Incorporating Environmental Sustainability into Traditional Management Control

1. Incorporating Environmental Sustainability into Traditional Management Control Raef Lawson, Institute of Management Accountants David Marcinko, Skidmore College Saurav Dutta, SUNY Albany Production Technology Incorporating Shadow Prices Teaching Points A 100 unit budgeted level of output may be produced using any one of three production processes described below. Unit prices of material and labor are $7 and $11 respectively Let the unit cost of material increase to $15 to allow for the cost of discharges into the environment – a shadow price of $8. • Management accounting can support initiatives to improve corporate environmental performance. • Value Chain Analysis – Can be expanded to include sustainability measures. • Balanced Scorecard – An additional perspective can be added to capture environmental sustainability. • Cost variance analysis can be employed to address the full social cost of departures from efficient resource use. Process III is now optimal A Lesson on Sustainability Employing Cost Variances Isocost line contains all combinations of material and labor with total cost = $396 Isocost has rotated to reflect full cost of material A cost center manager is to produce a budgeted level of output using a cost-minimizing combination of direct labor and direct material. The nature of the material is such that any portion of the material that does not become part of the output is discharged into the environment. Conventional analysis ignores the impact of the environmental discharge. Such negative externalities can be assessed through the use of shadow prices. Process II is the minimum cost solution Expanded Cost Variance Analysis Development and Use of Shadow Prices Management again chooses Process I and operates it inefficiently consuming 44 units of material and 15.4 units of labor. Full social cost = $829.40. Total variance = $275.40 The firm only absorbs private costs resulting in the variances below: • Shadow Price − economic value of relaxing a constraint. • It can be used to measure the decrease in social welfare caused • by the emission of an additional unit of pollutant. • For example, shadow prices for carbon and sulfur have been • developed by • Environmental Protection Agency • Stern Report • UK Department for Environment Food and Rural Affairs • The Regional Greenhouse Gas Initiative • The shadow price provides a signal to managers regarding • the relative cost of activities resulting in emissions. Cost Variance Analysis Management chooses Process I, and operates it inefficiently consuming 44 units of material and 15.4 units of labor at a total cost of $477.40. Resulting total variance = $477.40 - $396 = $81.40 Input-choice Variance = Difference in cost between efficient operation of Process I and Process II = $434 - $396 = $38 Waste variance = Actual cost of operating Process I less the cost of efficiently operating Process I = $477.40 - $434 = $43.40