Professional Scheme
Relevant to Paper 3.3

This article is intended to help students understand environmental management accounting,

its increasing importance, and new developments.
The global profile of environmental issues has risen significantly during the past two

decades, precipitated in part by major incidents such as the Bhopal chemical leak (1984) and

the Exxon Valdez oil spill (1989). These events received worldwide media attention and

increased concerns over major issues such as global warming, depletion of non-renewable

resources, and loss of natural habitats.
This has led to a general questioning of business practices and numerous calls for change.

These questions have not only been raised by organisations such as Friends of the Earth,

Greenpeace, or groups of ‘eco-warriors’, but from the United Nations, the European Union,

the UK government, the British Bankers Association, insurance companies and pension funds.

Recognition that our current way of life poses a threat to us and our planet, has led to

global agreements on action to prevent future environmental damage. Such agreements include

the Montreal Protocol, the Rio Declaration, and the Kyoto Protocol.
Businesses have become increasingly aware of the environmental implications of their

operations, products and services. 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. Poor environmental behaviour may have a real adverse impact on the

business and its finances. Punishment includes 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.
Nearly all aspects of business are affected by environmental pressures, including

accounting. From an accounting perspective, the initial pressures were felt in external

reporting, including environmental disclosures in financial reports and/or the production of

separate environmental accounts. Much has been written about the nature and quality of these

accounts (see Gray and Bebbington, 2001 for an introduction into this area). However,

environmental issues cannot be dealt with solely through external reporting. Environmental

issues need to be managed before they can be reported on, and this requires changes to

management accounting systems.
Environmental Review of Conventional Management Accounting
In an ideal world, organisations would reflect environmental factors in their accounting

processes via the identification of the environmental costs attached to products, processes,

and services. Nevertheless, many existing conventional accounting systems are unable to deal

adequately with environmental costs and as a result simply attribute them to general

overhead accounts. Consequently, managers are unaware of these costs, have no information

with which to manage them and have no incentive to reduce them (United Nations Division for

Sustainable Development (UNDSD), 2003)). It must be recognised that most management

accounting techniques significantly underestimate the cost of poor environmental behaviour.

Many overestimate the cost and underestimate the benefits of improving environmental

practices.
Management accounting techniques can distort and misrepresent environmental issues, leading

to managers making decisions that are bad for businesses and bad for the environment. The

most obvious example relates to energy usage. A recent UK government publicity campaign

reports that companies are spending, on average, 30% too much on energy through inefficient

practices. With good energy management, we could reduce the environmental impact of energy

production by 30% and slash 30% of organisations’ energy expenditure. Frost and Wilmhurst

(2000) suggest that by failing to reform management accounting practices to incorporate

environmental concerns, organisations are unaware of the impact on profit and loss accounts

and the balance sheet impact 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. If management accounting as a discipline is to contribute to

improving the environmental performance of organisations, then it has to change.

Environmental Management Accounting (EMA) is an attempt to integrate best management

accounting thinking and practice with best environmental management thinking and practice.
Environmental Management Accounting
EMA is the generation and analysis of both financial and non-financial information in order

to support internal environmental management processes. It is complementary to the

conventional financial management accounting approach, with the aim to develop appropriate

mechanisms that assist in the identification and allocation of environment-related costs

(Bennett and James (1998a), Frost and Wilmhurst (2000)). The major areas for the application

for EMA are:
•in the assessment of annual environmental costs/expenditures
•product pricing
•budgeting
•investment appraisal
•calculating costs
and
•savings of environmental projects, or setting quantified performance targets.
EMA is as wide-ranging in its scope, techniques and focus as normal management accounting.

Burritt et al (2001) stated: ‘there is still no precision in the terminology associated

with EMA’. They viewed EMA as being an application of conventional accounting that is

concerned with the environmentally-induced impacts of companies, measured in monetary units,

and company-related impacts on environmental systems, expressed in physical units. EMA can

be viewed as a part of the environmental accounting framework and is defined as ‘using

monetary and physical information for internal management use’.
Burritt et al developed a multi-dimensional framework of EMA (Figure 1). Their framework

considers the distinctions between five dimensions:
•internal versus external
•physical versus monetary classifications
•past and future timeframes
•short and long terms
and
•ad hoc versus routine information gathering in the proposed framework for the application

of EMA.
Within this framework the different techniques of EMA – such as environmental lifecycle

costing or environmental cost accounting – can be placed and assigned. The management of a

company can choose appropriate tools on the basis of their information needs.
Similarly, in a series of publications (1997, 1998a, 1998b), Bennett and James describe the

diverse range and scope of environmental management accounting. They provide a set of useful

models, one of which is ‘The Environment-Related Management Accounting Pyramid’, to help

evaluate environmental management accounting practices as well as to help in the design and

implementation of new systems.
According to Bennett and James (1998a) (Figure 2), EMA is concerned with gathering data

related to the environment (lowest levels), which are converted through techniques and

processes (middle level) into information which is useful for managers (top). Key data is

both non-financial and financial in nature. Management accounting techniques such as

performance measurement, operational budgeting, costing or pricing are used for the

transformation.
Examples of techniques
Redefining Costs
A literature review reveals various approaches to the definition of environmental costs. In

1998, the US Environmental Protection Agency argued that the definition of environmental

costs depended on how a company intends to use the information, for example in capital

budgeting or product design. They introduced terminology that distinguishes between

conventional costs, potentially hidden costs, contingent costs, and image and relationship

costs.
Conventional costs are those raw material and energy costs having environmental relevance.

Potentially hidden costs are those which are captured by accounting systems, but then lose

their identity in ‘overheads’. Contingent costs may be incurred at a future date – for

example costs for cleaning up. They are also referred to as contingent liabilities. Image

and relationship costs are intangible in nature and include, for example, the costs of

producing environmental reports.
However, such costs pale into insignificance when compared with the costs associated with

being seen to behave in an irresponsible manner. The infamous Brent Spar incident that cost

the Shell oil company millions of pounds in terms of lost revenues via the resultant

consumer boycott, is an example of the powerful influence that environmental concern has in

today’s business environment. Shell learned the lesson, albeit somewhat belatedly, and as a

result completely re-engineered its environmental management system.
ACCA has also published a research report outlining an agenda for action on full cost

accounting (Bebbington, Gray, Hibbit and Kirk, 2001), which contains a detailed review of

the business case for adopting full environmental costing. One example of the potential

gains from using full costing (sometimes referred to as lifecycle costing, Bennett and James

(1998b)) 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).
UNDSD (2003) described total corporate environmental costs as environmental protection costs

(emission treatment and pollution prevention) plus costs of wasted materials, plus costs of

wasted capital and labour. Waste in this context means production inefficiency (purchase

value of non-material output). UNDSD stated that wasted materials account for 40% to 90% of

environmental costs according to a survey. One should recognise that environmental costs are

not a separate type of cost; rather they are part of money flowing throughout a corporation.
The main difficulty associated with environmental costs is their identification and

allocation. According to UNDSD (2003), conventional accounting systems tend to attribute

many of the environmental costs to general overhead accounts with the result that they are

‘hidden’ from management. Thus, management is often unaware of the extent of environmental

costs and cannot identify opportunities for cost savings. EMA attempts to make all relevant,

significant costs visible so that they can be considered when making business decisions

(Jasch, 2003). UNDSD (2003) identified management accounting techniques which are useful for

the identification and allocation of environmental costs as: input/output analysis, flow

cost accounting, activity-based costing (ABC), and lifecycle costing.
Input/output analysis
The input/output analysis is a technique that can provide useful environmental information,

sometimes referred to as mass balance (Envirowise, 2003). This technique records material

flows with the idea that ‘what comes in must go out – or be stored’ (Jasch, 2003).
As shown in Figure 3, the purchased input is regarded as 100% and is balanced against the

outputs – which are the produced, sold and stored goods and the residual (regarded as

waste). Materials are measured in physical units and include energy and water. At the end of

the process, the material flows can be expressed in monetary units. Process flow charts can

help to trace inputs and outputs, in particular waste. They demonstrate the details of the

processes so that the relevant information can be allocated to main activities.
Process flow charts bring together technical information and cost accounting information

(UNDSD, 2003). Flow cost accounting is a tool of a new management accounting approach –

flow management. It aims to ‘...organise production end-to-end in terms of flows of

materials and information –all structured in an efficient, objective-oriented manner’

(UNDSD, 2003). It is more than a simple assessment of environmental costs, because it is

focused on assessment of total costs of production.
Flow management involves not only material flows, but also the organisational structure.

Classic material flows are recorded as well as material losses incurred at various stages of

production. Flow cost accounting makes material flows transparent by using various data,

which are quantities (physical data), costs (monetary data) and values (quantities x costs).

The material flows are divided into three categories, material, system, and delivery and

disposal, as shown in Figure 4. The material values and costs apply to the materials which

are involved in the various processes. The system values and costs are the in-house handling

costs, which are ‘...incurred inside the company for the purpose of maintaining and

supporting material throughput, e.g. personnel costs or depreciation,’ (UNDSD, 2003).
The delivery and disposal values and costs refer to the costs of flows leaving the company,

for example transport costs or cost of disposing waste. EMA can benefit from flow cost

accounting because it aims to reduce the quantities of materials, which leads to increased

ecological efficiency (UNDSD, 2003).
Environmental Activity-Based Accounting
Activity-based costing (ABC) ‘...represents a method of managerial cost accounting that

allocates all internal costs to the cost centres and cost drivers on the basis of the

activities that caused the costs,’ (UNDSD, 2003). ABC applied to environmental costs

distinguishes between environment-related costs and environment-driven costs. The former are

attributed to joint environmental cost centres, for example incinerators or sewage plants.

The latter are hidden in the general overheads and do not relate directly to a joint

environmental cost centre, e.g. increased depreciation or higher cost of staff. Nevertheless

they vary with the amount of throughput.
Schaltegger and Muller (1998) stated ‘the choice of an adequate allocation key is crucial

for obtaining correct information’. The four main allocation keys are:
•volume of emissions or waste
•toxicity of emission and waste treated
•environmental impact added (volume x input per unit of volume) volume of the emissions

treated
and
•the relative costs of treating different kinds of emissions.
LifeCycle Costing
Environmental Management as part of Total Quality Management
The pursuit of environmental quality management via the development of an Environmental

Management System (EMS) can only be achieved if ‘environmental audit’ is a concomitant

feature of such a system. In this respect the organisation becomes self-regulating and the

undertaking of environmental audits on a regular basis provides the platform for

organisations to adopt a self-critical and analytical posture as part of their routine

organisational management processes. Organisations should be striving to achieve an

integrated environmental strategy underpinned by the same type of culture that is required

for the successful operation of a programme of total quality management (TQM).
It is arguable that the two are inextricably linked insofar as good environmental management

is increasingly recognised as an essential component of TQM. In common with TQM, the focus

is upon ‘continuous improvement’ and the pursuit of excellence. Such organisations pursue

objectives that may include zero complaints, zero spills, zero pollution, zero waste and

zero accidents. Information systems need to be able to support such environmental objectives

via the provision of feedback – on the success or otherwise – of the organisational

efforts in achieving such objectives. This approach to environmental quality management

requires the development of environmental performance measures and indicators that will

enable a comprehensive review of environmental performance to be undertaken. Many – if not

all – total quality management accounting techniques can be modified and effectively

adopted to help manage environmental issues.
Conclusion
It can be said that most companies do not know about the extent of their environmental costs

and tend to underestimate them. This leads to distorted calculations of improvement options.

For example, Amoco Yorktown Refinery estimated their environmental costs at 3% of non-crude

operational costs. Actually they comprised 22% of non-crude operating costs as the case

study of Ditz et al (1998) revealed. However, the study also discovered a large proportion

of environmental costs were caused by other processes that had not been identified by Amoco.
EMA can solve these problems. The above-mentioned accounting techniques are useful for EMA

to identify and allocate environmental costs. In addition, there are alternative techniques

to estimate environmental costs such as the ‘environmental cost decision tree’ as

described by Rimer (2000).
The most significant problem of EMA lies in the absence of a clear definition of

environmental costs. This means it is likely that organisations are not monitoring and

reporting such costs. The increase in environmental costs is likely to continue, which will

result in the increased information needs of managers and provide the stimulus for the

agreement of a clear definition. If a generally applicable meaning of environmental costs is

established, the use of EMA will probably increase with positive effects for both

organisations and the environment in which they operate. In the future it will not only be

large companies which can afford to implement EMA but also small and medium-sized

enterprises which have fewer available financial resources.