Using Flexible Budgeting to Improve Sustainability Measures 

Published January 23, 2017

Today, many companies report on their energy or water usage as part of their sustainability reports. Some organizations also report on their energy intensity or water intensity values such as energy per unit of output or water consumed per dollar of revenue.  In doing so some are making errors in presenting and interpreting these intensity values. This presentation creates an opportunity for CPAs in business and industry, who can use their expertise to provide the companies they work for with an appropriate characterization of the information. Similarly, CPAs in public practice can advise their clients in this area.

Annual changes in average intensity have been presented as a measure of efficiency improvements1.  It is true that changes in efficiency impact average intensity. However, average intensity is impacted by many other factors including (1) shifts in product mix, (2) outsourcing and insourcing, (3) changes in total production levels, and (4) acquisition and divestitures. The challenge in measuring efficiency improvement is to separate it from the other confounding factors. In this article we discuss the confounding influence of shifts in production.  In future articles we will address the other confounding factors.

We have observed that many errors in reporting on sustainability information occur when factors are considered to be related to one another when, in fact, they should be considered individually. The following example demonstrates our point. Consider a company producing two products, A and B, where A requires less electricity to be produced relative to B, and where a shift takes place in demand favoring A. In year 1, each unit of A requires one unit of electricity and each unit of B requires 2 units of electricity. The company produces 1,000 units of A and 3,000 units of B. Therefore, total output is 4,000 units and total electricity consumed is 7,000 kWh. Average intensity is 1.75 kWh of electricity per unit of output. In year 2, total production remains the same, but there is a shift in production, and the company now produces 3,000 units of A and 1,000 units of B. No efficiency improvement takes place: therefore, electricity requirements are constant for each unit of A and B. Total electricity increases to 3,000 kWh for A and declines to 2,000 kWh for B. Total combined electricity declines to 5,000 kWh and average intensity declines to 1.25 kWh. In this case, the company is less electricity intensive due to the change in product mix, not due to any improvement in efficiency. If the company reports this as a 29% ((.5*100%)/1.75)) improvement in the efficiency of the use of electricity, it is simply not true. 


Product 

 Year 1

Year 2 

 Production

Electricity
Used 

Production

Electricity
Used

 (Units)

 kWh

  (Units)

kWh

 A

 1,000

 1,000

 3,000

 3,000

 B

 3,000

 6,000

 1,000

 2,000

 Total

 4,000

 7,000

 4,000

 5,000

 Average Intensity
(kWh of electricity/unit of production)

 

 1.75

 

 1.25

 

To address this problem, a method to isolate changes in efficiency was jointly developed by accounting faculty at NC State University and Bacardi Limited. This method is based on flexible budgeting – a method understood and applied by CPAs and managerial accountants. Briefly, a company can budget electricity usage for new activity levels based on no efficiency changes and compare that to actual electricity usage. These differences are used to calculate the actual efficiency improvement.

In our example, the numbers were constructed based on no change in efficiency with a reduction in average intensity of electricity. Applying the flexible budget method to isolate efficiency, we calculate the amount of electricity expected to be used at the new activity levels for A and B in year 2 using the unit energy requirements for A and B in year 1, i.e., assume no change in efficiency. Budgeted electricity for A would be 3,000 units (3,000*1) and 2,000 for B (1,000*2), yielding a total budgeting amount of electricity of 5,000 (3,000+2,000). These numbers are compared to the actual amount of electricity used. In our example, the numbers are identical: 3,000, 2,000, and 5,000 for A, B, and total, respectively. So we see that the flexible budgeting approach correctly measures no efficiency change for A or B or for the total electricity used by the company. 
 


Product 

 Year 1

Year 2

 %
Change in
Efficiency

 Production

Electricity
Used

Rate 

Production 

Flexible
Budget
kWh 

Electricity
Used

 (Units)

 kWh

 kWh/Unit

(Units) 

 kWh

 kWh/Unit

 A

 1,000

 1,000

 1.0

 3,000

 3,000

 3,000

 0

 B

 3,000

 6,000

 2.0

 1,000

 2,000

 2,000

 0

 Total

4,000 

7,000 

 

4,000 

5,000 

5,000 

 0


We acknowledge actual companies are more complex than this example suggests, but flexible budgeting is readily adapted to more complex situations.

Many sustainability measures are developed and interpreted by individuals throughout the organization who may not have the expertise to develop and interpret the measures. This is where CPAs can apply their expertise to ensure such measures are faithful representations of reality – a hallmark of the accounting profession.

Our next article will further explain the use of flexible budgeting to isolate and report efficiency improvements for sustainability measurements.


Jon Bartley, CPA, Ph.D., is Professor Emeritus of Accounting and former Dean of the Poole College of Management, North Carolina State University in Raleigh, NC.  You can reach Jon at jon_bartley@ncsu.edu

Y.S. Al Chen, Ph.D., CPA, CITP, CGMA, CMA, CFM, is Professor of Accounting at the Poole College of Management, North Carolina State University in Raleigh, NC.  You can reach Al at alchen@ncsu.edu

Stephen K. Harvey, M.S., M.B.A., P.E., is former Global Director of Environment, Health and Safety for Bacardi Limited and is currently Industry Fellow in Corporate Responsibility at the Poole College of Management, North Carolina State University. You can reach Steve at skh1454@gmail.com

D. Scott Showalter, CPA, CGMA, CGFM, is Professor of Practice at the Poole College of Management, North Carolina State University in Raleigh, NC.  You can reach Scott at dsshowal@ncsu.edu

Gilroy Zuckerman, Ph.D., is Associate Professor of Accounting and former Associate Dean of Academic Affairs of the Poole College of Management, North Carolina State University in Raleigh, NC.  You can reach Gil at gilroy_zuckerman@ncsu.edu


1  The Greenhouse Gas (GHG) Protocol, Corporate Accounting and Reporting Standard (revised edition), World Business Council for Sustainable Development and World Resources Institute, 2014, www.ghgprotocol.org/files/ghgp/public/ghg-protocol-revised.pdf




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