Full cost of production

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Full cost of production can be determined by different methods. From conventional accounting aspects, such as conventional costing, absorption costing, the full cost of production of a product is divided into direct costs and indirect costs. However, there are other costs which outside the accounting frameworks have been ignored under generally accepted accounting principles (GAAP). Industries are now more aware of the financial effect caused by their environmental and social liabilities. As a result, sustainability management accounting and environmental management accounting have been derived. From the economic aspects, in environmental accounting, the full cost of production is majorly divided into internal costs and external costs, which is quite similar as sustainability management accounting but with more detailed cost type in environmental accounting.

Full cost of production in Accounting

Conventional costing

Full cost of the production can be measured in different methods in management accounting. Product is one kind of cost object. Cost object is mostly referred to product, service, customers, department, etc., anything that needs to be measured separately. The full cost of the cost object can be divided into two major costs, direct cost and indirect cost. Direct cost is referred to direct material cost and direct labour cost incurred from the manufacturing; this cost can be directly traced with source documentation to the cost object. Indirect cost is also called overhead, such as utilities, equipment depreciation; the measurement of this cost is typically allocated proportionally based on the allocation rate set by the organisation. To determine the full cost of a product, following steps need to be followed:

1. We need to identify the cost object (product, service, etc.)

2. Allocation rate of indirect cost needs to be determined

3. Based on the allocation rate, find out the amount of indirect cost of the cost object

4. Determine the full cost of cost object by summation of direct costs and related proportional of indirect cost

Absorption Costing

Main article: Total absorption costing

Absorption costing is one of the methods to determine the full price of products. Tracking direct material and direct labour costs and assigning a relevant proportion of variable and fixed indirect costs to custom or distinct products and services. Managers can use this figure to determine the market price of the product and budgeting and forecasting the future performance of the organisation. Job costing is used if the product is customized products while the process costing is used if the product is massive volume.

• Job costing
  • In absorption costing system, Job costing is one of the basic accounting methods to allocate costs to custom-made products, and also available to assign cost to batches of similar products by dividing total cost by the volume. This method is widely used by manufacturer of aircraft, motor vehicle, and custom design jewellers.
• Processing costing
  • Another basic accounting methods to allocate costs to massive volume of similar products, the production process for this kinds of products are mostly performed in a sequence of department, unlike the job costing which determine the cost by using division of total cost figure, process accounting firstly assigns cost to production department and then allocates the cost from departments to individual units as average costs for all units completed in a period. This method is commonly used by the manufacturer of food, beverages and plastic products.

There are two types of cost under these two methods, inventoriable product cost and period cost.

• Inventoriable product costs include the direct cost, indirect cost incurred in manufacturing process
• Period cost is a cost which is not included in the inventoriable product cost since this kind of cost is not contributed into the production of the cost, such as expense incurred by selling and administration; however, according to AASB 102 Inventories, this would not be considered when determining the cost of the product since period cost is non-manufacturing cost.

Activity based accounting (ABC)

Main article: Activity-based costing

Activity based costing is a modern accounting method which provides a more accurate allocation of costs to products or other cost objects. Unlike the conventional cost accounting system, ABC costing is focusing on activities for cost collection; activity in here means a type of task or function performed in an entity. For example, the activities in manufacturing firm include engineering, inspection, customer support and information system; with regards to service organisation, the activities could be marketing and information technology, client support.

Under this accounting method, the procedure of tracing direct material and direct labour cost is same as the conventional accounting method, the difference is the way that allocate the overhead cost. Each activity has their own cost pool, the overhead cost would firstly allocated to activity cost pools related to each activities in the organisation, then proportionally allocated to individual product using the corresponding cost driver.

Sustainability management accounting

Main article: Sustainability accounting

In sustainability management accounting, there are five types of costs to determine the cost incurred by the production, which include conventional costs, hidden costs, contingent costs, image and relationship costs, and societal costs. However, all of these costs except the societal one are financial figures that significantly effect the reporting entity's profit; we call the summation of these cost ‘Private cost’. The societal cost is mostly ignored when calculating the cost of production under management accounting since this is an externality which unlikely influences the organisation's profit; but the cost is considered when it has been realized and internalised under sustainability accounting system.

• Conventional cost, the most general term of cost in determining the cost generated by production department. To begin with, the cost of the direct raw materials for production, utilities, labour, supplies, structures, capital equipment and its related depreciation expense. These are the costs components in determining cost of production under Cost accounting.
• Hidden cost, these are the costs not included in the determination of production cost. These comprise of upfront environmental costs, initial design costs of environmentally preferable products, regulatory costs and future decommissioning or remediation costs.
• Contingent cost, as the name suggested, this cost is a probabilistic term; this cost will only be charged if the entity violates the environmental requirements or regulation; for example, fine, clean-up costs, lawsuits relating to unsound products or service provision.
• Image and relationship costs, although the determination of the cost is complicated and rarely be separately identified within the accounting system, they have an effect on the value of some intangible asset of the organisation, such as goodwill.
• Societal costs, in sustainable accounting, it has been referred as externalities; these costs typically ignored by most of the reporting entities; the cost can be charged due to the consequence of their production on the environment, and it could be also because of the adverse health effect by organisation-generated emissions.

Inclusion of these costs provides useful information for decision makers, but the measurement of these costs are complicated to determine, mostly changing with the scope of the investigation and not reliable and unbiased.

Full cost of production in Economic

Main article: Environmental accounting

Social and environmental liabilities are the main factors which mostly are considered by the industrial companies in recent decade, because these factors significantly influence their financial figures. However, due to the uncertainty existing in determination of environmental and social liabilities, some entities found that it is difficult for them to understand how their environmental liabilities could affect their corporate images and reporting. In order to distinguish financial effect caused by the environmental liabilities, environmental evaluation and accounting techniques need to be used.

Environmental accounting

Environmental accounting is one of the accounting techniques which help managers to understand environmental impacts and associated financial effects, and also contribute in industrial decision making in the developed countries. Managers of industrial company could manage, measure and improve their environmental aspects of their operations by using this accounting tool. By avoiding the environmental liabilities, company is able to earn significant financial pay off with environmental beneficial investment. For example, General motors, an American vehicle manufacturer, successfully lower their disposal cost by introducing an environmental friendly container program.

Environmental costs

There are two types of cost involved in environmental accounting, internal cost and external costs.

Internal cost

This type of costs mostly has direct impact on the company's financial statement, such as hidden cost, contingent costs, conventional costs and image or relationship costs. All of these have same as those in sustainability management accounting.

External cost

External cost is not accountable, it is defined as adverse effect of business's activity and decision which is not accountable for organisation, such as water pollution by discharging polluted wastewater, air pollution due to the emission of air pollutant; these are the cost normally not compensated by industrial firms. To consider external cost into environmental accounting, the financial value of these factors are subjective and hard to determine. A number of techniques are available for monetising these negative effect on environment and society; they are categorized into two categories: dose-response techniques and behavioural methods.

Methods for monetizing the social and environmental cost

	Behavioural methods	Dose-response techniques (damage function approach)	Dose-response techniques (cost of control approach)
Suitable cost	contingent valuation, hedonic pricing and travel costs	Damage costs	avoidance, restoration, abatement and maintenance cost
Explanation	measure the money value of a specific impact effected by the stakeholders' preference or behaviour	Measure the value of adverse impact caused by specific pollutant from a specific site	Measure the value of cost incurred by the protecting mechanism for reducing the pollution
Way to access the price	market data, or questionnaires, surveys or experimental techniques	Scientific, statistical and behavioural valuation methods	Using 'real' market prices
Advantage	Straightforward and uncontroversial since the price is based on actual market price	Based on scientific information	Figure is less controversial than the damage function and provides more reliable valuation
Disadvantage	Inherent bias	Limitation on accessing the data, complex and time-consuming, numbers of assumptions and judgements are needed	Applicable if there is existing protecting mechanism, otherwise no reliable measurement can be generated.
Priority in using	3rd, if first two techniques cannot apply, or supplement for first two approaches	1st, Primary technique for valuing externalities	2nd, if too many uncertainties involved in damage function

The common limitation of these methods are they all providing an estimation of the cost. The reliability of the information behind the estimation is ambiguous due to the uncertainty existing in the evaluation of data.

Quantitative life cycle assessment

To get a comprehensive view of environmental effect and financial effects, combining quantitative life cycle assessment with environmental accounting will demonstrate detailed information about the environmental trade off. There are three steps in quantitative life cycle assessment

1. Compiling an inventory of relevant energy and material inputs and environmental releases

2. After the recognition of the inputs and releases, evaluation of corresponding environmental and social impacts.

3. Making informed decision by analyzing the output of the evaluation.

Total cost assessment

This terminology has the same concept as Full environmental cost accounting, total cost accounting and full cost accounting. Total cost assessment environmental accounting system consider the full life cycle of the product or process, take the quantitative life cycle assessment into account, provide insight in understanding of environmental and human health costs and impacts related to projects, accounting for both internal and external costs.

Cost-benefit analysis (CBA)

To determine the feasibility of a business activity, Cost-benefit analysis is one of the conventional methodologies of economic analysis. Under Cost-benefit analysis, project is economically feasible if the total benefit is greater than zero, where Bt >0

Bt = Bi+ Be - OC

• Bt: total benefit (total income - total cost)
• Be: external benefit (positive externalities - negative externalities)
  • external benefit, e.g. health and environmental benefits
  • external cost, e.g. biological and chemical risks
• Bi: internal benefit (internal income - internal cost)
  • internal benefit, e.g. sales income from regenerated products or recycled sub-products
  • internal cost, e.g. investment costs, operating and maintenance costs, finance costs
• OC: opportunity cost
  • opportunity cost is defined the value of next best alternative use of the resource

EEGECOST model (Environmental Engineering Group Environmental cost model) in South Africa

This model was established based on the total cost assessment environmental accounting system. This model is helping users to analyse the cost incurred by environmental and human health related decision, activities and result over the full life cycle of a product or process at present and especially for the future. There are five steps need to be undertaken in EEGECOST model:

1. Determining the objectives and scope of the analysis

2. Applying the life cycle assessment (LCA) of the process of product

3. Identifying the related costs and allocating them into corresponding cost type

4. Conducting the impact assessment for significant impact cost types

5. Providing the informative result for decision makers.

Advantage over traditional environmental accounting system:

• Wider horizon in cost and benefit items
• Lower risk and uncertainty
• Quantifying the unquantified item in traditional accounting system
• Specifically allocate the related cost to corresponding cost driver

1.Objective statement and scope of analysis

The objective of the analysis is providing an insight in product or process for statement's users. And the scope of the analysis is divided into two sectors which are time frame and type of cost comparison.

Time frame is basically referred to the period of analysis, because the discount factor on price will be varied with different terms of period, in other words, the involved future cost will change base on the discount rate; as a consequence, we need to define the time horizon before we start the analysis for evaluation of decisions.

Five different kinds of cost comparisons in this system

• Existing process analysis
• Existing process compares to existing process analysis
• Existing process compares to new process analysis
• New process compares to new process analysis
• Capital budgeting analysis

2.Life cycle assessment (LCA)

A manual procedure, output of LCA can be used as the input of EEGECOST model, which provide informative value in environmental cost by converting each cost type into economic values in cost inventory form. There are five type of costs involved in the cost allocations:

• Type I: site costs
  • Type I a: non-recurring site costs
  • Type I b: recurring site costs
• Type II: Corporate costs
• Type III: Impact costs
• Type IV: internal intangible costs
• Type V: external costs

3. Environmental cost inventory

Once the allocation of the cost type and conversion to economic value are completed, cost inventory forms will be further categorized into different environmental media categories:

• Air and climate
• Waste
• Wastewater
• Soil and groundwater
• Noise and vibration
• Biodiversity and landscape
• Radiation
• Other costs

These environmental medias categories can separated in three types of sections

• treatment, operation and prevention
• general and beyond
• environmental revenues

Treatment, operation and prevention

Treatment, operation and Prevention	Type I or Type II	explanation
Depreciation costs	Type II cost	depreciation expense, allocated the cost of acquiring an asset in terms of different ways, such as unit of production, number of year. Depends on the company's policy, straight line depreciation or fixed percentage depreciation
Cost for maintenance and operating materials	Type II cost	Referred to those involved in administration and production process, not raw material of products, such as oils lubricants chemicals paints varnishes diluting agents glues cleaning agents
Cost for external services	Type I or Type II cost	cost involved in environmental management functions, for example, site construction legal aid functional management environment- related consultations training inspections audits communication These cost further categorized in to three types Type I (a) --> Non-recurring cost, especially for new site development Type I (b) --> Recurring cost, weekly maintenance fee Type II --> research and development
Personnel cost	Type II cost	Operating personnel, management
Cost related to fee, taxes and charges	Type I or Type II cost	Fees, taxes and charges Disposal and effluent fees cost for specific licenses environmental taxes permit fee for air emissions and wastewater discharges
Cost of fines and penalties	Type III cost	Violation to environmental regulations, fines and penalties illegal discharges to the environment release to the environment above permitted quantities
Insurance cost	Type II	insurance for environmental liability insurance against damage to individuals, goods and biodiversity insurance of transportation of hazardous materials
Cost of provisions for environmental management	Type II or Type III cost	provisions for environmental management (contingent future expense) remedial activities equipment repairs groundwater contamination surface water contamination air emissions due to breakdown of control equipment radioactive emissions soil contamination

General and beyond

General and beyond	Type of cost	Explanation
General environmental management activities	Type I or Type II	Staff expense of general environmental management activities travel expenses discussion sessions of environmental management activities and projects Audit fee for compliance and external communication
Research and development	Type I or Type II	Type I a --> New site development Type I b --> upgrade for existing site and relevant research Type II --> cost related to production research, process and system innovation
Extra expenditure for cleaner technologies	Type I or Type II	Expense on cleaner technologies, such as integrated pollution prevention measures interest expense on debt related to sustainable environmental management
general direct costs	Type I or Type II	Similar to those in management accounting raw materials auxiliary materials, e.g. glue packaging costs utilities Cost incurred by volunteer or prison labour in operation transportation cost
General indirect costs	Type I or Type II	costs related to operations and environmental media advertising fee telephone costs
internal intangible costs	Type IV	Internal cost related to intangible environmental activities annual environmental report costs community relations activities voluntary environmental activities, e.g. tree planting pollution prevention program staff mortality and morbidity
External costs	Type V	cost of an environmental and social impact but the entity has no financial responsibility

Environmental revenue

Earning from environmental friendly investment and cost saving from those investment and project, mostly referred to revenue from recycled material and subsidies.

Environmental revenue

Environmental revenue	explanation
Revenue from recycled materials and subsidies	Investing in environmental protection will be awarded by subsidies, tax exemption and non-fiscal advantages

5. Cross-balance and reporting

Compiling the final report with informative result for decision makers, which incorporate the value of costs and their cost types. EEGECOST model provide a cross-balance function and checking about the allocation of cost. The cost report form of this model composed by

• costs incurred by media
• future costs by type
• revenue received by media
• cost incurred by type
• interactive costs incurred by media graph
• interactive cost types by year graph

Reference

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