3. Environmental Management AccountingMetrics: Procedures and Principles1

Christine JaschDirector of the Institute for Environmental Management and Economics, Vienna, Austria;E-mail: info@ioew.at

3.1. Introduction

This paper aims to define principles and procedures for environmental managementaccounting (EMA). It focuses on techniques for quantifying environmental expendituresor costs. These EMA metrics can be used by national governments as a starting point fordeveloping EMA guidelines that are adapted to national circumstances and needs, and bycompanies and other organisations seeking to improve their control and benchmarkingsystems.

3.2. EMA metrics

Physical and financial

EMA metrics include both physical metrics (materials and energy consumption, flows,and final disposal) and financial metrics (costs, savings, and revenues related to activi-ties with a potential environmental impact).

Conventional corporate monetary accounting comprises:

financial accounting (bookkeeping, balancing, consolidation, auditing of the financialstatement and external reporting);management accounting (also called ' cost accounting' );corporate statistics and indicators (past-oriented);budgeting (future-oriented);investment appraisal (future-oriented).

Conventional accounting systems

Management accounting constitutes the central tool for internal management deci-sions such as product pricing, and is not regulated by law. This internal information systemdeals with questions such as ' what are the costs of production for different products,and what should be their selling prices?'. The main stakeholders in management and costaccounting are members of the managerial staff of the organisation, in various positions(e.g. executive, site, product and production managers).

Unfortunately, many companies do not have a separate cost accounting system, andtherefore make calculations on the basis of the financial accounting data from book-keeping. Financial accounting is designed mainly to satisfy the information needs of

1 This chapter results from research done for the UN. Source: Environmental Management Accounting:Procedures and Principles, United Nations Division for Sustainable Development, Department of Economicand Social Affairs (United Nations publication, Sales No. 01.II.A.3). The website where this publication andothers will be available is http://www.un.org/esa/sustdev/estema1.htm.

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M. Bennett et al. (eds.), Environmental Management Accounting: Informational and InstitutionalDevelopments, 37–50.© 2002 Kluwer Academic Publishers. Printed in the Netherlands.

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external shareholders and financial authorities, both of whom have a strong interest instandardised, comparable data and in receiving true and fair information about the actualeconomic performance of the company. Therefore, financial accounting and reportingare dealt with in national laws and international accounting standards.

Environmental management information

The core of environmental information systems consists of materials flow (or mass)balances measured in physical units of material, water and energy flows within the bound-aries of a well-defined system. This can be at corporate level, but also at the level of costcentres and production processes or even of individual items of machinery and products.In the latter case, process technicians have to trace the data needed (see Figure 3.1).

EMA derives its data from both financial accounting and cost accounting, and isinstrumental in increasing materials efficiency, in reducing environmental impact and risk,and in reducing the costs of environmental protection. EMA uses both financial and physicaldata (see Figure 3.2).

EMA applications

Key application fields for the use of EMA data are:

assessment of annual environmental costs/ expenditures;product pricing;budgeting;investment appraisal, calculating investment options;calculating costs and savings of environmental projects;design and implementation of environmental management systems;

Environmental Management Accounting Metrics. Procedures and Principles 39

environmental performance evaluation, indicators and benchmarking;setting quantified performance targets;cleaner production and eco-design projects;external disclosure of environmental expenditures, investments and liabilities;external environmental or sustainability reporting;other reporting, such as the reporting of environmental data to statistical agenciesand local authorities.

EMA data and its application can be divided into past-oriented and future-oriented tools(see Figure 3.3).

Figure 3.4 provides an overview of the different types of EMA.

Defining environmental costs

The main problem in environmental management accounting is the lack of a standarddefinition of environmental costs. Depending on various interests, these can include avariety of costs, e.g. disposal costs or investment costs and, sometimes, also externalcosts (i.e. costs incurred outside the company and borne by others). Of course, also the

40 Environmental Management Accounting: Information and Institutional Developments

Environmental Management Accounting Metrics: Procedures and Principles 41

opposite occurs: benefits such as environmental cost savings may remain hidden. Moreover,many environmental costs that a company pays for are difficult to trace as they are notsystematically allocated to appropriate processes and products, but simply allotted togeneral overheads.

Distorted calculations

The fact that environmental costs are not recorded, or only poorly, often distorts calcu-lations that could underpin improvement options. This, for instance, may mean that possiblebeneficial environmental projects that prevent emissions and waste at source (avoidanceoption) are not identified and therefore not implemented. The economic and ecologicaladvantages that could be derived from such measures are foregone. Without the correctfigures, those in charge often fail to realise that the costs related to producing waste andemissions can often be higher than the costs of disposing them.

Access to information

Experience shows that environmental managers frequently do not have access to the actualcost accounting figures of the company. On the other hand however, accountants andfinancial controllers, who in principle have the information, are unable to distinguish whichcosts are environmentally relevant without further guidance. As well as the inadequacy ofthe figures, environmental staff and accountants/financial controllers tend to live in dif-ferent worlds and find it hard to communicate with each other for want of a commonlanguage. EMA is intended to help to bridge this gap.

Hidden costs

In conventional cost accounting, environmental and non-environmental costs are usuallyrecorded together without differentiation in general overhead accounts, so that manyenvironmental costs tend to remain ' hidden' from management. There is substantialevidence that management often tends to underestimate the extent and growth of suchcosts. By identifying, assessing and allocating environmental costs, EMA allows manage-ment to identify opportunities for cost savings. A prime example is the savings that canresult from replacement of toxic organic solvents by non-toxic substitutes, thus eliminatingthe high and growing costs of regulatory reporting, hazardous waste handling and othercosts associated with the use of toxic materials. Many other examples refer to moreefficient use of materials, highlighting the fact that waste is expensive not only becauseof the costs of its disposal but also because of the purchase value of the wasted mate-rials.

Cost internalisation

Environmental costs comprise both internal and external costs and relate to all costsincurred because of environmental damage and protection. Environmental protectioncosts include costs of prevention, disposal, planning, control, shifting actions and damagerepair as they occur in different types of organisation. This paper deals only

2 VDI, the German Association of Technicians, together with German Industry representatives, havedeveloped a guidance document on the definition of environmental protection costs and other terms ofpollution prevention, VDI 2000.

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with corporate environmental costs, and does not attempt to consider external costs, whichresult from corporate activities but are not internalised via regulations and prices. It is therole of governments to apply political instruments such as eco-taxes and emissions controlregulations in order to enforce the ' polluter-pays' principle and thus integrate externalcosts into corporate calculations. When this happens, external costs are transformed intointernal costs, i.e. they are 'internalised'.

3.3. How to define corporate environmental costs

What then are corporate environmental costs? Costs incurred to deal with contaminatedsites, effluent control technologies and waste disposal may come first to mind.

Measures for environmental protection comprise all activities taken for legal com-pliance, compliance with own commitments, or voluntarily. The criterion is not economiceffects, but the effect on the prevention or reduction of environmental impacts (VDI, 2000).

Corporate environmental protection expenditure includes all expenditure onmeasures for environmental protection of a company or on its behalf to prevent, reduce,control and document environmental aspects, impacts and hazards, as well as disposal,treatment, sanitation and clean up expenditure. The amount of corporate environmentalprotection expenditure is not directly related to the environmental performance of acompany (VDI, 2000).

For calculating a company's internal environmental costs, one should look not only atexpenditures on environmental protection. The concept of 'waste' has a double meaning.Waste is a material which has been purchased and paid for, but which has not beenconverted into a marketable product. Waste therefore signals inefficiency. The costs ofwasted materials, capital and labour have to be totalled in order to arrive at total corpo-rate environmental costs as a sound basis for further calculations and decisions. 'Waste'is used in this context as a general term for solid wastes, waste water, and air emissions,and thus comprises all non-product output.

Adding the purchase value of non-materials output such as solid wastes and wastewaterto the environmental costs increases the proportion of ' environmental' costs in relationto other costs.

EMA as an eye-opener

The most important role of EMA is to make sure that all relevant costs are consideredwhen making business decisions. In other words, ' environmental' costs are just a subsetof the bigger cost universe that corporate decision-makers need to take into account.

Environmental Management Accounting Metrics: Procedures and Principles 43

' Environmental' costs are part of a company's usual materials and money flows. EMA canbe an eye-opener to those in charge of accounting and management decisions in stimu-lating the company's processes to be viewed in a different way, to reflect new priorities.EMA's focus on materials flows is no longer intended to assess the total ' environmental'costs, but to develop a different look at the production costs that takes a company'senvironmental effects seriously.

Annual corporate figures as first step

In the methodology adopted in this paper, the environmental cost assessment scheme isfirst used for the assessment of annual corporate environmental expenditure of the previousyear, which can then be broken down to cost centres and processes. Total annual figureshave limited value as such, but are a first step in a top-down approach of environmentalcost management. Annual expenses are the best available data source; a further distinc-tion into cost centres, processes, products and materials flow balances should then bedone in a step-by-step procedure, gradually improving the information system. Calculatingsavings, investment options or estimating future price changes requires the considerationof future costs, and is dealt with separately.

From treatment to prevention

The environmental cost categories that a company uses reflect the past process of aware-ness in this area.

The first block of environmental cost categories comprises conventional waste disposaland emission treatment costs, including related labour and maintenance materials costs.Insurance and provisions for environmental liabilities also reflect the spirit of treatmentrather than prevention. This first block corresponds to the conventional definition of envi-ronmental costs and consists of all treatment, disposal and clean-up costs of existing wastesand emissions.

The second block is termed prevention and environmental management and addslabour costs and external services for good housekeeping as well as the ' environmental'share and extra costs of integrated technologies and green purchases, if significant. Themain focus of the second block is on annual costs for prevention of waste and emissions,but without calculated cost savings. They include higher pro-rata costs for environment-friendly auxiliary and operating materials, low-emission process technologies and thedevelopment of environmentally benign products.

Conventionally, three production factors are distinguished: materials, capital (invest-ments, related annual depreciation and financing cost) and labour. The next two blocksconsider the costs of wasted materials, capital and labour due to inefficient production,generating waste and emissions.

In the third block, the wasted materials purchase value is added. All non-productoutput is assessed by a materials flow balance. Wasted materials are evaluated with theirmaterials purchase value or materials consumed value in the case of stock management.

Lastly, the production costs of non-product output are added, including therespective production cost charges, which include labour hours, depreciation of machinery,and operating materials. In activity-based costing and flow cost accounting, the flows ofresidual materials are more precisely determined and allocated to cost centres and costcarriers.

Environmental revenues derived from sales of waste, grants and subsidies areaccounted for in a separate block.

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Costs that are incurred outside the company and borne by the general public (externalcosts) or that are relevant to suppliers and consumers (life cycle costs) are not dealt with.

Figure 3.6 shows the environmental cost assessment scheme developed for EMA.

Non-product output

The basis of environmental performance improvements and for assessing the amounts andcosts of non-product output (NPO) is the recording of materials flows in kilograms by anInput-Output Analysis. The system boundaries can be at the corporate level, or brokendown further to sites, cost centres, processes and product levels. The materials flow balanceis an equation based on ' what comes in must go out (or be stored)'. In a materials flowbalance, information on both the materials used and the resulting amounts of product,waste and emissions are stated. All items are measured in physical units in terms of mass(kg, t) or energy (MJ, kWh). The purchased input is cross-checked with the amountsproduced and sold as well as the resulting waste and emissions. The goal is to improvethe efficient use of materials, from both an economic and an environmental point ofview.

A materials flow balance can be made for a few selected materials or processes or forall materials and wastes of an organisation. The aim of process balances is to track mate-rials on their way through the company. The starting point is often the corporate level,as much information is available on this system boundary, and this is also the level whichis used for disclosure in corporate environmental reports.

During its first environmental review, most companies draw up a materials flow balancewithout going into much detail. This provides a basis on which to gain knowledge onwhere to achieve improvements in performance and information gathering. By improvingthe quality of the information and the information systems, a regular monitoring systemcan be established. This monitoring system shows resource input and production and wasteoutput on a monthly basis. As a next step, the materials flows can be subdivided furtheraccording to processes and cost centres, and can also be subject to monetary evaluation.

Input-output balance

Figure 3.7 shows the generally applicable structure of the input-output balance at acorporate level, which could also be used for environmental reporting. Specific subcate-gories will be needed for different sectors, but it should always be possible to aggregatein a standardised manner, in order to be able to compare them.

The input-output balance at corporate level is drawn up on an annual or a monthlybasis and is linked to the bookkeeping, cost accounting, storage and purchase systems.All materials flows should be listed with their values and amounts per year. The assess-ment scheme for the materials flow balance should therefore record the amounts inkilograms, the values and the corresponding accounts. In addition, it should indicatewhether materials are registered by materials stock number, and whether there isinventory management. It should also indicate whether there is consumption-based stockwithdrawal according to cost centres. As the first step in setting up the materials input-output statement at corporate level, quantitative data are collected from the accountingand stock-keeping systems. The accounting system offers annual data on a company'sinputs, and on the output in so far as it involves sales. All materials purchased willeventually leave the company as either product or waste; in between, they can also bestored. An annual input-output balance has to reflect these three possibilities.

Environmental Management Accounting Metrics: Procedures and Principles 45

46 Environmental Management Accounting: Information and Institutional Developments

Gradual process

Figure 3.8 shows the assessment scheme for the materials input-output statement. indi-cates the likely data source or the records which are likely to be of relevance. It servesthe purpose of gradually improving the recording of materials flows. Given its complexity,the work to accomplish this is unlikely to be completed within a single year, so the methodpresented here is geared at step-by-step tracking and tracing the materials as completelyand consistently as possible, in storage administration, cost centres and in productionplanning.

The next step, after environmental cost assessment and materials flow balances at acorporate level, is to allocate the data from the system boundary of the company to internalprocesses.

Process flow charts (see also Figure 3.9), which trace the inputs and outputs of mate-rials flows on a technical process level, give insights into company-specific processes andallow the determination of losses, leakages and waste streams at the originating source.This requires a detailed examination of individual steps in production – again in the formof an input-output analysis, but sometimes linked to technical Sankey diagrams. The processflow charts combine technical information with cost accounting data. These are done noton an annual basis but for a specified production unit, machinery or cost centre. In total,they should aggregate to the annual amount.

Technicians will do this level of materials flow analysis, but the data gathered shouldbe cross-checked to ensure consistency with the cost accounting system. Frequently, dueto lack of inter-departmental communication such a harmonisation of technical data withdata from financial bookkeeping is not undertaken, but experience has shown that sucha consistency check has great optimisation potentials, and has thus become a major toolin environmental accounting. Therefore, a great advantage lies in having compatibletechnical and financial records.

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Detailed corporate flows

Splitting up the corporate flows into cost centres, or even down to specific productionequipment allows for more detailed investigation of technical improvement options, butalso for tracing the sources of costs. Special attention should be drawn to the quantita-tive recording of materials on a consistent kilogram basis. The key questions answered bythe approaches of activity-based costing and cost flow accounting are:

which cost centres have processed the materials, and how much?can materials input be further divided into production lines or specific equipment?how large were the resulting emissions, scrap and waste, preferably recorded sepa-rately for each cost centre, production line and machinery?what is the correct allocation of costs to products, thus reducing the amount of costshidden in overhead cost categories?

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3.4 Environmental indicators and investment appraisal

Indicators

Environmental performance indicators condense extensive environmental data intocritical information that allows monitoring, target setting, tracing performance improve-ments, benchmarking and reporting. Several publications and pilot projects highlight theirrelevance for supporting environmental management systems. As a general outline forgeneric indicators that can be applied throughout all sectors, the following items shouldbe monitored. Sector-specific, more detailed indicators may be valuable, but aggregation

Environmental Management Accounting Metrics: Procedures and Principles 49

to general categories should be possible. The indicator system should cover all majorinput and output categories (see Figure 3.10).

Investment appraisal

Most methods of investment appraisal assume that all inputs and outputs of an invest-ment decision can be expressed in money terms. The high risks, the difficulty of estimatingacceptable monetary values, and the uncertainty that surrounds future environment-relatedcosts and potential future cost savings make the assessment of long-term investmentsquestionable. In certain cases end-of-life expenses (e.g. costs of dismantling, as with theBrent Spar) can be extremely high, but are discounted away by common discountingprocedures. However, the methods are still widely used. The task of EMA is not so muchto change the concept of discounting future cash flows, but to ensure that all relevantearnings and expenses (including reputational damage) are taken into account.

In addition to initial investment and annual operating expenditure,

future liability costs andsavings potentials

need consideration for investment appraisal.Initial investment costs can comprise several items in addition to the purchased

equipment.Annual operating costs can relate to all the other cost categories of the assessment

scheme. Therefore, annual assessment of total expenditure is vital as a starting point inenvironmental management accounting as it assures confidence that all relevant costs havebeen included in the analysis of costs to specific cost centres or equipment.

Measures for pollution prevention help to reduce disposal and emission treatment costsand to increase the efficient use of purchased materials. Often, when calculating invest-ments, the reduced costs for materials and emission treatment are not completely calcu-lated, which results in distorted investment decisions.

Additionally, future liability costs and less tangible benefits should be estimated.Future Liability Costs: Two general forms of future liability costs can be distinguished:

liability for personal injury or property damage (e.g. liability stemming from a leakinglandfill), and penalties and fines for violation of environmental regulations. When calcu-lating future risks and liabilities, an estimate of avoided future liability is also required.

Saving potentials: Less tangible benefits from pollution prevention investments, suchas increased revenue from enhanced product quality, company reputation or productimage, and the effects of improved health conditions on productivity are difficult to predictand quantify.

In addition to savings, other positive effects can arise from environmental management.These so-called soft factors, structured by stakeholder relations, can be:

increased turnover, customer satisfaction, new markets, differentiation from competi-tors;image enhancement;better relations with authorities, reduced regulatory compliance costs;better creditworthiness, reduced insurance rates, good ratings by investment brokersand agencies;better public shareholder and community relations;increased job motivation and satisfaction, less absenteeism and illness.

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3.5. Conclusion

This paper has highlighted the limitations of traditional accounting and has shown whatEMA can do to overcome them, in the light of the need for companies to take theenvironment seriously.

Business risk can be defined as any chance that an organisation will not achieve itsbusiness objectives. Environmental aspects cannot be ignored when defining one'sobjectives, and therefore become part and parcel of any serious business activity. This iswhy environment is increasingly incorporated in corporate risk management and man-agement control. EMA makes it possible to do this effectively.