What are Replacement Cost Approach and its Limitations?
Human resources of an organization are to be valued on the assumption that a new similar organization has to be created from scratch and what would be the cost to the firm if the existing resources were required to be replaced with other persons of equivalent talents and experience. It takes into consideration all cost involved in recruiting, hiring, training and developing the replacement to the present level of proficiency and familiarity with the organization. This approach is more realistic as it incorporates the current value of company’s human resources in its financial statements prepared at the end of the year. It is more representative and logical.
But it suffers from the following limitations:
- This method is at variance with the conventional accounting practice of valuing assets.
- There may be no similar replacement for a similar certain existing asset. It is really difficult to find identical replacement of the existing human resource in actual practice.
- The determination of a replacement value is affected by the subjective considerations to a marked extent and therefore, the value is likely to differ from man to man.