Environmental Management Accounting

Environmental accounting is the method that companies prevent, monitor, and evaluate their impact on the environment. It analyzes both financial and non-financial information to provide clear guidance to management to decide on the company’s position toward the environment. 

The government, community, and society require companies to reduce the negative footprint on the environment. They think that companies that run businesses within the community must take full responsibility for any negative impact. If we ignore this concern, we will face a penalty from the government. Moreover, it will damage our image in society as well.

Components of environmental cost include:

  • Conventional cost is the cost of raw material and energy cost, which has an impact on the environment. Some raw materials will cause more damage by their nature compared to other materials. For example, the burn of fossil fuels will increase the amount of carbon dioxide in the climate. According to research, it represents 87% of human carbon dioxide emissions. This material usually used to burn to generate heat and energy for plants, cars, planes, and industrial facilities.  The energy used by factories mostly has a negative impact on the environment. The more we use, the higher the cost.
  • Potentially hidden cost within the overhead. Some parts of the costs already recorded into the accounting system, but they are classified as overhead costs. 
  • Contingent Costs: Cleaning and site restoration is the kind of contingent costs that will happen at the end of projects. It may make more impact than its sound depending on the size of damage which causes by our company operation. It sometimes includes the obligation to remove the assets after the end of their useful lives and restore the site. For example, the business that involves oil rig or nuclear power plant. The cost of restorations will huge and can not be ignored. 
  • The image and relationship cost, which include the cost of preparing the annual environmental report and our reputation. Reputation is a huge problem when we create a serious impact and the public aware of that. It could be lead to lost revenue, and customers boycott if it is so severe. 

Category of environmental cost

  • Environmental CostPrevention is the cost that the company sets up the policy to reduces waste, energy consumption to reduce negative impact. We can set the target of waste to the design team when they develop a new product, and it should be as low as possible. We can also reduce energy usage by purchasing new equipment for the factory. 
  • The appraisal is the monitoring cost that incurs due to compliance with environmental law and regulation.
  • Internal Failure is the cost that incurs due to the elimination of the negative impact of the environment created by the company. 
  • External Failure is the cost of restoration, which is imposed by the government due to our operation. For example, Deepwater Horizon oil spill, the company spend billions of dollars to deal with the lawsuits and restore the damaged. 

How to Prevent Environmental Impact?

How to Prevent Environmental Impact
Include environmental cost into new investment Before making any new investment, the company must include the possible environmental cost of that project and subtract from the profit. We have to ensure that there is no contingency liability that will happen to us without any preparation. So management will be able to invest in the less negative environmental project rather than the high profit.
Minimize waste The company should develop a new system that can minimize the production wastage which pollutes the environment. The more waste we produce the higher the risk of getting punishment from the government. Moreover, we also can cut the cost of production by producing less waste.
Develop a new environmentally friendly product It will improve the company brand when new products are environmentally friendly, customers are will to support us. For example, Tesla has developed electric cars and receive huge support from customers around the world due to a positive impact on the environment.
Include environmental information in the annual report The annual report should be incorporate the environmental data of the company toward the public and stakeholders. Management will know the company’s position and be able to take action to prevent any damage due to environmental issues.

How to Account for Environmental Cost?

Input and Output analysis

As the name suggests, this method looks into what comes in and what went out of the production. Any loss or residual is considered as waste. The higher the waste, the more damage we have created to the earth. This method will suggest the company have a process flow to trace every material in and out of the factory.  

Flow cost accounting

This is the future development of input and output analysis. It measures the input and output of each process within the factory. 

What are the limitations of Environmental Management Accounting?

Limitation of Environmental Accounting
There is no specific standard to follow. As a certified accountant, we need to prepare financial statements by using IFRS and any other local guideline. These accounting standards provide us the specific rule to follow with technical experts who are ready to share experience and discuss the issue. However, environmental accounting does not have specific guidelines for us, some countries may have strict law enforcement while others not.
Different countries use different methods, so it hard to make comparisons. As we have mentioned above, different countries use different rules and regulations to force the company to follow. So it is hard to compare two companies from different countries regarding their level of environmental impact.
It is hard to measure cost and environmental accounting. When it comes to implementing a new system or process, we usually consider its cost and benefit. But for environmental accounting, it is not easy to tract the benefit. Like we have mentioned, it will help us prevent the penalty, improve our image to the public. These kinds of benefits are abstract and hard to quantify. We can only sum up the total cost which happens due to the implementation of it.
We need to integrate with financial accounting which is very hard. Environmental accounting cannot be used alone as it will not provide the full picture, so it must be integrated with the annual financial reports to provide a meaningful statement. But due to the lack of guidelines, it hard to integrate.