Doctoral thesis

Integrated Investing

TU_Darmstadt_LogoHow to integrate environmental impacts in investment processes of companies.

Technische Universität Darmstadt (D17)

Faculty of Civil and Environmental Engineering

Approved doctoral thesis with the intention to achieve the degree Dr. rer. pol.

Author

Simon Weihofen, MSc.

Doctoral supervisor

Prof. Dr. rer. nat. Liselotte Schebek

Technische Universität Darmstadt

Institute IWAR

Chair of Material Flow Management and Resource Economy

Second supervisor

Prof. Dr. rer. pol. Edeltraud Günther

Technische Universität Dresden

Faculty of Economics

Chair of Environmental Management and Accounting

ISBN-13: 978-1530650460,

ISBN-10: 1530650461 

Weihofen, Simon (2016) Integrated Investing – How to integrate environmental impacts in investment processes of companies. Darmstadt, Germany, self-published, printed by CreateSpace

Handed in on 24 September 2015, disputation on 10 December 2015, published on 23 April 2016 in Darmstadt, Germany

Oh, Mother Earth,
With your fields of green
Once more laid down
by the hungry hand
How long can you
give and not receive
And feed this world
ruled by greed
And feed this world
ruled by greed.

Oh, ball of fire
In the summer sky
Your healing light,
your parade of days
Are they betrayed
by the men of power
Who hold this world
in their changing hands
They hold the world
in their changing hands.

Oh, freedom land
Can you let this go
Down to the streets
where the numbers grow
Respect Mother Earth
and her healing ways
Or trade away
our children's days
Or trade away
our children's days.

Respect Mother Earth
and her healing ways
Or trade away
our children's days.

Mother Earth (Natural Anthem)

Neil Young, 1990

The results, opinions and conclusions of this dissertation are not necessarily the same as the Volkswagen Group.

Abstract

Environmental management systems aim to ensure legal compliance on the one hand and continuous improvement of environmental performance on the other hand. Due to its cross-sectional character, environmental management systems affect all parts of the organisation. Another cross-sectional system is the management accounting system which intends to support ex-ante internal management decision-making processes. The overlapping part of both systems deals with environmental issues in business planning processes and is commonly referred to as environmental management accounting. However, the field of environmental management accounting is still young and corresponding methods are currently under development.

Besides financial goals, companies increasingly start formulating strategic environmental goals. However, the management and control of these goals remains a challenge. Thus, the formulation of strategic environmental goals in qualitative terms limits their management and control. On the other hand, the systematic integration of strategic environmental goals in management accounting processes, such as investment appraisals and decisions, represents a research gap.

Therefore, this thesis aims to develop a method that is able to systematically integrate financial and environmental data in investment processes to support the achievement of strategic environmental and financial goals of companies. This new integrated investing method intends to provide a sufficient degree of scientific quality on the one hand and practical applicability on the other hand.

In context of this thesis, a deficit analysis assesses reasons why current methods of environmental management accounting have not established as common business practice so far. During the first part of the subsequent method development a set of seven requirements is composed. On basis of these requirements additional methods of environmental management and management accounting systems are evaluated resulting in a final set of three approaches representing the basis of developing the new integrated investing method. After developing and describing the new integrated investing method, the method is applied in seven case studies within the Volkswagen Group. This method application verifies the method’s practical applicability as well as its ability to manage and control strategic environmental and financial goals.

In conclusion, this dissertation contributes to the development and application of a new integrated investing method that aims to ensure a sufficient degree of scientific quality and practical applicability. With the help of this method, it is able to systematically integrate environmental impacts in investment processes of companies in order to manage and control the achievement of strategic environmental and financial goals.

The recommendations for future research address the limitation of the Ecological Scarcity Method, on which the integrated investing method is based, as well as the application of the new integrated investing method in contexts outside the Volkswagen Group.

Preface

This thesis evolved in context of my time as a doctoral candidate at the Volkswagen Group Research Environmental Affairs department, in which I had the pleasure to support the environmental management team. During the first few months, while I was searching for an appropriate topic for my dissertation, the team was faced with an increasing amount of enquiries. These enquiries requested a method for a decision-making process that balances financial and environmental aspects. While the financial costs and benefits of an investment could be identified and quantified, decision-makers were uncertain about the quantification of environmental impacts associated with the investment.

The more my colleagues and I immersed into this topic, the more controversial and complex were the associated discussions, which finally led us to the necessity for a sound academic but also pragmatic solution in form of my dissertation. Hence, this thesis addresses environmental management and management accounting professionals, who are faced with similar enquiries on the one hand and the scientific audience on the other hand, which is cordially invited to discuss my proposed method.

This thesis would have never been written without the support of my family, friends and colleagues. First of all, I am very grateful to Judith for her endless support and belief in me, not only during the time of my dissertation, but also for encouraging me in whatever I have done so far – be it studying and working abroad or all of my additional projects, which mostly take place far away from our shared home. In this context, I am especially pleased to count on my grandparents, parents and my sister, who constantly believe in the success of my projects, which always encourages and motivates me.

I have also not forgotten the inspiration of Tim Kaske, who encouraged me to even think about the option of writing a dissertation. At that point of time, writing a dissertation seemed to me as an unreachable goal. Without his inspiration, I would have never applied for the job offer as doctoral candidate at the Volkswagen Group.

During my time as doctoral candidate, I had the pleasure to work together with lots of bright colleagues, who took the time to listen to my thoughts and who did not hesitate to provide valuable and constructive feedback. In this context, I am especially thankful for the constant help of Steffen Wellge in form of time, guidance, motivation, trust, creativity, open and honest feedback. Without Steffen’s support, I would simply not have been able to finish my dissertation in three years’ time and working on my dissertation would not have been that much fun.

Furthermore, I was supported by my supervisors, Günter Damme, Dr. Liendel Chang and Gerhard Mogg, who enabled me to present my dissertation to broad audiences within the Volkswagen Group Research but also in context of external scientific conferences.

I am additionally thankful for various colleagues who supported me in conducting the case studies: Kai Schweingruber, Kai Jaekel, Christian Pressel, Marius Rode, Markus Meyer, Dr. Stefan Brinkmann, Dr. Jens Asche, Marcin Grochowski, Stefan Rose, Erhan Icten, Malte Gebler, Volker

Hillers, Ralf Steffen, Carsten Weinz, Hans-Joachim Blunck, Arnd Müller, Reinhard Marowsky, Martin Müller, Markus Lange, Johannes Meichsner, Stefanie Hofmann, Florian Müller, Yvonne Thoben, Robert Schmidt, Micha Bruchmüller, Cynthie Gadiel, Vitali Hartfelder, Thomas Kitzmann, Thomas Krösche, Thomas Belger, Dr. Klaus Matalla and Silke Härtel. Thanks also to Astrid Kuwert-Behrenz, Britta Mostert and Beate Hainke who helped me with the professional layout of my dissertation and to Katharina Storm who invested a tremendous effort for eliminating all the typos in this dissertation.

Last but not least, I am very grateful for the support of my doctoral supervisor Prof. Dr. Liselotte Schebek and my second supervisor Prof. Dr. Edeltraud Günther, who not only agreed to supervise my thesis, but also took their time to provide constructive and valuable feedback, which helped me to keep focused and to solve all emerging issues.

If you have comments or if any questions remain unanswered at the end, please do not hesitate to send me an e-mail:

simon@integrated-investing.com

Simon Weihofen

Wolfsburg, Germany

September 2015

Academic background of the author

2007 – 2011:      Bachelor of Business Administration (BBA) in International Business and Management Studies at Fontys International Business School in Venlo, the Netherlands

2011 – 2012:      Master of Science (M.Sc.) in Sustainable Business at Manchester Metropolitan University Business School in Manchester, United Kingdom

2012 – 2015:      PhD Student at Group Research Environmental Affairs Production at Volkswagen in Wolfsburg, Germany

1. Introduction

Environmental management systems have experienced increased importance within companies to address public and legal environmental concerns. The aim of environmental management systems is to ensure legal compliance on the one hand and continuous improvement of environmental performance on the other hand (Förtsch and Meinholz, 2014). Due to its cross-sectional character, environmental management affects all parts of the organization. Besides managing environmental performance of existing business operations, environmental management systems also focus on business planning processes (Burschel, 2004).

Another cross-sectional system is the management accounting system. In contrast to financial accounting, which is concerned with external reporting of ex-post financial performance, management accounting intends to support ex-ante internal management decision-making processes. These decision-making processes comprise amongst others cost-benefit analyses, budgeting processes, cost allocation processes or investment appraisals. Hence, the management accounting system is also referred to as the internal accounting system. (Zimmermann, 2011)

The overlapping part of both systems deals with environmental issues in business planning processes. When building a new plant or replacing equipment, costs and benefits need to be forecasted to support the upcoming investment decision. In addition, these decisions have an impact on the environmental performance as well. This overlap of environmental information in form of physical flows with monetary information is referred to as environmental management accounting (IFAC, 2005).

However, the field of environmental management accounting is still young and environmental management accounting methods are currently under development (Faßbender-Wynands et al., 2009), leading to the subsequent problem situation of this thesis.

1.1. Problem situation

The strategic goals of a company are typically expressed in quantitative financial values (Hungenberg, 2012). Hence, target values in form of financial ratios or figures are formulated on company level and broken down to its organisational units. For instance, the targeted percentage of return on investment (ROI) is determined at ten percent as strategic goal. In this case, this strategic goal is broken down to the business units of a company. Therefore, the expected returns of competing investment objects are calculated and investment objects with a ROI below the targeted ten percent are excluded from further consideration. With this procedure, management accounting professionals ensure that investment decisions support achieving the targeted strategic financial goal.

Besides financial goals, companies increasingly start formulating strategic environmental goals (Burschel, 2004). Nonetheless, challenge remains regarding the achievement of these environmental goals (Liesen et al., 2013). This challenge originates from two sources, which is on the one hand the formulation of the environmental goals and on the other hand the management accounting system missing to support the achievement of these environmental goals.

Environmental goals are regularly expressed in a qualitative way. Nevertheless, to enable monitoring the achievement of strategic environmental objectives, the associated accounting ratios need to reflect the values of the strategic goals (Gladen, 2011). Hence, environmental goals need to be expressed in quantitative values. Due to the qualitative expression of environmental goals, possible conflicts with quantitative financial goals remain intangible. This conflict mainly comprises the incomparability between qualitative and quantitative strategic goals. With the establishment of quantitative environmental goals, this subtle conflict turns tangible especially with environmental management measures that do not provide any profitability (Dyckhoff and Souren, 2008). As a consequence, the decision-maker becomes aware of the environmental impacts besides the already-known financial impacts in order to come to a comprehensive investment decision.

In addition, companies need a systematic integration of indicators or ratios in the decision-making processes that is analogous to achieving financial goals. Therefore, it is necessary to link physical environmental information with the underlying monetary information of investment decisions . This physical environmental information is tracked by the environmental management system. Hence, the environmental accounting system as overlapping system intends to provide such a comprehensive data base.

However, the systematic integration of environmental management information in management accounting processes such as investment appraisals remains a research gap (Herzig and Schaltegger, 2009). While academic literature discusses possible integrated environmental investment appraisal methods, none of these methods has established as accepted standard so far.

1.2. Research objective

Basing on the identified research gap in the previous subchapter, the first step of this thesis intends to assess methods dealing with the integration of environmental impacts in investment processes. This step further aims to perform a deficit analysis to identify reasons which have prevented these methods to establish as accepted standard in business. The concluding step reveals the development of a method based on the insights of the deficit analysis.

Hence, the research objective of this thesis is to develop a method to systematically integrate environmental impacts in investment decisions within companies (integrated investing method) and to verify its practical applicability. With the help of such an integrated investment decision, companies should be able to execute environmental management accounting to consequently achieve strategic environmental and financial goals. Therefore, the main research question is formulated as follows:

Main research question:
How to integrate financial and environmental data in investment processes to achieve strategic environmental and financial goals of companies?

1.3. Methodology

The methodology describes the way to solve the problem situation by achieving the research objective. However, to answer this research question, it is necessary to develop an integrated method that offers a sufficient degree of scientific quality on the one hand and is able to be applied in business practice on the other hand. Hence, the integrated investing method needs to meet requirements corresponding to theory and practice.

Regarding the theoretical development of the integrated investing method, the requirements originate from the outcome of the deficit analysis of existing methods. Additional requirements emerging from method development, as discussed in current academic literature, aim to ensure a sufficient degree of scientific quality. In conclusion, the first sub-research question is formulated as follows:

Sub-research question 1:
Which requirements does the integrated investing method need to meet in order to ensure a sufficient degree of scientific quality?

Besides requirements ensuring scientific quality, the other aim is to ensure successful practical application of the integrated investing method. In this context, current academic literature on method development reveals a set of additional requirements which the method needs to meet. Therefore, the second sub-research question is formulated as follows:

Sub-research question 2:
Which requirements does the integrated investing method need to meet in order to ensure its practical applicability?

After conducting the deficit analysis of currently existing methods and composing a set of requirements ensuring sufficient scientific quality and practical applicability, the concluding step comprises the method development. As already indicated in the introductory passage, the integrated method can be categorised in the field of environmental management accounting, which overlaps with management accounting and environmental management systems. Both systems provide methods that have already established as common accepted standard. Therefore, it is necessary to assess methods that might be able to serve as a basis of the concluding method development. To provide a suitable framework for this assessment, the previously developed set of requirements provides the basis of this method screening and evaluation. Hence, the third sub-research question is formulated as follows:

Sub-research question 3:
How well do additional methods from environmental management and management accounting systems meet the requirements to qualify as a basis for the development of the integrated investing method?

Besides the compliance with requirements ensuring scientific quality, the integrated investing method also needs to be applied in a real life business context to verify its successful applicability in practice. Furthermore, the method application intends to verify whether the integrated investing method is able to support the strategic environmental goals of an existing company. Hence, the fourth sub-research question is formulated as follows:

Sub-research question 4:
Does the method application verify the practical applicability of the developed method and the ability to manage and control strategic environmental goals of an existing company?

Structure of this dissertation

To describe the current state of academic knowledge and business practice, it is necessary to deal with the main object of this thesis which is the investment process. Hence, the second chapter comprises an introduction into the investment process within companies as well as the most common conventional investment appraisal methods. The second part of this chapter discusses current methods aiming to integrate environmental impacts in investment decisions. The discussion intends to identify reasons for their immaturity in practical application with the help of a deficit analysis.

Based on the results of the deficit analysis and current academic literature on method development, a set of requirements, ensuring sufficient scientific quality on the one hand and practical applicability on the other hand, is intended to be developed in the third chapter. Thus, the first two sub-research questions are answered within the first part of the third chapter. Moreover, the third chapter aims to identify and evaluate additional methods which might serve as a basis for the development of the new integrated investing method. The result of the evaluation of the identified methods according to the requirements provides the answer to the third sub-research question. The final part of the third chapter intends to comprise the development of the new integrated investing method.

The result of the method development process is described in the fourth chapter containing the description of the new integrated investing method. This method description is structured along the previously identified main object of this dissertation in form of the investment process in companies.

After having developed the new integrated investing method, the fifth chapter intends to apply the method in real life business context in order to provide an answer to sub-research question four. Moreover, this method application chapter intends to verify the method’s practical applicability on the one hand and its ability to manage and control environmental goals of an existing company on the other hand.

Finally, the validity and reliability of the results are discussed in chapter six to finally provide the conclusion and recommendations for further research within the subsequent chapter. Within this last chapter, the main research question of this thesis is going to be answered as well.

The methodological structure of this dissertation is also illustrated in Figure 1.

Figure 1: Methodological structure of this dissertation

Source: Own illustration

2. State of current academic knowledge

This chapter represents an introduction to the current academic knowledge of the corresponding issues of this thesis. While the first subchapter highlights the investment process within companies, the second subchapter discusses conventional investment appraisal methods which are commonly used in business practice. The following subchapter analyses environmental modifications of the previously identified investment appraisal methods. Finally, before the final deficit analysis summarises the weaknesses of the discussed methods, the current academic knowledge regarding environmental impact assessments in companies is introduced.

2.1. Investment decisions in companies

2.1.1. Attributes and characteristics of investments in literature

Purpose of investments

According to Poggensee (2011), investment decisions are a critical factor for the success of a company since the invested capital is bound for long time. This in turn restricts the scope of action of a company. Hence, it is important to invest into projects that support the company’s strategy so that strategic goals can be achieved. Therefore, investment decisions describe the direction of the future development of a company (Jasch and Schnitzer, 2002) and thus need to be taken with the intention to support strategic goals of a company.

Hence, the origin of the necessity for investments can be found in the formulation of strategic goals. These goals are typically formulated as financial values such as a targeted return on investment or a targeted net present value which should be added to the company value (Hungenberg, 2012). However, also qualitative goals are formulated such as a top position in an external ranking or a defined amount of patent applications (Gladen, 2011).

Strategy implementation describes the way to achieve these goals. Hence, the task of the product management is to achieve these goals with either existing products or by developing, marketing and selling new products. The underlying strategic marketing decisions are either based on a previous outside-in or inside-out analysis. While the inside-out analysis focuses on the question which products can be developed and sold on which markets with existing resources, the outside-in analysis works with the opposite perspective. Hence, the outside-in perspective starts with an analysis of the target market to derive a product idea to finally identify the internal resources necessary to produce and sell this product (Grünig and Kühn, 2011).

In conclusion, before the investment planning process is started within a company, strategic goals need to be determined and decisions regarding new product development or marketing measures of existing products need to be made. These decisions, in turn, impact on the production facilities of a company. Hence, new plants need to be established or existing plants are extended or adjusted.

The extent to which these measures are examined is limited by the capital budgeting process which runs parallel to these strategic decisions. Therefore, the marketing or sales management has to forecast sales and expected turnover which in turn determines the size of capital budgets, cost budgets and targeted profits. (Zimmerman, 2011)

The subsequent operational strategy implementation begins with comprising amongst others the investment planning process. This process serves to support the strategic goal by identifying the most efficient way of investing. (Grünig and Kühn, 2011)

The following figure provides an overview over the different purposes of investments in companies:

Figure 2: Characteristics of the investment attribute ‘purpose’

Source: Own illustration based on sources above

Scope of investments

Regarding the scope of investments, the differentiation between single investments and investment programs is vital for the investment process. As described above, the strategic goals of a company influence the investment planning process. In case the achievement of strategic goals requires investing in several mutually non-exclusive investment objects, the assessment of the best combination of these objects is referred to as investment program planning (Becker, 2012).

The scenario in which another department (e.g. sales, marketing, product management, etc.) determines the size of capital budgets is referred to as ‘successive investment program planning’. In contrast to that, the interdependencies and given limitations are recognised and sorted out in close cooperation between both departments with simultaneous programming. (ibid.) The following figure provides an overview of the different scopes of investments in companies:

Figure 3: Characteristics of the investment attribute ‘scope’

Source: Own illustration based on sources above

Process of investments

The investment processes for single investments contains six steps which are iteratively run through. First, the problem situation is formulated pointing towards an investment need. The second phase is characterised by research for investment objects which might be able to solve the previously-described problem situation. The next step comprises the appraisal of competing investment objects. In this phase, the profitability of each investment object is projected and compared to the other investment objects. While the fourth phase is defined by the actual investment decision, the investment object is realised in phase five. Finally, the last phase deals with the ex-post analysis of the originally projected profitability with the actual profitability of the investment object. (Poggensee, 2011; Prätsch et al., 2012) The following figure provides an overview over the different process steps of investments in companies:

Figure 4: Characteristics of the investment attribute ‘process’

Source: Own illustration based on sources above

Focus of investments

Prätsch et al. (2012) differentiate between two perspectives when defining investments. On the one hand, there is a cash flow-focused investment definition. Thus, investments are defined as cash flows which are characterised by outflows at the beginning of an investment with associated cash inflows at later points of time. On the other hand, there is the reporting-focused investment definition which concentrates on the financial localisation of investments within the company’s balance sheet.

Poggensee (2011) also constitutes a lack of consistency in defining investments. He identifies three popular perspectives from which to define investments. One perspective corresponds with Prätsch et al. (2012) in recognising the timing of cash flows as central point of the definition. The second perspective deals with the intention of the investment which is to acquire fixed (tangible or intangible) assets. The third perspective concentrates on the investment appraisal itself and its intention to create a basis of comparison to alternative investment objects. (Poggensee, 2011) The following figure provides an overview of the different focuses of investments in companies:

Figure 5: Characteristics of the investment attribute ‘focus’

Source: Own illustration based on sources above

Ownership of investments

Besides these capital asset-oriented investment definitions, Pape (2011) adds a financial perspective. Hence, investments can also comprise the merger or acquisition of external companies but also the acquisition of financial entities generating profit such as financial derivatives, loans, bonds or securities.

While literature on investments usually assumes the acquisition of an asset, leased assets are also part of this discussion. McLaney (2009) differentiates between operating and finance leases. While operating leases comprise hiring an asset instead of purchasing it, finance leases occur in form of sale and leaseback contracts, in which the user purchases the asset at first place, sales it to a financier in a second step to finally lease it back in order to continue its utilisation. (ibid.) Although the actual ownership is transferred to a third party (financier), the control and operation remains at the user.

The following figure provides an overview over the different ownership options of investments in companies:

Figure 6: Characteristics of the investment attribute ‘ownership’

Source: Own illustration based on sources above

Types of investments

In addition to various definitions of investments, the literature describes three main categories regarding the type of investments. The first category refers to foundational investments to acquire the first property plant and equipment allowing a start-up business to set up its operations. The second category comprises continuous investments for existing plants and equipment, for instance investments preserving production capacity such as renovation or retrofitting of existing plants and equipment. The third category is characterised by complementary investments. On the one hand, this can involve expansion of production capacity by acquiring additional plants or equipment. On the other hand the efficiency of already existing machinery can be increased by rationalisation investments. In addition, this third category also comprises diversification investments necessary, for instance, to meet the trend of mass customisation, for instance. (Prätsch et al., 2012)

Apart from these three main types of investments, the literature highlights two additional terms which roughly summarise the variety of investment categories. On the one hand, there is the term of ‘greenfield investments’ which described the establishment of new facilities from scratch. These new facilities can either serve as foundational investment or as complementary (e.g. for expansion or diversification) investment. On the other hand, there is the term of ‘brownfield investment’ which involves the acquisition of existing facilities. This might be the case for continuous investments or complementary (e.g. rationalisation) investments. (Morschett et al., 2010)

The following figure provides an overview of the different types of investments in companies:

Figure 7: Characteristics of the investment attribute ‘types’

Source: Own illustration based on sources above

Time period of investments

Another important issue regarding relevant specifications is the time period under consideration. The concept of life cycle costs (LCC) sums up all costs associated with an asset along its complete life cycle. Since the term ‘life cycle’ is used by several academic professions, it is important to differentiate between the environmental and economic definition of life cycle. Both professions refer to the term ‘life cycle’ when considering more than just the production and utilisation of a product. However, the biggest difference concerns the focus of the phases before and after production and utilisation.

While the economic life cycle ranges from research and development of the product, over production to marketing (i.e. utilisation of the product from a company’s perspective) and finally removal from the market, the ecological life cycle ranges from resource extraction to production and utilisation of the product to finally end with its disposal.

With regard to the activities prior to production, the environmental life cycle perspective considers all activities necessary to extract and process the resources needed to manufacture the product. In contrast to that, the economic life cycle perspective considers research and development activities as relevant step prior to production. Also the phases after the production and utilisation differentiate between both perspectives. While the economic perspective assumes the end of manufacturing and marketing activities of the product, the environmental perspective focuses on the disposal of the product and its impact on the environment.

According to Schebek (in Ausberg et al., 2015), both perspectives influence each other. In order to generate an environmental impact in form of resource extraction, a product first needs to be developed. During production and utilisation, the product consumes resources and causes emissions impacting on the environment. Finally, when it is not economically viable to manufacture and market the product, the impact decreases. However, at the end of the functional life cycles of the products, the disposal causes additional impacts on the environment. Hence, environmental impacts are connected to market mechanisms such as economic life cycles. (ibid.)

When discussing the concept of LCC, the economic perspective of the life cycle is assumed as underlying basis. Ideally, the costs of an asset are recorded in the different phases which are structured into research and development, production and construction, operation and support as well as dismantling and disposal of an asset (Lichtenvord et al., 2008). While conventional economic concepts of LCC focus on all associated direct and indirect costs, environmental LCC studies complement these data with corresponding external costs (i.e. environmental impacts from resource consumption and emissions) which should be internalised to represent all relevant costs (ibid.).

Nevertheless, the existence of various actors involved in the life cycle of an asset creates the problem of who should bare which costs. Especially, since the costs of one actor might be the revenues of another actor. Therefore, the term of total cost of ownership (TCO) narrows down the scope and time period of recorded costs. As Thiede et al. (2012:275) claim: “TCO subsumes all cost proportions that occur for the operator of a machine”. Examples for these subsumed costs may involve “acquisition, installation, training, energy, maintenance, planned or unplanned downtime and disposal” (ibid.:276). Additional costs under consideration might involve costs of capital and depreciation.

The following figure provides an overview over the periods of time under consideration of investments in companies:

Figure 8: Characteristics of the investment attribute ‘time period’

Source: Own illustration based on sources above

The various attributes and their corresponding characteristics which are discussed in the literature addressing investments are summarised in the following figure:

Figure 9: Overview of attributes of investments as described in literature

Source: Own illustration based on sources above

2.1.2. Attributes and characteristics of investments in context of this thesis

Since there is a huge variety of characteristics and no consistent definition of investments, it is necessary to determine the attributes and characteristics of investments for the context of this thesis.

Regarding the purposes of investments, this thesis focuses on the aim to support the achievement of strategic goals of a company, since the alternative strategy implementation does not necessarily involve investment decisions. In addition, the investment appraisals in today’s business practice are expressed along the quantified strategic goals of a company. Hence, decision-makers aim to support strategic goals of a company with their investment decisions.

The scopes of investments differentiate between investment programs and single investments. Since the sum of single investments form an investment program, the scope focuses on assessing single investments in context of this thesis.

Regarding the processes, this thesis discusses the implications of the complete investment process, ranging from investment planning, over its decision to the investment realisation. This decision is taken based on the various opportunities the complete process offers for the integrated investing method to adjust and extend existing investment practice in companies.

Concerning the focuses, the cash flow-based definition is considered as result of systematic exclusion. While the investment appraisal-based definition highlights only one phase of the investment process, the reporting-based definition is concerned about the localisation of investments in the balance sheet. This localisation, however, does not offer enough level of detail since it sums up each investment value in one aggregated figure at only one point of time within a balance sheet.

The ownership attribute differentiates between acquisition and leasing fixed assets. Due to the cash flow-based definition of investments, which recognise an initial cash outflow at the beginning of ownership of the fixed tangible-assets, leasing is not considered to be part of this thesis. In addition, the literature discusses leasing options as part of corporate financing which is also not covered by this thesis. Since the acquisition of intangible assets and financial assets do not necessarily involve an environmental impact, the acquisition of fixed tangible assets is part of the characteristics in context of this thesis.

Furthermore, the literature differentiates between several types such as greenfield and brownfield investments. The existence of environmental impacts is the reason behind the choice of investment types. As a consequence, greenfield investments as well as brownfield investments are considered within further research and discussion.

With regard to the time period under consideration, the ownership of the fixed tangible asset is considered from the operator’s view, which includes the phases described within the TCO-approach (i.e. construction, operation and support as well as dismantling and disposal).

Definition of investments in context of this thesis

Investments are defined as single investments in form of cash outflows enabling to acquire fixed tangible assets for greenfield or brownfield sites, which generate (imputed) cash inflows over the time of the operator’s ownership, aiming to eventually help a company in achieving its strategic goals.

Hence, cash outflows in form of direct and indirect costs (and also imputed cash inflows in form of avoided costs) are considered as long as the investment object is owned and controlled by the company.

The following figure summarises the definition of investments used in context of this thesis.

Figure 9: Attributes and characteristics of investments in context of this thesis

Source: Own illustration based on sources above

2.2. Conventional investment appraisal methods

Investment decision vs. investment appraisal

The literature often suggests that the result of the investment appraisal already implies the investment decision. However, Prätsch et al. (2012) argue for a strict separation between investment appraisal and investment decision as the people involved within these two phases are separate persons. While management accounting professionals are responsible for the calculation of the investment appraisal, the executive management is responsible for making the investment decision (ibid.).

Poggensee (2011) also argues for a strict separation since investment appraisal methods work with simplified models trying to express reality in quantitative values. This representation of reality involves a reduction of complexity with the help of assumptions. Nevertheless, the decision-maker has to consider also non-monetary and qualitative criteria to make a comprehensive investment decision.

Another argument can be seen in the different objectives of the two phases. On the one hand, the investment appraisal intends to create a quantitative value for each investment object. The quantitative values of the competing investment objects can be compared to each other to determine their relative advantageousness. On the other hand, the investment decision aims for an improvement of the current state of the company. This improvement is achieved by adding value to the company value through the returns or saved operating expenses caused by the investment object. Hence, investments aim to enable the company in achieving its strategic goals. (ibid.)

Classification of investment appraisal methods

The classification of investment appraisal methods depends on the formulation of strategic goals which the methods intend to support. Hence, the first step is to distinguish between quantitative and qualitative strategic goals. Furthermore, the second step is to clarify whether investment appraisal methods have to support one strategic goal or whether there are several goals that have to be achieved equally. The third step comprises a differentiation between single independent investments and an investment program in which several investments depend on each other. (Poggensee, 2011)

Figure 10 provides an overview of the classification of strategic goals and the corresponding investment appraisal methods.

Figure 10: Classification of strategic goals and corresponding investment appraisal methods

Source: According to Poggensee, 2011

While static investment appraisal methods mostly concentrate on the profitability and payback period of an investment, dynamic investment appraisals recognise the points of time of cash inflows and outflows. Hence, dynamic investment appraisal methods include interest rates to calculate the net present value of an investment or the internal rate of return. Dynamic investment appraisal methods are perceived as superior to static investment appraisal methods since the recognition of the time value of money enables the calculation to produce more realistic results. (Jasch and Schnitzer, 2002)

Although static investment appraisal methods do not qualify as the only basis of investment decisions, since they lack recognising the time value of money, they are still commonly used in companies (Poggensee, 2011). One reason for this contradiction can be seen in the simple calculation enabling a quick application and rough orientation. Hence, the most common static investment appraisal methods (i.e. return on investment, payback period, cost or benefit comparison) are discussed in this thesis as well.

Risk and uncertainty in investment appraisal methods

Other important aspects when discussing investment appraisal methods are the issues of risk and uncertainty. While risk is commonly stated as the damage impact multiplied by the probability of occurrence of a negative event, uncertainty deals with the lack of knowledge about the consequences of the investment as well as uncertainty about the data quality level. (Poggensee, 2011)

However, risk management and also uncertainty originating from a low level of data quality are not in the focus of this thesis. Hence, the premise is given that the person calculating the investment appraisal retrieves data and also considers relevant risks in all conscience according to the general prudence principle in accounting.

According to a survey of Truong et al. (2008), the investment appraisals net present value, internal rate of return, payback period as well as return on investment are the most popular and thus most used among companies worldwide. Hence, the following subchapters introduce and discuss these methods in addition to further approaches completing the most-relevant investment appraisal methods in today’s practice.

2.2.1. Payback period

The payback period (PBP) is defined as the period of time in which the invested capital is amortised by the cash inflows of the investment object. The result of the payback period calculation can be expressed in days, weeks, months or years. (Prätsch et al., 2012)

On the one hand, the existence of a payback period itself can already be regarded as an indicator of a profitable investment. Nevertheless, when comparing the relative advantageousness of competing investment objects, the investment object with the shortest payback period indicates the best alternative. This time-based view represents a basic risk assessment, as the near future is perceived as less risky than the distant future. In conclusion, investments with short payback periods express a higher chance of amortising the invested capital than investment objects with long payback periods. (Poggensee, 2011) In addition, quick cash inflows can be re-invested earlier than cash flows occurring in distant future, providing a company financial flexibility, especially in uncertain times.

Due to its simple calculation, the payback period enables quick decision-making. However, Poggensee (2011) argues that it cannot serve as single basis for investment decisions as the payback period does not recognise the lifetime of the investment object. Additional difficulties occur when comparing the payback period of several investment objects with different amounts of capital investment.

A simplified example illustrating this problem can be retrieved in Table 1.

Table 1: Simplified example for payback periods of two investment objects

Source: Own example

When comparing the investment objects given in Table 1, investment object B shows a better payback period with only one year of amortisation. Hence, the decision-maker would prefer investing in object B, assuming that no additional information is available. However, the expected lifetime of the two investment objects differs widely. Considering the ten years lifetime of investment object A, in contrast to only three years lifetime of investment object B, the decision-maker might invest in object A, since the accumulated profit of investment object A is superior to object B.

2.2.2. Cost comparison and benefit comparison

The two investment appraisal methods comparing costs and benefits are similar to each other, which is the reason for describing them together in this subchapter. As the name already indicates, the focus of the cost comparison method is on the expected costs of the investment objects. Based on these cost projections, the investment objects are compared to each other. Hence, the relative advantageousness can be concluded from the investment object with the lowest amount of costs. Nonetheless, the absolute advantageousness can only be determined in case of replacement or rationalisation investments when comparing the business-as-usual scenario (i.e. opportunity costs of not investing) with the costs of investing into the investment object. (Götze et al., 2008)

The considered expenses comprise operating costs (e.g. for personnel expenses, costs for raw materials, energy, repair and maintenance) as well as financial costs (e.g. depreciation, interest and taxes). The method does not differentiate between fixed and variable costs since all cost accounts of an investment object are accumulated. (Poggensee, 2011)

The cost comparison method bases on the assumption that the revenues and production capacities of the competing investment objects are equal. Since variable costs depend on the planned production capacity, which might be subject to frequent changes, the cost comparison method calculates with the average costs. (Götze et al., 2008) Hence, the cost comparison method ignores the different points of time on which costs and benefits might occur, which therefore classifies as static investment appraisal.

The basic assumptions of similar production capacities and revenue amounts of competing investment objects as well as the ignorance of the time value of money are major points of criticism. Hence, the calculated amounts of costs provide a low likelihood to occur in reality after the investment object has been realised. (Poggensee, 2011)

The benefit comparison method compares the profits of competing investment objects. Hence, the amount of costs as result of the cost comparison method is deducted from the projected revenues of the investment object. Besides this difference, the same assumptions (i.e. identical production capacities and average of variable costs) are applied within the benefit comparison method, concluding the same criticism. (Götze et al., 2008)

With regard to the absolute advantageousness, the investment object should be realised if the profitability is greater than zero. When comparing several investment objects to each other, the relative advantageousness is determined for the investment object with the highest profitability. (ibid.)

2.2.3. Return on Investment

The financial ratio Return on Investment (ROI) determines the profitability of an investment object by calculating the relation of profit and invested capital. The result of the ROI ratio is expressed in a percentage. (Poggensee, 2011)

The ROI ratio is mostly applied on company-level to serve as an indicator of the profitability of the whole company. In this case, the literature refers to the ROI as a profitability ratio pyramid since the nominator and denominator are composed by ratios as well. (Lachnit and Müller, 2012) However, when applied on an investment object, the composition of the ratio is less complex. The ROI, which is also referred to as Accounting Rate of Return (ARR), is determined by the average profit divided by the average invested capital in an investment object (see formula below). While the profit is calculated by the difference between cash inflows and cash outflows over the lifetime of an investment object, the invested capital represents the value necessary to acquire the investment object. (Zimmerman, 2011) Thus, the formula for the ROI can be displayed as follows:

Equation 1: Return on Investment formula for capital investment objects

The expression of the ROI as a percentage enables a conclusion about the efficiency of an investment. If ROI > 0%, the result implicates that the investment is amortised, even without knowing the exact point of time when the investment object amortises. Nevertheless, the decision-maker would decide to invest, since the investment is able to add value to the company’s capital anyway.

When comparing the ROI of several investment objects the investment object with the highest percentage is regarded as the most advantageous. Nonetheless, if there is a minimum percentage value defined for the ROI in companies (e.g. requiring a higher ROI than the costs of capital or the market-based interest rate), the decision-maker might tend towards underinvestment since investment alternatives might not meet the minimum required return rate, especially in high interest market environments.

In contrast to the payback period, the ROI is able to consider the lifetime of an investment object. However, the expected profit in the nominator is calculated by averaging the expected cash inflows and cash outflows of the investment object across its lifetime. Hence, the ROI ignores the fact that an investment object’s profitability might vary over its lifetime. Just as the payback period, the ROI does not consider the time value of money and thus, is referred to as static investment appraisal method.

2.2.4. Net Present Value and Compound Value

The Net Present Value (NPV) considers the time value of money and therefore classifies as dynamic investment appraisal method. From the date of investment, future expected cash inflows and outflows are discounted or compounded via an interest factor to transfer these cash flows to the same point of time (mostly present time as with the NPV). The discounted cash outflows are subtracted from the cash inflows to calculate the net present value. Hence, the result of the NPV calculation is expressed in absolute monetary value. (Poggensee, 2011)

Figure 11 illustrates the calculation of the NPV:

Figure 11: Illustration of the Net Present Value calculation

Source: Based on Prätsch et al., 2012:347

In case NPV > 0, the decision-maker would decide to invest since the investment object is able to add value to the company. In addition, the investment decision is perceived as less risky since the NPV tries to sketch reality by considering the time value of money in form of the discount factor. Furthermore, the cash flows of the whole lifetime of the investment object are taken into consideration.

However, the decision-maker might tend to overinvest when deciding to invest in each investment object with a positive NPV. That is why the NPV does not reveal any information about the relation between the investment need and the generated profit such as the ROI. Nevertheless, the decision-maker is able to compare several investment objects with the help of the NPV. In this case, the investment object with the highest NPV is regarded as the most profitable over its lifetime.

The Compound Value method (CV) is similar to the NPV. Both methods are classified as dynamic investment appraisal methods by recognising the time value of money. Nonetheless, the biggest difference between these two methods is the point of time future cash flows are transferred to. While the NPV calculates the added value of future cash flows at the starting point of the investment, the CV focuses on the end point of the investment object’s lifetime. While the NPV therefore makes use of a discount factor, the element transferring cash flows to the end point of the investment object’s lifetime is the compound factor. Nevertheless, both factors base on an interest rate which is mostly based on the weighted average cost of capital or market-based interest rates. (Poggensee, 2011; Götze et al., 2008)

The underlying decision criterion with the CV is the same as with the NPV. Hence, absolute advantageousness is given with an investment object showing a CV > 0 while relative advantageousness is assigned to the investment object with the highest CV.

The following figure illustrates the calculation of the CV:

Figure 12: Illustration of the Compound Value calculation

Source: Based on Prätsch et al., 2012:344

2.2.5. Internal Rate of Return

The internal rate of return (IRR) is the discount factor leading to a NPV of zero. While a discount rate for the NPV calculation is based on general assumptions, the IRR calculates the effective discount rate leading to NPV = 0. Hence, it sets the relation of the investment and the future discounted cash flows and thus, provides an indicator of the efficiency and quality of an investment. In addition, the IRR recognises the time value of money and therefore classifies as dynamic investment appraisal. (McLaney, 2009)

To derive the relative advantageousness of several investment objects, the investment object with the highest IRR is preferred. However, in case of no competing investment objects, the decision-maker would decide to invest if the IRR is higher than the costs of capital or the market-based interest rate. This decision is made on the premise that more value can be added to the company’s value by the investment object than with a financial investment on the capital market. (Poggensee, 2011)

The calculation of the IRR is complicated since it is mostly derived by trial-and-error. Furthermore, the IRR leads to unrealistic return rates in some constellations (Zimmerman, 2011). Investment objects with cash flows changing from positive cash flows in one year to negative cash flows in the concluding year even reveal more than one IRR. In this case, it is difficult for the management accounting professional to determine the correct value for the IRR as a basis for decision-making.

2.2.6. Utility Value Analysis

The discussed methods within the previous subchapters can either be classified as a static or a dynamic investment appraisal method and support single quantitative strategic goals. However, in case of multiple quantitative strategic goals or in case of qualitative goals, these investment appraisal methods do not offer a helpful result (compare Figure 10).

Hence, the corresponding investment appraisal methods in these cases must be derived from the group of Multiple Attribute Decision-Making (MADM) methods. The most popular method of this group is the Utility Value Analysis which is therefore in the scope of this thesis (Götze et al., 2008).

The Utility Value Analysis (UVA) intends to calculate a value that consists of a weighted sum of several sub-goals. When conducting the UVA, the first step is to determine the sub-goals under consideration. These sub-goals might comprise various quantitative goals (e.g. NPV, ROI, IRR, etc.), a combination of quantitative and qualitative goals or solely qualitative goals. The second step within the Utility Value Analysis assigns weightings to the sub-goals. Each sub-goal is assigned with a relative importance (step two) so that the sum of all weighted sub-goals is equal to 1 or 100. (Poggensee, 2011; Götze et al., 2008)

Afterwards, the third step comprises a judgement of how far each investment object meets each sub-goal. This judgement can either be conducted on basis of a nominal, ordinal or cardinal scale. These assigned values of the expert judgements are multiplied with the weightings of the sub-goals in the following step (step four) to derive a utility value for each sub-goal. (ibid.)

Finally, the utility values of the sub-goals are added to calculate the overall utility value of each investment object (step five). Hence, unfavourable results of one sub-goal can be compensated by favourable results of other sub-goals unless no minimum value was previously determined functioning as a threshold value. (ibid.)

A generic example of the underlying calculations of a UVA can be retrieved from the following table:

Figure 13: Generic example of Utility Value Analysis

Regarding the investment decision, the absolute advantageousness is given if an investment object is above a targeted utility value. Alternatively, the relative advantageousness is given for the investment object with the highest utility value compared to its competing alternatives. (Götze et al., 2008)

As already indicated the UVA experiences increased popularity within business practice. One reason is the fact that the result in form of a single-score value is easily comprehensible. In addition, the method offers a structured procedure and its underlying simple calculations can be conducted also by non-financial experts. (ibid.)

However, the UVA also faces criticism which mainly focuses on the subjective judgements of the person conducting the method. Besides these judgements, the determination of sub-goals and assignment of weightings to these sub-goals represent subjective steps. The steps of weighting the sub-goals as well as the judgement of the utility values require extensive timely effort. Furthermore, the resulting utility values are accompanied with uncertainty, which is why sensitivity analyses should be conducted to assess the degree of deviation of results, in case assumptions, weightings or judgements change. (Poggensee, 2011)

2.3. Modifications of conventional investment appraisal methods

Before describing the literature on environmental investment appraisal methods, the definition of environmental investments needs to be discussed. Günther (2008) defines environmental investments as all investments providing an ecological relevance. In addition, the author states that environmental investments can either be enforced by legislation or implemented voluntarily. Furthermore, environmental investments might comprise either investments in assets for environmental protection or investments extending, substituting or increasing the efficiency of already existing assets. (ibid.) As a consequence, this broad definition can be applied on the majority of regular investments since there is hardly any asset that does not have an ecological relevance.

Baumast (2009) defines environmental investments as the acquisition of assets for the purpose of protecting the environment. Hence, environmental investment appraisal methods assess the profitability of environment protection investments. In addition, Baumast (2009) refers to the option of the ex-post analysis of environmental investment appraisals to analyse the profitability of past environmental protection investments. On the one hand, this definition narrows down the scope by focusing on assets with the aim of environmental protection rather than all investments with an ecological relevance. On the other hand, this definition concentrates on assessing the profitability of these environmental protection investments. However, the environmental impact of the investment objects is neglected in this definition.

The third definition in this context focuses on the integration of economic and ecological considerations in the investment decisions. Assuming a given strategic environmental goal of a company, Isensee and Michel (2011) state that environmental investments have to contribute to this goal. Hence, the environmental impact of the investment object needs to be quantified and integrated into the calculation of the economic advantageousness. This, in turn, enables the decision-maker to choose the optimal investment object contributing to the environmental and financial goals of the company.

In context of this thesis, the definition of environmental investments is a mixture of the three previously discussed positions. The definition can be separated into two parts. While one part deals with the purpose of the investment object, the other part focuses on the intention of analysis.

With regard to the purpose of the investment object, narrowing down the scope of analysis on assets for environmental protection would represent a too narrow limitation, since other assets also provide a significant environmental impact.

Hence, also investments with the purpose of substituting or extending already existing assets can contribute to minimising the environmental impact and thus should also be regarded as environmental investment.

Concerning the intention of analysis, the definition by Isensee and Michel (2011) represent a comprehensive view by also quantifying the environmental impacts of an investment object. This comprehensive view enables the decision-maker to take an integrated decision representing the contribution to environmental and financial goals of the company. Furthermore, in analogy to the previously discussed financial investment appraisal methods, an ex-post analysis as described by Baumast (2009) is essential to substantiate the financial and environmental effectiveness of investment objects.

Definition of environmental investments in context of this thesis

Hence, the definition of environmental investments for this thesis can be formulated as follows: An environmental investment is the acquisition of a fixed tangible asset that enables a company to contribute to its environmental goals by being able to quantify its environmental impacts to provide the basis of an ex-post analysis.

2.3.1. Ecological Payback Period

As already explained, the financial payback period intends to calculate the amount of time needed to recover the initial capital investment by cash inflows of an investment object. The Ecological Payback Period (EPP) picks up this idea by replacing the cash inflows and outflows with environmental aspects. Hence, the EPP determines the relation of the environmental aspects occurring with the production of the investment object with the annual amount of environmental aspects, which are avoided by operating the investment object (Schaltegger and Sturm, 2000). Therefore, the formula for the EPP can be expressed as follows:

Equation 2: Ecological Payback Period formula for capital investment objects

The underlying idea originates from the renewable energy sector where the energy payback “gives the ratio of net energy produced during the lifetime of the facility, divided by the energy required to build, maintain and supply the facility during all that time.” (Guerrero-Lemus and Martínez-Duart, 2013:29).

On the one hand, the comprehensive view, including the environmental aspects caused by the production of the investment object, appears to be ecologically useful. On the other hand, however, practitioners are faced with three problems. First, the quantitative data on environmental aspects caused by the production of the investment object are difficult to collect. Second, the EPP is calculated with only one environmental aspect at a time. Hence, it is necessary to find an indicator which is able to represent also other environmental indicators. Third, no environmental impact assessment is conducted which is eventually the aim of this thesis.

2.3.2. Ecological Return on Investment

As described above, the financial ROI determines the profitability of the investment. The calculation divides the average profits generated through the investment object by the capital investment needed to acquire the investment object. Schaltegger and Sturm (2000) suggest a transfer of the ROI to an Ecological Return on Investment (EROI). As with the EPP, financial cash flows are replaced with environmental aspects. Hence, the avoided environmental aspects over the operational lifetime of the investment object are set in relation to the environmental aspects caused over the investment object’s life cycle (ibid.). Therefore, the formula can be expressed as follows:

Equation 3: Ecological Return on Investment formula for capital investment objects

Schaltegger and Sturm (2000) claim that an investment should be regarded as efficient if the outcome is > 1. However, in case of investments not intending to avoid emissions (i.e. investments expanding already existing facilities), the decision-maker should invest in the object which is closest to zero (ibid.).

In contrast to the EPP, the EROI focuses on the life cycle of the project. On the one hand, this comprehensive view satisfies scientific requirements since relevant environmental aspects are not excluded from the analysis. On the other hand, the same criticism applies for the EROI as with the EPP.

2.3.3. Ecological Net Present Value

The financial NPV method classifies as dynamic investment appraisal method since it considers the time value of money. Cash inflows and cash outflows, which occur at different points of time, are discounted or compounded to the same point of time via an interest factor. The discount factor is also in the focus of suggestions regarding an Ecological Net Present Value (ENPV).

Günther (2008) discusses possible adjustment opportunities of the discount factor within the NPV calculation. The premise of the author is that the decision-maker tends to prefer investment objects with cash outflows in the distant future than investment objects with cash outflows in the near future (ibid.). The underlying argument is again the time value of money. One monetary unit in distant future implies less value compared to one monetary unit in near future due to inflation (Götze et al., 2008).

Building on this premise, Günther (2008) discusses transferring this issue on investments and their impacts on the environment. On the one hand, the author claims that expected technical development should lead to an increase of the discount factor since cost savings are expected in distant future. On the other hand, expected stricter threshold values should lead to a decrease of the discount factor, offering the incentive for immediate investment. (ibid.)

The discussion about adjusting the discount factor, with the intention to recognise future environmental impacts, gained popularity with the Second Assessment Report (SAR) of the Intergovernmental Panel on Climate Change (IPCC) published in 1996. The SAR differentiates between a prescriptive discount rate (in literature also referred to as the social or environmental discount rate) and a descriptive discount rate. (Halsnaes et al., 2007)

The descriptive discount rate bases on market-based interest rates. These interest rates are either determined by central banks and are referred to as prime rates or base rates. Another option is the London Interbank Offered Rates (LIBOR), which is defined by the British Bankers’ Association and represents the daily average inter-bank interest rate. An alternative to LIBOR is the EURIBOR, which is published by the European Banking Federation and focuses on the average inter-bank interest rate of financial institutions within the European Union. (Becker, 2012)

In contrast to this, the prescriptive discount rate tries to sketch the tendency of humans to prefer paying costs for environmental protection in distant future than paying these costs today. This tendency is also referred to as pure-time preference. (Kula, 2011) Halsnaes et al. (2007:136) define the prescriptive discount rate as “the sum of the rate of pure-time-preference and the rate of increased welfare derived from higher per capita incomes in the future”.

While descriptive discount rates tend towards high rates of four percent or more (especially for risky funds), prescriptive discount rates tend to be the opposite (Halsnaes et al., 2007). In this context, Stern (2007:45) points towards the controversial discussion about environmental discount rates since high discount rates “favour avoiding costs of reducing emissions now, since the gains from a safer and better climate in the future are a long way off and heavily discounted”.

Shaikh (2012) notes that the debate about discounting environmental impacts overloads the ability of the discount rate since the debate diverges from the original intention of the discount rate, which is the representation of the time value of money. In addition, the debate concentrates on defining an appropriate level for an environmental discount rate and not on the question whether or not discounting is the right tool to achieve inter-generational equity in financial projections. Shaikh (2012) adds that economists generally do not intend to discuss ethical questions within their calculations.

Besides the vast criticism, the government of the UK has determined a discount rate for public long-term projects that declines over the years (see Table 2). While France also prescribes a four percent discount rate for projects below 30 years and a two percent discount rate for projects of over 30 years lifetime, the US government suggests voluntary implementation of declining environmental discount rates. (Halsnaes et al., 2007) However, there is no transparent reasoning behind the determination of these discount rates. In addition, whether or not the level of these discount rates is appropriate with regard to a fair representation of generations of today and the future, is a discussion which is unlikely to end with a globally accepted consensus in the near future.

Table 2: Environmental discount rates as prescribed by the UK Government

Source: According to Halsnaes et al., 2007

In its discussion about adjusting the discount factor within the NPV calculation, Günther (2008) refers to the inability of the discount factor to appropriately represent inter-generational equity. This argumentation is also shared by Schaltegger and Sturm (2000), who also argue that an adjustment of the discount factor would contradict the inter-generational paradigm as described in the Brundtland report.

2.4. Environmental impact assessment in companies

The problem situation of this thesis highlights amongst others the necessity to express strategic environmental goals in quantitative values to determine environmental impacts of decisions and to enable supporting these strategic goals. However, to determine the environmental impacts of an investment decision, it is necessary to collect, monitor and analyse environmental data in the same quality as corporate financial data is collected, monitored and analysed.

The department coordinating environmental data is the environmental management of a company. The main purpose of environmental management is to ensure a continuous improvement of a company’s environmental performance (Förtsch and Meinholz, 2014). Hence, the organisation along the Plan-Do-Check-Act (PDCA) cycle ensures a standardised way of repetitively defining environmental goals, organisational structures, responsibilities, the execution of programs and audits as well as its documentation (Müller-Christ, 2010).

Successful environmental management necessitates cross-functional collaboration with other departments. In this context, Rathje (2009) assesses the organisational positioning of environmental management departments in companies. Since the author identifies a variety of locations within the organisational structures, Ratje (2009) concludes that the location depends on the overall organisational structure of the company. Nevertheless, since environmental management affects all areas of a company, the hierarchical location of the department plays a minor role when assessing the degree of cross-departmental collaboration regarding environmental management issues. (ibid.)

As the aim of an environmental management system is the continuous improvement of a company’s environmental performance, this performance needs to be quantified so that development can be monitored, documented and reported. This process of measuring, monitoring and reporting environmental performance data is referred to as ‘environmental management accounting’ (IFAC, 2005).

Burschel (2004) notes that the current academic literature has not agreed on a uniform definition of environmental management accounting due to its intense discussion and diverse dissemination in business practice. The author analyses different forms of environmental management accounting systems and differentiates between:

- the connection of environmental management accounting to financial accounting

parallel system to financial accounting

extension of financial accounting

- the scale of assessment of environmental management accounting

focus on physical input and output flows

focus on monetary flows

- the scope of assessment of environmental management accounting

assessing environmental impacts of products and processes

assessing environmental impacts of the whole company (ibid.)

Nevertheless, Baumast (2009) defines environmental management accounting as subsystem of the management accounting business function that extends the classical management accounting tools by ecological components to integrate environment-related issues. Faßbender-Wylands (2009) agrees by referring to the functions of environmental management accounting which match with the functions of a financial management accounting system. Although the author claims that classical management accounting instruments are not originally designed and thus not suited for tracking environmental performance. In addition, the author notes that suitable instruments of environmental management accounting are still under development (ibid.).

Tschandl and Posch (2012) focus on the task of providing information on eco-efficiency and eco-effectiveness as well as identifying opportunities and threats of sustainable development practices. Therefore, environmental management accounting concentrates on physical flows such as waste, water, emissions, energy or other related consumption of resources. (ibid.)

The basis for environmental management accounting is an integrated environmental information system which records all relevant environmental aspects of a company (ibid.). According to an analysis by Isensee and Michel (2011), the most-advanced companies in integrating environmental management accounting still face a lack of additional and detailed environmental data. In most cases, companies are not able to track and monitor data on environmental aspects on equipment level. Resource and emission flows are only available on an aggregated level (i.e. plant or hall level) requiring additional measuring points on equipment level. This fact leads the authors to the conclusion that the development of environmental management accounting is still far from established professional application (ibid.).

Besides the location of measurement equipment of resource and emission flows, an additional issue for the environmental management accounting system concerns the scope of measurement. While the financial management accounting is primary interested in cost-related environmental aspects (e.g. energy or water), the environmental management has to track additional resource and emission flows due to compliance checks with given threshold values.

When exploring the underlying reasons for the lacking detail of environmental performance data, the differentiation between environmental aspects and environmental impacts is vital. According to the ISO (2009:11), an environmental aspect is defined as an “element of an organization’s […] activities or products or services that can interact with the environment”.

Furthermore, the literature differentiates between direct and indirect environmental aspects. Direct environmental aspects are defined as decisions and activities in the context of business operations of the own company. These activities comprise amongst others the development, production, transport and marketing of products. In contrast to that, indirect environmental aspects comprise decisions and activities of suppliers or business partners of a company. (Prammer, 2009)

While this definition of environmental aspects emphasises the interaction between the operations of a company with the environment, the ISO (2009) recommends the establishment of an input-output model as a basis for further quantification and measurement. In this context, the IFAC (2005:30) suggests “accounting for all energy, water, materials and wastes” in order to build a so-called “input-output balance”.

The European Commission (2009:22) provides a more comprehensive list which adds to the following environmental aspects:

- “legal requirements and permit limits

- emissions to air

- releases to water […]

- use and contamination of land

- use of natural resources and raw materials […]

- local issues (noise, vibration, odour, dust, visual appearance, etc.), […]

- risks of environmental accidents and impacts arising, or likely to arise, as consequences of incidents, accidents and potential emergency situations,

- effects on biodiversity.”

While this list also reveals qualitative environmental aspects, it could even be extended by referring to additional literature. However, the environmental management system focuses on the most relevant environmental aspects. Hence, the European Commission (2009:22) assists in determining the relevance of environmental aspects by defining:

“- size, number, frequency and reversibility of the aspect or impact

- existence and requirements of relevant environmental legislation

- importance to the stakeholders and employees of the organisation”

The step of identifying the most relevant environmental aspects provides the basis of assessing the impacts on the environment. While the definition of environmental aspects concentrates on the interaction of business activities with the environment, the definition of environmental impacts focuses on the consequences of this interaction. Prammer (2009) classifies environmental impacts into three categories:

- change of amounts of natural resources (mostly depletion)

- change of material composition of the natural environment

- change of ecosystems and landscape.

In addition, the author states that environmental impacts can be short-term, mid-term or long-term, reversible or irreversible, constant or of temporary character (ibid.). While environmental aspects can be quantified with the help of measurement technology, quantifying environmental impacts is difficult. The lacking knowledge of cause-and-effect of environmental aspects leads to the necessity of assumptions which are hard to determine in an objective and plausible manner. (Tschandl, 2012; Loew et al., 2003)

Furthermore, the environmental impacts under consideration depend on the scope of assessment. Original Equipment Manufacturers (OEM) of the automotive industry, for instance, face responsibility for the environmental impacts of their products occurring from materials used, air emissions, noise and fuel consumption. With regard to the production, environmental impacts occur from emissions into the air or surface waters, consumption of materials, energy or freshwater, noise emissions, waste, land contamination and many more. (Gruden, 2008) With other industries or products under consideration, this set of environmental impacts would vary significantly.

Because of this variety of environmental impacts, the literature discusses several methods assessing and aggregating environmental impacts in indicators or ratios with the aim of measuring and monitoring the environmental performance of a company (Dyckhoff and Souren, 2008). The aim of these methods is to aggregate environmental impacts to function as a basis for decision-making. Therefore, environmental indicators or ratios should be able to compare alternatives or represent the environmental impacts on different levels (i.e. local, regional, national or international level). (Tschandl, 2012)

Yet, the immaturity of most of the environmental indicators is a restricting factor for application in business practice (ibid.). Pöder (2006:141) recognises “significant difficulties in adequate and reproducible assessment of their [companies] environmental aspects”. As a consequence, the author observes two kinds of companies. On the one hand, most companies apply intuitive expert judgements, while on the other hand companies tend to install complex and formal assessment schemes (ibid.). In this context, Lion et al. (2013) complains about an increasing complexity of environmental impact assessment tools which result in a lack of understanding at business practitioners.

Besides the lack of comprehension of environmental impact assessment methods at business professionals, a survey of large German companies conducted by Schaltegger et al. (2011a) reveals another problem. The survey results reveal that only 9.7 percent of the companies apply an environmental accounting. Furthermore, the authors point towards a low involvement of finance and accounting department in sustainability management which is why “a stronger involvement of finance, accounting and management control is highly recommended” (Schaltegger et al., 2011b:144).

These results highlight the necessity of increased collaboration between management accounting professionals and environmental management professionals. Dyckhoff and Souren (2008) claim that the degree of collaboration of both professions depends on their ability to accept mutual agreement. However, in case the environmental management professional strictly keeps the focus on improving environmental impacts and the management accounting professional strictly keeps focusing on profitability, this mutual agreement between both parties is difficult to find (ibid.).

Another problem hindering increased collaboration between both professions is the lacking communication (IFAC, 2005). Since environmental management and management accounting originate from other professions, it is important to find a common wording to enable mutual understanding.

Finally, the uncertainty of interpreting environmental performance data restricts its popularity of applying it in internal decision-making processes. Since a decrease in environmental impacts can be caused through increased resource efficiency, it is difficult to delimit environmental management measures from general efficiency efforts originating from management accounting measures. On the other hand, it is still unclear how far an environmental management system causes an increase in turnover. (Müller-Christ, 2010)

While the effort of increasing resource efficiency represents a common ground of both professions, the collaboration is at risk in case profitability and environmental protection represent conflicting goals. In this context, Müller-Christ (2010) claims that companies shall declare strategic financial goals superior to strategic environmental goals. One reason for this declaration can be seen in the focus of environmental management systems on standardisation and formalisation of an environmentally-focused PDCA cycle. Hence, environmental management systems are unable to resolve possible conflicts between conflicting goals of profitability and environmental protection. (ibid.) These possible conflicts need to be recognised and resolved comprehensively.

2.5. Deficit analysis

The introduction of the conventional investment decision-making processes in companies revealed the differentiation between the phase of the investment appraisal and the phase of the actual investment decision. On the basis of this differentiation the focus of this thesis is on the most common investment appraisal methods as this phase represents the foundation for the actual investment decision.

Hence, the goal of the investment appraisal is to sketch a realistic picture of the expected profitability, cash flows or risk over the lifetime of the investment object so that the decision-maker can compare this to competing investment objects. The introduction of the most common investment appraisal methods revealed that each method investigates another aspect of the investment object. While the payback period focuses on the point of time till amortisation, the ROI sets the averaged relation between invested capital and expected profits. In addition, the comparison of costs or benefits represents basic financial assessments. Cost/benefit comparison, payback period and the ROI represent static investment appraisal methods and thus do not recognise the time value of money. However, their advantage can be seen in a simple and quick calculation that is easy to comprehend also to non-financial professionals.

With regard to the dynamic investment appraisal methods, the NPV records the point of time of cash inflows and cash outflows and transfers them via a discounting factor to the present value. In analogy, the CV transfers the cash flows of an investment to the end point of the investment object’s lifetime. Therefore, NPV and CV represent the value of the investment object that is added to the company’s value. In addition, the IRR provides the discounting factor leading to a zero NPV, which provides the decision-maker an impression about the sensitivity of the investment object. Hence, the IRR sets the relation of the investment and the future discounted cash flows and thus represents an indicator for the efficiency and quality of an investment.

Since no investment appraisal method is able to assess all relevant aspects, a set of indicators is needed for a comprehensive investment decision. While the investment appraisal is able to generate quantitative figures, the decision-maker also takes qualitative factors into consideration. The UVA represents a popular method to compose such a set. Nevertheless, the allocation of weightings to the corresponding sub-goals as well as the judgement of the utility values depend on subjective weightings and are in the focus of criticism.

In addition to the most common investment appraisal methods, modifications of conventional investment appraisal methods are discussed to assess their ability to integrate environmental impacts. The EPP and EROI represent environmental analogies to the payback period and ROI. Nonetheless, EPP and EROI differentiate with extending the boundary of assessment by taking into consideration the environmental aspects occurring in the production phase of the investment object. The problem, which practitioners are confronted with, is the lack of environmental data of this production phase.

Another problem is the absence of an environmental impact assessment within EPP and EROI. In addition, both methods are only able to assess one environmental aspect at a time. Therefore, a comprehensive environmental impact assessment cannot be conducted on the basis of EPP and EROI.

The third environmental investment appraisal method is the ENPV which mainly focuses on the opportunity to adjust the discount factor with the intention to influence the investment behaviour of the decision-maker. Nevertheless, finding an appropriate level of this environmental discount rate is a controversially discussed issue in literature. Hence, the common criticism notes that adjusting the discount factor overwhelms the ability of the discount rate which is originally intended to represent a trade-off between investing now or later. Furthermore, the management accounting professionals do not intend to answer macroeconomic questions or the ethics of inter-generational equity.

Evidence for the low popularity in applying modified investment appraisal method is represented by a study of Schaltegger et al. (2011a) revealing that only 9.7 percent of the surveyed companies apply environmental investment appraisal methods.

Besides discussing the investment process within companies, conventional investment appraisal methods and their modifications, the state of current academic knowledge regarding environmental impact assessment in companies is highlighted. The environmental management department aims for continuous improvement of the environmental performance of the company.

This continuous improvement involves the collection, monitoring and analysis of environmental data which is also referred to as environmental management accounting. In contrast to this, authors see the field of environmental management accounting as a subsystem or extension of conventional management accounting (compare Baumast, 2009). While this involves collaboration between environmental management and management accounting, a survey reveals a lack of such collaboration. Possible reasons can be found in missing communication as well as the inability of resolving conflicting goals.

Besides organisational issues, the data quality regarding the measurement of relevant environmental aspects, which build the basis for a subsequent impact assessment, remains an issue which needs to be solved by the installation of additional measurement technology. Hence, integrated environmental information systems provide an overview about environmental aspects but lack detailed insights on equipment level. In context of investment decisions, this lack concludes the problem of executing validity checks. In addition, different perspectives of financial and environmental management accounting professionals have impact on the scope of measurement. While financial management accounting is concerned with cost-related resource and emission flow, the environmental management accounting is interested in a wider scope due to compliance checks of given threshold values.

Finally, the instruments of assessing the environmental impacts are still under development. The immaturity of environmental impact assessment methods is expressed in their inability of offering reproducible and comparable results on the one hand and an increased complexity leading to high effort and a lack of comprehension at practitioners on the other hand.

This deficit analysis intends to assess the underlying reasons for the lack of application of environmental investment appraisal methods in practice. One main reason can be found in the weaknesses of EPP, EROI and ENPV resulting in a low degree of practical applicability. Besides organisational issues focusing on the collaboration between environmental management and management accounting professionals, the immaturity of environmental impact assessment methods can be regarded as main reason as well.

Therefore, it is necessary to develop a method that is able to overcome the weaknesses and problems identified in this deficit analysis. This integrated investment method needs to comprise an environmental impact assessment, which implies that all relevant environmental aspects are previously identified and measured. In addition, the method must represent a low degree of complexity to ensure that also non-professionals are able to comprehend the underlying rationale of the investment appraisal. This is especially important when regarding the cross-functional collaboration of environmental management accounting issues. Furthermore, the method needs to generate reproducible results which also provide the basis for comparison. Finally, the results need to be traceable and expressed in monetary terms to increase acceptance and thus successful practical applicability.

3. Method development

The current state of academic knowledge reveals in its concluding deficit analysis that the available environmental investment appraisal methods show a low popularity due to their lack of practical applicability. This chapter intends to identify and discuss additional methods that can serve as a basis for developing a new environmental investment method.

However, before discussing these additional methods, the basis for such a discussion needs to be determined. This basis is represented by a set of requirements according to which the methods are assessed. The set of requirements is composed by the results of the deficit analysis of the previous chapter on the one hand and the literature on environmental performance measurement on the other hand. Besides defining these requirements, the assessment criteria need to be determined as well to ensure a standardised evaluation procedure.

Therefore, this chapter is structured into three parts. The first part reveals the definition of requirements and the corresponding evaluation parameters. The second part introduces additional approaches which can function as a basis for further method development. These approaches are clustered into three groups – environmental cost accounting methods, flow-based cost accounting methods and additional methods of integrating environmental impacts. The second part also represents the evaluation of the approaches on basis of the previously defined requirements. Finally, the third part discusses the implications of the method screening and evaluation for the development of the new integrated investing method, before the interim results of this chapter are summarised and discussed in subchapter 3.4.

3.1. Determination of requirements

The discussion of environmental management accounting in the previous chapter revealed requirements with regard to measuring and monitoring all relevant environmental aspects. Hence, the physical flows of an investment object need to be predicted and their relevance needs to be assessed to compose an environmental inventory of all relevant environmental aspects associated with the investment object.

Furthermore, the continuous improvement of environmental performance in the context of environmental management requires an environmental impact assessment of the previously identified and quantified relevant environmental aspects. The results of this environmental impact assessment need to be reproducible and comparable to competing investment objects.

In addition, the deficit analysis revealed the problem that existing methods of assessing the environmental impacts are too complex and thus require a high timely effort on the one hand and lead to a limited degree of comprehensibility on the other hand. Hence, the requirement of comprehensibility is added to the set.

Besides the results of the deficit analysis, the academic literature on environmental performance measurement reveals additional requirements. Recker (2013) claims that validity and reliability are important attributes when assessing the scientific quality of methods. While reliability ensures that the application of the methods lead to the same reproducible results, validity ensures that the method serves the intended aim (ibid.)

Figure 14 shows the necessity for meeting both requirements by visualising the reliability and validity of fictitious measurement data.

Figure 14: Visualisation of different levels of reliability and validity of measurement results

Source: Recker, 2013:69

Prammer (2009) lists requirements concerning the application of environmental assessment methods in business practice. Besides a solid scientific basis, the methods need to be comprehensible and practicable to reach general acceptance (ibid.). In addition, Günther (2008) claims that the method needs to be applied within appropriate timely effort, which leads to increased practical applicability.

Another important requirement is the transparency of a method. Transparent methods enable decision-makers to understand the origin of the underlying data as well as the calculations and rationales behind the methods. This in turn increases the method’s credibility. (Schwegler et al., 2011)

In addition to comprehensibility and transparency of the method, the requirement of monetary evaluation aims at increasing the method’s practical applicability. In this context, it is important to differentiate monetary evaluation from monetarisation. While monetarisation intends to assign a monetary value to an environmental impact, the term ʻmonetary evaluationʼ aims to express the result of a method in monetary values (FEM, 2003). The expression of the results in monetary values intends to increase the acceptance of the management since it represents a “language that business managers understand” (IFAC, 2005:41).

For a structured discussion in the course of this chapter, the requirements originating from the deficit analysis and the current academic literature are clustered into two groups. While one group represents requirements aiming at a sufficient degree of scientific quality, the other group of requirements aims for a successful practical application of the method.

The following table represents a summary of the requirements, which are defined in detail in the following subchapters:

Table 3: Summary of requirements as a basis for the method screening and evaluation

Source: Own representation

3.1.1. Requirements ensuring scientific quality

Environmental inventory

The targeted integration of environmental impacts bases on the method’s ability to measure and quantify environmental aspects. Therefore, the environmental inventory requirement assesses whether all relevant environmental aspects are directly measured and quantified.

However, before assessing the methods in this chapter, three key elements, which are part of this requirement, need to be defined to ensure a uniform understanding of the requirement itself. These three key elements comprise:

- environmental aspect

- relevance

- scope of measurement and quantification

The International Organization for Standardization (ISO) provides a definition of environmental aspects in its norm addressing environmental management systems. According to the ISO (2009:11), an environmental aspect is an “element of an organization’s […] activities or products or services that can interact with the environment”. While this definition emphasises the interaction between the operations of a company with the environment, the ISO (2009) recommends the establishment of an input-output model as a basis for further measurement and quantification. The suggested inputs and outputs cover:

“- emissions to air,

- releases to water,

- releases to land,

- use of raw materials and natural resources,

- use of energy,

- energy emitted e.g. heat, radiation, vibration,

- waste and by-products” (ISO, 2009:26f.).

While conforming with the ISO regarding the recommended input-output model, the European Commission (2009) adds in its published regulation on the European Eco-Management and Audit Scheme (EMAS) additional environmental aspects.

These additional aspects include:

“- use and contamination of land […]

- use of additives and auxiliaries as well as semi-manufactured goods [...]

- transport issues […]

- risks of environmental accidents and impacts arising, or likely to arise, as consequences of incidents, accidents and potential emergency situations.” (European Commission, 2009:22)

The assessment of both standards on environmental management systems reveals an extensive list of possible environmental aspects. However, which environmental aspects need to be considered depends on the one hand on the investment object and on the other hand on the relevance of the environmental aspect. Hence, it needs to be defined when an environmental aspect can be regarded as relevant.

Concerning the definition of relevance, the ISO (2009:11) states that “a significant environmental aspect has or can have a significant environmental impact”. While this definition connects environmental aspects with their impacts on the environment, it is not helpful in determining the relevance of environmental aspects.

Although the European Commission (2009:22) also describes this connection, further assistance in assessing the significance of environmental aspects is provided:

“- size, number, frequency and reversibility of the aspect or impact
- existence and requirements of relevant environmental legislation
- importance to the stakeholders and employees of the organisation”

In conclusion, the relevance of an environmental aspect can be determined on the basis of several parameters such as physical quantities, environmental legislation or outcomes of stakeholder dialogues. In the context of this thesis, the relevance is determined according to the quantities of environmental aspects. Moreover, the proportion of the total measured and quantified environmental aspects is important when determining the relevance of environmental aspects.

In addition, the scope of measurement and quantification needs to be determined. In the context of this thesis, the scope is set on direct environmental aspects which can be measured on the company’s site (gate-to-gate). Furthermore, the scope is set on the environmental aspects resulting from the operation of the analysed investment object and not on the environmental aspects resulting from its establishment or disposal.

Finally, the evaluation question regarding the environmental inventory requirement can be formulated as follows:

Are all relevant environmental aspects directly measured and quantified?

The following table summarises the evaluation parameters of the environmental inventory requirement with their corresponding definitions:

Table 4: Definition of evaluation parameters of the environmental inventory requirement

Source: Own representation

Environmental impact assessment

After the basis of the method’s ability to measure and quantify environmental aspects is assessed, the concluding step is the environmental impact assessment. This step is important since the sole relevance of the environmental aspect does not provide any conclusion about the severity or damage to the environment. Hence, this requirement evaluates whether the analysed method is able to assess and to integrate the environmental impacts of the relevant environmental aspects.

However, before analysing the methods on the basis of this requirement, two parts need to be determined beforehand. First, the term ‘environmental impact assessment’ needs to be defined. Secondly, the differentiation between direct and indirect environmental impact assessment needs to be clarified. Finally, a definition of environmental impact assessment in the context of this thesis is derived.

The ISO (2009:11) defines an environmental impact as “any change to the environment […], whether adverse or beneficial, wholly or partially resulting from an organization’s […] environmental aspect”. While the definition of environmental aspects concentrates on the interaction between a company’s operations and the environment, this definition highlights the consequences of such interaction to the environment. In this context, Prammer (2009) determines three major categories of environmental impacts:

- change of resource inventory

- change of material composition of the natural environment

- change of ecosystem and landscape

In addition, Prammer (2009) differentiates between direct and indirect environmental impacts. While direct environmental impacts cause changes to the environment by operations of the company itself, indirect environmental impacts are caused by suppliers or clients.

In the context of this thesis, the emphasis is set on direct environmental impacts, which is also in line with the gate-to-gate scope of the environmental inventory requirement. Moreover, the emphasis is set on the severity of the change to the environment and not on the type of environmental impact category and its detailed consequences. This emphasis is set in order to enable integration in investment decisions since a detailed description of the consequences would result in limited comparability of investment objects within the investment appraisal.

Finally, the question regarding the environmental impact assessment requirement can be formulated as follows:

Is the method able to assess the environmental impacts of the relevant environmental aspects?

The following table summarises the evaluation parameters of the environmental inventory requirement with their corresponding definitions:

Table 5: Definition of evaluation parameters of the environmental impact assessment requirement

Source: Own representation

Validity

The validity requirement assesses whether the methods analysed in this chapter serve the intended purpose. Hence, it needs to be verified that investment decisions based on the integrated investment method lead to an improved financial and environmental performance of the company. Finally, the investment decisions should support the company in achieving the strategic environmental and financial goals. In this context, the terms ‘financial performance’ and ‘environmental performance’ need to be determined.

With regard to financial performance, the definition focuses on the financial and commercial efficiency of the company and on its ability to add value to the total value of the company (Günther et al., 2006). Hence, the literature on performance measurement lists several indicators and ratios to measure this efficiency. As a representative of a broad consensus Gladen (2011) lists among others indicators such as sales turnover, costs per product, profitability or liquidity. With regard to investment appraisals, the methods introduced in the previous chapter refer, amongst others to PBP, ROI, NPV, CV, IRR, etc. (Poggensee, 2011).

Concerning the definition of ‘environmental performance’ of a company, Günther et al. (2006) discuss eight different definitions provided in literature. As a result, the authors analyse two main perspectives. On the one hand, definitions of environmental performance concentrate on the activities of a company such as activities of the environmental management department. On the other hand, definitions concentrate on the total amount of environmental aspects of a company and their impacts on the environment. (ibid.)

The ISO (2000) established an international standard on environmental performance evaluation. Within this standard, environmental performance is defined as the result of “an organization’s management of its environmental aspects” (ISO, 2000:5). In close relation to the standard concerning environmental management systems, the environmental performance evaluation is described PDCA cycle aiming at a continuous improvement. This aspect is also addressed by Günther et al. (2006), who declare the reduction of environmental aspects of a company from one year to another as ‘environmental profit’.

In the context of this thesis, financial performance is defined as economic and commercial efficiency of a company. The determination of environmental performance is in line with the definition of financial performance. Hence, environmental performance is defined as the reduction of environmental impacts. In both cases, it is assumed that strategic financial and environmental company goals exist so that investment decisions can be taken with the aim to achieve these goals.

Therefore, the validity requirement intends to assess whether there is a correlation between the investment decision and the strategic environmental and financial goals of the company. This is the case, for instance, if the method assesses the financial and environmental efficiency of the investment object and if investment decisions aim to increase this efficiency.

In conclusion, the main question for the validity requirement can be formulated as follows:

Does the decision based on the integrated investment method lead to an improved financial and environmental performance of the company?

The following table summarises the evaluation parameters of the validity requirement with their corresponding definitions:

Table 6: Definition of evaluation parameters of the validity requirement

Source: Own representation

Reliability

The final requirement ensuring scientific quality assesses the reliability of the discussed methods in this thesis. Hence, the requirement analyses whether the method leads to the same results after repeating the calculations under the same circumstances and with the same assumptions (Recker, 2013).

Hence, the consistency of the results depends on the reproducibility of the method’s application. In conclusion, the method should reveal the same result if:

a) one person repeats the calculation of the method after some period of time or
b) two different persons conduct the method’s calculation independently (ibid.).

Transferred to this thesis, the reliability requirement assesses whether the investment decisions based on the method’s results are the same, whether one person repeatedly conducts the calculation after some period of time, or whether two independent persons conduct the method’s calculation separately.

In this thesis, the decision-maker is assumed to take investment decisions rationally. Furthermore, the reliability can be increased by a detailed description of applying the analysed methods and their underlying calculation. With such a detailed description, uncertainty in application is decreased as well as room for subjective judgement and interpretation leading to lower variation of results.

Thus, the question regarding the reliability requirement can be formulated as follows:

Does the method lead to the same result when repeating its underlying calculations?

The following table summarises the evaluation parameters of the reliability requirement with their corresponding definitions:

Table 7: Definition of evaluation parameters of the reliability requirement

Source: Own representation

3.1.2. Requirements ensuring practical applicability

After the scientific requirements are determined, this subchapter focuses on the requirements regarding a successful practical application. However, it needs to be emphasised that the chances of a successful practical application of the method are increased if all scientific requirements are met. Nevertheless, the literature suggests additional requirements.

This subchapter bases on the assumption that practical application of the method is successful if the user of the method, who is in this case the management, accepts the developed method. The literature focusing on software development picks up this issue by describing acceptance tests as an approach to ensure a successful application of the developed software (Ricca et al., 2009).

Ricca et al. (2009) describe common gaps between software developers and clients resulting in non-effective software products. The majority of the described gaps result in a lack of understanding of the software by the user and thus can be summarised under the term ‘comprehensibility’. Besides a sufficient degree of comprehensibility of the method, Pointner (2010) adds the transparency of the underlying data as requirement of acceptance of a method. Finally, the third requirement assesses whether the method expresses its result in monetary terms. Since managers mainly think in monetary terms and base their decisions on monetary values, this requirement also aims to establish management acceptance.

Comprehensibility

The aim of this subchapter is to ensure management’s acceptance of the method which consequently leads to a successful practical application. In this context, the comprehensibility of the method, especially to non-experts, is identified to be an important requirement for management acceptance.

Hence, the question assessing the comprehensibility requirement can be formulated as follows:

Does the method provide a sufficient degree of comprehensibility also to non-experts?

Milde (2009) defines comprehension as the ability to represent a message which enables a person to draw own conclusions. In order to achieve such ability, the research field of information science identifies a clear structure and complexity of communicated messages as main drivers for their comprehensibility (Weitlander et al., 2013). In addition to these two drivers of comprehensibility, the language of the communicated content is regarded as vital. According to Weitlander et al. (2013) a balance between plain language and precise technical terms, which are complemented with graphical illustrations, supports the comprehension of the communicated content.

In this context, Milde (2009) refers to the comprehension concept which was originally developed by Langer, Schulz von Thun and Tausch in 1974. The concept assesses textual comprehensibility on the basis of four dimensions:

- Simplicity

- Arrangement and structure

- Briefness and conciseness

- Activating add-ons

(Milde, 2009).

Based on the given definitions above, the comprehensibility requirement of this thesis is composed of the following sub-requirements:

- Clear and logical structure

- Low degree of complexity in calculations

- Concise language used for explanation

Concerning the evaluation parameters, the comprehensibility requirement is regarded as being met if all three sub-requirements are met as well. In case only one or two sub-requirements are met, the final comprehensibility requirement is evaluated as being partly met. The comprehensibility requirement is not met in case none of the sub-requirements could be met.

Hence, the following table summarises the parameters of the comprehensibility requirement:

Table 8: Definition of evaluation parameters of the comprehensibility requirement

Source: Own representation

Transparency

The transparency requirement intends to support the objective of achieving management acceptance. With a sufficient degree of transparency, the developed method is likely to be accepted by management and thus to be applied in practice.

Hence, the question regarding the transparency requirement can be formulated as follows:

Does the method provide a sufficient degree of transparency?

However, before assessing the methods of this chapter, the term ʻtransparencyʼ needs to be defined. Bogna (2008) defines transparency as an ideal situation in which all participants in a market have access to all relevant information. Nevertheless, the author also admits that this definition is an utopic situation. In addition, Svetlova (2010:83) defines transparency as “the increased flow of timely and reliable economic, social and political information”. In this definition, transparency is used as a synonym for an increased disclosure of information. In this context, Stiglitz (2000:1466) even states “transparency – another name for information”. The demand for information represents the shared core of all these three definitions.

Nonetheless, what the authors do not include in their definitions are the motivations behind this demand for information. In this regard, Stehr and Wallner (2010) identify a growing demand for public transparency with a moral and political motivation. The authors recognise an increasing demand for public participation in information flows and decision-processes. This participation bases on the motivation to push companies and politics to account for their responsibility towards the environment and the society. (ibid.)

Transferred to the context of business, Prat (2005) deals with the growing demand of transparency by referring to the principal-agent theory. Therefore, transparency is “the ability of the principal to observe how the agent behaves and the consequences of the agent’s behaviour” (Prat, 2005:862). Obviously, the central motivation behind the increased demand for transparency in this context is control of the principal over the agent.

Another motivation can be seen in the opportunity to reconstruct and understand the reasons for decisions which were taken in the past (Svetlova, 2010). Bogna (2008) picks up this idea and even goes further by suggesting to augment the compulsory external financial reporting with voluntary information about the internal decision-making processes. In this context, Pointner (2010) suggests to publicly provide the relevant data with their sources and origins which have led to decisions.

While the motivations behind the demand for transparency vary from influence over control to understanding decisions in business, the motivation of fighting corruption pre-dominates the majority of literature on transparency. Sampson (2010:101) highlights the efforts of Non-Governmental Organisations (NGOs), such as Transparency International, on fighting corruption by “naming and shaming” corrupt processes, companies or states.

Nevertheless, Sampson (2010) also complains about the work of Transparency International by focusing on the Corruption Perception Index (CPI). This index is published annually and assigns a single indicator value of perceived corruption to each country. The author criticises the non-transparent way of assembling a single indicator value out of surveys, studies and journalists’ opinions. Due to missing standardised definitions on corruption and on the evaluation of the countries’ situation, the results of the CPI are questionable since room for manipulation is given. (ibid.)

This in turn, reveals another aspect of transparency which is the need for standardisation. Behrens and Fluthwedel (2012) claim that standardised processes increase comparability as well as reproducibility and thus lead to transparency and trust. Schäfermeyer et al. (2012) add the increased quality resulting from standardised processes to the list of advantages of transparency. Furthermore, the room for manipulation and subjective judgement is reduced by means of standardisation.

Transferred to this thesis, the requirement assesses whether the method provides a sufficient degree of transparency. Based on the definitions discussed in this subchapter, the assessment needs to evaluate whether all necessary and relevant information are available for the decision-maker. In addition, the origin and quality of data need to be assessed to ensure that they are publicly available and objectively measured. This in turn leads the way to the third sub-requirement aiming at the standardisation of the assessed methods. Highly standardised methods offer less room for manipulation and lead to comparable, reproducible results of high quality.

Therefore, the discussion about the definitions and the underlying motivations of transparency revealed the following sub-requirements:

– Relevance and completeness of information or data

– Origin and quality of information or data

– Degree of standardisation of the method

Regarding the evaluation parameters of the transparency requirement assessment, the requirement is met if all sub-requirements are met. In contrast, the requirement is not met in case none of the sub-requirements are met. In the event that at least one of the sub-requirements is met while others are not met, the transparency of the method is limited and thus evaluated with a ‘medium’ degree of transparency.

Hence, the following table summarises the parameters of the transparency requirement:

Table 9: Definition of evaluation parameters of the transparency requirement

Source: Own representation

Monetary evaluation

The third requirement aiming to ensure practical applicability is the ability of expressing the results of the method in monetary values. Since practical applicability can only be achieved with management accepting the method, the monetary evaluation requirement represents a vital part of the assessment.

According to the IFAC (2005:41), the chances of practical application of environmental management methods increase with their ability to “translate environmental performance into “cost and savings” language that business managers understand”. Hence, the IFAC (2005) argues for linking physical inputs and outputs with monetary values. In this context, Klaschka (2002) states that the perceived value of natural resources increases with expressing their values in monetary terms. Jasch and Schnitzer (2002) also note that monetary evaluation is the very basis for integrating environmental aspects in investment decisions.

This requirement intends to assess whether the method is able to express the calculated result in monetary terms. It is important to note that such an expression of results in monetary terms does not intend assigning a price to environmental impacts. Therefore, the definition of the IFAC (2005:45) holds that monetarisation is defined as “the valuation of a use or damage in units of money”.

This differentiation between monetary evaluation and determining prices for natural resources is important since the latter involves unsolved weaknesses so far. In this context, Klaschka (2002) focuses on the problem of considering time in pricing natural resources. The author refers to the example of humus which needs between 100 and 300 years to build a thickness of about one centimetre (ibid.). Considering the price for one cubic metre of humus would result in a price which would be way higher than the market is willing to pay. Hence, Klaschka (2002) states that it is impossible to determine a price which is in consensus between the market and natural science. Schwermer (2007) adds to these weaknesses the inability of market prices to represent the environmental impact on natural resources.

Therefore, the question regarding the monetary evaluation requirement can be formulated as follows:

Does the method express its result in monetary terms?

The following table summarises the evaluation parameters of monetary evaluation requirement with their corresponding definitions:

Table 10: Definition of evaluation parameters of the monetary evaluation requirement

Source: Own representation

Finally, the previously defined requirements and their corresponding evaluation parameters for assessing the introduced methods within this chapter can be summarised in Figure 15. The requirements validity and reliability are highlighted since they represent key requirements. Without meeting these requirements, methods are likely to fail practical application, since the investment decisions based on the method do not improve the financial and environmental performance and the results cannot be reproduced after repeating the underlying calculations. While the importance of the two key requirements are emphasised, the other requirements are of equal importance.

Figure 15: Overview of requirements and evaluation parameters of this thesis

Source: Own illustration

After determination of the relevant requirements and the definition of the corresponding evaluation parameters, this chapter introduces methods which can serve as a basis for developing the new integrated investing method.

The introduction of additional methods is clustered into three groups. The first group discusses environmental cost accounting methods. The projection of costs represents a preparatory step in front of conducting investment appraisal methods. In case, environmental costs can be delimited from other operating costs of an investment object, a conventional investment appraisal method could be applied. Hence, environmental approaches are part of this chapter since a delimitation of environmental costs represents an indirect integration of environmental aspects in investment decisions.

The second group of introduced methods clusters the flow-based cost accounting methods. These methods aim to allocate operating costs to a flow model of production. Thus, the costs are directly connected with the environmental aspects of an investment object. Therefore, the integration of environmental aspects in investment decisions indirectly takes place, since environmental costs are delimited in a step prior to the investment appraisal method.

The third group of methods clusters additional methods which could not be categorised in one of the previous two groups. Within the third group, the methods of internalising externalities, environmental indicators as well as the VDI-guideline 3800 are introduced. While the latter represents a hybrid between delimitation of environmental costs and proposing a way of integrating environmental aspects in investment appraisals, the first two methods of this group intend to expand accounting systems by recording additional environmental costs or by representing additional indicators.

The discussion of the introduced methods, based on the previously set requirements, is located at the end of each group. In addition, a table summarising the results of all intermediate discussions and conclusions is located at the end of subchapter 3.2. This final discussion aims to identify the method meeting most of the requirements and therefore is best qualified to represent a basis for further method development.

3.2. Method screening and evaluation

3.2.1. Environmental cost accounting methods

Before dealing with environmental cost accounting, it is important to discuss the various definitions of environmental costs in literature. As with the definition of environmental investments, there is no consensus regarding a definition of environmental costs in literature.

3.2.1.1. Defining environmental costs

Baumast (2009) defines environmental costs as the result of environment-related measures which are expressed in monetary units. While this definition demonstrates a rather broad character, the definition of the German Federal Environmental Ministry (FEM) focuses on the contextual systems within a company in which environmental costs can occur. Hence, environmental costs are defined as expenditures “in connection with environmental management, environmental protection measures and environmental impacts” (FEM, 2003:45) of a company. With describing the context in which environmental costs can occur, the FEM misses to provide a concrete definition of environmental costs as such.

A more comprehensive definition is contributed by the US Environmental Protection Agency (USEPA). In a training manual, the USEPA (1995) differentiates between four levels of environmental costs. The first level is represented by direct costs which are related to environmental investments, resources as well as operating and maintenance costs. The second level deals with hidden costs, which are difficult to measure (as illustrated in Figure 16). These costs can occur, e.g. for legal restrictions or the costs for measuring, monitoring or reporting environmental data. The third level deals with costs caused by liability risks that might occur through contaminated sites or environmental fines. These costs, which are typically booked under accruals, are often referred to as costs for omitted environmental protection. Lastly, the fourth level deals with costs caused by environmental client expectations. (USEPA, 1995)

Figure 16: Four levels of environmental costs according to the USEPA

Source: Own illustration based on USEPA, 1995

With the definition of the USEPA (1995), it is obvious that most of the environmental costs (levels two, three and four) are difficult to clearly identify as they are mostly ‘hidden’ in overhead or indirect costs. Even if the focus is on direct costs (level 1) such as environmental investments, there is still the problem of identifying the ‘environmental proportion’ of the investment object.

The International Federation of Accountants (IFAC, 2005) realised the issue of missing transparency within environmental costs and thus established an international guidance document on environmental accounting.

Table 11 illustrates the environment-related cost categories as identified by the IFAC:

Table 11: Environment-related cost categories, defined by the IFAC

Source: According to IFAC, 2005:38

In contrast to the definition of USEPA (1995), the IFAC adds details to the block of direct costs. Assuming that there are detailed information given for material costs as well as waste and emission control costs, this definition does not necessitate to expand the given cost information by an ‘environmental proportion’.

Environmental costs in context of this thesis

Hence, in the context of this thesis, the focus is set on direct and indirect costs, assuming that relevant cost information are already tracked by the internal accounting system. With the focus on direct and indirect costs, cost categories which are difficult to measure (e.g. accruals for liability risks or expected fines and charges, costs for stakeholder relations or costs for improving the company image, etc.) are excluded and thus outside the scope of this thesis.

With regard to the requirements of this thesis, the focus on direct and indirect costs increases the acceptance of the management. Costs can directly be traced back and can be tracked down in detail with an acceptable additional timely effort. However, the problem of identifying the environmental proportion within the direct and indirect cost pool is still present. Although various sources identify this problem, only a few authors suggest adequate solutions. The following subchapters present approaches trying to solve this problem.

3.2.1.2. Defining environmental cost accounting

After having dealt with environmental costs, the definition of environmental cost accounting sets the framework for the context and purpose of environmental costs. As with the definition of environmental investments or environmental costs, several definitions with different focus areas conclude a lack of consensus and consistent understanding of the term ‘environmental cost accounting’.

According to the FEM (2003:45), environmental cost accounting is the “collective term for various methods, approaches and processes for determining environmental costs and showing them for internal or external company purposes”. While this definition lacks naming the methods, approaches or processes, the aim of them is formulated specifically, which is to determine environmental costs. The second part of this definition focuses on the internal and external reporting, but again lacks naming the purposes precisely.

In addition, the definition by the IFAC (2005) refers to the same content with the term ‘environmental management accounting’ (EMA). According to the IFAC (2005:19), “environmental management accounting is broadly defined to be the identification, collection, analysis and use of two types of information for internal decision-making:

- physical information on the use, flows and destinies of energy, water and materials (including wastes) and

- monetary information on environment-related costs, earnings and savings.”

In contrast to the FEM, this definition highlights the environmental perspective and also adds details to the monetary perspective with the extension of environment-related earnings and savings. Furthermore, the IFAC (2005) only identifies the purpose for internal decision-making unlike the definition by FEM (2003), which also identifies external company purposes.

These differing definitions already show a lacking consensus. The IFAC (2005) picks up this issue by stating that every organisation has to determine its own interpretation of environmental management accounting. Hence, it is up to the management of a company to either decide for an EMA framework focusing on a narrow range of environmental costs or for broader interpretation also allowing strategic costs and benefits to be part of the accounting framework.

In the context of this thesis, the environmental cost accounting framework is determined according to the definition of environmental costs. Hence, environmental cost accounting focuses on direct and indirect costs that are already tracked by the internal management accounting system.

Loew et al. (2003) take over this narrow interpretation of an environmental cost accounting (see Figure 17). The intention is to identify the environmental costs within the already tracked costs of the accounting system. Hence, the first step is to differentiate the ‘environmental proportion’ within the cost-type accounting step. When purchasing raw materials, for instance, the additional costs for purchasing ‘environmental-friendly’ raw materials can be claimed as environmental costs. However, it is not always obvious to identify and clearly differentiate environmental costs within the cost pool. Hence, additional administrative costs occur for the identification of environmental costs. (ibid.)

The second step allocates the identified costs to the cost centres. Loew et al. (2003) suggest establishing a cost-centre for end-of-pipe measures to allocate all overhead costs, related to end-of-pipe measures, according to the cost-units, causing the necessity for these end-of-pipe measures. Depending on the production design of the analysed plant, such an allocation might be complex and not obvious in every case. In addition, the problem of identifying integrated environmental protection measures is still a matter of academic debate.

The third step represents the cost-unit accounting which provides the basis for internal decision-making. Within this step, direct costs of the cost-type accounting step as well as the allocated indirect costs of the cost-centre accounting step get summarised among various items. These items are established according to the management’s preference of analysis. Hence, the management might want to analyse, for instance, which costs occur for environmental protection and how these costs are composed. (ICV, 2010)

Figure 17: Illustration of an environmental cost accounting system

Source: Based on ICV, 2010:22

According to the FEM (2003), three benefits of establishing an environmental cost accounting framework can be identified. First, tracking environmental costs helps to visualise the environmental proportion and thus helps to integrate environmental aspects in the decision-making process within companies.

Therefore, a cost-effective implementation of investments in environmental protection can be ensured. Second, environmental cost accounting can reveal so-called ‘win-win situations’ in which an improvement in environmental performance concludes cost reductions. Finally, strategic environmental goals of companies can be tracked and communicated for marketing products with an improved environmental performance. (ibid.)

While a well-established environmental accounting framework reveals several benefits, the biggest challenge can be seen in its establishment. It needs to be analysed, for instance, whether the additional administration costs for the identification of environmental costs justify the resulting benefits of these insights.

In addition, the IFAC (2005:26) criticises that “many types of environment-related cost information are not found in the accounting records”. This criticism can be extended by pointing at the environmental performance. Tracking environmental costs and increasing or decreasing these costs does not necessarily lead to an improved environmental performance.

3.2.1.3. Environmental activity-based cost accounting

The basic concept of activity-based costing (ABC) is to allocate overhead costs to defined processes, which are subdivided in main processes and sub-processes, according to common cost drivers (Walter and Wünsche 2013). Loew et al. (2003) extend this concept with the application on environmental costs. Hence, costs for environmental management or environmental protection measures, such as end-of-pipe measures, get allocated to the main and sub-processes of a company (see Figure 18).

Figure 18: Illustration of environmental activity-based cost accounting

Source: Based on ICV, 2010:23

One advantage can be seen in the fact that the allocation is based on the polluter pays principle (Loew et al., 2003). Therefore, processes and the resulting products with less environmental significance are accredited with less environmental overhead costs than processes and products with high environmental significance. Although this allocation is more realistic, the benefit for the environmental management is questionable. As a consequence, every process owner would aim for a reduction of the apparently avoidable environmental cost allocation.

On the one hand, the environmental impact would decrease since processes would become more environmentally friendly (e.g. by increasing resource efficiency). On the other hand, however, the remaining fixed overhead costs for environmental management would still need to be allocated. In conclusion, the paradox situation can occur that environmental cost allocation stagnates (or even increases for the remaining cost centres), although processes have become more environmentally friendly.

In addition, the allocation of environmental costs on cost centres comprises the message that costs for environmental protection are avoidable costs. While this is a positive aspect on one side since management and process owners would be sensitised for environmental protection, the communication via costs neglects the positive aspects and the accompanying chances of environmental protection.

3.2.1.4. Japanese environmental accounting guidelines

In the year 2000, the Ministry of the Environment in Japan (MEJ) published first results of a working group that assessed the potential of implementing an environmental accounting framework in companies (MEJ, 2000). Two years later, a first version of the Environmental Accounting Guidelines was published followed by an updated version in 2005.

In a survey, Konkubu and Nashioka (2005) assess the degree of implementation of the Environmental Accounting Guidelines. They reveal that over 187 companies that are listed on the Tokyo Stock Exchange have introduced “environmental accounting either for external disclosure or internal management” (ibid.:327).

According to the MEJ (2005:3) environmental accounting “aims at achieving sustainable development […] and pursuing effective and efficient environmental conservation activities”. While the achievement of sustainable development represents a broad goal, the pursuit of efficient and effective environmental conservation activities is realised with the help of quantitative measurements in monetary values or physical units. Hence, the structure of the environmental accounting framework as described by the MEJ is illustrated as follows:

Figure 19: Illustration of Japanese Environmental Accounting Framework

Source: Based on MEJ, 2000:6

Regarding the cost side of the environmental accounting framework, the MEJ (2005) differentiates between investments and expenses. In this context, environmental investments are defined as “the expenditures of investments a company spends on depreciable assets for the purpose of environmental conservation” (MEJ, 2005:13). Since investment-related costs are listed on the cost side, the amount for acquiring the investment is not listed but instead the associated depreciation of the investment object. Hence, the accumulated depreciation at the end of the investment object’s lifetime represents the original acquisition value.

In contrast to investments, expenses on the cost side are defined as “the company’s overall expenses and […] the amounts used for the purpose of environmental conservation” (MEJ, 2005:13). Furthermore, the corresponding costs are differentiated in more detail within seven categories, which are listed in the table below:

Table 12: Categories of corresponding costs to business activities

Source: MEJ, 2005:14

It is noticeable that these seven cost categories represent a comprehensive view on environmental costs. Especially, the category concerning upstream and downstream costs emphasise the company’s responsibility over the whole life cycle of the product. However, collecting data on upstream and downstream operations is regarded as difficult due to the lack of reliable data (Li and Lin, 2006). These costs represent external costs which are internalised at this point. Nonetheless, these internalised costs cannot be found in financial statements as they are not backed-up by any real cash flows.

The guidelines also deal with the problem of identifying environmental costs and separating them from ‘ordinary’ costs. Hence, the MEJ (2005) introduces the terms ‘direct costs’ and ‘complex costs’. While direct costs can be entirely attributed to costs related with environmental protection, complex costs partly serve environmental protection but also serve other purposes (e.g. increasing quality, decreasing operating costs, increasing productivity, etc.).

In addition to this separation of terminology, the MEJ (2005) suggests three methods to aggregate complex costs. The first method is called ‘difference aggregation’ and can be used if the exact proportion of environmental protection of an investment (e.g. special filter systems) is given. Hence, the difference of this environmental component to the remaining investment value is aggregated as environmental costs.

The second method suggested for the aggregation of complex costs is called ‘allocation aggregation’. The example that is provided by the MEJ (2005) deals with the allocation of personnel costs. Hence, the “distribution rate for hours spent on environmental conservation activities versus those spent on other tasks” can serve as a basis for aggregating complex costs (ibid.:24).

Finally, the third category is called ‘simple methods’ and lists three additional suggestions how to aggregate complex costs. While one suggestion is not to aggregate complex costs if environmental costs represent a minor proportion, the total costs can be aggregated in case environmental costs represent the major proportion. The third suggestion under the ‘simple methods’ category comprises setting a percentage, based on an expert’s opinion which indicates the proportion of environmental costs. (ibid.)

Concerning the benefit side of the environmental accounting framework, the MEJ (2005) differentiates between the environmental