Environmental Management Accounting (EMA)

In a bid to help control environmental costs many firms are adopting environmental
management accounting techniques.

Environmental Costs

Environmental costs can be split into two categories:

Internal costs

These are costs that directly impact on the income statement of a company.

For example:

improved systems and checks in order to avoid penalties/fines

waste disposal costs
product take back costs
regulatory costs such as taxes
upfront costs such as obtaining permits
back-end costs such as decommissioning costs on project completion
External costs

These are costs that are imposed on society at large, but not borne by the company
that generates the cost in the first instance.

For example,

carbon emissions
usage of energy and water
forest degradation
health care costs
social welfare costs
However, governments are becoming increasingly aware of these external costs and
are using taxes and regulations to convert them to internal costs. For example,
companies might have to have a tree replacement programme if they cause forest
degradation, or they receive lower tax allowances on vehicles that cause a high
degree of harm to the environment.

Drawbacks of traditional management accounting

Management accounts provide us with an analysis of the performance of the

business. However, traditional accounting systems are unable to deal adequately
with environmental costs. As a result, managers are unaware of these costs and
have no information with which to manage or reduce them.

Illustration - Reputational costs

In April 2010 a blast at the Deepwater Horizon rig in the Gulf of Mexico killed eleven
people and caused one of the worst oil spills in history. The US presidential
commission concluded that the oil spill was an avoidable disaster caused by a series
of failures and blunders made by BP, its partners and the government departments
assigned to regulate them. It also warned that such a disaster was likely to recur
because of complacency in the industry.

For BP, the company at the heart of the disaster, the effects have had a deep and
widespread impact. The company has become synonymous with everything that is
dangerous about oil exploration causing massive reputational damage.

Using environmental management accounting to address these problems

To ensure that environmental costs are fully considered and to improve the
environmental performance of an organisation, a new technique called
environmental management accounting (EMA) has been introduced.

EMA:

identifies and estimates the costs of environment-related activities and seeks to

control these costs
identifies and separately monitors the usage and cost of resources such as water,
electricity and fuel and enables these costs to be reduced
ensures environmental considerations form a part of capital investment decisions
assesses the likelihood and impact of environmental risks
includes environment-related indicators as part of routine performance monitoring
benchmarks activities against environmental best practice.
In summary, the focus of EMA is not all on financial costs but it also considers the
environmental cost or benefit of any decisions made.

EMA techniques

Four key techniques are often used within EMA. The techniques can assist an
organisation in improving its performance. They are not mutually exclusive.

Activity-based costing (ABC)

ABC distinguishes between:

environment-related costs which can be attributed directly to a cost centre, e.g. a

waste filtration plant, and
environment-driven costs which are generally hidden in overheads.
The environment-driven costs are removed from general overheads and traced to
products or services. This means that cost drivers are determined for these costs
and products are charged for the use of these environmental costs based on the
amount of cost drivers that they contribute to the activity. This should give a good
attribution of environmental costs to individual products and should result in better
control of costs.

Input/output analysis

This technique records material inflows and balances this with outflows on the basis
that what comes in, must go out.

For example, if 100kg of materials have been bought and only 80kg of materials
have been produced, then the 20kg difference must be accounted for in some way.
It may be, for example, that 10% of it has been sold as scrap and 90% of it is waste.
By accounting for outputs in this way, both in terms of physical quantities, and, at
the end of the process, in monetary terms too, businesses are forced to focus on
environmental costs.

Flow cost accounting

This technique uses not only material flows, but also the organisational structure.

It makes material flows transparent by looking at the physical quantities involved,

their costs and their value.

It divides the material flows into three categories : material, system and delivery
and disposal. The values and costs of each of these three flows are then calculated.
The aim of flow cost accounting is to reduce the quantity of materials which, as well
as having a positive effect on the environment, should have a positive effect on a
business' total costs in the long run.

Lifecycle costing

Lifecycle costing considers the costs and revenues of a product over its whole life
rather than one accounting period. Therefore, the full environmental cost of
producing a product will be taken into account. In order to reduce lifecycle costs an
organisation may adopt a TQM approach.

It is arguable that TQM and environmental management accounting are inextricably

linked insofar as good environmental management is increasingly recognised as an
essential component of TQM. 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.

NB: The benefit of each of the techniques must be weighed against the cost of
providing the additional information.

Illustration - Cost reduction at McCain Foods

One example of energy saving is McCain Foods, which buys an eighth of the UK's
potatoes to make chips.

It has cut its Peterborough plant's CO2 footprint by two-thirds, says corporate affairs
director Bill Bartlett. It invested 10m in three 3MW turbines to meet 60 per cent of
its annual electricity demand. McCain spent another 4.5m on a lagoon to catch the
methane from fermenting waste water and particulates, which generates another

10 per cent of the site's electricity usage. It also wants to refine its used cooking oil,
either for its own vehicles fleet or for selling on.

McCain want to become more competitive and more efficient.

EMA and effect on financial performance

There are a number of ways in which environmental issues can have an impact on
the financial performance of organisations.

Improving revenue

Producing new products or services which meet the environmental needs or

concerns of customers can lead to increased sales. It may also be possible to sell
such products for a premium price. Improved sales may also be a consequence of
improving the reputation of the business.

It is possible that in the future, rather than good environmental management

resulting in improved sales, poor management will lead to losses. All businesses will
be expected to meet a minimum standard related to environmental issues.

Cost reductions

Paying close attention to the use of resources can lead to reductions in cost. Often
simple improvements in processes can lead to significant costs savings.

Increases in costs

There may be increases in some costs, for example the cost of complying with legal
and regulatory requirements, and additional costs to improve the environmental

image of the organisation. However some of these costs may be offset by

government grants and this expenditure may save money in the long-term as
measures taken may prevent future losses.

Costs of failure

Poor environmental management can result in significant costs, for example the
cost of clean-up and fines following an environmental disaster.