For a long time, I have pondered how companies treat their employees. Often, I think to myself that I want to work at a company which treats its employees like valuable assets, instead of just labor costs to be minimized. Well, last week I learned something that just blew me away, and confirmed what I have always thought!
The reason that, when times get hard, the first thing that most companies do is lay off employees, is that GAAP Accounting rules dictate that they do so! I studied accounting at community college when I was first getting into Purchasing, but I don’t remember running across this particular rule. GAAP means “Generally Accepted Accounting Principles”, and it is the Bible of standard accrual accounting that most companies use. Those accounting principles dictate that Employees of a company are treated solely as Labor Costs on the company’s Income Statement, rather that Balance Sheet Assets. I have to acknowledge that I learned this from a (Wall Street) Journal Report on C-Suite Strategies last week. The title of the article is How a Common Accounting Rule Leads to More Layoffs and Less Job Training.
The article lays out the rules, and that for decades auditors and shareholders when they read the companies’ annual reports, have to basically think of employees as not valuable assets which keep the company and the economy running, but simple Labor Costs to be reduced at the first sign of hardship. And yes, laying off people when you can’t afford to pay them might be a short-term way to reduce costs, but when times improve they may be hard to re-hire. Here is the money quote from the article.
There are now proposals before the SEC that would require companies to report simple human-capital measures, such as total spending on labor, not just employees, and spending on training. In theory, companies would no longer have strong incentives to use leased employees, drop accrued benefits and skimp on worker development. Those costs would no longer look like spending on coffee.
Perhaps it’s time for the FASB (Financial Accounting Standards Board) to consider a new measure of Human Capital and not just labor costs.
Calling-all-RushBabes 
Pingback: Instapundit » Blog Archive » SOMETIMES COMPANIES ARE FORCED TO MAKE BAD DECISIONS: It’s the Accounting Rules, Stupid!
So according to this argument, labor would no longer be expensed on an income statment, but capitalized as an asset?
Let’s see, a company has 1 million in sales, 800,000 in labor costs, and 100,000 in other costs giving them net income of 100,000 based on accrual accounting.
Under these new rules, labor would not be expenses on income statement, but instead end up on balance sheet as a fixes asset, giving the company now, 900,000 in net income.
Sounds good on paper, what could go wrong?
No, not necessarily. It would take some study to come up with a better solution. I cannot claim to have any answers!
Assets are things owned. Slaves would be accounted as assets and would be depreciated over working lives.
Expense items are things paid for and used up in the same period. Like hired labor, as you pay for what you use as you use it.
Corporate accounting already has things like “Goodwilll” and “intangible asset”. It sounds like this would be another form of intangible asset for employee training, skills and retention. A cost of replacement or value above average worker or something.
Like Bob the line worker who has been making cars for 30 years and has 0 defects on cars that roll off his line. It should count as a loss of value when the company loses him to layoffs or retirement.
You gotta be careful replacing a peverse incentive to make sure you aren’t creating another.
When your “valuable asset” walks out the door a 5 pm every day, it’s not an asset.
GAAP are part of the rules for reporting to shareholders the financial condition of the firm. To extend GAAP strictures as a method for managing and treating the workforce is to ask GAAP perform a function it is unsuited. This is square peg, round hole territory.
If you sent employees to industry certification trainings with an expiration date, and required them to pay you back an amortized amount if they quit wiithin a stated time, well then you had better start carrying that training as an amortizable intagible, and write off the unamortized amount if you fire them or lay them off.
If you can depreciate them as an asset, perhaps you would think twice about laying them off. I did this post because it made me think in a new way, not to advocate for any particular action. The situation is quite complicated, isn’t it?
There’s no theory in GAAP accounting that would treat an employee other than a cost. It costs dollars (in materials, machinery or labor) or produce a good for sale. If you start treating employees as a capital asset, how could a P&L accurately reflect the revenue from that asset?
I think this really reflects PUBLIC COMPANY behavior that have responsibilities to public marketplace shareholders. Private companies don’t have the same performance needs.
The way to treat employees is through good corporate culture. Good culture will keep valuable employees during tougher times. I happen to work for a firm that spends a ton of money on creating and maintaining a good corporate culture; all of us run through walls for clients because of it.