When times are bad, training budgets are among the first to be slashed. Why is that? Is training not a valued organizational resource? In this essay, I explore one possible reason for training's (mis)treatment at the hands of corporate managers.
Training: Cost or Investment?

Table of Contents

Gus Prestera, March, 2002

Introduction

When an individual starts a new job, there are usually some costs associated with orienting and training that person. Formal training costs can include trainer salaries, training materials, equipment and facility, time spent away from work, travel and lodging, as well as the trainee's incidental expenses. Even if no formal training is provided, the new hire will likely go through a period of inefficiency, and improve as he/she learns on-the-job, which has certain costs associated with it. For example, untrained or poorly trained workers may commit more mistakes, leading to angry customers, and/or wasted materials. They may miss opportunities to make a positive impact, reflecting an opportunity cost (e.g., lost sales). Also, as new hires are learning, other employees have to compensate, for example, by spending more time fixing mistakes than producing output of their own. Generally speaking, training has costs associated with it regardless of how that training takes form. Central to this essay is the question of whether or not those costs should be treated as expenditures or investments, or to use accounting terms, as assets or expenses. My answer, in brief, is yes. I will elaborate and present both sides of the argument.

Why training is an expense

In financial accounting, most financial transactions fall into one of four inter-related categories: asset, liability, revenue, and expense. An asset represents capital owned, things that have been received (e.g., cash, receivables, supplies, equipment) in exchange for cash, merchandise, or payables, while a liability is the opposite of that (representing capital owed). Both are continuous. Revenue represents income earned in a given period only, while expenses are costs incurred during a period for the purpose of generating revenue. Expenses are tax-deductible, while the other three are not. Currently, generally accepted accounting principles (GAAP), the primary standards used in the accounting field, recommend that training costs, and other intangibles like advertising costs and R&D, should be recorded as expenses and reported that way in financial statements. This seems reasonable on the surface, since training is not something that can be liquidated (like most assets) and, like other expenses, represents resources that are consumed in the ordinary course of business (e.g., utilities, rents, salaries, production costs, etc.). On the other hand, the aforementioned intangibles do create a long-term economic benefit (that stretches beyond the boundaries of an accounting period), pay dividends if you will, much the way many assets do (e.g., equipment, machinery, and securities). It is this distinction that makes it difficult to dismiss training, advertising, R&D, and development costs as simply expenses. Their unique, yet intangible, contribution to the overall success of an organization cannot be completely ignored.

Nevertheless, the practice of recording and reporting these intangible assets as expenditures continues. The reason for this stems from both the mission of financial accounting and the bookkeeping systems that exist to support that mission.

Mission. The primary mission of financial accounting is to provide a reliable system of tracking financial information about an organization. Its purpose is not necessarily to provide management with real-time performance indicators. Although managerial accounting procedures - which attempt to transform financial data into more useful forms to facilitate decision-making - typically complement financial ones and both are working with the same basic unit of data (i.e., ledger entries), they represent separate and distinct systems. If ultimately managers are assessed based on bottom line performance (i.e., revenue minus expenses), it is only natural that they will always look to maximize revenue while controlling expenses. It is for this reason that human resource and marketing professionals would prefer not to have their departmental units be considered cost centers. If they were treated as investments, management would be less likely to slash their budgets whenever times are lean and more likely to expand their efforts with capital investments. Nevertheless, the intent of financial accounting is not to establish a value system within an organization… its intent is merely to track financial information reliably. This objective pursuit of system reliability has led to the development of rigid bookkeeping rules and frameworks, which often set accounting practices at odds with the various cost centers in organizations.

System. There are generally two types of accounting methods: cash and accrual. For each method, there are GAAP guidelines designed to maintain internal reliability. Under the accrual method of accounting, the cost of long-term assets such as fixed asset purchases (e.g., a real estate property) and goodwill are recorded as investments (Note: goodwill represents the purchase price of an asset minus its book value). These costs are incurred for items that have a useful life beyond one year, and these assets are then depreciated over their stipulated useful lives. There are inherent difficulties in treating training as an investment in this system. How would one determine the value and useful life of a training asset in order to depreciate it? What is the asset? Is it the sum of all of the (past, present, and future) training costs for the period divided by the number of employees trained? Is it the "intellectual capital," if such a thing can be quantified, or is it the cost of replacing those newly trained employees? If the value is somehow inherent in the individual being trained, consider the variability of employment status. Workers switch jobs frequently (once every three years is a common figure) and are sometimes terminated (perhaps more so in "at will" states)? Would the value of training ebb and fall with the head count? As for calculating useful life, it is possible that some training "assets" would have different useful lives depending on who received the training? These are just some of the sparks that fly from clashing financial accounting methods with this issue.

Intangible assets are difficult for accountants to deal with reliably and conservatively even under good circumstances. They are inherently difficult to quantify in a reliable and valid manner. Goodwill, for example, is a tricky asset for accountants to record. They normally do not record it as an accounting entry until the organization has purchased a high-value asset, say a competing business, and paid a premium for it. That goodwill remains in the company until it is either sold or depreciated down to zero over time. Note that this goodwill value represents what a company was willing to pay for something above and beyond its book value. Why would a firm do that? Organizations pay premiums on assets for a variety of reasons, including brand recognition, patents, expertise, and other intangible benefits. Note that accountants do not determine the value of goodwill. It is determined by the price an organization is willing to pay above and beyond book value, which is a reliable, quantifiable phenomenon. Calculating the value of training, on the other hand, is not.

To summarize, the philosophical foundation of financial accounting places its systems at odds with financial events that cannot be quantified in a way that maintains high reliability and validity. The system is by its nature conservative and so therefore errs on the side of caution with regards to change. Also, the system serves many stakeholders outside of the organization's management, including: domestic and international investors, government agencies, and the general public. Therefore, changing this system, even in a way that improves its effectiveness, can have potentially negative repercussions on a broader scale.

Limitations of this argument. While the mission of financial accounting may be a broad one, geared towards serving a variety of internal and external stakeholders, it does not minimize the need for the accounting department to support management in its decision-making efforts. To this end, more efforts can/should be made to promote managerial accounting systems, which provide metrics that act as performance indicators and facilitate managerial control mechanisms. As to the difficulties of quantifying the value of training, certainly there is an abundance of numerical performance data, such as error rates, productivity rates, dollars per transaction, quality award ratings, and a wide range of other criteria. There is also, in many companies, sufficient existing information to estimate less tangible measures, such as return on training dollars, opportunity cost, intellectual capital, and a variety of other training-related metrics. Metrics, however, do not appear in financial statements and it is unfortunately (or fortunately) the bottom line that often drives decision-making in corporations, not necessarily internal metrics.


Why training is also an investment

Training adds value to the operations of an organization in ways that are difficult to measure with empirical precision. Training is commonly used to promote customer service, goodwill towards the organization, productivity, operating proficiency and efficiency, safety, and awareness of policies (sexual harassment, security, diversity, etc.), which can contribute to increased sales, profitability, and morale as well as reduced turnover, absenteeism, spoilage, and legal claims. The extent of both the effectiveness of training and its relative contribution to organizational performance are still highly unresolved issues. In the marketing and R&D fields, professionals face the same questions. Henry Ford once said something to the effect of: I know that only half of my advertising dollars makes a difference, but I don't know which half. This same sentiment could be expressed about training. Nonetheless, the fact that management professionals ask the question how much does training contribute to organizational performance is an indication in and of itself that training does contribute to it and is more than simply an expense; it can be a long-term investment in organizational performance.

Competitive advantage. Training can, if leveraged properly, create a competitive advantage for an organization. According to Barney (1991) in Wright and McMahan (1992), four criteria must be attributable to a resource in order for it to be considered a sustained competitive advantage:

  1. It must add positive value

  2. It must be unique or rare among current and potential competitors

  3. It must be imperfectly imitable

  4. It cannot be substituted with another resource by competitors (p.301)

Training can be used to cultivate and leverage the localized expertise existing within decentralized organizations to form a culture of learning and performance that is positive, rare, imperfectly imitable, and unsubstitutable. Southwest Airlines is an excellent example. Southwest has been the only major airline that has remained profitable in the moths following the September 11th tragedy, and has even expanded its routes as other carriers close them. While its success is attributable to a variety of factors, its reputation for service and quality has been a critical element in retaining the goodwill of flyers. This goodwill serves as a sustained competitive advantage thanks in large part to Southwest's recruiting and training efforts.

Bottom-line results. Unfortunately, the majority of training programs do not have the organizational impact that those in companies like Southwest Airlines have. While several possible explanations for this exist, including a lack of strategic focus among many training professionals, the categorization of training as an expense should not be underestimated as a contributing factor. As mentioned above, organizational leaders in corporate environments take their cue from financial performance measures, typically those found on financial statements. Why? In many cases, those measures are the most important ones for financial analysts, investors, creditors, and other important stakeholders. Indicators, such as inventory turns, acid ratio, asset utilization, leverage, and a host of others, are based primarily on publicly-available information (i.e., listing information and articles in business journals and the financial statements in the prospectuses).

Internal metrics, such as return on training investments or employee turnover statistics are rarely published and so therefore have little impact on stakeholders. If they have little impact on stakeholders, they are less likely to have an impact on senior management. If they are not considered important by senior managers, they are less likely to be perceived as important within the rest of the organization. While some exceptions certainly exist, the current status of training as a cost center does little for the viability of using training as a strategic asset. Therefore, if training as a tool for creating competitive advantage is to become an important organizational factor, more information about its impact on performance should be made available to stakeholders so that they can truly begin to see training as an investment in long-term success. As stakeholders react to the impact of training (whether good or bad), upper management will take notice and direct more of its attention (positively or negatively) towards training efforts. With that attention typically comes greater expectations, responsibility, political power, and accountability, four critical and yet often lacking elements in the success of training efforts.


Training metrics

So what kind of metrics would stakeholders need in order to make business decisions about the impact of training? There are two types of metrics that I believe are relevant: project-specific and global contributions to performance.

Project-specific metrics. Project-specific metrics would depend somewhat on the type of performance improvement project (i.e., what metric is it trying to improve), but most would include some type of return on investment estimate. Since a major cost variable of training is in salaries (of trainers, designers, trainees, subject-matter experts, and other resources), this would require a system in which workers tracked and coded their working hours by project (the same way in which it is currently done in consulting firms and many other project-based organizations). This can be somewhat chaotic. For example, time cards might need to be approved by managers from multiple projects or departments if a worker is on several project teams at once. In some organizations, time is also coded by the type of work being done (e.g., analysis, design, implementation, etc.). This is a somewhat pedantic, time-consuming procedure that lends itself to errors, yet it may be appropriate in some settings where such data can be used to improve efficiency (e.g., shrinking development cycles or improving the accuracy of budgets).

Global performance metrics. While many training efforts are project-based, some are ongoing and have an incremental impact on organizational performance. In addition, projects can have indirect effects on the overall performance of an organization, beyond the specific metrics they are trying to improve. Therefore, it is important to compare training expenditures with broad organizational health indicators, such as employee turnover, error rates, productivity, spoilage, service ratings, and efficiency measures. In addition, depending on an organization's strategic and tactical goals, training departments may link their performance with the metrics pertaining to those organizational goals as a way of focusing their departments' efforts. If compensation is to be linked to performance measures, and I believe they should be, both global and project-specific metrics should be used.

Why training will remain a cost center

Two separate yet related arguments have been discussed thus far. Should financial accounting modify its mission and practices to enable training and other intangible assets to be recorded and reported as investments instead of expenditures? Secondly, should internal metrics be used to guide and justify the performance of training departments? As for the first question, practically speaking, it would be a monumental task for financial accounting to reconstruct its systems such that training and other intangible assets were recorded and reported as investments instead of expenditures. As discussed, the recording of goodwill transactions is not an everyday event… it normally occurs only in major transactions where an organization pays significantly more for an asset than its book value indicates. Recording of training expenses as asset purchases would require a fundamental change in the bookkeeping framework currently in place. It would also represent a major philosophical shift for the field if it were to change its mission from that of providing reliable financial information to something less empirically rigorous.

From a tax accounting perspective, the change would mean that training costs would no longer be tax-deductible in and of themselves. Rather, as assets, they would be depreciated and those depreciation values would become tax deductible. Not being an accountant myself, it is difficult to say what the ramifications are of such a change for the IRS and SEC, two major governmental stakeholders. Investors, also, might not welcome the change, seeing it as way for management to hide poor expenditure decisions.

Even if financial accounting, as a field, is unable or unwilling to modify its mission and systems in order to more accurately depict the construct of training as an investment, it is still important for management professionals to view training costs as investments in the short-term and long-term success of the organization. For this reason, training professionals must take it upon themselves to work with their accounting colleagues to establish performance metrics even if they are purely for internal purposes. If training is to be a vanguard in the organization's performance improvement, it must first focus its performance improvement efforts on itself and hold itself to high performance standards.

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