Using Management Accounting to Drive Environmental Performance

Global Knowledge Gateway

Performance & Financial Management

Using Management Accounting to Drive Environmental Performance

by Anthony Pember, Chief Executive Officer, Pilbara Group; Mark Lemon, Manager, Global Public Sector Practice, Grant Thornton LLP; and Stathis Gould, Head of Professional Accountants in Business, IFAC | April 25, 2014 |

Organizations face mounting pressure to limit their impact on the environment. Reducing that impact often requires an organization to change the way it conducts its business, and thus can have a significant financial impact on the organization. Therefore, it is in the interest of these organizations to manage environmental sustainability initiatives in an effective and efficient manner.

Management accounting (MA),or managerial accountingmethodologies and tools, has been utilized by many organizations to help manage their finances efficiently and effectively.It, therefore, makes business sense to utilize MA tools to help drive environmental performance.

We seek to explore to what extent organizations are using MA tools, such as activity-based costing/management (ABC/M), to manage their environmental impacts.

Accountants do not need to look far to see how they can help improve the environmental performance of organizations. MA, and the array of tools and techniques embraced in the MA profession,can be used by organizations to support decisions that enhance environmental sustainability and financial performance.

One particular tool familiar to accountants is ABC/M.Accurately quantifying the costs of environmental impacts and remediation efforts is challenging because they do not show up as part of traditional cost accounting models where important data are hidden in overhead accounts.

The Consortium of Advanced Management – International (CAM-I), a collaborative forum of thought leaders developing practical and effective management approaches to advance the way organizations manage costs, processes, and performance, has been considering how MA can be applied to environmental sustainability.

CAM-I defines ABC/M as: A methodology that measures the cost and performance of activities, resources, and cost objects. Resources are assigned to activities, then activities are assigned to cost objects based on their use. ABC recognizes the causal relationships of cost drivers to activities.

Why is it Important

For years, organizations have been pressuredby shareholders and other stakeholders to address environmental issues. For most organizations, consumers are the main driver of change with an increasing preference by many to purchase from environmentally conscious organizations.

From a regulatory perspective, many countries now require organizations to measure and disclose scope 1 (direct) and scope 2 (indirect from consumption of purchased electricity, heat, or steam) greenhouse gas (GHG) emissions. Scope 3 emissions (other indirect such as business travel, purchased materials, and fuel use for transport)are important components of cost and environmental performance.

Investors and their agents are also demanding relevant information as climate change is clearly becoming a strategic risk issue that may damage the companies in which they invest. Investors are typically interested in short-term risk information, such as costs related to a carbon price on regulated markets, an increase in energy prices, new taxes, and energy efficiency standards (e.g., for cars and buildings). Calculating exposure to these risks requires data on year-to-year emission levels, as well as information on management action to mitigate these risks or turn them into an opportunity for business growth.

To satisfy the demands of the shareholders and stakeholders, organizations need to know their emissions profile, the costs associated with regulatory compliance, and the impact on financial performance.

An ABC/M model puts cost and GHG emissions data into the same terms for improved analysis and decision-making.  Putting a) cost and revenue and b) emissions data into the same terms allows managers to determine bothactivity- and product/service-level data.This data provides critical information upon which decisions impactingboth financial and environmental performance can be made.

Combining cost, revenue, and GHG emissions in the same model allows for the correlation of GHG emissions to other business-specific cost and performance metrics, providing a more robust assessment of performance to management.Such a comprehensive model allows organizations to measure profit and GHG emission impacts for product lines or services, which could be further extended to anorganization’s supply chain. It also highlights how the GHG footprint of particular products, services, and activities relate to profit that provides direction on prioritizing practices that yield the lowest GHG footprint and the most value.

The relationship between value and footprint
 

How Does it Work?

In the same way that a traditional ABC/M model assigns cost to particular products, services, and activities within an organization, an environmentalABC/M model leverages anorganization’s emissions inventory and GHG footprint and assigns that footprint to particular products, services, and activities. In this way, the ABC/M model directs attention to those products, services, and activities that have the highest GHG footprint and greatest impact on monetary value.

The structured approach to such modeling provides a basis for confidently disclosing emissions data and directing management attention to reducing its environmental impact through changes to processes and activities to achieve efficiencies, investing in other resource or energy inputs, or by trading in emissions permits.

Traditional [MH1] and activity-based view of environmental costs

 

Traditional View

 

 

Activity-Based View

 

$

 

Cost Pool

$

Activity

$

Electricity

80,000

 

Electricity for HVAC

20,000

Develop schedule

7,500

 

 

 

Electricity for manufacturing

40,000

Process raw material

15,000

 

 

 

Electricity to run servers

15,000

Manufacture product

60,000

 

 

 

Electricity for lighting

5,000

Ship products

22,500

Natural gas

30,000

 

Natural Gas for manufacturing

25,000

HR management

10,000

 

 

 

Natural Gas for HVAC

5,000

Financial management

10,000

Petrol/diesel

25,000

 

Petrol for vans/forklifts

5,000

IT management

25,000

 

 

 

Diesel for trucks

20,000

 

 

Work-related travel

15,000

 

Work-related air travel

10,000

 

 

 

 

 

Work-related train travel

1,000

 

 

 

 

 

Work-related motor vehicle travel

4,000

 

 

 

 

 

 

 

 

 

TOTAL

150,000

 

TOTAL

150,000

TOTAL

150,000

 

Traditional and activity-based view of GHG footprint

 

Traditional View

 

Activity-Based View

 

MTCO2e

 

Cost Pool

MTCO2e

Activity

MTCO2e

Electricity

20,500

 

Electricity for HVAC

5,000

Develop schedule

3,750

 

 

 

Electricity for manufacturing

10,000

Process raw material

3,750

 

 

 

Electricity to run servers

3,500

Manufacture product

12,750

 

 

 

Electricity for lighting

2,000

Ship products

22,500

Natural gas

3,500

 

Natural gas for manufacturing

2,500

HR management

13,250

 

 

 

Natural gas for HVAC

1,000

Financial management

9,750

Petrol/diesel

25,000

 

Petrol for vans/forklifts

5,000

IT management

10,250

 

 

 

Diesel for trucks

20,000

 

 

Work-related travel

27,000

 

Work-related air travel

15,000

 

 

 

 

 

Work-related train travel

2,000

 

 

 

 

 

Work-related motor vehicle travel

10,000

 

 

 

 

 

 

 

 

 

TOTAL

76,000

 

TOTAL

76,000

TOTAL

76,000

 

Applying the Theory in Practice

Using ABC/M in this way has clear benefits for identifying and comparing the GHG footprint of particular products, services, and activities. This allows decisions on how to improve performance.

While there are clearly identified benefits, we have found that ABC/M models are not widely used to manage environmental sustainability initiatives.One potential explanation is that ABC/M models do not automatically reveal environmental-relatedcosts until the source data has been identified and an automatic feed put in place. Engagement with other parts of an organization to secure appropriate data inputs takes time and relevant expertise. Organizations need to be able to analyze unit information from individual responsibility centers, and, for scope 3, emissions will rely on receiving information from an organization’s suppliers. Several types of data are needed to support the model, including:

  • General ledger information, such as supplier and raw material expenses;
  • Human resources information to determine where employees work, what tasks they are performing, and the time spent on the tasks; and
  • Emissions data, requiring the amount of emissions associated with a given activity (which will vary depending on location), and resource/activity metric volume information (e.g., amount of electricity an activity consumes). The input of operational and environmental managers may also be required to capture relevant environmental costs.

Once the data sources have been identified, and automated where possible, an ABC/M emissions model can be built. It will include the emissions factors information, organizational resource information, the activities that consume the resources, and the relationship to the cost objects (products or services) that consume the activities.

We think it is likely that carbon-intensive organizations would benefit the most from using an ABC/M model, at least to point out where the costs of data collection and model development are exceeded by the resulting business intelligence. However, anecdotal feedback so far from a small pool of organizations is that using ABC/M for managing environmental performance is the exception rather the norm. So what factors are holding companies back from using ABC/M to help improve organizational efficiency? Is it a lack of regulatory guidance, the cost of data collection and analysis, a lack of understanding of the power of ABC/M, a non-belief in the importance of environmental sustainability, or a combination of all these factors?

We would welcome feedback on how organizations are using ABC/M, or costing more broadly, to help understand and improve environmental performance, and the barriers to taking such initiatives forward.

This article is based on a CAM-I report available at http://www.cam-i.org/index.php/columns-news

CMA Canada members can access the report on the CMA Canada website at http://managementaccounting.org/en/Emerging%20Issue%20Papers/Environmental%20sustainability%20EIP. CMA Canada is a member of CAM-I, as is The Institute of Cost Accountants of India.

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