Carbon Business Accounting

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Carbon Business Accounting: The Impact

of Global Warming on the Cost and

Management Accounting Profession

JANEK T. D. RATNATUNGA*

KASHI R. BALACHANDRAN**

The concentrations of greenhouse gases in the atmosphere have risendramatically, 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 lowcarbon dioxide (CO2) 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

333


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carbon dioxide (CO2) 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 CO2 than its assigned amount only if it can simultane-

ously sequester the equivalent amount in allowable 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 CO2 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

CO2 emissions. Examples of the lifestyle changes that are required by govern-

ments, organizations, and individuals to reduce CO2 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 coursebetween 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 thisAPEC agreement, such as China, Japan, Canada, and Indonesia, have already signed the Kyoto Proto-col. Since Australias ratification of Kyoto in 2007, the United States is the only major industrialcountry (among the very small group of countries overall) that is still not a signatory to the KyotoProtocol. Developing countries, including China, India, and Indonesia, have ratified the protocol butare 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, andin some rankings is the number one emitter (Netherlands Environmental Assessment Agency, seehttp://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 worlds shipping could have a more serious impact on

global warming than air travel.2 Although CO2 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 CO2 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 CO2 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 tocheap 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

countrys 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 carbon 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 aviationindustry, which is subject to far greater scrutiny, contributes only 2 percent (Vidal [2007]). CO2emissions from ships do not come under the Kyoto Protocol, and therefore, only a few studies havebeen undertaken.

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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 CO2 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 AccountingFrom 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

organizations 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 management 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, costanalysis 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 financial 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

costs3

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

usable form for manufacturing using significant energy and thus has related CO2emissions.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 ofraw materials, human input (labor), and overhead (rent, depreciation etc.).

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



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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 facility, 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 CO2 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 CO2 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 CO2 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 taxcredits 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

5. See http://www.epa.gov/oppt/library/pubs/archive/acct-archive/index.htm.



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

CNW Marketing Research6 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 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 battery for the Toyota Prius is

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

of the provinces 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 its manufac-

tured into nickel foam, and then onto Toyotas 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 milesmostly by container ship, butalso 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

CO2. (Martin [2007])

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



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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 Australias 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 companys 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 Priusranking 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 thehighest-cost car ($15.96, ranked 284).



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TABLE1

TheWhole-of-LifeImpactofCarbonEmissionEfficienciesonCosts

andRevenues

AreasofCostReduction

or

RevenueGenerationvia

Efficient

CarbonCostManagement

PresaleEnvironmentalImpact

PostsaleEnvironmentalImpacta

RawMaterials

Productionwaste

Landfillwaste

HumanInput

Wastedtimeonrejectsandrecovery

Timetoseparaterecyclablecomponents

TraditionalOverheadE

xpenses

Electricity

Alloftheseoverheaditemshavecarbonemissionsthatwillaffectiftheorganizationisanet-sequesterornet-emitter.

TechniquesutilizedtoreduceC

O2

emissionsviausingalternativeenergysou

rcesetc.willaffectthecarboncreditcost

itemshownundertheEnvironm

entaloverheadcategory.

Rental

Marketing

Transportation

Administration

DepreciationofMachinery

After-saleServiceCosts

EnvironmentalOverhea

d

RegulatoryCosts

Meetingemissionsstandards

Litigationco

stsofenvironmentalpollution

WasteManagement

Productionwaste

Landfillwaste

Recycling

Thesecostscanbereducedviatheproperdesignofcomponentsatpreproductionstage.Suchdesigncostsshouldbe

amortizedoverlifeofproduct,vialife-cyclecosting.

AmortizationofDesignC

osts

CarbonCredits

Thiscanbeacostorrevenueitem

dependingoniftheorganiza-

tionisanet-sequesterornet-em

itter.

Purchase/saleofcarboncreditsdependingonifthe

organizationisanet-sequesterornet-emitter.

FinancingCosts

StockHoldingCosts

Thesecostsincludethoseofcapital,

excesshandling,obsoles-

cence,deterioration,stockadministration,andinsurance

Thesecostsincludethoserelatingtowarrantyreturns

suchasex

cesshandling,deterioration,stock

administra

tion,

andinsurance

DebtorsCosts

None

Thesecostsincludethoseofcapitalandtheriskof

baddebts

CarbonTax

Thistaxcouldbeanadditionalco

storrevenueitem(TaxCredit)dependingon

iftheorganizationisanet-sequesteror

net-emitter

Note:

a

Thesepostenvironm

entalcostscanbeincorporatedintoproductcos

tsusingprobabilityestimates.


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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-

ias 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 ProfitabilityAnalysis

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 organizations image and brand with regards to

being a responsible carbon citizen of the world.



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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 worlds 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-CO2 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 CO2-

neutral products and services to play their part in reducing CO2 emissions.

These decisions and their consequences will affect the accounting profession

significantly, especially the business accounting areas of strategic cost manage-

ment and strategic management 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 Porters Five Forces Model: the impact on

the Industry of Carbon regulation (Porter [1980, 1983]).

Gap Analysis Strategies considered to close the gap between current emissionlevels 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 cashflows and reputation of the company

as a resultof thecarbonstrategy positioningof thecompany. Risk vs.

Reward outcomes (e.g., cash flowat 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 organizations carbon footprint.

Marketing Strategy

Products and Markets Carbon impact considerations considered systematically in allproduct-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 DevelopmentStrategies

Incorporating carbon efficiency as an attribute in new product designs tokeep 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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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.

TABLE 3 (Continued)



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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 financing in ECM

activities.

Weighted Average Cost of

Capital (WACC)

If financing of carbon-related investments can be isolated, then calcu-

lating an organizations 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. Ifcarbon-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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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 CO2 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 worlds 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 CO2 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

CO2 released to the atmosphere from activities producing greenhouse gases. Confidence

in the CES accounting system is fundamental to building confidence in use of CO2sequestration 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 Climate

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, andphotographs of trees are good for publicity.



17/24

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-selectingthe 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 inmanagement accounting, and at least five-years relevant experience. A majority of members alsohave a masters in accounting or a masters of business administration.



18/24

(Preston and OBannon [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 theory building research of a normative or prescriptive nature. Such theory build-

ing research is just starting in financial accounting. This study looked instead at the costmanagement and management accounting area (referred to collectively as Business

Accounting) by undertaking structured qualitative research study 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 qualitative 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



19/24

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 others

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

Strategic Cost Management (SCM) and Strategic Management Accounting (SMA). 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 summarizedand 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 issuesespecially those relating to the

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

keting communication, and cost of capitalwere discussed in almost all seminars.

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