Integrating Environmental Factors into Life Cycle Costing - Research Paper Example

Introduction In the current global situation, perhaps no other issues or problems are discussed deeply and passionately than environmental issues andproblems. There is already an increasing public awareness and concern on the consequences of these issues and the factors (LeVan, 1995) and how various products may have an impact on the environment. However, saying that they do have a negative impact and actually quantifying such an impact are two different things. The actual quantification of such an impact is important as it gives us a deeper understanding on how a certain product affects our environment. This paper aims to discuss one of the recommended strategies to quantify the impact a product has on the environment, and this is life cycle costing or LCC. It provides an introduction on the concept of LCC. It describes various approaches to LCC and how these approaches contribute to getting an understanding on how a certain product affects the environment. Lastly, it includes several recommended improvements on life cycle methods. Life Cycle Costing The life cycle cost of a certain asset is defined as the “total cost throughout the life” of the asset, including the cost to plan, to design or to acquire (New South Wales Treasury, 2004), to operate, to maintain, to convert and/or to decommission an asset, particularly a fixed asset (Barringer, 2003). LCC techniques are used for various purposes, from the acquisition of the asset to deciding when to retire the aging asset (p. 30, Dhillon, 1989). LCC is used across several disciplines such as accounting, finance, engineering and statistics (p. 35, Dhillon, 1989). It offers a lot of advantages for the entity that applies this concept. It enables the entity to choose “the most beneficial procurement strategy”, offers incentives to suppliers and establish long – term mutual beneficial relationships with them, choosing the optimal solutions for the entity, formulating effective (and realistic) budgets and, generally, effectively controlling the project and/or the acquisition of the assets (p. 30, Dhillon, 1989). Life Cycle Costing and the Environment Although the LCC is a methodology to gather the costs for further analysis and monitoring, it is inevitable that LCC will also be looked at as a possible means to solve the environmental issues faced by the world today. According to Hunkeler and Rebitzer (as quoted by Guidice, La Rosa and Risitano, 2006), LCC can play an active and important role in addressing environmental issues and concerns as “it acts as a primary link between environmental demands and the production strategies of manufacturing companies”. By integrating environmental concerns into the product’s LCC, LCC took on a new objective, that of providing “a framework for finding the total cost of design / development, production, use and disposal of the product with an intention of reducing the total cost” (Kumaran, et. al., as quoted by Guidice, La Rosa and Risitano, 2006). Approaches to Life Cycle Costing LCC has become a vital contributor for the long – term survival and advancement of any business entity. Various approaches to LCC have been discussed, rehashed and improved during the last decade or so. However, one major criticism is that most of these approaches integrate environmental costs to the product life cycle cost. This section aims to examine some of these various approaches and to assess whether or not they contribute in helping an organization integrate environmental costs to the life cycle costs of a product. The Simple LCC Analysis or LCCA The most basic approach is the simple LCC Analysis or LCCA. This is termed ‘simple’ because it only takes into account the relevant costs of constructing or acquiring an asset. According to Sienglinde Fuller (2009), these costs include the initial costs of acquiring or constructing the asset, the costs of fuel, maintenance, operating and repairs, the costs to replace the asset, the cost to dispose the asset, the financing costs and the “non-monetary…costs”. This method is appropriate for accounting the actual cash outlay for building or acquiring the asset and, ultimately, for disposing or replacing the asset. However, it is too simplistic in the sense that it does not take into consideration other costs associated with the asset, such as the eco-costs as described by Kumaran, et. al (2000). Thus, this ‘simple’ LCCA will not be likely to contribute to the successful integration of environmental factors on the business entity’s organizational performance assessment. Activity Based Costing Activity based costing or ABC is an economic model that “identifies the cost pools or activity centers in an organization and assigns costs to cost drivers based on the number of each activity used” (Akyol, Tuncel and Bayhan, 2005). Although the ABC method is a standalone costing method used by manufacturing companies, it is also a method that was combined with LCC to develop the Activity – Based LCC method (p. 285, Emblemsvag, 2003).This method is thought to be better than the traditional LCC method as it is “process oriented”, can handle “both costs and cash flows…and overhead costs”, can establish “cause and effect relationships” and can “estimate the costs of all cost objects of a business unit simultaneously” (p. 286, Emblemsvag, 2003). The Activity – Based LCC method may be one step above the traditional LCC method but it does not seem to take into account the environmental impact of the product. Although there is a forward – looking aspect in this method, it still revolves around historical costs that may not actually take into account the environmental impact and costs. However, it is interesting to note that, in an article from the FSN website (2006), it advocates the ABC method because the business entity can actually account for its product’s environment costs by using this approach. The premise around this is that ABC can also take into account the cost of recycling or cleaning up or even disposal of the product. The article does not provide more guidance on how this can be done, however, if this is really the case; then the ABC method can be a contributing factor towards the business entity’s assessment of the environmental impact and costs of its products. Design to Cost Life Cycle Model Design to cost (DoC) is a “step-by-step process that is both deliberate and iterative” (p. 7, Michaels and Wood, 1989). It is a commitment deliberately entered into by management to make substantial investments at the beginning of the product’s development to ensure the long – term benefits from such a product (p. 8, Michaels and Wood, 1989). Two of the major elements of this model are the proper estimation of costs at the beginning of the project and the effective controlling of such costs. Cost estimation is not only a critical element for the successful implementation of the DoC, it is also an important offshoot of the most critical phase in the designing stage of a product. As a matter of fact, “75% of the total life cycle cost is committed” (Blanchard as quoted by Hari, Shoval and Kassel, 2008) in the conceptualizing and designing stages of a certain product. On the other hand, this model requires a firsthand knowledge of the actual costs of the product. This knowledge may not actually be there when it comes to assessing the actual environmental costs of a certain product, as such costs may be unknown during the conceptualizing and designing stages of the product or such costs may be incurred in the far away future that it is virtually impossible to estimate them during the same stages. With this, the DoC model may not be appropriate for an entity when it comes to integrating the environmental costs in its product life cycle costs. Total Cost Assessment In a manual prepared by the American Institute of Chemical Engineers or AIChe (2000), TCA was described as a “dynamic and emerging concept that seeks to provide a process for quantifying all environmental and health costs; both internal and external, associated with a business decision”. The TCA is considered as a valid approach for companies to meet their dual goals of sustainability and environmental efficiency by objectively identifying all the risks and costs related to the product and its production process. The TCA takes into account not only the direct and tangible costs of a product, but also the indirect and hidden costs, as well as the future contingent costs of the product, which are the costs usually associated with the environmental costs of the product. In its ideal sense, TCA then can contribute to any entity using it in assessing the environmental impact and costs of its product. Whole Life Cycle Costing Whole life cycle costing (WLCC) is an offshoot of the LCC concept and is an emerging approach mainly designed for the construction industry. It’s main purpose is to “aid capital investment decision making by providing forecasts of the long – term costs of construction and ownership of a building or structure” (p. 3, Boussabaine and Kirkham, 2004). It is touted as an approach that is more dynamic than LCC. According to Boussabaine and Kirkham (2004), the WLCC is said to address the expectation of more efficient building structures, even long after the construction of the building has been completed. The development and subsequent promotion of WLCC as a better alternative than LCC recognizes the fact that environmental problems actually came out as a result of construction activities. According to Boussabaine and Kirkham (2004), the global environmental impact is one of the major problems linked with the activities related to the building of assets. With the WLCC, one of its advantages is that it takes into consideration the environmental impact or risks of building an asset and how to address such a risk. The risk management process, which is a component of WLCC, is the process responsible for identifying these environmental risks (among others) and for identifying ways to address these risks (including who is responsible for managing the risks). Thus, the WLCC (at least in theory) integrates into the entity’s planning and monitoring processes the considerations of the environmental factors and impact of building an asset and how the impact can be addressed even after the asset has been constructed. How Product Life Cycle Costing Methods Can Be Improved It is worthwhile to note that almost all of the models or approaches described in the previous section of this paper have already managed to integrate the environmental impact in their product life cycle cost model. However, there is a noticeable lack of a distinct formula that integrates the accounting for the eco-costs as described by Kumaran, et. al. (2000). There is also a lack of information on the results of the actual application of these LCC methods. In addition, these are merely quantification of the eco-costs. But what about the system that needs to be in place to identify these costs in the first place? First of all, any product life cycle costing method that aims to integrate the environmental costs in the costing method will not be effective if the entity does not develop an “efficient environmental management systems including hidden and unaccounted environmental costs” (Kumaran, et. al., 2000). Side – by – side with developing a costing method, the entities should also have a system in place that can account for such hidden costs. Lack of awareness of such costs will mean that these will not be fully integrated in the costing method, making the method ineffective as far as accounting for these environmental costs is concerned. Second, 100% accounting of the actual eco-costs is also vital to ensure the effectiveness of the LCC approach. The entity should study and fully identify these costs to make the inputs to its costing method more accurate and complete. Part of this identification of eco-costs is the thorough consideration of alternatives and initiatives available to the entity as far as the environmental impact and considerations are concerned. Third, it is quite possible that there will be a lot of environmental impact, issues and even costs of a certain product. Inclusion of all of them may not be feasible based on a cost – benefit analysis, thus, the environmental costs and considerations should be filtered and only those considered truly vital should be included in the calculation of the product life cycle cost. To this end, the entity should make an analysis on the optimal formula that it can use for its product life cycle cost, a formula that will also integrate the vital environmental costs without sacrificing the quality and importance of the results produced by such method. Fourth, the entity’s management should be fully sold to the idea of integrating the environmental costs to its costing method and to its assessment of the over – all performance of the entity. Management should realize what the benefits and drawbacks are as far as integrating the environmental costs in its costing method and system. Without this realization, no LCC method, no matter how thorough its formula and inputs are, will be successful. Fifth, prior to implementing or improving its LCC method, the entity should have a thorough knowledge of its production process and identify areas where it can achieve the “greatest reduction in environmental burden…and minimize direct pollution and other environmental burdens” (LeVan, 1995). No matter how good the costing method is in theory, it will not be effectively implemented if the entity does not know what factors, costs and processes need to be considered in completing the LCC formula. Sixth, the methods should integrate both qualitative and quantitative data as far as assessing the actual environmental costs of the product is concerned. Considerations of both sets of data will ensure that the product life cycle costs are more flexible and more in tune with the actual reality of the environmental impact of the product. Lastly, the entity and the method should take into consideration the prevailing regulations and public expectations as far as the environmental impact are concerned. Currently, the International Organization for Standardization or ISO has already issued ISO 14001:2004 and 14004:2004 (ISO, 2010), both of which deal with the environmental management system. The World Resources Institute and the World Business Council for Sustainable Development (2009) have also issued the Product Life Cycle Accounting and Reporting Standard. Awareness of these issuances and, ultimately, compliance to them will go a long way towards ensuring an effective LCC method for the entity. Conclusion The LCC has come a long way towards meeting the needs of the business entities as far as quantifying and analyzing their product life cycle costs are concerned. Various approaches, methods and formulas have already been developed to accommodate the various needs of these business entities. However, the growing awareness on the environmental impact and costs of various products has resulted to these methods being analyzed as to their effectiveness in integrating these costs in the product life cycle costs. This resulted to improvements on these methods, as well as integration of some of these methods to produce more responsive product life cycle cost methods. What needs to be done now is to back up these improvements with actual case studies and actual results. Only when these methods are proven highly successful in the real world can it be truly said that they are effective in fully integrating the environmental factors and costs in the life cycle cost of a product. References Akyol, D., Tuncel, G. and Bayhan, G. M. (2005). World Academy of Science, Engineering and Technology. March 2005. Available at: http://www.waset.org/journals/waset/v3/v3-11.pdf (Accessed: April 28, 2010). American Institute of Chemical Engineers (2000). 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