## **Learning Outcomes**

After studying this article, you will be able to identify and classify environmental costs, describe key environmental management accounting (EMA) techniques, and explain sustainability KPIs and triple bottom line (TBL) reporting. You will be equipped to apply cost classifications, recommend EMA approaches, and select suitable KPIs in typical ACCA PM scenarios.

## **ACCA Performance Management (PM) Syllabus**

For ACCA Performance Management (PM), you are required to understand the role of environmental and sustainability management in performance measurement and decision-making. This article covers the following key syllabus areas:

- The identification and classification of environmental costs, including internal and external categories
- Application of environmental management accounting (EMA) techniques such as input/output analysis, flow cost accounting, and activity-based costing for environmental costs
- Classification of prevention, detection, internal failure, and external failure costs
- Selection and use of sustainability key performance indicators (KPIs), including those for triple bottom line (people, planet, profit) reporting
- The role of the management accountant in supporting sustainability objectives in budgeting and performance management

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which of the following is an internal environmental failure cost?
   a) Paying an environmental audit fee  
   b) On-site treatment of waste water  
   c) Cleaning up an oil spill in a nearby river  
   d) Community compensation for health impacts

2. What does input/output analysis help management achieve in environmental management accounting?
   a) Apportion indirect costs using machine hours  
   b) Minimize staff costs by process  
   c) Reconcile and cost all material inflows and outflows  
   d) Ignore the cost of hazardous waste

3. True or false? External failure costs are always incurred by the business and never by society or the environment.

4. Name two KPIs commonly used in sustainability (triple bottom line) reporting to assess environmental performance.

## **Introduction**

Environmental and sustainability management are now regarded as essential for effective performance management in every sector. Increasingly, businesses must account not only for economic results, but also for their environmental and social impact. Environmental management accounting (EMA) helps managers identify, track, and control costs related to environmental activity and waste. Sustainability KPIs are used by organisations to set goals, monitor improvement, and report transparently to stakeholders.

> **Key Term: environmental management accounting (EMA)**
> The process of identifying, collecting, and analysing environment-related cost and performance data for management decision-making within the organisation.

## **CLASSIFYING ENVIRONMENTAL COSTS**

Environmental costs can be grouped in several ways. Most visibly, they are split between costs borne by the organisation (internal) and those imposed on others (external).

- **Internal environmental costs**: Costs that appear in the company’s financial records, such as waste handling fees, emission taxes, energy use, or investment in clean technology.
- **External environmental costs**: Costs damaging society or the environment, unrecorded by the business itself, such as air or water pollution, health impacts, or deforestation.

> **Key Term: internal environmental cost**
> A cost related to environmental activity that is reflected in the company’s accounts and affects its profit.
>
> **Key Term: external environmental cost**
> A cost arising from the company’s activities but borne by society at large, not recorded in the company’s accounts.

Environmental costs are often further classified as:

- **Prevention costs**: Expenditure to avoid environmental harm (e.g., pollution control, eco-design).
- **Detection costs**: Monitoring activities (e.g., environmental audits, emissions measurement).
- **Internal failure costs**: Dealing with waste before it leaves the business (e.g., water treatment, scrapping defective product on-site).
- **External failure costs**: Cleaning up after environmental damage has occurred outside the business (e.g., fines, compensation, or land restoration).

> **Key Term: prevention cost**
> The cost of activities intended to prevent the creation of waste or emissions.
>
> **Key Term: detection cost**
> The cost of measuring, auditing, and monitoring environmental performance.
>
> **Key Term: internal failure cost**
> The cost resulting from environmental waste or emissions that are managed within the company’s operations.
>
> **Key Term: external failure cost**
> The cost incurred to remedy environmental harm that has already occurred beyond the business, such as pollution of land or water.

## **ENVIRONMENTAL MANAGEMENT ACCOUNTING TECHNIQUES (EMA)**

EMA aims to make environmental costs visible and assignable, enabling managers to identify waste, set accurate targets, and manage compliance.

### Input/Output Analysis

Tracks all material, energy, and waste flows entering and leaving each process. The method highlights the financial impact of any losses and uncovers hidden inefficiencies that traditional accounting might miss.

### Flow Cost Accounting

Goes beyond input and output tracking, dividing physical flows and associated costs into categories such as "materials," "system," and "delivery/disposal." Each flow is costed to show how resource use, waste, and inefficiency translate into avoidable expense.

> **Key Term: flow cost accounting**
> A method that traces and values material flows (input, system, delivery/disposal) through the business to clarify the cost of waste and improve efficiency.

### Activity-Based Costing (ABC) for Environmental Costs

ABC can help attribute environmental costs to specific activities—such as waste disposal, audits, or regulatory reporting—by using cost drivers like volume of waste or number of inspections.

### Lifecycle Costing (LCC) in Environmental Context

Considers all environmental costs a product incurs from raw material acquisition to final disposal. This provides a ‘cradle to grave’ view and is increasingly used to assess total impact.

### **Worked Example 1.1**

A business buys 1,200 kg of materials each month. It produces 980 kg of saleable product, 180 kg of waste that is disposed of at a cost, and 40 kg of offcuts that are recycled (for negligible revenue).

**Question:** How should this company use input/output analysis to support environmental management decisions?

> **Answer:**
>
> All 1,200 kg of input must be accounted for: 980 kg output, 180 kg waste, 40 kg recycled. The company should assign costs to each outflow (including material, handling, disposal), identify the high cost of waste disposal, and use the data to set targets or invest in process improvements to reduce waste.

## **CLASSIFICATIONS AND MANAGEMENT OF ENVIRONMENTAL COSTS**

Regulators and professional bodies such as the US EPA often split environmental costs more granularly:

- **Conventional costs**: Usual direct costs of materials, energy, water (with environmental relevance).
- **Potentially hidden costs**: Costs buried in general overheads, e.g., environmental staff, reporting, or compliance efforts.
- **Contingent costs**: Future possible costs from environmental harm, e.g., lawsuits or site decommissioning.
- **Image and relationship costs**: Diminution of brand, loss of stakeholder trust, or costs incurred to improve public perception.
- **Prevention, detection, failure costs**: (As above) Used to support environmental decision-making and performance appraisal.

### **Worked Example 1.2**

A manufacturer spends \$8,000 per year on staff environmental training, \$4,500 on routine waste audits, and pays a \$12,000 regulatory fine for a chemical spill. What category best fits each cost?

> **Answer:**
>
> - Environmental training: prevention cost
> - Waste audits: detection cost
> - Regulatory fine: external failure cost

## **EMA TECHNIQUES: PUTTING THEORY INTO PRACTICE**

Key EMA tools used by businesses include:

- Input/output analysis: Checks that incoming material equals outgoing products, waste, and inventory. Gaps alert management to hidden loss.
- Flow cost accounting: Assigns a cost to every output (good, scrap, waste) proportionally, driving process improvement.
- Environmental ABC: Uses practical drivers (e.g., "number of solvent discharges") to allocate costs to activities/products.
- Lifecycle costing: Combines all environmental impacts and costs from development to disposal for optimal decision-making.

### **Worked Example 1.3**

A printing company regularly spends \$16,000 per year on landfill for disposal of non-recycled waste. If it invests \$11,000 per year in recycling capability, annual landfill charges fall to \$5,500, and recycled paper sales bring in \$2,500. What is the annual savings (or cost) of the recycling initiative?

> **Answer:**
>
> Annual cost before initiative: \$16,000  
> After: \$11,000 (recycling) + \$5,500 (residual landfill) - \$2,500 (recycled sales) = \$14,000  
> Annual savings: \$16,000 - \$14,000 = \$2,000 per year.

### **Exam Warning**

> Do not confuse internal failure costs (dealing with waste before it leaves your company) with external failure costs (when pollution or waste affects outside parties and you become liable for remediation). Misclassification may lead to poor performance analysis and incorrect recommendations in the exam.

## **SUSTAINABILITY KPIs AND TRIPLE BOTTOM LINE REPORTING**

Sustainability KPIs help quantify "people, planet, profit" in business performance. Environmental KPIs are used to monitor and target resource usage, waste, and compliance.

**Typical environmental KPIs** include:

- Total energy use per unit produced
- Water consumption and percentage reused or recycled
- Greenhouse gas emissions (CO₂ or equivalent per period)
- Waste generated: amount sent to landfill vs. percentage recycled
- Environmental fines, incidents, or non-compliance events
- Percentage of suppliers meeting sustainability minimum standards

**Triple bottom line (TBL) reporting** extends conventional reporting—balancing economic, environmental, and social results:

> **Key Term: triple bottom line (TBL) reporting**
> The presentation of performance data covering financial (profit), environmental (planet), and social (people) outcomes.

Common social and governance KPIs relevant to TBL:

- Lost-time workplace accidents
- Employee diversity/diversity ratios
- Community service hours or donations

### **Worked Example 1.4**

A company aims to reduce its CO₂ emissions by 20% in three years. Its baseline is 5,000 tonnes per year. If emissions fall to 4,200 tonnes by year 2, is it on track?

> **Answer:**
>
> The target is a reduction of 1,000 tonnes (20% of 5,000). After 2 years, emissions have fallen by 800 tonnes (5,000 – 4,200), which is 80% of the goal. The company is ahead of schedule for its three-year target.

### **Revision Tip**

Know how to define and classify environmental costs and link KPIs to TBL categories. Be ready to explain the difference between internal/external costs, and to apply EMA techniques in scenario questions.

## **Summary**

Environmental management accounting and sustainability KPIs are now fundamental to performance management. EMA techniques help identify hidden environmental costs, drive waste reduction, and improve compliance. TBL and sustainability KPIs ensure a balanced assessment of financial, environmental, and social results, supporting responsible, long-term business decision-making.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The distinction between internal and external environmental costs, with practical examples
- How to classify prevention, detection, internal failure, and external failure costs
- The fundamental techniques of environmental management accounting (input/output analysis, flow cost accounting, environmental ABC, lifecycle costing)
- The role and structure of sustainability KPIs, including triple bottom line reporting categories
- Typical environmental, social, and governance KPIs used by modern organisations
- Pitfalls in cost classification and reporting for environmental management

## **Key Terms and Concepts**

- environmental management accounting (EMA)
- internal environmental cost
- external environmental cost
- prevention cost
- detection cost
- internal failure cost
- external failure cost
- flow cost accounting
- triple bottom line (TBL) reporting


Quality, JIT, and environmental management - Environmental management accounting and sustainability KPIs