A member of the Paper F5 examining team provides students with an introduction to environmental management accounting

The new Paper F5 syllabus, which is effective from June 2011 onwards, introduces the area of environmental management accounting for the first time. It has, so far, been examined only in Paper P5 but, with its growing importance, it seemed appropriate to introduce it at an earlier level. The two requirements of the Paper F5 syllabus are as follows:

·           discuss the issues businesses face in the management of environmental costs

·           describe the different methods a business may use to account for its environmental costs.

You should note that the Paper F5 syllabus examines 'environmental management accounting’ rather than ‘environmental accounting’. Environmental accounting is a broader term that encompasses the provision of environment-related information both externally and internally. It focuses on reports required for shareholders and other stakeholders, as well of the provision of management information. Environmental management accounting, on the other hand, is a subset of environmental accounting. It focuses on information required for decision making within the organisation, although much of the information it generates could also be used for external reporting.

The aim of this article is to give a general introduction on the area of environmental management accounting, followed by a discussion of the first of the two requirements listed above.

Many of you reading this article still won’t be entirely clear on what environmental management accounting actually is. You will not be alone! There is no single textbook definition for it, although there are many long-winded, jargon ridden ones available. Before we get into the unavoidable jargon, the easiest way to approach it in the first place is to step back and ask ourselves what management accounting itself is. Management accounts give us an analysis of the performance of a business and are ideally prepared on a timely basis so that we get up-to-date management information. They break down each of our different business segments (in a larger business) in a high level of detail. This information is then used to assess how the business’ historic performance has been and, moving forward, how it can be improved in the future.

Environmental management accounting is simply a specialised part of the management accounts that focuses on things such as the cost of energy and water and the disposal of waste and effluent. It is important to note at this point that the focus of environmental management accounting is not all on purely financial costs. It includes consideration of matters such as the costs vs benefits of buying from

suppliers who are more environmentally aware, or the effect on the public image of the company from failure to comply with environmental regulations.

Environmental management accounting uses some standard accountancy techniques to identify, analyse, manage and hopefully reduce environmental costs in a way that provides mutual benefit to the company and the environment, although sometimes it is only possible to provide benefit to one of these parties. For example, activity-based costing may be used to ascertain more accurately the costs of washing towels at a gym. The energy used to power the washing machine is an environmental cost; the cost driver is ‘washing’.

Once the costs have been identified and information accumulated on how many customers are using the gym, it may actually be established that some customers are using more than one towel on a single visit to the gym. The gym could drive forward change by informing customers that they need to pay for a second towel if they need one. Given that this approach will be seen as ‘environmentally-friendly’, most customers would not argue with its introduction. Nor would most of them want to pay for the cost of a second towel. The costs to be saved by the company from this new policy would include both the energy savings from having to run fewer washing machines all the time and the staff costs of those people collecting the towels and operating the machines. Presumably, since the towels are being washed less frequently, they will need to be replaced by new ones less often as well.

In addition to these savings to the company, however, are the all-important savings to the environment since less power and cotton (or whatever materials the towels are made from) is now being used, and the scarce resources of our planet are therefore being conserved. Lastly, the gym is also seen as an environmentally friendly organisation and this, in turn, may attract more customers and increase revenues. Just a little bit of management accounting (and common sense!) can achieve all these things. While I always like to minimise the use of jargon, in order to be fully versed on what environmental management accounting is really seen by the profession as encompassing today, it is necessary to consider a couple of the most widely accepted definitions of it.

In 1998, the International Federation of Accountants (IFAC) originally defined environmental management accounting as:

‘The management of environmental and economic performance through the development and implementation of appropriate environment-related accounting systems and practices. While this may include reporting and auditing in some companies, environmental management accounting typically involves lifecycle costing, full cost accounting, benefits assessment, and strategic planning for environmental management.’

Then, in 2001, The United Nations Division for Sustainable Development (UNDSD) emphasised their belief that environmental management accounting systems generate information for internal decision making rather than external decision making. This is in line with my statement at the beginning of this article that EMA is a subset of environmental accounting as a whole.

The UNDSD make what became a widely accepted distinction between two types of information: physical information and monetary information. Hence, they broadly defined EMA to be the identification, collection, analysis and use of two types of information for internal decision making:

·           physical information on the use, flows and destinies of energy, water and materials (including wastes)

·           monetary information on environment-related cost, earnings and savings.

This definition was then adopted by an international consensus group of over 30 nations and thus eventually adopted by IFAC in its 2005 international guidance document on ‘environmental management accounting’.

To summarise then, for the purposes of clarifying the coverage of the Paper F5 syllabus, my belief is that EMA is internally not externally focused and the Paper F5 syllabus should, therefore, focus on information for internal decision making only. It should not be concerned with how environmental information is reported to stakeholders, although it could include consideration of how such information could be reported internally. For example, Hansen and Mendoza (1999) stated that environmental costs are incurred because of poor quality controls. Therefore, they advocate the use of a periodical environmental cost report that is produced in the format of a cost of quality report, with each category of cost being expressed as a percentage of sales revenues or operating costs so that comparisons can be made between different periods and/or organisations. The categories of costs would be as follows:

·           Environmental prevention costs: the costs of activities undertaken to prevent the production of waste.

·           Environmental prevention costs: the costs of activities undertaken to prevent the production of waste.

·           Environmental detection costs: costs incurred to ensure that the organisation complies with regulations and voluntary standards.

·           Environmental internal failure costs: costs incurred from performing activities that have produced contaminants and waste that have not been discharged into the environment.

·           Environmental external failure costs: costs incurred on activities performed after discharging waste into the environment.

It is clear from the suggested format of this quality type report that Hansen and Mendoza’s definition of ‘environmental cost’ is relatively narrow.

MANAGING ENVIRONMENTAL COSTS

There are three main reasons why the management of environmental costs is becoming increasingly important in organisations. First, society as a whole has become more environmentally aware, with people becoming increasingly aware about

the ‘carbon footprint’ and recycling taking place now in many countries. A ‘carbon footprint’ (as defined by the Carbon Trust) measures the total greenhouse gas emissions caused directly and indirectly by a person, organisation, event or product.

Companies are finding that they can increase their appeal to customers by portraying themselves as environmentally responsible. Second, environmental costs are becoming huge for some companies, particularly those operating in highly industrialised sectors such as oil production. In some cases, these costs can amount to more than 20% of operating costs. Such significant costs need to be managed. Third, regulation is increasing worldwide at a rapid pace, with penalties for non-compliance also increasing accordingly. In the largest ever seizure related to an environmental conviction in the UK, a plant hire firm, John Craxford Plant Hire Ltd, had to not only pay £85,000 in costs and fines but also got £1.2m of its assets seized. This was because it had illegally buried waste and also breached its waste and pollution permits. And it’s not just the companies that need to worry. Officers of the company and even junior employees could find themselves facing criminal prosecution for knowingly breaching environmental regulations.

But the management of environmental costs can be a difficult process. This is because first, just as EMA is difficult to define, so too are the actual costs involved. Second, having defined them, some of the costs are difficult to separate out and identify. Third, the costs can need to be controlled but this can only be done if they have been correctly identified in the first place. Each of these issues is dealt with in turn below.

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