FIGURE 3

Misallocation of environmental costs under traditional cost accounting system.

production of B to the extent of most of the cost of the Toxic WasteB. Observe that under this traditional system, the production manager for Widget A can reduce the costs allocated to A's production only by reducing A's consumption of labor hours relative to those of B. Clearly, the production manager of B has little incentive either to reduce the use of Toxic WasteB or to search for and invest in improved production technologies that will eliminate the use of the chemical.

The research question for the reduction and elimination of environmental wastes thus revolves about the problem of the assignment of the costs of such wastes to the individual product managers who are in a position to control and ultimately eliminate the wastes. Assignment of the costs requires that all costs be identified with individual products to the extent possible.

An Environmentally "Enlightened" Cost Accounting System

Figure 4 modifies the traditional accounting system (Figure 2) to indicate how the accounting and "accountability" system needs to be changed to provide both the opportunity and the incentives to the manager of Widget B to reduce toxic waste. If the cost of the chemical is removed from the overhead pool and applied directly to Widget B, just as LaborB and MaterialsB are applied, then the manager of B will have an immediate incentive to focus attention on the control Of the cost. This system makes it possible to (1) ascertain the relevant controllable costs, (2) determine the operating risks (e.g., contingent liabilities resulting from the production of Toxic WasteB), and (3) seek other, less costly means of production for the product or contemplate its elimination from the product line.

Perhaps the most difficult issue to resolve is that of manager B's incentive compensation contract, if it is based at least partially on the profitability of B. Manager B will clearly suffer loss of wealth if the cost structure is arbitrarily changed. Thus, an essential part of the transition to a new accountability system is



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