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Importance Of Environmental Costing

Posted in Finance Articles, Total Reads: 4727 , Published on September 19, 2012

In recent times, the awareness about environmental issues has increased sizably. This has not only led the Government to lay down norms and regulations relating to the environment, but also the trade and industries have had to be careful about proper and safe treatment of effluents and their disposal, as well as solid waste disposal. Be it solid or liquid waste disposal, everything has a cost. Even disposing off the classified solid wastes at the Solid waste disposal site (SWDS), at Nandesari brings a cost to an enterprise.

MSMEs have not been left out of the folds of these environmental trends. At a time when it is becoming an acute necessity for the units to handle the waste by consuming resources, it becomes imperative, especially for MSMEs for whom every additional cost needs to be adjusted and managed into their budgets with critical difficulty due to the size of operations, the cost of resources used in waste management and environment protection to be managed so as to ensure that the environment protection drive continues as per the requirements of the society and at the same time product cost also remains within control. Just celebrating Environment Day on June 5 every year, is not enough after all!

Some of the main reasons why environmental cost management is increasingly important in SMEs is-

  1. Environmental costs in many industries like petrochemical, industrial chemicals, paints, colours, fertilizers, agro-chemical industries, refineries, food industries, etc has risen to about 10-20% of the operating costs. SMEs may not be directly playing in all of these sectors, but they are indirectly influenced by them.
  2. The regulatory requirements have gone up and compliance has been tightened, involving huge fines and penalties, sometimes leading even to complete closure of the plant.
  3. The society is also becoming demanding that the industries become more and more environment-friendly.

Thus, it is essential that the SMEs accept the fact that taking appropriate measures for the environment protection from their wastes and effluents will build their image in the society, which will have a positive impact on the demand of their products and they will also gain sustainability with their competitors in the market. These developments require that the SMEs pay greater attention to this component of their cost sheets and develop a system of measuring, reporting and monitoring environmental costs.

Many SMEs and sometimes even bigger industries are unable to identify their total environmental costs and do not recognize that such costs are measurable and controllable and can even be reduced. In fact, most cost accounting systems do not provide for capturing such costs separately and assigning them to the related products.

These environmental costs then remain hidden under the categories of factory overheads and general overheads and are then apportioned to the products being produced on arbitrary basis when the factory overheads or the general overheads, as the case may be, get apportioned. The opportunity to identify the environmental costs and establishing the relationship between them and the responsible product goes entirely missed. Knowledge of these costs will enable the management to not only manage these costs but also redesign the production process and reduce the pollutants being released into the environment.

Expert cost accountants – Hensen and Mendoza, believe that environmental costs are often received because poor environmental control exists. This cost is considered to be similar to the cost of quality, that is, the cost incurred in reworking due to poor quality. They advice that an environmental cost report should be generated periodically based on the principles of cost of quality report to indicate the total environmental costs to the organization associated with the creation, detection, remedy and prevention of environmental degradation.

The classification of environmental costs is generally done into four –

  1. Environmental prevention cost – cost of activities undertaken to prevent production of waste that could cause environmental damage.
  2. Environmental appraisal cost – cost of inspection and checking of compliance, incurred by enterprises that comply with mandatory and voluntary regulatory standards
  3. Environmental internal failure cost – cost of efforts to bring excess level of pollutants (solids/liquid/gaseous) within the prescribed set limits or recycling the wastes within the plant to comply with standards
  4. Environmental external failure cost – cost of rectification of damage done to the environment done by the enterprise, by discharging waste/effluent into the environment

The costs that are covered in the above four categories may be one time revenue nature costs like fines, penalties, soil cleaning cost, etc or recurring costs like cost on regular training to employees, organizing workshops on environmental issues and protection measures, salary and wages paid to the safety and environment officers and workers, cost of operating the effluent treatment plant, water and other chemical consumption in environmental  damage control or capital costs incurred for environmental compliances which include cost of instruments which measure pollution levels in air, water, earth, cost of building the effluent treatment plant, plant for recycling of toxic wastes, pipelines for waste transportation from plant to an internal pond or to remote locations like a sea or a water body wherever such a discharge is allowed by the Government and the GPCB.

For instance, the Bharuch Echo-aqua infrastructure ltd (BEAIL) laid a whole pipeline from Ankleshwar and Bharuch industrial areas in south Gujarat up to the sea near Dahej for transporting the internally treated effluents of chemical and pharmaceutical plants for draining it into the sea.

So, the environmental costs incurred by the enterprise should be reported to the government, industries forums and the stakeholders of the enterprise through news agencies and the reports should reflect the cost as a percentage of revenue and also the total operating cost so as to make it comparable with cost of other units for a given period as also with the previous periods.

Such reports would reveal the costs incurred by the enterprise but are silent on the costs caused by the enterprise but incurred by the society. For instance, the huge land reserved for accumulating and stacking solid waste at a central place as in the case of the SWDS at Nandesari, could otherwise be used for recreational purposes by the society, diversion of scarce resources by the Government or the municipal corporation for environmental protection measures from using them for other purposes which could meet the needs of the poor of the society.

It would actually, however, be much easier and less costly for the firms and the society if appropriate measures are taken for environment protection with the help of the life cycle costing method of cost reduction. This will enable the companies to think environment-friendly right from the design stage of the product so that less pollution is required to be handled rather than focusing on these issues in the manufacturing phase where the product redesign and processes are already determined and the costs are committed.

This article has been authored by Bhavi Patel from IRMA.

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