Cost Identification and Estimation

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Cost Identificationand Estimation

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Introduction to Cost Identification and

Estimation

[15 minutes]

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Decision-making factors

Project selection

Technical

Organizational

FinancialRegulatory

Today’s focus

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Costs are an important aid in translating environmental needs to business needs. In addition, they already serve as an “official language” in the company.

The language of business

Adapted from “Pilot program for the promotion of environmental management in developing countries” (P3U). Environmental Cost Management. GTZ-P3U. Bonn, Germany

project profitability market

share

capital investment overhead costs

profit centre

unit pricecost allocation

ROI

regulatory compliance

incinerator banCDO

wastewaterdioxin energy

efficiencyrecycling

With the cost translation, the business and environmental manager can communicate and co-operate more effectively.

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Financial analysis steps

Cost identification & estimation

Project profitability evaluation

We will discuss this now

We will discuss these tomorrow

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Initial investment costs– e.g., equipment, installation, training

Annual operating costs, savings,and revenues– current operations, before the project– after project implementation– e.g., materials, energy, labour

Need to identify, estimate and allocate all relevant and significant items impacted by the project

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Small group exercise:Cost Identification at

the PLS Company

[75 min]

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The PLS Company

A medium-sized manufacturer of food packaging materials

Major manufacturing steps are Printing, Laminating, and Slitting

Waste management includes incineration and wastewater treatment

Cleaner Production has reduced volume of solid scrap and annual operating costs

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INVENTORY

SLITTING

Manufacturing steps at the PLS company

— Materials flow map

solvent airemissions


printed laminated

filmplastic film, inkproduct

plastic film, aluminium film, adhesive

PRINTING LAMINATION

Liquid wasteink

Solid scrap

to waste management

to waste management

Solid scrapSolid scrap

printed

film

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Waste management at the PLS company — Materials flow map

air emissions

dirty scrubber water

OFF-SITELANDFILL

INCINERATOR WASTEWATER TREATMENTsolid scrapfrom printing,laminating,slitting steps

fuel and fueladditive

fresh water

wwtp chemicals air

emissions

Cleanerwater to a nearbystream

ash sludgeliquid inkwaste from printing step

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Exercise instructions

Introduction (10 min.), detailed in your handout

Review the written description and flow maps for the PLS Company (10 min.)

Question 1 (15 min.) Question 2 (15 min.) Discuss your answers with the other

small groups and the instructor (20 min.) Lessons learned (5 min.)

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Three broad categoriesof costs

The cost of manufacturing inputs– Materials, energy, labour, capital, etc.

The cost of waste management– Waste handling, regulatory compliance,

waste treatment and disposal, etc. Less tangible costs

– Production throughput, product quality, company image, liability, etc.

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Checklist:

“The Investment Decision Cost/Savings Checklist”

Checklist:


Refers to the checklist document

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The cost of wasteat the PLS company

The total Cost of Waste due to the generation of solid scrap during print runs was estimated to be US$213,000 per year, including:– Cost of lost direct manufacturing inputs

(e.g, plastic film, ink, energy, labour)– Cost of waste management (e.g.,

incinerator operation, wastewater treatment plant operation, final waste disposal)

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Problematic accounting practices—what might

make it difficult to estimate costs accurately

(Particularly costs related to waste)

Let’s Brainstorm![30 min]

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Problematic accounting practices?

Various costs at a facility might be...– “Hidden” in the accounting records– Misallocated from overhead accounts– Classified as fixed when they are really

variable, or semi-variable– Not found in the accounting records at

all– (Can you think of others?)

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2%

Material loss peraccounting records

52%

Actualmaterial

loss

“Hidden” costs of lost raw materials

Manufacture of plastic rear panels for automobiles

(as a percentage of input materials)

Adapted from: Rooney, Charles. “Economics of Pollution Prevention:How Waste Reduction Pays.” Pollution Prevention Review.Summer 1993.

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“Hidden” costs of lost raw materials

at the PLS company The PLS accounting records show:

– The amount of raw materials used– The amount of final product shipped

But the records do not show:– The amount of solid scrap waste

generated– The amount of any other lost raw

materials

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Direct vs. Indirect Costs (1)

Direct Costs are costs that can be easily traced to a unit of product– e.g., direct materials, direct labour

Indirect Costs are costs that cannot be traced as easily to a unit of product– e.g., facility energy use, insurance,

maintenance, waste treatment A cost considered “direct” at one firm

may be considered “indirect” at another firm

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Direct vs. Indirect Costs (2)

In general, direct costs within an industrial firm are assigned directly to the process, product, or project responsible for generating the cost

Indirect costs are assigned to facility, division, or company overhead accounts

It can be difficult to find costs “hidden” in overhead accounts

21Source: Green Ledgers: Case Studies in Corporate Environmental Accounting. World Resources

Institute. May 1995.

Environmental management costs

“hidden” in an overhead account

Product Manufacturing Cost Statement

Variable CostsRaw MaterialsIntermediatesAdditivesUtilitiesDirect LabourPackagingWastewater Treatment

$2.27/lb.$0.87/lb. $0.41/lb. $0.96/lb.

$11.32/lb. $10.31/lb. $9.14/lb.$0.04/kW-h $0.07/kW-h

$27.40/hr $31.43/hr.$0.60/pkg. $0.57/pkg

$0.01/gal.

Fixed CostsSupervisorFixed LabourDepreciationDivisional OverheadGeneral Services &

Administration

$4,600$57,800$1,227

$13,662

$1,294

Total Variable CostTotal Fixed Cost

Total Manufacturing CostTotal Cost

• legal expenses• environmentally

driven R&D• permitting time and

fees• environmental

training

Fixed costsSupervisorFixed labourDepreciationDivisional overheadGeneral services & administration

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Survey of industry accountants

in the US

Survey of industry accountants

in the US

Findings:– Environmental management costs

such as waste handling, treatment, and disposal predominantly assigned to overhead accounts

– Even energy and water costs (manufacturing inputs) are usually assigned to overhead accounts

Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995

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Cost assignmentat the PLS company

Cost assignmentat the PLS company

The cost of direct materials, labour, and energy are assigned directly to the manufacturing steps

In contrast, waste treatment and disposal costs are assigned to an overhead account in the Office of the Business Manager

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Cost allocationCost allocation

Costs initially assigned to overhead accounts are usually allocated back to processes, products, or projects using an allocation basis such as

– Quantity of raw materials used– Production volume– Machine hours– Labour hours– Floor space

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Cost allocationat the PLS company

Cost allocationat the PLS company

Solid scrap waste

Treatment and disposal costs

Printing

Laminating

Slitting

How would youallocate?

On the basis of:• # of set-up runs?• raw materials use?• machine hours?• amount of scrap?• some other basis?

Allocated from overhead

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Problematic accounting Practices?




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Fixed vs. Variable Costs (1)

Fixed Costs are costs that do not vary with production level or other factors – e.g., equipment depreciation, labour

Variable Costs are costs that do (or can) vary with production level or other factors– e.g., raw materials use, energy use

A cost considered “fixed” at one firm may be considered “variable” at another firm

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The goal of Cleaner Production is to reduce variable costs

Therefore, it is important to correctly distinguish between fixed and variable costs when identifying and estimating costs to support CP efforts

If CP efforts will reduce a cost — then it is variable!

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Fixed vs. Variable Costsat the PLS company

Incinerator operating costs at PLS include:– Fuel, fuel additive– Operating labour– Trucking ash to landfill– Equipment depreciation costs

PLS views these waste treatment costs as essentially fixed costs — do you agree?

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It is important to remember:

Future fixed costsare not fixed yet!

Cleaner Production nowcan reduce the size & cost of

treatment equipment thatyou may have to purchase

in the future

It is important to remember:

Future fixed costsare not fixed yet!

Cleaner Production nowcan reduce the size & cost of

treatment equipment thatyou may have to purchase

in the future

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Costs missing fromthe accounting records


In general, two types of costs may be entirely missing from the accounting records: Future costs

– Future variable costs, e.g., landfill fees– Future fixed costs, e.g., future depreciation

costs of new waste treatment equipment

Less tangible costs– e.g., lost profit from reduced production

throughput

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at the PLS company Lost profit from reduced

production Future regulatory costs (e.g.,

stricter wastewater regulations) Potential liability Negative company image (Can you think of others?)

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Ease of identifyingand estimating costs

In general,as you go down this list, costs are more likely to be hidden or difficult to quantify(but every case is different!)

LESSHIDDEN

MOREHIDDEN

Equipment purchase,direct materials, energy, labour

Waste disposal

Recycle/rework, treatment, waste handling

Regulatory compliance, other indirect costs

Less tangible costs

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Potential Sourcesof Cost Data

Let’s Brainstorm!

[15 min]

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Potential sources of cost data

Internal data sources – The accounting system– Original data records in different departments– Colleagues/employees

External data sources– Industry colleagues or trade associations– Vendors and consultants– Business partners (e.g., insurance firm)– Government (e.g., environmental agency)– National Cleaner Production Centre

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Review of What We have Covered so Far

[15 min]

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Cleaner Production

The cost of waste – Usually underestimated!

Profiting from Cleaner Production– Cleaner Production as waste prevention

and on-site recycling Cleaner Production

– Benefits– Implementation steps

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Cost odentification and estimation

Cost identification– Introduction to PLS company (will see

more of PLS tomorrow)– Categories of costs (manufacturing

inputs, waste management, less tangible costs)

– Problematic accounting practices– Sources of cost data

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Coming up... Cost estimation tools

– Process mapping, material flows Project profitability assessment

– Cash flows– “Simple Payback” indicator– “Time-value-of-money” concept– “Net Present Value (NPV)” indicator– Other indicators– Other profitability assessment issues

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Questions or comments?

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Small group exercise:Cost Estimation at the

PLS Company

[60 min]

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Exercise instructions

Introduction (5 min.), detailed in your handbook

Question 1 (20 min.) Question 2 (15 min.) Discuss your answers with the

other small groups and the instructor (15 min.)

Lessons learned (5 min.)

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Tools For Data Identification and

Estimation

[30 min]

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Tools:Original data records

Tools:Original data records

Source: Northeast Waste Management Officials’ Association

Purchase order/invoices Production records Waste shipment records Equipment logs Engineering estimates Regulatory reports Staff interviews

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Checklist:

“Cleaner Production Data Sources”

Checklist:

“Cleaner Production Data Sources”

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Tools: Materials flow map

INVENTORY

SLITTING



printed laminated

filmplastic film, inkproduct

plastic film, aluminium film, adhesive

PRINTING LAMINATION

Liquid wasteink

Solid scrap

to waste management

to waste management

Solid scrapSolid scrap

printed

film

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MANUFACTURINGPROCESSINPUTS

PRODUCT

NON-PRODUCT OUTPUT (WASTE)

Tools:The materials balance

Physical analogy to financial balance sheet

Compares all material inputs and outputs

Identifies sources of waste and data gaps

Provides basis for cost evaluation

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Tools:Cost checklist

Tools:Cost checklist

Consider tailoring a generic checklist for routine use with specific industry sectors and/or for specific process/project types

Determine if each item on the list is:– Not relevant– Relevant but quantitatively insignificant– Relevant and quantitatively significant– Relevant but not quantifiable

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Checklist:


— We used it yesterday

Checklist:


— We used it yesterday

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Investment decisionCosts & savings

Initial investment costs Annual operating costs and

savings– The cost of operating inputs– The cost of waste management– Less tangible costs– Revenues

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Tools:Activity Based Costing

(ABC)

Tools:Activity Based Costing

(ABC)

Under ABC, costs are allocated from overhead accounts – To the processes, products, or projects that

actually generated the costs– On the basis of activities with a direct

relationship to cost generation

ABC will not eliminate overhead accounts, but will ensure the availability of more accurate cost information for decision-making

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Tools:External expertise

for less tangible costs

Examples: Insurance sector— liability

estimation Marketing Firms— value of

company image Environmental agencies —

estimates of current and future regulatory compliance costs

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Cost identification and estimation

Summary of tools (1) Work as a team— talk to everyone Do a facility walk-through Map process steps, materials

flows, employee activities, etc. Do materials and energy balances Use a comprehensive cost/savings

checklist External expertise for less

tangible costs

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Cost identification and estimation

Summary of tools (2) Do a check on data from the

accounting records– overhead costs appropriately allocated?– accurate characterization of fixed vs. variable?

Compare accounting record data to information from your maps, materials balances, staff interviews

Go back to the original data sources Think creatively

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To quantify or not to quantify?

To quantify or not to quantify?

How do you know if a relevant cost or savings is quantitatively significant before you go ahead and quantify it?

You don’t.

Try to do at least a rough, first-cut estimate of all quantifiable costs — then decide whether or not refining the estimate is worth the effort.

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Do a balancing act...Do a balancing act...

Don’t spend any more time than necessary collecting and analyzing data

but Make sure you have really included

all of the most significant costs & savings in the analysis

Make sure that you are not neglecting other CP alternatives for the same waste stream that might be even more profitable!

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Cost Identification and Estimation

Summary and Q&A

[15 min]

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Small group exercise on cost identification

Problematic accounting practices Potential sources of cost data Small group exercise on cost

estimation Tools for data estimation

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Cost identification and estimation at your

organization[15 min]

Take this time to write down some next steps for cost identification & estimation at your organization– What accounting practices might you want to

understand better?– What other data sources might be the most

valuable?– What cost identification & estimation tools

might be the most useful?

Documents

Cost Identification and Estimation