Environmental Accounting 2

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Environmental Accounting

What is Environmental Accounting? The term environmental accounting is frequently used within the

accounting and environmental management literatures. Environmentalaccounting is a broader term that relates to the provision of environmental-performance-related information to stakeholders both within, and outside, anorganisation.

An important function of environmental accounting is to bringenvironmental costs to the attention of corporate stakeholders who may beable and motivated to identify ways of reducing or avoiding those costs whileat the same time improving environmental quality. (According to the UnitedStates Environment Protection Agency or US EPA)

It is a Growing field that identifies resource use, measures andcommunicates costs of a company or the national economy actual orpotential impact on the environment.

It is sometimes referred to as green accounting, resourceaccounting or integrated economic and environmental accounting whichis about the modification of the System of National Accounts to incorporate

the use or depletion of natural resources. Furthermore, it incorporatesenvironmental assets and their source and sink functions into national andcorporate accounts.

What is SNA?It is a set of accounts which national governments compile routinely to

track the activity of their economies. The SNA data are used to calculatemajor economic indicators including gross domestic product (GDP), grossnational product (GNP), savings rates, and trade balance figures. The dataunderlying these aggregate indicators are also used for a wide range of lesspublicized but equally valuable policy analysis and economic monitoring

purposes.

Non-marketed GoodsThe environment provides many goods which are not sold, but which arenevertheless of value; e.g., fuel wood and building materials gathered inforests, meat and fish captured for consumption, and medicinal plants. Somecountries do include these in their national income accounts, estimating totalconsumption, and then using market prices for comparable products as aproxy to calculate the value of non-marketed goods. However, suchestimation is incomplete, and cannot always be disaggregated from productswhich are sold.

Non-marketed servicesSimilarly, the environment provides unsold services, such as watershedprotection by forests or water filtration by submerged vegetation. These arenot included in the SNA. It can be very difficult to estimate their economicvalue; this is sometimes done by calculating the cost of obtaining equivalentservices from the market.

Consumption of Natural CapitalThe SNA treats the gradual depletion of physical capital - machines and otherequipment - as depletion rather than income, in accordance with

conventional business accounting principles. However, the depletion ofnatural capital -forests, in particular - is accounted for as income. Thus theaccounts of a country which harvests trees very quickly will show quite highincome for a few years, but nothing will show the destruction of a productiveasset, the forest. Most experts on environmental accounting agree that thedepletion of natural capital should be accounted for in the same way as otherproductive assets.

What is Environmental Accounting System?


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It is composed of environmentally differentiated conventionalaccounting and ecological accounting. Environmentally differentiatedaccounting measures impacts of the natural environment on a company innominal or monetary terms.

What is Ecological Accounting?It measures the impact a company has on the environment, but in

physical units (e.g. kilograms of waste produced, kilojoules of energy

consumed) rather than in monetary units.

What is the rationale behind Environmental Accounting? There are many reasons why businesses may consider adopting

environmental accounting as part of their accounting system:1) Possible significant reduction or elimination of environmental costs.2) Environmental costs and benefits may be overlooked or hidden in

overhead accounts3) Possible competitive advantages as customers may prefer

environmentally friendly products and services.4) Can support the development and running of an overall environmental

management system, which may be required by regulation for sometypes of businesses.

5) Possible revenue generation may offset environmental costs (e.g.transfer of pollution allowances).

6) Improved environmental performance which may have a positiveimpact on human health and business success.

7) May result in more accurate costing or pricing of products and moreenvironmentally desired processes.

History of Environmental AccountingEnvironmental issues have found a reflection in the accounts only in the last

part of the twentieth century. The chronology of important developments inenvironmental accounting and environmental issues reflected in theaccounts we find at Ienciu (2009) which presents then following rhythms:

Period 1971-1987: represents the beginning of the first environmentalaccounting research due to the importance that begins to gain this area. Thefirst period takes into account the literature in this field through studiestreating social and environmental accounting in the same way. Since theearly 80s, surveys suggest that the separation of environmental accountingand social accounting is starting, due to increased interest in environmentalreporting compared to the social. Also in this period begin to appear

accounting books dealing with aspects of social and environmentalaccounting. According to research from this period, environmental auditingand environmental management accounting were not treated separately. Asa first step in the development of environmental accounting the articlespublished on this subject have been in a small number, just like theregulations regarding environmental accounting.

Period 1988-1994: the problem of environmental accounting isbecoming an area of interest. In this period of increased interest ofresearchers for this area, managers and even accountants begin to payattention to the problem of environmental accounting. It also increases

research in environmental accounting terms at the expense of research onsocial accounting. In this period, the concepts of sustainability andenvironmental audit begin to interest the users. There were a number ofbooks and articles that dealt with the environmental accounting,environmental accounting showing the state of knowledge both withinuniversities and in the accounting. The progress in environmentalaccounting regulations is slow, but much faster in comparison with that ofsocial accounting.


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Period 1995-2001: environmental accounting at both theoretical andpractical level starts to address on a large scale especially in developedcountries. The number of studies in this period begins to grow; this periodcan be called "the cornerstone" of accounting environment. Sub domains ofenvironmental accounting begin to develop, such as environmental costs,environmental management accounting and environmental auditing. Theconcept of environmental audit occurred in the USA at the beginning of the80 for evaluating ecological performances of some units in the oil field and

chemical industry. So as to avoid the payments incurred by environmentalpollution, buyers systematically proceeded to acquisitions from the units thatimplemented environmental protection policies (Beianu Leontina et all,2008). Environmental accounting researchers are beginning to give greaterimportance to this area, begin to increase significantly the number ofstudies, environmental reports of remain the main sub domain researcherstreated. This sub domain begins to interest due to the implementation ofstandards for environmental management, which contain a part of the auditor verification.

Period 2002-present: there is a widening of this area of research in

numerous developing countries including Romania. At the international levelare issued guidelines on reporting environmental information and regulationsappearing in the accounting environment. The number and quality of articleson environmental accounting continues to grow. Year 2002 is the year that inRomania the conceptual studies are beginning to appear. Studies inenvironmental accounting are becoming more numerous, more extensive,outstanding contributions to the development of this field of research have:C. Deegan, O'Donovan, Freedman and Stagliano, Cormier, Mbus, Gray,Chatterge, Aerts and Cornier. Regarding the Romanian researchers, weinclude here the study by Lungu (Lungu et all, 2008), which proposes "newapproach" for corporate reporting and report of social and environmental

information. In Romania, there are studies of authors: Caraiani, Dumitrana, Jianu Tbr, and Nu, Ienciu, Cenu, which present the environmentalaccounting as an system composed of three parts: the reporting, themanagement and the environmental audit. Environmental managementaccounting experiences a development, both in terms of published studiesand the quality and diversity of concepts and theories discussed. In Romania,there are theoretical papers which treat environmental costs (Dumitrana,2005), analysis of the product life cycle (Creu, 2004), environmentalperformance and its implications on the financial performance of the entity(Creu, 2004; Caraiani, 2007; Bonaci and Ienciu, 2007). The environmentalaudit is treated increasingly more in this period, with the first work in

Romania dealing with this problem (Borza, 2007). Involvement of Romaniasaccounting in the business of environmental protection is even stronger withthe entry into force on January 1, 2010 of the Order 3055/2009 for approvingthe Accounting Regulations in accordance with European directives, so in thechart of accounts, a new account is inserted, account 652 "Expenditure onenvironmental protection. With this account are kept environmentalprotection expenditure recorded in the relevant period, for example,environmental taxes paid, and the certificates of emissions of greenhousegases effect purchased.

From the presented it results that research into environmental

accounting have come to the forefront of accounting research, outpacingother chapters, such as social accounting, given the importance ofenvironmental issues on the community. Environmental reports remain anarea of interest for researchers, but other research subfields also haveinterest from researchers, namely, environmental management accountingand environmental auditing.

What are environmental costs?These comprise costs both internal and external that relate to all costs

occurred regarding with environmental damage and protection. This can


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include costs incurred to clean up and remediate contaminated sites,effluent control technologies, and waste disposal. They are also costs likeenvironmental fines, penalties, and taxes, purchase of pollution preventiontechnologies and waste management costs.

Types of Environmental CostsPrivate Environmental Costs are those borne by a company or individual.Examples would be costs incurred by a company to comply with

Environmental Protection Agency (EPA) regulations or to clean up a pollutedlake.

Social Environmental Costs are those borne by the public at large. Examplesof these include costs borne by the tax payers to staff the EPA; costs borneby the taxpayers to clean up a polluted lake or river; costs borne byindividuals, insurance companies, and Medicare due to health problemscaused by pollutants; and the unquantifiable quality-of-life costs we all bearfrom a degraded environment.

Visible Social Environmental Costs are those that are known and clearly

identified as tied to environmental issues.

Hidden Social Environmental Costs include those costs that are caused byenvironmental issues but have not been so identified as such.

Monitoring Costs Costs of monitoring the production process to determine ifpollution is being generated (e.g. costs of testing wastewater forcontaminants)Abatement costs Costs incurred to reduce or eliminate pollution (e.g.changing a products design to use more expensive materials that do notresult in environmental contamination).

Remediation Costs (i.e. clean-up costs)On-site remediation costs of reducing or preventing the discharge into theenvironment of pollutants that have been generated in the productionprocess (e.g. cost of installing scrubbers on a smokestack to remove certainair pollutants in the smoke).Off-site remediation costs of reducing or eliminating pollutants from theenvironment after they have been discharged (e.g. cost of cleaning up ariver polluted by a companys operations).

Environmental Cost Strategies

End-of-pipe strategy under this approach, companies produces the wasteor pollutant, and then cleans it up before it is discharged into theenvironment. Smokestack scrubbers, wastewater treatment, and carbon airfilters are examples of end-of-pipe strategies.

Process improvement strategy under this approach, companies modifyproducts and production processes to produce little or no pollutants, or findways to recycle wastes internally.

Prevention strategy the ultimate strategy for maximizing the value ofpollution-related activities involves... not producing any pollutants in the first

place. With this strategy, companies avoid all problems with regulatoryauthorities and, in many cases, generate significant profit improvements.

What are environmental expenditures?Expenditures to protect the environment from harm, or to mitigate thatharm, cannot be identified from the data in the accounts. Such expendituresinclude the costs incurred to prevent environmental harm, such as pollutioncontrol equipment purchased by factories or catalytic converters in cars.They also include the costs of remedying that harm; medical expenses,replacement of property destroyed in landslides caused by deforestation, or


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drinking water filtration required because intake water is highly sediment.These expenditures are already included in the income accounts, along withall other intermediate or final consumption. However, they cannot bedisaggregated to highlight the costs incurred to prevent or mitigateenvironmental degradation.

Annual Corporate Environmental Expenditurea) Waste and emission treatment

b) Depreciation for related equipmentc) Maintenance and operating material and servicesd) Related personnele) Fees, taxes, chargesf) Fines and penaltiesg) Insurance for environmental liabilityh) Provisions for clean-up costs, remediation, etc.

Major Cost Categories1) Materials Cost of Product Outputs-Thepurchase costs of natural resources such as water and other materialsthat are converted into products, by-products and packaging.

2) Materials Cost of Non-Product Outputs- The purchase costs of inputs/materials bought, inventoried, put intoprocess but did not become part of a saleable finished product (waste andemissions).3) Waste and Emission Control Costs- This corresponds to the conventional definition of environmental costscomprising all treatment, disposal, and clean up costs in existing wastes andemissions.

4) Prevention and other Environmental Management Costs- Prevention costs and costs for general environmental activities

5) Research and Development Costs- Includes the costs for Research and Development projects related to

environmental issues.

6) Less Tangible Costs- Includes both internal and external costs related to less tangible issues.

What are environmental revenues?

These are actual earnings from recycled/recyclable materials. They can alsobe subsidies given due to environmentally related factors.

What are environmental liabilities?A legal obligation to make future expenditure due to the past ongoingmanufacture, use, release, or threatened release of a particular substance,or other activities that adversely affect the environment. A potentialenvironmental liability is a potential legal obligation to make a futureexpenditure due to the ongoing or future manufacture, use, release, orthreatened release of a particular substance, or other activities thatadversely affect the environment. An obligation is potential when it depends

on future events or when a law or regulation creating the liability is not yet ineffect. A "potential environmental liability" differs from an "environmentalliability" because an organization has an opportunity to prevent the liabilityfrom occurring by altering its own practices or adopting new practices inorder to avoid or reduce adverse environmental impact.Types of Environmental Liability

Environmental liabilities arise from a variety of sources. Federal, state,and local environmental statutes, regulations, and ordinances, whetherenforced by public agencies or through private citizens' suits, give rise tomany types of environmental liabilities. Another legal source of these


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liabilities is "common law" (i.e., judge-made law). The following broadcategories of environmental liabilities:

compliance obligations related to laws and regulations that apply tothe manufacture, use, disposal, and release of chemical substancesand to other activities that adversely affect the environment

remediation obligations (existing and future) related to contaminatedrealproperty

obligations to pay civil and criminal fines and penalties for statutory

or regulatory non-compliance obligations to compensate private parties for personal injury,

property damage, and economic loss obligations to pay "punitive damages" for grossly negligent conduct obligations to pay for natural resource damages

The following paragraphs elaborate on each of these types of environmentalliabilities.

Compliance obligations. The costs of coming into compliance can range frommodest outlays required to conform to administrative requirements (e.g.,recordkeeping, reporting, labelling, training) to more substantial outlays,

including capital costs (e.g., to pre-treat wastes prior to land disposal orrelease to surface waters, to contain spills, to "scrub" air emissions). Lawsand regulations also impose "exit costs" (e.g., to properly close wastedisposal sites and provide for post-closure care, and to decommissionnuclear power reactors at the end of their useful lives).

Remediation obligations are sometimes subsumed under "compliance"because some property clean-up requirements have been enacted as part ofregulatory programs applicable to operating facilities. This can includeexcavation, drilling, construction, pumping, soil and water treatment, andmonitoring, and can include the response costs incurred by regulatory

agencies. Remediation costs also can include the provision of alternatedrinking water supplies for affected community residents, and, in somecircumstances, purchase of properties and relocation expenses. Technicalstudies and the expenditure of management, professional, and legalresources add to the cost of remediation.

The remediation obligation is distinctive because a company may faceremediation obligations due to contamination at inactive sites that areotherwise unregulated; at property formerly but not currently owned or used;at property it never owned or used, but to which its wastes were sent; and,at property it acquired but did not contaminate.

Fines and penalties. Companies that are not in compliance with applicablerequirements may be subject to civil or criminal fines or penalties fornoncompliance and/or expenses for projects agreed to as part of asettlement for noncompliance. Such payments fulfill punitive and deterrentfunctions and are in addition to the costs of coming into compliance.

Compensation obligations. Under common law and some state and federalstatutes, companies may be obligated to pay for compensation of "damages"suffered by individuals, their property, and businesses due to use or releaseof toxic substances or other pollutants. These liabilities may occur even if acompany is in compliance with all applicable environmental standards.

Distinct subcategories of compensation liability include personal injury (e.g.,"wrongful death," bodily injury, medical monitoring, pain and suffering),property damage (e.g., diminished value of real estate, buildings, orautomobiles; loss of crops), and economic loss (e.g., lost profits, cost ofrenting substitute premises or equipment).

Punitive Damages. To supplement compensatory payments to those harmedby the actions of others, the law allows the imposition of what are called"punitive damages" to punish and deter conduct viewed as showing a callousdisregard for others. Punitive damages are often many times larger than the


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costs of compensation. Punitive damages tend to be more common inproduct liability than environmental liability cases.

Natural resource damages. A relatively new category of environmentalliability is best termed "natural resource damages." This liability generallyrelates to injury, destruction, loss, or loss of use of natural resources thatdo not constitute private property. Rather, the resources must belong to orbe controlled by federal, state, local, foreign, or tribal governments. Such

resources include flora, fauna, land, air, and water resources. The liabilitycan arise from accidental releases (e.g., during transport) as well as lawfulreleases to air, water, and soil. To date, most natural resource damagepayments have been relatively small.

Different Environmental Accounting DisciplinesEnvironmental Accounting can be broken down into three disciplines:1) Global Environmental Accounting (GEA)2) National Environmental Accounting (NEA)3) Corporate Environmental Accounting (CEA)

Corporate Environmental AccountingAt its simplest, corporate environmental accounting is about making

environment related costs more transparent within corporate accountingsystems and reports.

One of the major distinctions within the field is whether the primaryfocus is to report environment related costs within internal managementaccounts or external financial accounts or other public reports.

Benefits of Corporate Environmental Accounting The benefit of undertaking a corporate environmental accounting

initiative is that the identification and greater awareness of environment

related costs often provides the opportunity to find ways to reduce or avoidthese costs, whilst also improving environmental performance.

It can be further sub-divided into three (3) categories:1) Environmental Management Accounting2) Environmental Financial Accounting3) Environmental Audit

Global Environmental AccountingGlobal Environmental Accounting is an accounting methodology that dealswith energetic, ecology and economics at a global scale. The earth is the

system of interest with the input, sequestration, and dissipation of solarenergy which constitutes its energy budget.

National Environmental AccountingNational Environmental Accounting is an accounting approach that dealswith the economics on a national level. National Environmental Accounting isa macroeconomic measure that looks at the use of natural resources and theimpacts of national policies on the government.

SEEAInternationally environmental accounting has been formalized into the

systems of Integrated Environmental and Economic Accounting, known asSEEA. SEEA grows out of the System of National Accounts.

It is used to record the flows of raw materials (water, energy, minerals,wood, etc.) from the environment to the economy, the exchanges of thesematerials within the economy and the returns of wastes and pollutants to theenvironment. SEEA is used by 49 countries around the world.

The Environmental Protection and Resource Management Accounts ofSEEA provide for the assignment of transactions to the following classes:a) Protection of ambient air and climateb) Wastewater management


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c) Waste managementd) Protection of soil and groundwatere) Noise and vibration abatementf) Protection of biodiversity and landscapeg) Protection against radiationh) Research and Developmenti) Other Environmental Protection Activities

Environmental and Natural Resources Accounting Project The Philippine Environmental and Natural Resources Accounting

Project, 1991-2000 (ENRAP) addresses deficiencies in the System of NationalAccounts to reflect economic-environmental interactions by explicitlyrecognizing that the natural environment is a productive economic sector.

Theory of Environmental Accounting2 Distinct Interpretations

Environmental accounting refers to adjustments in the conventionalmeasures of economic performance, such as the GDP, NDP, GNP or NNP, inorder to make these measures more sensitive to changes in the natural

environment. This view of accounting focuses on its scorekeeping role:accounting as a tool for measuring performancethe performance of abusiness or an entire economy (Peskin, 1996).

Consistent with this line of theoretical development, an alternativefocus of accounting is not on the scorekeeping function, but rather on itsmanagement role.This involves the use of accounting as a means to assemble information in alogical manner in order to support theoperations of a business or an entire economy. For management purposes,the structure of the accounts is more important than the implications of thisstructure on performance indices

ENRAP Framework The ENRAP accounting structure is based on the premise that an

economic account should attempt to cover all the economic inputs andoutputs that, together, comprise an economic system. For inputs and outputsto be economic, they need not have market prices. Rather, they must bescarce enough, if marketed, to attract a non-zero price. The naturalenvironment is one major source of non-marketed but economically scarceinputs and outputs. ENRAP essentially expands conventional economicaccounting structures to cover the input and output services of non-marketed (essentially environmental) capital.

The reason for ENRAPs emphasis on a complete accounting of alleconomic inputs and outputs is that ENRAP is primarily a tool of policy. Bypolicy, we mean those governmental actions that are intended to alter theamount, composition, and distribution of system outputs. The ultimate objectof economic policy is to find the level, the composition, and the distributionof economic outputs that attain agreed upon social objectives in an efficientand fair manner. Naturally, for every level, composition and distribution ofeconomic outputs there correspond levels of use of economic inputsincluding those based on environmental assets.

Even though ENRAP is popularly viewed as a system of environmentalaccounts, because it attempts to cover all economic inputs and outputs,whether environmental or non-environmental, it is more than a tool ofenvironmental policy. It is, also, a tool of a more general economic policy. Those who have expressed concerns about environmental-economicinteractionsthe effect of the environment on the economy and the effectof economic activity on the environmentare really expressing a need forthis more general economic policy.

The starting point for ENRAP is the conventional national economicaccounts. One way of viewing the conventional accounting entries is to notethat they all represent flows of goods or services generated by marketed


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capital. These goods and services are generated by plant and equipment, byhuman capital (labor), and by Nature (raw materials). Although theconventional accounts do cover some of the outputs generated by thenatural environment, these are limited to outputs with market prices. Thosenatural goods and services that are not marketed, even though they areeconomic, are not included. These excluded goods and services fall intoone of three categories: input services (the more important being wastedisposal services); output or environmental quality services (such as

recreation and aesthetic services); and negative outputs (e.g., pollution).The basic ENRAP strategy is to append these non-marketed services to themarketed services already accounted for in the conventional accounts. Themonetary values of these services are obtained by using estimated shadowprices set to an approximate value that would be expected were these goodsand services marketed.

ENRAP Accounting Framework (Consolidated Account)Table 1 illustrates the ENRAP accounts (below the shaded block) as

supplementing the conventional consolidated account summarizing alleconomic activity (in the shaded block). As is the case with conventional

accounting, these ENRA-modified consolidated accounts are built from manydetailed sub-accounts and data sets. Entries in all capital letters representthe sum of all entries above them. Thus, CHARGES AGAINST GROSSDOMESTIC PRODUCT is the sum of Compensation of Employees, ProprietorsIncome, Indirect Taxes and Gross Returns to Capital. GROSS DOMESTICPRODUCT is the sum of Personal Consumption, Investment, InventoryChange, Exports less Imports and Government Expenditures. Note thatthese two sums are also in the conventional accounts. Thus, the ENRAPframework preserves all the elements of conventional income accounting.The three most significant new entries are Environmental Waste DisposalServices (entered negatively), Environmental Damages (also entered

negatively) and Direct Consumption of Environmental Quality Services(entered positively). As the waste disposal services are free inputs to thoseestablishments needing to dispose of wastes, they are analogous to asubsidy, or unpaid inputs. Thus, they are treated like input subsidies inconventional accountingthat is, as negative inputs. Environmentaldamages are treated as negative output.

The entry Net Environmental Benefit (Disbenefit) serves threepurposes. First, it is a balancing entry, defined as the difference between theabsolute value of all environmental services (waste disposal andenvironmental quality services) and damages. It thus assures that the inputside and the output side of the modified accounts will have the same total.

Second, it can be used as a crude measure of the efficiency of environmentalmanagement. It can be shown (Peskin 1989) that if environmental servicesand damages are valued at the margin (that is, at the shadow price of themarginal unit), a Net Environmental Benefit (NEB) equal to zero implies aPareto optimal allocation of environmental services.

If NEB is negative, then the level of services is too high (i.e., too muchpollution or over use of the environment); if NEB is positive, then wastedisposal and environmental quality services are too low. (Any losses in wellbeing due to more pollution would be more than offset by freeing upresources that could serve other beneficial purposes.) Thirdly, since NEBmeasures the net current account value of the environment, the

accumulated, discounted NEB provides a measure of the asset value ofNature; changes in this asset value measures depreciation.

The modified accounts are completed with two other entries. The first,Non-marketed Household Production, covered in ENRAP accounts only for thenon-marketed household production represented by firewood collection andupland cultivation by informal users of steeply-sloped land (e.g., slash-and-burn farming and upland agriculture). These entries were included becauseof the potential importance of such activities on de-forestation and thetendency of formal data gathering institutions to exclude them.


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The final entry is Natural Resource Depreciation, included, along withconventionally measured Capital Depreciation. Natural resource depreciationis the (net) change in the value of natural assets, reflected by changes in thevalue of future stream of resource-based commodities. Both naturalresource and capital depreciation entries are included to provide a measureof MODIFIED NET NATIONAL PRODUCT, modified to include the depreciationof natural assets as well as marketed assets. Net National Product is actuallya measure of income. It measures income after offsetting, through

investment, the loss in capital services measured by depreciation. As firstdefined by Prof. Hicks, it is a measure of income intended to give peoplean indication of the amount, which they can consume without impoverishingthemselves.

In principle, since the loss in the capital services that generate incomeis being offset, such a level of income could be maintained indefinitely(although not necessarily in per capita terms). Net income, so defined,provides a measure of sustainable income. This treatment follows thepractice of other environmental accounting systems, such as SEEA.

If the current allocation of environmental services is not Paretooptimal, it would then be possible to find another allocation that would at

least make one person better off without making anyone else worse off. Asthe net income measure in the ENRAP accounts focuses on sustainableincome (as intended by Prof. Hicks) and not sustainable product,depreciation must necessarily refer to true economic depreciation,meaning, the decline in the value of assets over timenot necessarily thedecline in their physical condition. Even if an asset never declines physicallyits value and, hence, its ability to sustain income, can decline if the servicesgenerated decrease in value. While physical depletion is usually associatedwith true economic depreciation, the association can be complex. Simpleestimates of depreciation, such as using the replacement value of the lostcapital, can be very misleading. Often replacement value provides far too

high an estimate especially when the lost units of capital have little effecton the stream of generated services.

The link between an assets physical condition and its value can beespecially weak with natural resource and environmental assets. Part of theproblem is that most environmental assets generate more than one type ofservice. The value of some of these can depend on both physical conditionand demand. Consider, for example, a lake. The lake can be a source ofrecreation, drinking water, waste disposal, and surface transportation. Itsrecreation value depends not only on its physical conditionfor example, itslevel of pollutionbut also on the demand for water-based recreation. Therecreation demand, in turn, depends on such factors as income and

population. Certainly, the value of the drinking water service is also pollutionand population related. On the other hand, the level of pollution could havelittle effect on the lakes ability to generate waste disposal and surfacetransportation services.

ENRAPs desire to measure true economic depreciation forces one todeal with these complexities. However, easier but misleading estimates,based, say on replacement costs, can be very different and, therefore, canhave very different implications for policy.

Benefits of Corporate Environmental AccountingWith the pressure on business to improve environmental performance,

corporate environmental accounting can provide a valuable tool that enablesbusiness to respond to environmental challenges whilst retaining focus onbottom-line imperatives.

Corporate Environmental Accounting and Emerging FieldCorporate Environmental Accounting is being undertaken by:1) United Nations Division for Sustainable Development2) National Governments3) Professional Accounting Bodies4) Leading Companies


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Most of these initiatives have to date looked at the area of EnvironmentalManagement Accounting.

Environmental Management AccountingIt is essentially involves refining a management accounting system so

that it more tightly and rigorously accounts for environment related costs.

Purpose of Environment Management Accounting

Its intention is to identify environmental costs in order to enable moreinformed decisions about how these costs can be better managed andintegrated into operational and strategic decision-making.

Drivers of Environmental Management AccountingThe drivers behind why an organization might consider undertaking an

EMA initiative include a mix of external and internal environmental andfinancial pressures. This could include increasing community, governmentand market expectations as to how a business manages its environmentalimpacts, as well as an organization seeking out new opportunities to reducecosts.

The benefits of Environmental Management Accounting1) Identifying cost saving opportunities2) Better decisions with regard to product mix and pricing3) Avoiding future costs through better investment decisions4) Financial justification for environmental initiatives

Transparent AccountingEnvironmental Management Accounting involves the more transparent

accounting of environment related costs within an organizationsmanagement accounting system. Management accounting systems have the

purpose of providing cost information for internal management use indecisions such as cost management, product pricing, and investmentappraisal.

Environmental Management Accounting mainly focuses on identifyingthe private environmental costs that would normally be captured within anorganizations accounting system. Often these environmental costs are lost ingeneral overhead accounts and therefore not focused on by management.

Hidden CostsWhilst many environmental costs can be considered hidden, they are

also often found to be under-estimated. For example, waste costs are often

simply identified as the costs associated with the actual disposal, rather thanalso including the cost of lost raw materials, license fees etc.

Reporting True ValueCentral too many approaches to Environmental Management

Accounting are the concepts of material tracking; activity based costing andfull-cost accounting. These concepts all aim to more accurately identifywhere environmental costs are being incurred as well as report their truevalue within the accounts. As a result, undertaking an EnvironmentalManagement Accounting initiative often not only leads to a betterunderstanding of environmental costs, but also, a much better

understanding of the physical process and environmental impacts generatedby an organization.

Life Cycle AssessmentA life cycle assessment (LCA, also known as life cycle analysis, life

cycle costing, eco-balance, cradle-to-grave-analysis, well-to-wheel analysis,and dust-to-dust energy cost) is the assessment of impact of a given productor service throughout its lifespan.

The goal of LCA is to compare the environmental performance ofproducts and services, to be able to choose the least burdensome one. The


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term life cycle refers to the notion that a fair, holistic assessment requiresthe assessment of raw material production, manufacture, distribution, useand disposal including all intervening transportation steps.

Life Cycle of the ProductThis is the life cycle of the product. The concept also can be used to optimizethe environmental performance of a single product or to optimize theenvironmental performance of a company. The term emergy is often used

as an analysis tool to determine embodied energy.

EmergyEmbodied energy refers to the quantity of energy required to manufactureand supply to the point of use, a product, material or service.Traditionally considered, embodied energy is an accounting methodologywhich aims to find the sum total of the energy necessary from the rawmaterial extraction, to transport, manufacturing, assembly, installation aswell as the capital and other costs of a specific material to produce aservice or product and finally its disassembly, deconstruction and/ordecomposition.

Environmental Financial AccountingEnvironmental Financial Accounting is used to provide information needed byexternal stakeholders on a companys financial status. This type ofaccounting allows companies to prepare financial reports for investors,lenders, and other interested parties.

Environmental Audit The financial benefits and improved efficiencies from adopting cleanerproduction and eco-efficiency encourage firms to undertake audits. ButEnvironmental Audit can also be an effective risk management tool.

By compliance with environmental legislation companies avoid the risk ofprosecution and fines arising from potential environmental breaches.

Components of an Environmental AuditA good audit will include a number of components, some of which are listedbelow.Data Collection: to identify and measure all inputs and outputs from theproduction process and provide baseline for comparison against targets anda background for improvement.Compliance: to review and compare a companys activities and businesstargets against all relevant regulations, codes of conduct and government

policies to assess compliance.Documentation: to document all aspects of audit to assess progress at afurther date and to verify environmental performance to staff, regulators andthe general community.Periodic Audits: to assess the impacts of new or changed legislation onoperations and to assess whether internal targets for environmentalefficiency are being met.Benefits of Environmental Audit

An environmental audit can be modified according to size andcomplexity of a business. For example, a small business may simply

concentrate on such things as paper usage and water and energy consumed,whereas a large organization may have a broader range inputs and outputsto be measured.

An environmental audit can give a company a much clearerunderstanding of its operations and impacts, and ultimately, provides astarting point for other environmental initiatives.

International Accounting Standards 37Objectives of IAS 37


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1) Appropriate recognition criteria and measurement bases are applied toprovisions2) Contingent Liabilities and Contingent Assets and that sufficientinformation is disclosed to the notes to financial statements in order for theusers to understand their nature, timing and amount.3) A provision should be recognized only when there is a liability.4) The Standard thus aims to ensure that only genuine obligations aredealt with in the financial statements - planned future expenditure, even

where authorized by the board of directors or equivalent governing body isexcluded from recognition.

Scope of IAS 371) This standard shall be applied by all entities in accounting provisions,contingent liabilities and contingent assets, except:a) Those resulting from executor contracts, except where the contract isonerousb) Those covered by another standard2) This standard does not apply to financial instruments (includingguarantees) that are within the scope of IAS 39.

3) Executory contracts are contracts under which neither party hasperformed any of its obligations or both parties have partially performedtheir obligations to an equal extent. This standard does not apply to executorcontracts unless they are onerous.4) Where another standard deals with a specific type of provision,contingent liability or contingent asset, an entity applies that standardinstead of this standard. For example, IFRS 3 Business Combinationsaddresses the treatment by an acquirer of contingent liabilities assumed in abusiness combination. Similarly, certain types of provisions are alsoaddressed in standards on:a) Construction contracts (IAS 11)

b) Income taxes (IAS 12)c) Leases (IAS 17)d) Employee benefits (IAS 19)e) Insurance contracts (IFRS 4)5) Some amount s treated as provisions may relate to the recognition ofrevenue, for example where an entity gives guarantees in exchange for afee. This standard does not address the recognition of revenue. IAS 18Revenue identifies the circumstances in which revenue is recognised andprovided practical guidance on the application of the recognition criteria.This standard does not change the requirements of IAS 18.6) This standard defines provisions as liabilities of uncertain timing or

amount. In some countries, the term provision is also used in the contextof items such as depreciation, impairment of assets, and doubtful debts:these are adjustments to the carrying amounts of assets and are notaddressed in this standard.7) Other standards specify whether expenditures are treated as assets oras expenses. These issues are not addressed in this standard. Accordingly,this standard neither prohibits nor requires capitalization of the costsrecognized when a provision is made.8) This standard applies to provisions for restructurings (includingdiscontinued operations). When restructuring meets the definition of adiscontinued operation, additional disclosures may be required by IFRS 5.

DefinitionsProvision is a liability of uncertain timing or amount.Liability is a present obligation of the entity arising from past events, thesettlement of which is expected to result in an outflow from the entity ofresources embodying economic benefits.Obligating event is an event that creates a legal or constructive obligationthat results in an entity having no realistic alternative to settling thatobligation.


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Legal Obligation is an obligation that derives from a contract, legislation orother operation of law.Constructive obligation is an obligation that derives from an entitys actionwhere by an established pattern of past practice, published policies or asufficiently specific current statement, the entity has indicated to otherparties that it will accept certain responsibilities and as a result, the entityhas created a valid expectation on the part of those other parties that it willdischarge those responsibilities.

Contingent LiabilitiesA contingent liability is a possible obligation that arises from past

event and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within thecontrol of the entity.

A contingent liability is apresent obligation that arises from past eventbut is not recognizedbecause it is not probable that an outflow of resourcesembodying economic benefits will be required to settle the obligation or theamount of the obligation cannot be measured reliably.

If the present obligation is probable and the amount can be measured

reliably, the obligation is a not a contingent liability but shall be recognizedas a provision. In other words, a contingent liability is either probable ormeasurable but not both.

An entity should not recognise a contingent liability. An entity shoulddisclose a contingent liability, unless the possibility of an outflow ofresources embodying economic benefits is remote.

Treatment of Contingent LiabilityA contingent liability shall not be recognized in the financial

statements but shall be disclosedonly. The required disclosures are:a. Brief description of the nature of the contingent liability.

b. An estimate of its financial assets.c. An indication of the uncertainties that exist.d. Possibility of any reimbursement.If a contingent liability is remote, no disclosure is necessary.

Contingent AssetsPAS 37 defines contingent asset as a possible asset that arises from

past event and whose existence will be confirmed only by the occurrence ornon-occurrence of one or more uncertain future events not wholly within thecontrol of the entity. An example is a claim that an entity is pursuingthrough legal processes, where the outcome is uncertain.

A contingent asset shall not be recognized because this may result torecognition of income that may never be realized. However, when therealization of the income is virtually certain, the related asset is no longercontingent asset and its recognition is appropriate.

A contingent asset is only disclosed when it is probable. The disclosureincludes brief description of the contingent asset and an estimate of itsfinancial effects. If a contingent asset is only possible or remote, nodisclosure is required.

ProvisionsA provision shall be recognized when:

a) An entity has a present obligation (legal or constructive) as a result ofa past event;b) It is probable that an outflow of resources embodying economicbenefits will be required to settle the obligation; andc) A reliable estimate can be made of the amount of the obligation.If these conditions are not met, no provision shall be recognized.

MeasurementBest Estimate


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The amount recognized as a provision shall be the best estimate of theexpenditure required to settle the present obligation as the balance sheetdate.

The best estimate of the expenditure required to settle the presentobligation is the amount that an entity would rationally pay to settle theobligation at the balance sheet date or to transfer it to a third party at thattime.

The estimates of the outcome and financial effect are determined by

the judgment of the management of the entity, supplemented by experienceof similar transactions and, in some cases, reports from independentexperts. The evidences considered include any additional evidence providedby events after the balance sheet date.Factors that may affect the Best Estimate1) Risk and Uncertainties the risk and uncertainties that inevitablysurround many events and circumstances shall be taken into account inreaching the best estimate of a provision.2) Present Value where the effect of the time value of money ismaterial, the amount of a provision shall be the present value of theexpenditures expected to be required to settle the obligation.

3) Future Events future events that may affect the amount required tosettle an obligation shall be reflected in the amount of a provision wherethere is sufficient objective evidence that they will occur.4) Expected disposal of assets gains from the expected disposal ofassets shall not be taken into account in a measuring a provision.

DisclosuresFor each class of provision, an entity shall disclose:a) The carrying amount at the beginning and end of the period.b) Additional provisions made in the period, including increases toexisting provisions.

c) Amounts used (incurred and charged against the provision) during theperiod.d) Unused amounts reversed during the period.e) The increase during the period in the discounted amount arising fromthe passage of time and the effect of any change in the discount rate.An entity shall disclose the following for each class of provision:a) A brief description of the nature of the obligation and the expectedtiming of any resulting outflows of economic benefits.b) An indication of the uncertainties about the amount or timing of thoseoutflows. Where necessary to provide adequate information, an entity shalldisclose the major assumptions made concerning future events.

c) The amount of any expected reimbursement, stating the amount ofany asset that has been recognized for that expected reimbursement.

Unless the possibility of any outflow in settlement is remote, an entityshall disclose for each class of contingent liability at the balance sheet date abrief description of the nature of the contingent liability and wherepracticable:a) An estimate of its financial effects, measure under the best estimateb) An indication of the uncertainties relating to the amount or timing ofany outflowc) The possibility of any reimbursement.

Where an inflow of economic benefits is probable, an entity shall disclose

a brief description of the nature of the contingent assets at the balancesheet date, and, where practicable, an estimate of their financial effect,measured using the principles set out for provisions.

It is important that disclosures for contingent assets avoid givingmisleading indications of the likelihood of income arising.

Illustrative Problem:

XXX Company is an oil transportation and refinery company. On year2005, one of the pipe leaked. The management formed an assessment team


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to determine if theres a contamination in the land. The team incurred200,000 and the assessment shows that the land area was contaminated. Itis estimated that it would cost 25,000,000 to clean up the contamination andit is probable that the company would be obligated by the government toclean up the area.

Journal Entries:

To record the cost of assessmentOperating Expense 200,000

Cash 200,000

To record the setting up of a provisionEnvironmental Expense 25,000,000

Provisions for Environmental Damages 25,000,000

To record the actual clean-upProvisions for Environmental Damages 25,000,000

Cash 25,000,000

DEPLETION

PFRS 6 (Exploration and Evaluation of Natural Resources)The objective of this standard is to specify the financial reporting for

the exploration and evaluation of the mineral resources. Mineral resourcesinclude minerals, oil, natural gas and similar non-regenerative resources.

The term exploration for and evaluation of mineral resources isdefined as the search for mineral resources after the entity has obtainedlegal rights to explore in a specific area as well as the determination of thetechnical feasibility and commercial viability of extracting the mineral

resources. The expenditures incurred by an entity in connection with the

exploration for the evaluation f the mineral resources before the technicalfeasibility and viability of extracting a mineral resource are known asexploration and evaluation expenditures

Exploration and evaluation expendituresExploration and evaluation expenditures include the following:1. Acquisition of the rights to explore2. Topographical, geological, geochemical, and geophysical studies3. Exploratory drilling

4. Trenching5. Sampling6. Activities in relation to evaluating the technical feasibility andcommercial viability of extracting a mineral resource.7. General and administrative costs directly attributable to theexploration and evaluation activities.

Expenditures related to development of mineral resources, forexample, preparation for commercial production, such as building roads andtunnels, cannot be recognized as exploration and evaluation expenditures.

Exploration and evaluation asset

The exploration and evaluation expenditures may qualify asexploration and evaluation asset. However, the standard does not provide aclear-cut guidance for the recognition of the exploration and evaluationasset.

Accordingly, an entity must develop its own accounting policy forthe recognition of such asset. As a matter of fact, the standard permits anentity to continue to apply its previous accounting policy provided that theresulting information is relevant and reliable.

Measurement and classification


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If the entity's accounting policy results in the recognition of anexploration and evaluation asset, such asset shall be measured initially atcost. After the initial recognition, an entity shall apply either the cost modelor revaluation model.

Exploration and evaluation asset is classified either tangible asset oran intangible asset. For example, vehicles and drilling rigs would beclassified as tangible assets and drilling rights would be classified asintangible assets.

ImpairmentThe standard provides that the exploration and evaluation asset shall beassessed for impairment when facts and circumstances suggest that thecarrying amount may exceed recoverable amount. Facts and circumstancesthat may indicate impairment include:a. The period for which the entity has the right to explore in a specific areahas expired and is not expected to be renewed.b. Substantive expenditure for exploration and evaluation is neitherbudgeted nor planned.c. The exploration and evaluation activities have not led to the discovery of

commercially viable quantity of mineral resource and the entity hasdecided to discontinue such activities.d. Sufficient data indicate that the carrying amount of the exploration andevaluation asset is unlikely to be recovered in full successful developmentor by sale.

Wasting AssetsWasting assets are material objects of economic value and utility to

man produced by nature. Actually, wasting assets are natural resources.Natural resources usually include coal, oil, ore, precious metals like gold andsilver, and timber.

Wasting assets are so called because they are physically consumedand once consumed, they cannot be replaced anymore. If ever, they can bereplaced only by the process of nature. Natural resources cannot beproduced by man. Thus, wasting assets are characterized by two mainfeatures:a. they are physically consumed.b. they are irreplaceable.

Cost of Wasting assetEntities follow a wide variety of practices in accounting for an extractiveindustry. At present, there is no comprehensive standard that is applicable to

the extractive or mining industry. In general, the cost of wasting asset ormineral resource can be divided into four categories, namely:a. Acquisition costb. Exploration costc. Development costd. Estimated restoration cost

Acquisition costAcquisition costis the price paid to obtain the property containing the

natural resource. Unquestionably, this is the initial cost of the wasting asset.Generally, the acquisition cost is charged to any descriptive natural resource

account.If there is a residual land value after the extraction of the natural

resource, the portion of the acquisition cost applicable to the land may beincluded in the natural resource account or may be set up in a separateaccount and the remaining cost should be charged to the natural resourceaccount. Actually, the land value is the residual value of a wasting asset forpurpose of computing depletion. Thus, this should be deducted from the totalacquisition cost to get the depletable cost.

Exploration cost


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As stated earlier, exploration cost is the expenditure incurred beforethe technical feasibility and commercial viability of extracting a mineralresource are demonstrated.

Simply stated, the exploration cost is the cost incurred in an attempt tolocate the natural resource that can economically be extracted or exploited.The exploration may result in either success or failure. Accordingly, theexploration cost may be accounted for the following two methods, namelysuccessful effort method and full cost method.

Under the successful effort method, only the exploration cost directlyrelated to the discovery of commercially producible natural resource iscapitalized as cost of the resource property. The exploration cost related todry well or unsuccessful discovery is expensed in the period incurred.

Under the full cost method, all exploration costs, whether successfulor unsuccessful, are capitalized as cost of the successful resource discovery.

This is on the theory that any exploration cost is wild goose chaseand therefore necessary before any commercially producible and profitableresource can be found. The cost of drilling dry wells is part of the cost oflocating productive wells.

Both methods are used in practice. Most large and successful oil

entities follow the successful effort methods. The full cost method is popularamong small oil entities.

Development costDevelopment cost is the cost incurred to exploit or extract the natural

resource that has been located through successful exploration.Development cost may be in the form of tangible equipment and

intangible development cost. Tangible equipment includes transportation equipment, heavy

machinery, tunnels, bunker and mine shaft. The cost of tangible equipmentis not capitalized as cost of natural resource but set up in a separate account

and depreciated in accordance with normal depreciation policies.Intangible development cost is capitalized as cost of the natural

resource. Such cist includes drilling, sinking mine shaft and construction ofwells.

Restoration cost The resource property may sold after extracting activities are

complete. The amount to be derived from such sale represents the residualvalue of the resource property.

To prepare the property for sale, however, restoration cost mat\y benecessary to bring the property to its original state. Such restoration cost

may be added to the cost of the resource property or netted against theexpected residual value of the resource property.

DepletionThe removal, extraction or exhaustion of a natural resource is called

depletion.

Depletion, as an accounting procedure, is a systematic allocation of thedepletable cost of wasting asset over the period the natural resource isextracted or produced.

In essence, however, depletion is recognized as cost of the material

used in production and thus becomes the finished product of the extractiveentity since the wasting asset is conceived as the total cost of the materialsavailable for production.

Depletion methodNormally, depletion is computed using the output or production

method. Following the output method, depletion is computed as follows:The depletable cost of wasting asset is divided by the units estimated

to be extracted to obtain a depletion rate per unit. The depletion rate per


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unit is then multiplied by the units extracted during the year to arrive at thedepletion for the period.

For instance, a wasting asset entity has acquired the right to use a propertyto explore a natural resource. The acquisition cost is P3, 000,000, anddevelopment costs incurred in erecting wells and drilling the deposit are P5,000,000. Total costs of the wasting asset therefore amount to P10, 000,000.

It is estimated that the resource deposit is approximately 1,000,000units. The depletion rate per unit is computed as follows:Depletion rate per unit = P10, 000,000/1,000,000

= P10

If the 250,000 units are extracted in the first year of operations, thenthe depletion for the year is P2, 500,000, computed by multiplying theproduction of 250,000 units by the rate of P10. The entry to record thedepletion is:

Depletion 2,500,000Accumulated depletion 2,500,000

In the income statement, the depletion is classified as part of the costof production or cost of sales. If the statement of financial position isprepared at the end of the first year, the wasting asset would be shown asseparate line item as follows:

Resource deposit, at cost 10,000,000Less: accumulated depletion 2,500,000Book value 7,500,000

Another method of computing depletion is the straight line method.

The straight line approach is not generally favoured because of theuncertainty of production. It is often difficult to estimate the life of a wastingasset in terms of years.

Revision of depletion rateNot frequently, the original estimate of the resource deposit has to be

changed either because new information is available or because productionprocess has become more sophisticated.

The revision of the original estimate of the recoverable resourcedeposit gives rise to the same faced in accounting for change in estimateconcerning the useful life of property, plant and equipment.

Changes in estimate are to be handled currently and prospectively, ifnecessary. Accordingly, the procedure is to revise the depletion rate on aprospective basis, that is, by dividing the remaining depletable cost ofwasting asset by the revised estimate of the productive output.

For instance, assume that, in the preceding example, additionaldevelopment costs of P3, 750,000 are incurred in the second year, andrecoverable deposits are estimated to be 1,250,000 units at the beginning ofthe second year is computed as follows:

Original cost of wasting asset 10,000,000Additional development cost in 2nd year 3,750,000

Total 13,750,000Less: Accumulated depletion 2,500,000Remaining depletable cost 11,250,000

Depletion rate per unit (11,250,000/1,250,000 units) = P 9

If the 300,000 units are extracted in the second year, the entry to record thedepletion for the period is:

Depletion (300 000 units x P9) 2,700,000Accumulated depletion 2,700,000


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Depreciation of mining propertyAgain, tangible equipment such as transportation equipment, heavy

machinery, mine shaft and other equipment used in the mining operationsshall be reported in separate accounts and depreciated following normaldepreciation polices.

Generally, the depreciation of equipment used in mining operations isbased on the life of the equipment or the life of the wasting asset, whichever

is shorter.If the life of the equipment is shorter the straight line method of

depreciation is normally used.But if the life of wasting asset is shorter, the output method of

depreciation is frequently used.However, if the mining equipment is movable and can be used in

future extractive project, the equipment is depreciated over its useful lifeusing straight line method.

IllustrationFor instance, assume that the natural resource deposit is estimated to

contain 450,000 units. Heavy equipment necessary to extract the deposits isacquired at cost of P9, 000,000. The life of the equipment is 10 years.

If it is estimated that 30,000 units will be extracted each year, then thedeposit will be exhausted in approximately 15 years (450,000 units dividedby 30,000 units), whichever is longer than the 10-year life of the equipment.

The equipment then should be depreciated over 10 years following thestraight line method giving an annual depreciation of P900, 000 (P9, 000,000divided by 10 years).

However, if it is estimated that 50,000 units would be extracted each

year, then the deposit would be exhausted in approximately 9 years, whichis shorter than 10-year life of the equipment.

Depreciation then on the equipment shall be based on the life of thedeposit following the output method of depreciation. The depreciation for thefirst year is computed as follows:

Depreciation per unit (9,000,000/ 450,000 units) = P20Depreciation (50,000 units extracted x P20) = P1, 000,000

ShutdownWhen the output method is used in depreciating mining property, in

the event of shutdown, such method cannot be used. In this case, thedepreciation in the year of shutdown is based on the remaining life of theequipment following the straight line method.

In other words, the remaining book value of the equipment is dividedby the remaining life of the equipment to arrive at the deprecation in theyear of shutdown.

Thus, in the preceding example, if there is a shutdown in the secondyear, the depreciation is determined as follows:

Equipment, at cost 9,000,000Less: accumulated depreciation 1,000,000

Book value (beginning of 2nd year) 8,000,000

Depreciation for 2nd year (8,000,000/9years) 888,888

When the operations are resumed, the depreciation is again computedfollowing the output method. But in this case, a new depreciation rate perunit is computed by dividing the remaining book value of the equipment bythe remaining or revised estimate of the deposit.


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Thus, if the third year, operations are resumed and 60,000 units areextracted, the depreciation on the equipment is computed as follows:

Equipment, at cost 9,000,000Less: acc. Depreciation (1M + 888,888) 1,888,888Book value 3rd year 7,111,112

Original estimate of deposit 450,000 units

Less: extracted in 1st

year 50,000 unitsRemaining estimate of the deposit 400,000 units

Depreciation rate per unit(7,111,112/400,000) 17.78

Depreciation for the 3rd year(60,000 units x 17.78) 1,066,800

Trust fund doctrineUnder this doctrine, the share capital of a corporation is conceived as a

trust fund for the protection of creditors. Consequently, such capital cannot

be returned to shareholders during the lifetime of the corporation.However, the corporation can pay dividends to shareholders but

limited only to the balance of the retained earnings.Accordingly, the corporation cannot pay dividends if it has a deficit

because this would be tantamount to a return of capital to shareholders.

Wasting assets doctrineUnder this doctrine, a wasting asset corporation or an entity engaged

in the extraction of a natural resource can legally return shareholders duringthe lifetime of the corporation.

Accordingly, a wasting asset corporation can pay dividend not only to

the extent of the retained earnings but also to the extent of the accumulateddepletion.

The amount paid in excess of the retained earnings is accounted for aliquidating dividend or return of capital.

The wasting asset doctrine is therefore an exception to the trust funddoctrine.

For instance, assume that a wasting asset corporation shows the followingaccounts, among others:

Wasting asset, at cost 1,000,000Accumulated depletion 100,000

Retained earnings 200,000

The maximum dividends that can declared by the wasting assetcorporation would be P300, 000, the retained earnings balance of P200, 000plus the accumulated depletion balance of P100, 000. If the same is declaredas dividends, the entry is:

Retained earnings 200,000Capital liquidated 100,000

Dividends payable 300,000

The dividend of P100, 000 in excess of the retained earnings balance isactually a liquidating dividend and thus accounted for as a return of capitalto the shareholders. Although this dividend is based on the accumulateddepletion balance, the accumulated depletion account is not chargedbecause the same is not a source of dividend unlike the retained earnings. The accumulated depletion balance is used only for the purposes ofdetermining how much capital can be legally returned to shareholders.

The capital liquidated account is an equity item. It is a deductionfrom the total shareholders.


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Philosophy of the wasting asset doctrine The wasting asset doctrine which authorizes the declaration of

dividends in excess of the retained earnings of the corporation is based onthe philosophy that to limit dividend declaration to the retained earningsbalance would have the effect of retaining in the business funds which arenot needed because the wasting assets are irreplaceable. The funds thenwould only be given to the shareholders when the corporation is finally

dissolved and liquidated.The unnecessary and undue retention of funds is unfair to shareholders

because such funds actually costs recovered.Moreover, the creditors are aware of the decreasing capital

requirements which are peculiar to the corporations engaged in theexploitation or extraction of natural resources.

Complete formulaThe complete formula in determining the maximum dividend that can

be declared and paid by a wasting asset corporation is as follows:

Retained earnings xxAdd: Acc. Depletion xxTotal xxLess: capital liquidated in prior years xx

Unrealized depletion in ending inventory xxxx

Maximum dividend xx

IllustrationFor instances, assume the following balances in December 31 of the currentyear:

Wasting asset, at cost 8,000,000Accumulated depletion 3,000,000Share capital 5,000,000Capital liquidated 500,000Retained earnings 2,000,000Depletion for the current year based on50,000 extracted at P20 per unit 1,000,000Inventory of resource deposit (5,000 units) 300,000

The maximum dividend that can be declared on December 31 is determined

as follows:

Retained earnings 2,000,000Add: Acc. Depletion 3,000,000Total 5,000,000Less: capital liquidated 500,000

Unrealized depletion in ending inventory(5,000 units x P20 per unit) 100,000 600,000

Maximum dividend 4,400,000

If the amount of P4, 400,000 is declared as dividend on December 31, theentry is:

Retained earnings 2,000,000Capital liquidated 2,400,000

Dividends payable 4,400,000

Environmental Accounting 2

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