EPA An Introduction to

Environmental

Accounting

As A Business

Management Tool:

Environmental

As A Business

Management Tool:

Key Concepts And Terms

United States Office of Pollution EPA 742-R-95-001

Environmental Protection Prevention And Toxics June 1995

Agency (MC 7409)

Washington, D.C. 20460

)

- iii. -

U.S. Environmental Protection Agency

Design for the Environment Program

Environmental Accounting Project

 This paper was prepared by ICF Incorporated under EPA Contract

No. 68-W2-0008, Work Assignment 82. The EPA Work Assignment

Managers were Marty Spitzer and Holly Elwood. Carlos Lago served as

the EPA Project Officer. The ICF Work Assignment Manager was Paul

Bailey.
Disclaimer

 This primer refers to environmental accounting activities at

several companies in North America. These examples are by no

means exhaustive of the many laudable efforts underway to implement

environmental accounting at firms in many different industries.

Moreover, by mentioning these examples, EPA is not necessarily

endorsing their approaches or terminology.

- iv. -

Acknowledgments

 The Environmental Protection Agency (EPA) would like to thank all

of the individuals who took the time to review earlier drafts of this

paper and offered their helpful comments and suggestions. Their

contributions are very much appreciated. The reviewers included the

following individuals:

Robert W. Backes, Manager

Accounting Implementation and

Control

Schering-Plough Corporation

Corinne Boone

Advisor: Full Cost Accounting

Environmental and Sustainable

Development Division

Ontario Hydro

Rick Brenner

Strategic Planning and

Prevention Division

EPA, Federal Facilities

Enforcement Office

Mary Ann Curran

Risk Reduction Engineering

Laboratory

EPA, Office of Research and

Development

Paul P. Danesi, Jr., Controller

Worldwide Products

Texas Instruments, Inc.

Daryl Ditz, Associate

World Resources Institute

Julian Freedman

Director of Research

Institute of Management

Accountants

George Garland

Municipal and Industrial Solid

Waste Division

EPA, Office of Solid Waste

Terri Goldberg

Pollution Prevention Program

Manager

Northeast Waste Management

Officials’

Association (NEWMOA)

Lou Jones, Manager

Corporate Accounting

Caterpillar Company

Joseph J. Martin, CMA

Assistant Controller

IBM Corporation

Robert C. Miller

Assistant Controller

Boeing Commercial Airplane

Group

Edward W. Trott, CPA

Partner

KPMG Peat Marwick

Keith Weitz

Environmental Scientist

Research Triangle Institute

Allen White, Director

Risk Analysis Group

Tellus Institute

Jeannie Wood, Manager

AT&T Global Information

Solutions

- v. -
 Dr. Marty Spitzer, EPA Office of the Administrator, deserves

special recognition for preparing earlier versions of this paper and

offering his thoughts throughout the preparation and review of

subsequent drafts.

Acknowledgments (continued)

- vi. -

TABLE OF CONTENTS

Acknowledgments

Purpose of this Document

 

A. Introduction

B. Why Do Environmental Accounting?

C. What Is Environmental Accounting?

D. What Is An Environmental Cost?

E. Is There a Proper Scale and Scope for

Environmental Accounting?

F. What Is The Difference Between Private Costs and

Societal Costs?

G. Who Can Do Environmental Accounting?

H. Applying Environmental Accounting to

Cost Allocation

I. Applying Environmental Accounting to

Capital Budgeting

J. Applying Environmental Accounting to 

Process/Product Design

K. Key Terms and Underlying Concepts

L. Conclusion: Moving Ahead

v

viii

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1

7

13

14

17

18

24

26

38

Page

2

28

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PURPOSE OF THIS DOCUMENT

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The central purpose of this primer is twofold: (1) to orient readers to

key concepts often referred to as environmental accounting, and (2) to

explain how the terms that refer to environmental accounting are currently

being used, so that confusion about the terms does not impede progress in

understanding and applying the core concepts.

EPA prepared this document to be a starting point for readers who have

questions about environmental accounting. The intended audience includes

business managers and other professionals who wish to understand

environmental accounting. In addition, people involved with activity-based

costing, total quality management, business re-engineering, or design for the

environment should find environmental accounting to be compatible with and

potentially helpful to their programs.

EPA’s Environmental Accounting Project has produced this primer at the

behest of stakeholders who have suggested that an important step in

promoting environmental accounting is to clarify key concepts and terms to

facilitate more widespread adoption of environmental accounting practices. 1

1

 In December 1993, a national workshop of experts drawn from

business, professional groups, government, nonprofits, and academia

produced an Action Agenda “to encourage and motivate businesses to

understand the full spectrum of environmental costs and integrate these

costs in decisionmaking.” Stakeholder’s Action Agenda: A Report of the

Workshop on Accounting and Capital Budgeting for Environmental Costs,

December 5-7, 1993; EPA 742-R-94-003 (May 1994). The Agenda identifies

four overarching issue areas that require attention to advance environmental

accounting: (1) better understanding of terms and concepts, (2) creation of

internal and external management incentives, (3) education, guidance, and

outreach, and (4) development and dissemination of analytical tools,

methods, and systems. The purpose of this document is to help address the

first recommendation. The U.S. Chamber of Commerce, the Business

Roundtable, the American Institute of Certified Public Accountants, the

Institute of Management Accountants, AACE International (the Society of

Total Cost Management), and the U.S. EPA co-sponsored the Workshop.

This primer focuses on environmental accounting as a

management tool for a variety of purposes, such as improving

environmental performance, controlling costs, investing in "cleaner"

technologies, developing "greener" processes and products, and

informing decisions related to product mix, product retention, and

product pricing. The primer does not cover all of these potential

applications but does summarize how environmental accounting can

be applied to cost allocation, capital budgeting, and process/product

design. Specific applications of environmental accounting are

illustrated in case studies that EPA has prepared documenting

companies' programs to implement environmental accounting. For

more information on EPA's activities in this area or for copies of the

case studies, please contact the EPA's Pollution Prevention

Information Clearinghouse at (202) 260-1023.

- ix. -
AN INTRODUCTION TO ENVIRONMENTAL ACCOUNTING

A. Introduction

 The term environmental accounting has many meanings and uses.

Environmental accounting can support national income accounting,

financial accounting, or internal business managerial accounting. This

primer focuses on the application of environmental accounting as a

managerial accounting tool for internal business decisions. Moreover,

the term environmental cost has at least two major dimensions: (1) it

can refer solely to costs that directly impact a company's bottom line

(here termed "private costs"), or (2) it also can encompass the costs to

individuals, society, and the environment for which a company is not

accountable (here termed "societal costs"). The discussion in this

primer concentrates on private costs because that is where companies

starting to implement environmental accounting typically begin.

However, much of the material is applicable to societal costs as well.

B. Why Do Environmental Accounting ?

Environmental costs are one of the many different types of costs

businesses incur as they provide goods and services to their customers.

Environmental performance is one of the many important measures of

business success. Environmental costs and performance deserve

management attention for the following reasons:

(1) Many environmental costs can be significantly 

reduced or eliminated as a result of business 

decisions, ranging from operational and housekeeping 

changes, to investment in “greener” process 

technology, to redesign of processes/products. Many 

environmental costs (e.g., wasted raw materials) may 

provide no added value to a process, system, or 

product.

(2) Environmental costs (and, thus, potential cost 

savings) may be obscured in overhead accounts or 

otherwise overlooked.

(3) Many companies have discovered that environmental costs

can be offset by generating revenues through sale of waste

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by-products or transferable pollution allowances, or licensing of clean 

technologies, for example.

(4) Better management of environmental costs can result in 

improved environmental performance and significant benefits 

to human health as well as business success.

(5) Understanding the environmental costs and performance of 

processes and products can promote more accurate costing and 

pricing of products and can aid companies in the design of more 

environmentally preferable processes, products, and services for 

the future.

(6) Competitive advantage with customers can result from processes,

products, and services that can be demonstrated to be environmentally

preferable.

(7) Accounting for environmental costs and performance can support a

company’s development and operation of an overall environmental 

management system. Such a system will soon be a necessity for 

companies engaged in international trade due to pending 

international consensus standard ISO 14001, developed by the 

International Organization for Standardization.2

EPA's work with key stakeholders leads it to believe that as businesses

more fully account for environmental costs and benefits, they will clearly see the

financial advantages of pollution prevention (P2) practices. Environmental costs

often can be reduced or avoided through P2 practices such as product design

changes, input materials substitution, process re-design, and improved operation

and maintenance (O&M) practices. For example, increased environmental costs

may result from use of chemical A (e.g., a chlorinated solvent), but not from

chemical B (e.g., an aqueous-based solvent). This is true even though chemical

A and chemical B can be substitutable. Another example: some environmental

compliance costs are required only when use of a substance or generation of a

waste exceeds a defined threshold. A company that can reduce chemical use

below such thresholds or employ substitutes for regulated chemicals can realize

substantial cost savings from design, engineering, and operational decisions.

2 See ISO 14001: Environmental Management System Specification

(Committee Draft, February 1995). ISO 14000 guidance document General

Guidelines on Principles and Supporting Techniques (Committee Draft, February

1995) adds that tracking environmental benefits and costs can support the

appropriate allocation of resources for achieving environmental objectives.

- 2 -

 In two of the most thorough reports on the subject of pollution

prevention in the industrial community, the not-for-profit group INFORM3

studied 29 companies in the organic chemical industry in 1985 and

again in 1992. This research found that chemical "plants with some

type of environmental cost accounting program" had "an average of

three times as many" P2 projects "as plants with no cost accounting

system."4

 The study also showed that the average annual savings per

P2 project in production facilities, where data were available, were just

over $351,000, which equalled an average savings of $3.49 for every

dollar spent. Not only were substantial savings and returns on

investment documented for P2 projects, but an average of 1.6 million

pounds of waste were reduced for each project.

Results like these have highlighted the potential benefits of

environmental accounting to the business community. For example,

responses to a questionnaire administered by George Nagle of the

Bristol-Myers Squibb Company at the Spring 1994 Global

Environmental Management Initiative (GEMI) Conference showed that

corporate professionals are placing a high priority on environmental

accounting.5 Of the 25 respondents to the informal survey, half stated

that their company had some form of a tracking system for

environmental costs. All but two reported that they believed

environmental accounting issues would be more important to their

companies in the near future. In addition, the Business Roundtable

expects to turn its attention to environmental accounting issues in 1995,

and companies of all sizes in the U.S. are beginning to consider

implementing environmental accounting in their facilities.6

3 Cutting Chemical Wastes (1985), INFORM, New York, NY;

Environmental Dividends: Cutting More Chemical Wastes (1992),

INFORM, New York, NY.

4

 Environmental Dividends, at page 31.

5

 “Business Environmental Cost Accounting Survey,” Global

Environmental Management Initiative ‘94 Conference Proceedings, p.

243, March 16-17, 1994, Arlington, VA.

6 See Green Ledgers: Case Studies in Corporate Environmental

Accounting, edited by Daryl Ditz, Janet Ranganathan, and Darryl Banks

(World Resources Institute, 1995) and Environmental Accounting Case

Studies, EPA 742-R-95-00X (forthcoming).

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C. What Is Environmental Accounting?

Different uses of the umbrella term environmental accounting arise

from three distinct contexts:

National income accounting is a macro-economic measure. Gross

Domestic Product (GDP) is an example. The GDP is a measure of the

flow of goods and services through the economy. It is often cited as a key

measure of our society’s economic well-being. The term environmental

accounting may refer to this national economic context. For example,

environmental accounting can use physical or monetary units to refer to the

consumption of the nation’s natural resources, both renewable and

nonrenewable. In this context, environmental accounting has been termed

“natural resources accounting.”

Financial accounting enables companies to prepare financial reports

for use by investors, lenders, and others. Publicly held corporations report

information on their financial condition and performance through quarterly

and annual reports, governed by rules set by the U.S. Securities and

Exchange Commission (SEC) with input from industry's self-regulatory

body, the Financial Accounting Standards Board (FASB). Generally

Accepted Accounting Principles (GAAP) are the basis for this reporting.

Environmental accounting in this context refers to the estimation and public

reporting of environmental liabilities and financially material environmental

costs.

Type of Environmental Accounting Focus Audience

(1) national income accounting

(2) financial accounting

(3) managerial or management

 accounting

nation

firm

firm, division, 

facility, product

line, or system

external

external

internal

- 4 -

Management accounting is the process of identifying, collecting,

and analyzing information principally for internal purposes.7

 Because

a key purpose of management accounting is to support a business's

forward-looking management decisions, it is the focus of the

remainder of this primer. Management accounting can involve data

on costs, production levels, inventory and backlog, and other vital

aspects of a business. The information collected under a business's

management accounting system is used to plan, evaluate, and

control in a variety of ways:

 (1) planning and directing management attention,

 (2) informing decisions such as purchasing (e.g., make vs. buy),

capital investments, product costing and pricing, risk 

management, process/product design, and compliance 

strategies, and

 (3) controlling and motivating behavior to improve business 

results.

Unlike financial accounting, which is governed by Generally

Accepted Accounting Principles (GAAP), management accounting

practices and systems differ according to the needs of the

businesses they serve. Some businesses have simple systems,

others have elaborate ones. Just as management accounting refers

to the use of a broad set of cost and performance data by a

company’s managers in making a myriad of business decisions,

environmental accounting refers to the use of data about

environmental costs and performance in business decisions and

operations. Exhibit 1 lists many types of internal management

decisions that can benefit from the consideration of environmental

costs and benefits. This primer later summarizes how environmental

accounting can be integrated into cost allocation, capital budgeting,

and process/product design.

7 “Management accounting is the process of identification,

measurement, accumulation, analysis, preparation, interpretation,

and communication of financial information used by management to

plan, evaluate, and control within an organization and to assure

appropriate use of and accountability for its resources....” Institute of

Management Accountants Statement on Management Accounting,

No. 1A.

- 5 -
EXHIBIT 1

Types of Management Decisions Benefitting from

Environmental Cost Information

Product Design Capital Investments

Process Design Cost Control

Facility Siting Waste Management

Purchasing Cost Allocation

Operational and Mix

Risk Management Product Pricing

Environmental

Compliance Strategies Evaluations

Performance

Product Retention

- 6 - - 7 -

D. What Is An Environmental Cost?

Uncovering and recognizing environmental costs associated

with a product, process, system, or facility is important for good

management decisions. Attaining such goals as reducing

environmental expenses, increasing revenues, and improving

environmental performance requires paying attention to current,

future, and potential environmental costs. How a company defines

an environmental cost depends on how it intends to use the

information (e.g., cost allocation, capital budgeting, process/product

design, other management decisions) and the scale and scope of the

exercise. Moreover, it may not always be clear whether a cost is

"environmental" or not; some costs fall into a gray zone or may be

classified as partly environmental and partly not. Whether or not a

cost is "environmental" is not critical; the goal is to ensure that

relevant costs receive appropriate attention.

Identifying Environmental Costs

Environmental accounting terminology uses such words as full,

total, true, and life cycle to emphasize that traditional approaches

were incomplete in scope because they overlooked important

environmental costs (and potential cost savings and revenues).8 In

looking for and uncovering relevant environmental costs, managers

may want to use one or more organizing frameworks as tools. This

section presents examples of environmental costs as well as a

framework that has been used to identify and classify environmental

costs.

There are many different ways to categorize costs. Accounting

systems typically classify costs as:

(1) direct materials and labor,

(2) manufacturing or factory overhead (i.e., operating

costs other than direct materials and labor),9

8

 See, for example, Paul E. Bailey, “Full Cost Accounting for Life

Cycle Costs --- A Guide for Engineers and Financial Analysts,”

Environmental Finance (Spring 1991), pp. 13-29.

9

 Manufacturing or factory overhead typically includes indirect

materials and labor, capital depreciation, rent, property taxes,

insurance, supplies, utilities, repairs and maintenance, and other

costs of operating a factory.
- 8 -

(3) sales,

(4) general and administrative (G&A) overhead,10 and

(5) research & development (R&D).

Environmental expenses may be classified in any or all of these

categories in different companies. To better focus attention on

environmental costs for management decisions, the EPA Pollution

Prevention Benefits Manual and the Global Environmental

Management Initiative (GEMI) environmental cost primer use similar

organizing frameworks to distinguish costs that generally receive

management attention, termed the "usual" costs or "direct" costs,

from costs that may be obscured through treatment as overhead or

R&D, distorted through improper allocation to cost centers, or simply

overlooked, termed "hidden," "contingent," "liability" or "less tangible"

costs.11 Exhibit 2 lists examples of these costs under the labels

"conventional," "potentially hidden," "contingent," and

"image/relationship" costs.

Conventional Costs. The costs of using raw materials, utilities,

capital goods, and supplies are usually addressed in cost accounting

and capital budgeting, but are not usually considered environmental

costs. However, decreased use and less waste of raw materials,

utilities, capital goods, and supplies are environmentally preferable,

reducing both environmental degradation and consumption of

nonrenewable resources. It is important to factor these costs into

business decisions, whether or not they are viewed as

“environmental” costs. The dashed line around these conventional

costs in Exhibit 2 indicates that even these costs (and potential cost

savings) may sometimes be overlooked in business decision-making.

10 General and administrative costs may be pooled with sales

costs (i.e., SG&A) or as part of “technical, sales, and general

administrative” costs (i.e., TSGA).

11 The EPA’s Pollution Prevention Benefits Manual (October

1989) introduced the terminology distinguishing among usual, hidden,

liability, and less tangible costs. This framework was largely adopted

in Finding Cost-Effective Pollution Prevention Initiatives:

Incorporating Environmental Costs into Business Decision Making

(1994, Global Environmental Management Initiative (GEMI)), which

uses the terms direct, hidden, contingent liability, and less tangible

costs.

Regulatory

 Notification

 Reporting

 Monitoring/testing

 Studies/modeling

 Remediation

 Recordkeeping

Plans

Training

Inspections

Manifesting

Labeling

Preparedness

Protective equipment

Medical surveillance

Environmental

insurance

Financial assurance

Pollution control

Spill response

Stormwater 

management

Waste management

Taxes/fees 

Upfront

Site studies

Site preparation

Permitting

R&D

Engineering and

procurement

Installation

Voluntary

(Beyond Compliance)

Community relations/

outreach

 Monitoring/testing

 Training

Audits

Qualifying suppliers

Reports (e.g., annual

environmental reports)

Insurance

Planning

Feasibility studies

Remediation

Recycling

Environmental studies

R & D

Habitat and wetland

protection

Landscaping

Other environmental

projects

Financial support to

environmental groups 

and/or researchers 

Back-End

Closure/

decommissioning

Disposal of inventory

Post-closure care

Site survey

EXHIBIT 2

Examples of Environmental Costs Incurred by Firms

 Corporate image

 Relationship with 

customers

Relationships with 

investors

Relationship with insurers

Remediation

Property damage

Personal injury

 damage

 Future compliance costs

 Penalties/fines

 Response to future 

releases

Relationship with

professional staff

Relationship with 

workers

Relationship with

suppliers

Legal expenses

Natural resource

damages

Economic loss 

damages

Relationship with

lenders

Relationship with 

host communities

Relationship with

regulators

Potentially Hidden Costs

Contingent Costs

Image and Relationship Costs

- 9 -

Conventional Costs

 Capital equipment

 Materials

 Labor

 Supplies

 Utilities

 Structures

 Salvage value
Potentially Hidden Costs. Exhibit 2 collects several types of

environmental costs that may be potentially hidden from

managers: first are upfront environmental costs, which are

incurred prior to the operation of a process, system, or facility.

These can include costs related to siting, design of

environmentally preferable products or processes, qualifications of

suppliers, evaluation of alternative pollution control equipment,

and so on. Whether classified as overhead or R&D, these costs

can easily be forgotten when managers and analysts focus on

operating costs of processes, systems, and facilities. Second are

regulatory and voluntary environmental costs incurred in

operating a process, system, or facility; because many companies

traditionally have treated these costs as overhead, they may not

receive appropriate attention from managers and analysts

responsible for day-to-day operations and business decisions.

The magnitude of these costs also may be more difficult to

determine as a result of their being pooled in overhead accounts.

Third, while upfront and current operating costs may be obscured

by management accounting practices, back-end environmental

costs may not be entered into management accounting systems

at all. These environmental costs of current operations are

prospective, meaning they will occur at more or less well defined

points in the future. Examples include the future cost of

decommissioning a laboratory that uses licensed nuclear

materials, closing a landfill cell, replacing a storage tank used to

hold petroleum or hazardous substances, and complying

with regulations that are not yet in effect but have been

promulgated. Such back-end environmental costs may be

overlooked if they are not well documented or accrued in

accounting systems.

Exhibit 2 contains a lengthy list of "potentially hidden"

environmental costs, including examples of the costs of upfront,

operational, and back-end activities undertaken to (1) comply with

environmental laws (i.e., regulatory costs) or (2) go beyond

compliance (i.e., voluntary costs). In bringing these costs to light,

it also may be useful to distinguish among costs incurred to

respond to past pollution not related to ongoing operations; to

control, clean up, or prevent pollution from ongoing operations; or

to prevent or reduce pollution from future operations.

- 10 -

Contingent Costs. Costs that may or may not be incurred at some

point in the future -- here termed "contingent costs" -- can best be

described in probabilistic terms: their expected value, their range, or the

probability of their exceeding some dollar amount. Examples include the

costs of remedying and compensating for future accidental releases of

contaminants into the environment (e.g., oil spills), fines and penalties for

future regulatory infractions, and future costs due to unexpected

consequences of permitted or intentional releases. These costs may

also be termed "contingent liabilities" or "contingent liability costs."

Because these costs may not currently need to be recognized for other

purposes, they may not receive adequate attention in internal

management accounting systems and forward-looking decisions.

Image and Relationship Costs. Some environmental costs are

called "less tangible" or "intangible" because they are incurred to affect

subjective (though measurable) perceptions of management, customers,

employees, communities, and regulators. These costs have also been

termed "corporate image" and "relationship" costs. This category can

include the costs of annual environmental reports and community

relations activities, costs incurred voluntarily for environmental activities

(e.g., tree planting), and costs incurred for P2 award/recognition

programs. The costs themselves are not "intangible," but the direct

benefits that result from relationship/corporate image expenses often are.

Is It An “Environmental” Cost?

Costs incurred to comply with environmental laws are clearly

environmental costs. Costs of environmental remediation, pollution

control equipment, and noncompliance penalties are all unquestionably

environmental costs. Other costs incurred for environmental protection

are likewise clearly environmental costs, even if they are not explicitly

required by regulations or go beyond regulatory compliance levels.

- 11 -
There are other costs,

however, that may fall into

a gray zone in terms of being

considered environmental costs.

For example, should the costs

of production equipment be

considered "environmental"

if it is a "clean technology?"

Is an energy-efficient

turbine an "environmental"

cost? Should efforts to monitor the shelf life of raw materials and

supplies in inventory be considered "environmental" costs (if discarded,

they become waste and result in environmental costs)? It may also be

difficult to distinguish some environmental costs from health and safety

costs or from risk management costs.

The success of environmental accounting does not depend on

"correctly" classifying all the costs a firm incurs. Rather, its goal is to

ensure that relevant information is made available to those who need or

can use it. To handle costs in the gray zone, some firms use the

following approaches:

 allowing a cost item to be treated as “environmental” for 

one purpose but not for another,

treating part of the cost of an item or activity as 

“environmental,” or

treating costs as “environmental” for accounting 

purposes when a firm decides that a cost is more than 

50% environmental.

There are many options. Companies can define what should

constitute an "environmental cost" and how to classify it, based on their

goals and intended uses for environmental accounting. For example, if

a firm wants to encourage pollution prevention in capital budgeting, it

might consider distinguishing (1) environmental costs that can be

avoided by pollution prevention investments, from (2) environmental

costs related to remedying contamination that has already occurred.

But for product costing purposes, such a distinction might not be

necessary because both are costs of producing the good or service.

The goal of environmental accounting

is to increase the amount of relevant

information that is made available to

those who need or can use it. The

success of environmental accounting

does not depend on “correctly”

classifying all the costs a firm incurs.

- 12 -

E. Is There a Proper Scale and Scope for Environmental 

Accounting?

Environmental accounting is a flexible tool that can be applied at

different scales of use and different scopes of coverage. This section

describes some of the options for applying environmental accounting.

Scale. Depending on corporate needs, interests, goals, and

resources, environmental accounting can be applied at different scales,

which include the following:

Specific environmental accounting issues or challenges may vary

depending on the scale of its application.

 Scope. Whatever the scale, there also is an issue of scope. An

initial scope question is whether environmental accounting extends

beyond conventional costs to include potentially hidden, future,

contingent, and image/relationship costs. Another scope issue is whether

companies intend to consider only those costs that directly affect their

bottom line financial profit or loss (e.g., see examples of costs listed in

Exhibit 2 above), or whether companies also want to recognize the

environmental costs that result from their activities but for which they are

not accountable, referred to as societal or external costs. These latter

costs are described in Section F.

individual process or group of processes

(e.g., production line)

system (e.g., lighting, wastewater

treatment, packaging)

product or product line

facility, department, or all facilities

at a single location

regional/geographical groups of 

departments or facilities

corporate division, affiliate, or the

entire company

- 13 -
Thus, the scope of environmental accounting refers to the types of

costs included. As the scope becomes more expansive, firms may

find it more difficult to assess and measure certain environmental

costs. This is illustrated by Exhibit 3.

EXHIBIT 3

The Spectrum of Environmental Costs

F. What Is The Difference Between Private Costs and 

Societal Costs?

Understanding the distinction between private and societal

costs is necessary when discussing environmental accounting,

because common terms are often used inconsistently to refer to one

or both of those cost categories. Exhibit 4 provides a graphical

representation of the important difference between private and

societal costs. It also shows that many private costs are not

currently considered in decision-making. This perspective can apply

to a process, product, system, facility, or an entire company.

Easier to Measure More Difficult to Measure

Conventional

Costs

Hidden

Costs

Contingent

Costs

Relationship/

Image Costs

Societal

Costs

- 14 -

SOCIETAL COSTS

Environmental Costs Potentially Overlooked in

Decision-Making (i.e., Regulatory, Voluntary,

Upfront, Operational, Back-end, Overhead,

Future, Contingent, and Image/Relationship Costs)

SOCIETAL 

COSTS

Conventional Company

Costs Often

Factored Into DecisionMaking

SOCIETAL 

COSTS

PRIVATE COSTS

- 15 -

EXHIBIT 412

Private and Societal Environmental Costs

12 Adapted from Allen T. White, Monica Becker, and Deborah

E. Savage, “Environmentally Smart Accounting: Using Total Cost

Assessment to Advance Pollution Prevention,” Pollution Prevention

Review (Summer 1993), pp. 247-259.
 The innermost box labeled "conventional company costs" includes

the many costs businesses typically track well (e.g., capital costs, labor,

material). Many of these costs may already be directly allocated to the

responsible processes or products in cost accounting systems and be

included in financial evaluations of capital expenditures. The larger

unshaded box includes all of the potentially overlooked costs a business

incurs. Examples of these costs are shown on page 9 at Exhibit 2.

Together, the unshaded area

represents "private costs,"

which are the costs a

business incurs or for

which a business can be held

accountable (i.e., legally

responsible). These are the

costs that can directly affect

a firm's bottom line.

The outside shaded box

labeled "societal costs"

represents the costs of

business' impacts on the

 environment and society for

which business is not legally accountable. (These costs are also called

"externalities" or "external costs.") Societal costs include both (1)

environmental degradation for which firms are not legally liable and also

(2) adverse impacts on human beings, their property, and their welfare

(e.g., employment impacts of spills) that cannot be compensated

through the legal system. For example, damage caused to a river

because of polluted wastewater discharges, or to ecosystems from solid

waste disposal, or to asthmatics because of air pollutant emissions are

all examples of societal costs for which a business often does not pay.

Because laws can vary from state to state, the boundary between

societal and private costs may differ as well. At present, valuing societal

costs is both difficult and controversial; nevertheless, some businesses

are attempting to address these costs and EPA supports their efforts. A

major North American power utility, Ontario Hydro, has made a

corporate commitment to determine external impacts and, to the extent

possible, value societal costs in order to integrate them into its planning

and decision-making.13 EPA urges businesses to address all private

13 See “Full Cost Accounting” at Ontario Hydro: A Case Study, EPA

742-R-95-00X (forthcoming).

- 16 -

Life Cycle Perspective Can Help to Identify

Private and Societal Costs

The life cycle of a product, process, system, or

facility can refer to the suite of activities starting

with acquisition (and upfront pre-acquisition

activities) and concluding with back-end

disposal/decommissioning that a specific firm

performs or is responsible for. This life-cycle

perspective can foster a thorough accounting of

private costs (and potential cost savings) in

addition to facilitating a more systematic and

complete assessment of societal impacts and

costs due to a firm’s activities.

environmental costs shown on Exhibit 2, including hidden, future,

contingent, and image/relationship costs, to the extent practical.

Companies are also encouraged to move beyond consideration of

private costs to incorporate societal costs, at least qualitatively,

into their business decisions.

G. Who Can Do Environmental Accounting?

 Environmental accounting can be employed by firms large and

small, in almost every industry in both the manufacturing and services

sectors. It can be applied on a large scale or a small scale,

systematically or on an as needed basis. The form it takes can reflect

the goals and needs of the company using it. However, in any business,

top management support and cross-functional teams are likely to be

essential for the successful implementation of environmental accounting

because:

Environmental accounting may entail a new way of looking at a 

company's environmental costs, performance, and decisions. 

Top management commitment can set a positive tone and 

articulate incentives for the organization to adopt environmental 

accounting.

Companies will likely want to assemble cross-functional teams to

implement environmental accounting, bringing together 

designers, chemists, engineers, production managers, operators,

financial staff, environmental managers, purchasing personnel, 

and accountants who may not have worked together before. 

Because environmental accounting is not solely an accounting 

issue, and the information needed is split up among all of these 

groups, these people need to talk with each other to develop a 

common vision and language and make that vision a reality.

AT&T is one example of a company that has combined senior 

management support and use of a cross-functional team for its 

environmental accounting initiative.14

14 See Introducing “Green Accounting” at AT&T: A Case Study,

EPA 742-R-95-00X (forthcoming).

- 17 -
 

Companies with formal environmental management systems may

want to institutionalize environmental accounting because it is a logical

decision support tool for these systems. Similarly, many companies

have begun or are exploring new business approaches in which

environmental accounting can play a part:

Activity-Based Costing/Activity-Based Management

Total Quality Management/Total Quality Environmental 

Management

Business Process Re-Engineering/Cost Reduction

Cost of Quality Model/Cost of Environmental Quality Model

Design for Environment/Life-Cycle Design

Life-Cycle Assessment/Life-Cycle Costing

All of these approaches are

compatible with environmental

accounting and can provide

platforms for integrating

environmental information

into business decisions.

Companies using or evaluating

these approaches may want to consider explicitly adopting

environmental accounting as part of these efforts.

Small businesses that may not have formal environmental

management systems, or are not using any of the above approaches,

have also successfully applied environmental accounting. As with larger

firms, management commitment and cross-functional involvement are

necessary.

H. Applying Environmental Accounting to Cost Allocation

An important function of environmental accounting is to bring

environmental costs to the attention of corporate stakeholders who may

be able and motivated to identify ways of reducing or avoiding those

costs while at the same time improving environmental quality.

Environmental accounting can be an

important component of overall corporate

environmental management, quality

management, and cost management.

- 18 - - 19 -

COST ALLOCATION

This can require, for example, pulling some environmental costs out of

overhead and allocating those environmental costs to the appropriate

accounts. By allocating environmental costs to the products or

processes that generate them, a company can motivate affected

managers and employees to find creative pollution prevention

alternatives that lower those

costs and enhance profitability.

For example, Caterpillar's

East Peoria, Illinois, plant no

longer dumps waste disposal costs into an overhead account; rather,

the costs of waste disposal are allocated to responsible commodity

groups, triggering efforts to improve the bottom line through pollution

prevention.15

Overhead is any cost that, in a given cost accounting system, is not

wholly attributed to a single process, system, product, or facility.

Examples can include supervisors' salaries, janitorial services, utilities,

and waste disposal. Many environmental costs are often treated as

overhead in corporate cost accounting systems. Traditionally, an

overhead cost item has been handled in either one of two ways:

(1) it may be allocated on some basis to specific products, or

(2) it may be left in the pool of costs that are not attributed to any

specific product.

If overhead is allocated incorrectly, one product may bear an overhead

allocation greater than warranted, while another may bear an allocation

smaller than its actual contribution. The result is poor product costing,

which can affect pricing and profitability. Alternatively, some overhead

costs may not be reflected at all in product cost and price. In both

instances, managers cannot perceive the true cost of producing

products and thus internal accounting reports provide inadequate

incentives to find creative ways of reducing those costs.

15 Jean V. Owen (senior editor,) “Environmental Compliance:

Managing the Mandates,” Manufacturing Engineering (March 1995).
Separating environmental

costs from overhead accounts

where they are often hidden and

allocating them to the appropriate

product, process, system, or

facility directly responsible

reveals these costs to managers,

cost analysts, engineers,

designers, and others. This is

critical not only for a business

to have accurate estimates of

production costs for different

product lines and processes,

but also to help managers target

cost reduction activities that can also improve environmental quality.

The axiom “one cannot manage what one cannot see” pertains here.

There are two general approaches to allocating environmental costs:

(1) Build proper cost allocation directly into cost accounting 

systems, or

(2) Handle cost allocation outside of automated accounting 

systems.

Companies may find that the latter approach can serve as an interim

measure while the former option is being implemented.

Steps in Environmental

Cost Allocation

1. Determine scale and scope

2. Identify environmental costs

3. Quantify those costs

4. Allocate environmental costs to

responsible process, product,

system, or facility

- 20 - - 21 -

EXHIBIT 5

TRADITIONAL COST ACCOUNTING SYSTEM

Labor

A

Material

A

Labor

B

Material

B

Widget A Widget B

Overhead

Supervisors' Rent Salaries

Human

Resources

Toxic

Waste

A simple example illustrates the problem.16 Exhibit 5 depicts a

traditional accounting system that assigns environmental and certain

other costs to overhead. Such overhead costs generally are allocated to

Widgets A and B in proportion to their consumption of labor and

materials.

16 This example and the diagrams are derived from Rebecca Todd,

“Accounting for the Environment: Zero-Loss Environmental Accounting

Systems,” Presented at the National Academy of Engineering, Industrial

Ecology/Design for Engineering Workshop, July 13-17, 1992.
Overhead

Widget A Widget B

Waste

Toxic

B

Overhead

Other

EXHIBIT 6

Misallocation of Environmental Costs Under

Traditional Cost System

Exhibit 6 highlights the misallocation of environmental costs.

Suppose Widget B is solely responsible for toxic waste management

costs, and Widget A creates no toxic waste costs. The misallocation

occurs because the toxic waste management cost is lumped together in

an overhead cost pool that is misallocated to both Widgets A and B,

even though none of the toxic waste management cost results from the

production of Widget A. The effect is to distort the actual costs of

producing Widget A and Widget B.

- 22 -

 Exhibit 7 illustrates a cost accounting system that correctly

attributes the environmental costs of Widget B only to Widget B. By

breaking environmental costs out of overhead and directly attributing

them to products, managers will have a much clearer view of the true

costs of producing Widget A and B. Alternatively, environmental costs

can be allocated to responsible processes, systems, or departments.

Environmental costs resulting from several processes or products may

need to be allocated based on a more complex analysis. And future

costs (e.g., toxic waste disposal) may need to be amortized and allocated

to proper cost centers.

The preceding discussion applies equally to the appropriate

crediting of revenues derived from sale or use of by-products or

recyclables (e.g., raw materials and supplies). Although the focus of cost

allocation is on environmental costs, environmental revenues should be

treated in a parallel fashion.

EXHIBIT 7

Revised Cost Accounting System

Labor

A

Material

A

Labor

B

Material

B

Widget A Widget B

Overhead

Rent Human

Resources

Toxic

Waste B

Supervisors'

Salaries

- 23 -
I. Applying Environmental Accounting to Capital Budgeting

Capital budgeting includes the process of developing a firm's

planned capital investments. It typically entails comparing predicted

cost and revenue streams of current operations and alternative

investment projects against financial benchmarks in light of the

costs of capital to a firm.17

It has been quite common for

financial analysis of investment

alternatives to exclude many

environmental costs, cost savings, and revenues. As a result,

corporations may not have recognized financially attractive investments

in pollution prevention and "clean technology." This is beginning to

change.

When evaluating a potential

capital investment it is important

to fully consider environmental

costs, cost savings, and revenues

to place pollution prevention

investments on a level playing

field with other investment

choices. To do this, identify and

include the types of costs

(and revenues) (i.e., the "cost

inventory") that will help to

demonstrate the financial viability

of a cleaner technology investment. Analyze qualitatively those data

and issues that cannot be easily quantified, such as the potential less

tangible benefits of pollution prevention investments. Exhibit 2 may help

in identifying potentially relevant costs (and savings).

17 Allen White and Monica Becker, “Total Cost Assessment:

Catalyzing Corporate Self Interest in Pollution Prevention,” New

Solutions, (Winter, 1992), p. 34. See also, “Total Cost Assessment:

Accelerating Industrial Pollution Prevention through Innovative Project

Financial Analysis, With Applications to the Pulp and Paper Industry,”

U.S. Environmental Protection Agency (May, 1992) EPA-741-R-92-002.

CAPITAL BUDGETING

Integrating Environmental Accounting into

Capital Budgeting

1. Inventory and quantify environmental costs

2. Allocate and project environmental costs

and benefits

3. Use appropriate financial indicators

4. Set reasonable time horizon that captures

environmental benefits

- 24 -

After collecting or developing environmental data (either from the

accounting system or by manual means), allocate and project costs,

cost savings, and potential

revenues to the products,

processes, systems, or

facilities that are the focus

of the capital budgeting

decision. Begin with

the easiest to estimate costs

and revenues and work toward

the more difficult to estimate environmental costs and benefits such as

contingencies and corporate image. The benefit of

improved corporate

image and relationships

due to pollution

prevention investments

can impact costs and

revenues in ways that

may be challenging

to project in dollars and cents.

(See sidebar) For example,

a company selected as

"Clean Air Partner of the

Year" under a Colorado

partnership program

attracted several new

clients from the positive

publicity.18 Information

about past expenditures

on corporate image also

may be helpful in estimating

future benefits

(e.g., potential savings or

reductions in those outlays

resulting from the investment)

for companies that want to

go beyond the qualitative

consideration of these benefits.

18 Reported by representative of Majestic Metals, March 22, 1995,

at EPA Regional Office training program on pollution prevention.

Potential Less Tangible Benefits of

Pollution Prevention Investments

● Increased sales due to enhanced

company or product image

● Better borrowing access and terms

● Equity more attractive to investors

● Health and safety cost savings

● Increased productivity and morale of

employees, greater retention, reduced

recruiting costs

● Faster, easier approvals of facility

expansion plans or changes due to

increased trust from host communities

and regulators

● Enhanced image with stakeholders

such as customers, employees,

suppliers, lenders, stockholders,

insurers, and host communities

● Improved relationships with regulators

It may be easier to include environmental

costs in capital budgeting, if existing

processes, systems, and products are

already being assigned environmental

costs in cost accounting systems.

- 25 -
Be sure to use appropriate financial indicators that include the time

value of money (i.e., a dollar today is worth more than a dollar next

year). Sound financial indicators include net present value,19 internal

rate of return,20 and other profitability indices. Payback,21 although

commonly used, does not recognize the time value of money. Further,

payback may not recognize the long-term benefits of pollution prevention

investments.

Consider cash flows and the profitability of a project over a

sufficiently long time horizon (e.g., economic life of the capital

investment) to capture the long-term benefits of pollution prevention

investments. Finally, prepare the data and information in a format that

managers and lenders can understand and find useful.

For more information on integrating environmental costs into capital

budgeting, see EPA's Total Cost Assessment: Accelerating Industrial

Pollution Prevention through Innovative Project Financial Analysis (EPA

741-R-92-002, May 1992).

J. Applying Environmental Accounting to Process/Product Design

The design of a process or product significantly affects

environmental costs and performance. The design process involves

balancing cost, performance,

cultural, legal, and

environmental criteria.22

19 The present value of the future cash flows of an investment less

the investment’s current cost. It incorporates the time value of money.

20 The discount rate at which the net present value of a project is

equal to zero.

21 The time period required for revenues or cost savings to equal

costs; payback typically does not involve discounting.

22 EPA Life Cycle Design Guidance Manual: Environmental

Requirements and the Product System, EPA-600-R-92-226 (1993).

PROCESS/PRODUCT DESIGN

- 26 -

Many companies are adopting

"design for the environment" or

"life cycle design" programs to take

environmental considerations into

account at an early stage. To do so,

designers need information on the

environmental costs and performance

of alternative product/process

designs, much like the information

needed in making capital budgeting

decisions. Thus, making

environmental cost and

performance information

available to designers can

facilitate the design of

environmentally preferable

processes and products.

For example, the Rohm and

Haas Company has developed

a model to estimate in R&D

the environmental cost of new

processes. The model includes

conventional, hidden, contingent,

and relationship costs. In early phases of process development, the

cost model prompts process researchers to select and justify process

chemistries, operating conditions, and equipment that embody the

principles of pollution prevention. As the project progresses, the model

identifies environmental cost reduction opportunities. The model can

provide financial analysts with an economic picture of the potential

environmental risk of a new process prior to its commercialization.23

23 Suzanne T. Thomas, Victoria Weber, Scott A. Berger, and I. Leo

Klawiter, Estimate the Environmental Cost of New Processes in R&D,

prepared for American Institute of Chemical Engineers (AIChE) Spring

National Meeting (April, 1994).

Integrating Environmental

Issues Into Design

1. Include environmental issues in 

needs analysis

- consider environmental costs 

and performance in defining 

scope of design project

- establish baseline environmental

cost and performance

2. Add environmental requirements to 

design criteria

3. Evaluate alternate design solutions 

taking into account environmental 

cost, performance, cultural, and legal

requirements

- 27 -
K. Key Terms and Underlying Concepts

 A company that wants to use environmental accounting for

management purposes may find the terminology confusing and used

rather loosely. This section identifies and explains some commonly

encountered terms, and, most importantly, their underlying concepts.

Unlike a glossary, the following discussion does not prescribe how these

terms should be used. The section has six parts: the first part

recapitulates the three different uses of the term environmental

accounting; the second part reviews such terms as environmental cost

accounting, full cost accounting, total cost assessment, and related

terms, highlighting critical distinctions that can clarify what people intend

to mean in using these terms; the third part summarizes some life-cycle

terms and concepts that relate to environmental accounting; the fourth

part comprises terms describing key applications of environmental

accounting: cost allocation, capital budgeting, and process/product

design; the fifth part lists a series of terms used to categorize or

describe environmental costs; and the last part presents two other terms

related to environmental accounting.

Environmental Accounting. As noted earlier, the term

environmental accounting has three distinct meanings:

● Environmental accounting in the context of national 

income accounting, refers to natural resource accounting, 

which can entail statistics about a nation's or region's 

consumption, extent, quality, and value of natural resources, both

renewable and non-renewable.

● Environmental accounting in the context of financial 

accounting usually refers to the preparation of financial 

reports for external audiences using Generally Accepted 

Accounting Principles.

● Environmental accounting as an aspect of management 

accounting serves business managers in making capital 

investment decisions, costing determinations, process/product

design decisions, performance evaluations, and a host of 

other forward-looking business decisions.

- 28 -

Commonly Used Terms. Exhibit 8 lists nine terms that frequently

are used in various ways with the same or different meanings. To

understand what someone means when using these terms it is essential

to determine whether they are referring to a specific management

application of environmental accounting (e.g., cost accounting, capital

budgeting, process/product design) and the scope of environmental

costs meant to be included (e.g., private costs only, both private and

societal costs).

Sometimes, the terms are used to refer to a specific application of

environmental accounting. As noted below, total cost assessment is

often used to refer to the act of adding environmental costs into capital

budgeting, whereas life-cycle costing may be most frequently used to

refer to incorporating environmental accounting into process and

product design. Whether or not one uses these terms to refer to

environmental cost allocation, capital budgeting, process/product

design, or other applications, there is another key difference in the way

the terms are commonly used. Some professionals use the terms to

refer to

● a firm’s private costs only (i.e., those that directly affect the firm’s

bottom line), or

● both private and societal costs, some of which do not show up

directly or even indirectly in the firm’s bottom line.

For some people, full cost accounting, full cost environmental

accounting, total cost accounting and the other terms refer only to

private costs. Other people may use the terms to refer to both private

and societal costs. Some people use one of the terms for private costs

alone and another of the terms for both private and societal costs

together. Understanding the basic distinction between private and

societal costs makes it possible to clarify the intended meanings of the

vocabulary and thereby hold a conversation with anyone interested in

environmental accounting. (See Section F.)

- 29 -
EXHIBIT 8

Common Terms and Potential Meanings

Environmental

Accounting

TERMS

(What Term(s)

is (are) Used?)

Cost Accounting

Capital Budgeting

Process/Product Design

Other

Cost Accounting

Capital Budgeting

Process/Product Design

Other

Private Costs Only

Soc ei at l Cos st

Pr vi a et

and

SCOPE OF COSTS

(What Costs

are Covered?)

APPLICATIONS

(What Applications

are Intended?)

This difference is at the heart of much of the confusion in environmental

accounting terminology. It confuses those items that can be handled

more easily __ incorporation of private costs __ with those that are more

difficult to address __ societal costs. Clarifying what someone means

when using environmental accounting terms is the first step to advance

communication and cooperation.

● Environmental cost accounting is a term used to refer to the

addition of environmental cost information into existing cost 

accounting procedures and/or recognizing embedded 

environmental costs and allocating them to appropriate products or

processes.

- 30 -

Environmental

Cost Accounting

Full Cost

Accounting

Full Cost

Environmental 

Accounting

Life Cycle

Assessment

Life Cycle 

Costing

Total Cost

Accounting

Total Cost

Assessment

True Cost 

Accounting

- 31 -

● Full cost accounting is a term often used to describe desirable

environmental accounting practices. In the accounting profession,

“full cost accounting” is a concept and term used in various 

contexts.24 In management accounting, “full costing” means the

allocation of all direct and indirect costs to a product or product line

for the purposes of inventory valuation, profitability analysis, and

pricing decisions.25

● Full cost environmental accounting embodies the same concept

as full cost accounting but highlights the environmental elements.

● Total cost accounting, an often used synonym for full cost 

environmental accounting, is a term that seems to have origins

with environmental professionals. It has no particular meaning to

accountants.

● Total cost assessment has come to represent the process of

integrating environmental costs into a capital budgeting analysis.

It has been defined as the long-term, comprehensive financial

analysis of the full range of private costs and savings of an 

investment. Adding to the confusion, the acronym for total cost

assessment (TCA) is the same as the acronym for total cost 

accounting (TCA).

24 For example, as required by GAAP for external financial and

income tax reporting, accountants calculate the costs of goods sold and

value inventory using full absorption costing (also called “absorption

costing”) which assigns all types of manufacturing costs (direct material

and labor as well as manufacturing overhead) to products. In this

context, full costs per unit equals full absorption cost per unit plus

selling, general and administrative, and interest expenses, per unit.

See, for example, Stickney, Weil, and Davidson, Financial Accounting

(6th Ed., 1991). An alternative procedure, known as “variable costing,”

is often considered superior for certain internal management purposes.

A “full cost method of accounting” is available for oil and gas producing

activities that includes the capitalization and amortization of upfront

activities (e.g., acquisition, exploration, development), estimated future

expenditures of developing proven reserves, and estimated back-end

costs of dismantlement and abandonment. See Regulation S-X

governing financial statements to be filed with the SEC, Section 50410

Rule 4-10.

25 See Statement on Management Accounting No. 2A (Nov. 30,

1990) issued by the Institute of Management Accountants.
● True cost accounting is a less used synonym for full cost 

accounting. The EPA Office of Solid Waste in its program to 

encourage local governments to apply full cost accounting to 

municipal solid waste management uses the term "true cost 

accounting" to encompass both private and societal costs while

employing the term "full cost accounting" to refer exclusively to

costs that affect the bottom line of solid waste management 

activities.

Life-Cycle Terminology. Life-cycle terms also are used in

connection with environmental accounting. These terms include: lifecycle design, life-cycle assessment, life-cycle analysis, life-cycle cost

assessment, life cycle accounting, and life-cycle cost.

● Life-cycle design has been defined as an approach for designing

more ecologically and economically sustainable product systems,

integrating environmental requirements into the earliest stages of

design. In life cycle design, environmental, performance, cost,

cultural, and legal requirements are balanced.26

● Life-cycle assessment has been described as a holistic approach

to identifying the environmental consequences of a product, 

process, or activity through its entire life cycle and to identifying

opportunities for achieving environmental improvements. EPA has

specified the four major stages in the life cycle of a product, 

process, or activity as raw materials acquisition, manufacturing,

consumer use/reuse/maintenance, and recycle/waste 

management.27 By itself, life-cycle assessment focuses on 

environmental impacts, not costs.

● Life-cycle analysis is sometimes used as a synonym for life-cycle

assessment. The U.S. EPA uses the life-cycle assessment term.

Neither term addresses the costs and revenues of environmental

consequences and improvements, however.

● Life-cycle cost assessment is a term that highlights the costing

aspect of life-cycle assessment. It has been termed a systematic

process for evaluating the life-cycle costs of a product, product

line, process, system, or facility by identifying environmental 

26 EPA Life Cycle Design Guidance Manual: Environmental

Requirements and the Product System, EPA-600-R-92-226 (1993)

27

 Life Cycle Assessment: Inventory Guidelines and Principles,

EPA-600-R-92-245 (1993).

- 32 -

consequences and assigning measures of monetary value to

those consequences. Ideally, life-cycle cost assessment can be

used to evaluate options for reducing total life-cycle costs and

optimizing the use of resources. Some people view life-cycle cost

assessment as basically adding cost information to life-cycle 

assessments.

● Life-cycle accounting is a term used to describe the assignment

and analysis of product-specific costs within a life-cycle framework

including usual, hidden, liability, and less tangible costs.28

● Life-cycle cost, according to the U.S. Office of Management and

Budget, means the sum total of the direct, indirect, recurring,

nonrecurring, and other related costs incurred, or estimated to be

incurred, in the design, development, production, operation, 

maintenance, and support of a major system over its anticipated

useful life span.29 More recently, life-cycle cost has been 

defined in an Executive Order as the amortized annual cost of

a product, including capital costs, installation costs, operating

costs, maintenance costs, and disposal costs discounted over the

lifetime of a product.30 The term may also be used more 

expansively to include societal costs.

These life-cycle terms are also subject to terminological confusion.

For example, some people view life-cycle costing as referring only to

private costs, while others view it as including both private and societal

costs. Some apply a life-cycle perspective to capital budgeting, while

others apply life-cycle concepts to process and product design. As

previously mentioned, the key to facilitating communication is to

recognize the different uses of common terms and to be able to identify

underlying concepts. A threshold question is to determine whether

someone is using an environmental accounting term to include solely

private or both private and societal costs. A related question is to

determine what application(s) a person has in mind when using these

terms.

28 EPA Life Cycle Design Guidance Manual: Environmental

Requirements and Product System, EPA-600-R-92-226 (1993),

pp. 122-9.

29 OMB Circular No. A-109 (April 5, 1976).

30 “Federal Acquisition, Recycling, and Waste Prevention,”

Executive Order 12873, Section 210 (October 20, 1993).

- 33 -
Scope of Costs. Because people may use environmental

accounting terminology to refer to specific sets of environmental costs,

or may be imprecise about what they mean, careful delineation of which

types of costs are intended to be within the scope of one term or

another can reduce confusion and enhance communication. This issue

is discussed further in Section K. There is an important distinction

between costs for which a firm is accountable and costs resulting from a

firm's activities that do not directly affect the firm's bottom line:

● Private costs are the costs a business incurs or for which a 

business can be held responsible. These are the costs that 

directly affect a firm's bottom line. Private costs are 

sometimes termed internal costs.

● Societal costs are the costs of a company’s impacts on the 

environment and society for which the business is not financially

responsible. These costs do not directly affect a firm's bottom line.

Societal costs may also be referred to as external costs or 

externalities. These costs may be expressed, qualitatively, in

physical terms (e.g., tons of releases, exposed receptors), or in

dollars and cents. Societal costs (or externalities) are sometimes

subdivided according to whether the impacts are environmental,

referred to as environmental costs or environmental externalities,

or social, referred to as social costs or social externalities.

● Internal costs -- a synonym for private costs.

● External costs -- a synonym for societal costs. Also termed

externalities.

● Social costs can be a synonym for societal costs or can refer to a

subset of external costs

● Environmental costs can refer to a subset of external costs or

can be used as a synonym for environmental externalities, societal

costs, private costs, or both private and societal costs.

Applications. Of the many types of forward-looking business

decisions (see Exhibit 1, page 6) that can benefit from environmental

accounting, this primer focuses on cost accounting, capital budgeting,

and process/product design:

- 34 -

● Cost allocation refers to the procedures and systems for 

identifying, measuring, and allocating or assigning costs for 

internal management purposes.

● Capital budgeting, also known as investment analysis and

financial evaluation, refers to the process of determining a 

company's planned capital investments.

● Process/product design refers to the process of developing

specifications for products and processes, taking environmental

costs and performance, among other factors, into account.

Environmental Costs. Terms used to classify or categorize

environmental costs are listed below:

● Regulatory costs are costs incurred to comply with federal, state,

or local environmental laws (also termed compliance costs).

● Voluntary costs represent costs incurred by a company which are

not required or necessary for compliance with environmental laws

but go beyond compliance.

● “Gray zone costs” refers to costs that are not solely or clearly

"environmental" in nature but may also be viewed, in whole or part,

as health and safety costs, risk management costs, production

costs, operational costs, etc.

● Upfront costs include preacquisition or preproduction costs 

incurred for processes, products, systems, or facilities (e.g., R&D

costs).

● Operational costs refer to costs incurred during the operating

lives of processes, products, systems, and facilities, as opposed to

upfront costs and back-end costs.

● Back-end costs include environmental costs that arise following

the useful life of processes, products, systems, or facilities. See

also exit costs.

● Conventional costs include costs typically recognized in capital

budgeting exercises such as capital equipment, raw materials,

supplies, and equipment. Referred to as usual costs in EPA 

Pollution Prevention Benefits Manual.

- 35 -
● Direct costs is an accounting term for costs that are clearly and

exclusively associated with a product or service and treated as

such in cost accounting systems.

● Usual costs -- see conventional costs.

● Hidden costs refer to the results of assigning environmental costs

to overhead pools or overlooking future and contingent costs.

● Overhead is often used synonymously with indirect or hidden

costs as comprising all costs that are not accounted for as the

direct costs of a particular process, system, product, or facility.

The underlying distinction is between (1) costs that are either

pooled and allocated on the basis of some formula, or not 

allocated at all, and (2) costs that an accounting system treats as

belonging (directly) to a process, system, product, or facility (i.e., a

cost center, in accounting terminology).

● Manufacturing or factory overhead refers to costs that are

allocated using more or less sophisticated formulae as contrasted

with "general and administrative (G&A)" overhead costs that

remain in pools and are not allocated.

● General & administrative (G&A) costs are overhead or indirect

costs that are not allocated to the costs of goods and services

sold.

● Research and development (R&D) costs can include the costs

of process and product design. See also upfront costs.

● Exit costs are the costs of proper closure, decommissioning,

and clean-up at the end of the useful life of a process, system, or

facility. See also back-end costs.

● Contingent costs refer to environmental costs that are not certain

to occur in the future but depend on uncertain future events (e.g.,

costs of remediating future spills). Sometimes referred to as 

"environmental liabilities," "liability costs," or "contingent

liabilities."

● Future (or prospective) costs refer to environmental costs that

are certain to be incurred at a later date, which may or may not be

known. Sometimes referred to as "environmental liabilities."

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● Environmental liabilities is an umbrella term used to refer to

different types of environmental costs including costs for 

remediating existing contamination, costs of complying with new

regulations, future environmental costs of current operations (also

known as back-end or exit costs), and/or contingent costs.

● “Less tangible costs” refers to expenses incurred for corporate

image purposes or for maintaining or enhancing relationships with

regulators, customers, suppliers, host communities, 

investors/lenders, and the general public. Also termed 

“relationship costs” or “image costs.”

Other Related Terms. Two other terms that are relevant to 

environmental accounting include the following:

● Activity-Based Costing (ABC) is a means of creating a system

that ultimately directs an organization’s costs to the products and

services that required these costs to be incurred. Using ABC,

overhead costs are traced to products and services by identifying

the resources, activities, and their costs and quantities to produce

output.31

● Materials accounting or materials balance refers to an 

organized system of accounting for the flow, generation, 

consumption, and accumulation of materials in a facility or process

in order to identify and characterize waste streams.32 Some view

a materials balance as a more rigorous form of materials 

accounting.33

31 See Practices and Techniques: Implementing Activity-Based

Costing, Statement on Management Accounting No. 4T (September 30,

1993) Institute of Management Accounting, reproducing the Society of

Management Accountants of Canada Management Accounting

Guideline 17, Implementing Activity-Based Costing.

32 See, e.g., Harry M. Freeman (ed.), Industrial Pollution

Prevention Handbook (McGraw-Hill, Inc., 1995).

33 Environmental Dividends, at page 8.

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L. Conclusion: Moving Ahead

A successful environmental management system should have a

method for accounting for full environmental costs and should integrate

private environmental costs into

capital budgeting, cost allocation,

process/product design and

other forward-looking decisions.

Companies can make progress

in environmental accounting

incrementally, beginning with

limited scale, scope, and applications. Companies can start with those

costs that they know the most about and work toward the more difficult

to estimate costs and revenues. Where private costs or revenues are

difficult to estimate, and there is little management support for

integrating them, then it may be best to handle them qualitatively. In

many instances, it may be unnecessary to quantify the more difficult to

estimate costs and benefits of capital investment choices because the

more easily measured costs (and benefits) are sufficient to justify an

investment in cleaner technologies. The same is true for

process/product design, if one design direction is clearly superior to the

alternatives. Ultimately, businesses will benefit from including

probabilistic and difficult to estimate costs in cost allocation, capital

investment, process/product design, and other decisions. The best

approach is to go as far as you can in integrating environmental costs,

including hidden, future, and contingent costs, into management

decisions.

Efforts to integrate societal costs into business decisions will

continue and expand. Most corporate information and decision systems

do not currently support such proactive and prospective decision

making.34 The capital markets do not yet have adequate ways to

evaluate the financial performance of progressive companies who do so.

Although some companies are at the leading edge of efforts to address

societal costs, it will likely be some time before societal impacts and

costs can be integrated into cost allocation, capital budgeting,

34 See Incorporating Environmental Costs and Considerations into

Decisionmaking: Review of Available Tools and Software, EPA 742-R95-OXX (1995).

 A successful environmental management

system should have an environmental cost

accounting system and a capital budgeting

process that considers a full array of private

environmental cost and revenue information.

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process/product design, and general business decisions. However,

there is a growing body of information documenting a variety of

businesses engaged in advancing the state of the art to bring societal

costs into their decision-making.

Sources of Further Information

EPA is committed to helping businesses understand their

environmental costs and integrate those costs into decision-making.

The EPA's Environmental Accounting Project performs education,

research, guidance, and outreach on this issue. Join EPA's

Environmental Accounting Network to keep informed of latest

developments by contacting EPA's Pollution Prevention Information

Clearinghouse (PPIC) and asking for a Network Membership Form.

PPIC also can provide a variety of materials including case studies and

lists of EPA and non-EPA publications on these topics. Please call PPIC

at 202/260-1023 for details and/or more information on the EPA

Accounting Project.

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