Incorporating Environmental Sustainability into Traditional Management Control

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Material

Labor

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Management accounting can support initiatives to improve corporate environmental performance.

•Value Chain Analysis – Can be expanded to include sustainability measures.

•Balanced Scorecard – An additional perspective can be added to capture environmental sustainability.

•Cost variance analysis can be employed to address the full social cost of departures from efficient resource use.

Teaching Points

Raef Lawson, Institute of Management Accountants David Marcinko, Skidmore CollegeSaurav Dutta, SUNY Albany

Development and Use of Shadow Prices

•Shadow Price − economic value of relaxing a constraint.It can be used to measure the decrease in social welfare caused by the emission of an additional unit of pollutant.

•For example, shadow prices for carbon and sulfur have been developed by Environmental Protection Agency Stern Report UK Department for Environment Food and Rural Affairs The Regional Greenhouse Gas Initiative

•The shadow price provides a signal to managers regardingthe relative cost of activities resulting in emissions.

Production Technology

A Lesson on Sustainability Employing Cost Variances

A cost center manager is to produce a budgeted level ofoutput using a cost-minimizing combination of direct laborand direct material. The nature of the material is such thatany portion of the material that does not become part of theoutput is discharged into the environment. Conventional analysis ignores the impact of the environmental discharge. Such negative externalities can be assessed through the use ofshadow prices.

A 100 unit budgeted level of output may be produced using any one of three production processes described below. Unit prices of material and labor are $7 and $11 respectively

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Cost Variance Analysis

Management chooses Process I, and operates it inefficiently consuming 44 units of material and 15.4 units of labor at a total cost of $477.40. Resulting total variance = $477.40 - $396 = $81.40

Input-choice Variance = Difference in cost between efficient operation of Process I and Process II = $434 - $396 = $38

Waste variance = Actual cost of operating Process I less the cost of efficiently operating Process I = $477.40 - $434 = $43.40

Process Units of Material Required

Units of Labor Required

Total Cost to Operate Process

I 40 14 $434II 22 22 $396III 12 34 $458

Incorporating Shadow Prices

Let the unit cost of material increase to $15 to allow for the cost of discharges into the environment – a shadow price of $8.

Process Units of Material Required

Units of Labor Required

Full Social Cost to Operate

ProcessI 40 14 $754II 22 22 $572III 12 34 $554

Expanded Cost Variance Analysis

Management again chooses Process I and operates it inefficiently consuming 44 units of material and 15.4 units of labor. Full social cost = $829.40. Total variance = $275.40

The firm only absorbs private costs resulting in the variances below:

Isocost has rotated to reflect full cost of material

Process III is now optimal

TotalVariance

Private(Firm’s) Cost

SocietalCost

Waste Variance 75.4 U 43.4U 32.0UInput-Choice Variance Process I vs. II

182.0U 38.0U 144.0U

Sustainability VarianceProcess II vs. III

18.0U 62.0F 80.0U

Total 275.4U 19.4U 256.0U

Isocost line contains all combinations of material and labor with total cost = $396

Process II is the minimum costsolution