Summary by Neil Escalante
Master of Accountancy Program
University of South Florida, Summer 2003
The idea behind this article is that when considering the actual cost of production, often the cost of disposing waste (as a byproduct of production) is overlooked. The article refers to this as environmental cost.
The article starts off by giving detail of a company, Myer Manufacturing, Inc., that had two choices when it came to selecting paint for transformer boxes: a solvent-based paint and a powder-paint. At first glance, the solvent-based paint seems the more practical choice with $100K less in annual cost. However, the article makes clear that this annual cost is only based off of equipment amortization and the cost of the paint. Environmental costs were not considered.
For the solvent-based paint, a wall of running water (called a water curtain) is needed to collect excess paint along the conveyor. This water turns into sludge and ends up in a pit which requires several hours each month to be cleaned. The contents of the pit are deemed to be hazardous waste by environmental regulations, and a license is needed to produce such waste. These regulations require that a licensed company be contracted to dispose of such waste. For Myers specifically, this cost $55K annually. Also the Environmental Protection Agency (EPA) demands that companies file annual reports on the toxic waste created as well as a Toxic Release Inventory Report giving detail of chemicals used and released into the environment.
There are many other costs related to toxic waste handling. A superfund fee is much like a tax usually charged per kilogram produced of toxic waste. This fee is paid by pollution-generating companies and is used to clean up hazardous waste sites. Also, workers must be trained to deal with hazardous materials to avoid spills, fires, or releases of hazardous waste. This training consists initially of 40 hours classroom work and 8 hours each year to keep the workers up to date. The company must keep detailed records of the training and workers’ grades. This training is not only expensive but also the cause of lost man hours.
Insurance is also a big cost incurred. A special policy is necessary for a hazardous waste producing company. In addition, the insurance company will send a “loss-control engineer” to assess the company’s risk. In turn, companies hire environmental engineers to review production procedures and solve or prevent any potential problems that may occur with the hazardous materials before looking around for the best insurance provider.
Another fee must be paid for the right to build a plant that emits pollutants into the air. This permit lasts five years and if the company emits more that the limit set by the original fee, it must pay another fee based on the new emission level. In addition to paying for this permit, an annual fee is paid based on the volume of pollutants released into the air. Some states charge this fee based on actual volume of pollutants and others charge on the total capacity of emission.
The last two environmental costs that this article lists in the Myers case are Record Keeping and Wastewater Treatment. According to the authors, a company must be able to produce, at any given time, complete records of the quantity of hazardous waste produced, the amount of time it spent in storage and the date it was turned over to a certified waste-disposal company. With regard to the wastewater treatment, The Clean Water Act of 1977 prohibits the release of toxic waste into US waters without a permit. Therefore, Myers must send the water from its water curtain to a treatment facility. This would cost approximately $25K per year.
After looking at all the factors, it is clear that the solvent-based paint would end up being about $146K more expensive (per year) than the powder. Without looking at the environmental costs, a very cost-inefficient decision could have been made.
The article continues to give three types of strategies to minimize environmental costs:
process improvements, and
End-of-pipe strategies maintain the production process running as usual and then incur costs to dispose of the waste produced. It is easy to implement because any modifications to production are only made at the finished stage; however, this strategy only increases cost and does not provide any additional value to manufacturing. Process improvements are phases of production that are integrated into the process to recycle or reuse the waste so as to cut down total consumption. The article gives the example of Dow Chemical, a company that recycled and reused a reactant that was previously incinerated after each use. This reduced the consumption of this reactant by 80%. Pollution prevent may require a complete overhaul of the production process. Pollution can be prevented by replacing hazardous materials with safe ones or by converting waste produced into usable products. The authors provide several examples, one of which is how a steel processing company that generated large amounts of pickling liquid and was able to sell this liquid to another company who used it in production. This not only reduced cost but also produced revenue for the company.
Calculating the cost of the end-of-pipe strategies may provide a good benchmark to set a limit for the other strategies. The authors go on to explain how another company, Milford, Inc., attempted to use these three strategies at different parts of the production process.
Milford, Inc. produces door locks under the brand name of Safelock. During production, a petroleum based liquid is used to carry away metal shavings and to cool down the parts. However, the residue from this liquid must be removed and the parts degreased. Currently, Milford is using the vapors from a chemical called trichloroethylene (TCE) to do the degreasing. However, the vapor’s emissions are classified as toxic. Milford , therefore, has to provide an annual report on toxic releases to the EPA and detailed records of TCE emissions to the regulators of air emissions, inspect TCE storage areas to ensure there is no leakage, and hire certified professionals to dispose of the TCE waste. Milford believes that the cost of purchasing and using TCE will increase over the next few years because it is a suspected carcinogen; it was one of the substances targeted in the Clean Air Act Amendments of 1990; it has a tendency to seep into the soil and to groundwater; and also because the government is increasing taxes on TCE to deter its use.
After estimating the increased cost of TCE along with the cost of new equipment needed to comply with upcoming regulations and the cost of disposing of TCE, a present value of the cost of continuing to use TCE was set at $845K. This end-of-pipe strategy cost was the standard by which all other strategies were to be set.
As part of the process improvements strategy, a consultant suggested that an alkaline-based material be used as the cleaning compound instead of TCE. This new material would allow the production process to be more automated and would make two worker positions obsolete. Also, there would be no training cost, monitoring cost or special disposal cost since this material is not hazardous. The net cash flow with this new process would have a present value of $698K.
Milford also entertained the idea of having a pollution prevention strategy, but this did not seem feasible. To redesign the product would cost anywhere from $500K to $1.5M. To redesign the production process could cost about $300K and new equipment would be around $5M. An even further discouraging factor of redesigning was that the current product line had undergone 50 years of evolution and perfecting. A new product line may take the same amount of time to develop to the previously established standard. Milford decided that pollution prevention was to be considered a possibility only for the future and should be kept in mind as incremental changes were made in the existing product.
The final section of the article is somewhat a blueprint for building a control system to identify and minimize environmental costs in a production company. According to this section, the first step in controlling environmental cost is by making these costs the responsibility of the line managers who are in charge of the processes that generate these costs. These lines managers should be privy to financial information so as to see the direct results of their decisions.
The authors state that, at times, it maybe be difficult to determine which line manager is responsible for various types of waste. To figure who is responsible, waste must be traced back to the source and then the decision maker for that source is responsible. Also, if several managers are responsible for a waste stream, then each manager should be given information for and be held responsible for mitigating the entire stream. According to the authors, splitting up the waste stream will only lead to arguments regarding the manner by which the costs were divided. The health, safety, and environmental officer is only a guide and is not responsible for reducing cost.
The article concludes that environmental costs can no longer be considered insignificant. These costs demand high level management attention.
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