Preface

Accounting is the language of business. Human resource (HR) management deals with the major asset of a business: the employee. Therefore, when dealing with employee issues, shouldn’t HR professionals use the language of business? Shouldn’t a connection exist between these important dimensions? Yet, as often noted by various people, HR management and accounting (finance also) come from different planets. This disconnect was discussed in an article published in the WorldatWork journal¹ a few years ago, “Finance Is from Mars, Human Resources Is from Venus,” by Wade Lindenberger, CPA, and Kayoko Lindenberger, CBP, Employee Benefits Training and Solutions. But both of these planets are from the same solar system, and commonsense logic suggests that both should be connected by the same force field.²

¹ WorldatWork is a premier association, globally, for compensation and benefits professionals.

² Lindenberger, W., and K. Lindenberger, “Finance Is from Mars, Human Resources Is from Venus,” Workspan, The Magazine of WorldatWork, January 2009, pp. 41–44.

So, why are they not connected? What are the main disconnects? What are the reasons for this disconnect? Why does the chasm exist? Why the gaps? What can be done to strengthen the links? What are the knowledge and skill gaps? What specific knowledge areas need to be addressed?

This book seeks to answer these questions, discussing in detail the specific connection points between accounting and finance and HR management.

Throughout this book, accounting and finance are combined into one discipline, although they are not necessarily the same. Simply stated, accounting people are record keepers, and finance people are the analyzers. However, both group’s core foundations are the numbers of the organization. Both groups have to be proficient in the language of business: accounting. Accountants keep the records of the numbers and are responsible for reporting those numbers using the guidelines and rules laid out for them by the rule-setting bodies (GAAP, IFRS, SEC, AICPA,³ and others). Finance people are analyzers and interpreters of the record. Therefore, a case can clearly be made that accountants and finance people are from the same planet, whereas HR professionals are from a different planet. The goal in this book is to bring these two force fields closer together by imparting to the HR community the finance and accounting skills needed (in a comprehensive manner) to talk the language of business. But why are these groups so far apart? After all, HR professionals also have to talk the language of business if they want to make strategic business decisions.

³ GAAP (Generally Accepted Accounting Principles), IFRS (International Financial Reporting Standards), SEC (Securities and Exchange Commission), AICPA (American Institute of Certified Public Accountants).

HR management as a function started off in the enlightened period of management, when employee productivity enhanced through improvement in morale, motivation, and commitment. During this period, work behavior started to be considered an important element in overall organizational success. The origins were in Western Electric via the Hawthorne studies. For the first time, studies showed that management had to pay attention to the welfare of employees if they were to achieve organizational success. From those early days, management got a new focus: employee relations. Management hired people to help them with employee welfare. These early employee welfare professionals were usually called employee relation specialists. Specialist here was a stretch. These early staffers were mostly administrators helping managers with the tasks associated with employee welfare. But, then workers started seeing that they could raise their bargaining power with their employers if they joined forces to form unions. Managers started seeing that they needed staffers to help them handle union-related issues, and thus came the advent of labor relation specialists.

Along with the growth in labor relation professionals, organizations during this period saw the growth of personnel administrators. Managers hired personnel administrators to assist them with employee management responsibilities. And so grew the functional specialties of personnel management: recruitment, wage and salary administration, policies and procedures, training and labor relations.

After Douglas McGregor’s bestselling book The Human Side of the Enterprise started gaining traction, the personnel department was renamed to HR management. The idea was to bring in more consideration to the human side of an organization. Therefore, managers hired and sought the guidance of “people specialists”: the HR professional.

HR people would be “people persons” (touch-feely or soft-skill experts). They would be guardians of the people side of the business. They would be advocates to management for the employee’s view of things and simultaneously represent to employees the management view of things. But the HR functions would continue to be responsible for helping managers with the day-to-day employee management issues, such as recruiting, compensation, benefits, training, development, and employee relations.

The skills and knowledge HR professionals needed to have to do their jobs effectively remained uncertain, and still does. Senior managers decided that HR professionals mainly needed people skills or soft skills. However, what were really the required core competencies vital for the HR professional? The answer was not clear and remains unclear still today.

During the past 20 years, attempts have been made to define HR core competencies. David Ulrich’s landmark book is a case in point, Human Resource Champions.⁴ Over the past 50 years, whether you are an internal HR staff member or an outside HR consultant or even an HR professor, it can safely be said that there still remains uncertainty as to what knowledge, skill, and core competencies are needed for the HR professional. Also, we remain unsure as to whether HR management is indeed even a profession.

⁴ Ulrich, D. Human Resource Champions: The Next Agenda for Adding Value and Delivering Results, Harvard Business School Press, 1997.

Let’s look at what the criteria are for a particular occupation to be regarded as a profession. For a class of activities to be considered a profession, the class jointly should have the following characteristics, among others:

• The public must recognize the occupation as a profession.

• There needs to be a central regulatory body.

• There needs to be a code of conduct.

• There has to be a careful management of knowledge.

• The activities the profession engages in should satisfy an essential societal need.

• There must be an official recognition of professional status by the government.

• There needs to be standards of competence.

From further analysis, consider these two intriguing characteristics:⁵

⁵ Adapted from a post written by R.J. Kizik, found at www.adprima.com/profession.htm.

• “A profession is based on one or more undergirding disciplines from which it builds its own applied knowledge and skills.”

• “Preparation for and induction into the profession are provided through a protracted academic program, usually in a professional school on a college or university campus.” This should be accentuated with rigorous testing and examination. Based on these criteria, many organizational activities certainly cannot be considered a profession.

Over time, things have changed. Indeed, the times are still changing. Now organizations all over the world are in a period of turmoil. Some call it creative destruction. Pressures have increased to create efficiencies, to reduce expenses, to manage costs, to stay focused on business strategies, to improve financial performance. This is the era of the “lean mean fighting machine.” Intense global competition, scarcity of resources, dried-up funding sources—all represent real organizational success impediments. In most organizations, labor costs are typically the largest cost component.

Over the past few decades, there has been a great deal of talk about the fact that HR professionals need to become a strategic business partner. But this has not become reality. More so than ever, it is now imperative that HR professionals understand and participate directly in the strategic initiatives of their organizations. HR has to move from a counseling role to a more primary role. Now financial realities exert relentless pressures. Customers are more demanding, and there is incessant pressure to reduce costs. Cost-effectiveness, conserving resources, and regulatory pressures have great impact on business operations. Turnover of critical talent remains a major concern. Globalization requires human resources to think and act globally. Now more so than ever, overhead departments are being asked to justify monies being spent for those departments. These departments are being asked to justify their value add. Foremost under this scrutiny is the HR function. The perception is that in the HR department a bunch of people sit around and do things that the senior management cannot clearly understand; that is, the “line of sight” is unclear between expenses made for this department and their staffs and the organization’s overall financial success. Senior managers are asking tough questions: Why are we doing this and that in the HR department? Can we outsource these activities and save money? Why do we need to staff this department with so many people? Are the large salaries being paid to these HR folks really worth it? Are they doing us any good? Can we do without them? Many business leaders wonder whether they even need HR departments. And so, HR departments are being asked to justify their activities using the language of business: accounting and finance. An interesting article appeared on this subject in the Fast Company magazine in August 2005 titled, “Why We Hate HR.” This article looks critically at the role of HR departments⁶ and stirred up a lot discussion and debate when it came out.

⁶ “Why We Hate HR,” by Fast Company staff, August 1, 2005.

Here is the dilemma: HR professionals realize that their survival depends on “coming to the table” (that is, being business savvy). It also means directly tying in HR activities with business strategies in the long term. At the same time, it also means tying these activities and their associated expenditures with the short-term bottom line. The dilemma occurs when we realize the current HR professional has come to this line of work from a whole host of different backgrounds. There are no common threads of knowledge, know-how, and skills in the current repertoire of the HR professional. This is not true with the accounting or finance professional. To work in their fields, accounting and finance professionals must have professional qualifications (CPA/CMA, BA/MA in accounting, MBA in finance, and so on). If they do not possess these qualifications they would have to secure professional credentials from a recognized credentialing body. This focused qualification credentialing does not exist in a comprehensive manner for the HR professional.

The various professional HR associations have started credentialing efforts, but these efforts remain voluntary. The WorldatWork organization has successful credentialing programs for the compensation and benefits professional (for example, Certified Compensation Professional [CCP] and Certified Benefits Professional [CBP]). In addition, there are no specific college degree requirements for working in the HR department. People working in HR departments have college degrees starting from theater arts to advanced graduate degrees in electrical engineering. Also, many successful HR folks have no college degrees whatsoever.

The orientations of the HR departments vary from organization to organization. No common threads can be discerned. As evidence of this, consider the mind-numbing plethora of terms and expressions that HR departments use: talent management, succession planning, organizational development, performance management, rewards management, work-life balance, total rewards, onboarding, downsizing, delayering, resizing, competency framework, internal consulting, assessment centers, and what not. No wonder HR consulting remains a growth industry. This is not true in accounting and finance departments. Every accounting department has to keep the books, develop and report financial information via standard financial statements, and follow the standards developed by standard setting bodies (such as the Federal Accounting Standards Board and the Securities and Exchange Commission in the USA). Every finance department has to analyze financial conditions using these standard rules and standards.

So, here we are: The HR professional is being required to talk the language of business, but the HR professional does not necessarily know the language of accounting and finance. Many organizations have efforts underway to develop the accounting and finance skills of HR professionals. In a January 2009 article in the Workspan magazine of the WorldatWork,⁷ authors Wade Lindenberger, CPA, and Kayoko Lindenberger, CBP, talk about American Express Company’s mandatory effort through a training program to develop the “financial acumen of our HR professionals.”

⁷ Lindenberger, W., and K. Lindenberger, “Finance Is from Mars, Human Resources Is from Venus,” Workspan: The Magazine of WorldatWork, January 2009, pp. 41-44.

But we think this knowledge gap is huge. WorldatWork in its credentialing education courses does have a course titled “Accounting and Finance for the Human Resource Professional.” But this general course covers subjects in a broad manner without going into the specifics and details of the connections between HR management topics and accounting and finance. This book is designed to fill this gap.

The HR department has many functions, including recruitment, compensation and benefits, and training. Among them, compensation and benefits is the most technical, requiring hard skills. This is because this function involves dealing with numbers. The activities involved in compensation and benefits are therefore the most affected by accounting and finance implications.

Also compensation and benefit expenses are often the largest individual line item expense in any organizational setting.⁸ Relevant data shows that total compensation expenses in organizations fall within 20% to 60% of gross revenue. In the service sector, this percentage is in the 50% to 60% range. If one considers salaries as a percentage of operating expense, the range can be from 15% to 50%. Data from the Bureau of Labor Statistics in 2008 suggests that in the healthcare industry the salaries to operating expenses ratio was as high as 52%. In for-profit service organizations, the ratio was 50%. In durable goods manufacturing, construction/mining, and oil/gas, the ratio was 22%. And in the retail sector, the salaries to operating expenses ratio was as low as 18%.

⁸ In fact, in the national economy, wages represent nearly three quarters of total costs.

Compensation and benefits is the largest expense item for any organization. Therefore, there is a need to clearly understand and articulate the links between compensation and benefits and accounting (finance). It also suggests a need for a closer alignment of accounting (finance) with the activities of compensation and benefits.

Note, as well, that many financial problems can be explained by compensation systems or by the specifics of the tax code. When one cannot explain a firm’s behavior with economic logic, the real answer may often lie in compensation systems. We will explore these connections in more detail throughout the book.

This book’s main objective is to fully examine the connection between compensation and benefits and accounting (finance). This book explores various aspects of accounting and finance as they relate to compensation and benefit analysis.

HR-related accounting and finance implications are usually captured in accounting and finance texts in an unconnected manner. In contrast, this book brings into focus in one single publication all of these compensation and benefit and accounting (finance) topics, discussing the major compensation and benefit subfunctions one by one. Within each subtopic, you learn the relevant accounting and finance implications.

Throughout this book, the compensation and benefit topics that have major accounting (finance) implications are discussed. Each chapter deals with a specific compensation and benefit topic, with no particular connective flow between the chapters. A lot of topics covered came from the author’s college lectures teaching accounting and finance and from compensation and benefit courses.

In recent years, there has been a transformation from independent applications of various compensation and benefits elements. Now organizations focus on the total compensation system to manage total compensation costs and to educate employees on the true costs of their total compensation package. A new term has been used recently: total rewards. Total rewards nomenclature is just a different way of referring to total compensation. Keeping this total compensation focus in mind, this book covers the major elements and program costs wherever necessary.

Before going into the detailed analytical connections between compensation and benefits and accounting (finance), it is important to understand the basics. So, defining terminology is an important first step. The basic framework for the connection that currently exists between the functions also needs to be understood. The first chapter lays the foundation before detailed analytical connections are explored.

When talking about compensation and benefits, you must consider that a total compensation program consists of various elements. Normally, a total compensation structure includes the following elements:

• Base

• Cash incentives or bonuses

• Equity compensation

• Cash-based long-term incentives

• Executive compensation

• Sales compensation

• Expatriate compensation

• Risk benefits

• Retirement benefits

• Perquisites

• Other Benefits

This book analyzes the accounting and finance implications for most of the elements of a total compensation structure. Note here that some of the compensation and benefit topics are more influenced by accounting and finance know-how than others. So, in this book, the topics that have more of an accounting and finance angle are covered in more detail. A good example of this is employee share plans and pension accounting; these topics are covered in longer chapters.

Part I of this book discusses terms and key concepts to lay a conceptual framework for the book.

• Chapter 1, “Introduction: Setting the Stage, covers the foundations of the total compensation system. Terms are defined, concepts are explained, and connections to finance and accounting are established.

• Chapter 2, “Business, Financial, and Human Resource Planning,” presents the connection between business/financial planning and compensation and benefit planning. Assuming that compensation and benefit expenses are indeed the highest expense category of any organization, Chapter 2 emphasizes the importance and explains the connections between the two critical planning processes.

• Chapter 3, “Projecting Compensation Costs,” introduces a financial projection model for forecasting fixed compensation costs. Again, the fixed element or the base salary of the compensation package can be the highest cost element in any organization. So, this discussion recognizes its importance by explaining a detailed cost forecasting model and process.

• Chapter 4, “Incentive Compensation,” deals with one of the most important elements of the total compensation package: incentive compensation. In an era of limited resources and cost reduction, incentive compensation has become important. A concept called pay at risk is being discussed a lot. This concept suggests reducing the fixed or base component of the pay package below the market average and then increasing the incentive component. The goal being the total cash compensation (base plus incentive) will be targeted much above the average in the market. If the financial goals of the company are met or exceeded, the employee’s total compensation will be above the market averages. The financial and accounting dimensions of incentive compensation are explained. Some financially rigorous metrics to be used as the triggering mechanisms for incentive and compensation programs are introduced. These concepts are economic value added, free cash flow, and residual income.

• Chapter 5, “Share-Based Compensation Plans,” discusses all the accounting and finance issues for share-based compensation plans. This area of a total compensation system has many finance and accounting implications, and therefore the discussions in this chapter are quite extensive.

• Chapter 6, “International and Expatriate Compensation,” covers all the finance and accounting dimensions of international compensation programs. This chapter focuses especially on expatriate compensation, which has many finance and accounting nuances.

• Chapter 7, “Sales Compensation Accounting,” provides a detailed analysis of the various accounting and finance issues that impact the effective development, design, and administration of sales compensation programs. Sales commission plan administration accounting is covered. This chapter briefly looks at the software packages available for administering sales commission plans.

• Chapter 8, “Employee Benefit Accounting,” discusses the accounting and finance issues impacting employee benefit programs. The accounting standards framework for employee benefit plan accounting is also discussed.⁹

⁹ Financial reporting standards under U.S. Generally Accepted Accounting Principles (GAPP) and the International Financial Accounting Standards (IFRS) are covered.

• Chapter 9, “Healthcare Benefits Cost Management,” covers employee healthcare benefits and costing. Because healthcare benefits cost is the compensation cost component with the highest inflation, this whole chapter is devoted to employee healthcare benefit cost containment. This topic is a hot-button issue in many contemporary debates and discussions.

• Chapter 10, “The Accounting and Financing of Retirement Plans,” covers retirement program financing and accounting in its entirety and discusses defined contribution and benefit plans in detail. This is another area of a total compensation system dominated by accounting and finance implications, so we devote a great deal of attention to thoroughly discussing all of these implications. After studying this chapter, you can appreciate all the finance and accounting nuances of defined benefit retirement programs

Part II of the book looks at various nontraditional concepts with regard to finance and accounting implications for global HR management. Key here are discussions about changing the accounting and finance paradigm and considering HR investments, a financial asset, that can be capitalized (rather than completely expensed as a period expense¹⁰).

¹⁰ Human asset contribution to organizational value generation increases over time.

Recently, human capital has been a widely discussed concept. Such an expression implies that the human assets of a company are capital assets, assets that generate value to an organization for a longer time period than just a single year. However, current accounting practice expenses these investments in the period in which they occur. Researchers have suggested that this is a flawed assumption. HR expenditures, they say, are investments, just like other intangible assets, whose value is derived over a period of time. The basis of this argument lies as the foundation of the concepts covered in Part II:

• Chapter 11, “Human Resource Analytics,” discusses the concept of HR measurements or HR effectiveness measures. In keeping with senior management’s demands to justify the business value, the use of appropriate effectiveness measures becomes very important. This chapter examines the various appropriate HR effectiveness measures.

• Chapter 12, “Human Resource Accounting,” covers the paradigm-shifting concept of HR accounting. Although this concept has been around for a while, the accounting profession has not yet endorsed it. Nevertheless, this chapter analyzes HR accounting methodologies and discusses their pros and cons.

Accounting standards are referred to quite often in this book. Currently in the United States, the governing standards are referred to as the Generally Accepted Accounting Principles (GAAP).¹¹ In the global environment, the governing standard is the International Accounting Financial Standards (IFRS). The movement to converge these standards into one is well on its way. With the advent of the global economy and preponderance of multinationals, the accounting profession realizes that it does not make sense to operate within a dual standard framework: U.S. GAAP + IFRS. Therefore, an effort is ongoing to converge the standards. A roadmap has been laid, and a transition plan has been implemented. Therefore, both these standards are discussed, when relevant, throughout this book.

¹¹ These standards are developed and promulgated in the United States by the Financial Accounting Standards Board (FASB).

Although this book is U.S. centric, it also has wide coverage of accounting and finance issues with implications for global HR management.

Finally, note that the tax accounting implications for global HR systems are discussed wherever appropriate in each chapter. If you want to learn more about relevant tax issues, refer to legal and tax publications.