14 HR Accounting, HR Audit and Knowledge Management: Measurement of Human Capital, HR Audit Approaches, and Tacit-Explicit Knowledge in Organisations

14.1 Putting Numbers and Discipline on People

If people are the most valuable resource, then they should be measured, audited and leveraged like any other strategic asset. HR accounting translates the human resource into financial figures. HR audit examines whether HR policies and practices are working as designed. Knowledge management ensures that what people know — and what they collectively learn — does not walk out the door at five o’clock or on retirement day.

14.2 A · HR Accounting

14.2.1 Concept

Human Resource Accounting (HRA) is the process of identifying, measuring and reporting information about human resources — their costs and value — and communicating this information to interested parties. The American Accounting Association’s Committee (1973) called it “the process of identifying and measuring data about human resources and communicating this information to interested parties.”

14.2.2 Why HRA Matters

Treats employees as assets, not only as expenses.
Helps decisions on recruitment, training, retention.
Useful for merger and acquisition valuation.
Improves accuracy of balance sheets.
Strengthens the strategic positioning of HR.

14.2.3 Two Major Approaches

Cost-Based vs Value-Based HRA

Approach	Logic	Sub-methods
Cost-based	What did it cost to acquire / develop the human resource?	Historical cost, Replacement cost, Opportunity cost, Standard cost
Value-based	What is the present value of the contribution the human resource will make?	Lev-Schwartz present value, Flamholtz stochastic rewards, Hermanson’s unpurchased goodwill, Likert-Bowers value model

14.2.4 Key Cost Methods

Cost-Based Methods

Method	What it captures	Pioneer
Historical cost	Actual cost of recruitment, hiring, training, development capitalised and amortised	R. Lee Brummet, William Pyle, Eric Flamholtz (R. G. Barber Co., 1968)
Replacement cost	Cost of replacing existing employees today	Eric Flamholtz
Opportunity cost	Value of the best alternative use of the employee	Hekimian and Jones
Standard cost	Standardised cost per grade × number of employees	David Watson

14.2.5 Key Value Methods

Value-Based Methods

Method	What it captures	Pioneer
Present-value of future earnings	Discounted lifetime earnings	Baruch Lev & Aba Schwartz (1971)
Stochastic rewards valuation	Probability-weighted value of expected services	Eric Flamholtz
Unpurchased goodwill	Excess earnings attributed to people	Roger Hermanson
Likert-Bowers	Causal-intervening-end-result model of organisational climate-to-performance	Rensis Likert & David Bowers

PYQ anchor — Lev-Schwartz model

The Lev-Schwartz (1971) present-value model is the most-tested value-based HRA method. It discounts the employee’s future earnings until retirement to present value at a risk-adjusted rate.

14.2.6 Indian Pioneers in HRA

BHEL, SAIL, MMTC, Cement Corporation of India, NTPC and ITC Bhadrachalam were among the first Indian organisations to publish HR accounting statements in annual reports — using primarily the Lev-Schwartz model.

14.3 B · HR Audit

14.3.1 What is HR Audit?

HR audit is the systematic, formal review of HR policies, practices, procedures, documents, strategies and outcomes — to assess effectiveness, compliance and alignment with business strategy.

14.3.2 Five Approaches

Five Approaches to HR Audit

Approach	What it does
Comparative approach	Benchmarks against another firm or industry standard
Outside authority approach	External consultant uses pre-defined model
Statistical approach	Generates HR metrics from the firm’s own data
Compliance approach	Reviews adherence to labour laws and internal policies
MBO approach	Audits against pre-set HR objectives

14.3.3 Methods of HR Audit

Document review.
Structured interviews with line managers and HR.
Employee questionnaires and climate surveys.
Observation of practices.
Statistical analysis of HR metrics.
Workshops with focus groups.

14.3.4 Five Sequential Steps

HR Audit Process

#	Step
1	Determine scope and objectives
2	Develop the audit plan
3	Collect data through review, survey, interview, observation
4	Analyse and benchmark
5	Report findings, recommend corrective action, follow up

14.3.5 Areas Typically Audited

Recruitment and selection effectiveness.
Training and development outcomes.
Performance management system.
Compensation and benefits design.
Industrial relations and grievance handling.
HR information systems and analytics.
Statutory compliance — PF, ESI, gratuity, minimum wages, contract labour.
HR strategy alignment with business strategy.

14.4 C · Knowledge Management

14.4.1 Concept

Knowledge Management (KM) is the systematic process of identifying, capturing, organising, sharing and applying an organisation’s knowledge assets so they remain available and usable across people, time and space.

14.4.2 Data → Information → Knowledge → Wisdom (DIKW Pyramid)

DIKW Pyramid

Level	What it is
Data	Raw facts, signals
Information	Data with context
Knowledge	Information with experience and judgement
Wisdom	Knowledge with insight into when and why to use it

14.4.3 Two Types of Knowledge — Polanyi / Nonaka

Explicit vs Tacit Knowledge

Type	What it is	How it transfers
Explicit	Codified — manuals, formulas, documents	Easily transferred and stored
Tacit	Embedded in experience, intuition, judgement	Transferred through observation, mentoring, socialisation

PYQ anchor — Polanyi distinguishes tacit from explicit

The tacit / explicit distinction comes from philosopher Michael Polanyi (1958, 1966) — “We know more than we can tell.”

14.4.4 Nonaka and Takeuchi’s SECI Model (1995)

The SECI model explains how organisational knowledge is created through four modes of conversion.

Nonaka-Takeuchi SECI Model

Mode	From → To	Example
Socialisation	Tacit → Tacit	Apprenticeship, on-the-job observation
Externalisation	Tacit → Explicit	Articulating intuition into a written best-practice
Combination	Explicit → Explicit	Combining manuals into a new document
Internalisation	Explicit → Tacit	Learning by doing; the manual becomes second nature

flowchart LR
  S[Socialisation<br/>Tacit→Tacit] --> E[Externalisation<br/>Tacit→Explicit]
  E --> C[Combination<br/>Explicit→Explicit]
  C --> I[Internalisation<br/>Explicit→Tacit]
  I -. spiral .-> S
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

14.4.5 “Ba” — Shared Context for Knowledge Creation

Nonaka and Konno later introduced Ba — the shared context (physical, virtual, mental) in which knowledge is created and shared. Four types correspond to the four SECI modes: originating, dialoguing, systemising, exercising.

14.4.6 Knowledge Management Strategies

Two Generic KM Strategies (Hansen, Nohria & Tierney, 1999)

Strategy	Logic	Typical user
Codification	Capture knowledge in documents, databases — people-to-document	Andersen Consulting, EY
Personalisation	Connect people who hold tacit knowledge — person-to-person	McKinsey, Bain

14.4.7 KM Enablers

Top-management sponsorship.
Culture of sharing — not knowledge hoarding.
Information technology — intranets, search, collaboration platforms.
Reward systems aligned with sharing.
Communities of practice.
Capturing knowledge from exiting employees.

14.4.8 Senge’s Learning Organisation

Peter Senge in The Fifth Discipline (1990) describes the learning organisation as one continually expanding its capacity to create its future, mastering five disciplines:

Senge’s Five Disciplines

#	Discipline
1	Personal mastery
2	Mental models
3	Shared vision
4	Team learning
5	Systems thinking (the fifth discipline)

PYQ trap — Systems thinking is the FIFTH discipline

Senge’s title The Fifth Discipline refers to systems thinking — the integrating discipline.

14.5 Practice Questions

Q 01 HRA approach Medium

Which is not a cost-based HRA method?

AHistorical cost
BReplacement cost
COpportunity cost
DPresent value of future earnings

View solution

Correct Option: D

Present value of future earnings is value-based; the other three are cost-based.

Q 02 Lev-Schwartz Hard

The Lev-Schwartz HRA model uses:

AHistorical training cost
BDiscounted future earnings until retirement
CReplacement cost of employees
DOpportunity cost

View solution

Correct Option: B

Lev-Schwartz (1971) — discounted future earnings.

Q 03 Indian HRA pioneer Medium

Among Indian organisations, an early adopter of HRA was:

ABHEL
BReliance Industries
CHUL
DWipro

View solution

Correct Option: A

BHEL, SAIL, NTPC and others among Indian HRA pioneers.

Q 04 HR audit approach Medium

An HR audit done by an external consultant using a pre-defined model is the:

AComparative approach
BOutside authority approach
CStatistical approach
DMBO approach

View solution

Correct Option: B

Outside authority approach.

Q 05 DIKW Easy

In the DIKW pyramid, "knowledge" sits between:

AData and information
BInformation and wisdom
CWisdom and intelligence
DIntelligence and decision

View solution

Correct Option: B

Data → Information → Knowledge → Wisdom.

Q 06 Tacit knowledge Medium

The tacit-vs-explicit knowledge distinction originated with:

ANonaka and Takeuchi
BMichael Polanyi
CPeter Senge
DKarl Weick

View solution

Correct Option: B

Michael Polanyi — "We know more than we can tell."

Q 07 SECI model Hard

In the SECI model, conversion of tacit knowledge into explicit knowledge is:

ASocialisation
BExternalisation
CCombination
DInternalisation

View solution

Correct Option: B

Tacit → Explicit = Externalisation.

Q 08 SECI order Hard

Arrange the SECI modes in correct order:

(i) Combination
(ii) Socialisation
(iii) Internalisation
(iv) Externalisation

A(ii), (iv), (i), (iii)
B(i), (ii), (iii), (iv)
C(iv), (iii), (ii), (i)
D(iii), (i), (iv), (ii)

View solution

Correct Option: A

S → E → C → I — Socialisation, Externalisation, Combination, Internalisation.

Q 09 Senge Medium

In Senge's framework, the "fifth discipline" is:

APersonal mastery
BShared vision
CTeam learning
DSystems thinking

View solution

Correct Option: D

Systems thinking is the integrating discipline.

Q 10 KM strategy Medium

A consulting firm that connects junior consultants with senior partners through expert-finder directories and conversations follows which KM strategy?

ACodification
BPersonalisation
CImitation
DRandom

View solution

Correct Option: B

Personalisation — person-to-person.

Q 11 Flamholtz Hard

The stochastic rewards valuation model of HRA was proposed by:

AEric Flamholtz
BLev and Schwartz
CHermanson
DLikert

View solution

Correct Option: A

Eric Flamholtz.

Q 12 HR audit Easy

HR audit is best described as:

AFinancial audit of payroll only
BSystematic review of HR policies, practices and outcomes
CEmployee opinion survey
DStatutory compliance check only

View solution

Correct Option: B

HR audit is the broad systematic review of HR.

Q 13 Match Hard

Match the contribution with the author:

(i)	Tacit vs explicit knowledge	(a)	Nonaka & Takeuchi
(ii)	SECI model	(b)	Peter Senge
(iii)	Learning organisation	(c)	Lev & Schwartz
(iv)	Present value of future earnings (HRA)	(d)	Michael Polanyi

A(i)-(d), (ii)-(a), (iii)-(b), (iv)-(c)
B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
C(i)-(b), (ii)-(d), (iii)-(a), (iv)-(c)
D(i)-(c), (ii)-(a), (iii)-(d), (iv)-(b)

View solution

Correct Option: A

Polanyi-tacit/explicit; Nonaka-SECI; Senge-learning org; Lev-Schwartz-PV.

Q 14 Ba concept Hard

The "Ba" concept — shared context for knowledge creation — extends the work of:

APolanyi
BNonaka and Konno
CSenge
DFlamholtz

View solution

Correct Option: B

Nonaka and Konno's extension of SECI.

Q 15 Audit area Medium

Which is not typically a focus of HR audit?

ARecruitment and selection
BPerformance management
CExternal market share
DStatutory compliance

View solution

Correct Option: C

Market share is a business-strategy concern outside HR's audit scope.

Q 16 Replacement cost Medium

Replacement-cost HRA measures:

ACost incurred earlier in hiring and training the employee
BCost that would be incurred today to replace the employee
CDiscounted future contribution
DValue of unpurchased goodwill

View solution

Correct Option: B

Replacement cost is today's cost.

Q 17 Knowledge type Easy

A surgeon's intuitive feel for tissue resistance during surgery is best classified as:

AExplicit knowledge
BTacit knowledge
CCodified data
DInformation

View solution

Correct Option: B

Intuition built from experience = tacit.

Q 18 Codification Medium

Hansen, Nohria and Tierney's codification strategy emphasises:

APerson-to-person knowledge sharing
BPeople-to-documents — storing knowledge in repositories
CNo knowledge sharing
DOutsourcing of HR

View solution

Correct Option: B

Codification = people-to-document.

Q 19 Senge disciplines Hard

Which is not a Senge discipline?

APersonal mastery
BMental models
CCharismatic leadership
DShared vision

View solution

Correct Option: C

Five: personal mastery, mental models, shared vision, team learning, systems thinking.

Q 20 Compliance audit Medium

An HR audit focused primarily on adherence to labour laws and policy is the:

AComparative approach
BCompliance approach
CStatistical approach
DOutside authority approach

View solution

Correct Option: B

Compliance approach.

14.6 Quick Recall

Quick recall

HR accounting measures human resources in financial terms — two approaches: cost-based (historical, replacement, opportunity, standard) and value-based (Lev-Schwartz PV, Flamholtz stochastic, Hermanson unpurchased goodwill, Likert-Bowers).
Lev-Schwartz (1971) — present value of discounted future earnings till retirement.
Indian HRA pioneers: BHEL, SAIL, NTPC, MMTC, ITC Bhadrachalam.
HR audit = systematic review of HR policies and practices. Five approaches: comparative, outside authority, statistical, compliance, MBO.
DIKW pyramid: Data → Information → Knowledge → Wisdom.
Polanyi distinguished tacit (experiential, intuitive) from explicit (codified) knowledge.
Nonaka-Takeuchi SECI model: Socialisation (T→T), Externalisation (T→E), Combination (E→E), Internalisation (E→T).
Ba — shared context for knowledge creation (Nonaka & Konno).
Hansen-Nohria-Tierney KM strategies: codification (people-to-document) vs personalisation (person-to-person).
Peter Senge (1990) — The Fifth Discipline. Five disciplines: personal mastery, mental models, shared vision, team learning, systems thinking (the 5th).