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LABOR

The Problem with
Accounting for Employees
as Costs Instead of Assets
by Ethan Rouen
OCTOBER 17, 2019

PHIL ASHLEY/GETTY IMAGES

You hear it all the time: companies touting employees as “their most valuable assets.” But under
current accounting standards, that is simply false. By definition, employees are not assets since
companies do not have control over them. Workers must convert raw materials – be they
commodities or blank computer screens – into finished inventory to be paid, but if these workers
want to quit, they can take their skills and training with them.

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The distinction matters because it allows companies to hide behind platitudes and not disclose
whether they invest in their workers in ways that promote long-term success. The current lack of
disclosure related to employment practices prevents policy makers and investors from rewarding or
punishing companies for how they actually treat their employees. Right now, there’s no universally
accepted way to track the management of human capital. We need a new way to account for labor so
that we can track and reward companies for how they actually treat their employees.

U.S. Generally Accepted Accounting Principles (GAAP) is an outdated and inadequate tool for
documenting the behaviors of the modern corporation. Companies report detailed information about
their capital investments but have almost no reporting requirements related to human capital. There
was a time when this practice made sense: Manufacturing was labor intensive, so opening a new
plant or buying a new machine required the hiring of employees to run that machine. The costs and
benefits of a machine are easier to estimate than the costs and benefits of training those employees,
so the machine went on the balance sheet, and the employees’ costs were expensed as incurred. But
automation and a move away from manufacturing have created a disconnect between physical
capital and the need for labor. The economy has grown in ways that leave the current rules behind,
and that is having negative consequences for the employees of these companies.

This lack of reporting on human capital discourages effective investment in workers for at least two
reasons. First, what is not measured cannot be rewarded. Sen. Mark Warner of Virginia summed up
this inadequacy during a recent speech, when he pointed out that government “provides a tax
deduction to the company that replaces a human with a robot, but offers nothing to the company that
trains that worker to remain employable.” Elected leaders who want to improve economies through
increased employment are no longer guaranteed the result they desire when dangling tax breaks for
private investment. This separation of capital from labor also creates frustrations for socially
responsible investors who want to reward companies for taking steps to tackle income inequality
through workforce retraining, or straight fiduciary asset managers whose thesis is that workplace
training will lead firms to outperform their peers.

Second, because of the failure to carefully and systematically document investment in human
capital, there is little evidence that these investments pay off. Managers’ big concern is related to that
definition of an asset. Companies do not own their employees, so training an employee risks making
that employee an attractive target for competitors.

Folk wisdom argues that investing in employees is essentially handing money to one’s competitor,
since employees can leave at any time. The problem with this argument is that there is little evidence
to back it up. It relies on the homo economicus view of the world where employees are mercenaries
just waiting for that better offer.

Anecdotal evidence, though, suggests that the folk wisdom is, at best, partially true. A recent Wall
Street Journal article focused on a KitchenAid plant in Ohio which hires based largely on the
willingness to work and provides six weeks of training to show new hires how to build the company’s

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https://www.wsj.com/articles/a-kitchenaid-recipe-for-a-tight-job-market-11550840415

ubiquitous stand mixer. Other than a willingness to work, “everything else can be taught,” said one
senior employee who started at Whirlpool, KitchenAid’s parent, right out of high school in the 1990s
and has stayed with the company, which has continued to train her and helped her pay for college.
Even large companies are gambling that workforce training can pay off. Starbucks made headlines in
2015 when it announced a program giving all employees the opportunity to earn a bachelor’s degree
for free while working for the company.

Programs like these make for feel-good corporate stories, but it remains to be seen whether they will
have a positive impact on the bottom line through factors like reduced turnover and increased
productivity. Unfortunately, without improved disclosures, we may never know their effects.

That is where legislators, regulators, and managers can come in. Companies provide as much as 10
pages of disclosures every year about the compensation of the executive team, but information about
other employees – who are collectively more costly and more important than the C suite – is
relegated to a brief comment in the 10-K about labor relations and an unseen, but large, component
of operating expenses.

Acknowledging this problematic lack of information, the SEC has begun exploring how companies
can better report human capital. One concern is that measuring human capital requires vague
estimates, but this argument is weak. Companies include depreciation in their financial statements,
which is not only an estimate but also likely a wrong estimate given that there are different
depreciation schedules for financial and tax reporting.

In addition, companies can provide concrete information that would be useful to stakeholders and
easy to provide. Specifically, much like banks already do, all companies could report the total wage
bill of the firm. The total amount spent on wages would provide insights into the efficiency of labor
across firms and turnover across time. Providing information related to the average length of tenure
would be insightful given that hiring is so costly. It could also offer a sense of the culture within the
company, encouraging firms to take steps to ensure that workers stay.

Lastly, companies should report their investment in training just like they do their investment in
capital. Detailed information on how much is spent and which types of employees get training
provide shareholders with a sense of how the company sees the future while further disaggregating
operating costs. A disclosure like this would also encourage firms to invest in their workers and
communicate to shareholders that, while the accountants require that training be reported as an
expense, managers see it as a long-term bet on their most valuable assets. The SEC is already
contemplating how to include human capital disclosures into financial reporting, but companies can
help guide regulators’ decisions, and help their shareholders understand what matters in human
capital, by voluntarily disclosing this information.

Ethan Rouen is an assistant professor in the Accounting and Management unit at Harvard Business School.

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