What are the Methods of Valuation of Expense Center Group?
Flamholtz proposes three methods for valuation of expense center groups. In all these measures, the surrogate value is used for estimation. The three methods are:
- Capitalization of Compensation.
- Replacement Cost Valuation.
- Original Cost Valuation.
Capitalization of Compensation:
Capitalization is the addition to the balance sheet as an asset of an amount that could otherwise have been treated as an expense. The term ‘capitalization’ is used only in relation to companies and not in respect of partnership firms or sole proprietorships. It is distinguished from capital which represents total investment or resources of a company. This method involve capitalizing a person’s salary and using it as a surrogate measure of human value. This value may be ascertained for groups as well as individuals. The value of the group is essentially the aggregate value of the individuals compromising the group.
Replacement Cost Valuation:
This is the measure of the cost to replace a firm’s existing human resources. This method has the advantages of adjusting the human value of price trends in the economy. It means the cost to replace the property on the same premises with other property of comparable material and quality used for the same purpose. This applies unless the limit of insurance or the cost actually spent to repair or replace the damaged property is less.
Original cost valuation:
Original cost (also called historic cost accounting or HCA) values assets based on what the company actually spent for the assets when they were acquired.
Original cost valuation has the advantages of:
- Being objective because the values are tied to financial records of actual transactions.
- Creating a match between the money that investors have provided and the money they get back.
Original cost valuation has the disadvantages of:
- Being difficult to implement where accounting records are poor.
- Understating the economic value of assets during times of high inflation.