Environmental cost accounting and auditing
Peter Letmathe
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.
Managerial Auditing Journal
15/8 [2000] 424±430
# MCB University Press
[ISSN 0268-6902]
[ 424 ]
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 0.6 C 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
The current issue and full text archive of this journal is available at
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(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 waste
water 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 could
reduce 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,
Peter Letmathe and
Roger K. Doost
Environmental cost
accounting and auditing
Managerial Auditing Journal
15/8 [2000] 424±430
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 accounting
shows 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 cost
accounting
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 waste
water 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 cost
accounting system
To identify and to assign environmental costs
correctly, the complex cause and effect of
[ 425 ]
Peter Letmathe and
Roger K. Doost
Environmental cost
accounting and auditing
Managerial Auditing Journal
15/8 [2000] 424±430
[ 426 ]
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.
Figure 1
The concept of 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 a
material 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. To
control 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
Peter Letmathe and
Roger K. Doost
Environmental cost
accounting and auditing
Managerial Auditing Journal
15/8 [2000] 424±430
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 impacts
All 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 impacts
cannot 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 control
provides 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 an
organization 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 environmentally
friendly 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 environmental
impacts 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 process
The 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 the
sum 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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Peter Letmathe and
Roger K. Doost
Environmental cost
accounting and auditing
Managerial Auditing Journal
15/8 [2000] 424±430
Figure 3
Bill of environmental impacts of a process
Figure 4
Bill of environmental impacts of a product
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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 to
plan, 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, the
calculation 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 and
recycle 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
Peter Letmathe and
Roger K. Doost
Environmental cost
accounting and auditing
Managerial Auditing Journal
15/8 [2000] 424±430
Figure 5
Calculation of internal prices for material and energy flows
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 cost
accounting 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 the
environmental 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 organization
documents 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 external
auditors 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 various
operations 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
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Peter Letmathe and
Roger K. Doost
Environmental cost
accounting and auditing
Managerial Auditing Journal
15/8 [2000] 424±430
[ 430 ]
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 substitution
of 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-audit
preparation 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 physical
features, 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 system
that 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 to
determine 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.
References
Ansari, S., Bell, J., Klammer, T. and Lawrence, C.
(1997), Measuring and Managing
Environmental Costs, Irwin, Chicago, IL.
Bundesverband der Deutschen Industrie (1979),
Anleitung zur Bestimmung der Betriebskosten
fuÈr den Umweltschutz in der Industrie, KoÈln.
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, MuÈnchen.
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, MuÈnchen.
Rubenstein, D.B. (1994), Envrionmental
Accounting for the Sustainable Coperation,
Quorum, Westport, CT and London.
Verein Deutscher Ingenieure (1979), VDI-
Richtlinie 3800 ± Kostenermittlung fuÈr Anlagen
und Maûnahmen zur Emissionsminderung,
DuÈsseldorf.
Further reading
Epstein, 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), ``Worrying
about environmental auditing'', in
Lehman, G. and Owen, D. (Eds), Social and
Environmental Accounting, Special Edition of
Accounting Forum, Vol. 19, pp. 205-18.