Layoffs and Human Capital Accounting

Lessons from the Great Recession of 08-09.

Many organizations like to say that their people are their most valuable asset.  Yet in the real world, and from an accounting perspective, people are viewed as expenses rather than assets.  This drives bust and boom cycles of hiring freezes, layoffs, unemployment, and then wasteful rehiring. The truth: you’re my most valuable asset until times are tough, and then you’re an expense to be shed.

Beyond being shortsighted, wasteful, and callous, simply getting rid of people when times are tough does little more than shifts costs from the corporations to all of us.  While a big contributor to the current economic mess, it provides a great opportunity to practice what corporations preach about valuing their human capital.

Putting aside the corporate-speak of “employees-as-assets,” the accounting profession is the true guardian of how people are viewed.  Generally Accepted Accounting Principles (GAAP) considers employees to be operating expenses that share the same accounting treatment as travel and entertainment spending, leases, and telephone bills. And when the Dow dips below 8,000, all of the above go on the chopping block.

GAAP beware: the rules need to change.

As my executive coaching colleague Frank Ball said to me recently, “As long as organizations stay in survival mode, thinking of their people not as their most valuable asset, but rather as an expense control item, we’ll end up in the same hole we’re in today.”  The most recent bloodletting of layoffs, followed by the “expense” of paying unemployment, and then reversing it all during the next uptick, tells a tale of waste in the public and private sector.  Let’s fix the accounting, and let it reflect the true value and contributions of our human resources.

What if we put employees and the expenses that go with them on the Balance Sheet—go ahead, just rip them from operating expense, and determine their value as assets?

Making the Case

Let’s look at the nature of what typically lands on a balance sheet.  Items can be:

•    An asset or a liability
•    Thought to have a financial value to the organization
•    Increased in value if “improved”
•    Revalued over time to impact the company’s net worth

Hence, Jack the head of sales, who isn’t doing any selling in this grim market, is an asset whose value has declined, while Suzanne, who’s running three call centers with high customer satisfaction, is a strongly-performing asset.  And, if you “improve” her (with training, coaching, good leadership, and other support) she can “appreciate,” as measured by her ability to run five call centers for roughly the same cost of her salary and benefits.  As any other asset, Suzanne is clearly subject to capital improvement.

I challenge organizations to ask themselves a fundamental question: are Jack and Suzanne more like a phone charge, or a building that has value and relevance to the needs of the organization?  Do they really belong with revenue and expenses on an Income Statement, or paired with capital assets on the Balance Sheet? 

Believe me, working with organizations day in and day out, I see how people are assigned an implicit value by each other.  Looking at employees as expenses is therefore an anomaly of accounting, one better left in the rear view mirror of lessons learned from the Great Recession of 08-09.

So let’s evolve this people-as-expenses paradigm into new rules and thinking that maximizes, rather than marginalizes our human capital.

David Peck
Executive Coach and President
Leadership Unleashed

Special thanks to Frank Ball, Ray J. Kelly, and Amy Schilling for contributing to this article!  -DP

Comments

[Dr Michael Reddy]

David, many thanks for your recent Layoffs and Human Capital Accounting blog. It chimed in closely with my own impatience at the “people are our biggest asset” mantra, partly because 9 times out of 10 the speaker doesn't have a second sentence to follow it. Partly, as you say, because it is dishonoured every day of the week by most organisations, and because it is short-sighted, wasteful and callous in the current economic crisis. A friend of mine, ex-CEO of an asset management firm with £75 billion of assets under management made the point that many of the well paid if not overpaid senior executives of his own firm could well have sacrificed some of their bonus benefits and redistributed them, in order to retain at least a handful, if not more, of highly specialised performers they would be re-recruiting within months.

The second point where I completely concur is that if improvement is to come from anywhere it will have to come from the accountants.

On the other hand I have my doubts whether people will ever find their way onto the balance sheet, if only because, as assets “on loan”, the business does not own them. Also the value of individuals, such as your Jack and Suzanne, fluctuates if not on an annual basis certainly from week to week and month to month. For the moment I am treating the balance sheet therefore as an instrument simply no longer fit for purpose. I also have an issue with the Profit and Loss account, where people are logged as costs, which to say the least is a strange rubric for an asset. Not only that but the cost of employing people as calculated on the P&L is invariably an undershoot, taking into consideration as it does only the crude costs of salary, benefits, training investments and so on. Most of the real costs of people are hidden under legal costs, insurance, oncosts, and the virtually unmeasurable soft costs of HR and management time. What this means is that the Finance Director is getting away, quarter after quarter, with a wholly inaccurate picture of the organisation's financial health. Not to mention getting away with a wholly inadequate reflection of the true value of a business this could be or possibly already is being assessed as an acquisition target. Business analysts, M and A firms and the like are often completely in the dark as to the true people value of a business they have their eye on. And it is common knowledge that if half of mergers fail, 70% of the reasons for the failure are likely to reside in untested HR audits.

If I wanted to rip people away from operating expense I'd love to experiment by putting them instead under the heading of investment. A CEO or a Board that proposed a complete review of the IT system, marketing and advertising approach, etc would almost certainly weigh the probable costs and amortise them over three or more years as R and D. Might some enlightened CEO or Board adopt the same approach to a radical conceptual revision of their people strategies and give them three or four years to mature? Doubtful –even if logical.

Maybe there is a more sensitive area where we could be a nuisance to the already harried FD? As a psychologist with some 20 years’ experience of working within organisations I could write a persuasive treatise on the subject of behavioural risk. I believe I could construct an interesting list of ways in which employee behaviour can be shown to incur quite concrete costs, costs which are unattended in any P&L I have ever seen. In other words attack the other side of the asset coin and trumpet the fact that “people are our biggest liability” (also notably absent from the balance sheet).

In the UK a highly touted government commission proposed in 2003 that, alongside the traditional balance sheet and P&L, a third financial reporting instrument should be made obligatory, outlining the strategies which had been adopted by the organisation over the previous year to manage their human capital, along with proposals already in the pipeline to measure improvement. The British government not surprisingly chickened out in 2005 under the pretext that the EU was pursuing a similar objective but in reality in the face of protests by big business to the effect that they would find it too difficult or too onerous.

An initiative which I am currently bringing close to fruition, as we complete the building of a Web2.0 interactive site, is to invite specialists from HR, psychology and the financial services to join forces, perhaps initially as three separate "tribes", before bringing them together to address the question in a unified manner. It may be a long shot but agreement on a third conventional financial reporting instrument, alongside the balance sheet and the P&L, could be the most promising way forward.

Michael Reddy PhD, Director Human Potential Accounting

LinkedIn Profile: http://uk.linkedin.com/in/michaelreddy1

Google Knol: http://knol.google.com/k/human-capital-and-financial-reporting#