Lev & Schwartz Model

Lev and Schw artz’s model is based on human capital theory. which recognizes

human capital as one of several forms of holding wealth for a business enterprise,

such as money, securities and physical capital. In this model of accounting, human

capital is treated like other forms of earning assets and thus is an important factor

explaining

and predicting the future economic growth of the company.

Lev and Schwartz (1971) proposed an economic valuation of employees based on

the

present value of future earnings

probability of employees’ death/separation/retirement

This method helps in determining what an employee’s future contribution is worth

today.

According to this model, the value of human capital embodied in a person who is ‘y’

years old, is the present value of his/her future earnings from employment and can

be calculated by using the following formula:

E(Vy) = Σ Py(t+1) Σ I(T)/(I+R)t-y

Where:

E (Vy) = expected value of a ‘y’ year old person’s human capital

T = the person’s retirement age

Py (t) = probability of the person leaving the organisation

I(t) = expected earnings of the person in period

r = discount rate

The basic theme of Lev, Schwartz model is to compute the present value of the future direct and indirect payments to their employees as a measure of their human

resource value. While doing so, the common assumptions set by the Indian

companies are the pattern of employee compensation, normal career growth, and

weightage for efficiency. Moreover, companies adapt this model to their practical

requirements by making necessary alterations. For instance, different organisations

use different discount rates for ascertaining the present value of future cash flows.

HRA IN INFOSYS

In the financial year 1995-96, Infosys Technologies (Infosys) became the first software company to value its human resources in India. The company used the Lev & Schwartz Model and valued its human resources assets at Rs 1.86 billion. Infosys had always given utmost importance to the role of employees in contributing to the company's success. Analysts felt that human resources accounting (HRA) was a step further in Infosys' focus on its employees. Narayana Murthy (Murthy), the then chairman and managing director of Infosys, said: "Comparing this figure over the years will tell us whether the value of our human resources is appreciating or not. For a knowledge intensive company like ours, that is vital information."

Infosys used the Lev and Schwartzmethod to value Human Resource

According to this model the present value of future earning capacity of anemployee, from the time of joining the organization till retirement was estimated.Infosys used this model based on the following assumption

•An employee’s salary package included all benefits, whether direct orotherwise, earned both in India and in a foreign Nation.

•The additional earnings on the basis of age group were also taken into account.

The method is as follows.

•All the employees of Infosys were divided into five groups, based on theiraverage age .Each group’s average compensation was calculated.

•Infosys also calculated the compensation of each employee at retirement byusing an average rate of increment.

•The increments were based on industry standards, and the employee’sperformance and productivity.

•Finally the total compensation of each group was calculated. This value wasdiscounted at the rate percent per annum which was the cost of capital atInfosys to arrive at the total human resources of Infosys.

Benefit experienced By Infosys by valuing its human resources.

1)Infosys could determine whether its human asset was appreciating overthe years or not. This information was important for the company as itssuccess depended solely on the knowledge of the employees.

2)The company could also use this information internally to compare theperformance and productivity of employees in various departments.

3)HRA also helped Infosys to decide the compensation of employees. Thecompany ensured that it compensated each employee according to his /her net worth.

4)HRA also helped Infosys in indentifying and retaining valuable employees.

5)It helped organization to take managerial decisions based on theavailability and the necessity of human resources.

6)When human resources gets quantified it gave Infosys investors and other clients true insights into the organization and its future potential. It restored faith amongst shareholders.

7)BY adopting HRS the following information could be obtained

•Cost per employee

•Human capital investment ratio

•The amount of wealth created by each employee

•The profit created by each employee.

•The ratio of salary paid to the total revenue generated.

To sum up HRA in Infosys helped in identifying the right person for the right job,

based on theperson’s specialized skills, knowledge, capabilities experience, etc.

Disadvantages for the evaluation of human capital.

1) Companies use various HRA models and comparing two companies using two

different models was difficult.

2)Companies could also misuse HRA to enhance their image .A company coulduse this image to prop up its image in the investors mind, and changeassumption to keep the values positive.

3)There could be a concern of the creditability of the numbers reported

4)The model was based on assumptions and was subjective. Hence figures

could be totally ambiguous.

5)Some employees may be underestimated since a numeric figure did not clearly

quantify whattheir true capabilities are