Environmental Accounting

1 Why environmental accounting?

Traditional costs were unable to relate environment and performance of the business

As time passed, government regulations became stringent so it was required to have some management function towards managing such costs in order to avoid getting into regulatory issues and so putting that in normal decision making process.

Also until now, environmental costs are treated as a way of penalizing organizations. So effort was needed to make managements across the globe to realize that its not only a matter of getting penalized but there are also some monetary incentives which they were not recognizing. This was mainly because not much work was done to link the environment with the performance of the business. And when it was considered than at most it was considered in relation to business goodwill and nothing beyond.

1.1 Why it was ignored/ not realized?

An environmental cost tends to be hidden in overheads. Management needs to identify them. Now as they were hidden, managements were unable to understand that by identifying them steps can be taken to reduce them. And this is what management is interested in every other cost as reducing costs results in increasing profits. For years this remained undiscovered but now we are discussing it under environmental management accounting.

Traditional cost accounting techniques accumulates costs until the product is sold to customer. Whereas environmental cost accounting suggests that costs must be accumulated until the last of product remains i.e. until product vanishes including how it has impacted the environment during its life and at the end of life. This was not recognized by absorption costing as it does not include the ‘future costs’ and intangible costs like litigations and claims that will be incurred e.g. water treatment costs, law suits by pressure groups for polluting air etc.

Problem of absorption costing to allocate more overheads to high unit products is still there and provides inaccurate view of products and thus wrong pricing decisions.

1.2 Why difficult to connect the two?

Accounting relates to costs and incomes generated during the business whereas economists calculate the impact on environment on the basis of how inputs have been translated to variety of outputs and how these outputs ultimately affected the environment. This is where problem exists. The point is business account for costs and incomes half way. Whereas economists start tracing costs and incomes where accountants stopped and thus both the parties not understanding each other. The concept of ‘external costs’ must be diluted and even the external costs should be realized as part of regular costing decisions so that business also starts taking responsibility. And once that is done, definitely it will be a burden on business and thus decreasing their profitability. And this is when managements will start taking care of the costs they are incurring and they will be motivated to control them and will go back to the starting point i.e. identifying the products which are actually causing such environmental costs and thus controlling the wastage right before it becomes the waste and not waiting for it have it and then thinking about disposing of such wastes.

Another possible reason why it stayed like this is not very common but important and that is usually the personnel deciding about the costs do not have complete information or is not provided with full information intentionally. Thus the people who can solve the problems have no clue about it and person who is holding it i.e. owner most of the time have no idea how to solve the issue as he lacks the understanding.

2 Environmental cost – actual and real cost

Enovironmental costs have two dimensions:

  • Damage to environment i.e. wasted efforts and money [corporate losses]
  • Protection costs i.e. making it useful again and resulting more cash outflow

Prices should reflect the real cost to the society

In order to put accountants and economists at one place environmental management accounting has two planes: Monetary and Physical. Figure representing overlapping of accounting and economics giving environmental management accounting.

2.1 Dealing with environmental costs

AT first place many organization adopt end-of-pipe technologies to fight environmental impacts. But students have shown that such technologies cause more costs ultimately and it is much better that steps should be taken that such wastes be avoided right from the beginning.

This is a two phase process:

  • changes in product design / process
  • better housekeeping assisted by environmental management system.

Waste has two meanings:

  • waste of capital employed and;
  • inability to recover the revenues that were expected from sales.

Costs paid include cost towards:

  • material (raw material and water and energy) and
  • labour.

Now if we understand that money flows with material then we can understand the channels in which money flowed in and out of the system and where it went. By tracing the material flow we will be able to understand how our money has been utilized and where it is wasted and how much. By doing this we will also be able to quantify the non-product output or wastes which traditional accounting systems were unable to do and thus management was without any hint of improvements towards wastages. Out of sight, out of mind!

IN order to evaluate the amounts and then ultimately impacts of wastages, four methods have been identified. By identifying such costs we will not only in a position to control such costs but also the research and development process to reduce such costs will also be initiated.