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Carbon Business Accounting: The Impact

of Global Warming on the Cost and

Management Accounting Profession

J

ANEK

T. D. R

ATNATUNGA

*

K

ASHI

R. B

ALACHANDRAN

**

The concentrations of greenhouse gases in the atmosphere have risen

dramatically, leading to the possibility of costly disruption from rapid

climate change. This calls for greater attention and precautionary

meas-ures to be put in place, both globally and locally. Governments,

busi-ness entities and consumers would be affected by the extent to which

such precautionary measures are incorporated in their decision-making

process.

Business entities need to consider such issues as trading in carbon

allowances (or permits), investing in low–carbon dioxide (CO

2

) emission

technologies, counting the costs of carbon regularity compliance, and

passing on the increased cost of carbon regulation to consumers

through higher prices. Such considerations require information for

informed decision making. This paper reports on a qualitative research

study undertaken to consider the impact of the Kyoto Protocol

mecha-nisms on the changing information paradigms of cost and managerial

accounting.

It is demonstrated that the information from strategic cost

manage-ment systems will be particularly useful in this new carbon economy,

especially in evaluating the ‘‘whole-of-life’’ costs of products and

ser-vices in terms of carbon emissions. Similarly, the study discusses how

strategic management accounting information would facilitate decisions

on business policy, human resource management, marketing, supply

chain management, and finance strategies and the resultant evaluation

of performance.

1. The Emerging Paradigm of Carbonomics

The Kyoto Protocol is the original international regulatory response to global

warming, under which more than 150 countries agreed to strive to decrease

*University of South Australia **New York University

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carbon dioxide (CO

2

) emissions. Whilst alternative social constructions have

been debated for the reduction of carbon emissions, such as that agreed to at the

recent Applied Power and Economics Conference (APEC) in Sydney (Mackey

[2007]),

1

the Kyoto Protocol remains the international standard. Under Kyoto, a

country can emit more CO

2

than its assigned amount only if it can

simultane-ously sequester the equivalent amount in ‘‘Ôallowable’’ carbon sinks (such as

trees, plankton, soils, and water bodies).

The Kyoto Protocol has developed various alternative social constructions

(or mechanisms) for reducing carbon emissions that would enable industrial

countries with quantified emission limitation and reduction commitments to

acquire greenhouse-gas reduction credits. Among these mechanisms is the

estab-lishment of an International Emission Trading (IET) scheme. Here countries can

trade in the international carbon credit (allowances) market. Countries with

sur-plus credits can sell them to countries with quantified emission limitation and

reduction commitments under the Kyoto Protocol (see Appendix A for a detailed

discussion of the measurement and assurance issues in carbon-emissions trading).

In countries subject to strict CO

2

emissions-reduction targets, the existence

of such mechanisms would necessitate a number of lifestyle changes (from

organizations and individuals in that country) to achieve a substantial decrease in

CO

2

emissions. Examples of the lifestyle changes that are required by

govern-ments, organizations, and individuals to reduce CO

2

emissions were listed in

TIME magazine (2007). A few of the recommended carbon-reduction methods

for business including changing light bulbs to low emission, switching off lights

at quitting time, letting employees work close to home, and buying green power.

Carbon reduction methods for individuals include flying a straight course

between locations, hanging up clothes to line dry, and insulating residential water

heaters.

On an individual level, in recent years, there has been a significant shift

from ‘‘localization’’ to ‘‘globalization,’’ especially with the opening up of China,

India, and the Eastern bloc (Levitt [2006]). However, as more people are

encour-aged to work closer to home, buy produce from the local farmer, and host a

‘‘green wedding’’ (e.g., by buying wine and other items locally) (TIME [2007]),

then a shift back to localization due to carbon-related reasons is possible. We

have termed such a shift in world trade as ‘‘carbalization.’’

1. The United States and Australia signed this Sydney agreement. The other signatories to this APEC agreement, such as China, Japan, Canada, and Indonesia, have already signed the Kyoto Proto-col. Since Australia’s ratification of Kyoto in 2007, the United States is the only major industrial country (among the very small group of countries overall) that is still not a signatory to the Kyoto Protocol. Developing countries, including China, India, and Indonesia, have ratified the protocol but are exempted from reducing CO2 emissions under the present agreement, despite their large

popula-tions and high emissions levels. China ranks behind only the United States in carbon emissions, and in some rankings is the number one emitter (Netherlands Environmental Assessment Agency, see http://www.mnp.nl/en/index.html). Australia, even though it is now a signatory, has not, as yet, agreed to any reduction targets, despite being the largest per capita polluter.

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Carbalization is based on the concept of

product-distance (in miles or

kilo-meters)—that is, the distance a product travels to get to its place of final

pur-chase for consumption. Separate studies by the oil giant BP (formerly British

Petroleum) and the German Institute for Physics and Atmosphere released earlier

this year revealed that the world’s shipping could have a more serious impact on

global warming than air travel.

2

Although CO

2

emissions on a per-kilogram basis

were significantly lower for shipping when compared with air freight, it is

dis-tance that has been targeted as most imports of fast-moving consumer goods

(FMCGs) are imported primarily via shipping lines. An example is given of

imported bottled water from Europe using approximately 80 kg of CO

2

emissions

per metric tons of bottles to be shipped to Australia, whereas from Egypt it is

70 kg and from nearby Fiji only 20 kg (Perkins [2007]). The message from such

analyses is similar to the

TIME magazine (2007) recommendations, that is, buy

from sources where the product or service originates as close as possible to point

of purchase.

A report produced by the

Business Roundtable on Climate Change in

Aus-tralia found that early action by companies to reduce CO

2

emissions would add

the equivalent of US$1.8 trillion to gross domestic product (GDP) by 2050 and

create more than 250,000 jobs (Weekes [2007]). Nevertheless, the governments

in many industrial countries (that are or will be subject to emissions-reduction

targets) are concluding that mandatory or voluntary carbon costs will eventually

flow on to prices and industry competitiveness. Recently, China (the

second-biggest polluter behind the United States) has stated that economic considerations

come first and thus will consider reducing carbon emissions only as a secondary

issue. Thus, Chinese products will continue to be ‘‘cheaper,’’ not only due to

cheap labor, but also due to the exclusion of carbon costs. Countries that import

such products will not only adversely affect the economic viability of their own

country’s businesses, but also will be the target of the Chinese ‘‘dumping’’

car-bon emissions on them. The only way (other than forcing China to accept their

responsibilities by negotiation) is to place a countervailing tax on such imports

(similar to that placed when companies ‘‘dump’’ products via transfer pricing)

based on a fair allocation of carbon costs to Chinese products.

It is clear that carbonomics and carbalization will produce winners and

los-ers in both the product and allowances markets, as well as in organizations and

countries. In the products and services market, the

winners will be the ‘‘low

car-bon intensity’’ firms and those that can pass on their carcar-bon costs. Some of these

firms could earn windfall profits. The

losers will be ‘‘high carbon intensity’’

firms and those that are unable to pass on their carbon costs. In the allowances

market, the

winners would include those countries that are on track for meeting

2. Annual emissions from shipping made up 5 percent of the global total, while the aviation industry, which is subject to far greater scrutiny, contributes only 2 percent (Vidal [2007]). CO2

emissions from ships do not come under the Kyoto Protocol, and therefore, only a few studies have been undertaken.

335

CARBON BUSINESS ACCOUNTING

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Kyoto standards. These countries (and companies within them) will have a

higher proportion of required allowances allocated free and could earn windfall

profits from the sale of these allowances. The losers will include countries a long

way from Kyoto compliance, that is, those that will need to purchase a higher

proportion of allowances from the market. In the rest of this paper, we discuss

how the impact of carbonomics, especially the (global) costs of CO

2

emissions

can be captured by accounting systems, how they can be built into the cost and

prices of different products and services. We also will discuss ways that

carbono-mics affect the strategic decision information systems of business organizations.

2. Carbon Business Accounting

From the discussion earlier on carbonomics, carbalization, and

carbon-emissions trading, it can be seen that business entities will need to consider new

business practices to take advantage of (or at least not be disadvantaged by) the

mandatory carbon-rationing and trading schemes under the Kyoto Protocol. The

existence of a carbon-rationing and trading market has the potential to affect an

organization’s business strategy, financial performance, and ultimately value.

Thus, accountants and other business information providers need to consider

measurements and strategies outside of conventional paradigms.

This requires a good understanding of a number of elements of cost

manage-ment and managemanage-ment accounting, and also of economics and business finance in

an integrated manner, such as the economic modeling of demand and supply of

carbon credits and allowances, forward and spot pricing, financial analysis, cost

analysis and risk analysis, risk management of reputation, business support, cash

flow and business value, capital allocation, and the (possible) International

Finan-cial Reporting Standards (IFRS) directives for finanFinan-cial reporting of

carbon-emissions management and related transactions. In addition, taxation issues of direct

carbon taxes, value-added taxes (VAT), and goods and services taxes (GST), as well

as transfer pricing implications of carbon trading, need also to be considered.

This paper focuses specifically on strategic cost management (SCM) and

strategic management accounting (SMA), which are referred to collectively as

‘‘business accounting.’’ First, the paper demonstrates that some of the classic

ideas of cost accounting may be central to the study of carbon costs. The costing

scheme proposed in the paper is shown to be a good fit with the traditional

life-cycle analysis of overhead cost allocations, where the overhead in question is the

costs of reducing global warming. It is demonstrated that if the overhead is

allo-cated in a precise fashion over the life of a product or service, goods and

ser-vices that seem to be low cost from a product costing viewpoint become high cost

from a life-cycle viewpoint and perhaps should not be manufactured or provided.

Next, the paper reports on a structured qualitative research study that was

undertaken at thirty-one research symposiums in twelve countries (638

respond-ents) to canvass the views of practitioners regarding the wider implications of

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carbon costs (and potential revenues) on SCM and SMA tools, techniques, and

practices. Some key issues, especially those relating to the impact of

carbon-emissions management on lean manufacturing, life-cycle costing, marketing

com-munication, and cost of capital are reported in this paper.

A literature review relating to SCM and SMA and pertaining to

environmen-tal cost accounting is provided in Appendix B. This review elaborates on any

conceptual frameworks that could be developed to help in the coding and

classi-fication of the data for carbon accounting.

2.1 Carbon Strategic Cost Management

Traditional cost management relates to accounting for direct and indirect

costs

3

and to the assignment of these costs to such objects as products, services,

customers, and organizational processes. A cost can be attached directly to a cost

object if it is traceable solely to that cost object; and if not, it is allocated (see

Sharma and Ratnatunga [1997] for a comprehensive discussion of costing

sys-tems). Recent discussions in the cost accounting literature have focused mainly

on the allocation of indirect costs; that is, whether using traditional allocation

systems with a single cost driver (such as direct labor) or using activity-based

costing systems (with multiple cost drivers) better describes the cause-effect

rela-tionships found in products, services, customers, and organizational processes

(Cooper and Kaplan [1988]). In product costing, the cost is computed up to the

stage that goods are available for sale. Costs incurred subsequent to the product

being sold are usually not calculated, except in the case in which a product

car-ries a warranty, or some other after-sales service component; then the expected

cost (based on a probability estimate) of that service is incorporated into the cost

(and therefore its price). Some costings may include the cost of money blocked

in accounts receivable, that is, the credit period being treated as an after-sales

service that has a cost associated with it.

Carbon cost management is a subset of the push toward ‘‘environmental cost

accounting’’ (see Mathews [1997]; Adams [2004]) that highlights the cost

impacts beyond those related to a specific cost object, such as a product. Let us

consider a computer printer as an example. The typical environmental costs (both

before and after the sale) are as follows.

2.1.1 Raw Material

The environmental costs are simply the cost of the raw materials, such as

plastics, cartridges, and steel in waste. Much of such raw material is brought into

usable form for manufacturing using significant energy and thus has related CO

2

emissions.

4

Every time a raw material is used and does not become a product, it

3. These cost categories are based on the nature of the expenditure items, such as the cost of raw materials, human input (labor), and overhead (rent, depreciation etc.).

4. Such as the energy used in mining and processing the materials.

337

CARBON BUSINESS ACCOUNTING

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becomes waste. Even when such material becomes a saleable product, when it

becomes obsolete, it goes into landfills as waste.

2.1.2 Labor

Labor requires energy to function, such as traveling time to a production

fa-cility and air conditioning at the fafa-cility, and thus significant CO

2

emissions are

associated with its use. Before the sale of the product, the typical labor

environ-mental costs would be the labor component of an off-specification product that

becomes waste. After the sale, the labor cost required to recycle the parts is an

environmental-related cost, which also generates CO

2

emissions.

2.1.3 Overhead

Utility costs, such as water and energy, are often overlooked in determining

the true cost of waste generation, both before and after a sale. These costs are a

significant item in CO

2

emissions management.

2.1.4 Waste Management

The most obvious environmental expenses are the treatment and disposal

costs of waste generated in the production process. Again, these processes

require significant energy and thus have associated CO

2

emissions. Other waste

management costs may include the expenses to collect samples, complete paper

work, and pay for permit fees, consulting fees, and (potentially) fines for

viola-tions. The flip side of the hidden costs and impacts of waste generation is the

hidden benefits resulting from actions taken to improve the environmental

per-formance of a particular facility.

2.1.5 Recycling

Recycling is a form of waste management at the obsolescence end of the

product life cycle. This requires a three pronged approach: (1) the opportunity

cost calculation (including the environmental impacts) of recycling components

of existing hardware compared with using new components, (2) locking in

recy-cling cost efficiencies at the design stage of new hardware, and (3) using a

cost-benefit analysis of the first two stages to influence government policy on tax

credits and so on for undertaking such environmentally sustainable programs.

The U.S. Environmental Protection Agency (EPA) has an Environmental

Accounting Project that encourages business to understand the full spectrum of

their environmental costs and integrate these costs into decision making.

5

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There are often conflicts among the different cost categories. A study by

CNW Marketing Research

6

says that the total energy cost used in manufacturing,

driving, and recycling a Hybrid Toyota Prius is higher than that of most

conven-tionally powered vehicles. The two-year study (claimed to have been

independ-ently funded) included factors such as the following:

.

How many years it took to develop the vehicles

.

How the material used was processed and how far these had to travel to

get to manufacturing stage

.

How far auto workers traveled, and whether or not they used public

transportation

.

The energy used in manufacturing

.

The percentage of materials that can be effectively recycled

.

The percentage of labor produced by robots versus humans

.

Variable estimated lifetime of components

.

Cost of fuel used over an estimated lifetime of 100,000 miles

.

Expected parts that would need to be repaired

This study showed that hybrid cars, while clearly using less fossil fuel to

run, are environmentally more expensive to manufacture and to recycle than

con-ventional cars (CNW Marketing [2007]). For example, the ‘‘whole-of-life’’ costs

for a Hummer H3 was $1.94 per mile, while the Toyota Prius Hybrid was $3.25

per mile. One of the least-cost cars in the study was the Jeep Wrangler (placed

number three overall in terms of least cost) with $0.60 per mile and the

highest-cost car was the Mercedes Benz Maybach with a highest-cost of $11.58 per mile (de

Fraga [2007]).

Martin (2007) shows why the Toyota Prius has such a high ‘‘whole-of-life’’

cost associated with it in terms of carbon emissions:

Let us consider, for example, the raw material costs of the special electric

bat-tery required by the hybrid. The nickel for the batbat-tery for the Toyota Prius is

mined in Sudbury, Ontario, and smelted at nearby Nickel Centre, just north

of the province’s massive Georgian Bay. The smelter has a 1,250-foot-tall

smokestack that is claimed to emit large quantities of sulfur dioxide to the

sur-rounding area. Toyota buys about 1,000 tons of nickel from the facility each

year, ships the nickel to Wales for refining, then to China, where it’s

manufac-tured into nickel foam, and then onto Toyota’s battery plant in Japan. That

alone creates a globe-trotting trail of carbon emissions that from start to finish

is estimated to travel more than 10,000 miles—mostly by container ship, but

also by diesel locomotive. At the end of its life, the battery has to go back to

Japan for recycling, again often traveling large distances and burning more

CO

2

. (Martin [2007])

6. See http://www.cnwmr.com/nss-folder/automotiveenergy/ (accessed May 6 2007).

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CARBON BUSINESS ACCOUNTING

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Due to such significant product-distance costs, it is claimed that to date none

of the Prius batteries in Australia have been sent back to Japan for recycling (de

Fraga [2007]). They will most likely go to landfills in Australia. This may be

true of the United States as well.

As expected, Toyota has challenged the CNW study, stating the energy

ratios used in the study pertaining to the manufacture-driving-recycle life cycle

of a car is quite different from other studies conducted by the Argonne National

Laboratory and the Massachusetts Institute of Technology. The latter studies

found that while hybrids require more energy to manufacture and recycle, 80 to

85 percent of the energy is used in driving, where the hybrids have a clear

advantage. The CNW study shows these percentages to be reversed (de Fraga

[2007]), hence disadvantaging the hybrids. The problem with studies of this

na-ture is that the complicated set of assumptions can greatly influence the outcome

(as will individual driving patterns).

7

When undertaking a life-cycle costing exercise using carbon allowance costs,

the issue of transaction costing versus opportunity costing needs to be

recog-nized. Some studies may take an opportunity cost approach and determine that

the freely allocated allowances are worth the same as purchased allowances.

Other studies may take a more transactional ‘‘environmental compliance

approach’’ and treat as a ‘‘hard cost’’ only the cost of purchased allowances over

the year.

As pointed out before in discussing CES accounting and assurance (see

Ap-pendix A), many accreditation approaches in the environmental arena have

dif-ferent measurement metrics. These measurement approaches also have a direct

impact on carbon cost calculations. No study or approach can be considered

de-finitive, but there is clearly a need for accurate carbon cost accounting using

life-cycle costing techniques. This accounting should consider not only costs to

bring a product or service to the point of sale, but also the carbon costs before

and after the manufacture of the product or the performance of the service. Such

costs are elaborated in Table 1.

Australia provides another example of life-cycle carbon cost accounting. The

power company, Origin Energy, began changing its environmental practices

when it audited the life cycle of its products, from production to consumption, to

discover it contributed about 30 million tones of carbon dioxide to the

environ-ment (about 8 percent of Australia’s total emissions). Since undertaking the

audit, Origin has invested $20 million in solar energy, spent an extra $500,000

converting to sustainable power for its own use, and signed up 12 percent of its

customers to a ‘‘green-power’’ alternative. The company’s work is audited by

7. In response to criticisms of its approach, CNW revised its methodological assumptions, espe-cially regarding the average driving miles of a Hummer H3 versus a Prius. This improved the Prius ranking in 2008 ($2.19, ranked 139) compared with the H3 ($2.30, ranked 154), but a host of con-ventional cars, off-roaders, and crossover vehicles still outrank the Prius. The Maybach remains the highest-cost car ($15.96, ranked 284).

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TABLE

1

The

Whole-of-Life

Impact

of

Carbon

Emission

Efficiencies

on

Costs

and

Revenues

Areas of Cost Reduction or Revenue Generation via Efficient Carbon Cost Management Presale Environmental Impact Postsale Environmental Impact a Raw Materials Production waste Landfill waste Human Input Wasted time on rejects and recovery Time to separate recyclable components Traditional Overhead Expenses Electricity All of these overhead items have carbon emissions that will affect if the organization is a net-sequester or net-emitter. Techniques utilized to reduce CO 2 emissions via using alternative energy sources etc. will affect the carbon credit cost item shown under the Environmental overhead category.

Rental Marketing Transportation Administration Depreciation

of Machinery After-sale Service Costs Environmental Overhead Regulatory Costs Meeting emissions standards Litigation costs of environmental pollution Waste Management Production waste Landfill waste Recycling These costs can be reduced via the proper design of components at preproduction stage. Such design costs should be amortized over life of product, via life-cycle costing. Amortization of Design Costs Carbon Credits This can be a cost or revenue item depending on if the organiza-tion is a net-sequester or net-emitter. Purchase/sale of carbon credits depending on if the organization is a net-sequester or net-emitter. Financing Costs Stock Holding Costs These costs include those of capital, excess handling, obsoles-cence, deterioration, stock administration, and insurance These costs include those relating to warranty returns such as excess handling, deterioration, stock administration, and insurance Debtors Costs None These costs include those of capital and the risk of bad debts Carbon Tax This tax could be an additional cost or revenue item (Tax Credit) depending on if the organization is a net-sequester or net-emitter No te : aT h es e p o st en v iro n me n tal co st s ca n b e in co rp o rat ed in to p ro d u ct co st s u si n g p ro b ab il it y es ti ma tes .

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accounting firm Ernst and Young, which uses the International Auditing and

Assurance Standards Board framework, ISAE 3000 (Walters [2006]).

Such examples show that companies that start managing for environmental

efficiency will automatically cut costs and ultimately boost revenue by selling

credits in the emissions trading markets. In fact, a view is developing in some

businesses that a direct measurable correlation can be made between

environ-mental efficiency and economic results. For example, Westpac, one of

Austral-ia’s large banks, no longer sees carbon costing as an add-on but rather as being

central to its operations. They claim that the reduction of emissions at the bank

have significantly boosted its bottom line (Weekes [2007]).

Life-cycle costing analyses, such the Toyota Prius example illustrated above,

fall within the general area of SCM, a term first encountered in Gupta and

Govin-darajan (1984). Since then, there has been numerous articles and books on SCM

(see, Jones [1988]; Shank and Govindarajan [1989, 1992a, 1992b, 1993a, 1993b];

Simons [1990]; Ratnatunga [1983, 1999]; Ewert and Ernst [1999]). Often,

how-ever, the papers focus on only a few SCM techniques, such as lean accounting,

life-cycle costing, target costing, back-flush costing, activity-based management,

and customer profitability analysis. Despite the vast body of work in the area, and

also the global concern that resulted in the Kyoto Protocol, no paper to date

addresses SCM approaches in efficient carbon management. The research study

reported in this paper, therefore, fills a significant and important gap in literature.

To develop a comprehensive conceptual framework for the area of carbon

management including a coding and classification system required for the

quali-tative research study (detailed in Appendix B), the researchers relied on SCM

documents of the Institute of Certified Management Accountants (ICMA) in

Aus-tralia. This document was a primary basis of the respondents (ICMA members)

at the thirty-one research symposiums to study this issue (see Appendix B for

details of the study). A framework for capturing the summarized views resulting

from the discussions at the symposiums is given in Table 2.

2.2 Carbon Strategic Management Accounting

Once product costs are known, the wider issues of strategic business

accounting (comprising management accounting and business finance) need to be

considered. The term SMA has been in the management accounting literature

since Simmonds (1981) coined the term. However, similar terms such as

‘‘mar-keting accounting’’ (Ratnatunga [1983]); ‘‘competitor accounting’’ (Ratnatunga

[1983]; Jones [1988] Guilding [1999];) and ‘‘customer accounting’’ (Simmonds

[1986]; Guilding and McManus [2002]) have been used to describe similar

prac-tices. These terms essentially describe practices that occur at the interface

between accounting and other functional areas of business. All of these practices

are geared essentially toward enhancing the competitive advantage of firms

(Por-ter [1980, 1983]). Over the last twenty-five years, been numerous articles and

books have been published on SMA (see Simmonds [1982]; Bromwich [1990];

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TABLE 2

Issues in Carbon Strategic Cost Management

SCM Issue Carbon Management Impact

Management Control Systems

Employee behavior modification to achieve carbon efficiency targets.

Production Management Lean production techniques. More attention to the use of energy in machinery, less materials and time wastage. Just-in-time philosophy.

Employee Safety Ensuring that low energy work environments do not cause hazardous working conditions.

Wages and Trade Union Demands

May demand more if comfort levels fall. More demands for the sharing of high carbon windfall profits.

Total Quality Management Carbon efficiency seen as part of quality equation.

Purchasing Management Production resources (components, labor, and overhead) sourced locally.

Cost Control Lean accounting. Significant attention paid to reduce carbon-emission costs. More use on back-flush costing methods.

Make or Buy Decisions Consideration given to carbon emissions when considering alternatives.

Cost Classification Carbon costs classified into direct, indirect, fixed, and variable costs. Allocating Indirect Costs Variation of ABC by having consideration of ‘‘carbon cost drivers’’

to link emission indirect overhead to products and services. Life-Cycle Costing Amortization of design costs to make products more carbon friendly

and worker training costs to reduce carbon emissions.

Target Costing Redesigning products and services to meet carbon-emission targets. Benchmarking Comparing the KPIs of world-class performers in carbon efficiency. Customer Profitability

Analysis

Segmenting customers by profitability per carbon usage.

Process Control and Activity-Based Management

Evaluating the performance of organizational processes, including white-collar departments in terms of achieving carbon efficiency KPIs.

Efficiency or Productivity Consideration given not only to economic efficiency but also to carbon usage efficiency.

Price Relationship or Re-covery

Reductions in purchase prices considered via the sale of carbon efficiency credits.

Overall Effectiveness The profitability of the bottom-line figure given in terms of both economic and environmental effectiveness.

Value-Adding/Non-Value-Adding Work

All reworks, recoveries, errors, etc. considered to be avoidable carbon-emitting activities.

Executive Information Sys-tems (EIS)

The drill-down facilities to be extended to financial and nonfinancial carbon-emitting measures.

Corporate Governance Accountability and transparency issues extended reporting on carbon management initiatives.

Enforcement and Compliance

Voluntary and mandatory enforcement of carbon-emission targets.

The Strategic Audit Extended to cover the expected future carbon footprint of the organization due to its production, marketing, logistics, capital investment, and human resource management (HRM) practices. Corporate Reputation

Audit

The evaluation of the organization’s image and brand with regards to being a responsible carbon citizen of the world.

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CARBON BUSINESS ACCOUNTING

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Wilson [1991]; Palmer [1992]; Ward [1992]; Morgan [1993]; Ratnatunga, Miller,

Mudalige, and Sohal [1993]; Lord [1996]; Tomkins and Carr [1996]; Ratnatunga

[1999]; Guilding, Cravens, and Tayles [2000]; Cravens and Guilding [2001]; Hoque

[2002]; Roslender and Hart [2003]). Despite this consistent stream of literature in the

area presenting different approaches to SMA, knowledge remains fragmented. Often,

the papers focus on a few SMA techniques, such as supply-chain management,

strate-gic pricing, and competitive position monitoring; and the extent of the use of such

techniques in practice. In spite of the vast body of work in SMA and SCM, no paper

to date addresses approaches to efficient carbon management despite the significant

global concern regarding global warming. The research study reported in this paper,

therefore, fills a significant and important gap in literature.

Table 3 summarizes the impact of SMA on carbon-emissions management

information systems resulting from the thirty-one research symposiums with

ICMA members.

The details provided in Table 3 show that carbon-emissions management cuts

across a wide spectrum of strategic issues, ranging from overall objectives to

mar-keting, new product development, pricing, international business, promotion,

sup-ply chain management, finance, and risk management. Clearly an integrative

approach, such as that suggested by Kaplan and Norton (2000), is required, with

‘‘carbon thinking’’ being an important part of the strategy focus of an organization.

This carbon-focused thinking will require new tools and management practices if

the accounting profession is to remain at the forefront of providing relevant

infor-mation for decision making in this new economic paradigm of carbonomics.

3. Conclusion

The concentrations of greenhouse gases in the atmosphere have risen

dra-matically leading to an out-of-balance greenhouse effect that most scientists

believe will continue to cause a rapid warming of the world’s climate. The

possi-bility of costly disruption from rapid climate change, either globally or locally,

calls for greater attention and precautionary measures to be put in place.

Govern-ments, business entities, and consumers would be affected by the extent to which

such precautionary measures are incorporated in their decision-making processes.

Business entities especially need to consider issues such as trading in carbon

allowances (or permits), investment in low-CO

2

emission technologies, counting

the costs of carbon regularity compliance, and passing on the increased cost of

carbon regulation to consumers through higher prices. Consumers need to

con-sider whether, given the choice, they are willing to pay a higher price for CO

2

-neutral products and services to play their part in reducing CO

2

emissions.

These decisions and their consequences will affect the accounting profession

significantly, especially the business accounting areas of strategic cost

manage-ment and strategic managemanage-ment accounting. Information from the strategic cost

and management accounting systems will be particularly useful in this new

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TABLE 3

Issues in Strategic Management Accounting

SMA Issue Carbon Management Impact

Business Policy

Primary Objective Sustainable value creation.

Competitive Advantage Carbon efficiency seen as a marketing mix variable in product differentiation. An Efficient Carbon Management (ECM) focus is also taken in cost leadership strategies.

Line of Business ECM seen as a potential line of business. Competition and Industry

Structures

Adding a sixth force to Porter’s Five Forces Model: the impact on the Industry of Carbon regulation (Porter [1980, 1983]). Gap Analysis Strategies considered to close the gap between current emission

levels and future emission targets.

Environmental Externalities Considered ‘‘internalities’’ in product-market decision making and human resource management (HRM).

Risk Management Consideration of the impact on cash flows and reputation of the company as a result of the carbon strategy positioning of the company. Risk vs. Reward outcomes (e.g., cash flow at risk) should be considered. Human Resource Management

Corporate Culture A carbon lifestyle culture from grassroots level upward. Low carbon footprint activities encouraged. Excellence sought in seeking continuous improvement in ECM.

Empowerment Employees given resources and responsibility to participate in ECM in lowering the organization’s carbon footprint.

Marketing Strategy

Products and Markets Carbon impact considerations considered systematically in all product-market strategies.

Marketing Research Undertaken to determine the needs of customers in terms of participating in reducing carbon emissions and the incremental price they are willing to pay for this (carbon consciousness). Market Segmentation Separating customers geographically, demographically, and

psychographically in terms of their carbon consciousness. Positioning Strategy Consideration of taking an ‘‘active’’ or ‘‘passive’’ positioning in

terms of ECM as a source of competitive advantage.

The Product Life Cycle (PLC) Consideration of the carbon footprint left by product throughout its life cycle, especially in the decline and obsolescence stages. Market Penetration Strategies Using carbon efficiency of existing products as an attribute to sell

more to existing carbon conscious customers.

Market Development Strategies Using carbon efficiency of existing products as an attribute to sell new carbon conscious customers in new segments.

Product Development Strategies

Incorporating carbon efficiency as an attribute in new product designs to keep existing carbon conscious customers loyal to the brand. Diversification Strategies Leaving industries that have products and markets seen as high

carbon emitting to new industries with better long-term carbon-sustainable prospects (includes investments in Joint Implementation [JI] and Clean Development Mechanisms [CDMs] under Kyoto). Experience Curves Organizations with high experience in ECM products and services

should have lower costs. Budgeting for Marketing

Activities

Budgets will incorporate ECM activities as potential revenues and cost savings. Carbon trading activities could be considered a separate line of business.

(continued )

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CARBON BUSINESS ACCOUNTING

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Product Marketing Strategies The Product Portfolio (BCG)

Matrix

Star products will have high market share and high market growth opportunities in industries with better long-term carbon sustainable prospects.

New Product Development (NPD)

Designing products and services to meet carbon-emission targets and marketing them as such.

Product Abandonment Approaches

Product review teams to consider carbon footprint in addition to profitability targets.

Inflation The passing on of mandatory carbon costs and taxes as higher prices to consumers will cause inflation.

Packaging Consideration given to carbon footprint of packaging, in terms of functionalism, convenience, recyclability, and also image. After Sales Service The carbon emission in terms of materials, labor, and overhead of

undertaking work due to meeting warranties and other after-sales services should be costed into the product.

Pricing Strategy

Pricing Analysis Carbon costs, carbon-related competitor activity, and the value of low-carbon-footprint products to carbon conscious customers should be considered in such analyses.

Elasticity of Demand The impact on demand due to changes in prices if carbon costs are incorporated.

Skimming Selling to high carbon conscious customers willing to pay a price well above costs.

Penetration Absorbing carbon costs of products and services sold to low carbon conscious customers to develop brand awareness. Productivity improvements can only be obtained either by lowering costs via ECM or changing customer carbon consciousness levels. International Business Strategy

Exporting vs. International Operations

Carbon costs can be reduced via JI and CDM investments as per the Kyoto protocol.

Price Differentials and Carbon Dumping

Competing with countries that do not have carbon costs. Influencing government policy to impose countervailing carbon taxes. Hedging Policies Ensuring that carbon credits in the overseas country is not devalued

in terms of the parent country carbon credit pricing.

Promotional Strategy Promotional ‘‘Pull’’ Strategy

(via Advertising etc.)

An Integrated Marketing Communication (IMC) approach should be taken to promote how the product or service is reducing carbon footprint, for example, via purchasing carbon offsets.

Promotional ‘‘Push’’ Strategy (via Sales Force)

Sales force budgets, targets, and incentive schemes geared toward extolling the attributes and pushing low carbon impact products. Traveling times on sales calls minimized to reduce carbon emissions. Biofuel cars used as sales vehicles.

Sales Response Functions Response of sales volume to carbon-related promotions tracked. Media Selection Strategies Electronic media given higher priority to print media to reduce paper

usage. Supply Chain Strategies

Product Distance Carbon emission measurements in terms of Product Distance. The longer the distance and the more players in the channels of distribution the higher is the carbon costs.

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The Level of Service The Service-Cost Trade-off required to ensure that the right product gets to the right place at the right time should consider the carbon emissions required to provide this level of service.

Distribution Cost Accounting Computation of carbon-related costs in order processing, warehous-ing, transportation, credit control, and inventory control. Transportation and Simplex

Models

The use of these models to reduce transportation time and resulting reduction in carbon emissions.

Channel Control Consideration of the motivation, relationships, and conflict issues that arise when channels are asked to on-sell products and services using ECM approaches themselves.

Channel Adaptability Consideration of the adaptability of channels to changes in product-market combinations as a result of reducing carbon footprint. Distribution Cost Control Using ratio analysis to ensure that, in addition to economic analysis,

ECM in supply chain activities is also evaluated. Performance Evaluation

Strategic Financial Structures (Gearing)

Consideration if carbon-related investments should be financed via debt or equity. Ability to obtain shareholder and debt holder fund-ing at favorable rates due to the use of such financfund-ing in ECM activities.

Weighted Average Cost of Capital (WACC)

If financing of carbon-related investments can be isolated, then calcu-lating an organization’s carbon-related Cost of Equity and Debt to calculate its overall Carbon-WACC. The equity and debt market may value discount carbon intensive businesses (causing high financing costs) and place a value-premium on low carbon emitting businesses (causing low financing costs). Corporate Performance

Perspectives

Return on Income (ROI) and Residual Income (EVA) used to evaluate not only economic performance but ECM performance. If carbon-related revenues and costs can be isolated as a separate line of business, this will enhance the evaluation.

Strategic Value Analysis Calculation of value enhancement (or diminution) due to strategies relating to carbon-related investments and operations.

Valuing Strategic Investments Valuation premium given to investments in ECM, such as invest-ments in alternative energy assets and abatement activities. Exam-ples are wind, biomass, solar, geothermal, nuclear, and clean coal. Valuing Strategic Operations These include operational adjustments to incumbent assets, changes

to energy prices, efficiencies in waste management, purchasing, and sale of carbon credits and carbon-related taxation.

Free Cash Flows Net cash flows generated by carbon-related activities less investments in carbon-related noncurrent and current assets

The Business Value The Net Present Value of expected future cash flows generated by strategic investments and operations in carbon-related business. The Balanced Scorecard Corporate Report Card to incorporate financial and nonfinancial KPIs

with carbon focus. This could be in addition to, or incorporated with the customer, innovation, internal business processes, and financial focus.

Economic Value Added (EVA) A charge against revenue is made for the cost of investments in carbon-efficient assets. A separate carbon-EVA can be calculated if carbon-related net-income, investments, and cost of capital can be isolated.

TABLE 3 (Continued )

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CARBON BUSINESS ACCOUNTING

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economy, termed carbonomics, brought on by global warming. New costing

tech-niques need to be considered to evaluate the whole-of-life costs in terms of

car-bon emissions relating to products and services. Similarly, new thinking will be

required to provide strategic management accounting information for business

policy, human resource management, marketing, new product development,

pro-motional, pricing, international business, supply chain management strategies,

and the resultant evaluation of performance evaluation.

The new paradigm of carbonomics, and the return to localization due to

place-distance carbon-emission costs (termed carbalization) will produce winners

and losers in both the product and allowances markets, as well as in

organiza-tions and countries. The cost management accounting profession must also

reen-gineer itself to be a winner in this new economic paradigm.

APPENDIX A

Measurement and Assurance Issues in Carbon Emissions Trading

One of the mechanisms of the Kyoto Protocol requires an emissions trading (known

also as

a cap-and-trade) scheme to be established in a country. It would work like this:

companies are told how much CO

2

they can emit (the cap). If they produce less than the

cap, they have surplus credits for sale.

8

If they emit more than their cap, they can buy

credits from other businesses that come in under their cap (the trade). Trade takes place

in an over-the-counter market, or via a carbon credit exchange trading market.

One of the earliest such trading schemes is the

European Union Emission Trading

Scheme (EU ETS), which is the world’s largest multicountry cap-and-trade system. The

EU has established a cap that limits emissions for its member states, each of which has

been given a specific number of credits. The total amount of credits cannot exceed the

cap, limiting total emissions to that level.

For a cap-and-trade scheme to work, there must be an agreed mechanism for

calcu-lating the quantum of CO

2

either emitted by a source or sequestered in a biomass sink

(see Ratnatunga [2007]).

9

The CES accounting mechanism must be sufficiently robust that

the carbon trading market has confidence that the amount of carbon sequestered can be

measured and considered to be equivalent in its impact on global warming potential to the

CO

2

released to the atmosphere from activities producing greenhouse gases. Confidence

in the CES accounting system is fundamental to building confidence in use of CO

2

sequestration in a carbon trading market, thereby underpinning growth and investment in

new carbon sequestration activity (Tandukar [2007]).

10

As can be appreciated, the detailed requirements for a CES accounting system are

continually being developed by organizations such as the Intergovernmental Panel on

Cli-mate Change (IPCC [2007]) under the United Nations Framework Convention on CliCli-mate

8. Called Renewable Energy Credits (RECs).

9. These measures are referred to as ‘‘carbon emission and sequestration’’ (CES) accounting. 10. Tandukar (2007) states that forestry projects are the largest source of carbon offsets in Aus-tralia because Kyoto-compliant land (cleared before 1990) is plentiful, the science is available, and photographs of trees are good for publicity.

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Change (UNFCCC). Any CES accounting standard developed by a country or

nongovern-mental organization will need to be consistent with the IPCC principles before carbon

credits generated from carbon sinks can be used in an emissions-trading regime under the

Kyoto Protocol.

In addition to the numbers generated from CES accounting, there is the issue of

assurance of the calculated numbers. Currently, similar to the situation regarding

numer-ous CES accounting methodologies and approaches, the auditing and ranking of

environ-mentally sustainable initiatives is in chaos with dozens of organizations offering assurance

services, but none are being committed to a standardized methodology for auditing or

reporting corporate effort in the carbon-emissions management area (see Walters [2006];

Ratnatunga [2007]). This paper looks beyond these CES accounting and assurance issues

and concerns, and considers the cost and managerial accounting issues that arise if and

when an

efficient carbon trading market is established in a country.

APPENDIX B

Accounting for Carbon Trading: A Qualitative Research Study

In the period from mid-2003 to early 2007, thirty-one research symposiums (one-day

each) were undertaken in Australia (eight), Canada (four), India (one), China (one), Lebanon

(two), the Philippines (one), Papua New Guinea (two), Indonesia (four), Sri Lanka (four),

Malaysia (two), Singapore (one), and United Arab Emirates (one). Countries were chosen

based on the location of an established branch of the Institute of Certified Management

Accountants (ICMA). The participants were self-selecting—the symposiums were advertised

only to members of the ICMA, and participants had to pay a fee for attending. In all, 638

respondents at the levels of cost accountant, management accountant, business analyst, chief

financial officer, and chief executive officer (or similar) participated in the study.

11

The literature review undertaken before the commencement of this research study,

the coding and classification of the data, the data collection, and the discussion at the

symposiums will now be addressed.

B.1 Literature Review

There is now a significant body of literature in the academic journals in the area of

corporate social responsibility (CSR) (see Lantos [2001]; Matten and Crane [2005];

Shank, Manulland, and Hill [2005]; Ratnatunga, Vincent, and Duvall [2005]; PJCCFS

[2006]);

sustainability reporting (see European Commission [2001]; Global Reporters

[2004]; Amalric and Hauser [2005]; De Bakker, Groenewegen, and Den Hond [2005];

KPMG [2005]; Ratnatunga, Vincent, and Duvall [2005]; Salzmann, Ionescu-Somers, Steger

[2005]; GRI [2007]; DEH [2005]; CPA Australia [2005]; FEE [2006]; NIVRA [2007];

Mock, Strohm, and Swartz [2007]);

environmental accounting (Mathews [1997]; Adams

[2004]); and links between

CSR, environmental reporting, and financial performance

11. Members of the ICMA (Australia) must have a degree in accounting, specialist training in management accounting, and at least five-years relevant experience. A majority of members also have a masters in accounting or a masters of business administration.

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CARBON BUSINESS ACCOUNTING

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(Preston and O’Bannon [1997]; Waddock and Graves [1997]; Orlitzky [2001, 2005];

Orlitzky, Schmidt, and Rynes [2003]; Hopkins [2005]; Ratnatunga et al. [2005]; Shank,

Manulland, and Hill. [2005]). Surprisingly, however, very little academic literature dealt

specifically with the new information requirements in business organizations brought about

by the Kyoto Protocol.

Some reports from

governmental (COAG [2006]; Stern [2006]; DPMC [2007];

DEFRA [2007]; EC [2007]; IPCC [2007]; NSW Greenhouse Office [2007]) and

nongo-vernmental organizations (NGOs) (such as IETA [2002]; IGCC [2006]; ISO [2006]; CCE

[2007]; RGGI [2007]; World Business Council for Sustainable Development [2007]) deal

with issues of carbon trading in general terms, but again, no academic research is

refer-enced in these reports.

Early academic work specifically on the impact of the Kyoto Protocol on accounting

information and reporting systems was undertaken by Freedman and Jaggi (2005) in

studying the accounting disclosures of the largest global public firms from polluting

industries. A year later, Kundu (2006) looked at the financial aspects of carbon trading in

a professional journal article. Since then little research had been published in academic or

professional accounting journals until Callon (2008) discussed the many controversies

regarding carbon trading schemes and related measurement schemes. Much of the limited

recent academic literature, however, considered mainly the problems caused by

environ-mental accounting issues on conventional accounting reporting (see also Cook [2008];

Lohmanna [2008]). No literature available in the academic journals deals specifically with

the impact of carbon trading on

cost management and managerial accounting theory and

practice, that is, on leading rather than lagging indicators.

Undertaking an empirical-descriptive study of practices in the field is futile, because

the area is so new and there are little (if any) practices to report. What is required,

there-fore, is Ôtheory buildingÕ research of a normative or prescriptive nature. Such theory

build-ing research is just startbuild-ing in financial accountbuild-ing. This study looked instead at the cost

management and management accounting area (referred to collectively as ÔBusiness

AccountingÕ) by undertaking structured Ôqualitative research studyÕ and canvassing the

views of practitioners in the area. The literature pertaining to the areas of SCM and SMA

are covered in the main text.

B.2 Coding and Classification of Data

Whilst quantitative studies emphasize the measurement and analysis of causal

rela-tionships between variables, the word ÔqualitativeÕ implies an emphasis on process and

meanings that are not rigorously examined or measured in terms of quantity, amount,

in-tensity, or frequency. Inquiry is purported to be within a value-free framework (see

Den-zin and Lincoln [1994]). The relationships being looked for are not statistical, but

descriptive. This requires one to view the data set from an experiential perspective from

the beginning.

The biggest obstacle in qualitative research is the coding and classification of data.

As opposed to quantitative research, qualitative hypotheses and theories often emerge

from the data set while the data collection is in progress and after data analysis started

(Morse and Field [1995]).

After the collection of the data, researchers usually have what is termed a ‘‘scissor

party’’ to cut out the individual data bits and then begin the laborious task of ‘‘scanning

the data for categories of phenomena and for relationships among the categories’’ (see

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Goetz and LeCompte [1981]; Carney, Joiner, and Tragou [1997]). Strauss and Corbin

(1998) also emphasize that theoretical categories are elaborated on during open and axial

coding procedures. Many qualitative researchers have, therefore, to continually examine

the collected data (which, in the case of this study, consisted of transcriptions of

inter-views), for descriptions, patterns, and relationships between categories, and tack backward

and forward between literature and data, which then leads to the development of a number

of theoretical categories (Spiggle [1994]). In this process, the researchers involved with

the study, independently develop categories, and then collectively look at each other’s

individual category sets for some agreed order in the classification.

This research study avoided this tacking back and forth aspect of the coding and

classi-fication process by approaching the data collection in a very structured manner. This was

done by using the classification framework provided in the syllabuses (theory) of the two

Institute of Certified Management Accountants (ICMA) subjects covering the syllabuses of

ÔStrategic Cost Management (SCM)Õ and ÔStrategic Management Accounting (SMA)Õ. The

reason for using this theoretical framework for coding and classification purposes (rather

than allow the classifications to emerge from the data) is elaborated in the main text.

B.3 Data Collection and Discussion at the Symposiums

The tools and techniques of SCM and SMA as well as issues of global warming and

carbon trading and the impact of these on the business accounting profession was the

focus of discussion at the symposiums. The theory of SCM and SMA were first discussed

in the seminars, and then the carbon-related issues were addressed and participant views

canvassed. Although the discussion of issues was free flowing, the researchers guided the

discussion to the carbon-emissions area. In the seminars there were always at least two

researchers who were involved in the project present, and the main consensus of the

dis-cussion was agreed by the researchers and the seminar participants and then summarized

and captured and classified electronically at the seminar. The key points extracted from

the symposiums are presented in Tables 2 and 3. Whilst not all issues listed in the Tables

were discussed at every seminar, every issue was discussed in at a minimum of three of

the thirty-one seminars conducted. Some key issues—especially those relating to the

impact of carbon-emissions management on lean manufacturing, life-cycle costing,

mar-keting communication, and cost of capital—were discussed in almost all seminars.

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