Accounting for Environmental Costs

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Environmental management accounting

Environmental management accounting uses some standard accountancy techniques to identify, analyse, manage and hopefully reduce environmental costs in a way that provides mutual benefit to the company and the environment, although sometimes it is only possible to provide benefit to one of these parties.

In 2003, the UNDSD identified four management accounting techniques for the identification and allocation of environmental costs: input/ outflow analysis, flow cost accounting, activity based costing and lifecycle costing.

1. Input/outflow analysis

This technique records material inflows and balances this with outflows on the basis that, what comes in, must go out.

Diagram

Input/output analysis according to Envirowise

The purchased input is regarded as 100% and balanced against the outputs – which are produced, sold and stored goods and the residual (regarded as waste).  Materials are measured in physical unit and include energy and water.

For example, if 100kg of materials have been bought and only 80kg of materials have been produced, then the 20kg difference must be accounted for in some way.

It may be that 10% of it has been sold as scrap and 90% of it is waste.

By accounting for outputs in this way, both in terms of physical quantities and, at the end of the process, in monetary terms too, businesses are forced to focus on environmental costs.

2. Flow cost accounting

This technique uses not only material flows but also the organisational structure.

It makes material flows transparent by looking at the physical quantities involved, their costs and their value.

It divides the material flows into three categories: material, system, and delivery and disposal.

i. The material values and costs apply to the materials which are involved in the various processes.

ii. The system values and costs are the in-house handling costs which are incurred to maintain and support material throughput e.g. personnel costs and depreciation.

iii. The delivery and disposal values and costs refer to the costs of flows leaving the company, e.g. transport costs or costs of disposing waste.

The values and costs of each of these three flows are then calculated.

The aim of flow cost accounting is to reduce the quantity of materials which, as well as having a positive effect on the environment, should have a positive effect on a business’ total costs in the long run.

Diagram

3. Activity-based costing (ABC)

ABC allocates internal costs to cost centres and cost drivers on the basis of the activities that give rise to the costs.

In an environmental accounting context, it distinguishes between environment-related costs, which can be attributed to joint cost centres (e.g. incinerators and sewage plants), and environment-driven costs, which tend to be hidden on general overheads, e.g. increased depreciation or higher cost of staff.

For example, activity-based costing may be used to ascertain more accurately the costs of washing towels at a gym.

The energy used to power the washing machine is an environmental cost; the cost driver is ‘washing’.

Once the costs have been identified and information accumulated on how many customers are using the gym, it may actually be established that some customers are using more than one towel on a single visit to the gym.

The gym could drive forward change by informing customers that they need to pay for a second towel if they need one. Given that this approach will be seen as ‘environmentally-friendly’, most customers would not argue with its introduction.

Nor would most of them want to pay for the cost of a second towel. The costs to be saved by the company from this new policy would include both the energy savings from having to run fewer washing machines all the time and the staff costs of those people collecting the towels and operating the machines.

Presumably, since the towels are being washed less frequently, they will need to be replaced by new ones less often as well.

In addition to these savings to the company, however, are the all-important savings to the environment since less power and cotton 
(or whatever materials the towels are made from) is now being used, and the scarce resources of our planet are therefore being conserved.

Lastly, the gym is also seen as an environmentally friendly organisation and this, in turn, may attract more customers and increase revenues.

4. Lifecycle costing

Within the context of environmental accounting, lifecycle costing (full costing) is a technique which requires the full environmental consequences, and, therefore, costs, arising from production of a product to be taken account across its whole lifecycle, literally ‘from cradle to grave’.

One example of the potential gains from using lifecycle costing can be seen in the case of Xerox Limited.

Xerox Limited, a subsidiary of Xerox Corporation, introduced the concept of lifecycle costing for its logistic chain. The core business of Xerox Limited is manufacturing photocopiers, which are leased rather than sold.

This means the machines are returned to Xerox Limited at the end of their lease.

Previously, machines were shipped in a range of different types of packaging, which could rarely be re-used by customers to return the old copiers.

The customer had to dispose of the original packaging and to provide new packaging to return the machine at the end of its lease, which in turn could not be used to re-ship other machines.

This meant Xerox lost the original costs and had to bear the costs of disposal of the packaging.

A new system was invented which used a standard pack (tote).

Two types of totes were introduced to suit the entire range of products sold by Xerox. Totes can be used for both new machines delivery and return carcasses.

The whole-chain cost analysis showed the considerably lower cost of the tote system, compared to the previously existing system and the supply chain became more visible.

The tote system resulted not only in cost savings but also in reduced ‘de-pack’ times and improved customer relations (Bennett and James, 1998b).

The above–mentioned accounting techniques are useful for environmental management accounting to identify and allocate environmental costs.

In addition, there are alternative techniques to estimate environmental costs such as the ‘environmental cost decision tree’.

Also, the undertaking of environmental audits on a regular basis provides the platform for a successful programme of total quality management (TQM).

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