Tag: Human Resource Accounting & Audit BMS Notes

While HRA has been in India for over a decade and leads BHEL, awareness is only being implemented now. However, the level is still small for awareness and acceptance, as many companies do not take the initiative, despite the fact that the data is available, to give shareholders public numbers.

The lack of an industry standard is a major deterrent. That means each company must develop its own standard, which can become an awkward process because many of them continue to improve their business. The establishment of a standard can help industrial organisations such as Nasscom. The need for extensive research is another aspect which works against accepting HRA. Many companies do not want to find their HR’s value complexly. While most (large) enterprises have access to these best practises, it is not an economically viable option for small and medium-sized enterprises. In addition, as is Naresh Taneja, HR Director of HCL Technologies, many people are uncertain how useful HRA is in decision-making (Mumbai, previously Gulf Computers). Due to the dynamism of this industry, it is difficult to predict what will be your future needs and how technology in the near future will shape. Only the HRA advantages are raised here. In addition, HR communication is voluntary. In this context, HR disclosures from companies across companies and industries are unstructured, inconsistent and incomparable. Even these HRA communications are of little assistance with decision making since they are unaudited and untrustworthy.

However, in order to overcome these problems, each company needs to develop its own standards which can be a tedious process, as no industry standard or industry standard exists. However, industrial groups such as Nasscom and Assocham can help to set a standard. Since the Indian Institute of Chartered Accountants (ICAI) does not have laws or rules in 1956, and since no accounting norm is in place, some companies have stopped this practise. ICAI and other regulatory and accounting authorities should draw up certain guidelines regarding the valuation and reporting of HR in order to ensure that the information disclosed is objective, reliable and relevant. A tool to compare and standardise HRA divulgations is the current HRADI. The accounting authorities should make efforts to integrate their opinions on this subject with the requests of decision makers to establish a uniformly acceptable HR assessment method and reporting method (management and investment). In knowledge-based sectors where HRA is regarded as the main elements to monitor its business activities, HRA can help organisations achieve their aims. In measuring and reporting on such valuable assets, the government and other professional and responsibility authorities should consider the high importance properly initiated by HRA at the national and international levels.

Capitalization of earnings is a method of determining the value of an organization by calculating the worth of its anticipated profits based on current earnings and expected future performance. This method is accomplished by finding the net present value (NPV) of expected future profits or cash flows, and dividing them by the capitalization rate (cap rate). This is an income-valuation approach that determines the value of a business by looking at the current cash flow, the annual rate of return, and the expected value of the business.

The capitalized earnings method consists of calculating the value of a company by discounting future profits with a capitalization rate adjusted to the determining date for the valuation.

In the context of the capitalized earnings method, a company is considered as an investment. Attention is therefore focused solely on the future profits that the company will make, on the associated risks or on earnings projections. Operating assets are seen only as a way of making profits and no specific value is allocated to these.

To calculate capitalized earnings, the company’s profits are estimated for the following two to five years from the valuation date. It is important to point out that this refers to adjusted profits. Extraordinary and non-operating income and expenses, along with salaries not conforming to the market, must be adjusted. Adjusted operating profits are discounted using a capitalization rate corresponding to an earnings projection adapted to the risk of this specific company. If the company has assets not essential to operation (e.g. real estate outside the company or surplus liquidities), these will be calculated separately, then added to the capitalized earnings calculated.

Calculating the capitalization of earnings helps investors determine the potential risks and return of purchasing a company. However, the results of this calculation must be understood in light of the limitations of this method. It requires research and data about the business, which in turn, depending on the nature of the business, may require generalizations and assumptions along the way. The more structured the business is, and the more rigor applied to its accounting practices, the less impact any assumptions and generalizations my have.

Determining a Capitalization Rate

Determining a capitalization rate for a business involves significant research and knowledge of the type of business and industry. Typically, rates used for small businesses are 20% to 25%, which is the return on investment (ROI) buyers typically look for when deciding which company to purchase.

Because the ROI does not include a salary for the new owner, that amount must be separate from the ROI calculation. For example, a small business bringing in $500,000 annually and paying its owner a fair market value (FMV) of $200,000 annually uses $300,000 in income for valuation purposes.

When all variables are known, calculating the capitalization rate is achieved with a simple formula, operating income/purchase price. First, the annual gross income of the investment must be determined. Then, its operating expenses must be deducted to identify the net operating income. The net operating income is then divided by the investment’s/property’s purchase price to identify the capitalization rate.

Drawbacks of Capitalization of Earnings

Evaluating a company based on future earnings has disadvantages. First, the method in which future earnings are projected may be inaccurate, resulting in less than expected yields. Extraordinary events can occur, compromising earnings and therefore affecting the investment’s valuation. Also, a startup that has been in business for one or two years may lack sufficient data for determining an accurate valuation of the business.

Because the capitalization rate should reflect the buyer’s risk tolerance, market characteristics, and the company’s expected growth factor, the buyer needs to know the acceptable risks and the desired ROI. For example, if a buyer is unaware of a targeted rate, he may pay too much for a company or pass on a more suitable investment.

Capitalized earnings = Long-term operating profit * 100 / Capitalization Rate

The capitalization rate is calculated as follows, remembering that the corresponding figures may vary depending on the company’s size, sector and individual circumstances.

• Risk-free interest rate
• Market risk premium
• Rate for small companies
• Rate of non-liquidity
• Rate for risk specific to the company: on a case-by-case basis

EVA is basically the working benefit after charge less a charge for the capital, the value just as an obligation, utilized in the business. Monetary Value Added (EVA) is a strategy to ascertain the financial benefit of an organization. EVA can determine as Net Operating Profit after charges less a charge for the chance expense of the capital contributed. The hidden standard of this technique is to decide; if the organization is procuring a higher pace of return on the assets contribute than the expense of the assets. Assuming it is acquiring a higher pace of return; it infers that the administration is adding more abundance to the investor’s worth.

It tends to characterize as a proportion of execution of an organization that centers more around riches or value creation for the investors instead of simply the bookkeeping benefits. For discovering genuine benefits which a firm acquires, every one of the expenses deduces from the incomes made and comparably; the expense of utilizing capital ought to likewise deduct whether it is obligation or value.

The Measure of Real Wealth Creation bookkeeper expressly deducts the expense of obligation for example interest from the incomes yet doesn’t think about the expense of value. In this way, positive bookkeeping benefit doesn’t mean riches/value creation however sure EVA would imply that the administration of the organization has progressed admirably and has made abundance for their investors. From that point of view, it gives an extreme rivalry to measurements like ROCE and ROI.

EVA is simply the operating profit after tax less a charge for the capital, equity as well as debt, used in the business.

EVA may be calculated as follows:

EVA= NOPAT – C x Capital

Where,

NOPAT = Net operating profit after tax

C = Weighted average cost of capital

Capital = Economic book value of the capital employed in the firm.

The idea behind EVA is that shareholders must earn a return that compensates for the risk taken. If EVA is zero; it is treated as a sufficient achievement on the ground that shareholders earned a return that compensated the risk.

Components of EVA:

These three components of EVA are described below:

(i) NOPAT:

NOPAT is defined as follows:

(Profits before interest and taxes) (1- tax rate)

(ii) Cost of capital:

Providers of capital (shareholders and lenders) want to be suitably compensated for investing capital in the firm. The cost of capital reflects what they expect.

The formula employed for estimating cost of capital is:

Cost of capital = (Cost of equity) (Proportion of equity in the capital employed) + (Cost of preference) (Proportion of preference in the capital employed) + (Pre-tax cost of debt) (1- tax rate) (Proportion of debt in the capital employed).

(iii) Capital employed:

To obtain capital employed, we have to make adjustments to the ‘accounting’ balance sheet to derive the ‘economic book value’ balance sheet. These adjustments are meant to reflect the economic value of assets in place of value determined by historical cost.

Advantages of EVA:

(i) EVA is a tool which helps to focus managers’ attention on the impact of their decisions in increasing shareholders’ wealth.

(ii) EVA is a good guide for investors; as on the bias of EVA, they can decide whether a particular company is worth investing money in or not.

(iii) EVA can be used as a basis for valuation of goodwill and shares.

(iv) EVA is a good controlling device in a decentralised enterprise. Management can apply EVA to find out EVA contribution of each decentralised unit or segment of the company.

(v) EVA linked compensation schemes (for both operatives and managers) can be developed towards protecting (or rather improving) shareholders’ wealth.

Disadvantages:

EVA is difficult to calculate the precise and correct cost of equity in the stock market.

Sometimes It does not helpfully the company in monitoring the problem areas; and, also hence taking misaction to not resolve those problems.

It can also improve the company’s corporate governance because since a higher EVA implies higher bonuses to the managers; they will be working hard and also honestly; which in turn augurs well for the company.

This can also improve the corporate governance of the company; sometimes it never can, because a higher EVA gives managers a higher bonus; Due to some negligence they do not even work hard and do not show honesty; So, the companies do not well developed.

It also helps company owners to identify the best person to run the company effectively and efficiently, and sometimes there are some omissions.

EVA is a good control device in a decentralized enterprise, they are just right. Management can apply EVA to find out the EVA contribution of each decentralized entity or segment of the company, but sometimes management cannot apply EVA in case EVA is simply a unit number.

The sum total of all the costs related to human resources is calculated to find out the value of a human resource. These costs include the cost of recruitment, selection, training, placement, and development of human resources of an organization.

Historical Cost Method was introduced by Brummet, Flamholtz and Pyle. This is the oldest method of valuation of human resource.

If the human assets are liquidated prematurely, the whole of the amount not written off is charged to the income of the year in which such liquidation takes place. If the useful life is recognized to be longer than originally expected, revisions are affected in the amortization schedule.

When a firm recruits an employee, he is employed with the obvious expectation that the returns from him will far exceed the cost involved in selecting, developing, and training in the same manner as the value of fixed assets is increased by making additions to them.

Such additional costs incurred in training and development are also capitalized and is amortized over the remaining life. The unexpired value is an investment in human assets.

The historical cost of human resources is very similar to the book value of the other physical assets.

Types of Historical Cost Method

Acquisition cost: It means the cost which is incurred on acquiring the human resource in the organization. The cost incurred at the time of recruitment, selection, and placement, etc.

Learning Cost: It means that cost is incurred at the time of providing training and development to the employees and managers.

Advantage of historical cost method

• Employers and employees can easily understand this method.
• This method follows the traditional accounting concept of matching costs with revenue.
• This method is very easy to calculate the value of a human resource.
• Return on the company’s investment in human resources can easily be calculated by this method.

Disadvantage of historical cost method

• In this method rate of amortization is very difficult to determine.
• Under this method it is very different to estimate the service period of an employee.
• As we know, the value of assets decreases with an increasing number of years or amortization. But in the case of human resources, it is just the opposite. The utility of employees increases with the increasing experience and training provided to them.

Human resource accounting has very high significance not only for the management, but also for analyst and even for employees. It helps management in better utilization, planning management of human resources in the organization while for analyst, Even today, when a good deal of work has been done in this field, it is very much unfortunate that there is not only set pattern or generally accepted method either for valuation of human resource or for their recording in books of accounts or for the disclosure of information by means of different statements. The study focuses on the calculation of the value of human resources at different levels of organization & to determine the human resource efficiency quotient.

The rationale behind introduction of HRA lies in the fact that human resources should be treated as physical assets and should be shown on the asset side of the balance sheet. Failing to exhibit such assets on the face of the balance sheet in the traditional accounting system indicates lack of reliability of the financial picture. Recognition of human resource as asset removes the obstacles of traditional accounting practice and reflects the actual financial status of an organization. HRA deserves the following benefits:

1. Any change in the investment in human resources affecting the earning capacity and growth of an organization cultivates the concept of HRA in which assets status is accorded to human resources and accordingly brought into account like other assets.
2. Acquisition, training and placement costs of human resources for productive purposes should be capitalized. HRA first justifies this truth. It will help the management in planning and executing personal policies.
3. Expansion of building, plant & machinery etc. obviously leads to enhancement in human resources. Hence, information in the form of HRA is necessary.
4. Additional information in the form of HRA inspires the shareholders and creditors to make long-term investment with confidence.
5. Cordial relationship among the employees in an organization is possible only when management realizes the importance of contribution made by the employees and workers in an organization.
6. HRA can be used as a tool in detecting the spirit of labor turnover, return on investment and utilization of potential capacity of an organization.
7. HRA helps in solving industrial disputes and collective bargaining process as management representative can put forward data in a systematic manner.

This method was first advocated by Kiman and Jones for a company with several divisional heads bidding for the services of various people they need among themselves and then include the bid price in the investment cost.

Opportunity cost is the value of an asset when there is an alternative use of it.

There is no opportunity cost to those employees that are not scarce, and also, those at the top will not be available for auction. As such, only scarce people should comprise the value of human resources.

The value of a human resource is determined based on the value of an individual employee in alternative use. If an employee is hired from an external source, there is no opportunity cost to him.

Benefits:

Relative Price: Another important benefit of considering your opportunity cost is it allows you to compare relative prices and the benefits of each alternative. Compare the total value of each option and decide which one offers the best value for your money. For instance, a business with an equipment budget of $100,000 may buy 10 pieces of Equipment A at $10,000 or 20 pieces of Equipment B at $5,000. You could buy some of A and some of B, but relative pricing would mean comparing the value to you of 10 pieces of A versus 20 pieces of B. Assuming you choose 20 pieces of B, you effectively decide this is more valuable to you than 10 pieces of A.

Awareness of Lost Opportunity: A main benefit of opportunity costs is that it causes you to consider the reality that when selecting among options, you give up something in the option not selected. If you go to a grocery store looking for meat and cheese, but only have enough money for one, you have to consider the opportunity cost of the item you decide not to buy. Recognizing this helps you make more informed and economically sensible decisions that maximize your resources.

Limitations:

• The total valuation of human resources for the competitive bid price may be misleading or inaccurate. It may be because a person may be an expert for one department and not so for the other department. He may be a valuable person for the department in which he is working and thus commands a high value but may have a lower price in the bid by the other department.
• It has specifically excluded from its preview the employees scarce or not being ‘bid’ by the other departments. This is likely to lower the morale and productivity of the employees who are not covered by the competitive process.
• Under this method, valuation based on opportunity cost is restricted to alternative use within the organization. In real life, such alternative use may not be identified because of the constraints in an organizational environment.
• Opportunity costs take time to calculate and consider. You can make a more informed decision by considering opportunity costs, but managers sometimes have limited time to compare options and make a business decision. In the same way, consumers going to the grocery store with a list and analyzing the potential opportunity costs of every item is exhaustive. Sometimes, you have to make an instinctive decision and evaluate its results later.

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.

Statutory Compliance of rules and regulations in HRMS& payroll is a grave legal matter for both employees and the organization’s social security. The Indian Government has declared various regulations and acts to process employee’s payment. Every company is liable to follow these rules to avoid any legal consequences. Though to follow it or not might be a company’s individual decision, but it may have some severe implications.

Statutory Compliance in HR is important, as seen from both employee and employer’s perspective. Indian Government provides employee benefit acts like industrial relations, minimum wages, social security, women and child employment, health and safety, and organization benefit acts like provident fund, trade union, ESI, professional tax, etc. We will further check all the details of these acts. These acts can vary from state to state and country to country. In India, these acts sometimes change for every state, but not necessary.

Non-agreement to such laws implicate legal consequences on business existence, that is why business representatives put a considerable amount of money, time, and people to adhere to these laws. Additionally, they also seek laws and finance taxation expert’s advice. To be a statutory compliant company, you must practice an efficient way to minimize these risks and update them with these laws.

Every type of organization, whether private, LLP, partnership-based, which provides a salary to their employees, must stick to these laws to avoid reputation and business threats during any statutory audit.

These regulations are checked during the statutory audit. A Statutory Audit is an inspection mandated by law to ensure the books of accounts presented by organizations are true according to the statutory audit checklist finalized.

Importance and Advantages of Statutory Compliance

The most important advantage of the list of statutory compliance to employees is that it ensures fair treatment of labour. It prevents employees from being exploited or made to work for unmanly hours or in inhuman conditions. It also ensures that they are paid fairly in proportion to the work that they have done, and that companies comply with the minimum wage rate.

The advantage to organizations is the timely payment of taxes, which avoids a lot of legal trouble like penalties and fines. A set of predefined rules makes it easier for the Government to collect revenue as well as for companies to organize their financials. Statutory compliance is important to prevent legal troubles. Companies can be fined monetarily as well as be tried in a court of law, depending on the scale of non-compliance. The Importance of statutory compliance in hr cannot be overlooked anymore. It needs to be taken far more seriously to reduce the frequency of fines and penalties.

Statutory Benefits Applicable

For Employee’s:

1. Ensures minimum wages and equal remuneration to men and women.
2. Fair treatment to employee and betterment of industrial relations.
3. Help avoids inhuman conditions of work and guarantees workplace health and security.
4. Provides social security through compensation and incentives.

For Employer’s:

1. Protection to the organization’s existence.
2. Protection against illegal wage demands from trade unions and employees.
3. Maintains the organization’s reputation and client engagement.
4. No risk of fines and penalties.

Industrial Relations Guide for Statutory Compliance

The Industrial Disputes Act, 1947

The industrial disputes act, enacted in 1947, to make provisions for investigating and settling disputes between employee-employee or employee-employer. The main objective of this Act is to ‘maintain peace and harmony in work culture in Indian Establishments.’

This Act applies to the whole Indian nation, including establishments for business, trade, manufacture, and distributions. However, it does not encircle persons in the managerial or administrative field and persons subject to Army, Air force, and Navy.

Women Benefits

Equal Remuneration act, 1976

As the name suggests, the Equal Remuneration Act encloses a gender-based payment equality policy of industrial. It ensures uniform payment to the employees irrespective of men or women to avoid gender bias. It came into the picture because payment given to women was lower than that of men, though the work amount being the same. Non-compliance with this Act can implicate serious fines and penalties.

Provisions under this Act include 1. Not to reduce employees’ salary to adhere to the Act 2. For the same nature and amount of work, no discrimination is allowed for women. 3. During the formation of an advisory committee that works to increase employment opportunities for women, work hours and its nature shall consist of half women members.

Maternity Benefit Act, 1961

The maternity benefit act passed in 1961. It helps women protect her employment and provides her certain months of paid leaves during her maternity to take care of her child. After maternity, she can continue with her job without any disturbance of made leaves.

This Act applies to all establishments like factories, shops, private and Government sectors with ten or more employees. During her maternity, she will be paid based on average daily wages. But to gain this benefit, she must be working for an organization for at least 80 days within the past 12 months.

Further amendments of this Act in 2017, guarantees

1. Increased amount of paid leaves during maternity ‘leaves are increased from the existing 12 weeks to 26 weeks.
2. Leave for adoption ‘women can leave for adopting a child below the age of 3 months and the commissioning mothers.
3. Work from home option ‘women, can now continue her work directly from her home with no leave requirements and is comfortable to her.

The Payment of Gratuity Act 1972

Payment of gratuity act guarantees benefits like gratuity and incentives to the employees working in railways, mines, factories, ports, oilfields, shops, and private sectors.

A certain amount is deducted from monthly wages and further provided after an employee’s retirement, offering monetary help, called gratuity. Gratuity is allowed to an employee who has given continuous service for at least five years for a particular organization. As per section 4(1), gratuity is mandatorily payable for employee death or disablement, even though five years of service is pending. Under section 4(3), the maximum gratuity amount an employee is beneficial for is Rs. 20,00,000, and is liable to tax for gratuity amount more than stated.

According to section1(2), state Jammu and Kashmir are not liable for this Act for plantation or ports. As per section1(3-A), in case the employee rate somehow drops below 10 for an establishment, the employer must not request for reducing gratuity. Under section2(e), this Act doesn’t apply to apprentices or civil service employees under the Central and State government.

Gratuity depends on the years of service and the last drawn salary and is calculated according to the formula

Gratuity = Last drawn salary *number of completed service years * 15/26

According to the above formula, the service year with more than six months will be considered one full year, and less than six years will be regarded as zero years.

For example, a service period of seven years and eight months will be eight years, and a service period of six years and four months will be six years.

The Employees’ Compensation (Amendment) Act, 1923

Many services involve hard work, risk of losses, critical injuries, or even death. Employees’ compensation act, enacted in 1923, protects an employee or his/her dependents through compensation during any conditions mentioned above.

According to Section 17A, every employee must be well-informed about his compensations at the time of joining by the employer. Failure of such tasks may result in penalties and fines of Rs. 5000 to 50,000 as imposed by Government, under section 18A.

The Employees’ Provident Fund & Miscellaneous Provisions (Amendment) Act, 1952

The statutory provident fund act is issued for the social security of the employee. Employees’ Provident Fund Act is liable for any establishment employing more than 20 employees. To make this possible, every employee during his/her employment contributes some amount from their salary to the Provident Fund. Even their employer is also required to contribute to this fund. This fund then ensures social security after employees’ termination or retirement. EPF of every corresponding employee must be deducted from his/her salary and filled before the PF return due date, which is the 15th of each month.

Employees’ PF calculation is based on basic salary and DA. Other allowances like HRA, overtime allowance, incentives, etc. are not included under this. The basic wage covered in this is Rs. 15,000 monthly. PF divides into two funds; EPF (Employees’ Provident Fund) & EPS (Employees’ Pension Scheme). Consider the following PF rates declared by the government:

Any failure in this Act may lead to 3 years of imprisonment and a penalty of Rs. 10,000. Apart from EPF, other provident fund meanings and types include

SPF: Statutory Provident Fund

SPF is only meant for employees who are enrolled in Government and Semi-government enterprises.

UPF: Unrecognized Provident Fund

Started by employers or employees in any organization, UPF is not a government-approved scheme.

PPF: Public Provident Fund

Whether an employer or not, PPF scheme that is savings-cum-tax-savings options, is open to every Indian citizen

The Employees’ State Insurance ESI Act, 1948

Employees’ State Insuranceactensures absolute medical security, including sickness, maternity, and injuries for employees working in non-seasonal factories, including power with more than ten employees and non-power and other establishments with more than 20 employees.

The wage limit covered under this Act is Rs. 15,000 per month. This Act applies to all states except Manipur, Sikkim, Arunachal Pradesh, and Mizoram. Benefits can be availed through ESIC online appointment for hospitals, clinics, and practitioners.

Both employee and the employer contributes to the ESI scheme on ESIC payment portal and ESI Percentage contributions made to the same are