Replacement cost Model Meaning, Advantages and Limitations

Replacement cost is that cost which is incurred on replacing the existing human resource by an identical one i.e. human resource capable of rendering similar services.

Replacement Cost Method was introduced by Rensis Likert and Eric G. Flamholtz. This method is different from the historical cost method. The historical method takes into account only the sunk cost which is immaterial to calculate the value of human resources and take a decision on that basis.

The replacement cost method is very realistic as it considers the current value of human resources in its financial statement.

Advantage of replacement cost method

• This method estimates the present value of human resources. This method is very logical and representative.
• This method can easily adjust the human value of price trends and can provide real value at the time of the rise in prices.

Disadvantage of replacement cost method

• The identical replacement of an employee is not always possible to find.
• The determination of replacement value is affected by subjective considerations to a marked extent, and therefore, the value is likely to differ from man to man.
• The cost of replacing the human resource is inconsistent with traditional accounting system based on the cost concept.