Carbon Business Accounting: The Impact of Global Warming on the Cost and Management Accounting Profession

JANEK T. D. RATNATUNGA* KASHI R. BALACHANDRAN**

The concentrations of greenhouse gases in the atmosphere have risen dramatically, leading to the possibility of costly disruption from rapid climate change. This calls for greater attention and precautionary measures to be put in place, both globally and locally. Governments, business entities and consumers would be affected by the extent to which such precautionary measures are incorporated in their decision-making process. Business entities need to consider such issues as trading in carbon allowances (or permits), investing in lowcarbon dioxide (CO2) emission technologies, counting the costs of carbon regularity compliance, and passing on the increased cost of carbon regulation to consumers through higher prices. Such considerations require information for informed decision making. This paper reports on a qualitative research study undertaken to consider the impact of the Kyoto Protocol mechanisms on the changing information paradigms of cost and managerial accounting. It is demonstrated that the information from strategic cost management systems will be particularly useful in this new carbon economy, especially in evaluating the whole-of-life costs of products and services in terms of carbon emissions. Similarly, the study discusses how strategic management accounting information would facilitate decisions on business policy, human resource management, marketing, supply chain management, and finance strategies and the resultant evaluation of performance.

1. The Emerging Paradigm of Carbonomics

The Kyoto Protocol is the original international regulatory response to global warming, under which more than 150 countries agreed to strive to decrease
*University of South Australia **New York University

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carbon dioxide (CO2) emissions. Whilst alternative social constructions have been debated for the reduction of carbon emissions, such as that agreed to at the recent Applied Power and Economics Conference (APEC) in Sydney (Mackey [2007]),1 the Kyoto Protocol remains the international standard. Under Kyoto, a country can emit more CO2 than its assigned amount only if it can simultaneously sequester the equivalent amount in allowable carbon sinks (such as trees, plankton, soils, and water bodies). The Kyoto Protocol has developed various alternative social constructions (or mechanisms) for reducing carbon emissions that would enable industrial countries with quantified emission limitation and reduction commitments to acquire greenhouse-gas reduction credits. Among these mechanisms is the establishment of an International Emission Trading (IET) scheme. Here countries can trade in the international carbon credit (allowances) market. Countries with surplus credits can sell them to countries with quantified emission limitation and reduction commitments under the Kyoto Protocol (see Appendix A for a detailed discussion of the measurement and assurance issues in carbon-emissions trading). In countries subject to strict CO2 emissions-reduction targets, the existence of such mechanisms would necessitate a number of lifestyle changes (from organizations and individuals in that country) to achieve a substantial decrease in CO2 emissions. Examples of the lifestyle changes that are required by governments, organizations, and individuals to reduce CO2 emissions were listed in TIME magazine (2007). A few of the recommended carbon-reduction methods for business including changing light bulbs to low emission, switching off lights at quitting time, letting employees work close to home, and buying green power. Carbon reduction methods for individuals include flying a straight course between locations, hanging up clothes to line dry, and insulating residential water heaters. On an individual level, in recent years, there has been a significant shift from localization to globalization, especially with the opening up of China, India, and the Eastern bloc (Levitt [2006]). However, as more people are encouraged to work closer to home, buy produce from the local farmer, and host a green wedding (e.g., by buying wine and other items locally) (TIME [2007]), then a shift back to localization due to carbon-related reasons is possible. We have termed such a shift in world trade as carbalization.

1. The United States and Australia signed this Sydney agreement. The other signatories to this APEC agreement, such as China, Japan, Canada, and Indonesia, have already signed the Kyoto Protocol. Since Australias ratification of Kyoto in 2007, the United States is the only major industrial country (among the very small group of countries overall) that is still not a signatory to the Kyoto Protocol. Developing countries, including China, India, and Indonesia, have ratified the protocol but are exempted from reducing CO2 emissions under the present agreement, despite their large populations and high emissions levels. China ranks behind only the United States in carbon emissions, and in some rankings is the number one emitter (Netherlands Environmental Assessment Agency, see http://www.mnp.nl/en/index.html). Australia, even though it is now a signatory, has not, as yet, agreed to any reduction targets, despite being the largest per capita polluter.

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Carbalization is based on the concept of product-distance (in miles or kilometers)that is, the distance a product travels to get to its place of final purchase for consumption. Separate studies by the oil giant BP (formerly British Petroleum) and the German Institute for Physics and Atmosphere released earlier this year revealed that the worlds shipping could have a more serious impact on global warming than air travel.2 Although CO2 emissions on a per-kilogram basis were significantly lower for shipping when compared with air freight, it is distance that has been targeted as most imports of fast-moving consumer goods (FMCGs) are imported primarily via shipping lines. An example is given of imported bottled water from Europe using approximately 80 kg of CO2 emissions per metric tons of bottles to be shipped to Australia, whereas from Egypt it is 70 kg and from nearby Fiji only 20 kg (Perkins [2007]). The message from such analyses is similar to the TIME magazine (2007) recommendations, that is, buy from sources where the product or service originates as close as possible to point of purchase. A report produced by the Business Roundtable on Climate Change in Australia found that early action by companies to reduce CO2 emissions would add the equivalent of US$1.8 trillion to gross domestic product (GDP) by 2050 and create more than 250,000 jobs (Weekes [2007]). Nevertheless, the governments in many industrial countries (that are or will be subject to emissions-reduction targets) are concluding that mandatory or voluntary carbon costs will eventually flow on to prices and industry competitiveness. Recently, China (the secondbiggest polluter behind the United States) has stated that economic considerations come first and thus will consider reducing carbon emissions only as a secondary issue. Thus, Chinese products will continue to be cheaper, not only due to cheap labor, but also due to the exclusion of carbon costs. Countries that import such products will not only adversely affect the economic viability of their own countrys businesses, but also will be the target of the Chinese dumping carbon emissions on them. The only way (other than forcing China to accept their responsibilities by negotiation) is to place a countervailing tax on such imports (similar to that placed when companies dump products via transfer pricing) based on a fair allocation of carbon costs to Chinese products. It is clear that carbonomics and carbalization will produce winners and losers in both the product and allowances markets, as well as in organizations and countries. In the products and services market, the winners will be the low carbon intensity firms and those that can pass on their carbon costs. Some of these firms could earn windfall profits. The losers will be high carbon intensity firms and those that are unable to pass on their carbon costs. In the allowances market, the winners would include those countries that are on track for meeting

2. Annual emissions from shipping made up 5 percent of the global total, while the aviation industry, which is subject to far greater scrutiny, contributes only 2 percent (Vidal [2007]). CO2 emissions from ships do not come under the Kyoto Protocol, and therefore, only a few studies have been undertaken.

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Kyoto standards. These countries (and companies within them) will have a higher proportion of required allowances allocated free and could earn windfall profits from the sale of these allowances. The losers will include countries a long way from Kyoto compliance, that is, those that will need to purchase a higher proportion of allowances from the market. In the rest of this paper, we discuss how the impact of carbonomics, especially the (global) costs of CO2 emissions can be captured by accounting systems, how they can be built into the cost and prices of different products and services. We also will discuss ways that carbonomics affect the strategic decision information systems of business organizations.

2. Carbon Business Accounting

From the discussion earlier on carbonomics, carbalization, and carbonemissions trading, it can be seen that business entities will need to consider new business practices to take advantage of (or at least not be disadvantaged by) the mandatory carbon-rationing and trading schemes under the Kyoto Protocol. The existence of a carbon-rationing and trading market has the potential to affect an organizations business strategy, financial performance, and ultimately value. Thus, accountants and other business information providers need to consider measurements and strategies outside of conventional paradigms. This requires a good understanding of a number of elements of cost management and management accounting, and also of economics and business finance in an integrated manner, such as the economic modeling of demand and supply of carbon credits and allowances, forward and spot pricing, financial analysis, cost analysis and risk analysis, risk management of reputation, business support, cash flow and business value, capital allocation, and the (possible) International Financial Reporting Standards (IFRS) directives for financial reporting of carbonemissions management and related transactions. In addition, taxation issues of direct carbon taxes, value-added taxes (VAT), and goods and services taxes (GST), as well as transfer pricing implications of carbon trading, need also to be considered. This paper focuses specifically on strategic cost management (SCM) and strategic management accounting (SMA), which are referred to collectively as business accounting. First, the paper demonstrates that some of the classic ideas of cost accounting may be central to the study of carbon costs. The costing scheme proposed in the paper is shown to be a good fit with the traditional lifecycle analysis of overhead cost allocations, where the overhead in question is the costs of reducing global warming. It is demonstrated that if the overhead is allocated in a precise fashion over the life of a product or service, goods and services that seem to be low cost from a product costing viewpoint become high cost from a life-cycle viewpoint and perhaps should not be manufactured or provided. Next, the paper reports on a structured qualitative research study that was undertaken at thirty-one research symposiums in twelve countries (638 respondents) to canvass the views of practitioners regarding the wider implications of

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carbon costs (and potential revenues) on SCM and SMA tools, techniques, and practices. Some key issues, especially those relating to the impact of carbonemissions management on lean manufacturing, life-cycle costing, marketing communication, and cost of capital are reported in this paper. A literature review relating to SCM and SMA and pertaining to environmental cost accounting is provided in Appendix B. This review elaborates on any conceptual frameworks that could be developed to help in the coding and classification of the data for carbon accounting. 2.1 Carbon Strategic Cost Management Traditional cost management relates to accounting for direct and indirect costs3 and to the assignment of these costs to such objects as products, services, customers, and organizational processes. A cost can be attached directly to a cost object if it is traceable solely to that cost object; and if not, it is allocated (see Sharma and Ratnatunga [1997] for a comprehensive discussion of costing systems). Recent discussions in the cost accounting literature have focused mainly on the allocation of indirect costs; that is, whether using traditional allocation systems with a single cost driver (such as direct labor) or using activity-based costing systems (with multiple cost drivers) better describes the cause-effect relationships found in products, services, customers, and organizational processes (Cooper and Kaplan [1988]). In product costing, the cost is computed up to the stage that goods are available for sale. Costs incurred subsequent to the product being sold are usually not calculated, except in the case in which a product carries a warranty, or some other after-sales service component; then the expected cost (based on a probability estimate) of that service is incorporated into the cost (and therefore its price). Some costings may include the cost of money blocked in accounts receivable, that is, the credit period being treated as an after-sales service that has a cost associated with it. Carbon cost management is a subset of the push toward environmental cost accounting (see Mathews [1997]; Adams [2004]) that highlights the cost impacts beyond those related to a specific cost object, such as a product. Let us consider a computer printer as an example. The typical environmental costs (both before and after the sale) are as follows. 2.1.1 Raw Material The environmental costs are simply the cost of the raw materials, such as plastics, cartridges, and steel in waste. Much of such raw material is brought into usable form for manufacturing using significant energy and thus has related CO2 emissions.4 Every time a raw material is used and does not become a product, it
3. These cost categories are based on the nature of the expenditure items, such as the cost of raw materials, human input (labor), and overhead (rent, depreciation etc.). 4. Such as the energy used in mining and processing the materials.

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becomes waste. Even when such material becomes a saleable product, when it becomes obsolete, it goes into landfills as waste. 2.1.2 Labor Labor requires energy to function, such as traveling time to a production facility and air conditioning at the facility, and thus significant CO2 emissions are associated with its use. Before the sale of the product, the typical labor environmental costs would be the labor component of an off-specification product that becomes waste. After the sale, the labor cost required to recycle the parts is an environmental-related cost, which also generates CO2 emissions. 2.1.3 Overhead Utility costs, such as water and energy, are often overlooked in determining the true cost of waste generation, both before and after a sale. These costs are a significant item in CO2 emissions management. 2.1.4 Waste Management The most obvious environmental expenses are the treatment and disposal costs of waste generated in the production process. Again, these processes require significant energy and thus have associated CO2 emissions. Other waste management costs may include the expenses to collect samples, complete paper work, and pay for permit fees, consulting fees, and (potentially) fines for violations. The flip side of the hidden costs and impacts of waste generation is the hidden benefits resulting from actions taken to improve the environmental performance of a particular facility. 2.1.5 Recycling Recycling is a form of waste management at the obsolescence end of the product life cycle. This requires a three pronged approach: (1) the opportunity cost calculation (including the environmental impacts) of recycling components of existing hardware compared with using new components, (2) locking in recycling cost efficiencies at the design stage of new hardware, and (3) using a costbenefit analysis of the first two stages to influence government policy on tax credits and so on for undertaking such environmentally sustainable programs. The U.S. Environmental Protection Agency (EPA) has an Environmental Accounting Project that encourages business to understand the full spectrum of their environmental costs and integrate these costs into decision making.5
5. See http://www.epa.gov/oppt/library/pubs/archive/acct-archive/index.htm.

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There are often conflicts among the different cost categories. A study by CNW Marketing Research6 says that the total energy cost used in manufacturing, driving, and recycling a Hybrid Toyota Prius is higher than that of most conventionally powered vehicles. The two-year study (claimed to have been independently funded) included factors such as the following:
. .

. . . . . .

How many years it took to develop the vehicles How the material used was processed and how far these had to travel to get to manufacturing stage How far auto workers traveled, and whether or not they used public transportation The energy used in manufacturing The percentage of materials that can be effectively recycled The percentage of labor produced by robots versus humans Variable estimated lifetime of components Cost of fuel used over an estimated lifetime of 100,000 miles Expected parts that would need to be repaired

This study showed that hybrid cars, while clearly using less fossil fuel to run, are environmentally more expensive to manufacture and to recycle than conventional cars (CNW Marketing [2007]). For example, the whole-of-life costs for a Hummer H3 was $1.94 per mile, while the Toyota Prius Hybrid was $3.25 per mile. One of the least-cost cars in the study was the Jeep Wrangler (placed number three overall in terms of least cost) with $0.60 per mile and the highestcost car was the Mercedes Benz Maybach with a cost of $11.58 per mile (de Fraga [2007]). Martin (2007) shows why the Toyota Prius has such a high whole-of-life cost associated with it in terms of carbon emissions: Let us consider, for example, the raw material costs of the special electric battery required by the hybrid. The nickel for the battery for the Toyota Prius is mined in Sudbury, Ontario, and smelted at nearby Nickel Centre, just north of the provinces massive Georgian Bay. The smelter has a 1,250-foot-tall smokestack that is claimed to emit large quantities of sulfur dioxide to the surrounding area. Toyota buys about 1,000 tons of nickel from the facility each year, ships the nickel to Wales for refining, then to China, where its manufactured into nickel foam, and then onto Toyotas battery plant in Japan. That alone creates a globe-trotting trail of carbon emissions that from start to finish is estimated to travel more than 10,000 milesmostly by container ship, but also by diesel locomotive. At the end of its life, the battery has to go back to Japan for recycling, again often traveling large distances and burning more CO2. (Martin [2007])

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

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Due to such significant product-distance costs, it is claimed that to date none of the Prius batteries in Australia have been sent back to Japan for recycling (de Fraga [2007]). They will most likely go to landfills in Australia. This may be true of the United States as well. As expected, Toyota has challenged the CNW study, stating the energy ratios used in the study pertaining to the manufacture-driving-recycle life cycle of a car is quite different from other studies conducted by the Argonne National Laboratory and the Massachusetts Institute of Technology. The latter studies found that while hybrids require more energy to manufacture and recycle, 80 to 85 percent of the energy is used in driving, where the hybrids have a clear advantage. The CNW study shows these percentages to be reversed (de Fraga [2007]), hence disadvantaging the hybrids. The problem with studies of this nature is that the complicated set of assumptions can greatly influence the outcome (as will individual driving patterns).7 When undertaking a life-cycle costing exercise using carbon allowance costs, the issue of transaction costing versus opportunity costing needs to be recognized. Some studies may take an opportunity cost approach and determine that the freely allocated allowances are worth the same as purchased allowances. Other studies may take a more transactional environmental compliance approach and treat as a hard cost only the cost of purchased allowances over the year. As pointed out before in discussing CES accounting and assurance (see Appendix A), many accreditation approaches in the environmental arena have different measurement metrics. These measurement approaches also have a direct impact on carbon cost calculations. No study or approach can be considered definitive, but there is clearly a need for accurate carbon cost accounting using life-cycle costing techniques. This accounting should consider not only costs to bring a product or service to the point of sale, but also the carbon costs before and after the manufacture of the product or the performance of the service. Such costs are elaborated in Table 1. Australia provides another example of life-cycle carbon cost accounting. The power company, Origin Energy, began changing its environmental practices when it audited the life cycle of its products, from production to consumption, to discover it contributed about 30 million tones of carbon dioxide to the environment (about 8 percent of Australias total emissions). Since undertaking the audit, Origin has invested $20 million in solar energy, spent an extra $500,000 converting to sustainable power for its own use, and signed up 12 percent of its customers to a green-power alternative. The companys work is audited by

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

TABLE 1 The Whole-of-Life Impact of Carbon Emission Efficiencies on Costs and Revenues

Areas of Cost Reduction or Revenue Generation via Efficient Carbon Cost Management Presale Environmental Impact Postsale Environmental Impacta Landfill waste Time to separate recyclable components Production waste Wasted time on rejects and recovery

Raw Materials

Human Input

Traditional Overhead Expenses Electricity Rental Marketing Transportation Administration Depreciation of Machinery After-sale Service Costs

All of these overhead items have carbon emissions that will affect if the organization is a net-sequester or net-emitter. Techniques utilized to reduce CO2 emissions via using alternative energy sources etc. will affect the carbon credit cost item shown under the Environmental overhead category.

Environmental Overhead Regulatory Costs Waste Management Recycling Amortization of Design Costs Carbon Credits

Meeting emissions standards Litigation costs of environmental pollution Production waste Landfill waste These costs can be reduced via the proper design of components at preproduction stage. Such design costs should be amortized over life of product, via life-cycle costing. This can be a cost or revenue item depending on if the organiza- Purchase/sale of carbon credits depending on if the tion is a net-sequester or net-emitter. organization is a net- sequester or net-emitter. These costs include those of capital, excess handling, obsolescence, deterioration, stock administration, and insurance

Financing Costs Stock Holding Costs

Debtors Costs

Carbon Tax

These costs include those relating to warranty returns such as excess handling, deterioration, stock administration, and insurance None These costs include those of capital and the risk of bad debts This tax could be an additional cost or revenue item (Tax Credit) depending on if the organization is a net-sequester or net-emitter

Note: a These postenvironmental costs can be incorporated into product costs using probability estimates.

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accounting firm Ernst and Young, which uses the International Auditing and Assurance Standards Board framework, ISAE 3000 (Walters [2006]). Such examples show that companies that start managing for environmental efficiency will automatically cut costs and ultimately boost revenue by selling credits in the emissions trading markets. In fact, a view is developing in some businesses that a direct measurable correlation can be made between environmental efficiency and economic results. For example, Westpac, one of Australias large banks, no longer sees carbon costing as an add-on but rather as being central to its operations. They claim that the reduction of emissions at the bank have significantly boosted its bottom line (Weekes [2007]). Life-cycle costing analyses, such the Toyota Prius example illustrated above, fall within the general area of SCM, a term first encountered in Gupta and Govindarajan (1984). Since then, there has been numerous articles and books on SCM (see, Jones [1988]; Shank and Govindarajan [1989, 1992a, 1992b, 1993a, 1993b]; Simons [1990]; Ratnatunga [1983, 1999]; Ewert and Ernst [1999]). Often, however, the papers focus on only a few SCM techniques, such as lean accounting, life-cycle costing, target costing, back-flush costing, activity-based management, and customer profitability analysis. Despite the vast body of work in the area, and also the global concern that resulted in the Kyoto Protocol, no paper to date addresses SCM approaches in efficient carbon management. The research study reported in this paper, therefore, fills a significant and important gap in literature. To develop a comprehensive conceptual framework for the area of carbon management including a coding and classification system required for the qualitative research study (detailed in Appendix B), the researchers relied on SCM documents of the Institute of Certified Management Accountants (ICMA) in Australia. This document was a primary basis of the respondents (ICMA members) at the thirty-one research symposiums to study this issue (see Appendix B for details of the study). A framework for capturing the summarized views resulting from the discussions at the symposiums is given in Table 2. 2.2 Carbon Strategic Management Accounting Once product costs are known, the wider issues of strategic business accounting (comprising management accounting and business finance) need to be considered. The term SMA has been in the management accounting literature since Simmonds (1981) coined the term. However, similar terms such as marketing accounting (Ratnatunga [1983]); competitor accounting (Ratnatunga [1983]; Jones [1988] Guilding [1999];) and customer accounting (Simmonds [1986]; Guilding and McManus [2002]) have been used to describe similar practices. These terms essentially describe practices that occur at the interface between accounting and other functional areas of business. All of these practices are geared essentially toward enhancing the competitive advantage of firms (Porter [1980, 1983]). Over the last twenty-five years, been numerous articles and books have been published on SMA (see Simmonds [1982]; Bromwich [1990];

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TABLE 2 Issues in Carbon Strategic Cost Management

SCM Issue Management Control Systems Production Management Carbon Management Impact Employee behavior modification to achieve carbon efficiency targets. Lean production techniques. More attention to the use of energy in machinery, less materials and time wastage. Just-in-time philosophy. Ensuring that low energy work environments do not cause hazardous working conditions. May demand more if comfort levels fall. More demands for the sharing of high carbon windfall profits. Carbon efficiency seen as part of quality equation. Production resources (components, labor, and overhead) sourced locally. Lean accounting. Significant attention paid to reduce carbon-emission costs. More use on back-flush costing methods. Consideration given to carbon emissions when considering alternatives. Carbon costs classified into direct, indirect, fixed, and variable costs. Variation of ABC by having consideration of carbon cost drivers to link emission indirect overhead to products and services. Amortization of design costs to make products more carbon friendly and worker training costs to reduce carbon emissions. Redesigning products and services to meet carbon-emission targets. Comparing the KPIs of world-class performers in carbon efficiency. Segmenting customers by profitability per carbon usage. Evaluating the performance of organizational processes, including white-collar departments in terms of achieving carbon efficiency KPIs. Consideration given not only to economic efficiency but also to carbon usage efficiency. Reductions in purchase prices considered via the sale of carbon efficiency credits. The profitability of the bottom-line figure given in terms of both economic and environmental effectiveness. All reworks, recoveries, errors, etc. considered to be avoidable carbon-emitting activities. The drill-down facilities to be extended to financial and nonfinancial carbon-emitting measures. Accountability and transparency issues extended reporting on carbon management initiatives. Voluntary and mandatory enforcement of carbon-emission targets. Extended to cover the expected future carbon footprint of the organization due to its production, marketing, logistics, capital investment, and human resource management (HRM) practices. The evaluation of the organizations image and brand with regards to being a responsible carbon citizen of the world.

Employee Safety Wages and Trade Union Demands Total Quality Management Purchasing Management Cost Control Make or Buy Decisions Cost Classification Allocating Indirect Costs Life-Cycle Costing Target Costing Benchmarking Customer Profitability Analysis Process Control and Activity-Based Management Efficiency or Productivity Price Relationship or Recovery Overall Effectiveness Value-Adding/Non-ValueAdding Work Executive Information Systems (EIS) Corporate Governance Enforcement and Compliance The Strategic Audit

Corporate Reputation Audit

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Wilson [1991]; Palmer [1992]; Ward [1992]; Morgan [1993]; Ratnatunga, Miller, Mudalige, and Sohal [1993]; Lord [1996]; Tomkins and Carr [1996]; Ratnatunga [1999]; Guilding, Cravens, and Tayles [2000]; Cravens and Guilding [2001]; Hoque [2002]; Roslender and Hart [2003]). Despite this consistent stream of literature in the area presenting different approaches to SMA, knowledge remains fragmented. Often, the papers focus on a few SMA techniques, such as supply-chain management, strategic pricing, and competitive position monitoring; and the extent of the use of such techniques in practice. In spite of the vast body of work in SMA and SCM, no paper to date addresses approaches to efficient carbon management despite the significant global concern regarding global warming. The research study reported in this paper, therefore, fills a significant and important gap in literature. Table 3 summarizes the impact of SMA on carbon-emissions management information systems resulting from the thirty-one research symposiums with ICMA members. The details provided in Table 3 show that carbon-emissions management cuts across a wide spectrum of strategic issues, ranging from overall objectives to marketing, new product development, pricing, international business, promotion, supply chain management, finance, and risk management. Clearly an integrative approach, such as that suggested by Kaplan and Norton (2000), is required, with carbon thinking being an important part of the strategy focus of an organization. This carbon-focused thinking will require new tools and management practices if the accounting profession is to remain at the forefront of providing relevant information for decision making in this new economic paradigm of carbonomics.

3. Conclusion
The concentrations of greenhouse gases in the atmosphere have risen dramatically leading to an out-of-balance greenhouse effect that most scientists believe will continue to cause a rapid warming of the worlds climate. The possibility of costly disruption from rapid climate change, either globally or locally, calls for greater attention and precautionary measures to be put in place. Governments, business entities, and consumers would be affected by the extent to which such precautionary measures are incorporated in their decision-making processes. Business entities especially need to consider issues such as trading in carbon allowances (or permits), investment in low-CO2 emission technologies, counting the costs of carbon regularity compliance, and passing on the increased cost of carbon regulation to consumers through higher prices. Consumers need to consider whether, given the choice, they are willing to pay a higher price for CO2neutral products and services to play their part in reducing CO2 emissions. These decisions and their consequences will affect the accounting profession significantly, especially the business accounting areas of strategic cost management and strategic management accounting. Information from the strategic cost and management accounting systems will be particularly useful in this new

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TABLE 3 Issues in Strategic Management Accounting

SMA Issue Business Policy Primary Objective Competitive Advantage Carbon Management Impact

Line of Business Competition and Industry Structures Gap Analysis Environmental Externalities Risk Management

Sustainable value creation. Carbon efficiency seen as a marketing mix variable in product differentiation. An Efficient Carbon Management (ECM) focus is also taken in cost leadership strategies. ECM seen as a potential line of business. Adding a sixth force to Porters Five Forces Model: the impact on the Industry of Carbon regulation (Porter [1980, 1983]). Strategies considered to close the gap between current emission levels and future emission targets. Considered internalities in product-market decision making and human resource management (HRM). Consideration of the impact on cash flows and reputation of the company as a result of the carbon strategy positioning of the company. Risk vs. Reward outcomes (e.g., cash flow at risk) should be considered.

Human Resource Management Corporate Culture A carbon lifestyle culture from grassroots level upward. Low carbon footprint activities encouraged. Excellence sought in seeking continuous improvement in ECM. Empowerment Employees given resources and responsibility to participate in ECM in lowering the organizations carbon footprint. Carbon impact considerations considered systematically in all product-market strategies. Marketing Research Undertaken to determine the needs of customers in terms of participating in reducing carbon emissions and the incremental price they are willing to pay for this (carbon consciousness). Market Segmentation Separating customers geographically, demographically, and psychographically in terms of their carbon consciousness. Positioning Strategy Consideration of taking an active or passive positioning in terms of ECM as a source of competitive advantage. The Product Life Cycle (PLC) Consideration of the carbon footprint left by product throughout its life cycle, especially in the decline and obsolescence stages. Market Penetration Strategies Using carbon efficiency of existing products as an attribute to sell more to existing carbon conscious customers. Market Development Strategies Using carbon efficiency of existing products as an attribute to sell new carbon conscious customers in new segments. Product Development Incorporating carbon efficiency as an attribute in new product designs to Strategies keep existing carbon conscious customers loyal to the brand. Diversification Strategies Leaving industries that have products and markets seen as high carbon emitting to new industries with better long-term carbonsustainable prospects (includes investments in Joint Implementation [JI] and Clean Development Mechanisms [CDMs] under Kyoto). Experience Curves Organizations with high experience in ECM products and services should have lower costs. Budgeting for Marketing Budgets will incorporate ECM activities as potential revenues and Activities cost savings. Carbon trading activities could be considered a separate line of business. Marketing Strategy Products and Markets

(continued )

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TABLE 3 (Continued )
Product Marketing Strategies The Product Portfolio (BCG) Star products will have high market share and high market growth Matrix opportunities in industries with better long-term carbon sustainable prospects. New Product Development Designing products and services to meet carbon-emission targets and (NPD) marketing them as such. Product Abandonment Product review teams to consider carbon footprint in addition to Approaches profitability targets. Inflation The passing on of mandatory carbon costs and taxes as higher prices to consumers will cause inflation. Packaging Consideration given to carbon footprint of packaging, in terms of functionalism, convenience, recyclability, and also image. After Sales Service The carbon emission in terms of materials, labor, and overhead of undertaking work due to meeting warranties and other after-sales services should be costed into the product. Pricing Strategy Pricing Analysis Carbon costs, carbon-related competitor activity, and the value of low-carbon-footprint products to carbon conscious customers should be considered in such analyses. The impact on demand due to changes in prices if carbon costs are incorporated. Selling to high carbon conscious customers willing to pay a price well above costs. Absorbing carbon costs of products and services sold to low carbon conscious customers to develop brand awareness. Productivity improvements can only be obtained either by lowering costs via ECM or changing customer carbon consciousness levels.

Elasticity of Demand Skimming Penetration

International Business Strategy Exporting vs. International Carbon costs can be reduced via JI and CDM investments as per the Operations Kyoto protocol. Price Differentials and Competing with countries that do not have carbon costs. Influencing Carbon Dumping government policy to impose countervailing carbon taxes. Hedging Policies Ensuring that carbon credits in the overseas country is not devalued in terms of the parent country carbon credit pricing. Promotional Strategy Promotional Pull Strategy (via Advertising etc.) Promotional Push Strategy (via Sales Force)

Sales Response Functions Media Selection Strategies Supply Chain Strategies Product Distance

An Integrated Marketing Communication (IMC) approach should be taken to promote how the product or service is reducing carbon footprint, for example, via purchasing carbon offsets. Sales force budgets, targets, and incentive schemes geared toward extolling the attributes and pushing low carbon impact products. Traveling times on sales calls minimized to reduce carbon emissions. Biofuel cars used as sales vehicles. Response of sales volume to carbon-related promotions tracked. Electronic media given higher priority to print media to reduce paper usage. Carbon emission measurements in terms of Product Distance. The longer the distance and the more players in the channels of distribution the higher is the carbon costs.

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TABLE 3 (Continued)
The Level of Service The Service-Cost Trade-off required to ensure that the right product gets to the right place at the right time should consider the carbon emissions required to provide this level of service. Computation of carbon-related costs in order processing, warehousing, transportation, credit control, and inventory control. The use of these models to reduce transportation time and resulting reduction in carbon emissions. Consideration of the motivation, relationships, and conflict issues that arise when channels are asked to on-sell products and services using ECM approaches themselves. Consideration of the adaptability of channels to changes in productmarket combinations as a result of reducing carbon footprint. Using ratio analysis to ensure that, in addition to economic analysis, ECM in supply chain activities is also evaluated.

Distribution Cost Accounting Transportation and Simplex Models Channel Control

Channel Adaptability Distribution Cost Control Performance Evaluation Strategic Financial Structures (Gearing)

Consideration if carbon-related investments should be financed via debt or equity. Ability to obtain shareholder and debt holder funding at favorable rates due to the use of such financing in ECM activities. Weighted Average Cost of If financing of carbon-related investments can be isolated, then calcuCapital (WACC) lating an organizations carbon-related Cost of Equity and Debt to calculate its overall Carbon-WACC. The equity and debt market may value discount carbon intensive businesses (causing high financing costs) and place a value-premium on low carbon emitting businesses (causing low financing costs). Return on Income (ROI) and Residual Income (EVA) used to Corporate Performance Perspectives evaluate not only economic performance but ECM performance. If carbon-related revenues and costs can be isolated as a separate line of business, this will enhance the evaluation. Strategic Value Analysis Calculation of value enhancement (or diminution) due to strategies relating to carbon-related investments and operations. Valuing Strategic Investments Valuation premium given to investments in ECM, such as investments in alternative energy assets and abatement activities. Examples are wind, biomass, solar, geothermal, nuclear, and clean coal. Valuing Strategic Operations These include operational adjustments to incumbent assets, changes to energy prices, efficiencies in waste management, purchasing, and sale of carbon credits and carbon-related taxation. Free Cash Flows Net cash flows generated by carbon-related activities less investments in carbon-related noncurrent and current assets The Business Value The Net Present Value of expected future cash flows generated by strategic investments and operations in carbon-related business. The Balanced Scorecard Corporate Report Card to incorporate financial and nonfinancial KPIs with carbon focus. This could be in addition to, or incorporated with the customer, innovation, internal business processes, and financial focus. Economic Value Added (EVA) A charge against revenue is made for the cost of investments in carbon-efficient assets. A separate carbon-EVA can be calculated if carbon-related net-income, investments, and cost of capital can be isolated.

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economy, termed carbonomics, brought on by global warming. New costing techniques need to be considered to evaluate the whole-of-life costs in terms of carbon emissions relating to products and services. Similarly, new thinking will be required to provide strategic management accounting information for business policy, human resource management, marketing, new product development, promotional, pricing, international business, supply chain management strategies, and the resultant evaluation of performance evaluation. The new paradigm of carbonomics, and the return to localization due to place-distance carbon-emission costs (termed carbalization) will produce winners and losers in both the product and allowances markets, as well as in organizations and countries. The cost management accounting profession must also reengineer itself to be a winner in this new economic paradigm.

APPENDIX A Measurement and Assurance Issues in Carbon Emissions Trading

One of the mechanisms of the Kyoto Protocol requires an emissions trading (known also as a cap-and-trade) scheme to be established in a country. It would work like this: companies are told how much CO2 they can emit (the cap). If they produce less than the cap, they have surplus credits for sale.8 If they emit more than their cap, they can buy credits from other businesses that come in under their cap (the trade). Trade takes place in an over-the-counter market, or via a carbon credit exchange trading market. One of the earliest such trading schemes is the European Union Emission Trading Scheme (EU ETS), which is the worlds largest multicountry cap-and-trade system. The EU has established a cap that limits emissions for its member states, each of which has been given a specific number of credits. The total amount of credits cannot exceed the cap, limiting total emissions to that level. For a cap-and-trade scheme to work, there must be an agreed mechanism for calculating the quantum of CO2 either emitted by a source or sequestered in a biomass sink (see Ratnatunga [2007]).9 The CES accounting mechanism must be sufficiently robust that the carbon trading market has confidence that the amount of carbon sequestered can be measured and considered to be equivalent in its impact on global warming potential to the CO2 released to the atmosphere from activities producing greenhouse gases. Confidence in the CES accounting system is fundamental to building confidence in use of CO2 sequestration in a carbon trading market, thereby underpinning growth and investment in new carbon sequestration activity (Tandukar [2007]).10 As can be appreciated, the detailed requirements for a CES accounting system are continually being developed by organizations such as the Intergovernmental Panel on Climate Change (IPCC [2007]) under the United Nations Framework Convention on Climate

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

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Change (UNFCCC). Any CES accounting standard developed by a country or nongovernmental organization will need to be consistent with the IPCC principles before carbon credits generated from carbon sinks can be used in an emissions-trading regime under the Kyoto Protocol. In addition to the numbers generated from CES accounting, there is the issue of assurance of the calculated numbers. Currently, similar to the situation regarding numerous CES accounting methodologies and approaches, the auditing and ranking of environmentally sustainable initiatives is in chaos with dozens of organizations offering assurance services, but none are being committed to a standardized methodology for auditing or reporting corporate effort in the carbon-emissions management area (see Walters [2006]; Ratnatunga [2007]). This paper looks beyond these CES accounting and assurance issues and concerns, and considers the cost and managerial accounting issues that arise if and when an efficient carbon trading market is established in a country.

APPENDIX B Accounting for Carbon Trading: A Qualitative Research Study

In the period from mid-2003 to early 2007, thirty-one research symposiums (one-day each) were undertaken in Australia (eight), Canada (four), India (one), China (one), Lebanon (two), the Philippines (one), Papua New Guinea (two), Indonesia (four), Sri Lanka (four), Malaysia (two), Singapore (one), and United Arab Emirates (one). Countries were chosen based on the location of an established branch of the Institute of Certified Management Accountants (ICMA). The participants were self-selectingthe symposiums were advertised only to members of the ICMA, and participants had to pay a fee for attending. In all, 638 respondents at the levels of cost accountant, management accountant, business analyst, chief financial officer, and chief executive officer (or similar) participated in the study.11 The literature review undertaken before the commencement of this research study, the coding and classification of the data, the data collection, and the discussion at the symposiums will now be addressed.

B.1 Literature Review There is now a significant body of literature in the academic journals in the area of corporate social responsibility (CSR) (see Lantos [2001]; Matten and Crane [2005]; Shank, Manulland, and Hill [2005]; Ratnatunga, Vincent, and Duvall [2005]; PJCCFS [2006]); sustainability reporting (see European Commission [2001]; Global Reporters [2004]; Amalric and Hauser [2005]; De Bakker, Groenewegen, and Den Hond [2005]; KPMG [2005]; Ratnatunga, Vincent, and Duvall [2005]; Salzmann, Ionescu-Somers, Steger [2005]; GRI [2007]; DEH [2005]; CPA Australia [2005]; FEE [2006]; NIVRA [2007]; Mock, Strohm, and Swartz [2007]); environmental accounting (Mathews [1997]; Adams [2004]); and links between CSR, environmental reporting, and financial performance

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

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(Preston and OBannon [1997]; Waddock and Graves [1997]; Orlitzky [2001, 2005]; Orlitzky, Schmidt, and Rynes [2003]; Hopkins [2005]; Ratnatunga et al. [2005]; Shank, Manulland, and Hill. [2005]). Surprisingly, however, very little academic literature dealt specifically with the new information requirements in business organizations brought about by the Kyoto Protocol. Some reports from governmental (COAG [2006]; Stern [2006]; DPMC [2007]; DEFRA [2007]; EC [2007]; IPCC [2007]; NSW Greenhouse Office [2007]) and nongovernmental organizations (NGOs) (such as IETA [2002]; IGCC [2006]; ISO [2006]; CCE [2007]; RGGI [2007]; World Business Council for Sustainable Development [2007]) deal with issues of carbon trading in general terms, but again, no academic research is referenced in these reports. Early academic work specifically on the impact of the Kyoto Protocol on accounting information and reporting systems was undertaken by Freedman and Jaggi (2005) in studying the accounting disclosures of the largest global public firms from polluting industries. A year later, Kundu (2006) looked at the financial aspects of carbon trading in a professional journal article. Since then little research had been published in academic or professional accounting journals until Callon (2008) discussed the many controversies regarding carbon trading schemes and related measurement schemes. Much of the limited recent academic literature, however, considered mainly the problems caused by environmental accounting issues on conventional accounting reporting (see also Cook [2008]; Lohmanna [2008]). No literature available in the academic journals deals specifically with the impact of carbon trading on cost management and managerial accounting theory and practice, that is, on leading rather than lagging indicators. Undertaking an empirical-descriptive study of practices in the field is futile, because the area is so new and there are little (if any) practices to report. What is required, therefore, is theory building research of a normative or prescriptive nature. Such theory building research is just starting in financial accounting. This study looked instead at the cost management and management accounting area (referred to collectively as Business Accounting) by undertaking structured qualitative research study and canvassing the views of practitioners in the area. The literature pertaining to the areas of SCM and SMA are covered in the main text. B.2 Coding and Classification of Data Whilst quantitative studies emphasize the measurement and analysis of causal relationships between variables, the word qualitative implies an emphasis on process and meanings that are not rigorously examined or measured in terms of quantity, amount, intensity, or frequency. Inquiry is purported to be within a value-free framework (see Denzin and Lincoln [1994]). The relationships being looked for are not statistical, but descriptive. This requires one to view the data set from an experiential perspective from the beginning. The biggest obstacle in qualitative research is the coding and classification of data. As opposed to quantitative research, qualitative hypotheses and theories often emerge from the data set while the data collection is in progress and after data analysis started (Morse and Field [1995]). After the collection of the data, researchers usually have what is termed a scissor party to cut out the individual data bits and then begin the laborious task of scanning the data for categories of phenomena and for relationships among the categories (see

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Goetz and LeCompte [1981]; Carney, Joiner, and Tragou [1997]). Strauss and Corbin (1998) also emphasize that theoretical categories are elaborated on during open and axial coding procedures. Many qualitative researchers have, therefore, to continually examine the collected data (which, in the case of this study, consisted of transcriptions of interviews), for descriptions, patterns, and relationships between categories, and tack backward and forward between literature and data, which then leads to the development of a number of theoretical categories (Spiggle [1994]). In this process, the researchers involved with the study, independently develop categories, and then collectively look at each others individual category sets for some agreed order in the classification. This research study avoided this tacking back and forth aspect of the coding and classification process by approaching the data collection in a very structured manner. This was done by using the classification framework provided in the syllabuses (theory) of the two Institute of Certified Management Accountants (ICMA) subjects covering the syllabuses of Strategic Cost Management (SCM) and Strategic Management Accounting (SMA). The reason for using this theoretical framework for coding and classification purposes (rather than allow the classifications to emerge from the data) is elaborated in the main text. B.3 Data Collection and Discussion at the Symposiums The tools and techniques of SCM and SMA as well as issues of global warming and carbon trading and the impact of these on the business accounting profession was the focus of discussion at the symposiums. The theory of SCM and SMA were first discussed in the seminars, and then the carbon-related issues were addressed and participant views canvassed. Although the discussion of issues was free flowing, the researchers guided the discussion to the carbon-emissions area. In the seminars there were always at least two researchers who were involved in the project present, and the main consensus of the discussion was agreed by the researchers and the seminar participants and then summarized and captured and classified electronically at the seminar. The key points extracted from the symposiums are presented in Tables 2 and 3. Whilst not all issues listed in the Tables were discussed at every seminar, every issue was discussed in at a minimum of three of the thirty-one seminars conducted. Some key issuesespecially those relating to the impact of carbon-emissions management on lean manufacturing, life-cycle costing, marketing communication, and cost of capitalwere discussed in almost all seminars.
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