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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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Cost identification & estimation
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
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:
“The Investment Decision Cost/Savings 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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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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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?
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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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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Fixed vs. Variable Costs (2)
Fixed vs. Variable Costs (2)
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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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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Costs missing fromthe accounting records
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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Costs missing fromthe accounting records
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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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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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
solvent airemissions
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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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:
“The Investment Decision Cost/Savings Checklist”
— We used it yesterday
Checklist:
“The Investment Decision Cost/Savings 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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Cost identification & estimation
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?
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