Using Flexible Budgeting to Improve Sustainability Measures, Part III

In two previous articles Using Flexible Budgeting to Improve Sustainability Measures, Part 1 and Part 2, we demonstrated that the average intensity commonly used in sustainability reporting is problematic when used as a measure of efficiency improvement.[1] We described how several factors, including changes in efficiency, impact average intensity, and demonstrated how flexible budgeting can be used to isolate and measure efficiency improvements more accurately. The focus of this article is to consider the impact of factory utilization on efficiency measurement. To be clear at the start, companies are constantly seeking to improve factory utilization most often by increasing production volumes. All other things being the same, increased production improves average intensity, but will not in itself create an efficiency improvement for environmental aspects.

When production volume changes, financial managers must recognize the dichotomy of fixed and variable costs. As activity increases, the total variable costs increase, but fixed costs remain constant resulting in lower average cost per unit. Similarly, companies often face both fixed and variable components for environmental aspects. As with budgeting for cost, one needs to first budget separately for the fixed and variable components of the environmental aspect. This article considers four examples based on water usage.                                                 

The base example is a single facility where production increases, all water usage is variable with production, and no efficiency improvements occur in the use of water. The second example builds on the first with the addition of a fixed component of water. The third example combines a fixed component of water with a decline in production. The last example demonstrates the measurement of average efficiency for a company with two facilities both experiencing production changes and improvements in water efficiency.

In the base example, manufacturing plant A uses water in the production process of X, and this water usage is totally variable (and linear). In year 1, plant A manufactures 20,000 bottles of output using 7,000 gallons of water in the process (see Table 1). This results in a water usage rate of 0.35 gallons per bottle of output (7,000/20,000) that also is the water intensity. In year 2, production increases to 28,000 bottles of output. Since there is no efficiency improvement and no fixed usage of water, total water usage increases proportionally to 9,800 gallons (0.35*28,000), i.e., the flexible budget and actual are the same. Water intensity remains the same as in year 1 (9,800/28,000 = 0.35). This example serves as the baseline for comparison because there is no change in efficiency.

Example 1

In the second example, some water usage is fixed causing the water intensity to change with no change in efficiency. In this example, the manufacturing plant A uses 7,000 gallons of water to produce the same 20,000 bottles of output in year 1. However, 2,000 gallons of the 7,000 gallons used are fixed (see Table 2). The 5,000 gallon variable component yields a variable usage rate of 0.25 gallons of water per bottle of output. Note that the water intensity is still 0.35, the same as example 1 (7,000/20,000). In year 2, production again increases to 28,000 bottles of output. Total fixed water remains at 2,000 gallons and variable water used increases proportionally to 7,000 gallons (0.25*28,000). Again, efficiency is held constant so the flexible budget and actual results are the same. It is important to compare example 1 with example 2. In both cases water usage increases as production increases, but in example 2 water increases by a smaller amount (9,000 v. 9,800) because the fixed component does not increase. Therefore, one expects water intensity to decline at this higher level of production. In example 2, water intensity declines to 0.32 (9,000/28,000) in year 2. Because the fixed component of water usage causes a decline in water intensity when production increases, logically one expects that a decline in production with the fixed component of water will result in an increase in water intensity. This relationship is observed in example 3.

Example 2

Example 3 begins with the same scenario for year 1 as in the previous example, but production declines to 15,000 bottles of output in year 2 (see Table 3). The fixed component of water usage remains constant at 2,000 gallons, but variable water usage declines to 3,750 gallons (0.25*15,000). Total water usage drops to 5,750 gallons, and water intensity increases as expected to 0.38 (5,750/15,000). Both examples 2 and 3 demonstrate that intensity is not a reliable metric of sustainability performance. The changes in water intensity shown in these examples may mislead the users about efficiency improvement or degradation.

Example 3

Before exploring the last example, let’s summarize what the previous examples have demonstrated. Holding efficiency and other factors constant, a fixed component of a sustainability aspect causes a decline in the intensity of that aspect when production increases and an increase in intensity when production falls. Therefore, intensity is not a useful measure of sustainability efficiency which must be measured using the flexible budgeting methodology we are demonstrating.

The last example is more complicated and more realistic of actual application (see Table 4). In this example, a company has two manufacturing facilities. The first facility is identical to plant A in example 2 for year 1. The second facility, plant B, manufactures Y and produces 100,000 tons in year 1. Both facilities have fixed and variable components of water usage. Plant A experiences an increase in production to 28,000 bottles in year 2, and plant B experiences a decline in production to 80,000 tons. Actual water usage is 8,900 gallons for plant A and 19,000 gallons for plant B. Water intensity in plant A decreases from 0.35 in year 1 to 0.32 in year 2. In plant B, water intensity increases from 0.23 to 0.24.

Example 4

The flexible budget for plant A in year 2 indicates 9,000 gallons of water would be used assuming no improvements in efficiency. However, actual usage is only 8,900, yielding an efficiency improvement of 1.1% [((9,000-8,900)/9,000)*100]. The flexible budget for plant B is 20,000 gallons of water in year 2 compared to 19,000 gallons that are actually used, indicating an efficiency improvement of 5% [((20,000-19,000)/20,000)*100]. Note that plant B experiences an improvement in water efficiency, but water intensity increased potentially giving users the erroneous impression that sustainability performance worsened. 

The flexible budget methodology easily handles the calculation of changes in efficiency for the entire company. When both plants are analyzed in the aggregate, the total flexible budget amount for water is 29,000 gallons (9,000+20,000). Total actual usage is 27,900 gallons (8,900+19,000) resulting in an overall efficiency improvement of 3.8% [((29,000-27,900)/29,000)*100].

In calculating the overall average water intensity, many companies simply sum differing units of output, as in this example where product X is measured in bottles and product Y is measured in tons. A common solution to this problem is to convert physical measures of output to the sales value of output and then combine revenue totals. Unfortunately, this approach adds to the confounding factors impacting intensity measures when prices are changing. Note that differing output measures do not present a problem for the flexible budget approach. This is because the production output is used only to calculate the flexible budget value that in our example is expressed as gallons of water regardless of how units of production are measured. Notice that although water efficiency improves in example 4, overall water intensity increases. This is due to the fact the production mix shifts from the less water intensive product Y to the higher water intensive product X. This product mix shift dominates the efficiency improvement.In conclusion, the flexible budgeting approach to measuring changes in sustainability aspect efficiency correctly adjusts for the presence of fixed components of aspect consumption (or production as in the case of greenhouse gases). In contrast, intensity measures fail to adjust for the fixed and variable components of sustainability aspects and do not provide an accurate indication of the actual change in efficiency. When production volumes change, fixed components of sustainability aspects cause intensity measures to change even when there is no change in aspect efficiency.

As corporate responsibility reporting becomes mainstream around the globe, organizations look to CPAs to provide analysis and reliable measurements to monitor their sustainability performance. The AICPA urges its members to be the forerunners in the sustainability reporting movement by elevating its credibility.[2] Therefore, in our next article, additional issues in the implementation of the flexible budgeting approach for measuring efficiency improvements will be explored. Specifically, we will discuss the challenges in defining the appropriate degree of refinement in segmenting a company, materiality considerations for fixed components, and issues relating to confounding factors influencing the sustainability aspect such as variations in the weather.


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

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

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

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

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


[1] AICPA, January 26, 2017

AICPA, April 17, 2017

[2] The CPA’s Role in Sustainability Assurance. Balancing Priorities: Profits, People and Planet, AICPA, 2015.