discussion
4.2. Conclusion
4.3. Recommendations

5. Chapter:5 - References

EXECUTIVE SUMMARY

This AMP is carried out as a research toward finding and relating the company’s Human Capital with its desired performance. It has also suggested the method by which the company can reliably reports its Human Capital as the strongest company’s asset in its financial statements. From the Background context of given issue the evidence looks prominent and right that in the current scenario Human Capital is considered to be as the key success factor. The Literature Review section, in relation to the definition of Human Capital, the arguments of both Becker (1993) and Davenport (1999) makes sense and also looks generous. Becker (1993) defined Human Capital as a composition of four characteristics (Credentials, Reputation, Personality and Appearance). While on the other side, Davenport (1999) made a figure of by combining all aspects (Employee effort, behaviour, ability & time) together to give final shape to undergoing definition. In relations to the measurement methods of Human Capital, there are many Scholars who came forwards and proposed different methods. It has been regarded and acknowledged that work of certain Authors: Kaplan & Norton (1992), Monti-Belkaou & Riahi-Belkaoui (1995), Brown (1999) and Weiss (1999) is prominent. Out of these four studies Monti-Belkaou & Riahi-Belkaoui (1995) took the fame as their model have both aspect: practical implementation and recognition of value added by the company’s demployed Human Capital in its overall financial performance and operational excellence. The objectives of this AMP have been achieved. From the models like Balanced Scorecard and Kaplan’s Seven Step Framework and also from the case studies like Huselid, et al (1997) and Delery & Doty, (1996), it has been cleared and understood that the company’s Human Capital has implications on its business performance (success). From the studies like Kaplan & Norton (1992), Monti-Belkaou & Riahi-Belkaoui (1995), Brown (1999) and Weiss (1999), it has illustrated that these are the certain methods by which the company could include Human Capital as the company’s most significant in its financial reporting. Out of these four studies, Monti-Belkaou & Riahi-Belkaoui (1995) took the fame. So the need of an hour is to select it as the common framework for the reporting of Human Capital as the company’s most powerful assets.

CHAPTER:1- AIMS & OBJECTIVES

1.1. BACKGROUND CONTEXT

The standard which is commonly discussed after IFRS implementation by the financial experts is the IAS 38¹. In today’s economy (Service Base Economy), companies are increasingly invested in the intangible assets as they realised that it is key success factor which is not easily to be intimated by their competitors. Doyle (2000) and Kanodia, et al. (2004) discussed that in today’s world company’s portion of Intangible Assets are more than their Tangible Assets. Gupta, et al. (2004) elaborate this point by saying that invesment in intangible assets are increasing as it is crutial to company’s shareholders so one can say now shareholders value is also depending on the amount of Intangible assets the company have. Riahi-Belkaoui (2003) preceived intangible as the only source of companies wealth creation. So up to this situation we understand the importance of Intangible Assets in the Service-Based Economy.

Human Capital is also categorise under the type of Intangible as it is defined as a combination skills, knowledge and experience. So for the its measurement and valuations companies follows all the guidance explained under IAS-38.

There is growing evidence that Human Capital Management (HCM) is viewed as an important component in firm;s competitive advantage and if correlated in a manner then it will results in competitive performance. UK’s economy transformation towards Service-Based economy acknowledges Knowledge as a key differentiator among all companies participating in any industry. But the thing which raised an issue is that currently Human Capital is not included in company’s financial reports and thus shows that companies are still hesitates to offer significant data on Human Capital to its Shareholders in the company annual reports. This behaviour of companies management not only showing wrong companies position to its stakeholders but also creates hurdle for them to take right investment decisions. .

Major topic of discussion among many Financial Reporting scholars and professionals is the treat of Human Capital as an asset within companies’ financial reports (Kanodia, et al., 2004; Von Coble, 2005). Lev (2001) states that the field of accounting always trouble or struggle with the task of determination of the financial value of value of Human assets. So this point directed our attentions towards the fact because of Financial Reporting standards companies are only handicapped to depict in financial reports about their fare in people investment. Although they acknowledged people as greatest assets in the narrative nothing is given in term of financial value, which raise the issues like transparency and disclosure of financial information of company’s Human Assets.

1.2. PROBLEM DISCUSSION

In UK, the valuation of Human Capital as an asset is main topic for discussion within the profession of Accounting. Of which some of the issues will be discussed in this chapter (Aims & Objectives) while the remaining will be discussed in the Literature review section. But most of the issues are originated from the main purpose of financial reporting which to represent the true picture of the organisation (Smith, 2006). Some assets under IFRS² are not being allowed to recognise on company’s Statement of Position (Balance-Sheet), so this point can challenge the main purpose of financial report to reflect the true picture of an organisation (KANODIA, et al., 2008).

Moreover the valuation Human Capital is also discussed on frequent basis. Choi, et al. (2000) have depicted that different method used for the valuation of Human Assets resulted in a different values depending on given components. They further explained that the companies which constitutes or consists of more human capital are more likely to show wrong picture in the company’s financial reports. But Kumar (2005) justify this problem by saying that Human Assets are very difficult to be valued and that is why companies are included Human Capital as an Asset in the Balance Sheet.

The connection (relation) between company’s equity market and the book value of equity is also remains a point of interest among many scholars. Of those many of them have explained the shown the difference between both values and also recommended discrepancies through different explanations (Stewart, 1997; Kaplan, 1998; Fincham & Roslender, 2003; Kanodia, et al., 2004). But Fincham & Roslender (2003) simply states the only difference both values (market value & book value of equity) is the value of Intangible assets which also includes the value of Human Capital (the cost and investment of acquiring and retaining talent wthin an organisation).

Whitwell, et al., 2006 explained that the ongoing confusion about Human Capital have potential which could cause a problem to the market economy and could reults in the form of accounting scandals. Furthure they elaborated that over-valuation of Intangible assets including human capital was the major cause of downfall of big firms like WorldCom, Euron, HIH and One Tel. A common framework for handling Human Capital recognition and valuation would lessen the chance of downfall like this and thus will boost up the overall confidence of shareholder which will helps them to take effective decision on time.

1.3. PROBLEM STATEMENT (QUESTION)

The problem statement for the AMP is consists of two parts which are explained below:

a) Investigate the correlation between Human Capital and Business success in term of company performance.
b) Evaluate different methods by which Human Capital can be shown as an asset on company’s financial statements.

1.4. AIMS

The aim of this AMP is to get knowledge about the importance of Human Capital within an organization and what type of benefits will the company will enjoy if it manage to disclose and report human capital in the company’s financial report. The second aim of this report is to conduct in-depth analysis based on all secondary data with an intention to give opinion with the justifiable logic and example through the academic journals and case studies.

1.5. OBJECTIVES

The objectives of this AMP on Human Capital are listed below:

- To identify the link between Human Capital and company’s performance in term of different indicators being used measure and observe firm’s success.
- To understand the importance of financial reporting. And also to understand how it affects the overall objectives of financial if Human capital are not measured and reported in the company’s financial statements.
- To discover certain models which are introduced by different scholars for linking human capital with the company profitability? And also to evaluate certain methods which can be used reliably to report human capital in company’s annual reports.

1.6. SUMMARY

There is a increasing evidence among Economics and Financial Scholars that in 21st Century Human Capital is considered as a significant factors in company’s success which thus results as company’s competitive edge concurrent with the competitive performance. As UK’s economy is transforming towards service based economy, knowledge will be a key differentiator and employees’ cost will account for about 40% of firm’s expense. And knowledge is also getting significance even manufacturing based businesses with high value-addition. But still company’s acknowledged people as company’s greatest asset but are doing nothing when it comes to report Human Capital on Financial reports to their shareholders.

CHAPTER:2- LITERATURE REVIEW

2.1. HUMAN CAPITAL

Human Capital (HC) is significant in creating high performance working environment. Organisations should need to control and manage HC from all the stage’s of employee’s or worker’s work life. So it means it should be started to be managed from the recruitment process to the training & development phase and then afterward to the retention phase, This overall process is known as Human Capital Management (HCM). And this process all about acquiring right people with right capabilities (skills) at the right employment level (position) at the right time and then rewards him/her with right compensation & benefit plan in order to make him/her to perform right task (function) in the right working environment with an intention to himself/herself effective and efficient in the desired profession, This process sometime also includes training and development of capital in order to enhance employees’ out/productivity level. The overall aim of HCM is to maximise organisation’s Human Capital which made possible the accumulation of all organisation’s individual human capital. Strategically Human Capital Management (HCM) is form of workforce’s employ, deploy, development and evaluation model, which emphasis more on result rather than on the processes.

HC is first time used as a term by Scholars named Laureate & Schultz in 1961 in the Economic Review Article (Investment in Human Capital). The HC is used as a term to reflect the combination or collection of person’s skills, knowledge and experience (Flamholtz & Lacey, 1981). But another author has further elaborates HC as the skills, knowledge, competencies and other characteristics developed in an individual or in group which are acquired through their working life which thus help them in producing specified products or services (Westphalen, 1999). HC not only makes an employee productive but also helps him to earn income in return as well.

Becker (1993) described HC as a combination of four components which are Credentials, Reputation, Personality and Appearance. Where as Davenport (1999) by combining different definition from different scholars and has made a HC Investment Model shown below:

illustration not visible in this excerpt

FIGURE 1 HUMAN CAPITAL INVESTMENT MODEL, ADAPTED FROM DAVENPORT (1999)

The word ‘capital’ used in term HC refers to the productivity of labour or worker. This word used to build a relationship between human capital and employee’s training and development like for increasing physical capital, company invest in its available resources so in this manner company can invest in labour’s education or training to boost up their productivity level. So we can say that in both scenarios explained above costs are incurred in present but will deliver an extra value or benefit for a time in future.

Particularly in Service-Based economy economists are increasing urging that the accumulation of both capitals (human & physical) will prove to be a crucial factor. But after in-depth empirical analysis, it has been found that there is no common framework or measure for purpose of Human Capital valuation. Even the companies operating in the same companies have adopted different methods. Through formal and informal training companies can build-up Human Capital. With the help of this training companies can share both types of knowledge either tacit³ or explicit⁴. So, one can say that the tacit knowledge with the successful incorporation with explicit knowledge can improves company’s knowledge-base. The sources of both knowledge types are shown below:

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¹ International Accounting Standard for the recognition and measurement of Intangible Assets.

² International Financial Reporting Standards

³ The thing employees already knew but failed to express.

⁴ The knowledge which is to be transmitted as a result of using formal or systematic language.