This article is intended to help students understand environmental management accounting, its increasing importance, and new developments.
The global profile of environmental issues has risen significantly during the past two decades, precipitated in part by major incidents such as the Bhopal chemical leak (1984) and the Exxon Valdez oil spill (1989). These events received worldwide media attention and increased concerns over major issues such as global warming, depletion of non-renewable resources, and loss of natural habitats.
This has led to a general questioning of business practices and numerous calls for change. These questions have not only been raised by organisations such as Friends of the Earth, Greenpeace, or groups of 'eco-warriors', but from the United Nations, the European Union, the UK government, the British Bankers Association, insurance companies and pension funds. Recognition that our current way of life poses a threat to us and our planet, has led to global agreements on action to prevent future environmental damage. Such agreements include the Montreal Protocol, the Rio Declaration, and the Kyoto Protocol.
Businesses have become increasingly aware of the environmental implications of their operations, products and services. Environmental risks cannot be ignored, they are now as much a part of running a successful business as product design, marketing, and sound financial management. Poor environmental behaviour may have a real adverse impact on the business and its finances. Punishment includes fines, increased liability to environmental taxes, loss in value of land, destruction of brand values, loss of sales, consumer boycotts, inability to secure finance, loss of insurance cover, contingent liabilities, law suits, and damage to corporate image.
Nearly all aspects of business are affected by environmental pressures, including accounting. From an accounting perspective, the initial pressures were felt in external reporting, including environmental disclosures in financial reports and/or the production of separate environmental accounts. Much has been written about the nature and quality of these accounts (see Gray and Bebbington, 2001 for an introduction into this area). However, environmental issues cannot be dealt with solely through external reporting. Environmental issues need to be managed before they can be reported on, and this requires changes to management accounting systems.
Environmental review of conventional management accounting
In an ideal world, organisations would reflect environmental factors in their accounting processes via the identification of the environmental costs attached to products, processes, and services. Nevertheless, many existing conventional accounting systems are unable to deal adequately with environmental costs and as a result simply attribute them to general overhead accounts. Consequently, managers are unaware of these costs, have no information with which to manage them and have no incentive to reduce them (United Nations Division for Sustainable Development (UNDSD), 2003)). It must be recognised that most management accounting techniques significantly underestimate the cost of poor environmental behaviour. Many overestimate the cost and underestimate the benefits of improving environmental practices.
Management accounting techniques can distort and misrepresent environmental issues, leading to managers making decisions that are bad for businesses and bad for the environment. The most obvious example relates to energy usage. A recent UK government publicity campaign reports that companies are spending, on average, 30% too much on energy through inefficient practices. With good energy management, we could reduce the environmental impact of energy production by 30% and slash 30% of organisations' energy expenditure. Frost and Wilmhurst (2000) suggest that by failing to reform management accounting practices to incorporate environmental concerns, organisations are unaware of the impact on profit and loss accounts and the balance sheet impact of environment-related activities. Moreover, they miss out on identifying cost reduction and other improvement opportunities, employ incorrect product/service pricing, mix and development decisions. This leads to a failure to enhance customer value, while increasing the risk profile of investments and other decisions with long-term consequences. If management accounting as a discipline is to contribute to improving the environmental performance of organisations, then it has to change. Environmental Management Accounting (EMA) is an attempt to integrate best management accounting thinking and practice with best environmental management thinking and practice.
Environmental Management Accounting
EMA is the generation and analysis of both financial and non-financial information in order to support internal environmental management processes. It is complementary to the conventional financial management accounting approach, with the aim to develop appropriate mechanisms that assist in the identification and allocation of environment-related costs (Bennett and James (1998a), Frost and Wilmhurst (2000)). The major areas for the application for EMA are:
- product pricing
- investment appraisal
- calculating costs and
- savings of environmental projects, or setting quantified performance targets.
EMA is as wide-ranging in its scope, techniques and focus as normal management accounting. Burritt et al (2001) stated: 'there is still no precision in the terminology associated with EMA'. They viewed EMA as being an application of conventional accounting that is concerned with the environmentally-induced impacts of companies, measured in monetary units, and company-related impacts on environmental systems, expressed in physical units. EMA can be viewed as a part of the environmental accounting framework and is defined as 'using monetary and physical information for internal management use'.
Burritt et al developed a multi-dimensional framework of EMA. Their framework considers the distinctions between five dimensions:
- internal versus external
- physical versus monetary classifications
- past and future timeframes
- short and long terms and
- ad hoc versus routine information gathering in the proposed framework for the application of EMA.