Management of Environmental Costs

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What is environmental accounting?

It focuses on reports (including environment-related information both externally and internally) for shareholders and other stakeholders.

What is environmental management accounting?

Environmental management accounting is simply a specialised part of the management accounts that focuses on things such as the cost of energy and water and the disposal of waste and effluent.

It is a subset of environmental accounting.

It focuses on information required for decision making within the organisation (internally focused), although much of the information it generates could also be used for external reporting.

The focus of environmental management accounting is not all on purely financial costs.

It includes consideration of other non-financial matters such as the costs vs. benefits of buying from suppliers who are more environmentally aware, or the effect on the public image of the company from failure to comply with environmental regulations.

Defining environmental costs

Many organisations vary in their definition of environmental costs.

A useful cost categorisation is that provided by the US Environmental Protection Agency in 1998. 

They stated that the definition of environmental costs depended on how an organisation intended on using the information. 

They made a distinction between four types of costs:

  1. conventional costs: raw material and energy costs having environmental relevance

  2. potentially hidden costs: costs captured by accounting systems but then losing their identity in ‘general overheads’

  3. contingent costs: costs to be incurred at a future date, e.g. clean up costs

  4. image and relationship costs: costs that, by their nature, are intangible, for example, the costs of producing environmental reports.

The UNDSD, on the other hand, described environmental costs as comprising of:

1. costs incurred to protect the environment, e.g. measures taken to prevent pollution; and

2. costs of wasted material, capital and labour, i.e. inefficiencies in the production process.

Neither of these definitions contradict each other; they just look at the costs from slightly different angles.

Managing environmental costs – its importance

Environmental risks cannot be ignored, they are now as much a part of running a successful business as product design, marketing, and sound financial management.

There are three main reasons why the management of environmental costs is becoming increasingly important in organisations.

  • society as a whole has become more environmentally aware, with people becoming increasingly aware about the ‘carbon footprint’  and recycling taking place now in many countries. 

    Companies are finding that they can increase their appeal to customers by portraying themselves as environmentally responsible.

  • environmental costs are becoming huge for some companies, particularly those operating in highly industrialised sectors such as oil production. 

    In some cases, these costs can amount to more than 20% of operating costs. Such significant costs need to be managed.

  • regulation is increasing worldwide at a rapid pace, with penalties for non-compliance also increasing accordingly. 

    Penalties include fines, increased liability to environmental taxes, loss in value of land, destruction of brand values, loss of sales, consumer boycotts, inability to secure finance, loss of insurance cover, contingent liabilities, law suits and damage to corporate image.

In the largest ever seizure related to an environmental conviction in the UK, a plant hire firm, John Craxford Plant Hire Ltd, had to not only pay £85,000 in costs and fines but also got £1.2m of its assets seized.

This was because it had illegally buried waste and also breached its waste and pollution permits.

And it’s not just the companies that need to worry.

Officers of the company and even junior employees could find themselves facing criminal prosecution for knowingly breaching environmental regulations.

In 2010, the failure of a 40-ft-tall blowout preventer has severely damaged BP’s image and wiped out more than $20 billion of the company’s stock market value.

BP claimed it was spending $6 million a day on the salvage effort.

The spill cost BP more than $4.6 billion in containment and clean-up expenses.

The oil spill also affected the Louisiana fishing industr and the tourism business along the Florida coast .

By failing to incorporate environmental concerns, organisations are unaware of the impact on the income statement and statement of financial position of environment-related activities.

Moreover, they miss out on identifying cost reduction and other improvement opportunities, employ incorrect product/service pricing, mix and development decisions.

This leads to a failure to enhance customer value, while increasing the risk profile of investments and other decisions with long-term consequences.

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