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UNIT I HRA Inflation Accounting


SMU                                        AFM -MBA

                             UNIT – I Accounting for Managers

Human Resources Accounting

       “Our main assets is our people”
       Labour as the father of wealth in the sense of generator of wealth.
       Employees of any organization as its precious wealth
       Employees is a Backbone play a stupendous role in its developmental and productive

Many companies start to assess the real value of human assets. While most organizations can
readily give detailed information about their tangible assets, such as plant and machinery, land &
buildings, transport and office equipment, there is no formal record of investment in employees.

Human Assets accounting or human resources accounting (HRA) which stands for measurement
and reporting of the cost and value of people as organizational resources, is still to become an
accepted trend in the Indian IT industry.

Meaning of HRA

Human resources Accounting aims at depicting the human resource potential in money terms
while casting the organization’s financial statements. With the emergence of Knowledge
economy, recognition of human capital as an important part of the enterprise’s total value has
gained importance.

P.K.Gupta, Director of Strategic development-intercontinental operations, of Legato Systems
India.”HRA is basically an information system that tells the management what changes are
occurring over time to the human resources of the business. It also involves accounting for
investment in people and their replacement costs and the economic value of the people in an
organization. The current accounting system is not able to provide the actual value of employee
capabilities and knowledge. This indirectly affects future investments of a company, as each
year, the cost on human resources development and recruitment increases.


American Accounting Association committee defined HRA as “The process of identifying and
measuring data about human resources and communicating this information to interested


   1. HRA system generates information on various aspects – Acquisition, development,
      allocation, utilization and replacement.
   2. HRA identifies, quantifies and reports the amount of expenditure incurred or capital
      employed to recruitment, acquire, train, familiarize and develop the human resources.

KSRCE                                       MBA-AFM                                        UNIT - I
SMU                                        AFM -MBA

   3. HRA helps the management deals with the different aspects of employees, such as
      acquiring, developing, allocating, utilizing, rewarding and evaluating.

   Importance of HRA

            It supports to take an effective measurement, reporting system for decision-
            Decision making in the areas of :
             1. Programming policies and programmes for the development of human
             2. Decisions regarding cost reduction programmes.
             3. Training and development
             4. Recruitment and selection
             5. Manpower planning and control
             6. Conservation and reward of human resources.
             7. Making a choice between various types of human investment and investments
             in other assets.

        Classification of Human resources Costs

        1. Acquisition costs – reporting for duty of employees (Advt, application processing,
           screening, conducting test and Interviews, remuneration and other admin expenses.
        2. Development Costs – Placing the persons (salary of trainees and trainers, cost of
           study materials, consultancy fee, a share of administrative expenses and others)
        3. Operational Wages and Salaries - Periodical payment to the employees (Employees
           insurance fund and provident fund, cost of non-monetary facilities to the employees).

Human Resources Accounting in India

The concept of HRA - implemented in Public sector and Private sector and IT industries.

1.BHEL 2. Cement Coporation of Indai Limited (CCI) 3. ONGC 4.Minerals and metals trading
corporation (MMTC). 5. Engineers India Limited (EIL) 6. SAIL 7. Southern petrochemicals
and industries corporation (SPIC) and A. ACC (Associated Cement Company).

Inflation Accounting

Inflation accounting is a term describing a range of accounting systems designed to correct
problems arising from historical cost accounting in the presence of inflation.[1] Inflation
accounting is used in countries experiencing high inflation or hyperinflation. For example, in
countries experiencing hyperinflation the International Accounting Standards Board requires
corporate financial statements to be adjusted for changes in purchasing power using a price

KSRCE                                      MBA-AFM                                        UNIT - I
SMU                                         AFM -MBA

Historical costs basis in Inflation Accounting

Fair value accounting (also called replacement cost accounting or current cost accounting) was
widely used in the 19th and early 20th centuries, but historical cost accounting became more
widespread after values overstated during the 1920s were reversed during the Great Depression
of the 1930s. Most principles of historical cost accounting were developed after the Wall Street
Crash of 1929, including the presumption of a stable currency.

Measuring unit principle

Under a historical cost-based system of accounting, inflation leads to two basic problems. First,
many of the historical numbers appearing on financial statements are not economically relevant
because prices have changed since they were incurred. Second, since the numbers on financial
statements represent dollars expended at different points of time and, in turn, embody different
amounts of purchasing power, they are simply not additive. Hence, adding cash of $10,000 held
on December 31, 2002, with $10,000 representing the cost of land acquired in 1955 (when the
price level was significantly lower) is a dubious operation because of the significantly different
amount of purchasing power represented by the two numbers.

By adding dollar amounts that represent different amounts of purchasing power, the resulting
sum is misleading, as one would be adding 10,000 dollars to 10,000 Euros to get a total of
20,000. Likewise subtracting dollar amounts that represent different amounts of purchasing
power may result in an apparent capital gain which is actually a capital loss. If a building
purchased in 1970 for $20,000 is sold in 2006 for $200,000 when its replacement cost is
$300,000, the apparent gain of $180,000 is illusory.

Misleading reporting under historical cost accounting

“In most countries, primary financial statements are prepared on the historical cost basis of
accounting without regard either to changes in the general level of prices or to increases in
specific prices of assets held, except to the extent that property, plant and equipment and
investments may be revalued.”

 Ignoring general price level changes in financial reporting creates distortions in financial
statements such as

reported profits may exceed the earnings that could be distributed to shareholders without
impairing the company's ongoing operations

       the asset values for inventory, equipment and plant do not reflect their economic value to
        the business
       future earnings are not easily projected from historical earnings
       the impact of price changes on monetary assets and liabilities is not clear
       future capital needs are difficult to forecast and may lead to increased leverage, which
        increases the business's risk

KSRCE                                       MBA-AFM                                        UNIT - I
SMU                                         AFM -MBA

       when real economic performance is distorted, these distortions lead to social and political
        consequenses that damage businesses (examples: poor tax policies and public
        misconceptions regarding corporate behavior)

History of inflation accounting

Accountants in the United Kingdom and the United States have discussed the effect of inflation
on financial statements since the early 1900s, beginning with index number theory and
purchasing power. Irving Fisher's 1911 book The Purchasing Power of Money was used as a
source by Henry W. Sweeney in his 1936 book Stabilized Accounting, which was about
Constant Purchasing Power Accounting. This model by Sweeney was used by The American
Institute of Certified Public Accountants for their 1963 research study (ARS6) Reporting the
Financial Effects of Price-Level Changes, and later used by the Accounting Principles Board
(USA), the Financial Standards Board (USA), and the Accounting Standards Steering Committee
(UK). Sweeney advocated using a price index that covers everything in the gross national
product. In March 1979, the Financial Accounting Standards Board (FASB) wrote Constant
Dollar Accounting, which advocated using the Consumer Price Index for All Urban Consumers
(CPI-U) to adjust accounts because it is calculated every month.

During the Great Depression, some corporations restated their financial statements to reflect
inflation. At times during the past 50 years standard-setting organizations have encouraged
companies to supplement cost-based financial statements with price-level adjusted statements.
During a period of high inflation in the 1970s, the FASB was reviewing a draft proposal for
price-level adjusted statements when the Securities and Exchange Commission (SEC) issued
ASR 190, which required approximately 1,000 of the largest US corporations to provide
supplemental information based on replacement cost. The FASB withdrew the draft proposal.

Inflation accounting models

Inflation accounting is not fair value accounting. Inflation accounting, also called price level
accounting, is similar to converting financial statements into another currency using an exchange
rate. Under some (not all) inflation accounting models, historical costs are converted to price-
level adjusted costs using general or specific price indexes.

Income statement general price-level adjustment example

       On the income statement, depreciation is adjusted for changes in general price levels
       based on a general price index.
                        2001     2002      2003      Total
Revenue               33,000 36,302     39,931     109,233
Depreciation          30,000 31,500 (a) 33,000 (b) 94,500
Operating income      3,000 4,802       6,931      14,733
Purchasing power loss -       1,500 (c) 3,000 (d) 4,500
Net income            3,000 3,302       3,931      10,233
       (a) 30,000 x 105/100 = 31,500

KSRCE                                       MBA-AFM                                         UNIT - I
SMU                                            AFM -MBA

        (b) 30,000 x 110/100 = 33,000
        (c) (30,000 x 105/100) - 30,000 = 1,500
        (d) (63,000 x 110/105) - 63,000 = 3,000

Constant dollar accounting

Constant dollar accounting is an accounting model that converts nonmonetary assets and equities
from historical dollars to current dollars using a general price index. This is similar to a currency
conversion from old dollars to new dollars. Monetary items are not adjusted, so they gain or lose
purchasing power. There are no holding gains or losses recognized in converting values.

International standard for hyperinflationary accounting
The International Accounting Standards Board defines hyperinflation in IAS 29 as:"the
cumulative inflation rate over three years is approaching, or exceeds, 100%."

Companies are required to restate their historical cost financial reports in terms of the period end
hyperinflation rate in order to make these financial reports more meaningful.

 The restatement of historical cost financial statements in terms of IAS 29 does not signify the
abolishment of the historical cost model. This is confirmed by PricewaterhouseCoopers:
"Inflation-adjusted financial statements are an extension to, not a departure from, historical cost


KSRCE                                           MBA-AFM                                      UNIT - I

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