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"The most valuable of all capital is that invested important factor in explaining and pre-
in human beings." Alfred Marshall, Principles of dicting economic growth [2], etc. Human
EconaOmics.
capital is thus treated in modern economic
INTRODUCTION theory on a par with other forms of earn-
T EHEdichotomy in accounting between ing assets.
human and nonhuman capital is On the other hand, the different attitude
fundamental; the latter is recognized of accountants toward human capital was
as an asset and therefore is recorded in the succinctly expressed as follows:
books and reported in the financial state- A favorite cliche for the president's letter in cor-
ment, whereas the former is totally ig- porate reports is "our employees are our most im-
portant-our most valuable-asset." Turning
nored by accountants. Most economists, from the president's letter and looking to the re-
on the other hand, have a different view on mainder of the report, one might ask, "where is
this issue. Milton Friedman, for example, this human asset on these statements which serve
states: as reports of the flim's resources and earnings?
What is the value of this most important or most
From the broadest and most general point of valuable asset? Is it increasing, decreasing, or
view, total wealth includes all sources of "income" remaining unchanged?" [4, p. 217]
or consumable services. One such source is the
productive capacity of human beings, and ac- The objective of this article is to provide
cordingly this is one form in which wealth can be a practical measurement procedure by
held. [8, p. 4]
which some of the questions raised in the
The definition of wealth as a source of in- preceding quotation can be answered.
come inevitably leads to the recognition of Specifically, the possibility of using the
human capital as one of several forms of economic concept and measurement of
holding wealth, such as money, securities, The authorsare deeplyindebtedto ProfessorSidney
and physical (nonhuman) capital. This Davidson, Dean of the GraduateSchool of Business,
attitude toward human capital has a Universityof Chicago,for helpfulcomments.
broad range of applications in economics. Baruch Lev is Chairman of the Depart-
For example, the value of human capital mrent of Business Administration at The
appears in some demand functions for Hebrew University of Jerusalem and Visit-
money (of business enterprises as well as ing Assistant Professor of Accounting and
households) as an argument along with Finance at the University of Chicago. Aba
other forms of nonhuman wealth [8, pp. 9, Schwartz is Lecturer in Economics at The
131, human capital is recognized as an University of Tel-Aviv, Israel.
103
groups of the labor force (see example in ber of employees) are held constant. It has
the Appendix). Several ratios are suggested been suggested that the aging of the firm's
by such a disaggregation; for example, the labor force affects its rate of growth and
ratio of the value of scientific staff to the relative share in the industry vis-a-vis the
total value of human capital. This ratio "younger" and more aggressive firms.
indicates the extent of "skill (scientific) Such hypotheses can be tested by using
intensity" in the firm. Skill intensive in- the reported values of human capital.
dustries are those with a relatively large (c) The difference between the general
scientific and research staff, e.g., chemical and specific values of human capital (dis-
products, electronics, pharmaceuticals, etc. cussed in the preceding section) is another
The effect of skill intensity on rate of re- source of valuable information for man-
turn and growth is a currently debated agement and the analyst. The specific
issue. Here again researchers use extremely value of human capital is based on the
crude measures to detect the effect of skill firm's actual wage scale while the general
intensity such as R & D expenses, number value is based on industry-wide wage
of college graduates as a percentage of the averages. The difference between the two
total number of employees, etc. Such mea- therefore indicates the level of the firm's
sures are not sensitive to variations within wage scale relative to the industry average.
the scientific employee group, whereas the Specifically, if the industry-wide wage
suggested measure reflects such variations. averages are taken as a standard, this
(b) Reported human capital values will difference indicates to what extent the
provide information about changes in the firm's wage scale is above, on a par with,
structure of the labor force. For example, or below the standard. Such information,
differences over time in the values of a which is not currently communicated to
firm's human capital may result from users, may explain the observed phenome-
changes in the age distribution (i.e., non of firms which consistently pay higher
"vintage") of employees. Recall that hu- wages than the industry averages. It is
man capital values are determined by sometimes argued that such firms employ
capitalizing earnings over the expected the professional elite and hence experience
useful life (to the enterprise) of employees. a higher rate of return or growth than their
Therefore, a change in the age distribution competitors. Others are skeptical about
of the labor force would obviously affect such a hiring policy claiming that when
the firm's human capital values. Suppose, wages are equal to employees' marginal
for example, that no change has taken place productivity6 then no extra returns can
in the structure of the labor force during result from employing superior employees.
1969 (i.e., no employees were hired or laid Reporting the general and specific values
off). In this case, the value of the firm's of human capital will thus enable users to
human capital at the end of 1969 would be investigate the effects of specific wage and
smaller than that of the previous year hiring policies.
(assuming, of course, no changes in the Management might try to increase pro-
earnings profiles). The firm's time series fits in the short run by hiring low quality
of human capital value thus contains in- employees. Such a policy can produce
formation about changes in the structure damaging effects which will be realized
of the labor force. The phenomenon of an only in the long run. However, if human
"aging firm" often discussed in organiza- capital values are reported they will cur-
tion theory, will be indicated by such a
' This will be the case when the firm's production
time series when other factors (e.g., num- function is homogeneous to the first degree.
reftly reflect the change in hiring policy cerns (e.g., merger), payment is often
and thereby deter management. made for intangible assets such as a stable
and high quality labor force.8 For example,
ISSUESIN REPORTING
CONCEPTUAL it is customary in the insurance industry to
HUMANCAPITALVALUES determine the value of the sales force at
The problem of reporting human capi- the time of acquisition or sale. This is us-
tal values in financial statements has two ually done by forecasting the firm's future
distinct aspects: (a) the measurement of earnings, determining its present value,
the value of the firm's work force which is and then allocating a portion of the present
the subject of this article, and (b) mea- value to the human resources. A firm's hu-
surement and amortization of the firm's man capital can thus be purchased and in
investment in human resources. The few a sense "owned" by it.
articles concerning human capital report- (b) It can be argued that the labor force
ing in financial statements [4, 5, 6, 13] deal is not an asset since it does not have a
exclusively with the second aspect.6 "service potential" extending beyond the
current period. Specifically, employees are
It is often assumed that the objective of human
resource accounting is to determine the net paid for rendering current services and no
worth, or dollar value of an individual employee asset is formed by these payments. If this
to a firm. This is not the case. Rather, we are were true then no firm would invest in (as
trying to develop concepts and techniques for opposed to maintain) human capital.
measuring a firm's investment in its human or-
ganization, the rate at which those investments
However, the prevalence of programs such
are being consumed, and which investments are as orientation courses for new employees,
more productive than others. This is not the same executive programs, employees' training
as measuring the value of individuals and surely programs, facilities for improving em-
raises fewer objections. [13, p. 46, emphasis sup- ployees' morale, etc., is evidence to the
plied]
contrary. Such expenditures are made with
What are the objections that can be raised the expectation of future returns, i.e.,
against the incorporation of human capital they increase the service potential em-
values in accounting reports? bodied in human capital and this creates
(a) It can be argued that human capital an asset.
(excluding a slave society) cannot be pur- The problem of reporting human capital
chased or owned by the firm and therefore values is closely related to the issue of
would not be recognized as an asset in long-term leases and other executory con-
accounting. This is obviously true with tracts. In both cases the firm rents the
respect to individual employees who can services of capital (human in the former,
usually resign at will;7 however it is not so physical in the latter) owned by others.
obvious with respect to the firm's labor Those who favor the Dresentation of
force as a whole. As long as employees can I Most of the research on the
subject has been
be replaced it does not matter for our pur- conducted by R. Lee Brummet, Willard Graham Pro-
pose whether the labor force always con- fessor of Business Administration at the University of
North Carolina, and William J. Pyle of the Institute for
tains the same persons or is a rapidly Social Research at the University of Michigan. Pre-
changing group. The labor force as a liminary results of this research are reflected in the
1969 financial reports of R. G. Barry Corporation which
whole is constantly associated with the was the first to report investment in human resources.
firm and it can be constructively regarded For a description of this case, see [13].
7 This statement ignores long-term employment con-
as being "owned" by it. tracts whose importance in the U. S. is declining.
Moreover, in modern economies where ' All payments for intangible assets are aggregated
by accountants in the goodwill resulting from acquisi-
firms are usually purchased as going con- tion.
leased assets on the balance sheet would the AAA committee in A Statement of Basic
similarly endorse the reporting of human Accounting Theory
capital. External users may wish to know degrees of em-
Accounting at present recognizes most market ployee morale, customer satisfaction, product
transactions involving goods, services or money as quality, and reputation of a given entity. If
one of the elements of the transaction. Present quantification of these were possible, a substantial
accounting also generally ignores, except in amount of additional relevant information could
special circumstances, transactions involving an be provided the external users. The accountant
exchange of a promise for a promise. Leases, pur- must constantly be alert to the possible applica-
chase commitments, executive and other labor tions of new measurement methods to develop
contracts are generally denied recognition until additional quantifiable information for external
the services or goods specified in the contract are users. [1, p. 291
either used, delivered, or paid for. Many of these
contracts meet the standards of verifiability, CONCLUDING
REMARKS
freedom from bias, and quantifiability at least as The value of the human capital associ-
well as other reported events. [1, p. 32]
ated with a business enterprise is not re-
In accordancewith the suggested presen- flected in its financial reports. While some
tation of long-term leases, human capital initial strides have been made toward
values may be presented on the assets side measuring and amortizing the investment
of the balance sheet and the present value in human resources, the determination of
of the firm's liability to pay wages and human capital values is still an unsolved
salaries on the liabilities side. The two (and untouched) problem. The economic
values are equal by definition: Changes in theory of human capital provides the basis
the values of human capital from period to for a practical solution to this problem.
period would not be recognizedas income The major limitation in the concept and
but would merely be matched by changes measurement procedures advanced above
in the liability. is that the firm's value of human capital
(c) Some accountants might accept the is not necessarily equal to the portion of
notion of human capital being an asset the firm's income contributed by the labor
yet object to reporting it on the grounds force. Specifically, labor is one of several
that it cannot be "objectively" measured. inputs in the production process; its value,
We feel, however, that the preceding sec- therefore, should be determined on the
tions demonstratedthat the degree of ob- basis of that portion of total income con-
jectivity in human capital measurements, tributed by it. Such a determination of
which are usually based on census data, is value accords with the well-known ac-
not lower than that of many conventional counting concept of "service potential."
valuations in accounting. For example, However, in real life, input factors are
depreciation charges are often estimated interdependent and there is probably no
from industry-wide equipment mortality practical way of dividing the total contri-
data,9 the determinationof reservesby life bution among them. Consequently, ac-
insurance companies is based on general counting values of physical assets are
mortality tables, pension liabilities and determined by their market prices and not
product guarantees are also statistically by their relative contribution to the firm.
estimated. Therefore it seems reasonable that values
The above arguments suggest that hu- of human capital may also be similarly
man capital values may be an integralpart
I See in this context a recent suggestion for using the
of financial statements. This conclusion
life expectancy of physical assets for estimating depre-
is consistent with the recommendationsof ciation [10].
TABLE3
TOTAL VALUES OF HuiAN CAPITAL (DoLLAs) BY AGE AN SoI RATE = 10 PERCENT)
(CAPITALIZATION