Q6 (a) The increasing general concern for the environment can be described as the combination of (the) growing awareness

of environmental issues by the general population and the increased nongovernmental organization (NGO) pressure and activity (which) has led many companies to reflect on and revise their corporate environmental responsibilities. The term organization performance can be defined as the accumulated results delivered to all stakeholders over the longer term by an organization. From this definition it can be seen that an organizations performance has two main components: i) the stakeholder - relates the magnitude of benefit each stakeholder receives at a given moment, and ii) time - relates to the accumulation of these benefits over time, that is, the value created over the longer term. All organizations and organizational entities have stakeholders. A stakeholder is someone with an interest in that organization. Major categories of organizational stakeholder include customers, shareholders, employees, suppliers and the community. The growing awareness of environmental issues and matters globally has pushed many businesses to engage in what previously was rare: corporate environmental management and corporate environmental performance reporting. Corporate environmental management can be described as the deliberate application of such a concept as Environment Management Accounting in managing a business organizations operations in relation to how they interact with their surroundings. Corporate environmental performance is the outcome of such a management process, usually seen in the form of the periodic environmental reports and statements that companies nowadays issue. Some of the impacts on corporate performance that have been reported to result from this move by corporations to where they are now conducting their business in an environmentally sensitive way include: x demonstration of coherence of overall management strategy to important external stakeholders By disclosing management strategies, systems and policies relating to the environment, an organization can demonstrate to its stakeholders its holistic approach to environmental responsibility. strengthening of stakeholder relations One of the benefits of increasing corporate transparency via an environmental report is that stakeholder relations are strengthened. Confidence and trust between the two parties are improved when organisations include stakeholders in the reporting process by actively engaging with them. Stakeholder dialogue is increasingly used by large companies to help identify the key issues which are of concern to their stakeholders. These issues should then be addressed in the environmental report.

increased competitive advantage (the first mover effect) An organisation which demonstrates full responsibility for its environmental impacts and then reports on them, benefits from gaining a competitive edge over its peers in the same sector which are not as open and transparent about such issues. public recognition for corporate accountability and responsibility The growing expectations of an emerging environmentally aware public need to be met. An organisation will gain external recognition as a responsible organisation if it produces a complete and credible environmental report. an organisations environmental performance improvement Public disclosure of targets act as an internal driver, continually improving an organisations environmental performance. Effective self-regulation minimizes risk of regulatory intervention By adopting high environmental standards, an organisation is prepared for current and future environmental regulation. Increased / improved access to lists of preferred suppliers of buyers with green procurement policies Corporate environmental stewardship now includes consideration of upstream processes. Suppliers who share the same high environmental values and can openly report on all aspects of their performance, thus giving a more complete and transparent view of the organisation.s managerial strategy and operations, are more likely to achieve preferred supplier status. reduced corporate risk, which may reduce financing costs and broaden the range of investors In the reporting cycle, it is common to identify areas of environmental risk which previously went unnoticed. By actively lowering these corporate risks (and therefore increasing the compliance rate and decreasing liabilities) an organization can enhance its investment potential. enhanced employee morale A company which has a more open and transparent style of business will motivate its employees.

improved profitability Improved environmental performance will often have a direct and measurable impact on profitability (the financial bottom line) through costs saved or avoided or through new revenues generated.

Q6 (b) Environmental Management Accounting 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: x in the assessment of annual environmental costs/expenditures, x product pricing, x budgeting, x investment appraisal, x calculating costs, and x 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 companyrelated 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'.

Traditional Management Accounting The traditional method of cost accounting refers to the allocation of manufacturing overhead costs to the products manufactured. The traditional method (also known as the conventional method) assigns or allocates the factory's indirect costs to the items manufactured on the basis of volume such as the number of units produced, the direct labor hours, or the production machine hours. Traditional management accounting is perceived as inadequate since it:
x x x x

concentrates on the manufacturing and neglects the high cost post-conversion activities; ignores the impact of other activities; fails to assess the relative cost positions of competitors; and over-reliance on existing accounting systems.

Environmental costs A cost is a sacrifice or use of resources for a particular purpose, frequently measured by the monetary units that must be paid for goods and services (Horngren, et al. 1999). There are many ways to classify costs. Costs can be classified into fixed, variable, step and mixed costs3, or into direct and indirect costs. Costs can also be categorized as: (a) direct materials and labor, (b) factory overhead, (c) marketing and sales, (d) general and administrative overhead, and (e) research and development. These various systems of cost classification lead to difficulties in defining environmental costs. Although environmental costs are the elements of EMA, there is no standardized definition of environmental costs. Environmental expenditures may be included in all of the abovementioned cost categories. Companies tend to use different concepts of environmental cost according to purpose for which the data is collected. One pragmatic definition of environmental costs adopted by the AT&T Green Accounting Team4 is costs for which the expertise of environmental professionals is important in their identification and management (Bennett and James, 1998). They consider the two generic categories of environmental costs as: Internal environmental costs expenses that are wholly or partially driven by environmental considerations, including environmental opportunity costs, and External environmental costs financial costs or other quantifiable disbenefits that are incurred outside the organization and not internalized within its accounts. In general, definitions of environmental costs tend to focus on defensive expenditures, such as pollution control equipment, rather than more proactive expenditures, such as investments in cleaner production.

x x

Examples of Environmental Costs

Potentially Hidden Costs

Regulatory Notification Reporting Monitoring/testing Studies/modeling Remediation Record-keeping Plans Training Inspections Manifesting Labeling Preparedness Protective equipment Upfront Site studies Site preparation Permitting R&D Engineering and procurement Installation Voluntary (Beyond Compliance) Community relations/outreach Monitoring/testing Training Audits Qualifying suppliers Environmental Reports Insurance Planning Feasibility studies Remediation Recycling Environmental studies R&D Habitat and wetland protection

Medical surveillance Environmental insurance Financial assurance Pollution control Spill response Storm water management Waste management Taxes/fees

Landscaping Other environmental projects Financial support to environmental groups and/or researchers

Contingent Costs
Future compliance costs Penalties/fines Response to future Releases Remediation Property damage Personal injury/damage Legal expenses Natural resource damage Economic loss damages

Image and Relationship Costs

Corporate image Relationship with customers Relationship with investors Relationship with Insurers Relationship with professional staff Relationship with workers Relationship with suppliers Relationship with lenders Relationship with host communities Relationship with regulators

The limitations of conventional management accounting The need for EMA was conceived in recognition of some of the limitations of conventional management accounting approaches for management activities and decisions involving: 1) significant environmental costs; and/or 2) significant environmental consequences/impacts. What are these limitations of conventional management accounting? Failure to adequately account for environmental costs I. First of all, conventional management accounting practices tend to track environmental costs inadequately. This is often due to the ongoing debate on what the exact definition of environmental costs is. A survey of management accountants in US companies illustrates the point that many environmental costs are not adequately considered in internal decision-making (White and Savage, 1995). When given a list of costs and asked which costs their firm "normally considered" when doing financial analysis for a capital investment project, the answers for different cost items ranged from 25% to 79% of respondents. Environmental costs on the low end of the response range included off-site wastewater or hazardous waste treatment; environmental staff time, environmental penalties/fines, and reporting to government agencies.

Which conventional management accounting practices might contribute to the inadequate consideration of environmental costs in internal decision-making? Several practices that can contribute are: the unintentional "hiding" of many environmental costs in overhead accounts; inaccurate allocation of environmental costs from overhead accounts back to processes, products, and process lines; inaccurate characterisation of environmental costs as "fixed" when they may actually be variable (or vice-versa); inaccurate accounting for volumes (and thus costs) of wasted raw materials; and the actual absence of relevant and significant environmental costs in the accounting record. Second, some environmental costs often are not included in conventional management accounting records at all. Two types of environmental costs that fall into this category are less tangible costs (i.e. difficult to predict and estimate) and future costs. An example of a less tangible cost is the cost to a company of poor environmental image in the eye of consumers, as expressed by lower market share. An example of a future cost is the cost of a future wastewater treatment plant upgrade due to a new environmental regulation. Potential future environmental liability is an example of a future environmental cost that is also less tangible.

II.

Failure to adequately inform environmental management activities Conventional management accounting focuses primarily on cost information for decisionmaking, while tracking cost drivers such as materials use, labour time, asset purchase and depreciation, etc. as necessary to inform costing. However, in order to make sound environmental management decisions, materials and energy flow information, such as data on resource use (e.g., energy and water use) and waste generation (e.g., volume and type of air emissions or wastewater) is particularly important. Physical flow data thus serve not only as a key driver of environmental costs related to resource inefficiency and waste management, but also as a basis for helping to characterise the environmental consequences or impacts of business decisions. Many conventional management accounting systems do not explicitly track physical flow information in a way that enables and encourages the "environmental management" part of EMA. Many companies do not adequately track materials and energy flows at all. Others may track subsets of materials and energy flow information separately from the general management accounting system, for very specific purposes. For example, in companies subject to strict environmental regulations, waste types, volumes, and fates may instead be tracked in a separate system geared solely towards regulatory compliance and reporting. Some companies may track raw materials inventories for inventory control and purchasing purposes, but not use the information for environmental management purposes.

Benefits and uses of EMA - How Environmental Management Accounting Overcomes Deficiencies of Traditional Management Accounting In conventional management accounting, the aggregation of environmental and nonenvironmental costs in overhead accounts results in their being "hidden" from management. There is substantial evidence that management tends to underestimate the extent and growth of such costs. By identifying, assessing and allocating environmental costs, EMA allows

management to identify opportunities for cost savings. Prime examples from the EMA literature are the savings that can result from replacement of toxic organic solvents by non-toxic substitutes, thus eliminating the high and growing costs of regulatory reporting, hazardous waste handling and other costs associated with the use of toxic materials. A rule of thumb of environmental management is that 20 per cent of production activities are responsible for 80 per cent of environmental costs. When environmental costs are allocated to overhead accounts shared by all product lines, products with low environmental costs subsidize those with high costs. This results in inefficient product pricing which reduces profitability. A relatively simple application of EMA that may yield large benefits is to waste management, as the costs of handling and disposing of waste are relatively easy to define and to allocate to specific products. Other environmental costs, including costs of regulatory compliance, legal costs, damage to the corporate image, and environmental liabilities and risks, are more difficult to assess. Some enterprises are now using EMA systems, most commonly large enterprises that process natural resources and are subject to extensive environmental regulations. The USEPA Environment Accounting Project had developed forty-five case studies of EMA applications and benefits in various industries. Examples that were presented and discussed in the Working Group meeting included DuPont in the United States and Siemens in Germany. Environmental regulations, consumer demands and public pressure concerning environmental performance are constantly changing. Companies with EMA systems can quickly determine the costs and implications of responding to such changing regulatory and market conditions and hence can gain a competitive advantage over other enterprises.

Q6 (c) Z, being a publicly quoted company, can use the recommendations proposed by the United Nations Centre for TranNational Corporations InterGovernmental Working Group of Experts on International Standards of Accounting and Reporting (UN CTC ISAR) as a guiding tool in determining what information might be required at board level and what information should be published. Briefly: i) at board level (in the dirrectors report) UN CTC ISAR recommends information on the following be included: x environmental issues pertinent to the company and industry; x environmental policy adopted; x enterprises environmental emission targets and performance against these; x response to government legislation; x material environmental legal issues in which the enterprise is involved; x effects of environmental protection measures on capital investment and earnings; x material costs charged to current operations; x material amounts capitalized in the period,

ii) and for the information that should be published (in the notes to the financial statements) UN CTC ISAR recommends that information on the following be included: x the accounting policies for recording liabilities and provisions for setting up catastrophe reserves and for disclosing contingent liabilities; x monetary amount of liabilities, provisions and reserves established in the period; x monetary amount of contingent liabilities; x tax effects; and x government grants received in the period. See attached copies of appendix 11.1 of an example of how such information may be presented. Discussion In the dialogue about business organizations moving towards where they are embracing more environmentalism there continues to be debate about: who the key drivers of this shift are, the regulatory role and where it is coming from, the role of accounting bodies and if there are any accounting standards or should be there any accounting standards to guide in environmental reporting, and about the need to continuously improve the prototypes. Key drivers The Economist Intelligence Unit of The Economist has identified in its report, Global trends in sustainability performance management, the following, in their order of importance, as the key drivers of corporate environmental management and environmental performance reporting: x Regulations. Governments at most levels have stepped up the pressure on corporations to measure the impact of their operations on the environment. Legislation is becoming more innovative and is covering an ever wider range of activities. The most notable shift has been from voluntary to mandatory sustainability monitoring and reporting. Customers. Public opinion and consumer preferences are a more abstract but powerful factor that exerts considerable influence on companies, particularly those that are consumer-oriented. Customers significantly influence a companys reputation through their purchasing choices and brand loyalty. This factor has led firms to provide much more information about the products they produce, the suppliers who produce them, and the products environmental impact from creation to disposal. NGOS and the media. Public reaction comes not just from customers but from advocates and the media, who shape public opinion. Advocacy organisations, if ignored or slighted, can damage brand value. Employees. Those who work for a company bring particular pressure to bear on how employers behave; they, too, are concerned citizens beyond their corporate roles.

Peer pressure from other companies. Each company is part of an industry, with the peer pressures and alliances that go along with it. Matching industry standards for sustainability reporting can be a factor; particularly for those who operate in the same supply chain and have environmental or social standards they expect of their partners. There is a growing trend for large companies to request sustainability information from their suppliers as part of their evaluation criteria. The US retailer Walmart announced an initiative for a worldwide sustainable-product index in July 2009. This initiative would create a database across leading retailers to facilitate comparisons of sustainability performance of leading products. Companies themselves. Corporations, as public citizens, feel their own pressure to create a credible sustainability policy, with performance measures to back it upbut with an eye on the bottom line as well. Increasingly, stakeholders are demanding explicit sustainability-reporting strategies and a proof of the results. So, too, are CEOs, who consider sound social and environmental policies a critical element of corporate success. Companies report that integrated reporting drives them to re-examine processes with an eye towards resource allocation, waste elimination and efficiency improvements. Balancing financial growth, corporate responsibility, shareholder returns and stakeholder demands also leads to an evaluation of the trade-off between short-term gains and longterm profits. Investors. Increasingly, investors want to know that companies they have targeted have responsible, sustainable, long-term business approaches. Institutional investors and stock exchange CEOs, for example, have moved to request increased sustainability reporting from listed companies, and environmental, social and corporate governance indices have been established such as the Dow Jones Sustainability Index. The Carbon Disclosure Project was developed in response to investor demand for a system for firms to measure and report greenhouse gas emissions and climate change strategies as a tool to set reduction targets and set individual goals.

Source: Global trends in sustainability performance management, Economist Intelligence Unit, The Economist, March 2010

Regulatory trends Drawing from the same report, three actors are seen as being in the lead in the push for more regulations when it comes to corporate environmental management and corporate environmental performance reporting. These actors are: I. Governments For example, increasingly in the US and the UK legislation, companies are being asked to report their green-house gas (GHG) emissions in sectors which they were not required before and they are now being asked to cover more

II.

III.

activities, that is government regulation is moving beyond Scope One (direct emissions) towards Scope Two (indirect emissions related to the consumption of purchased energy) and Scope Three (supply-chain and product-lifecycle emissions). The requirement that now, in several parts of the world, financial statements include corporate-responsibility policy statements and measures Denmark set the trend in 2009 by passing a law, an amendment to the Denmark Financial Statements Act, which requires Danish business organizations to disclose their corporate responsibility. The law is very specific because it has enshrined the concept of report-or-explain for both public and private companies. About 1,100 of Denmarks largest companies are affected by this legislation. The Apply-or-explain vs comply-or-explain concepts a) Comply-or-explain The principle of comply-or-explain means that companies have to take seriously the general principles of the relevant corporate governance codes but on points of detail they can be in non-compliance as long as they make clear in their annual report the ways in which they are non-compliant and, usually, the reasons why. Comply-or-explain is based on the principle that markets are able to punish non-compliance if investors are dissatisfied with the explanation (i.e. the share price might fall). b) Apply-or-explain concept Apply-or-explain concept introduces the idea of making environmental reporting mandatory. Professor Mervyn King explains it thus: With apply-or-explain, companies have to actually say they have applied the principles and practices, which ones they have not applied, and explain why they have applied another practice or principle. It sounds more laissez faire but is actually stricter. - Professor Mervyn King, international corporate governance expert and Chairman of the South Africas King III committee report. Source: Global trends in sustainability performance management, Economist Intelligence Unit, The Economist, March 2010

Accounting standards Environmental Management Accounting (EMA) is internally focused, that is, it provides information for internal decision making. It mainly includes consideration on how such information is reported internally. This aspect of EMA implies the process is not guided by any accounting standard; it only occasionally borrows from the accounting profession certain guidelines, for example from IAS 39 and IAS 37, to use them as a framework or basis on how to report or account for activities that carry costs that are of environmental nature and which influence internal decision making. What should be noted is that internal decision making is now not purely internal but there are other exogenous factors as outlined above that influence the process. These external factors are forever becoming stronger and this of

course may eventually lead to EMA, at some point, being guided by a set of accounting standards, especially when it comes to matters concerning disclosure, just as it is the case with financial reporting. Continuous improvement Environmental Management Accounting (EMA) is a relatively new concept; it is an ongoing experiment for many organizations that have decided to use it. This means, even for organizations that are leaders in the field see the appendix, there is still need for improvement on how the total activity of environment reporting should be carried out. For example, in the examples of the statements provided at the appendix section, there are glaring omissions on what indicators BSO uses to show that it is meeting its environmental performance targets. Hansen and Mendoza (2009) note this discrepancy in environmental reporting and say 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. Conclusion Globally, the current trend in corporate environmental management and corporate environmental performance reporting point to the following four observations: that, i. companies will implement detailed sustainability measures; ii. companies will shift from reporting impact to reporting and managing performance; iii. activities I&II will be carried out in line with the companys core strategy; iv. for all these to occur, everything has to originate from the board-room cascading downwards. For Environmental Management Accounting (EMA) the implications of the forgoing four observations are: i. personnel charged with the responsibility for collecting information to be used for EMA activities must thorough and complete; ii. personnel that are in-charge of preparing for EMA must be very clear and precise in defining performance parameters; iii. all EMA activities revolve the company strategy, there is no room for veering off; and iv. EMA activities will achieve a high rate of success when there is support from the top or top managers in organization are involved. References I. II. An Introduction to Environmental Reporting, ACCA, UK Global trends in sustainability performance management, Economist Intelligence Unit, The Economist, March 2010 Gray R., Bebbington J., Walters D., Accounting For The Environment, Paul Chapman Publishers Ltd, London, UK, 204-231 Improving Governments Role In the Promotion of Environmental Managerial Accounting, An initiative of the United Nations Division for Sustainable Development, First Meeting:

III.

IV.

Washington DC, 30-31 August 1999, Organized in partnership with the: United States Environmental Protection Agency Environmental Accounting Project (USEPA) United Nations Environment Programme (UNEP) Source: http://www.ertc.deqp.go.th/ertc/images/stories/user/ct/ct1/cp/cp_program_management/ UN%20Improving%20Promo%20of%20EA.pdf