Under the patronage of His Excellency Dr. Abdul Hussein bin Ali Mirza, the Minister of State and Chairman of National Corporation for Oil and Gas

The Kingdom of Bahrain

Convenes

The “Measuring Organizational Success through Human Capital” Conference

Human Resources Accounting

By

Mr. Talal Abu-Ghazaleh

Chairman of the Talal Abu-Ghazaleh Organization

Manama, December 12-14, 2005

Human Resources Accounting

I will talk about a topic that has not acquired the appropriate attention from those concerned with the human resources (HR) sector, namely the topic of human resources accounting.

The fundamental transformation in the global economy from an economy dependent on industry to one that is based on knowledge has led to the creation of a demand for “high-tech services” provided by individuals who enjoy extensive scholarly and professional skills. In an environment such as this, there is an increasing focus on human capital and less concentration on material capital for the provision of these services.

To prepare for the economy that is based on knowledge, large investments must be allocated to the field of HR. These investments include for example employment and training, which are investments that in some cases surpass what is allotted in material resources. So if an institution for example wanted to employ a high-ranking executive director, it may have to undertake an extensive search process, advertise in newspapers, incur expenses for calling in and interviewing potential candidates, and even pay a high fee to a specialized company to look for this executive. The investment in this executive director –which could amount to a high sum-, is treated as if it is operating expenses in accordance with currently known accounting principles, while a lesser investment in a laptop is dealt with on the basis that it is one of the institution’s assets. This means there is a clear defect in measuring income when all expenditures on HR are treated as expenses despite the fact that these expenses would not appear if they did not represent investments in human capital- an asset with expected future benefits.

Let us all agree that human resources are the most valuable assets in our institutions, yet we do not do anything to account for this enormous value in resources. In my organization alone, the Talal Abu-Ghazaleh Organization, we employ about 700 professionals who are highly qualified in their specializations. We spend enormous sums on the employment, training and qualification of our employees. Even so, our financial statements do not disclose any value for the human capital that we developed. Our business is similar to the business in other services organizations in its dependence on the value of people working for us. The human element is an essential factor in industrial institutions with major investments in material assets, and these assets remain inactive and require human interference to justify their value. So the services sector almost entirely depends on assets that we do not disclose in financial statements and therefore there is a mistake. Accounting standards have failed in acknowledging the most valuable asset we have, namely the human capital we developed.

What is noteworthy is that securities exchanges have recognized the value of human capital through placing a market value on services and technology companies that surpass the book value of their assets.

At the start of the 1960s, a research was completed to develop methods of human assets accounting. This research did not receive appropriate acceptance. We are now in the 21st century, close to the year 2006, and HR has never been at a higher value than the present. So this is our chance to take the initiative and start anew.

One of the topics presented by critics usually is that we have overcome the age of slavery and we do not own the people who work with us. This is true, yet let me tell you that there are cases in accounting where we recognize assets that we do not own. For example, capital leases do not represent legal ownership of assets, yet they are accounted for as if they were purchased operations of assets in installments because they are primarily of a leasing nature. Despite the fact that we do not own the people who work with us, there is a future benefit that can be reaped from the set of human resources that works in our service establishments, and we increase the volume of our business thanks to the competencies and qualifications of our employees. Therefore, we have a value eligible to be recognized as an asset in our balance sheet.

Accordingly, failure to recognize the value of human capital in our balance sheets leads to a number of misleading results:

First: Minimization of the value of assets. Investors definitely desire to know the value of human resources in an organization and analysts desire to come up with a better measurement of investment returns if all assets are accounted for including human capital.

Second: Minimization of the value of income. Recording the enormous costs in the employment, training and developmentof human resources as expenses will definitely minimize income.

Third: The possibility of manipulation in income taking place from one year to the next as a result of the changes in training and development costs. In years of a depression, organizations may reduce training and development costs and therefore minimize expenses and increase income. This policy with only a short-term outlook has the effect of damaging such organizations. But capitalization of HR will lead to the avoidance of these misleading results.

A number of methods have been presented for the recognition of the value of human resources. Some of these methods are more effective than others and I will discuss three of them.

1-Disclosure of training and development cost is permissible in the message of the chairman in the annual report. And while the disclosure is media-oriented to a large extent, it still carries the same significanceas it would had it been a report in the financial statements.

2-Complementary financial statements can be prepared which show the cost of training and development as an intangible asset subject to amortization. Once again, complementary statements do not replace the basic financial statements and can be ignored.

3-Traditional financial statements can appropriately show the cost of training and development as an asset subject to amortization. Of course, this presentation contradicts with the known and followed accounting principles, yet it leads to statements that are better for the financial status of those organizations that are dependent on human capital.

I believe the time has come to recognize in our financial statements the most valuable asset we have. Current international accounting standards stay away from caution and strict adherence to cost and allow the preparation of reports on the current values in basic financial statements. Accounting standards may also include provisions for the assessment of human capital.

After this presentation, there is a set of applicable issues that impose themselves and require processing:

1-What are the HR costs that should be treated as assets?

2-How are these costs to be measured in financial statements?

3-How are these costs supposed to be amortized?

4-Are there circumstances that require cancellation of these assets after their recognition?

I will address each one of these questions independently.

As for the first question relating to the HR costs that should be treated as assets, the basic standards followed in deciding whether expenditures should be considered assets or expenses are connected to the idea of future service. There can be no doubt that expenditures linked to HR employment, training and development are endured due to the possibility of future service that can be expected to result from these expenditures. Therefore, these expenditures meet the standards of recognition as assets and must be treated as such.

In regards to the second question relating to how to measure these costs in financial statements, I believe there are two approaches we might want to study. The first approach is the traditional way of showing these assets in accordance with the principle of the historically endured cost. We might want to begin with this traditional method so as to get used to the idea of capitalizing the expenditures linked to HR. As for the second method, it calls for showing human capital in the balance sheet according to its current value. The second way undoubtedly provides more beneficial information and is compatible with the manner of thinking of the current International Accounting Standards Board that supports showing a number of assets in accordance with their current value. Undoubtedly, there are many complex applicable issues related to determining the current value of HR in a particular institution. There is a need to conduct research in this field to define the methods that can be used. I am certain that some of these approaches will depend on deducted cash flows according to which the value of future services will be determined; this value can be acquired from HR expenditures and deducted from the present value. Regardless of the method used, the final result is defining the value of human resources that must be treated as an intangible asset subject to amortization.

Once human assets are capitalized, the third question becomes linked to measuring a part of these assets whose validity ends during a certain accounting period. Accountants use the estimates of individuals’ ages for the group of employees in calculating pension. A similar method can be used to reach the period in which there is a benefit from capitalized expenditures. The main aim behind the amortization of capitalized human resources is the conformity of HR consumption with the benefits resulting from it. The capitalized value of HR can be classified into a number of groups based on the type of employee, as expenditures linked to training technicians for example in a varying technological environment, can have an operating life that is dependent on the inevitable changes in technology.

As for the fourth and last question, it is linked to whether or not there are cases that call for the cancellation of human capital prior to its complete amortization. This issue is not exclusive to human capital, but rather applies to all capitalized expenditures. Human capital can be cancelled as a result of the unexpected movement of employees or change in the service periods estimated for groups of employees. The period of service estimated for the employee can change due to deteriorating health conditions, early retirement, dismissal and technical changes. As with all other assets, human resources shall not be registered in the balance sheet at a value that surpasses the amount it can attain by being used.

I believe I clarified my point of view regarding the capitalization of the most significant asset in our organizations. I will not talk about other accounting issues relating to the measurement of costs and expenses, but will leave these topics for an accounting conference to be held by our organization in collaboration with the Arab Society of Certified Accountants and the participation of specialized Arab and international bodies.

Finally, I would like to tell you about three services our organization provides to assist in HR development at other institutions.

First, through what is known as Abu-Ghazaleh Professional Recruitment, we help other establishments that search for highly competent professionals, and also assist professionals searching for positions in middle and upper management. This service saves a lot of time and resources for organizations that do not have an HR administration specific to it because our consultants undertake this role on their behalf since we are experts in selecting the required competences for the suitable jobs.

The second service is presented by the consultations sector that includes HR experts. The specialized consultants in this field design administrative structures, prepare the job description and conduct other related services. Abu-Ghazaleh Professional Recruitment completes the task of the consultations sector by finding capabilities for appropriate positions.

As for the third service, it is offered by Abu-Ghazaleh Professional Training, which is concerned with capacity-building and the provision of diversified professional training programs. These programs can be designed to be internal training programs that serve the specific interests of our clients or can be open for participation by different establishments. We strongly believe in continuous professional educational and updating the knowledge of professionals. As such, we present programs in various fields and at numerous levels in accordance with the needs of our clients. Some of our courses are dedicated to updating knowledge in financial and accounting topics, while others aim to train executive employees in business organizations to prepare business plans. We also offer courses for every area in between. I’m happy to inform you that our training sector has become a part of the Talal Abu-Ghazaleh College of Business which has been recently created as part of the German-Jordanian University. We now have the largest professional training centre at this college at the level of the Arab world.

It has been a joy to talk to you, and I wish you abundant success.