Cost Identification
and Estimation
1
Introduction to Cost
Identification and Estimation
[15 minutes]
2
Decision-making factors
Technical
Regulatory
Project
selection
Today’s focus
Financial
Organizational
3
The language of business
Costs are an important aid in translating environmental
needs to business needs. In addition, they already serve as
an “official language” in the company.
capital
investment
project
ROI
profit centre
market
profitability
cost allocation
share overhead costs
unit price
regulatory
compliance
incinerator ban
recycling
CDO
energy wastewater dioxin
efficiency
With the cost translation, the business and environmental
manager can communicate and co-operate more effectively.
Adapted from “Pilot program for the promotion of environmental management in developing
countries” (P3U). Environmental Cost Management. GTZ-P3U. Bonn, Germany
4
Financial analysis steps
 Cost identification & estimation
We will discuss this now
We will discuss these tomorrow
 Project profitability evaluation
5
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
6
Small group exercise:
Cost Identification at the
PLS Company
[75 min]
7
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
8
Manufacturing steps at the PLS company
— Materials flow map
plastic film, aluminium film, adhesive
solvent air
emissions
solvent air
emissions
INVENTORY
printed
laminated
printed
plastic film, ink
film
PRINTING
film
SLITTING
product
LAMINATION
Solid scrap
Solid scrap
Solid scrap
Liquid waste
ink
to waste
management
to waste
management
9
Waste management at the PLS company
— Materials flow map
air
emissions
wwtp chemicals
air
emissions
Cleaner
water to
a nearby
stream
fresh water
fuel and fuel
additive
INCINERATOR
ash
WASTEWATER TREATMENT
sludge
liquid ink
waste from
printing step
OFF-SITE
LANDFILL
10
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.)
11
Three broad categories
of 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.
12
Checklist:
“The Investment Decision
Cost/Savings Checklist”
Refers to the checklist document
13
The cost of waste
at 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)
14
Problematic accounting
practices—what might make it
difficult to estimate costs
accurately
(Particularly costs related to waste)
Let’s Brainstorm!
[30 min]
15
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?)
16
“Hidden” costs of lost raw materials
Manufacture of plastic rear panels for automobiles
(as a percentage of input materials)
Material loss per
accounting records
2%
Actual
material
loss
52%
Adapted from: Rooney, Charles. “Economics of Pollution Prevention:
How Waste Reduction Pays.” Pollution Prevention Review.Summer 1993.
17
“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
18
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
19
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
20
Environmental management costs
“hidden” in an overhead account
Product Manufacturing Cost Statement
Variable Costs
Raw Materials
Intermediates
Additives
Utilities
Direct Labour
Packaging
Wastewater
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 costs
Fixed Costs
Supervisor
Supervisor
Fixed Labour
Depreciation
Fixed labour
Divisional Overhead
General Services &
Depreciation
Administration
Divisional overhead
General services &
Total Variable Cost
Total Fixed Cost
administration
Total Manufacturing Cost
• legal expenses
• environmentally
driven R&D
• permitting time and
fees
• environmental
training
$4,600
$57,800
$1,227
$13,662
$1,294
Total Cost
21
Source: Green Ledgers: Case Studies in Corporate Environmental Accounting. World Resources
Institute. May 1995.
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
22
Cost assignment
at 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
23
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?)
24
Cost 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
25
Cost allocation
at the PLS company
Allocated from
overhead
 Solid scrap
waste
Printing
Laminating
 Treatment and
disposal costs
Slitting
How would you
allocate?
On the basis of:
• # of set-up runs?
• raw materials use?
• machine hours?
• amount of scrap?
• some other basis?
26
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?)
27
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
28
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!
29
Fixed vs. Variable Costs
at 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?
30
It is important to
remember:
Future fixed costs
are not fixed yet!
Cleaner Production now
can reduce the size & cost of
treatment equipment that
you may have to purchase
in the future
31
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?)
32
Costs missing from
the 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
33
Costs missing from
the 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?)
34
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?)
35
Ease of identifying
and 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!)
LESS
HIDDEN
Equipment purchase,
direct materials, energy, labour
Waste disposal
Recycle/rework, treatment,
waste handling
MORE
HIDDEN
Regulatory compliance,
other indirect costs
Less tangible costs
36
Potential Sources
of Cost Data
Let’s Brainstorm!
[15 min]
37
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
38
Review of What We have
Covered so Far
[15 min]
39
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
40
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
41
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
42
Questions or comments?
43
Small group exercise:
Cost Estimation at the PLS
Company
[60 min]
44
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.)
45
Tools For Data Identification
and Estimation
[30 min]
46
Tools:
Original data records







Purchase order/invoices
Production records
Waste shipment records
Equipment logs
Engineering estimates
Regulatory reports
Staff interviews
Source: Northeast Waste Management Officials’ Association
47
Checklist:
“Cleaner Production
Data Sources”
48
Tools:
Materials flow map
plastic film, aluminium film, adhesive
solvent air
emissions
solvent air
emissions
INVENTORY
printed
laminated
printed
plastic film, ink
film
PRINTING
film
SLITTING
product
LAMINATION
Solid scrap
Solid scrap
Solid scrap
Liquid waste
ink
to waste
management
to waste
management
49
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
INPUTS
MANUFACTURING
PROCESS
PRODUCT
NON-PRODUCT
OUTPUT (WASTE)
50
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
51
Checklist:
“The Investment Decision
Cost/Savings Checklist”
— We used it yesterday
52
Investment decision
Costs & savings
 Initial investment costs
 Annual operating costs and savings
–
–
–
–
The cost of operating inputs
The cost of waste management
Less tangible costs
Revenues
53
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
54
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
55
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
56
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
57
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.
58
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!
59
Cost Identification and
Estimation
Summary and Q&A
[15 min]
60
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
61
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?
62