environmental cost

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Environmental cost accounting and auditing

Peter Letmathe

Assistant Professor, Ruhr-Uni Bochum, Bochum, Germany

Roger K. Doost

Professor, School of Accountancy, Clemson University, Clemson,

South Carolina, USA

Introduction

The currently high consumption of goods and

services falls short of the vital necessity for

sustainable development. West European

countries seem to be further ahead with

regard to the environmental matters as

compared to the USA. For example, the

German Federal Environmental Agency (1997)

emphasizes the following alarming trends:. Increase in mean global air temperatures

by 0.3 to 0.6C since the end of the

nineteenth century.. Sea level rise of between 10-25 centimeters

over the last 100 years.. Depletion of the stratospheric ozone layer.. Accelerating species extinction.. Continued erosion and rapid loss of fertile

soil.. Pollution and overfishing of the seas.. Gradual over-taxation of the earth system

through anthropogenic loads.. A change of the direction of the Gulf

Stream which can result in chaos of the

whole world climate.

The total estimated damage caused to the

natural environment in one day according to

the German Federal Environmental Agency

(1997) is given by:. the destruction of 55,000 hectares of

tropical forest;. the reduction of arable land by 20,000

hectares;. the extinction of 100 to 200 species;. emission of 60 million tons of carbon

dioxide into the atmosphere.

Extension of traditional cost accounting

systems to account for environmental impacts

and their costs started towards the end of the

1970s in Germany. In 1979, two guidelines of

the Bundesverband der Deutschen Industrie(1979) and of the Verein Deutscher Ingenieure

(1979) were published which included rules on

how to calculate the business costs of

environmental protection. These guidelines

helped companies to comply with their

reporting requirements for public statistics in

Germany. But this approach was not decision-

oriented and, therefore, not suitable for

systematic environmental management.

Hence, many companies tried to achieve legal

compliance and to satisfy the interests of their

stakeholders mostly through self-designed

management methods.

During the 1980s and 1990s, the German

government introduced a number of new

regulations in the environmental area. As a

result, the legal compliance costs for wastewater purification and for filtering emissions

increased substantially. Further, the costs of

many undesired byproducts such as

hazardous waste and waste water increased

in many cases by several hundred percentage

points. This development motivated many

companies to look closer at the costs of their

output flows, and many case studies about

cost reduction through environmental

protection were published. Gege (1997), who

is a representative of an environmentally-

oriented association of enterprises (BAUM),

estimated in 1997 that companies couldreduce by 5 per cent their total costs with a

decision-oriented environmental

management system. These systems should

include reliable data about the costs of

material and energy. Gege's book contains

about 1,000 examples on how companies

achieved cost reduction through

environmental protection. Klassen and

McLaughin (1996) see a significant impact of

environmental management on firm

performance. As key advantages, they

mention cost reduction because of

technological changes and reduced material

and energy consumption. Eco-labeling of

products can result in a substantial gain in

the marketplace.

Letmathe (1998) provides more systematic

environmental cost accounting approaches,

The current issue and full text archive of this journal is available at

http://www.emerald-library.com

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Managerial Auditing Journal15/8 [2000] 424430

# MCB University Press[ISSN 0268-6902]

Keywords

Environmental impact,

Sustainable development,Hazardous materials,

Environmental audit, Law, Waste

Abstract

An environmental cost accounting

system is a flow- and decision-

oriented extension of traditional

cost accounting systems. It is

based on cause-and-effect

analysis which helps to assign the

costs of environmental impacts

correctly to their perpetrators.

This article attempts to

demonstrate how to use an

environmental cost accounting

system for internal and external

audits and performance

improvements. The generated

information is appropriate to see if

objectives and targets are

achieved. High amounts of

environmental impacts point to

inefficiencies in the production

area. Their elimination can help

accomplish both ecological and

business goals of a company.


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which were developed in this decade. He

focuses not only on the correct accounting for

the costs of environmental protection but

also considers the costs of environmental-related flows of materials and energy. The

overall goal is to accomplish both business

goals and improvements in the area of

environmental protection (see Hansen and

Mowen, 1999, ch. 12).

The flow- and decision-oriented

perspective of environmental cost accounting

supplements the more process-oriented way

of thinking of most companies. This is

especially advantageous if costs of materials,

processes, and products have an impact in

other areas, e.g. cost of waste disposal and

spoilage. Environmental cost accountingshows the real costs of inputs and the

business processes and ensures cost-efficient

legal compliance. In addition, the results can

be applied in other areas, e.g. for measuring

quality and service costs.

Environmental audits examine the whole

environmental management system. The

main goals are to check legal compliance and

to find inefficiencies which can reduce both

the amount of environmental impacts and

cost. An appropriate information base does

not only decrease the necessary efforts to

carry out the audit, it improves the results of

the audits as well. This paper shows how an

environmental cost accounting system works

and how it can improve the results of

performance-oriented audits.

Purpose of environmental costaccounting

An environmental cost accounting system is

a flow-oriented cost accounting system which

is based on a systematic cause-and-effect

analysis. Especially output-related costs, e.g.

for emissions, waste disposal and wastewater are assigned correctly to the inputs

which cause them. In traditional cost

accounting systems, these costs are treated

like other overhead costs and allocated

arbitrarily. For example, emissions, waste

disposal and waste water costs may be

accumulated and prorated arbitrarily among

the various cost centers regardless of which

ones caused those costs to occur in the first

place. This procedure does not include any

incentives for the cost centers to reduce

environmental impacts and their costs.

Ansari et al. (1997) argue that the correct

assignment of environmental costs to their

perpetrators can help reduce costs in other

areas too. A high amount of waste is very

often a sign of inefficiencies in business

processes. For example, spoiled production

not only increases costs of waste disposal, it

also leads to higher costs of manufacturing

because of additional material, labor, and

overhead which goes to spoiled goods.Environmental costing accounting

contributes to an internal pricing system

which evaluates inputs, processes and

products with their real costs. This procedure

creates both a decision-oriented information

base for the environmental management

system and for planning, control and

supervision of material and energy flows.

Therefore, environmental cost accounting is

an appropriate instrument to ensure legal

compliance with lower costs. It integrates

environmental aspects in all areas of

planning which use cost data automatically.Besides, environmental data improve the

understanding of the business processes. For

example, companies which have data about

output flows are often surprised about the

volume of their waste flows and the costs

which are related to them. This information

can help find measures and change the

attitude of the organization to environmental

protection (see Ansari et al., 1997).

To achieve this, it is necessary to extend

the existing cost accounting system. But

management will only agree with such an

extension if benefits of the additional

information are higher than the costs to get

them. Hence, the integration of the

traditional and the environmental cost

accounting systems must be justified.

Opportunities to extend and adjust the system

to meet changing business requirements

facilitate the decision to introduce such a

system. To run such a system, it is not

necessary that the cost area managers be very

knowledgeable about cause-and-effect of

environmental costs. The internal prices,

which include costs of environmental

impacts, are the main incentives to reduce

environmentally-related costs.The systematic consideration of the

environmental impacts also makes sense for

organizations with a defensive

environmental strategy. Even if an

organization does not have the explicit goal

of protecting the environment and only

reacts according to the environmental

regulations, there is considerable potential

for more success in achieving the traditional

company objectives such as, maximizing

profits or higher level of market share.

Structure of an environmental costaccounting system

To identify and to assign environmental costs

correctly, the complex cause and effect of

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Peter Letmathe andRoger K. DoostEnvironmental costaccounting and auditing



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environmental impacts should be considered.

The following approach emphasizes the task

of cost accounting to deliver information for

planning, control and supervision of

business processes. Figure 1 shows the

structure of this environmental cost

accounting system.

Only if flows of material and energy are

recorded and evaluated with their realistic

costs, environmental costing can help control

these flows in an appropriate way. To achieve

this target, five steps which are partly

carried out simultaneously are required:

1 At first, the EMS-group has to identify

environmental impacts of its

organization. This is also one of the

requirements of the ISO 14001 standard.

Normally, most of the impacts are related

to materials including storage,

production, and distribution. The cause

and the kind of environmental impacts

should be documented. In this step, the

EMS-group has to decide which of the

environmental impacts are of high or low

significance. Only the high-significance

impacts will be considered and evaluated

in an environmental cost accounting

system.

2 The next step is to figure out which flows

of material and energy are causing the

significant environmental impacts. If

possible, the impact of one item of amaterial or energy source should be

measured. A single material can cause

different environmental impacts. For

example, chlorofluorocarbons contribute

to the greenhouse effect and to the

depletion of the ozone layer.

3 To be able to calculate environmental

costs, the quantities of material and energy

have to be determined. For the purpose of

planning, it is useful to implement

environmental bills of materials and

energy and to assign them systematically

to inputs, processes and products. Tocontrol the flow of material and energy,

their actual volume can be compared with

the standard quantities. This procedure is

not only appropriate to reduce

environmental impacts, inefficiencies

which lead to higher cost and/or quality

problems can also be avoided.

4 After accounting for their quantities, the

flow of material and energy should be

evaluated with their realistic costs. Only a

realistic assignment can prevent that

environmental cost be underestimated

Figure 1

The concept of an environmental cost accounting system

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systematically. Besides the purchase cost,

other costs may also be relevant. Examples

are costs for the treatment and logistical

handling of purchased goods or waste.5 Finally, the environmental costs have to

be assigned correctly to their causing

objects like input, processes and products.

This will be carried out according to the

bills of material and energy which were

mentioned in step 3. Internal prices are

the result of adding all cost components of

a single material and energy sources.

These internal prices can be used for

planning and control of inputs, processes,

products and environmental impacts.

Bills of environmental impactsAll environmental impacts can be traced

back to flows of material and energy. To

assign them correctly to their perpetrators

three different kinds of environmental

impacts can be distinguished:

1 Input-related environmental impacts are

directly caused by the use of an input, like

the carbon dioxide emissions as the result

of burning coal, oil or other fossil energy

sources. Input-related environmental

impacts are independent of the process in

which the input is inserted.

2 Process-caused environmental impactscannot be assigned to a single input. They

are a consequence of carrying out a

specific process. They are caused by a

combination of inputs, like emission

which depends on the temperature of a

process.

3 Product-caused environmental impacts

can be traced back to a product but not to

a single input or process. An example is

the energy use during the consumption

phase or the waste after the product's use.

To investigate the flows of materials and

energy, these information sources may be of

interest:. The manufacturer of the machine which

is needed to carry out the production

process knows the materials and energy

sources which are required to run it.

Additionally, he/she can give details

about technological efficiency and the

spoilage rate. Customers, who already

work with this technology, can provide

further information.. The quality manager knows about the

existing and potential sources of quality

problems. Statistical quality controlprovides information about the optimum

specification of materials and other

process parameters to meet the quality

standards of the organization.

. Scientific literature gives further details

about the productivity and specific risks

of a production technology. Such

information is extremely valuable if anorganization wants to introduce a

technologically new process.. The environmental management gathers

data about environmental impacts of the

organization. Its experience and

knowledge can contribute to the

estimation of material and energy flows

and the process risks as well.. Communication with the organization's

stakeholders can reduce conflict of

interests. Ideally, members of the

stakeholder groups have knowledge

which can lead to a more environmentallyfriendly and cost efficient production.

As a result, bills of materials and energy can

be generated. This information can then be

used to plan environmental impacts in

advance and to control the level of impacts

during the production phase. If there are

significant differences between the standard

and actual environmental impacts, then

corrective action should be taken.

Bill of environmental impacts of an input

The bill of environmental impacts of an input

(see Figure 2) includes all environmentalimpacts which can be traced back to a single

material or energy source. This means that

the amount of environmental impact does not

depend on the process in which the input is

used. In this step, all the input-related

environmental impacts have to be assigned

to the input which caused them.

Bill of environmental impacts of a processThe bill of environmental impacts of a

process (see Figure 3) contains

environmental impacts which are caused if a

process is carried out. The total

environmental impacts of a process are thesum of both the direct process-related and the

input-related environmental impacts. The

direct process-related environmental impacts

cannot be assigned to a single input. The

input-related environmental impacts can be

calculated through the multiplication of

input-coefficients of the process with the

Figure 2

Bill of environmental impacts of an input

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input-related environmental impacts per unit

of the considered input. The input-related

environmental impacts are given by the bills

of environmental impacts of the inputs.

Bill of environmental impacts of a product

With the bill of environmental impacts of a

product (see Figure 4) significant

environmental impacts can be assigned

correctly to a product. The environmental

impacts of a product contain the direct

product-related environmental impacts and

all input-and process-related impacts which

are caused through the processes and inputs

to manufacture the product.

The described bills of environmental

impacts give a company the opportunity toplan, control and supervise its

environmental impacts much more

systematically. If the actual environmental

impacts, e.g. represented through the amount

of emissions or waste water, are higher than

the standard impacts, these indicate

inefficiencies in the business processes. Also

legal compliance can be achieved much

better with appropriate data. But because the

environmental impacts are only measured in

quantities, there is no way to ensure legal

compliance and the accomplishment of

business goals cost efficiently. Therefore, thecalculation of internal prices of material and

energy sources is the next logical step to

create a decision-oriented information base.

Internal pricing

The recorded quantities of material and

energy need to be evaluated with their

realistic costs. In addition to the purchase

costs, other cost components are often

relevant (see Figure 5):. Treatment costs result from the

separation, refinement, and cleaning of

used materials or undesired residuals like

waste, waste water, and emissions.. Logistic costs include the costs of storage

and transportation as well as costs for

security measures to avoid accidents and

uncontrolled environmental impacts.. In Europe, many manufacturers have to

take back their old products (see Epstein,

1996) after usage. An example is the new

European regulation which obliges all car

manufacturers to take back all old cars

from the year 2005. The amount of cost

depends on the ability to dismantle andrecycle the products. Processes which

improve the reusability of the products

can reduce such costs.. Costs of environmental risks are

determined by financial risks which are

uncertain with regard to their occurrence

and their amount. Examples are liability

risks of high environmental impacts (see

Rubenstein, 1994). The costs of

environmental risks can be estimated

through the expected value minus or plus

a security charge.. Supervision costs are incurred on the

documentation and control of harmful

substances and waste to achieve legal

compliance. The costs for the EMS

documentation are also included in this

category.. Additional control costs may be used to set

incentives to reduce the use of a material

which causes considerable environmental

impact. They help to control the use of

material and energy according to the

environmental objectives and targets in

the environmental program. It is also

conceivable to consider the externalities of

material and energy use.

The internal prices (Figure 5) change the

relative prices of inputs, processes and

products. The result indicates the

substitution of harmful material through

Figure 3

Bill of environmental impacts of a process

Figure 4

Bill of environmental impacts of a product

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other substances which are less harmful and

result in lower costs.

Auditing and environmental costs

Environmental cost accounting provides

information for planning, control and

supervision. All areas which use cost data

automatically integrate the extended

information into their own planning system.

Besides, information from an environmental

cost accounting system can be used for

investment decisions, for launching new

products, etc. The bills of environmental

impacts can be integrated in production

planning and control systems.

To examine how environmental costaccounting can deliver useful information for

auditing, it makes sense to distinguish

between internal and external audits.

External audits or third-party audits are

carried out to review the management system

by an independent external auditor or

registrar. The most common external audits

are the ISO 9000 and ISO 14001 audits which

review the quality management or

environmental management system. Both

audits are conducted to see if the management

system meets the requirements of the relevant

standards. Although they are formal and not

result-oriented standards, appropriate data

can support the work of the registrar. Data

about input and output flows of material and

energy show if the business processes are

properly documented. The ISO 14001 (see

Clemens, 1996) standard is dedicated to

continual improvement as the overall goal of

environmental management systems. To

accomplish this, the organization has to

define concrete objectives, targets, and

measures to achieve them. Concrete measures

and targets can include the reduction of

waste, waste water, and emissions. If these

outputs are accounted for through theenvironmental cost accounting system, it

would be much easier to compare the current

flow with the flow in the next period. This

gives the organization the opportunity to

review its improvements. To retain ISO 14001

or ISO 9000 certification, external audits must

be repeated frequently (see Culley, 1998).

Especially the way the organizationdocuments and supervises its improvements

may be viewed with much interest.

Internal audits can be carried out to

prepare for external audits for the mentioned

standards. They are also conducted to

ascertain compliance with management's

goals. These audits can use the information

base of an environmental cost accounting

system in the same way as the external

audits. The more work is done through

continuous and systematic review of the

company's environmental measures by the

internal auditors, the less time, effort, and

money need to be spent by the externalauditors in this area.

Another kind of audit is performance

auditing. Performance audits measure the

current performance of the organization and

try to identify potentials for improvement.

Performance audits can also be a basis for

defining objectives, targets and measures

which should be attained in the future. To

achieve an adequate level of a performance

audit, companies need to review (Cushing,

1994) their:. organizational arrangements to ascertain

that proper division of responsibilities

exist to achieve the organization's goals;. system planning to make sure about the

adequacy of system development projects

to handle the complexities of the proposed

cost system;. personnel policies to ascertain the

presence of proper standards for hiring,

training, and assigning of personnel to

handle the tasks necessitated as a result of

new requirements;. financial controls to make certain about

the adequacy of responsibility accounting

and reporting procedures for measuring

costs and variances attributed to variousoperations and cost flows; and. computer operations to ascertain about

proper data processing capabilities in

terms of equipment, software, and

personnel.

For these tasks to be accomplished,

comprehensive information is needed which

is based on a cause-and-effect-analysis.

Very often, a high volume of waste, waste

water and emissions is the result of

inefficiencies. Inefficiencies can also be

pointed out by high variations of the amount

of undesired byproducts. Hence, performance

audits should prioritize areas/cost centers

which are responsible for most of the

environmental impacts. For example, a high

amount of wasted heat can indicate the need

for investment in a heat recovery system. A

Figure 5

Calculation of internal prices for material and energy flows

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high volume of fresh and waste water usage

can be reduced by a closed-loop cycle.

Spoilage can be avoided through technical

and organizational measures or substitutionof materials. Waste can be separated and at

least a part of it recycled. Another way is to

reduce the costs for waste disposal through

more efficient processes. This leads also to

lower purchase costs for raw material.

Because management is focusing on overall

costs and not only on purchase cost, it can

make more informed decisions.

A self-audit and inspection by the internal

audit department is often a necessity to satisfy

Environmental Protection Agency (EPA)

requirements and reduce potential additional

external costs. The Environmental Protection

Agency (EPA, 1998) has published a self-auditpreparation guide for organic coating

facilities which covers the following areas:. air emissions;. wastewater management;. hazardous materials/waste management;. solid waste management;. community right-to-know;. pollution prevention.

The first three areas are audited with the

help of several checklists which includes the

inspection of the following areas:. records to review;.

physical features to inspect;. responsibilities of supervisors and

managers;. supervisor's and manager's management

of the considered area and resource

recovery;. organic finishing facilities.

The reviewed records include data about the

amount of emissions, wastewater, and waste.

These flows can be reviewed much easier if

an environmental cost accounting system

provides the appropriate data. If the

inspectors see that these data are in

compliance with the inspected physicalfeatures, the whole inspection can be

accelerated. Where continuous supervision

of significant environmental impact is

present, the EPA finds few, if any, violations.

The recording of material and energy flows

documents the responsible handling of

environmental issues and is therefore a good

basis for demonstrating the organization's

environmental compliance.

Conclusion

An environmental cost accounting systemthat is based on a cause-and-effect

relationship is necessary. It is needed for

better identification and proper charging of

environmental related costs. Such a system

not only helps the company in terms of

performance improvements, but it provides a

very important road map for internal and

external auditors in their endeavors todetermine the entity's compliance with

company policies as well as environmentally-

related laws. Improvements achieved as a

result of creation and monitoring of an

effective environmental cost accounting

system can help the company achieve its

goals, comply with environmental laws, and

contribute to the health of the ecology for our

generation as well as generations to come.

ReferencesAnsari, S., Bell, J., Klammer, T. and Lawrence, C.

(1997), Measuring and ManagingEnvironmental Costs, Irwin, Chicago, IL.

Bundesverband der Deutschen Industrie (1979),

Anleitung zur Bestimmung der Betriebskosten

fu r den Umweltschutz in der Industrie, Ko ln.

Clemens, R.B. (1996), Complete Guide to ISO 14001,

Prentice-Hall, Englewood Cliffs, NJ.

Cushing, R. (1994), Accounting Information

Systems, Addison-Wesley, New York, NY.

Culley, W.C. (1998), Environmental and Quality

Systems Integration, Lewis, Boca Raton, LA.

Environmental Protection Agency (EPA) (1998),

Self-audit and Inspection Guide for Facilities

Conduction Cleaning, Preparation, and

Organic Coating of Metal Parts, EPA,

Washington, DC.Epstein, M.J. (1996), ``Accounting for product take

back'', Management Accounting, August,

pp. 29-33.

Gege, M. (1997), Kosten senken durch

Umweltmanagement, Vahlen, Mu nchen.

Hansen, D.R. and Mowen, M.M. (1999),

Management Accounting, 5th ed., South-

Western, Cincinetti, OH.

Klassen, R.D. and McLaughin, C.P. (1996), ``The

impact of environmental management on

firm performance'', Management Science,

Vol. 42, pp. 1199-214.

Letmathe, P. (1998), Umweltbezogene

Kostenrechnung, Vahlen, Mu nchen.

Rubenstein, D.B. (1994), Envrionmental

Accounting for the Sustainable Coperation,

Quorum, Westport, CT and London.

Verein Deutscher Ingenieure (1979), VDI-

Richtlinie 3800 Kostenermittlung fu r Anlagen

und Manahmen zur Emissionsminderung,

Du sseldorf.

Further readingEpstein, M.J. and Birchard, B. Counting What

Counts: Turning Corporate Accountability to

Competitive Advantage?

Federal Environmental Agency (Germany) (1997),

Sustainable Germany, Berlin.

Gallhofer, S. and Haslam, J. (1995), ``Worryingabout environmental auditing'', in

Lehman, G. and Owen, D. (Eds), Social and

Environmental Accounting, Special Edition of

Accounting Forum, Vol. 19, pp. 205-18.

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