Methods of Accounting the Environmental Costs - Essay Example

Management Accountancy Contents Introduction 3 Discussion 3 Role of a Management Accountant 3 Methods of accounting the environmental costs 5 Activity Based Costing Method 6 Input –output Flow Analysis Method 6 Flow Cost Accounting method 7 Lifecycle Cost Accounting Method 8 Issues faced in the supervision of costs relating to environment 8 The potential motives of a company in implementing EMA 9 Conclusion 10 References 12 Appendices 15 Appendix 1: Environmental cost incurred by firms 15 Introduction The concept of Environmental management accounting can be treated as a part of environmental accounting which deals on providing relevant information for the purpose of internal decision making in a company. The above system of accounting is fretful with the general accounting information requirements of the managers with respect to the business activities that impact the environment and the environment related operations and decisions in a company. Environmental management accounting involves both monetary and physical procedures and can be divided in two main parts which are the Physical EMA and the Monetary EMA. The physical EMA process involves the management of issues and cost related to the flows, utilization, delivery and disposal of materials in a business. The monetary EMA involves the management of the procedures related to the quantification of costs, revenues and savings which are associated with the existing and future environmental strategies and effects of a business. This report includes an analysis of the role of management accountants in the introduction of EMA in a company, the methods of accounting environmental costs, the issues faced by companies in managing environmental costs and the motives of companies behind implementing the EMA systems. Discussion Role of a Management Accountant The role of a management accountant is crucial in a company that is wishing to implement environmental management accounting. The process of environmental management accounting involves the use of standard accounting methods to select, identify, evaluate, manage and control the costs of environmental management in a way that would act as an advantageous strategy for the company as well as be beneficial to the environment (Hendro, Ferreira and Moulang, 2008). Environmental management accounting is also useful for identifying the financial costs associated with environmental issues management and to identify and address several other business issues like negative public and media reactions, health and safety issues and non-compliance with the necessary environmental standards and procedures (Gale, 2006). As such, the roles of the internal stakeholders of a company are highly significant in the implementation of a suitable environmental management accounting system within the business. There are a number of ways in which the management accountants of a company can positively contribute to the environmental management accounting system and help the company to deal with the existing and potential environmental issues that may act as hindrances for the business (Schaltegger and Burritt, 2000). The management accountants of a company have a direct interest in reducing and controlling the expenses of the business and increase the profit margins for the same (Gibson and Martin, 2004). A management accountant generally has the required experiences and skills to measure, monitor and control the expenses of the business in relation to the supervision of technological systems and information systems that may help the company to produce outputs that are reliable and accurate and to provide important and beneficial advice to the other departments of the business. Apart from these, a management accountant also plays a significant role in the implementation of management accounting by enabling the accounting department and the company to devise as well as implement suitable financial and non-financial strategies, formulate financial budgets that support the environmental management accounting projects. A management accountant also helps in the overall process of the implementation and subsequent use of the new EMS. Since, EMA is a subset of the management accounting system, therefore the role of the management accountant and other financial staffs in the company always remains significant. Without the proper support and contribution of the existing accountants and other financial staffs of the business, a company would invariably face a number of constraints in the way of using this new management system. Two main accounting skills commonly found among the management accountants of companies are particularly relevant for the successful formulation and implementation of this kind of management system in a company. These are investment appraisal skills and costing skills (Burritt, 2004). The investment appraisal skills are necessary for the environmental management accounting systems because the management accountants have to ensure that all the associated environmental costs are considered within the project proposals of environmental management accounting. The skills related to costing are also mandatory because the management accountants have to consider and evaluate the environmental costs of the products and services and allocate these costs properly so that the costs can be effectively managed by the business. The proposals regarding the pricing strategies of the products and services related to environmental costs are also prepared by the management accountants (Scavone, 2006). Since, a main aim of the environmental management accounting method is to control the environmental issues and costs faced by a company, therefore, the financial and accounting aspect of the system always remains a high priority for the business. The management accountants of the company act as significant entities in the whole process of EMA introduction, implementation and review. Methods of accounting the environmental costs A business may use a number of accounting methods to identify, control and report its environmental costs. These accounting methods are used in the internal reporting processes related to environmental cost identification and management as well as in the management accounting processes used for the identification, management and allocation of the different types of environmental costs (Gulch, 2000). The most common methods which a business uses to account for the environmental costs are activity based costing method, input-output flow analysis method, flow cost accounting method and lifecycle method of cost accounting. Activity Based Costing Method The activity based costing method is a common accounting method used by businesses in their costing processes. This accounting method can also be used by companies to account for the environmental costs. The activity based costing method is a traditionally used accounting technique for businesses in the domain of accounting of environmental management. The activity based costing accounting method involves the allocation of the internal costs of the business to primary cost drivers and cost centres on the basis of the identification of the activities which incur the costs. In the context of environmental accounting, this accounting method is used to segregate the environment related expenses of a business which can be attributed to the joint cost centres and the environmental costs which are found to be hidden within the general overheads of the company (Wayuni, 2009). Input –output Flow Analysis Method The input output flow analysis method of accounting the environmental costs of a business uses the technique of recording the inflows of materials into the business and compares and balances these material inflows with the material and product outflows of the business. This technique is based on the concept that “what comes in must also goes out” (Hamner and Stinson, 2005). For example, if 100 kilograms of raw materials are used in a business and 90 kilograms of materials have been produced, then the business has to account for the 10 kg difference in some manner. This can be accounted as 10% of the materials have been sold out as scrap items and 90% of the materials are discarded as wastes in the operational processes. By accounting for the outputs in this manner, the businesses become more equipped and accountable in the area of focusing on the environmental costs. This process of accounting of the difference between the inflows and outflows of the materials involves the accounting of the outputs in conditions of substantial quantities and also in terms of monetary values at the conclusion of the accounting process (Burritt, Herzig and Tadeo, 2009). Flow Cost Accounting method The flow cost accounting method involves the use of the organizational structure along with the consideration of the material inflows into the business. This accounting technique is especially useful in the modern business environment because it considers the physical quantities of material, the cost and value of these materials involved in the process of inflow and therefore, makes the system of material inflows look more transparent (Bennett and James, 2007). This accounting method segregates the material inflows into three major categories which eventually help to make the accounting process transparent and methodical. These three categories of material inflow are system and delivery of materials, disposal of materials and quantity of materials. The costs and values of these three streams are then identified and evaluated. The main aim of the flow cost accounting method is to control and reduce the quantity of raw materials used in the operational processes of a company because the reduction of the quantity of materials consumed by a business has a direct positive impact on the external environment. By reducing the usage of materials, the business can have a positive effect on the environment and also be equipped to reduce the total expenses incurred by the company in its daily operations in the short term as well as the long term (Bartolomeo, 2000). Lifecycle Cost Accounting Method Lifecycle cost accounting method is also a commonly used accounting technique in the context of accounting of environmental management. This accounting method requires the analysis of the complete environmental consequences of the individual activities and processes of a business. Thus, in this method the costs that arise from the creation of merchandise and services are to be taken into account by considering the whole product lifecycle starting from the inception phase of the product to the delivery of the end product to the consumer for final consumption (De Beer and Friend, 2006). The inventory analysis done for materials in this accounting method is diagrammatically represented in Figure 1. Figure 1: LCA Inventory Analysis (Source: Gray, Bebbington and Walters, 2003). Issues faced in the supervision of costs relating to environment The management of the environmental costs in a business include five main phases. These are identifying the environmental costs, defining the environmental costs, managing the environmental costs and controlling the environmental costs. The management of the environmental costs in a company may be an extremely difficult business process because the environmental management accounting system is a complex process in which the identification and definition of the environmental costs are the most difficult steps (United Nations Division for Sustainable Development, 2001). Secondly, after the identification of the environmental costs associated with a business, the company also has to segregate the costs under different heads in order to efficiently manage the environmental costs incurred by the business. However, placing the costs under specific heads often becomes a difficult task because the costs may belong to overlapping sections. Also, controlling the environmental costs may lead to operational inefficiencies in the business (Dierkes and Preston, 2011). The management of the company often has to find the most optimal method in which the environmental costs in the company are managed while being able to maintain an environment friendly image for the company and while ensuring that the productivity of the company is not affected in any manner (Figge, Hahn, Schaltegger and Wagner, 2002). The potential motives of a company in implementing EMA The changing requirements of the global business environment have made it necessary for all types of companies to introduce environment friendly processes in their business. The maintenance of an ethical and sustainable image is largely dependent on the degree to which a company is able to manage the environmental costs and environmental impacts (Burritt, Hahn and Schaltegger, 2002). The companies aim to reduce both the inner and the outer costs of environment through the use of the environmental systems of management accounting. The internal and external costs of a company are given in Figure 2. Figure 2: Internal and external environmental costs (Source: United States Environmental Protection Agency, 2000) Also, the motives of a company behind the implementation of the EMA systems are often that the companies want to reduce the environmental costs and create a base for the long term strategic planning related to financial budgets and forecasts (Saka, 2006). Conclusion It can be summarized that environmental management accounting is an improved management accounting system which is useful in the current business environment as it focuses on the most sensitive area of business conformance which is environment. The EMA systems are not only beneficial for the companies across the globe but also are value adding accounting systems that help in reducing the environmental impacts of businesses. However, the process of introduction and implementation of an EMA is not a simple task. The companies have to focus on developing strategies that would help them to successfully negate the barriers and constraints to the management of environmental costs. Also, each company has to select the most appropriate accounting method for reporting the environmental costs incurred in the business so as to be able to use the EMA in the most beneficial manner. References Bartolomeo, M. 2000. 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