v>EPA
        United States
        Environmental Protection
        Agency
              Office of Pollution Prevention
              and Toxics (MC 7409)
              Washington, D.C. 20460
EPA 742-R-95-005
 September 1995
Environmental Cost
Accounting for Capital
Budgeting:

A Benchmark Survey of
Management Accountants
        Environmental
        Accounting
        Project
        USEPA

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                                                 OMB #2070 0138
                 Prepared for:

           Pollution Prevention Division
      Office of Pollution Prevention and Toxics
Office of Prevention, Pesticides, and Toxic Substances
       U.S. Environmental Protection Agency
                       By:

                 Tellus Institute
               Allen L. White, Ph.D.

             Deborah E. Savage, Ph.D.
                Julia Brody, Ph.D.
                 Dmitri Cavander
                    Lori Lach

                 September 1995

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                              ACKNOWLEDGEMENTS

       This study was funded under Cooperative Agreement # 821580-01  between the Tellus
Institute and the U.S. Environmental Protection Agency (EPA).

       The study was made possible by EPA's Environmental Accounting Project, a component of
its Design for the Environment program.  The Environmental Accounting Project works to
encourage and motivate businesses to understand the full spectrum of environmental costs, and to
incorporate those costs into decision-making. For information on this project, its publications and
its activities, please contact the Pollution Prevention Information Clearinghouse at (202) 260-1023.

       We gratefully acknowledge the management and technical support of Marty Spitzer of the
EPA Administrator's Pollution Prevention Policy Staff, who served as EPA's Project Manager for
most of this study. Holly Elwood and Susan McLaughlin of the Environmental Accounting Project
guided the report through its final stages. The study was made possible by Social Science Research
Funds from EPA's Office of Research and Development. In addition, under the guidance of Harriet
Tregoning, the Waste Policy Branch of EPA's Office of Policy, Planning, and Evaluation provided
funding for the Sujperfund portion of the study. We received extremely valuable review of the
survey instrument and sample design from Carl Koch and Jim Daley, also of EPA's Office of Policy,
Planning, and Evaluation.

       Julian Freedman, Director of Research at the Institute of Management Accountants (IMA),
arranged for IMA collaboration on this project, including access to IMA membership lists and
permission for mention of IMA in our advance communications with survey respondents. This
assistance is but one example of his continuing efforts to bring environmental accounting issues to
the attention of the profession.

       Review of early drafts of the survey instrument was coordinated and/or provided by George
Nagle  and Allan Rosenfeld of Bristol-Myers Squibb, Scott Noesen of Dow Chemical, Walter
Dickerson of Polaroid Corporation, and Tom Klammer of the University of North Texas. We
appreciate the time and insights of these individuals in helping to revise and streamline the survey
questionnaire.  We  also thank Daryl Ditz of the World Resources Institute, Marc Epstein of the
Stanford Graduate School of Business, and George Nagle for their comments on the  draft final
report.

       A special thanks for the early inspiration for Tellus  Institute's work in environmental
accounting, dating to 1989, is due to Dick MacLean, now with Arizona Public Service Company,
and Matt Polsky, of the New Jersey Department of Environmental Protection, Division of Science
and Research.

       Finally, we appreciate the cooperation of all survey respondents for their participation in this
study.  In times of burgeoning information requests to the business community, it is easy to ignore
yet another mailing asking for time and data. For those management accountants who saw value in
the survey and responded to our inquiry with care and precision, we appreciate your collaboration.

Any errors in analysis and interpretation of data remain the sole responsibility of the authors.

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                           TABLE OF CONTENTS


EXECUTIVE SUMMARY

INTRODUCTION	1

THE MANAGEMENT ACCOUNTANT PERSPECTIVE	4

RESEARCH DESIGN	5

RESPONDENT PROFILE	*	8

CAPITAL BUDGETING PROCESS		-.	12

  TRENDS IN CAPITAL BUDGETING		17
  TRACKING ENVIRONMENTAL COSTS	18

 THE COST INVENTORY	.	,	20

  How WIDE is THE NET?	20
  ARE ENVIRONMENTAL COSTS QUANTIFIED?	25
  SUPERFUND LIABILITY: MAJOR OR MINOR PLAYER?	28

COST ALLOCATION	33

FINANCIAL INDICATORS: THE BOTTOM LINE	,		39

CONCLUSIONS	47

REFERENCES

APPENDIX A ADVANCE AND FOLLOW UP LETTERS TO SURVEY RESPONDENTS

APPENDIX B SURVEY QUESTIONNAIRE

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                               TABLES AND FIGURES
TABLES

Table 1. Contacts with survey sample	5
Table 2. Follow-up results	6
Table 3. Terms firms use to categorize capital projects	14
Table 4. Who develops cost estimates for environmental projects?	17
Table 5. Costs normally considered in financial analysis	23
Table 6. Cost items for which specific values are calculated	27
Table 7. Initial assignment of costs	35


FIGURES

Figure 1. Respondent's product line (by SIC code)...	.8
Figure 2. Respondent's position at firm	9
Figure 3. Number of employees worldwide	9
Figure 4. Most recent annual sales	10
Figure 5.  Annual corporate budget	11
Figure 6.  Level at which capital budgeting occurs	12
Figure 7.  Limit on discretionary capital spending	13
Figure 8. Who makes initial decision to place an environmental project	15
Figure 9. Level at which environmental costs tracked	19
Figure 10. Level at which environmental costs tracked	19
Figure 11.  Cost boundaries...	21
Figure 12.  How Superfund is handled	30
Figure 13.  Factors accounted for by liability assessment method	31
Figure 14. Basis for allocating costs to product/processes from overhead	37
Figure 15. Sources of cost information when assigning costs to products/processes	38
Figure 16. Financial indicators used for screening projects	40
Figure 17. Financial indicators used for full project justification	41
Figure 18. Payback period used, payback users only	42
Figure 19. IRR required for approval, IRR users only	43
Figure 20. Time horizon for NPV, NPV users only	44
Figure 21. IRR tune horizon used, IRR users only	44
Figure 22. Approval thresholds for environmental projects	45

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A Benchmark Survey of Management Accountants
    nvironmental cost accounting — the identification, compilation, analysis, use, and reporting
    of environmental cost information — has emerged as one of the foremost items  on the
agenda of business in the 1990s.  The reasons for this phenomenon are many and varied, and
originate both within and outside the firm.

       For internal decision-making, environmental costs impinge upon many facets of business
operations.   For  legal  staff,  meeting the  Securities and  Exchange Commission  (SEC)
requirements for disclosure  of environmental  liabilities  (most notably remediation costs)
demands regular and systematic appraisal of the anticipated costs "reasonably likely to  have a
material effect" on the financial condition of the firm.  For the accounting staff, compliance with
Financial Accounting Standard  (FAS) No. 5 on contingency costs creates  the  same need for
tracking and reporting environmental liabilities that affect the balance sheet of the firm. And for
financial staff responsible for monitoring and maximizing the value of the firm, disclosure of any
kind of environmental information — pollution levels or their cost repercussions — may influence
the stock market's perception of the firm's value.

       Though the formal requirements of the SEC and Financial Accounting Standards Board
(FASB) have attracted much attention, they are by no means the only reason for firms to put in
place workable environmental costing systems.  For product managers, properly inventoried and
allocated environmental costs may make the difference between a profitable and unprofitable
product  line.   For  the environmental or production engineer, a  rigorous  accounting  of
environmental compliance costs is integral to identifying and prioritizing process improvements.
For the plant manager facing an increasingly competitive domestic and global  marketplace of
products with low profit margins, effective control  of environmental costs may be critical to
ensuring long-term viability.   And, at the highest management level, the  chief executive
committed to continuous improvement should have a working knowledge of environmental costs
to benchmark a firm's performance against its competitors and industry as a whole.

       On the external front, pressures are mounting to  encourage or require tracking  and
disclosure  of various types of environmental costs.  The debate over how to improve national
income accounts to account for  use and depletion of natural assets has spilled into the corporate
arena in the form of pronouncements on "full-cost accounting" (FCA).  Though definitions vary,
the vision is  common ~  creating  accounting systems that will allow both  firms and their
stakeholders (investors,  customers, environmental organizations, host communities)  a  clear
perspective on the total environmental effects of a company or facility. The emergence of life-
cycle analysis, including its monetary component life-cycle costing (or "impact valuation"), ic a
reflection  of this  movement  toward greater  public accountability of  the environmental
consequences of product manufacture,  use, and disposal.   Though few firms have yet to take
steps in the direction of reporting such cost information, pressures to do so will continue to grow
as part  of the  broader  movement toward  higher standards for   corporate environmental
management systems, public accountability, and accounting.
                                       ES- 1

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                                             Environmental Cost Accounting for Capital Budgeting
PURPOSE AND
       The  purpose of this  study is to benchmark current corporate  environmental cost
accounting practices as they are applied to the capital budgeting decisions in U.S. manufacturing
firms.  It seeks to provide business managers and government agencies with an understanding of
how firms are integrating environmental cost considerations into decisions about environmental
investments.  Such an understanding can assist firms in comparing their practices with industry
averages and hi prioritizing improvements. For government agencies, a profile of environmental
accounting in relation to environmental investments  can help target technical assistance  and
policy initiatives as well pinpoint those areas of cost accounting where innovation is most visible
or, alternatively, most lagging.

       In this study, "environmental investments" is broadly defined, encompassing any capital
project — compliance or non-compliance -- that has as a major (though not necessarily exclusive)
objective the control, reduction, or prevention of pollution. Though all types of investments and
other business decisions certainly stand to benefit from improved environmental accounting, a
focus on environmental investments offers the most accessible "window" into current corporate
practices. This is the case because most corporate environmental accounting innovations thus far
have been linked to, and driven by, decisions surrounding environmental projects.   Thus, the
study findings are confined to one application of environmental cost accounting as an internal
decision support tool. The costs of interest are all those which are "internal" (versus external or
social) in nature, that is, costs that are material to the firm's decisions  about if, when, and how
much of its capital resources ought to be allocated to specific environmental investments.
       The survey targeted corporate management accountants in U.S. industrial firms based on
the judgment that the accounting function hi business, if properly informed and mobilized, can
play a key role in advancing environmental accounting practices in business organizations. This
is not to say that management accountants currently play such a catalyst role.  Indeed, to date,
environmental staff probably have been the prune movers in rethinking how accounting systems
can better serve the firms' long-range environmental management objectives. At the same time,
the accounting profession remains dominated by financial accountants whose responsibility is
largely information-gathering to  support external reporting  to  shareholders and regulators.
Advances in the management accounting community have occurred, but progress has been
slower in revamping cost accounting systems to provide relevant information to modern business
decision-making.  Nonetheless, besides being an excellent source of benchmarking information
for  the  business and  government  audiences, the  opportunity is at hand to activate  the
management accountant profession in support of improved environmental accounting.

       The survey sample was selected from a list of approximately  5,000 members of the
Institute  of Management  Accountants (IMA) using two  criteria:  (1) employment  in  the
manufacturing sector (SICs 20-39) and (2)  self-identification as responsible for planning and
budget or cost functions within their respective firms.
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A Benchmark Survey of Management Accountants
       Of the estimated 787 eligible respondents, we received 149 completed questionnaires, a
response rate of 19%.  Though the survey  sample was randomly drawn,  respondents were
decidedly weighted toward larger firms.  Forty-two percent have 5000 employees or more
worldwide, whereas only 8% have fewer than 200 employees.  Moreover, 49% report annual
worldwide sales of over $500 million and only 3% report sales under $10 million.
       How do firms structure and manage their capital budgeting processes, specifically with
respect to environmental projects?   Are such projects given special treatment in the form of
earmarked funds  or budget caps?  What business functions regularly participate in the capital
budgeting process? Major findings from the survey indicate that:

      •     The  single  most common structure, reported by  30% of  all respondents,  is
            budgeting at three business levels -- plant, division, and corporate. Corporate only,
            division only, and plant only represented 17%, 16%, and  16%, respectively.

      •     Discretionary spending for capital projects is a feature often associated with firms
            with multiple  plants.   In total, 72%  of respondents report some level  of
            discretionary spending  allowed  at  individual facilities,  ranging from  $5000-
            $100,000.

      •     The vast majority of respondents (86%) report a single capital funding pool for all
            capital projects, environmental or otherwise.

      •     Product/operations, environmental, and finance/accounting personnel are the most
            routine contributors to costing environmental projects, followed by consultants and
            purchasing staff.
        Moving from questions of capital budgeting in general to the question of environmental
 costing practices:

      •      71% of respondents reported that their company tracks some environmental costs on
             a company-wide basis.

      •      Among those who  track  environmental  costs on a company-wide  basis, 64%
             reported tracking at plant level,  63%  at the corporate  level, and 44%  at the
             divisional level.  These figures reflect multiple responses (i.e., tracking may be
             occurring at more than one level within the firm).
                                        ES- 3

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                                             Environmental Cost Accounting for Capital Budgeting
  IE COST INVENTORY* MOW wrai is THE
       What internal costs are included in environmental project financial evaluation?  And to
what extent are such costs quantified hi the project justification process, as opposed to handled in
qualitative fashion only?

     •      Environmental costs most often considered hi project financial evaluation are those
            that are the most tangible and quantifiable, for example:   on-site air/wastewater/
            hazardous waste testrng/monitoring, on-site  wastewater pretreatment/treatment/
            disposal, on-site hazardous waste pre-treatment/treatment/disposal, off-site hazard-
            ous waste transport, and waste manifesting are considered by more than 60% of the
            respondents.

     •      Environmental  costs least frequently  considered in project  financial evaluation
            include:   environmental  fines and penalties, corporate image,  insurance costs,
            personal  injury claims, marketable by-products, natural resources damage costs,
            legal staff tune, and sales of environmentally friendly/green products. Based on
            earlier  studies, these are also the costs generally perceived as less tangible,
            contingent, and difficult to quantify.
       To  what extent, then, are "considered"  costs also quantified?   Among  those  costs
normally considered in project financial evaluation, which are assigned a "specific dollar value"
for costs or savings?

     •      In general, firms who consider a specific cost item are inclined to take the next step
            and quantify such costs.  For example, while only 55% report considering insurance
            costs, 84% of those respondents quantify these costs.  This pattern generally  holds
            true across all cost items.

     •      For two-thirds of all environmental costs, 70% of firms who report they consider
            such costs also quantify them during project financial evaluation.
                                           0R
       Among all environmental costs on the minds of corporate managers, one deserves special
attention — Superfund liability.  We asked respondents if and how Superfund liability affects
various aspects of internal management decision-making hi the area of capital budgeting.

     •      Among all respondents, only 32% indicated they consider Superfund in capital
            environmental project evaluation.

     •      Among those who do consider Superfund, 33% assign a specific dollar value, 23%
            do not, and 44% combine qualitative and quantitative evaluation methods. This
                                        ES- 4

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A Benchmark Survey of Management Accountants


            suggests that somewhere between only 7-14% of all respondents regularly quantify
            Superfund liability during project financial evaluation.

     •      If liability is considered in any form, it generally appears after financial evaluation
            is complete and a project is brought to upper management for final  review and
            approval.

     •      For the few firms who consider a project's effect on hazardous waste ("Superfund")
            liability in preparing an appropriations request for an environmental project, 74%
            use an assessment method developed internally.

     •      By a substantial margin, the most frequently cited hurdle (58%) to  quantifying
            liability is difficulty in estimating pliability costs will occur. Following this is the
            difficulty in estimating the magnitude of costs (45%) and -when liability will occur
            (29%).

     •      Contrary to conventional wisdom that legal concerns play a key role in excluding
            liability from investment decisions, remarkably few identified "If I quantify, I may
            be subject to toxic torts"  (5%) and "If I quantify, I have to disclose to the SEC"
            (3%) as barriers to quantifying liability.

     •      A total of 61% of survey respondents  indicated that Superfund liability was either
            very important (27%) or somewhat important (34%) in determining priorities for
            environmental  projects,  suggesting  that  the general appreciation   of  liability
            avoidance well exceeds concrete  steps to quantify it.
       When firms incur environmental costs,  not all processes and products are equally
responsible for cost generation.  Even in modest-sized manufacturing firms with two or three
production  lines, the  costs  of licensing,  monitoring,  waste  storage, emissions  controls,
environmental staff time, off-site disposal,  insurance, future regulatory compliance,  and even
liability  are not  driven equally by each production line.   Some process lines may be more
hazardous materials-intensive, generate more emissions per unit output, require more frequent
and intensive inspection and monitoring, and generate greater quantities of waste requiring off-
site disposal.  Similarly, particular processes, or products, may cause a disproportionate share of
costs associated with training and reporting to government agencies, or give rise to risks that may
result in higher insurance costs or risks of future personal or property damages. In short, when it
comes to environmental costs, not all processes and products are created equal.

       To obtain a glimpse of current practices, we asked respondents to describe their current
practices in cost allocation across a range of 17  environmental costs.  For each cost item,
respondents were asked to check whether the initial cost assignment  was: always to overhead,
usually to overhead, usually to product/process, or always to product/process.
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                                             Environmental Cost Accounting for Capital Budgeting
           For every cost item, "always to overhead" is the most frequent response. Virtually
           all costs fall in the 55-75% response range; that is, well over half of respondents
           report initially assigning environmental costs always to overhead accounts.

           Costs most often initially assigned to overhead  — from licensmg/permittmg to
           insurance costs — are those most typically associated with central staff functions or
           plant-, division-, or corporate-wide overhead costs, e.g.,  legal, environmental, and
           training staff activities.

           The pattern of diminishing frequency from overhead to product/process assignment
           holds steadily for all entries, regardless of how tangible costs are.

           58% of those who initially assign costs to an overhead account later reallocate to a
           product or process. This translates into about 44% of all survey respondents.

           Labor hours (55%) and production volume (53%) are by far the most common bases
           for allocating overhead costs back to products/processes, followed by materials use
           (27%) and square footage of facility space (24%).

           Financial/accounting systems data, mentioned by 51% of respondents, is the most
           frequent source of environmental cost information. This is followed by purchasing,
           production/operation  logs,  engineering  estimates,   and  materials  tracking
           information.
FINANCIAL
                                  TUB
       Improving the cost inventory and cost allocation methods are major steps toward greater
balance and rigor  hi  evaluating environmental projects.  Two  other variables that can play a
decisive role in determining whether projects survive the intense competition for scarce capital
resources are the choice of project financial indicators and the related issue of analysis time
horizons.

       In addition to then- less tangible and contingent nature, many environmental costs and
savings materialize only hi the mid- and long-term.  In contrast to costs of activities such as on-
site air and  hazardous waste testing, monitoring, handling, and manifesting,  other  costs (or
savings/revenues) linked to corporate image, liability, and green product sales are by nature those
with longer-term time horizons.  In the case of future compliance costs, the very term implies
costs that will materialize only some years into the future. Thus, if any of these costs form part
of the cost/benefit calculation of a proposed environmental project, an analytical method that is
insensitive to mid- and long-term cost and revenue  streams will be incapable of capturing the
long-term profitability of the proposed project.  Pollution prevention projects are especially
vulnerable to this shortcoming. This is the case because many rely on product redesign, process
modification, and materials substitution that may be capital intensive but yield attractive returns
beginning 3-5 years after the initial capital outlay.
                                         ES- 6

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A Benchmark Survey of Management Accountants
            74% of respondents indicated they perform "a less detailed/informal screening" of
            environmental projects prior to a detailed financial analysis.

            For those firms that  perform informal screenings,  Return on Investment (ROI)
            (25%) and Payback (25%) are the most commonly used financial indicators. Eleven
            percent of respondents report use of qualitative methods.

            For full  project justification, ROI at 24% is  the leading quantitative indicator,
            followed by Internal Rate of Return (IRR)  at  18%.   However, for 27%  of
            respondents,  the single  most frequent response  to this  question, is that  their
            "evaluation is qualitative only." This strikingly high figure may be explained by the
            tendency of some respondents to interpret environmental projects as compliance-
            driven or "must-do," thereby not warranting the resources to develop a full financial
            evaluation.

            Among all respondents,  56% indicate no "standard hurdle rate, or threshold" is
            required before approving an environmental project.  Moreover,  57% report equal
            hurdle rates for environmental and non-environmental projects, 36%  report that
            hurdle rates are lower for environmental investments.

            Among those respondents who use Payback at any stage of project justification, 1-2
            years is by far the most common (50%) hurdle rate  required for project approval.
            For IRR users (48% of respondents), hurdle rates reported are 10-19%, followed by
            20-30% (25% of respondents) and greater than 30% (18% of respondents).
       Among the  many  internal  business functions  served  by  rigorous,  disaggregated
environmental cost information,  capital  budgeting for environmental projects  is  one of the
principal  beneficiaries.   Accounting systems  to  identify,  compile,  analyze,  and report
environmental  cost  information  in  a  timely and  rigorous  fashion are a prerequisite  to
understanding the sources and magnitude of environmental costs in the firm. Only if these costs
are understood can managers maintain a clear picture of the true costs of current production
processes and products.  This, in turn, allows managers to direct attention to opportunities to
minimize compliance  costs, .reduce operating costs, and fully mesh the  environmental and
financial performance goals of the organization.

       Concerning the key issues of environmental cost inventory and cost allocation methods,
the survey suggests that much work remains before business practices provide managers with a
comprehensive and transparent look at "true" costs of processes and products. While most firms
quantify the more obvious and measurable environmental  costs, substantially fewer have
grappled with those that  are less tangible, uncertain, and difficult to quantify.  Estimates of
environmental costs in the  range of 3%-20% of facility operational  or product line costs as
reported by some companies may, after a closer look, be substantially understated.
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                                              Environmental Cost Accounting for Capital Budgeting
       Dealing systematically with these types of costs is not new to corporations. In the normal
course of business, managers regularly look into the future to forecast everything from the price
of oil to consumer demand for a new line of computers.  Applying these approaches, including
those drawn from risk analysis, to estimate less tangible costs would represent  a major step
toward characterizing current and future environmental costs.

       Cost allocation, too,  remains  a major challenge.  Most firms continue to place most
environmental costs initially into overhead accounts. Though some subsequently allocate these
costs to products or processes, the basis upon  which these allocations are made  are often ill-
conceived, that is, they bear  little or no relationship to the activities which are responsible for
their  creation.   When proper allocation  does  not occur,  managers receive distorted signals
regarding the true costs and benefits of retaining or changing processes and products. Moreover,
like incomplete cost inventories, misallocation of environmental costs stands in the  way of
effective performance monitoring, product pricing, incentives and rewards systems, and other
activities essential to maintaining a competitive enterprise.

       Upgrading the  capital budgeting system  through improved environmental accounting
systems is best viewed in the broader context of strategic  planning.  With multiple forces
working to fuse environmental and financial objectives of the firm, it is critical to exercise an
even hand in evaluating the returns to all capital investments, environmental or otherwise. When
cost inventory and  cost allocation  practices  fail to provide  a level playing  field for  all
investments, managers are left without the information they need to make optimal use of limited
resources.  In particular, those environmental projects with strong pollution prevention content,
as well as those with side benefits unrelated to environmental improvement per se -- e.g., process
optimization and yield, market penetration, corporate image — are particularly vulnerable to the
adverse effects of incomplete cost information.

       While many social benefits may result from improved internal environmental accounting,
the case for such improvements may be made purely on the basis of the firm's self-interest.  This
is the central message that public policymakers,  professional associations, trade associations and
stakeholders should deliver to firms seeking to understand and apply environmental accounting
techniques to their capital budgeting processes.
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A Benchmark Survey of Management Accountants
    nvironmental cost accounting — the identification, compilation, analysis, use, and reporting
    of environmental cost information — has emerged as one of the foremost items on the
agenda of business in the 1990s.  The reasons for this phenomenon are many and varied, and
originate both within and outside the firm.

       For internal decision-making, environmental costs impinge upon many facets of business
operations.   For  legal  staff,  meeting  the  Securities and Exchange  Commission (SEC)
requirements for  disclosure  of environmental liabilities  (most  notably  remediation  costs)
demands regular and systematic appraisal of the anticipated costs "reasonably likely to have a
material effect" on the financial condition of the firm (Edwards 1992).  For the accounting staff,
compliance with Financial Accounting Standard (FAS) No. 5 on contingency costs creates the
same need for tracking and reporting environmental liabilities  that affect the balance sheet of the
firm.  And for financial  staff responsible for monitoring and  maximizing the value of the firm,
disclosure of any kind of environmental information — pollution levels or their cost repercussions
— may influence the stock market's perception of the firm's value (Freedman 1993).

       Though the formal requirements of the SEC and Financial Accounting Standards Board
(FASB) have attracted much attention, they are by no means the only reason for firms to put in
place workable environmental costing systems (Ditz, Ranganathan and Banks 1995; Todd 1994).
For product managers, properly inventoried and allocated environmental costs may  make the
difference between a profitable and unprofitable product  line.  For the environmental or
production  engineer, a rigorous accounting of environmental compliance costs is integral to
identifying and prioritizing process improvements. For the plant manager facing an increasingly
competitive domestic and global marketplace of products with low  profit margins, effective
control of environmental costs may be critical to ensuring long-term viability. For the personnel
officer seeking to create  fair and effective  employee  incentive and  reward programs,
environmental costs may be a key ingredient in measuring staff performance.  And, at the highest
management level, the chief executive committed to  continuous improvement should have a
working  knowledge of  environmental costs to benchmark  a firm's performance against its
competitors and industry as a whole.

       On  the external  front,  pressures are  mounting to encourage or require  tracking and
disclosure of various types of  environmental costs.   The debate over how to modify national
income accounts to incorporate  the use and depletion of natural assets (Repetto 1989) has spilled
into the corporate arena in the form of pronouncements about "full-cost accounting" (FCA)
 (Popoff and Buzzelli 1993).   Though  definitions  vary,  the  vision is  common ~ creating
 accounting systems that will allow both firms and their stakeholders  (investors, customers,
 environmental  organizations, host communities) a clear perspective on the total environmental
 effects of a company or facility. The emergence of life-cycle analysis, including its monetary
 component, life-cycle costing (or "impact valuation"), is a reflection  of this movement toward

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                                               Environmental Cost Accounting for Capital Budgeting
RESPONDENT PROFILE
     Higure 1 depicts the distribution of respondents by SIC code.  Nearly half (48%) work for
     firms in one of four equipment manufacturing sectors plus miscellaneous  manufacturers.
We  lumped  these five SICs together to control the length of the questionnaire:  industrial
equipment,  electric  equipment,  transportation  equipment,  instruments  and  miscellaneous
manufacturing.  The remainder are scattered across the other nine  categories, with the heaviest
representation in chemicals and petroleum/coal (12%) and metals (12%).  Those least represented
in the sample are printing (3%) and rubber/plastics (1%).   The former is not surprising since
printing firms, though large in number, are generally small establishments of 30 employees or
less.  These types of firms are unlikely to have a full-time accountant responsible for planning
and  budgeting  or cost functions; our survey sample,  on the other hand, focuses  on such
accountants.
                   Figure 1. Respondent's product line (by SIC code)
                                               20,21: Food, Tobacco
                                                     8%
                                                        22,23: Textiles, Apparel
                                                               6%
         35-39: Industrial/Electric/
         Transportation Equipment,
         Instruments, Miscellaneous
              Manufacture
                48%
24,25,26: Lumber, Furniture,
        Paper
         6%
  27: Printing
     3%
                                                                28,29: Chemicals, Petroleum/Coal
                                                                         12%
                                                            30: Rubber/Plastics
                                                                 1%
                                                         32: Stone/Clay/Glass
                                                              4%
                                          33,34: Metals
                                              12%

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A Benchmark Survey of Management Accountants
       Respondents are located with  almost equal frequency in corporate  (32%),  divisional
(31%) and individual plants (31%) (Figure 2). Slightly less than two-thirds (61%) are registrants
with the Securities and Exchange Commission (SEC). With respect to employees (Figure 3),
somewhat under half (42%) have over 5000 employees worldwide, while only 8% have fewer
than 200 employees. The remaining 50% are mid- to mid-large-size enterprises in the 200-999
range and 1000-5000 employee range.
                       Figure 2. Respondent's position at firm
                                                     Corporate
                                                       32%
                                          Divisional
                                            31%
                      Figure 3.  Number of employees worldwide
                                     24%
                                                          42%
                                               26%
                          <200
                                    200-999     1000-5000
                                       No. of employees
                                                          >5000

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                                              Environmental Cost Accounting for Capital Budgeting
       Annual sales volume approximately mirrors the employment profile of the respondents
(Figure 4). Nearly half have annual worldwide sales greater than $500 million, while only 3%
report  sales of under $10 million.   Using 200  employees and  $10  million annual sales as  a
general rule for distinguishing small businesses from medium and larger enterprises, our sample
is clearly weighted toward the latter. This, again, is expected given our criteria for inclusion in
the sample.   Professional  management  accountants  with  planning,  budgeting,  and  cost
responsibilities are likely to be affiliated with larger corporate organizations  with routinized
planning and budgeting cycles,  multiple plants and divisions, and complex cost  structures
requiring dedicated accounting staff for management and oversight.  And, of course, they also are
likely  to  have  the  financial and human resources to  devote to  completion  of a  survey
questionnaire in comparison to the greater resource constraints facing smaller firms.
                          Figure 4.  Most recent annual sales
                                                               49
                  50 -
                         <$10         $10-        $101-
                         million         100         $500
                                     million        million

                                        Annual sales
>$500
million
                                             10

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A Benchmark Survey of Management Accountants
       Finally, annual corporate capital budgets track the pattern of company size reflected in
sales and employment levels (Figure 5).  About half (51%) of the respondents report capital
budgets greater than $10 million, 89% over $1 million, and only 5% less than $.5 million.  The
medium- and large-scale weighting of our sample is again evident.
                       Figure 5. Annual corporate budget


                                      < $0.5 million
                                           5%     $0.5 - $1 million
                                                       6%
                    >$ 10 million
                        51%
$1 - $10 million
     38%
                                           11

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                                              Environmental Cost Accounting for Capital Budgeting
CAPITAL BUDGETING PEOCEBS
      ow do firms structure and manage their capital budgeting process, specifically with respect
      to  environmental projects?   Are such projects given special treatment in the  form of
earmarked funds  or budget caps?  What business functions regularly participate in the capital
budgeting process?

       A look at the  data (Figure 6) reveals that the  single most common  combination of
responses was  budgeting at all three levels,  a process described by 30% of all respondents.
Corporate only, division only,  and plant only represented 17%,  16%, and 16% respectively.
Based on Tellus'  experience working with firms during the last five years, the prevalence of this
tiered-type structure  is typical  of  medium- to large-size  firms,  wherein  initial project
identification and justification begins at the plant level, moves up to divisional or group review
(unless a project is small enough to qualify for discretionary spending at the facility level), and
finally is approved or  rejected by corporate management. A number of respondents indicated
some variation on the  category names, e.g., "departmental," "operating unit," and "branch."
Interestingly,  only one respondent  indicated budgeting by  "product  line."   Among  all
respondents, virtually all (95%) budget on a  regular  as opposed to an ad hoc  basis, a finding
expected for a sample dominated by mid- to large-size manufacturers. Four of the five firms
whose budgeting  is ad hoc fall within the lower half of firm sizes (p<.05)2 as measured by annual
sales.
                         Figure 6. Level at which capital budgeting occurs
                               Plant only
                                 16%
Other  Corp, div,
 3%  plant, other
        3%
                       Division only
                          16%
                            Corporate only
                               17%
                                                         Corp, div, & plant
                                                             30%
           Corporate & plant
                6%
   Division & plant
        5%
                                       Corporate & division
                                            4%
 1 Pearson chi square test were used for all statistical analyses atp < .05.
                                            12

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A Benchmark Survey of Management Accountants
       Discretionary spending for capital projects is a feature often associated with firms having
multiple plants.  In these instances, plant managers are allowed to spend up to a predetermined
fixed amount for projects without the formal justification process and  divisional or corporate
approval required for larger expenditures.   When asked if such discretion exists, respondents
indicated a wide range of such caps (Figure 7). At the low end, 28% indicated no discretionary
spending whatsoever, or "no limit";  all  expenditures,  no  matter  how small, require upper
management approval.   After this no-limit category, respondents  reported  in roughly equal
fractions (12%-18%) discretionary caps ranging from $5000 to  over $100,000.3  Thus, in total,
72% report some level  of discretionary spending allowed in their firms.   As  in the case  of
budgeting  cycle, and consistent with our expectations, it is the larger firms that give individual
plants  greater independence in undertaking capital projects with upper management approval (p
<.05).   For example, 80 percent of firms  with annual  sales under $10 million indicated no
allowance  for discretionary spending, whereas only 13% of firms with sales  greater than $500
million reported such a procedure.
         35 T
                       Figure 7. Limit on discretionary capital spending
                                                                             17
                no limit
                            up to
                            $5000
 up to
$10,000
 up to
$50,000
  up to
$100,000
                                     other
                                          Spending Limit
3One respondent reported that the discretionary cap depends on who is the highest ranking plant personnel. The
figure ranges from $25,000 for a "Director" to $250,000 for an Assistant Vice President and $500,000 for a Vice
President. Another respondent reported that the discretionary cap is variable and depends on plant size.
                                             13

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                                             Environmental Cost Accounting for Capital Budgeting
       Firms use a wide range of categories to classify projects as they enter the budget cycle,
and category names may be critical (White, Becker, and Goldstein, 1991b).  Those bearing an
"environmental" tag may be viewed as inherently non-value adding. These projects are seen as
necessary but unprofitable uses of capital and, perhaps, are subject to a lower hurdle rate, if any.
Alternatively, a project labeled "profit-adding"  or "cost-saving" will be more  welcome by
management in the course of project justification.  It is sometimes the case that a project with
strong environmental  content  may be  automatically  labeled  "environmental"  and escape
systematic financial analysis even though it may, in fact, yield a competitive rate of return if
profitability analysis were performed.

       Given a list of 14 project categories, respondents were asked which are used to classify
projects in their firms (Table 3). At the high end (60% or greater reporting the use of a category)
are "cost-saving,"  "environmental," "replacement," and "expansion."  Among other  potential
environmentally-related categories, about a third, 32%, use the term "compliance," 25% use
"waste treatment," 20% use "pollution prevention," and 17% use "waste reduction."  Thus,
overall, "environmental" is  by  far the most common environmentally-related category, which
may be interpreted as an indication that most firms lump environmental projects of all types into
a single category.  Insofar as this is the case, the tendency not to discriminate between different
types of environmental projects may cloak important contributions of pollution prevention (P2)
and  waste reductions  to non-environmental objectives such as overall yield enhancement and
product quality, as well as profit-adding and cost-saving.
                  Table 3. Terms firms use to categorize capital projects
                             Term
               Cost saving
               Environmental
               Expansion of existing operations
               Replacement
               Maintenance
               Expansion into new operations
               Compliance
               General/Administrative
               Waste treatment
               Pollution prevention
               Profit adding
               Waste reduction
               Profit sustaining
               Abandonment
Percent who use term
         73
         67
         64
         64
         54
         50
         32
         27
         25
         20
         20
         17
         13
          3
                                            14

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A Benchmark Survey of Management Accountants
       Which business functions tend to assign environmental projects to individual categories?
Among the  eight  choices available and  allowing for one  answer  only (Figure  8), plant
environmental  staff most often make this critical  determination  (29%), followed  by plant
finance/accounting  (12%) and corporate finance/accounting staff (12%).  Among those who
responded "other,"  a variety of staff functions were named:  engineering, plant engineering,
capital planning committee, division manager, consultants, product/process engineer,  corporate
manufacturing, and president. Another 15% report using "no categories." Thus, after eliminating
"other"  and  "no categories,"  55% of respondents indicate "plant  environmental" and "plant
finance/accounting" as those responsible for project classification.  The pivotal role of these staff
in project categorization should make the staff a prime target for initiatives -- originating either
internal or external  to the firm — to upgrade and refine the project classification process to avoid
the aforementioned pitfalls in financial analysis.
                  Figure S.  Who makes the initial decision to place an
                    environmental project in a particular category?
                                               Corporate
                                           finance/accounting
                                                 12%
                    We do not use
                     categories
                       15%
                     Plant environmental
                           29%
                                                            Divisional
                                                         finance/accounting
                                                               6%
         Plant
    finance/accounting
          12%
    Corporate
  environmental
      6%
 Divisional
environmental
    8%
       Are environmental projects, both compliance and non-compliance,  accorded a separate
capital budget pool or, alternatively, do they compete with other contending projects for capital
resources?  The vast  majority of respondents (86%) report a single pool, whereas only 11%
report a separate pool for environmental projects and 3%  for compliance projects.  This is a
finding of substantial consequence for pollution prevention projects.  It once again reinforces the
                                             15

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                                              Environmental Cost Accounting for Capital Budgeting
importance of rigorous cost analysis if P2 projects are to compete effectively, since special set-
aside funds are the decided exception and intense competition the rule.  Though 94% report
annual environmental project expenditures have either "no set cap" or "vary from year to year,"
the general absence  of earmarked funds implies an intense annual  competition  for capital
resources.

       In the course of environmental project justification, many staff functions may contribute
to developing cost information for environmental projects (White, Becker, Goldstein 1991a and
1991b).  These  staff functions may include environmental,  operations,  accounting, financial,
purchasing, and facilities management.  As the cost net extends to  encompass  less tangible
longer-term costs,  savings, and  revenues,  other staff functions  (e.g.,  legal and  marketing)
increasingly become  important sources of information.  In  fact, there is a direct correlation
between the rigor of cost analysis and the number of staff involved in identifying, compiling, and
analyzing cost information.   The more numerous  and less tangible project costs  are --  a
characteristic typical of many P2 investments ~ the more different staff functions are required to
do the job right.  For example, costs/savings associated with liability avoidance, future regulatory
compliance, compliance with future international environmental management systems standards,
and penetration  of green product markets -- all may require input from staff not traditionally
involved in the project justification process.

       When given seven typical  sources of cost information and allowed multiple responses,
respondents most often cited product/operations, environmental, and finance/accounting staff as
routine contributors  to  costing environmental projects (Table  4).   Over  a  third  indicated
consultant (38%) and purchasing (36%) participation, followed by vendors (23%) and legal staff
(20%).  "Others" included  a strong showing by engineering/plant engineering (13 respondents)
plus an assortment  of single mention of others, including: industrial  engineering,  facilities
engineering, corporate engineering, and maintenance.  The strong showing of environmental and
production/operations is not surprising given the state-of-the-art of environmental project costing
in general,  which heavily emphasizes  conventional  company costs.     As awareness of less
tangible costs/savings increases, we are likely to see a more active  role on the part of staff
functions such as legal  and marketing.  Finally, the appearance of vendors and consultants,
though not surprising, is a reminder that these parties should be included  in any initiative  aimed
at strengthening the costing methods used by manufacturing  firms in evaluating environmental
projects.
                                            16

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A Benchmark Survey of Management Accountants
            Table 4.  Who develops cost estimates for environmental projects?
                 Department
Routinely involved (%)
     Production/Operations
     Environmental
     Finance/Accounting
     Consultants
     Purchasing
     Vendors
     Legal
     Other
          65
          64
          64
          38
          36
          23
          20
          13
Trends in Capital Budgeting

       Are capital budgeting practices in general changing in U.S. manufacturing firms? Are
such practices following the rapid pace of change in business organizations, change spurred by
such forces as merger and acquisition activity, new product  development,  and changing
environmental  regulations?  Are efforts to achieve environmental improvements affecting the
way firms manage their capital resources or, as some observers argue, are past practices and
traditional shareholder value drivers intact despite pressures to become increasingly  "green"
(Walley and Whitehead 1994)?

       When presented with eight potential changes to their firms' capital  budgeting practices
during  the last  three  years, the  common answer (60%) was  "no  change."    Raising  the
discretionary cap on facility-level capital expenditures was a distant second at 17%, which may
reflect primarily  an inflation adjustment and not a real dollar increase. Four options explicitly
related to  environmental projects4  were each mentioned by no more than  7% of respondents.
Thus,  a picture of essentially unchanging capital budgeting practices emerges, at least for the
changes identified in the survey instrument. Of course, this does not preclude the possibility that
firms are making changes unrelated to those that affect their handling of environmental projects.
Notwithstanding  this possibility,  it  appears  that capital  budgeting practices, at least for
environmental projects, have remained  relatively constant amidst downsizing, re-engineering,
and other trends and styles that are reshaping American manufacturing industry (Klammer 1994).
 4 Whether the firm stopped or started classifying environmental projects separately from other capital projects, and
 whether the firm stopped or started distinguishing environmental compliance from non-compliance projects.
                                             17

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                                             Environmental Cost Accounting for Capital Budgeting
Tracking Environmental Costs

       Moving from questions of capital budgeting in general to the question of environmental
costing practices, our survey found 71%  of respondents reporting that their company tracks
environmental costs on a company-wide basis.  This is a surprising finding.  In work with many
different firms during the last five years, Tellus Institute has found few instances -- certainly less
than the majority reported in this survey — of accounting systems designed to tag or segregate
environmental costs on a routine basis.  The  survey finding may be attributable to one or a
combination of four explanations:

•   the respondents self-selected in favor of those management accountants whose firms  are
    more apt to practice advanced environmental accounting methods;

•   Tellus' earlier work (White, Becker and Goldstein 199la; White, Savage and Dierks 1995),
    covering a diverse but small sample of firms, is not representative of company practices in
    general;

•   "tracking environmental costs" may be defined more loosely by respondents than intended by
    the question, thereby leading to an increased number of positive responses; and

•   "company-wide" may have been loosely defined by respondents.

The nature of the question allowed respondents to either choose an option ("no") that implied
their company did not track environmental costs at all or choose "company-wide" ("yes").  In
other words, "company-wide" was interpreted as "at all" or "at any level."

        Figure 9 depicts the most common organizational level at which  environmental costs are
tracked. Among those who track environmental costs company-wide, slightly under two-thirds
reported tracking at plant level and at the corporate level, and 44% at the divisional  level.  This
probably reflects the absence of divisions in many of the respondents' firms, as well as factors
related to the accounting structure. Figure 10 sheds further light on the  tracking question. Here
we see the most common structure among those who track environmental costs is participation of
all three levels - plant, division, and corporate ~ followed closely by plant only and corporate
only.   This  response,  as in  the  earlier  "do  you track" question,  may also reflect varying
interpretations of "environmental costs."   Those firms who report the involvement  of all three
levels probably have  in  place  the most  systematic and tiered procedure for compiling  and
reporting environmental  costs  originating  at the plant level  and moving  up  the  corporate
hierarchy. For those in almost equal numbers who report plant-only and  corporate-only tracking,
we suspect a less  comprehensive and routinized tracking system.   For example,  plants may
compile relatively  straight-forward costs like waste handling  and disposal, whereas  corporate
tracking may focus on Superfund liability.
                                            18

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A Benchmark Survey of Management Accountants
                       Figure 9.  Level at which environmental
                                    costs tracked
                          (n=104, multiple answers accepted)
                              64%
                                                      63%
                                                     Corporate
               Figure 10. Level at which environmental costs tracked
30% -r
                                                                       28%
                                             Level
                                          19

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                                            Environmental Cost Accounting for Capital Budgeting
THE COST INVEHTOHY
How Wide is the Net?

       Definitions of environmental costs are subject to enormous variation (GEMI 1994, Fagg
et al 1993). Figure 11 presents a three-part, "nested" scheme for distinguishing different types of
costs (Shapiro, Savage, and White forthcoming).  For most firms, current tracking practices
encompass only Box A (conventional costs) including items such as:

       •  off-site waste disposal,
       •  purchase and maintenance of air emissions control systems,
       •  utilities costs,
       •  and perhaps costs associated with permitting of air or wastewater discharges.

Beyond this conventional cost domain is Box B, encompassing a wide range of less-tangible
costs (and savings and revenue streams) such as:

       •  liability,
       •  future regulatory compliance,
       •  enhanced position in "green" product markets,
       •  and the  economic  consequences  of changes  in  corporate  image  linked  to
          environmental performance.

Probably more than any other less-tangible cost, especially in relationship to SEC requirements
and financial reporting in general, liability has been the subject of substantial discussion within
and outside the accounting profession  (Canadian Institute  of Chartered Accountants 1993;
Surma and Vondra 1992; Newell, Kreuze,  and Newell 1990).  Also included  in Box B are
changes in stock value linked to environmental performance,  an elusive yet  potentially
significant less-tangible item of special interest for publicly  traded firms (Cohen  1995).
Together, Boxes A and B comprise the internal domain, the collection of costs for which firms
are accountable (or otherwise experience) under current and foreseeable regulatory and market
conditions.
                                           20

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A Benchmark Survey of Management Accountants
                              Figure 11. Cost Boundaries
                                          K"« '-4$f-*£ r
               , VaS*:
Less Tangible, Hidden,
Indirect Company Costs
                              Conventional Company Costs
                 CA  3-
                                ^•*f/^ *•
                                 •^ ^.ji
                               -*y» >  .
Internal Cost Domain

External Cost Domain
                                       Full
                                                           Total Company Costs
                         rife-Cycle Costs
       Box C comprises external costs, or "externalities" in the language of economics.  These
costs entail those for  which the firm is not accountable or are not of material economic
consequence to the firm under current and foreseeable regulatory and market conditions. Box C
may include,  for example, adverse health effects for air emissions  that result even if such
emissions are within compliance levels; damages to buildings or crops resulting from SO2
emissions; and irreversible damage  to ecosystems or species owing to  mining or forestry
activities. A few firms  have taken the first step toward developing accounting systems that track
and, in some  instances, report the physical and economic magnitudes of these external costs
(Boone 1995, Elkington 1991).  Certainly the pronouncements of business  leaders suggest that
the future may see further corporate initiatives to track and report these costs as part  of the
general movement toward enlightened public accountability (Popoff and Buzzelli 1993;  Andraca
and McCready 1994).

       With continuously  evolving U.S. environmental regulations and public expectations and
with emerging international  environmental  management systems standards, the boundaries
depicted in Figure 11  are anything but static.  Costs in Box C today may well be in Box B
tomorrow. In the same vein, the less tangible nature of Box B costs such as liability and
                                           21

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                                              Environmental Cost Accounting for Capital Budgeting
corporate image will change as more rigorous measurement techniques are developed to quantify
such costs. For now, however, putting in place systems to more effectively track Box A and Box
B costs is the nearer-term, high-payoff challenge facing most firms.

       Within this conceptual framework, what internal (Box A and Box B) costs are included in
environmental project financial evaluation as  reported by the management accountants in our
sample?  And to what extent are such costs quantified in the project justification process,  as
opposed to handled in qualitative fashion only?

       The first of these questions, the inclusiveness of the cost inventory, is reported in Table 5.
This table  presents the percent of respondents who "normally" consider 28 different types  of
costs (or savings or revenues) in preparing financial justification for environmental projects. This
cost inventory includes items ranging from the conventional, tangible, and measurable — e.g.,
production efficiency/yield, energy, water, hazardous waste pre-treatment/treatment/disposal — to
those which, in the eyes of most corporations today, would be regarded as less conventional, less
tangible, and less measurable (White, Becker, and Savage  1993).
                                            22

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A Benchmark Survey of Management Accountants
                 Table 5. Costs normally considered in financial analysis
                                Cost Item
Percent who
  consider
     Energy costs


     Licensuig/permitting
        ;,"*> X-Tfl;
     Production efficiency/yield

     On-site hazardous waste handling (storage, labelling)

     Employee safety/health compensation claims

     Manifesting for off-site hazardous waste transport

     Future regulatory compliance costs

     Insurance costs

     Personal injury claims

     Frequency of plant shutdown

     Property damage

     Air pollutant emission credits (SOx, NOx)
     Natural resource damage
     Sales of environmentally friendly/green products
       Note that this list is neither exhaustive of all cost items that ought to be considered in
project justification, nor are the listed items pre-defined as "environmental." In fact, there is no
single standardized list of "environmental costs" to which all firms adhere, nor is there likely to
be one in the foreseeable future (Ditz, Ranganathan, and Banks 1995).  Because environmental
costs are simply those incurred in meeting the environmental objectives of the firm, and such
objectives vary across firms  and even within firms at different points in time, developing a
standardized list is infeasible.  Moreover, devoting substantial energy to defining what is and is

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                                              Environmental Cost Accounting for Capital Budgeting
not an. "environmental" cost diverts attention from the fundamental challenge: enlarging the cost
inventory to ensure that all costs, environmental and non-environmental, are properly accounted
for in the capital budgeting process. Toward this end, Table 5 is empirically-based, containing
cost items  which are (a) associated with environmental projects  and (b) frequently, in Tellus'
experience, wholly or partially absent in appropriation requests for capital funds. For this reason,
many conventional cost items such as equipment, direct labor, and raw material inputs do not
appear on our list.

       Scanning Table 5 reveals, aside from a few surprises, an ordering of cost items one might
expect given the state-of-the-art of environmental accounting.  The highest percent responses are
generally costs which  are front-line  (often on-site)  waste management costs  that motivate
environmental  project proposals in the first  place:  on-site air/wastewater/hazardous waste
testing/monitoring, on-site wastewater pre-treatment/treatment/disposal, on-site hazardous waste
pre-treatment/treatment/disposal, off-site hazardous waste transport, and waste manifesting. By
and large,  they fall within Box A of Figure  11.  All are considered by  60+ percent of the
respondents.

       Also included in the upper half (over 59% or greater) of responses are energy  and water
costs.   Though normally  classified as standard utility costs, they  nonetheless  are subject to
change insofar as environmental  projects directly or indirectly alter the water and energy
requirements of a new production process. In the same vein, production efficiency/yield, which
is normally considered by about three-quarters of respondents,  is usually not viewed  as  an
environmental cost per se.  Nonetheless, product yield,  for example,  in the chemical and
petroleum  industry is often a concurrent beneficiary of projects whose principle aim is emissions
reductions through process modifications or simply housekeeping measures.

        One unexpected finding is  the appearance of future regulatory compliance costs  in the
upper half of  Table 5.  Though marginally falling into the  upper  half (59% report that it is
normally considered), even this modest showing suggests that  a significant  number of  firms
increasingly are looking for ways to avoid future compliance costs in addition to controlling or
eliminating  current regulatory pressures.  Such behavior -  reflecting a desire to get off the
"regulatory  treadmill"  ~  may portend a future of greater  visibility for prevention-oriented
projects in the capital budgeting process.

        At the  lower half of the response list (57% or less) are costs that most firms would view
 as less tangible, though by no means less significant, contributors to the future stream of costs
 and savings associated  with environmental  projects.   In  this category  fall  such costs as
 environmental fines and penalties, corporate image, insurance costs, personal injury claims at the
 higher end of the response ranking; and marketable by-products, natural resources damage costs,
 legal  staff tune, and sales of environmentally friendly/green products at the lower  end of the
 response ranking.  Not surprisingly, many of these costs are of a contingent, or probabilistic,
 nature. That is, whether and when they materialize, and what their costs  to the firm will be, all
 are subject to substantial  uncertainty.  Nonetheless, acute events (e.g., fire, spill, or explosion)
 owing to  the  use or manufacture of hazardous materials do  occur, and projects that reduce or
 eliminate  the probability of such accidents are rightfully credited with an avoided cost.  A recent
                                             24

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A Benchmark Survey of Management Accountants
example of the financial benefits  of such risk reduction is  demonstrated in an accelerated
corporate-wide phase-out of PCBs by a large manufacturer (White, Savage, and Dierks 1995).  In
this instance, a project which languished in the capital budgeting process was given new life and
approved by  upper  management  when  the appropriations  request  incorporated  explicit,
quantitative, and monetized estimates of avoided risks of a PCS spill, fire, and plant shut-down.
Still,  the responses in Table 5 suggest that as a group, such  contingent costs have yet to be
routinely included into the capital budgeting process for at least 40%, and as much as 69% (in the
case of natural resource damages), of the firms represented by the respondents.

       Other less tangible costs also are subject to omission by many firms. Corporate image,
undoubtedly  one of the most difficult to measure among all less-tangible costs, is normally
considered by 55% of respondents, a surprisingly high response (even if limited to a qualitative
consideration)  given  the elusive nature of image effects.  At 40%,  air emission credits, a
relatively new development spurred by the Clean Air Act Amendments of 1990, may simply be
outside the realm of possibilities for a majority of the respondents.  Sales of environmentally
friendly/green products, at 25% the lowest response of all items, also may be applicable only to a
small fraction of firms in the consumer product business. In contrast to primary or intermediate
industries (e.g., petroleum, most chemicals, metals), consumer products manufacturers are more
sensitive  to  attaining a  "green"  product image that may  be   enhanced  through  certain
environmental investments.

       Finally, insurance  costs,  reporting to government  agencies, environmental staff labor
time,  and legal staff labor time are all cost items that traditionally fall within the centralized
administrative functions of the firm.  Their relatively high rate of omission from the capital
budgeting process may be linked to the tendency to pool such costs in overhead categories (as we
discuss in the next section), thereby disconnecting such costs from the processes and sources that
generate  them in the  first place.  Of course, for some environmental projects, managers may
correctly view such costs as fixed - that is, invariant with  respect to a proposed environmental
project.  Legal and environmental staff costs,  for example, may not decline to any significant
degree as a result of  a proposed environmental project; most  of their environmentally-related
functions -litigation,  reporting, manifesting ~ will continue in essentially the  same fashion as
before the project is implemented.   However, firms  should be  cautious of making these
assumptions before such pooled costs are properly disaggregated.  This will  enable firms to
clearly understand what exactly these costs are, what portion is fixed and what portion is variable
and, finally, which  costs are controllable and which are  not  (Ditz, Ranganathan, and Banks
1995).
Are Environmental Costs Quantified?

       Considering environmental costs in the capital budgeting process is an important, but
only a  first, step in bringing rigor  and comprehensiveness to  the financial evaluation of
environmental projects.  Monetization of such costs — estimating specific dollar values ~ is the
                                           25

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                                              Environmental Cost Accounting for Capital Budgeting
second and ultimate measure of how far firms are in realizing the full benefits of a complete cost
inventory, one which encompasses both tangible and less tangible internal costs as depicted in
Box A and Box B of Figure 11.  To  what extent, then, are "considered" costs also quantified?
Among those costs normally  considered in project financial evaluation, which are  assigned a
"specific dollar value" for costs or savings? Table 6 reports responses to this question. Note that
the percentages in Table 6 reflect responses provided by a subset of the total survey sample (i.e.,
those who answered "Yes" to the question of whether they consider a specific cost item at all in
preparing environmental project financial evaluation).
                                             26

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A Benchmark Survey of Management Accountants
                Table 6. Cost items for which specific values are calculated
                          among those who "consider" each cost
                                 Cost Item
                                                              Percent who
                                                                calculate
Energy costs
                                                                           92
            >i       ,i*<                   ,  ,i
            llfll^^                                               iiit-V
       Marketable by-products
        ^^^c^^^g^^^^^^^^^^r^r^ *• "T^W*^ xi-L^ T T '^i^- =* ^^* Tr^iw^^f!^^^
        8js|ji$§^
       On-site air/wastewater/hazardous waste testing/monitoring

       Insurance costs

       On-site air emission controls
                                                                   {>.;• •,; , -Y>
                                                                   ^_-iiS:, '-
                                                                   84
       Environmental staff labor time
       Itegai staftiajb|ptiim& v^^^
       Off-site hazardous waste transport
                   ^
       On-site hazardous waste handling (storage, labellhig)
       Sales of environmentally friendly/green products

          f*EE&₯?;S?vI3niIiiIZi^S,TiS^1S₯Tr^-3S^SlAZi'^R
       Manifesting for off-site hazardous waste transport
Employee safety/health compensation claims

Staff training for environmental compliance

8igK^«Rssc5ya5at^
Natural resource damage

Corporate image effects
                                                                   84
                                                                   85
                                                                   sl
                                                                   1
                                                                   79
                                                                   _»,

                                                                   77
                                                                   75
   73
r^pp^^y??
   71

   "63"

                                                                           26
        Several findings in Table 6 are noteworthy.  First, percentages are higher than in Table 5.
 This suggests that those who consider a particular cost item are inclined to take the next step and
 quantify such costs. For example., in the case of marketable by-products, only 36% consider the
 cost, but a full 89% of these respondents report quantifying this same item.  Similarly, whereas
 only 55% report considering insurance costs, 84% of those quantify these costs.  This  pattern
 holds generally true across all cost items. The median value in Table 6 is 76.5%, well above the
                                             27

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                                              Environmental Cost Accounting for Capital Budgeting
58% in Table 5. Indeed, for more than two-thirds of all cost items in Table 6, greater than 70%
of respondents who report considering such costs also quantify them. Moreover, for one-third of
these costs, over 80% report quantification.  One not surprising exception is the first item in
Table 6, corporate image: 55% consider this cost while only 26% quantify it, less than half the
percentage of the second least-quantified item (reporting to government agencies). Image value
is among  those less tangibles for which quantification techniques are essentially non-existent.
Notwithstanding this exception, the overall message of Table 6 is clear — more than conventional
wisdom may suggest, many firms are finding ways to quantify costs, even costs usually regarded
as less tangible and difficult to monetize. Further understanding of how this occurs, though
outside the scope of this survey, is a valuable direction for future research.


Superfund Liability:  Major or Minor Player?

       Among all environmental costs on the minds of corporate managers, one deserves special
attention:   Superfund liability  — the  cost of remediating contaminated  sites, which  faces
companies who are identified under the law as "potentially responsible parties." With the strict,
joint, and several liability standard of the Superfund law, firms that contributed wastes to any
listed federal Superfund site may be responsible for a  small  or large fraction of the costs of
remediation as  a result of the negotiation process. How such costs are handled for purposes of
SEC filings and for financial reporting in general has been the subject of voluminous discussion
(CICA 1993; Crough, Cahan, and Leonard 1992; Edwards 1992; Newell, Kreuze, and Newell
1990; Price Waterhouse 1994).

       In this survey, our interest in Superfund liability is of a different nature.  In contrast to
issues of financial accounting and external reporting, we queried respondents as to if and how
Superfund liability affects various aspects of internal management decision-making in the area of
capital budgeting.  These questions are of interest for policy as well as benchmarking purposes.
They are also of direct interest to EPA as the agency considers ongoing and future options for
restructuring Superfund programs to serve the multiple objectives of expediting the remediation
of hazardous sites, equitably sharing the cost of such remediation, and creating the incentives to
avoid future waste disposal practices that threaten human health and the environment.

       The survey  intentionally used  the phrase "hazardous waste ('Superfund')  liability"
instead of "Superfund" alone to help respondents quickly identify the kind of liability in which
we were interested.  However, for some in the business community, "Superfund" has evolved
into a generic term to encompass  a wide range of costs associated with mismanaging waste, e.g.,
administrative  fines, penalties for corrective  actions  at waste sites imposed by states,  and
violations of federal "RCRA" (waste transport and facility) regulations. Thus, while our survey
sought to elicit corporate perspectives and practices specific to Superfund liability, the survey
respondents  may well have  considered other waste-related liability as well in responding to
questions.
                                            28

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A Benchmark Survey of Management Accountants
       It is reasonable to speculate that after more than a decade the threat of Superfund costs
may be spurring environmental investments which eliminate the waste streams that eventually
lead to Superfund clean-up costs for generating firms. Whether the threat is a strong or weak
incentive  (or  no  incentive  at all) undoubtedly  is  firm-rspecific.   Those firms  involved as
potentially responsible parties (PRPs) in multiple sites already may have taken action to avoid
future liability burden. This may occur in the form of:

     1. regular certification and monitoring of waste disposal vendors,
     2. maintaining contractor-owned but dedicated disposal facilities,
     3. gradually moving all waste treatment and disposal to on-site systems,
     4. redesigning processes and materials that generate the hazardous waste stream in the first
        place.

In some instances, incremental waste volumes shipped to a site that already is Superfund-listed
does not necessarily lead to  incremental liability exposure  under the strict, joint, and  several
liability standard of Superfund. Liability exposure will depend as much on which firms are PRPs
and how "deep" their pockets are as it does on the volume and hazard of the wastes disposed by
any individual  firm. Recent  initiatives to change Superfund's strict, joint, and several liability
standard may alter the way liability burdens are spread among PRPs (Sussman 1994).

       Keeping these variables in mind, we asked respondents if they consider "a project's effect
on hazardous  waste  (Superfund) liability in  preparing an  appropriations  request   for
environmental  projects."  Among all  respondents,  only  32%,  or slightly less than one-third,
indicated they do consider Superfund.  A "No" response to this question does not preclude the
possibility that Superfund is acting as a driver to improved corporate environmental management
practices  overall,  e.g.,  improved materials  accounting,  record-keeping,  monitoring,  and
manifesting.  Superfund liability may also affect the degree of scrutiny firms apply in selecting
waste transport and  disposal  vendors, since mismanagement by vendors can result in penalties
for the waste generator.  Nonetheless, the low "Yes" response rate does suggest that Superfund
liability, in comparison to other items in the firms' cost inventory, has yet to enter the capital
budgeting decisions of most firms surveyed.

       Because liability is one of a family of contingent costs which,  as earlier discussed, is
subject to the vagaries of many variables (e.g., future waste volumes and composition, the quality
of on-site  waste treatment, the distance to and site  of disposal facilities, and even the number and
economic resources of PRPs), firms are understandably reluctant to place a dollar value on future
Superfund liabilities. Reinforcing this view is the  belief that quantification itself may subject the
firm to higher penalties in  the event  that it becomes  a  PRP.   Some managers  fear  that
quantification of liabilities is, in effect, an admission of known (and, by implication, preventable)
risks which in future may be held against the firm in the course of litigation.

       How, then, is liability handled among firms  that do  consider it in the project financial
evaluation process?  Figure 12 shows a mix of responses, split between qualitatively only (33%),
specific dollar  value (23%), and a combination of qualitative and quantitative (44%). Focusing
                                            29

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                                              Environmental Cost Accounting for Capital Budgeting
on the second category, and remembering that Figure  12 reflects the practices of only those
respondents who consider liability (1/3 of all respondents), then only about 7% of all survey
respondents regularly quantify liability during project financial evaluation.  Even if we assume
half of the "mixed" responses (.5 x 44%) regularly quantify, the figure rises to 14% of all survey
respondents. Thus, it appears that liability quantification remains a practice of few mid- and
large-size firms in the U.S. manufacturing sector.
                          Figure 12. How Superfund is handled
                                           n = 50
                Qualitatively only
                      33%
                                                           Both qualitative
                                                           and quantitative
                                                                44%
                          Specific $ value
                               23%
       Whether quantified or not, the firms that consider liability in any form report a variety of
approaches and staff responsibilities.  The most  common  situation  (42%) among the three
specific options given in the survey is consideration by financial or legal staff when reviewing
appropriations requests prepared by environmental or other staff. This suggests that if liability is
considered in any form, it appears after financial evaluation is complete and a project is brought
to upper management for final review and approval.  At this juncture, liability  benefits of a
project may be handled in a side bar,  discussed as a less tangible  or contextual  variable in  a
column  of  the  appropriations  request  typically  labeled  "other  considerations"  or  "non-
quantifiable issues."  In fewer instances, liability is left to the individual preparer's judgment
(22%) or, alternatively, this same individual  follows guidelines  from financial or legal staff
(26%). That only a quarter of all respondents report the latter is consistent with earlier findings
that most  firms ~ owing to either legal concerns or skepticism about quantifiability ~ remain
hesitant to systematize their consideration of liability in project financial evaluation. For the few
who do, the most common (74%) approach is a method developed internally.  For the remainder,
the EPA Pollution Prevention Benefits Manual (U.S. EPA 1989) is a distant second.

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A Benchmark Survey of Management Accountants
       Many variables form part of the liability equation, but a few dominate the methods used
by those respondents who consider liability in any form.   Figure 13 shows that waste volume,
waste toxicity, and waste form (solid, liquid, gaseous) are the three most frequent variables,
followed by treatment technology, transport mode, and compliance status of receiving facility.
These  variables  comprise the core considerations  in the engineering  approach to  liability
estimation, in which risk is assumed to be driven principally by the hazard level of the material,
transport  mode,  and receiving  facility (MacLean  1987,  General Electric Corporation  1987,
Aldrich 1994). An alternative approach adopts an actuarial perspective in which risks are based
on the frequency of past incidents and legal verdicts in cases roughly analogous to the conditions
under consideration, i.e., similar chemical composition and volumes, similar waste treatment
methods, and similar type and size of manufacturing firm (White, Savage,  and Dierks 1995).
Both approaches have their  strengths  and limitations.  From the responses in this survey,  it
appears that the engineering approach remains dominant.
           Figure 13. Factors accounted for by Superfund liability assessment method
                             (n=50, multiple answers accepted)
       90%
                                             Method
        From the perspective of all respondents, including those that do not currently consider
 liability in the project evaluation process, what stands in the way of quantifying liability in the
 future?   By a substantial margin, the most frequently  cited hurdle (58%) is  difficulty in
 estimating  if liability  costs will occur.   Following  this is the  difficulty in  estimating the
 magnitude  of costs  (45%) and  when  liability will  occur (29%).  Contrary to  conventional
 wisdom, remarkably few identified "If I quantify, I may be subject to toxic torts" (5%) and "If I
                                             31

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                                              Environmental Cost Accounting for Capital Budgeting
quantify, I have to  disclose to the SEC" (3%).  The conventional wisdom holds that legal
repercussions are a significant barrier to disclosure.  Our findings suggest, however, that this is
not the case: methodological barriers are a far greater impediment to calculating liability.

       The "when" of liability estimation is a particularly critical variable of financial evaluation
owing to the powerful effects of discounting and the time value of money.  A liability cost
incurred in year 5 of a project's life has a dramatically greater impact on project profitability than
a cost incurred in year 10. Of course, all three barriers — estimation of if, at what magnitude, and
when liability costs will materialize ~ lie at the heart of any risk analysis. The perception that
these are the key barriers may be related to the unfamiliarity of the management accounting
community with the techniques of risk analysis as well as the reluctance to deal with expected
values (rather than the  customary solid  and certain costs) in managing the firms'  economic
resources.  This suggests an opportunity and  need to  bring  risk analysis techniques to the
attention of the accounting community to strengthen its capacity to handle key less tangible
costs.

       What does the future hold for incorporating Superfund liability in the capital budgeting
process? A total of 61% of all survey respondents indicated that Superfund liability was either
very important (27%) or somewhat important (34%) in determining priorities for  environmental
projects. This is almost double the number who currently consider liability in developing project
appropriation requests.  The results suggest that the general appreciation of liability avoidance as
an environmental project benefit far exceed  concrete steps to formally bring this cost  into the
project evaluation process, a situation undoubtedly linked  to  the methodological  issues
mentioned earlier. When asked if they have plans in the next two years to consider liability in
the budgeting process, only 23% of those who currently do not consider this cost item plan to
change practices during this time frame. This suggests that relatively few respondents are poised
to dramatically depart from current practices.
                                             32

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A Benchmark Survey of Management Accountants
Coax ALLOCATION
        hen firms incur environmental costs that they do not link to processes and products,
        managers are deprived of a clear picture of where and how costs are generated. Even in
modest-sized manufacturing firms with two or three production lines,  the costs of licensing,
monitoring, waste  storage, emissions controls, environmental staff time,  off-site disposal,
insurance,  future regulatory compliance, and even liability are not driven equally by each
production line.  Some process lines may be more hazardous materials-intensive, generate more
emissions per unit output, require more frequent and intensive inspection and monitoring, and
generate greater quantities of waste requiring off-site disposal. Similarly, particular processes, or
products, may cause a disproportionate share of costs associated with training and reporting to
government agencies, or give rise to risks which may result in higher insurance costs or risks of
future personal or property damages.  In short, when it comes to environmental costs, not all
processes and products are created equal.

       Numerous observers have recognized the complexity, consequences, and necessity of
rationalizing accounting systems to ensure proper allocation to the sources within the firm that
are responsible for such costs (Johnson and  Kaplan 1991, Cooper et al. 1992, Todd 1994, Ness
and Cucuzza  1995).  Understanding  cost  drivers and allocating  costs accordingly is the
conceptual cornerstone of activity-based costing (ABC).  ABC has  evolved rapidly  since
emerging as a new management tool in the  198.0's. It is an approach to cost management that
moves management focus beyond the traditional emphasis of short-term planning, control and
decision-making, and product costing to a more integrated, strategic, competition-sensitive way
of looking at internal costs structures. It is especially germane to environmental costs because of
the diffuse, long-term, and less tangible nature of so many environmental  costs, all attributes that
make allocation particularly challenging from an accounting perspective.

       In its first generation, ABC  helped redefine cost drivers to move  beyond factors such as
simple volume measures to include "transaction" cost  drivers  such as setups, work orders,
product lines,  and others with a non-linear relationship to output levels (Mecimore and Bell
1995). At the same time, first-generation ABC articulated the critical difference between value-
added and nonvalue-added components, thereby directing management attention to eliminating
those steps in the production process that added nothing to product value yet consumed the firm's
resources.

       In rapid succession,  second-generation ABC defined process-related costs - those linked
to but distinct from the narrow confines of production (e.g., distribution, selling, and various
subcomponents of administrative  expenses, such  as  procurement  of  people,  supplies,  and
equipment).  Ignoring these  costs is incompatible  with the  modern  concept of continuous
improvement since such improvement requires an integrated and encompassing perspective of
stages in the product cycle and the cost implications of each stage.
                                           33

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                                              Environmental Cost Accounting for Capital Budgeting
       Most recent, third-generation ABC enlarges the scope of costs to focus on the business
unit (versus only the cost center),  the firm's  activities (versus only products and processes),
internal and external costs (versus only manufacturing, administrative, and selling), and "value
chain costing" (versus only product costing and process-costing).  Through this enlarged vision
of where and how costs are created, it enables managers to think and act strategically, and to
attend to activities upstream and downstream of the immediate production process.

       While improved allocation cannot help but rationalize management decisions, it is neither
without cost itself nor without consequences for product line and facility managers.   The value
of disaggregating cost information  must always be weighted against the benefits of doing so.
Setting up and maintaining the  accounting infrastructure to collect, analyze, and report on a
continuing basis highly disaggregated information requires staff hours to both operate the system
and digest its outputs.  Though modern information technology allows for  such intricate cost
accounting  systems, and even  the co-existence of two systems  (for internal  and external
reporting), start-up costs can be high even if amortized over many years of decision-making.

       In  addition  to  resource requirements, another  organizational barrier to  ABC  is
noteworthy.  Improved allocation may  be good news to some managers struggling to justify
facility expansion when pooled savings or revenue streams (environmental or otherwise) are
removed from overhead and applied to specific processes and products.  However, the converse
also is true. New allocation methods may be  unwelcome news to product or facility managers
whose operations appeared to be profitable under the old overhead allocation methods but who
are suddenly tagged with formerly pooled costs. Temporary protection against penalizing such
managers is essential to building staff investment in the accounting methods while avoiding the
dispiriting effects of winners abruptly becoming losers.

       The allocation challenge is further complicated by the recognition that even processes and
products may not provide an adequate basis for allocating costs.  Instead, it is "activities" of the
firm - introducing a new product line, set-up time, distribution,  marketing  - that are the true
cost drivers (Cooper 1989; Cooper and Kaplan 1991;  Cooper et al. 1992). In  any case, the
challenge is certainly not confined to environmental costs; misallocation of any type of cost
distorts the information which management depends on to conduct a host of essential and routine
business functions.   These  functions include:  pricing products, determining  product mix,
evaluating opportunities for cost control, rewarding plant managers  for efficiency  gains, and
justifying plans for capacity expansion.

        Environmental  costs are just  one  target for correcting typical  allocation  practices.
However,  because they traditionally are  lumped into overhead/administrative accounts,  and
because of their often less tangible and difficult-to-quantify nature, environmental costs  are
particularly susceptible to disconnection from the products, processes, or activities responsible
for their creation.  Yet, learning from recent  studies, misallocating costs that may represent as
much as  20% of the  controllable  operating  costs  of a facility cannot help but have adverse
consequences for management of many business decisions (Ditz, Ranganathan, and Banks 1995).
                                            34

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A Benchmark Survey of Management Accountants
       To obtain a glimpse of current practices, we asked respondents to describe their current
cost allocation across a range of 17 environmental costs (Table 7).  These were selected from the
earlier cost inventory list based on experience in assessing the capital budgeting procedures in a
wide variety of firms (Tellus Institute 1993). For each cost, one of four responses was possible,
ranging  from allocating "always  to  overhead" to "always to product/process,"  with the latter
representing the practice most consistent with the objective of linking costs to sources.
                             Table 7. Initial assignment of costs
                                              Always to    Usually to   Usually to   Always to
                                               overhead    overhead     product/     product/
                                                                        process      process
On-site air/wastewater/hazardous waste testing
and monitoring
                                                  58
             23
                                                                         12
 On-site wastewater pre-
 treatment/treatment/disposal
 On-site hazardous waste handling (e.g. storage,
 labelling)
 lvfeijife$ti%fot:o'ff-site hazardous* waste  .  -^
              "     *        "
                                            '" ""55--^* - '  22 ""

                         18
Off-site hazardous waste transport
Off-site wastewater/haz., waste pre-
trpatment/treatnient  -"
Energy costs
Water costs
Licensing/permitting
                                                  58
             29"~ l^r"   J   9
            >,,"•'" ^^  j,.  '
             28     "" ^O"
            "28,   '"x;'l4
  Environmental penalties/fines

  Staff training fojpenvironmentSl compliance^""'

  Environmental staff labor time

  Legal'starHabortTme  -        *     , >    _-
      ^         /££*  .j  "  r *_, r ^  "     ^^     v«s  /
                                                  60
                                              ^-   *rslr *
                                              •'^.  •'•^^•!*-™
                                              '^67"
 68
-74
                                                             22


                                                             29*


                                                            -5^-

                                                            -27"
                                                             26
  5

"f fi"-1
   j

" 12
                                                                          23
                          8
                                  -
                   -','•" f* ~ -vv" - /y-;': ' V"U°" - «*" ' - '? %' 0?** ,Sf^?'.>
                   rf^^A'^.'^Kf^i^^*^^
                          8           2
                                                                         "o ^ *T '  *' ~'WH3"|
                                                                              ^ * ^    _
        A number of findings in Table 7 are noteworthy.  First, for every cost item, "always to
 overhead" is the most frequent response. Virtually all costs fall in the 55-75% response range,
                                               35

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                                              Environmental Cost Accounting for Capital Budgeting
with the notable exceptions of energy and water costs.  That these should be allocated with
slightly greater frequency to products or processes is not surprising: relative to other cost items,
they are more measurable and  physically traceable to processes that  are  energy and water
consumers.  But at 44% for energy and 51% for water, the difference is small and certainly falls
well short of consistent allocation to processes and products.

       Second, those costs with the highest column 1 percentages -- from licensing/permitting to
insurance costs — are those  most typically associated with central staff functions or plant-,
division-, or corporate-wide  overhead costs.  Legal, environmental, and  training staff,  for
example,  typically  charge their time to  general  accounts  which bear no relationship to  the
processes, products, or activities which require their services.

       Third, the pattern of highest to lowest percentages across rows holds for all costs in Table
7, with the sole exception of energy showing a slightly higher percentage response in column 3
versus column 2. Thus, while there may be as much as 20% difference in column 1 figures, the
pattern of diminishing frequency from overhead to product/process allocation holds steadily for
all entries, regardless of how tangible they happen to  be.  This finding  comports  with earlier
anecdotal evidence gathered in case studies of corporate environmental cost management, which
suggests that environmental costs, at least in the initial stage of accounting, are  pooled into
overhead accounts (Ditz,  Ranganathan, and Banks 1995).

       For some firms,  initial allocation to  overhead is not the last step  in the  accounting
process.  When asked "if some or all costs are initially assigned to an overhead account, do you
later reallocate to a product or process," 58% of the sample answered "Yes."  Thus, for roughly
70-80% of respondents (depending on the specific cost item) who  "always" or  "usually" first
allocate to overhead, well over half then proceed to move such costs to  products or processes
using some type of allocation formula.  Taking 75%  as the average of those who always or
initially allocate, and multiplying that figure times the 58% who subsequently shift costs to
products or processes, we find that about 44% of all respondents follow this two-step procedure.

       Allocation requires some driver,  or basis, for  partitioning costs  across  processes and
products whether it occurs initially (as in the case of 15-20% of respondents) or in a second step
(as it does for 44%). Figure 14 shows the range of such cost drivers when firms were given five
choices and asked to identify  the two most commonly used.  Labor hours  (55%) and production
volume (53%) are by far  the most common, followed by materials use (27%) and square footage
of facility  space (24%).   An assortment  of "other"  drivers  were mentioned, including:
machine/equipment hours, engineering estimates,  the speed  with which products flow through
the  facility, head count,  number of set-ups, and tons made.  One respondent noted that  "each
overhead account has its  own unique driver that is used to allocate costs," and another answered
that the driver "depends upon the origin of the cost and the relationship to a product line activity,
and could be any or a combination of the above."
                                           36

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A Benchmark Survey of Management Accountants
              60%
                           Figure 14. Basis for allocating costs to
                              product/processes from overhead
                                (n=88, two answers accepted)
              o%
                                           Basis
       Finally, Figure 15 provides some insight into the sources of cost information used to
make allocation  choices.   With  each respondent  allowed to name  up to  three  sources,
financial/accounting  systems  data is the  most  frequent  source (mentioned by 51%  of
respondents), followed by purchasing, production/operation logs,  engineering  estimates,  and
materials tracking, all with scores of at least 20%. This diversity of sources reaffirms what is
increasingly evident in environmental accounting  case studies:  essential environmental cost
information is spread through multiple staff functions, and  modifying accounting systems to
better  track  and  allocate such  costs  necessitates  a  cross-functional  approach  to  ensure
completeness and compatibility of information.  It is fair to say that as firms move toward greater
coverage in their environmental cost inventory and better assignment of costs to processes and
products, more and more staff functions are inevitably drawn into the environmental accounting
process.
                                           37

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                                   Environmental Cost Accounting for Capital Budgeting
               Figure 15.  Sources of Cost Information
            When Assigning Costs to Products/Processes
                   (n=88, three answers accepted)
    60%
P*
     0%
                              Information sources
                                  38

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A Benchmark Survey of Management Accountants
                  INDICATORS:; THE BOTTOM LINE
H mproving cost inventory and cost allocation methods are major steps toward improving the
•I evaluation of environmental projects in the capital budgeting process.  However, there
remain two other variables that play a decisive role in determining whether projects survive the
intense competition for scarce capital resources: the choice of project financial indicators and the
related issue of time horizons.

       In addition to their less tangible and contingent nature, many environmental costs and
savings materialize only in the mid- and long-term.  In contrast to costs of activities such as on-
site air and hazardous waste testing, monitoring,  handling, and manifesting,  other costs (or
savings/revenues)  linked to corporate image, liability, and green product sales are by nature those
with  longer-term  time horizons.   In the case of future compliance costs,  its  very definition
implies a cost that will materialize only some years into the future.  Thus, if any of these costs
form part  of  the  cost/benefit calculation of a proposed environmental  project,  an analytical
method that is insensitive to mid- and long-term cost and revenue streams will be incapable of
capturing the  long-term profitability of a proposed project.  Pollution prevention projects are
especially  vulnerable  to this shortcoming  because many  rely  on product redesign,  process
modification, and materials substitutions that may be capital intensive but yield attractive returns
beginning 3-5 years after the initial capital outlay.

       To take stock of current practices, we asked respondents a series of questions regarding
their  current selection and application of profitability indicators  for evaluating environmental
projects. Seventy-four percent of respondents indicated they perform "a less detailed/informal
screening" of environmental projects prior to a detailed financial analysis. This common practice
allows firms a quick glimpse of a project's economics before committing the resources required
for a full financial  evaluation. If a project appears profitable at this juncture, many firms do not
conduct a more in-depth evaluation.  If a project does not appear profitable after the first quick
screening, then expanding the cost inventory and more rigorously allocating costs to depict the
true costs  of  a current practice  may make the difference in illustrating the  benefits of an
alternative practice. This tier-type approach ~ beginning with conventional, tangible costs and
then moving, as necessary, to less tangibles,  was first advocated in EPA's Pollution Prevention
Benefits  Manual (U.S. EPA  1989).  Of course, an  enlarged cost inventory may reveal hidden
costs as well as savings, thereby making a project less, rather than more, profitable.

       For  those  firms performing  any initial  screenings,  Figure  16 shows that Return on
Investment (ROI,  36%) and Payback (34%) are  the most commonly used financial indicators.
These are followed by Internal Rate of Return (IRR) and Net Present Value (NPV), both at 23%.
Interestingly, 16% of respondents report use of qualitative methods only. ROI,  IRR, and NPV
fall into the category of discounted cash flow methods, which take into account the time value of
money.  They usually, though not necessarily, cover a time horizon longer than the  1-2 year
period typical of Payback  analysis, which does not incorporate discounting methods.  Many
firms may look at  ROI, IRR, or NPV over a relatively short horizon, say five years or less. In
                                           39

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                                             Environmental Cost Accounting for Capital Budgeting
these cases, excluding the long term costs and benefits of a P2 project (e.g., omission of the
expected value for the avoided liability in Year 8, or anticipated compliance costs in Year 6) may
bias the profitability analysis to the disadvantage of the proposed P2 project.  In any case, over
half of those firms who do screen use some form of discounted cash flow method.
             Figure 16. Financial indicators used for screening projects
                         (n=102, multiple answers accepted)
                                              Indicator
                                            40

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A Benchmark Survey of Management Accountants
       Turning to the full project justification, a somewhat different pattern emerges (Figure 17).
Once again ROI is the leading quantitative indicator, followed by IRR at 18%.  However, for
27%  of respondents,  the  single most frequent  response reported in Figure  17 is that their
"evaluation is qualitative  only."  This strikingly high  figure is nearly  twice as  high as the
comparable figure for the project screening phase.
               Figure 17. Financial indicators used for full project justification
                                    Profitability index
                              NPV        2%
                               10%
                                                    None, qual. only
                                                         28%
                            Payback
                              12%
       How might one explain this finding? While we cannot be certain from the survey data, a
clue may reside in a follow-up  question  as  well as in side comments  from a  handful of
respondents  who noted (unsolicited) that environmental projects  are  "legally  required,"
"mandated" and "required."   When  asked if the preferred  financial indicator is  used for
"regulatory  compliance projects as well  as non-compliance, or discretionary,  projects,"  44%
responded "No."  This  suggests that some, perhaps most, who report qualitative evaluation
during full project evaluation are those who lump all environmental projects into the "must-do"
category.  This, more often than not, unfortunately  leads to the concurrent and often erroneous
conclusion that systematic financial analysis of environmental projects is not necessary and may
be a waste of the firm's resources.

       The  choice of hurdle rates — the threshold  economic return to gain project  approval —
offers still another perspective on how environmental projects are handled vis a vis other projects
which enter the capital budgeting  process.  Among all respondents, 56% indicate no "standard
hurdle rate, or. threshold" is required before approving an environmental project. This suggests
that a slight majority of firms exercise  discretion in reviewing the  profitability of projects,
perhaps taking into  account the less tangible benefits that, in their view, are not amenable to
quantification.
                                            41

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                                            Environmental Cost Accounting for Capital Budgeting
       Among those respondents who use Payback at any stage of project justification, 1-2 years
is by far the most common (50%) hurdle rate required for project approval (Figure 18). Only 8%
report  payback periods of greater  than  4  years.  Limiting the  analysis to  this time frame
introduces a substantial probability  of omitting outyear benefits common to many P2 projects.
For IRR users (Figure 19), hurdle rates are defined in percentage terms.  Here the most frequent
range is 10-19% (48% of respondents), followed by 20-30% (25%) and greater than 30% (18%).
                 Figure 18. Payback period used, payback users only
                                        (n=72)
          1
               60%
               50% •
               40% •
               30% -
           f>   20% +
               10% --
                                                               Greater
                                                               than 4
                                                               years
                                       Payback period
                                           42

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A Benchmark Survey of Management Accountants
                   Figure 19.  IRR required for approval, IRR users only
                 g
                 o
                 o.
                &
                    60% T
                    50% --
                    40% --
                    30% --
                    20% -
                    10% -
                     0% •
                                         48%
                             10%
                                                      25%
                                                                  18%
                             Less
                             than
                             10%
10-
19%
Greater
 than
 30%
                                            IRR required
       Time horizon also may play a decisive role in the environmental project approval process.
For those who use NPV, or normalized NPV, 47% use a 6-10 year time horizon and another 6%
use 10 years  or greater (Figure 20). For IRR users, the comparable figures are 49% and 3%
(Figure 21).  Thus, consistent with the underlying differences between Payback versus NPV and
IRR, those who use discounted cash flow methods are markedly more inclined to take a long-
term view of the economics of their environmental investments.
                                          43

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                            Environmental Cost Accounting for Capital Budgeting
   Figure 20. Time horizon for NPV, NPV users only

                        (n=51)
             47%
                           47%
                         Time horizon
       Figure 21. ERR time horizon used, IRR users only

                           (n=65)
             48%
                            49%
&
a
a,


I

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A Benchmark Survey of Management Accountants
       Finally, we queried respondents as to whether hurdle rates for environmental projects
differ from those  applied to non-environmental projects  (Figure 22).  Again, the earlier bias
toward special treatment of environmental projects becomes evident.  While a majority (57%)
report equal hurdle rates, a notable 36% report that hurdle  rates  are  lower for environmental
investments.  These respondents undoubtedly include a range of perspectives, from those who
use no threshold whatsoever (the "must-do" viewpoint) to those who exercise discretion owing to
the knowing  exclusion of, but  appreciation for, the  less tangible costs  associated  with
environmental projects.
                                      Figure 22. Approval thresholds for environmental
                                       projects compared to non-environmental projects
                                                        Higher for
                                                      environmental
                                                        projects
                                                          7%
                                             Lower for
                                           environmental
                                             projects
                                              36%
  Same for
environmental
  projects
   57%
       How   persistent   this
practice has been over time must
remain conjecture since we do
not  enjoy  the benefit of an
earlier survey  against which to
benchmark  our findings.   The
reported different hurdle  rates
stand in contrast to the finding,
discussed earlier, that  the  vast
majority of firms (86%) do not
maintain separate budget pools
earmarked  for  environmental
projects. Some recent evidence
suggests   that  environmental
issues increasingly  will blend
into the  more  general practices
and  trends  that continue  to
redefine  corporate organizational  and competitive strategy (e.g., re-engineering, total quality
management,   product  stewardship).    The  meshing  of overall  corporate  strategy  with
environmental performance certainly bodes well for P2 projects. Projects that focus on upstream
processes and  materials (as P2 normally does) often simultaneously increase  efficiency and
enhance  systems performance,  while reducing pollution.  These joint results render moot the
traditional distinctions between environmental and non-environmental projects.

       Equal treatment is rational  management provided that cost inventory and cost allocation
methods are systematic, rigorous, and applied equally across all types of projects, and financial
analysis  provides  a clear picture of true profitability.  The evidence collected in this survey
suggests that many firms still are inclined to quickly dismiss environmental projects as "must-
do" mandates,  subjecting them to perfunctory or no systematic profitability assessment.  In so
doing, opportunities often  are  lost  for discerning between alternative methods for achieving
environmental  compliance.   While barriers to  P2  persist,  regulations  increasingly  allow
flexibility hi meeting standards.  Simple distinctions between compliance and non-compliance
projects  increasingly are obsolete; multiple options for  achieving  compliance  include  P2
approaches, which, if thoughtfully conceived, promise to make positive contributions to broader
                                            45

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                                              Environmental Cost Accounting for Capital Budgeting
corporate strategic objectives.  It is these dual and commingled benefits that may elude those
firms who are too quick to pigeonhole all environmental projects as capital drains with negative
rates of return.

       Whether a single budget pool and uniform hurdle rates for all projects are becoming the
norm in  U.S.  manufacturing firms  (not just relatively larger ones which dominate our sample)
can only be answered in future studies.
                                             46

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A Benchmark Survey of Management Accountants
      mong the many internal business functions served  by environmental cost information,
      capital budgeting  for  environmental projects  is  one  of the principal  beneficiaries.
Accounting systems to identify, compile, analyze, and report environmental cost information in a
timely and rigorous  fashion is a prerequisite to understanding the  sources and  magnitude of
environmental costs  in the firm.  Only if these are understood can  managers maintain a clear
picture of the true costs of current production processes and products.  This, hi turn, allows
managers to direct attention to minimizhig compliance costs, reducing operating costs, and fully
meshing the environmental and financial performance goals of the organization.

       With few exceptions, this survey of management accountants of U.S. manufacturers
confirms anecdotal evidence based on earlier case studies of capital budgeting for environmental
investments hi large  and medium-size firms. Some key findings consistent with earlier studies
include:

   •   The budgeting function normally is a tiered process, with participation of plant, division,
       and corporate levels the single most common arrangement.

   •   Discretionary spending of $100,000 or less on capital projects is allowed in virtually all
       firms.

   •   Environmental cost information is gathered by many staff functions located throughout
       the  firm; production/operations, environmental, and finance/purchasing  are the  most
       frequent contributors.

   •   Tangible, quantifiable environmental  costs are normally considered by well over half of
       all firms; less tangible, more difficult to  quantify environmental costs are less often
       normally considered in the capital budgeting process.

   •   Costs that  are considered at all  are  generally quantified; the  more  tangible  and
       quantifiable they are, the more often they are monetized in project evaluation.

   •   Only a third of respondents consider the effect of a proposed environmental project on the
       firm's Superfund liability exposure, and only 7-14% regularly quantify such costs.

   •   Initial allocation to overhead accounts is the most common  practice for a majority of
       firms for virtually all types of environmental costs;  routine initial allocation to products
       or processes is reported by under 10%  of respondents for virtually all environmental
       costs.

       However, some unexpected findings also emerged from the survey:
                                           47

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                                             Environmental Cost Accounting for Capital Budgeting
   •   Over eight out often respondents ~ 86% - report a single funding pool for all projects,
       environmental or otherwise.

   •   A majority of firms (71%) track environmental costs in some form at the corporate level.

   •   Among the  few firms that quantify  liability, three quarters  use  methods  developed
       internally as opposed to those available through EPA or other public sources.

       Concerning the key issues of environmental cost inventory and cost allocation methods,
the survey suggests that much work remains before business practices can provide managers with
a comprehensive and transparent look at "true" costs of processes and products.  While most
firms quantify the more obvious and measurable environmental costs, substantially fewer have
grappled with those that are less  tangible, uncertain, and difficult  to quantify.  Estimates of
environmental costs in the range of 3-20% of facility operational or product line costs as reported
in other studies may, after a closer look, be substantially understated when the less tangible costs
are added.

       Dealing systematically with these types of costs is not new to corporations. In the normal
course of business, managers regularly look into the future to forecast everything from the price
of oil to consumer demand for a new line of computers.  Applying these approaches, including
those drawn from risk analysis, to estimate  less tangible costs would represent a major  step
toward characterizing current and future environmental costs.

       Cost  allocation, too,  remains  a major challenge.  Most firms continue to place most
environmental costs initially into overhead accounts.  Though some subsequently allocate these
costs to products or processes, the basis upon which these allocations are made are often ill-
conceived. When proper allocation does not occur, managers receive distorted signals regarding
the true costs and  benefits of retaining or changing processes and products. Moreover, like
incomplete cost inventories, misallocation of environmental costs stands in the way of effective
performance monitoring, product pricing,  incentive  and reward systems, and  other activities
essential to maintaining a competitive enterprise.

       Upgrading the capital budgeting system  through improved environmental  accounting
systems is best viewed in the  broader context of  strategic planning.  With multiple forces
working to fuse environmental and financial objectives of the firm, it is critical to exercise an
even hand in evaluating the returns to all capital investments, environmental or otherwise. When
cost  inventory and cost  allocation  practices fail  to  provide  a level playing field  for  all
investments, managers are left without the information they need to make optimal use of limited
resources. In particular, those environmental projects with strong pollution prevention content,
as well as those with side benefits unrelated to environmental improvement per se ~ e.g. process
optimization and yield, market penetration, corporate image ~ are particularly vulnerable to the
adverse effects of incomplete cost information.
                                            48

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A Benchmark Survey of Management Accountants
       While many social benefits may result from improved internal environmental accounting,
the case for such improvements may be made purely on the basis of the firm's self-interest.  This
is the central message that public policymakers, professional associations, trade associations and
stakeholders should deliver to firms seeking to understand and apply environmental accounting
techniques to their capital budgeting processes.
                                           49

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                                  REFERENCES
Aldrich, James R.  1994.  "Expected Value Estimates of the Long-Term Liability from
Landfilling Hazardous Waste," Journal of Air & Waste Management. Vol. 44.  June.

Andraca, Roberto de, and McCready, Ken F..  1994. Internalizing Environmental Costs to
Promote Eco-Efflciency. Business Council for Sustainable Development, Geneva.

Bristol-Myers Squibb Company.  1994. "Business Environmental Cost Accounting Practices
Survey: Summary of Responses," Global Environmental Management Initiative Conference,
Environmental Cost Accounting Concurrent Session. Arlington, VA. March 16.

Boone, Corinne. 1995. "Full Cost Accounting at Ontario Hydro." Presentation to Corporate
Environmental Accounting Conference, Houston, TX.  May.

CICA 1993. The Canadian Institute of Chartered Accountants. Environmental Costs and
Liabilities: Accounting and Financial Reporting Issues. Toronto, Ontario.

Cascio, Joe.  1994.  "International Environmental Management Standards, ISO 9000's Tractable
Siblings," ATSM Standardization News. April.

CERES. 1995. Coalition for Environmental Responsible  Economies. Annual Environmental
Report. Boston. Forthcoming.

Cohen, Mark A. 1995. "Environmental and Financial  Performance: Are They Related?"
Investor Responsibility Research Center, Inc. April.

Cooper, Robin. 1989.  "The Rise of Activity-Based Costing - Part Three: How many Cost
Drivers Do You Need, and How Do You Select Them?" Journal of Cost Management. 2(4).
Winter,  pp 34-46.

Cooper, Robin and R.S. Kaplan.  1991. "Project Priorities from Activity-Based Costing,"
Harvard Business Review. May-June, pp. 130-135.

Cooper, Robin, Robert S. Kaplan, Lawrence Maisel, Eileen Morrissey, and Ronald M. Oehm.
1992. Implementing Activity-Based Cost Management: Moving from Analysis to Action.
Mpntvale, N.J.: Institute of Management Accountants.

Crough, Maureen M., J.N. Cahan and L.L. Leonard. 1992. "Environmental Regulatory
Requirements and Liabilities," Understanding Environmental Accounting and Disclosure Today.
Executive  Enterprises Publications, Inc., New York, NY.
                                         R-l

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Ditz, Daryl, Janet Ranganathan and R. Darryl Banks, eds. 1995. Green Ledgers: Case Studies of
Corporate Environmental Accounting.  World Resources Institute.  May.

Edwards, Paul N.  1992.  "A Comparison of FASB and SEC Accounting and Disclosure
Requirements for Environmental Contingencies," Understanding Environmental Accounting and
Disclosure Today. Executive Enterprises, Inc. New York.

Elkington, J., and V. Jennings, "The Rise of the Environmental Audit, " Integrated
Environmental Management. No. 1, August 1991 (pp. 8-10).

Epstein, Marc J. 1995. Measuring Corporate Environmental Performance: Best Practices for
Costing and Managing Effective Environmental Strategy. Institute for Management Accountants
and Irwin Professional Publishing, Burr Ridge, IL.

Fagg, Brandon F., J.K. Smith, K.A. Weitz and J.L. Warren. 1993.  Life-Cycle Cost Assessment
(LCCA). Preliminary Scoping Report prepared for: U.S. Department of Energy.  October.

Freedman, Martin. 1993. "Accounting and the Reporting of Pollution Information," Advances in
Public Interest Accounting, Volume 5, pages 31-43.

Freeman, Harry, T. Harten, J. Springer, P. Randall, M.A. Curran, and K. Stone. 1992. "Industrial
Pollution Prevention:  A Critical Review, J. Air Waste Management Assoc.

General Electric Corporation.  1987. Financial Analysis of Waste Management Alternatives.
General Electric Corp.

Global Environmental Management Initiative (GEMI).  1994.  Finding Cost-Effective Pollution
Prevention Initiatives: Incorporating Environmental Costs into Business Decision Making.

 Gray, R.H. 1993. Accounting for the Environment. Markus Weiner Publishing, Inc. New York.

 Johnson, H. Thomas and R.S. Kaplan. 1991. Relevance Lost: The Rise and Fall of
Management Accounting.  Boston: - Harvard Business Press.

 Klammer, Thomas. 1994. Managing Strategic and Capital Investment Decisions: Going
 Beyond the Numbers to Improve Decision Making. Institute of Management Accountants and
 Irwin Professional Publishing, Burr Ridge, IL.

 MacLean, Richard W. 1987.  "Estimating Future Liability Costs for Waste Management
 Options," Hazardous and Solid Waste Minimization: Corporate Systems & Strategies
 Conference, Washington, DC.  November 19-20.

 Mecimore, Charles D. and A.T. Bell.  1995.  "Are We Ready for Fourth-Generation ABC?"
 Management Accounting. January.
                                          R-2

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Ness, Joseph A. And T.G. Cucuzza. 1995.  "Tapping the Full Potential of ABC," Harvard
Business Review. July-August, pp. 130-138.

Newell, Gale E., J.G. Kreuze and S.J. Newell. 1990. "Accounting for Hazardous Waste: Does
Your Firm Face Potential Environmental Liabilities?" Management Accounting. May, pp. 57-
61.

Popoff, Frank and D. Buzzelli. 1993.  "Full Cost Accounting," Chemical and Engineering News.
Vol. 71, No. 2, pp. 8-10.

Price Waterhouse. 1992. Accounting for Environmental Compliance: Crossroad ofGAAP,
Engineering, and Government. Survey #2.

Price Waterhouse. 1994.  Progress on the Environmental Challenge:  A Survey of Corporate
America's Environmental Accounting and Management. New York.

Repetto, Robert.  1989.  Wasting Assets: National Resources in the National Income Accounts.
World Resources Institute, Washington, DC.

Rubenstein, Daniel B. 1994. Environmental Accounting for the Sustainable Corporation:
Strategies and Techniques.  Westport, Connecticut:  Greenwood Press.

Savage, Deborah E. and Allen L. White. 1994-95. "New Applications of Total Cost
Assessment," Pollution Prevention Review. Winter.

Surma, John P. and A.A. Vondra. 1992. "Accounting for Environmental Costs: A Hazardous
Subject," Journal of Accountancy.  March.

Sussman, Robert.  1994.  "Quickly Fixing Superfund Matters Most."  Environmental Forum.
11(4), p. 46. July-August.

Tellus Institute. 1993. P2/FINANCE User's Manual. Boston.

Todd, R. 1994. "Zero-Loss Environmental Accounting Systems," in B.R. Allenby and D.J.
Richards (eds), The Greening of Industrial Ecosystems. National Academy Press, Washington,
D.C. pp. 191-200.

U.S. EPA 1989.  Pollution Prevention Benefits Manual. U.S. EPA, Prepared for Office of Solid
Waste and Office of Policy, Planning, and Evaluation. July.

U.S. EPA 1995. "An Introduction to Environmental Accounting as a Business Management
Tool: Key Concepts and Terms," Office of Pollution Prevention and Toxics, June.  EPA 742-R-
95-001.
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       INSTITUTE
       for Resource and Environmental Strategies
                                                                OMB No.: 2070 - 0138
                                                                     Expires: 12/31/95
                         €$$t Accounting far Capital JE&    ^
        A National Survey of Management Accountants
Tellus  Institute, a  non-profit  research  organization, in  association  with the Institute  of
Management Accountants' (IMA) Foundation for Applied Research and the U.S. Environmental
Protection Agency (EPA), is conducting a national survey of environmental cost accounting
practices in relation to capital budgeting. The purpose of the survey is to identify typical and
best practices in manufacturing firms to create a baseline for tracking change, and to inform IMA
and EPA in training and technical assistance programs.

Your name was chosen at random from the IMA membership list of "budgeting/planning" and
"cost accounting" job functions  in U.S. manufacturing firms.  You may recall our recent letter
regarding this project.

Please  take the  time to complete the questionnaire now and return it in the enclosed envelope.
All responses are strictly confidential and will be used for statistical purposes only.  Thank you
in advance for your participation. The results of the survey will be available in mid-1995.
                       ^aire Is-estiinsled t*> require & typical ^r«sjpo»cie»t" 1/2 &QUT to-
   
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 For each of the following questions, please mark the appropriate box(es).
|1.  BACKGROUND INFORMATION
Code
        1)  Please indicate your company's major product line. (Check one only)

         i  QSIC20, 21:  Food, Tobacco
         2  riSIC 22, 23:  Textiles, Apparel
         3  QSIC 24, 25, 26: Lumber, Furniture, Paper
         4  CjSIC 27: Printing
         s  rjSIC 28, 29:  Chemicals, Petroleum/Coal
         e  |   | SIC 30: Rubber/Plastics
         7  Li SIC 31: Leather
         s  LlJSIC 32: Stone/Clay/Glass
         9  [IjSIC 33, 34:  Metals
        10  rnsiC 35, 36, 37, 38, 39: Industrial/Electric/Transportation Equipment, Instruments,
              Misc. Manufacturing

        2)  Your position within the firm is at what level?

         i  |   '[Corporate
         2  |   i Divisional
         3  |   | Plant
       3)  Is your firm a registrant with the Securities and Exchange Commission (SEC)?

                     Yes                         o ;I   No
       4)  Number of employees worldwide:

         1  Q < 200
       ,  2  Q200-999
         3  |   11000-5000
         4  |   | > 5000

       5)  Most recent annual sales:
        i
        2  |   j $10- 100 million
        3  J3j$101 - $500 million
        4  j   j > $500 million
                                                Page 1

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        6)  Average annual corporate-wide capital budget during the last three years:
            |  | < $0.5 million
            Q$0.5-$1 million
            I  | $1-10 million
               > $10 million
|2.   CAPITAL BUDGETING PROCESS	|

 Please tell us about TYPICAL capita! budgeting practices for your company as a whole. In thinking about
 budgeting for "environmental projects", please include both compliance (necessary to meet regulations)
 and non-compliance (discretionary) projects.

        7)  At what level does capital budgeting occur in your firm? (Check all applicable)
•i
bi
              [Corporate
            f  I Division
            i  i Plant
            Q Other (specify)
        8)  Is your firm on a regular (e.g. annual, semi-annual) or ad hoc, irregular budgeting cycle?

         i   QjRegular (e.g. annual, semi-annual)
         2   j  | Ad hoc / Irregular

        9)  In many firms, individual  plants have the authority to make discretionary capital
           expenditures up to a specified dollar limit. What, if any, is the usual limit on
           discretionary capital spending for plants in your firm?

         i   j  | No limit - all expenditures require divisional or corporate approval
         j   [3Up to $5,000
         3   n up to $10,000
         4   |  | Up to $50,000
         %   Q Up to $100,000
         «   d Other	

        10) Does your firm use any of. the following terms to categorize capital projects?
           (Check all applicable)
        bl
        el
        dl
        •1
        II

        s'
        hi
        11

        jl
        u
        II
        ml
        nl
    I  j General/Administrative
    I  [Abandonment
    I  | Prof it adding
    rn Cost saving
    Q Expansion of existing operations
    Q Expansion into new operations
    Q Profit sustaining
    f  [Maintenance
    j  | Replacement
    I  | Environmental
    [  | Compliance
    Q]Waste reduction
    Q Pollution prevention
    QWaste treatment
                                                        Page 2

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 11) Who normally makes the INITIAL decision to place an environmental project in a
    particular category?  (Check one only)

  1   j~~| Corporate finance/accounting
  2   j   | Divisional finance/accounting
  3   |   [ Plant finance/accounting
  4   |   | Corporate environmental
  5   rn Divisional environmental
  e   I   i Plant environmental
  7   Fj We do not use categories
  s   PI Other
12) Is there normally a single budget pool for all capital projects, or do environmental projects
    (compliance and non-compliance) have a separate pool?  (Check one only)

  i   r"1 One budget pool for all capital projects
  2   I   j Separate budget pool for all environmental projects
  3   rj Separate budget pool for compliance projects

13) Which of the following best describes the typical annual  spending on environmental
    projects within your firm?  (Check one only)

  i   j   | No set cap
  2   |   | Cap on total amount
  3   LjCap on % of  total annual corporate capital budget
  4   |   | Varies from year to year

14) For each job function below, please indicate if individuals are ROUTINELY involved
    in developing cost estimates for environmental projects.  (Check all applicable)

 »i  | 1 Environmental
 hi  |~~] Finance/Accounting
 ci  [~~| Production/Operations
 di  |   | Purchasing
 «i  |   j Legal
 fi  FJ Vendors
 si  rn Consultants
 HI  rn Other (please specify)
                                            Page 3

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       15} Have any of the following changes occurred in your capital budgeting process in the last
           three years?  (Check all applicable)

        .1  Q]Raised the cap on discretionary capital expenditures at the facility level
        M  [^Lowered the cap on discretionary capital expenditures at the facility level
        ci  Q]New project categories have been created
        d,  [^Stopped classifying environmental projects separately from other capital projects
        „  Q^Began classifying environmental projects separately from other capital projects
        „  Q]stopped distinguishing environmental compliance from environmental non-compliance projects
        8i  [^Began distinguishing environmental compliance from  environmental non-compliance projects
        M  ["""[No changes in the last three years.

       16) Does your company track environmental costs company-wide?
            j   I No
Yes
        17)
  At what level are environmental costs tracked?  (Check all applicable)
  .1  |   |   Plant      M   Q Divisional       d '	(Corporate
|3.   COST  INVENTORY
   J
 Environmental projects have many direct and indirect effects on a facility's operations. The next set of
 questions looks at different dollar costs, savings, and revenue effects that may appear in a project financial
 analysis.  Again, we are interested in learning about TYPICAL practices for the firm AS A WHOLE, rather
 than practices specific to an individual plant.

 Please indicate rf the following costs, savings, or revenue effects are NORMALLY considered for inclusion
 In the financial analysis of a proposed environmental project.  If an 'item is normally considered, please tell us
 if you calculate a SPECIFIC DOLLAR VALUE for costs or savings to include in the project
 financial analysis.  {Check all applicable)
                                                       Normally considered?
                                                  Calculate specific $ value?
    18)     On-site air/wastewater/hazardous waste
            testing/monitoring

    19)     On-site air emission controls
    20)     On-site wastewater pre-treatment/
            treatment/disposal

    21)     On-site hazardous waste pre-treatment/
            treatment/disposal
                       No  i|   | Yes
                       No   i|   |  Yes
                                                bo [H No     i I   I  Yes
                  j   |  No   1 1   |  Yes
No
                                                                                     bO
                                                bO
                                  Yes
                                                                                           No     i|I  Yes
                                                      No     1!I  Yes
                                                      No     i|   I  Yes
                                                       Page 4

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22)     On-site hazardous waste handling
        (e.g. storage, labelling)

23)     Manifesting for off-site hazardous
        waste transport

24)     Off-site hazardous waste transport
25)     Off-site wastewater/haz. waste
        pre-treatment/treatment

26)     Energy Costs
27)     Water Costs
28)     Licensing/permitting
29)     Reporting to government agencies
30)     Environmental penalties/fines
31)     Staff training for environmental
        compliance
  Normally considered?

ao|   I  No  i.|  |  Yes
ao 1	j  No  11	j  Yes
,o|   i  No  if  j  Yes
  i   !  No  i:   |  Yes
ao:   '•  No  1 •   .  Yes
     i  No  11   |  Yes
       No  1 i   ;  Yes
                                                 ao
     •  No  1 j _ i  Yes
ao i   i  No  1'   i  Yes
 i!	|  No  11	|  Yes
                                                                                   Calculate specific $ value?
                               bo|   | No     i j   1  Yes
                                     No     i|   |  Yes
                                                                                bO'No
                                                 i  Yes
                               bo r_: No     11   i  Yes
                                                                                bo .	! No     11	j  Yes
                                                                                    j No     i||  Yes
                                                                                 • j	| No     11   j  Yes
                                                                                 11   I No     11   I  Yes
                                                                                bo,	j No     1 j	j  Yes
                                 >|	: No     i|   |  Yes
32)     Environmental staff labor time
33)     Legal staff labor time
34)     Insurance costs
35)     Production efficiency / yield
       No  i|   |  Yes
       No  i|   |  Yes
       NO
Yes
       No  i|~~1  Yes

              1	:	^
                                                                                      No     i|j  Yes
                                                                                bo i	I No     11   |  Yes
                                                                                      No     i|   |  Yes
                                                                                bo Q No     i|   |  Yes
                                                  Page 5

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                                                     Normally considered?
                                                                                  Calculate specific $ value?
   36)     Frequency of plant shutdown
37)     Marketable by-products
   38)



   39)


   40)


   41)
        Sales of environmentally friendly/
        green products


        Corporate image effects
                                                       No  i[|  Yes
                                                          No   i|   |  Yes
ao |   |  No  i i~~i Yes
 ,i   I  No  ii  ;  Yes
        Air pollutant emission credits (SOx, NOx)    ao I	;  No  i j	;  Yes
        Employee safety/health compensation
        claims
ao I   j  No   11   I Yes
                                                                                         No     i|  I   Yes
                                                                                    >rn No     i|  i   Yes
                                 > j	1  No     1 j   j  Yes
                                                                                 >[U No     i|   |  Yes
                                                                                 bO!
                                    j No     i||  Yes
                                                                                   bo i	| No     i ••   !  Yes
   42)     Future regulatory compliance costs
   43)     Natural resource damage
   44)     Personal injury claims
   45)     Property damage
                                                  11	|  No  i.	I Yes
                                                        No  11	1 Yes
                                                 aO|
  LJ  No   i|   i  Yes
                                                    aO
  L]  No   i|     Yes
                                                                                   bo:
                                                                                        ; NO
                                                                                        i  No
                                                                                 boj	; No


                                                                                 bo|   i No
                                                                                                    Yes
                                                                                                     Yes
                                                                                                  |   j  Yes
                                                                                                       Yes
The next few questions concern if, and how, hazardous or toxic waste ("Superfund") liability enters
your environmental project financial analysis and justification process.

       46) Do you consider a project's effect on hazardous waste ("Superfund") liability
           in preparing an appropriations request for environmental projects?
          1 j   '.Yes
            i
       47)  *->•  Is such an effect assigned a specific $ value,
                  or handled only on a  qualitative basis?

          1 j   i Specific $ value
          z |   | Qualitative only
          3 [H Both
                                                             oj~l      No
                                                                          Skip to question #51 .
                                                      Page 6

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48) Which best describes your approach to considering liability?  (Check one only)
     H]Left to individual's judgement in preparing appropriations request
    T^] Individual who prepares appropriations request follows specific guidelines from
        financial or legal staff
     I   | Financial or legal staff consider liability when reviewing appropriations request
        prepared by environmental or other staff.
     Q Other (please specify)          	
49) Which liability assessment method do you use?  (Check all applicable)

 ai   '   |A method developed internally
 ti   j   j EPA Pollution Prevention Benefits Manual method
 ci   Qj General Electric (GE) method
 di   LJ Other (please specify)         	
50) Indicate which factors your liability assessment method accounts for. (Check all applicable)
         /aste volume
 bi   Q Waste toxicity
 ci   QUWaste form (i.e. solid, liquid, etc.)
 di   Q Transport mode to waste management facility
 ei   [^Transport distance to waste management facility
 ii   Q Treatment technology
 9i   j   | Compliance status of receiving facility
 hi   i   | Performance history of receiving  facility
 n   |   | Liability history of your firm
 n   !   I Liability history of managing similar wastes
 ki   ~] Timing of potential liability

51) What do you consider to be the TWO most important barriers to quantifying Superfund liability?
     (Check two only)
 ai
 bl

 ci
 di
 e1

 f1
!~~| Difficulty in estimating IF liability costs will occur
r^j Difficulty in estimating WHEN liability costs will occur
Q Difficulty in estimating magnitude of costs
|   I If I quantify, I have to disclose to the SEC
|   | If I quantify, I may be subject to toxic tort lawsuits
Qj other (please specify)          	•
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       52) How important is the consideration of Superfund liability to your firm in determining priorities
           for environmental projects?

         i  1   | Very important
               Somewhat important
       •  s  j   | Not important

       53) If liability currently is NOT considered by your firm in capital budgeting for
           environmental projects, do you expect to do so within the next two years?
               Yes
         2  n NO
         3  :   | Not applicable; we already consider liability
|4.   COST ALLOCATION         |

 The next few questions relate to typical cost allocation practices in your firm.  Please indicate whether
 INITIAL assignment of each of the following cost items is to an overhead account, or, alternatively, directly
 to a product, production unit, or process.  (Check one answer for each cost item.)

                                                                       INITIAL ASSIGNMENT IS ...
       Cost item                                              '
                                                          Always to
                                                          overhead
54)    On-site air/wastewater/hazardous waste
       testing and monitoring                                 Qj
55)    On-site air emission controls                            |~i~j
56)    On-site wastewater pre-treatment/treatment/
       disposal                                              fTl
57)    On-site haz. waste pre-treatment/treatment/
       disposal                                              | i  |
58)    On-site hazardous waste handling (e.g. storage,
       labelling)                                             QJ
59)    Manifesting for off-site hazardous waste transport        QJ
60)    Off-site hazardous waste transport                      [JJ
61)    Off-site wastewater/haz. waste pre-treatment/
       treatment                                             [JJ
62)    Energy Costs                                         IT]
63)    Water Costs                                          [TJ
64)    Licensing/permitting                                   [TJ
65)    Reporting to government agencies                      [TJ
66)    Environmental penalties/fines                           [JJ
67)    Staff training for environmental compliance              QJ
68)    Environmental staff labor time                          [TJ
69)    Legal staff  labor time                                  QJ
70)    Insurance costs                                       QJ
                                                                           Usually to
                                                                           overhead
   Usually to      Always to
' product/process   product/process
                                                                             | 2 |

                                                                             CU


















                                                                             I 2 I
                                                                                                     G3
                                                                                                     I  4|
                                                     Page 8

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       71) If some or all costs are initially assigned to an OVERHEAD ACCOUNT, do you later reallocate to a
           product or process?
                                    il   I  Yes
                    No
                                                                                 (Go to question 74}
       72) In cases where you initially assign costs to an OVERHEAD ACCOUNT, what are the TWO most
           common cost drivers, or bases, for later allocating those costs to products/processes?  (Check two)

        ai   I  j Labor hours
        bi   L] Material use
        d   i  [Square footage of facility space
        di   j  | Production volume
        ei   Fj Other (please specify)
        n   I  !Not applicable - we do not allocate any costs to overhead

       73) In cases where you initially assign costs directly to a PRODUCT OR PROCESS, what are the
           THREE most common sources of cost information?  (Check up to three)
        ai   j	i Purchasing data
        bi   L] Materials tracking system data
        ci   PI Production/operation logs
        01   LD Financial accounting system data
        ei   [""I Product shipment manifest data
        n   rj Waste shipment manifest data
        ai   [~~l Engineer estimate
        M   rj Vendor estimate
        n   [~1 Other (please specify)
            |  "I Not applicable - no costs are allocated
|5.  FINANCIAL INDICATORS AND TIME HORIZONS

 Finally, we have a few questions on the financial indicators and time horizons you use in evaluating
 environmental projects.
       74) Prior to a detailed financial analysis of an environmental project, does your firm
           typically perform a less detailed/informal screening of a project's profitability?
                Yes
          2 i   I Sometimes
Continue to Question #75
Continue to Question #75
Skip to question #76.
                                                  Page 9

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75) What financial indicator is most commonly used in determining if a project
    passes the initial screening test?
     r~1 Payback
     Q] Return on Investment (ROD
     QNet Present Value (NPV)
     Q Normalized Net Present Value (Profitability Index)
     Q Internal Rate of Return (IRR)
     Q] Return on Total Assets  (ROTA)
     Q Other (please specify)
     QNone, the evaluation is qualitative only
76) For the complete environmental project analysis and project justification, is there a
    standard hurdle rate, or threshold, required for project approval?

  \   j   jYes
  o   :   !No
77) For the full environmental project justification, what financial indicator is most
    commonly used?  (Check one only)
     [  j Payback
     Fj Return on Investment (ROD
     [3 Net Present Value (NPV)
     [^Normalized Net Present Value (Profitability Index)
     rU'nternal Rate of Return (IRR)
     Q Return on Total Assets  (ROTA)
              (please specify)
 a   jT^None, the evaluation is qualitative only

78) Is this financial indicator applied to regulatory COMPLIANCE projects as well as
    NON-COMPLIANCE, or discretionary, projects?
 o   QNo

79) If you use payback at any stage of environmental project justification, what is the
    payback time period normally required for approval?

 i   QjLess than 1 year
 2   j  j 1-2 years
 3   j  1 3 - 4 years
 «   Qj Greater than 4 years
           do not use payback
                                            Page 10

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80) If you use Net Present Value (NPV), or normalized NPV, what is the time horizon typically used
    for calculating the NPV or Normalized NPV for an environmental project?
  1   f~n 1-5 years
  2   LD 6 - 10 years
  3   f~~| Greater than 10 years
  4   Q We do not use NPV or normalized NPV
81) If you yse Internal Rate of Return (IRR), what is the IRR normally required for approval of environmental
    projects?
  i   rntess than 10%
  2   rj10-19%
  3   LH20-30%
  4   |  ! Greater than 30%
  s      We do not use IRR
82) If you use Internal Rate of Return (IRR), what is the time horizon typically used for environmental
    projects?
  1   I  j 1-5 years
  2   Qj6'- 10 years
  3   j  1 Greater than 10 years
  4   r^jWe do not use IRR
83) In general, how do the hurdle rates (i.e. threshold for approval) for environmental
    projects compare to those for non-environmental projects?
 i
 2
 3
Q Hurdle rates are higher for environmental projects
I   | Hurdle rates are the same for environmental projects
L] Hurdle rates are lower for environmental projects
84) In the remaining space, please add any comments you wish regarding the current
    or anticipated capital budgeting practices of your firm in relation to environmental
    projects.
                                           Page 11

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Thank you for your participation. Please return your questionnaire in the enclosed, stamped envelope to:
                                           Tellus Institute
                                           11 Arlington St.
                                      Boston, MA 02116-3411
                                        Attention: EPA Survey
                                                Page 12

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