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Environmental Accounting

What is Environmental Accounting?

The term environmental accounting is frequently used within the
accounting and environmental management literatures. Environmental
accounting is a broader term that relates to the provision of environmental-
performance-related information to stakeholders both within, and outside, an
An important function of environmental accounting is to bring
environmental costs to the attention of corporate stakeholders who may be
able and motivated to identify ways of reducing or avoiding those costs while
at the same time improving environmental quality. (According to the United
States Environment Protection Agency or US EPA)
It is a Growing field that identifies resource use, measures and
communicates costs of a company or the national economy actual or
potential impact on the environment.
It is sometimes referred to as “green accounting”, “resource
accounting” or “integrated economic and environmental accounting” which
is about the modification of the System of National Accounts to incorporate
the use or depletion of natural resources. Furthermore, it incorporates
environmental assets and their source and sink functions into national and
corporate 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 calculate
major economic indicators including gross domestic product (GDP), gross
national product (GNP), savings rates, and trade balance figures. The data
underlying these aggregate indicators are also used for a wide range of less
publicized but equally valuable policy analysis and economic monitoring

Non-marketed Goods
The environment provides many goods which are not sold, but which are
nevertheless of value; e.g., fuel wood and building materials gathered in
forests, meat and fish captured for consumption, and medicinal plants. Some
countries do include these in their national income accounts, estimating total
consumption, and then using market prices for comparable products as a
proxy to calculate the value of non-marketed goods. However, such
estimation is incomplete, and cannot always be disaggregated from products
which are sold.

Non-marketed services
Similarly, the environment provides unsold services, such as watershed
protection by forests or water filtration by submerged vegetation. These are
not included in the SNA. It can be very difficult to estimate their economic
value; this is sometimes done by calculating the cost of obtaining equivalent
services from the market.

Consumption of Natural Capital

The SNA treats the gradual depletion of physical capital - machines and other
equipment - as depletion rather than income, in accordance with
conventional business accounting principles. However, the depletion of
natural capital -forests, in particular - is accounted for as income. Thus the
accounts of a country which harvests trees very quickly will show quite high
income for a few years, but nothing will show the destruction of a productive
asset, the forest. Most experts on environmental accounting agree that the
depletion of natural capital should be accounted for in the same way as other
productive assets.

What is Environmental Accounting System?

It is composed of environmentally differentiated conventional
accounting and ecological accounting. Environmentally differentiated
accounting measures impacts of the natural environment on a company in
nominal 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 accounts
3) 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 some
types of businesses.
5) Possible revenue generation may offset environmental costs (e.g.
transfer of pollution allowances).
6) Improved environmental performance which may have a positive
impact on human health and business success.
7) May result in more accurate costing or pricing of products and more
environmentally desired processes.

History of Environmental Accounting

Environmental issues have found a reflection in the accounts only in the last
part of the twentieth century. The chronology of important developments in
environmental accounting and environmental issues reflected in the
accounts we find at Ienciu (2009) which presents then following rhythms:

→ Period 1971-1987: represents the beginning of the first environmental

accounting research due to the importance that begins to gain this area. The
first period takes into account the literature in this field through studies
treating social and environmental accounting in the same way. Since the
early 80s, surveys suggest that the separation of environmental accounting
and social accounting is starting, due to increased interest in environmental
reporting compared to the social. Also in this period begin to appear
accounting books dealing with aspects of social and environmental
accounting. According to research from this period, environmental auditing
and environmental management accounting were not treated separately. As
a first step in the development of environmental accounting the articles
published on this subject have been in a small number, just like the
regulations regarding environmental accounting.

→ Period 1988-1994: the problem of environmental accounting is

becoming an area of interest. In this period of increased interest of
researchers for this area, managers and even accountants begin to pay
attention to the problem of environmental accounting. It also increases
research in environmental accounting terms at the expense of research on
social accounting. In this period, the concepts of sustainability and
environmental audit begin to interest the users. There were a number of
books and articles that dealt with the environmental accounting,
environmental accounting showing the state of knowledge both within
universities and in the accounting. The progress in environmental
accounting regulations is slow, but much faster in comparison with that of
social accounting.
→ Period 1995-2001: environmental accounting at both theoretical and
practical level starts to address on a large scale especially in developed
countries. The number of studies in this period begins to grow; this period
can be called "the cornerstone" of accounting environment. Sub domains of
environmental accounting begin to develop, such as environmental costs,
environmental management accounting and environmental auditing. The
concept of environmental audit occurred in the USA at the beginning of the
’80 for evaluating ecological performances of some units in the oil field and
chemical industry. So as to avoid the payments incurred by environmental
pollution, buyers systematically proceeded to acquisitions from the units that
implemented environmental protection policies (Beţianu Leontina et all,
2008). Environmental accounting researchers are beginning to give greater
importance to this area, begin to increase significantly the number of
studies, environmental reports of remain the main sub domain researchers
treated. This sub domain begins to interest due to the implementation of
standards for environmental management, which contain a part of the audit
or verification.

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

numerous developing countries including Romania. At the international level
are issued guidelines on reporting environmental information and regulations
appearing in the accounting environment. The number and quality of articles
on environmental accounting continues to grow. Year 2002 is the year that in
Romania the conceptual studies are beginning to appear. Studies in
environmental 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, Möbus, Gray,
Chatterge, Aerts and Cornier. Regarding the Romanian researchers, we
include here the study by Lungu (Lungu et all, 2008), which proposes "new
approach" for corporate reporting and report of social and environmental
information. In Romania, there are studies of authors: Caraiani, Dumitrana,
Jianu Tăbără, and Nuţă, Ienciu, Cenuşă, which present the environmental
accounting as an system composed of three parts: the reporting, the
management and the environmental audit. Environmental management
accounting experiences a development, both in terms of published studies
and 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 (Creţu, 2004), environmental
performance and its implications on the financial performance of the entity
(Creţu, 2004; Caraiani, 2007; Bonaci and Ienciu, 2007). The environmental
audit is treated increasingly more in this period, with the first work in
Romania dealing with this problem (Borza, 2007). Involvement of Romania’s
accounting in the business of environmental protection is even stronger with
the entry into force on January 1, 2010 of the Order 3055/2009 for approving
the Accounting Regulations in accordance with European directives, so in the
chart of accounts, a new account is inserted, account 652 "Expenditure on
environmental protection. With this account are kept environmental
protection expenditure recorded in the relevant period, for example,
environmental taxes paid, and the certificates of emissions of greenhouse
gases effect purchased.

From the presented it results that research into environmental

accounting have come to the forefront of accounting research, outpacing
other chapters, such as social accounting, given the importance of
environmental issues on the community. Environmental reports remain an
area of interest for researchers, but other research subfields also have
interest from researchers, namely, environmental management accounting
and 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
include costs incurred to clean up and remediate contaminated sites,
effluent control technologies, and waste disposal. They are also costs like
environmental fines, penalties, and taxes, purchase of pollution prevention
technologies and waste management costs.

Types of Environmental Costs

Private 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 polluted

Social Environmental Costs are those borne by the public at large. Examples
of these include costs borne by the tax payers to staff the EPA; costs borne
by the taxpayers to clean up a polluted lake or river; costs borne by
individuals, insurance companies, and Medicare due to health problems
caused by pollutants; and the unquantifiable quality-of-life costs we all bear
from 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 by
environmental issues but have not been so identified as such.

Monitoring Costs – Costs of monitoring the production process to determine if

pollution is being generated (e.g. costs of testing wastewater for
Abatement costs – Costs incurred to reduce or eliminate pollution (e.g.
changing a product’s design to use more expensive materials that do not
result in environmental contamination).

Remediation Costs – (i.e. clean-up costs)

On-site remediation – costs of reducing or preventing the discharge into the
environment of pollutants that have been generated in the production
process (e.g. cost of installing scrubbers on a smokestack to remove certain
air pollutants in the smoke).
Off-site remediation – costs of reducing or eliminating pollutants from the
environment after they have been discharged (e.g. cost of cleaning up a
river polluted by a company’s operations).

Environmental Cost Strategies

End-of-pipe strategy – under this approach, companies produces the waste
or pollutant, and then cleans it up before it is discharged into the
environment. Smokestack scrubbers, wastewater treatment, and carbon air
filters are examples of end-of-pipe strategies.

Process improvement strategy – under this approach, companies modify

products and production processes to produce little or no pollutants, or find
ways to recycle wastes internally.

Prevention strategy – “the ultimate strategy for maximizing the value of

pollution-related activities involves... not producing any pollutants in the first
place. With this strategy, companies avoid all problems with regulatory
authorities and, in many cases, generate significant profit improvements.”

What are environmental expenditures?

Expenditures to protect the environment from harm, or to mitigate that
harm, cannot be identified from the data in the accounts. Such expenditures
include the costs incurred to prevent environmental harm, such as pollution
control 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
drinking water filtration required because intake water is highly sediment.
These expenditures are already included in the income accounts, along with
all other intermediate or final consumption. However, they cannot be
disaggregated to highlight the costs incurred to prevent or mitigate
environmental degradation.

Annual Corporate Environmental Expenditure

a) Waste and emission treatment
b) Depreciation for related equipment
c) Maintenance and operating material and services
d) Related personnel
e) Fees, taxes, charges
f) Fines and penalties
g) Insurance for environmental liability
h) Provisions for clean-up costs, remediation, etc.

Major Cost Categories

1) Materials Cost of Product Outputs
- The purchase costs of natural resources such as water and other materials
that are converted into products, by-products and packaging.

2) Materials Cost of Non-Product Outputs

- The purchase costs of inputs/materials bought, inventoried, put into
process but did not become part of a saleable finished product (waste and
3) Waste and Emission Control Costs
- This corresponds to the conventional definition of environmental costs
comprising all treatment, disposal, and clean up costs in existing wastes and

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 also
be subsidies given due to environmentally related factors.

What are environmental liabilities?

A legal obligation to make future expenditure due to the past ongoing
manufacture, use, release, or threatened release of a particular substance,
or other activities that adversely affect the environment. A potential
environmental liability is a potential legal obligation to make a future
expenditure due to the ongoing or future manufacture, use, release, or
threatened release of a particular substance, or other activities that
adversely 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 in
effect. A "potential environmental liability" differs from an "environmental
liability" because an organization has an opportunity to prevent the liability
from occurring by altering its own practices or adopting new practices in
order 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, whether
enforced by public agencies or through private citizens' suits, give rise to
many types of environmental liabilities. Another legal source of these
liabilities is "common law" (i.e., judge-made law). The following broad
categories of environmental liabilities:
• compliance obligations related to laws and regulations that apply to
the manufacture, use, disposal, and release of chemical substances
and to other activities that adversely affect the environment
• remediation obligations (existing and future) related to contaminated
real property
• 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 environmental

Compliance obligations. The costs of coming into compliance can range from
modest 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 or
release to surface waters, to contain spills, to "scrub" air emissions). Laws
and regulations also impose "exit costs" (e.g., to properly close waste
disposal sites and provide for post-closure care, and to decommission
nuclear 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 of
regulatory programs applicable to operating facilities. This can include
excavation, drilling, construction, pumping, soil and water treatment, and
monitoring, and can include the response costs incurred by regulatory
agencies. Remediation costs also can include the provision of alternate
drinking water supplies for affected community residents, and, in some
circumstances, purchase of properties and relocation expenses. Technical
studies and the expenditure of management, professional, and legal
resources add to the cost of remediation.
The remediation obligation is distinctive because a company may face
remediation obligations due to contamination at inactive sites that are
otherwise 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 applicable
requirements may be subject to civil or criminal fines or penalties for
noncompliance and/or expenses for projects agreed to as part of a
settlement for noncompliance. Such payments fulfill punitive and deterrent
functions and are in addition to the costs of coming into compliance.

Compensation obligations. Under common law and some state and federal
statutes, companies may be obligated to pay for compensation of "damages"
suffered by individuals, their property, and businesses due to use or release
of toxic substances or other pollutants. These liabilities may occur even if a
company 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, or
automobiles; loss of crops), and economic loss (e.g., lost profits, cost of
renting substitute premises or equipment).

Punitive Damages. To supplement compensatory payments to those harmed

by the actions of others, the law allows the imposition of what are called
"punitive damages" to punish and deter conduct viewed as showing a callous
disregard for others. Punitive damages are often many times larger than the
costs of compensation. Punitive damages tend to be more common in
product liability than environmental liability cases.

Natural resource damages. A relatively new category of environmental

liability is best termed "natural resource damages." This liability generally
relates to injury, destruction, loss, or loss of use of natural resources that
do not constitute private property. Rather, the resources must belong to or
be controlled by federal, state, local, foreign, or tribal governments. Such
resources include flora, fauna, land, air, and water resources. The liability
can arise from accidental releases (e.g., during transport) as well as lawful
releases to air, water, and soil. To date, most natural resource damage
payments have been relatively small.

Different Environmental Accounting Disciplines

Environmental 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 Accounting

At its simplest, corporate environmental accounting is about making
environment related costs more transparent within corporate accounting
systems and reports.
One of the major distinctions within the field is whether the primary
focus is to report environment related costs within internal management
accounts 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 avoid
these costs, whilst also improving environmental performance.

It can be further sub-divided into three (3) categories:

1) Environmental Management Accounting
2) Environmental Financial Accounting
3) Environmental Audit

Global Environmental Accounting

Global Environmental Accounting is an accounting methodology that deals
with energetic, ecology and economics at a global scale. The earth is the
system of interest with the input, sequestration, and dissipation of solar
energy – which constitutes its energy budget.

National Environmental Accounting

National Environmental Accounting is an accounting approach that deals
with the economics on a national level. National Environmental Accounting is
a macroeconomic measure that looks at the use of natural resources and the
impacts of national policies on the government.

Internationally environmental accounting has been formalized into the
systems of Integrated Environmental and Economic Accounting, known as
SEEA. 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 these
materials within the economy and the returns of wastes and pollutants to the
environment. SEEA is used by 49 countries around the world.
The Environmental Protection and Resource Management Accounts of
SEEA provide for the assignment of transactions to the following classes:
a) Protection of ambient air and climate
b) Wastewater management
c) Waste management
d) Protection of soil and groundwater
e) Noise and vibration abatement
f) Protection of biodiversity and landscape
g) Protection against radiation
h) Research and Development
i) 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 National
Accounts to reflect economic-environmental interactions by explicitly
recognizing that the natural environment is a productive economic sector.

Theory of Environmental Accounting

2 Distinct Interpretations
• Environmental accounting refers to adjustments in the conventional
measures of economic performance, such as the GDP, NDP, GNP or NNP, in
order 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 performance—the performance of a
business or an entire economy (Peskin, 1996).
• Consistent with this line of theoretical development, an alternative
focus of accounting is not on the scorekeeping function, but rather on its
“management” role.
This involves the use of accounting as a means to assemble information in a
logical manner in order to support the
operations of a business or an entire economy. For management purposes,
the structure of the accounts is more important than the implications of this
structure 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 and
outputs that, together, comprise an economic system. For inputs and outputs
to be “economic,” they need not have market prices. Rather, they must be
scarce enough, if marketed, to attract a non-zero price. The natural
environment is one major source of non-marketed but economically scarce
inputs and outputs. ENRAP essentially “expands” conventional economic
accounting structures to cover the input and output services of non-
marketed (essentially environmental) capital.
The reason for ENRAP’s emphasis on a complete accounting of all
economic inputs and outputs is that ENRAP is primarily a tool of policy. By
“policy,” we mean those governmental actions that are intended to alter the
amount, composition, and distribution of system outputs. The ultimate object
of economic policy is to find the level, the composition, and the distribution
of economic outputs that attain agreed upon social objectives in an efficient
and fair manner. Naturally, for every level, composition and distribution of
economic outputs there correspond levels of use of economic inputs
including those based on environmental assets.
Even though ENRAP is popularly viewed as a system of environmental
accounts, because it attempts to cover all economic inputs and outputs,
whether environmental or non-environmental, it is more than a tool of
environmental policy. It is, also, a tool of a more general economic policy.
Those who have expressed concerns about environmental-economic
interactions—the effect of the environment on the economy and the effect
of economic activity on the environment—are really expressing a need for
this more general economic policy.
The starting point for ENRAP is the conventional national economic
accounts. One way of viewing the conventional accounting entries is to note
that they all represent flows of goods or services generated by marketed
capital. These goods and services are generated by plant and equipment, by
human capital (labor), and by Nature (raw materials). Although the
conventional accounts do cover some of the outputs generated by the
natural environment, these are limited to outputs with market prices. Those
natural goods and services that are not marketed, even though they are
“economic,” are not included. These excluded goods and services fall into
one of three categories: input services (the more important being waste
disposal 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 the
marketed services already accounted for in the conventional accounts. The
monetary values of these services are obtained by using estimated shadow
prices set to an approximate value that would be expected were these goods
and services marketed.

ENRAP Accounting Framework (Consolidated Account)

Table 1 illustrates the ENRAP accounts (below the shaded block) as
supplementing the conventional consolidated account summarizing all
economic activity (in the shaded block). As is the case with conventional
accounting, these ENRA-modified consolidated accounts are built from many
detailed sub-accounts and data sets. Entries in all capital letters represent
the sum of all entries above them. Thus, CHARGES AGAINST GROSS
DOMESTIC PRODUCT is the sum of Compensation of Employees, Proprietor’s
Income, Indirect Taxes and Gross Returns to Capital. GROSS DOMESTIC
PRODUCT is the sum of Personal Consumption, Investment, Inventory
Change, Exports less Imports and Government Expenditures. Note that
these two sums are also in the conventional accounts. Thus, the ENRAP
framework preserves all the elements of conventional income accounting.
The three most significant new entries are Environmental Waste Disposal
Services (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 those
establishments needing to dispose of wastes, they are analogous to a
subsidy, or unpaid inputs. Thus, they are treated like input subsidies in
conventional accounting—that is, as negative inputs. Environmental
damages are treated as negative output.
The entry Net Environmental Benefit (Disbenefit) serves three
purposes. First, it is a balancing entry, defined as the difference between the
absolute value of all environmental services (waste disposal and
environmental quality services) and damages. It thus assures that the input
side 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 environmental
management. It can be shown (Peskin 1989) that if environmental services
and damages are valued at the margin (that is, at the shadow price of the
marginal unit), a Net Environmental Benefit (NEB) equal to zero implies a
Pareto optimal allocation of environmental services.
If NEB is negative, then the level of services is too high (i.e., too much
pollution or over use of the environment); if NEB is positive, then waste
disposal and environmental quality services are too low. (Any losses in well
being due to more pollution would be more than offset by freeing up
resources that could serve other beneficial purposes.) Thirdly, since NEB
measures the net current account value of the environment, the
accumulated, discounted NEB provides a measure of the asset value of
Nature; 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 the
non-marketed household production represented by firewood collection and
upland cultivation by informal users of steeply-sloped land (e.g., slash-and-
burn farming and upland agriculture). These entries were included because
of the potential importance of such activities on de-forestation and the
tendency of formal data gathering institutions to exclude them.
The final entry is Natural Resource Depreciation, included, along with
conventionally measured Capital Depreciation. Natural resource depreciation
is the (net) change in the value of natural assets, reflected by changes in the
value of future stream of resource-based commodities. Both natural
resource and capital depreciation entries are included to provide a measure
of MODIFIED NET NATIONAL PRODUCT, modified to include the depreciation
of natural assets as well as marketed assets. Net National Product is actually
a measure of income. It measures income after offsetting, through
investment, the loss in capital services measured by depreciation. As first
defined by Prof. Hicks, it is a measure of income intended to “… give people
an indication of the amount, which they can consume without impoverishing
In principle, since the loss in the capital services that generate income
is 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 the
practice of other environmental accounting systems, such as SEEA.
If the current allocation of environmental services is not Pareto
optimal, it would then be possible to find another allocation that would at
least make one person better off without making anyone else worse off. As
the net income measure in the ENRAP accounts focuses on sustainable
income (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 time—not necessarily the
decline in their physical condition. Even if an asset never declines physically
its value and, hence, its ability to sustain income, can decline if the services
generated decrease in value. While physical depletion is usually associated
with true economic depreciation, the association can be complex. Simple
estimates of depreciation, such as using the replacement value of the “lost”
capital, can be very misleading. Often replacement value provides far too
high an estimate especially when the “lost” units of capital have little effect
on the stream of generated services.
The link between an asset’s physical condition and its value can be
especially weak with natural resource and environmental assets. Part of the
problem is that most environmental assets generate more than one type of
service. The value of some of these can depend on both physical condition
and demand. Consider, for example, a lake. The lake can be a source of
recreation, drinking water, waste disposal, and surface transportation. Its
recreation value depends not only on its physical condition—for example, its
level of pollution—but also on the demand for water-based recreation. The
recreation demand, in turn, depends on such factors as income and
population. Certainly, the value of the drinking water service is also pollution
and population related. On the other hand, the level of pollution could have
little effect on the lake’s ability to generate waste disposal and surface
transportation services.
ENRAP’s desire to measure true economic depreciation forces one to
deal with these complexities. However, easier but misleading estimates,
based, say on replacement costs, can be very different and, therefore, can
have very different implications for policy.

Benefits of Corporate Environmental Accounting

With the pressure on business to improve environmental performance,
corporate environmental accounting can provide a valuable tool that enables
business to respond to environmental challenges whilst retaining focus on
bottom-line imperatives.

Corporate Environmental Accounting and Emerging Field

Corporate Environmental Accounting is being undertaken by:
1) United Nations Division for Sustainable Development
2) National Governments
3) Professional Accounting Bodies
4) Leading Companies
Most of these initiatives have to date looked at the area of Environmental
Management Accounting.

Environmental Management Accounting

It 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 more
informed decisions about how these costs can be better managed and
integrated into operational and strategic decision-making.

Drivers of Environmental Management Accounting

The drivers behind why an organization might consider undertaking an
EMA initiative include a mix of external and internal environmental and
financial pressures. This could include increasing community, government
and market expectations as to how a business manages its environmental
impacts, as well as an organization seeking out new opportunities to reduce

The benefits of Environmental Management Accounting

1) Identifying cost saving opportunities
2) Better decisions with regard to product mix and pricing
3) Avoiding future costs through better investment decisions
4) Financial justification for environmental initiatives

Transparent Accounting
Environmental Management Accounting involves the more transparent
accounting of environment related costs within an organizations
management accounting system. Management accounting systems have the
purpose of providing cost information for internal management use in
decisions such as cost management, product pricing, and investment
Environmental Management Accounting mainly focuses on identifying
the private environmental costs that would normally be captured within an
organizations accounting system. Often these environmental costs are lost in
general overhead accounts and therefore not focused on by management.

Hidden Costs
Whilst 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 than
also including the cost of lost raw materials, license fees etc.

Reporting True Value

Central too many approaches to Environmental Management
Accounting are the concepts of material tracking; activity based costing and
full-cost accounting. These concepts all aim to more accurately identify
where environmental costs are being incurred as well as report their true
value within the accounts. As a result, undertaking an Environmental
Management Accounting initiative often not only leads to a better
understanding of environmental costs, but also, a much better
understanding of the physical process and environmental impacts generated
by an organization.

Life Cycle Assessment

A 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 product
or service throughout its lifespan.
The goal of LCA is to compare the environmental performance of
products and services, to be able to choose the least burdensome one. The
term ‘life cycle’ refers to the notion that a fair, holistic assessment requires
the assessment of raw material production, manufacture, distribution, use
and disposal including all intervening transportation steps.

Life Cycle of the Product

This is the life cycle of the product. The concept also can be used to optimize
the environmental performance of a single product or to optimize the
environmental performance of a company. The term ‘emergy’ is often used
as an analysis tool to determine embodied energy.

Embodied energy refers to the quantity of energy required to manufacture
and supply to the point of use, a product, material or service.
Traditionally considered, embodied energy is an accounting methodology
which aims to find the sum total of the energy necessary from the raw
material extraction, to transport, manufacturing, assembly, installation as
well as the capital and other costs of a specific material – to produce a
service or product and finally its disassembly, deconstruction and/or

Environmental Financial Accounting

Environmental Financial Accounting is used to provide information needed by
external stakeholders on a company’s financial status. This type of
accounting allows companies to prepare financial reports for investors,
lenders, and other interested parties.

Environmental Audit
The financial benefits and improved efficiencies from adopting cleaner
production and eco-efficiency encourage firms to undertake audits. But
Environmental Audit can also be an effective risk management tool.
By compliance with environmental legislation companies avoid the risk of
prosecution and fines arising from potential environmental breaches.

Components of an Environmental Audit

A good audit will include a number of components, some of which are listed
Data Collection: to identify and measure all inputs and outputs from the
production process and provide baseline for comparison against targets and
a background for improvement.
Compliance: to review and compare a company’s activities and business
targets against all relevant regulations, codes of conduct and government
policies to assess compliance.
Documentation: to document all aspects of audit to assess progress at a
further date and to verify environmental performance to staff, regulators and
the general community.
Periodic Audits: to assess the impacts of new or changed legislation on
operations and to assess whether internal targets for environmental
efficiency are being met.

Benefits of Environmental Audit

An environmental audit can be modified according to size and
complexity 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 outputs
to be measured.
An environmental audit can give a company a much clearer
understanding of its operations and impacts, and ultimately, provides a
starting point for other environmental initiatives.

International Accounting Standards 37

Objectives of IAS 37
1) Appropriate recognition criteria and measurement bases are applied to
2) Contingent Liabilities and Contingent Assets and that sufficient
information is disclosed to the notes to financial statements in order for the
users 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 are
dealt with in the financial statements - planned future expenditure, even
where authorized by the board of directors or equivalent governing body is
excluded from recognition.

Scope of IAS 37
1) 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 is
b) Those covered by another standard
2) This standard does not apply to financial instruments (including
guarantees) that are within the scope of IAS 39.
3) Executory contracts are contracts under which neither party has
performed any of its obligations or both parties have partially performed
their obligations to an equal extent. This standard does not apply to executor
contracts unless they are onerous.
4) Where another standard deals with a specific type of provision,
contingent liability or contingent asset, an entity applies that standard
instead of this standard. For example, IFRS 3 Business Combinations
addresses the treatment by an acquirer of contingent liabilities assumed in a
business combination. Similarly, certain types of provisions are also
addressed 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 of
revenue, for example where an entity gives guarantees in exchange for a
fee. This standard does not address the recognition of revenue. IAS 18
Revenue identifies the circumstances in which revenue is recognised and
provided 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 context
of items such as depreciation, impairment of assets, and doubtful debts:
these are adjustments to the carrying amounts of assets and are not
addressed in this standard.
7) Other standards specify whether expenditures are treated as assets or
as expenses. These issues are not addressed in this standard. Accordingly,
this standard neither prohibits nor requires capitalization of the costs
recognized when a provision is made.
8) This standard applies to provisions for restructurings (including
discontinued operations). When restructuring meets the definition of a
discontinued operation, additional disclosures may be required by IFRS 5.

Provision – is a liability of uncertain timing or amount.
Liability – is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits.
Obligating event – is an event that creates a legal or constructive obligation
that results in an entity having no realistic alternative to settling that
Legal Obligation – is an obligation that derives from a contract, legislation or
other operation of law.
Constructive obligation – is an obligation that derives from an entity’s action
where by an established pattern of past practice, published policies or a
sufficiently specific current statement, the entity has indicated to other
parties that it will accept certain responsibilities and as a result, the entity
has created a valid expectation on the part of those other parties that it will
discharge those responsibilities.

Contingent Liabilities
A 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 the
control of the entity.
A contingent liability is a present obligation that arises from past event
but is not recognized because it is not probable that an outflow of resources
embodying economic benefits will be required to settle the obligation or the
amount 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 recognized
as a provision. In other words, a contingent liability is either probable or
measurable but not both.
An entity should not recognise a contingent liability. An entity should
disclose a contingent liability, unless the possibility of an outflow of
resources embodying economic benefits is remote.

Treatment of Contingent Liability

A contingent liability shall not be recognized in the financial
statements but shall be disclosed only. 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 Assets
PAS 37 defines contingent asset as a “possible asset 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 the
control of the entity”. An example is a claim that an entity is pursuing
through legal processes, where the outcome is uncertain.
A contingent asset shall not be recognized because this may result to
recognition of income that may never be realized. However, when the
realization of the income is virtually certain, the related asset is no longer
contingent asset and its recognition is appropriate.
A contingent asset is only disclosed when it is probable. The disclosure
includes brief description of the contingent asset and an estimate of its
financial effects. If a contingent asset is only possible or remote, no
disclosure is required.

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

Best Estimate
The amount recognized as a provision shall be the best estimate of the
expenditure required to settle the present obligation as the balance sheet
The best estimate of the expenditure required to settle the present
obligation is the amount that an entity would rationally pay to settle the
obligation at the balance sheet date or to transfer it to a third party at that
The estimates of the outcome and financial effect are determined by
the judgment of the management of the entity, supplemented by experience
of similar transactions and, in some cases, reports from independent
experts. The evidences considered include any additional evidence provided
by events after the balance sheet date.
Factors that may affect the Best Estimate
1) Risk and Uncertainties – the risk and uncertainties that inevitably
surround many events and circumstances shall be taken into account in
reaching the best estimate of a provision.
2) Present Value – where the effect of the time value of money is
material, the amount of a provision shall be the present value of the
expenditures expected to be required to settle the obligation.
3) Future Events – future events that may affect the amount required to
settle an obligation shall be reflected in the amount of a provision where
there is sufficient objective evidence that they will occur.
4) Expected disposal of assets – gains from the expected disposal of
assets shall not be taken into account in a measuring a provision.

For 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 to
existing provisions.
c) Amounts used (incurred and charged against the provision) during the
d) Unused amounts reversed during the period.
e) The increase during the period in the discounted amount arising from
the 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 expected
timing of any resulting outflows of economic benefits.
b) An indication of the uncertainties about the amount or timing of those
outflows. Where necessary to provide adequate information, an entity shall
disclose the major assumptions made concerning future events.
c) The amount of any expected reimbursement, stating the amount of
any asset that has been recognized for that expected reimbursement.
Unless the possibility of any outflow in settlement is remote, an entity
shall disclose for each class of contingent liability at the balance sheet date a
brief description of the nature of the contingent liability and where
a) An estimate of its financial effects, measure under the best estimate
b) An indication of the uncertainties relating to the amount or timing of
any outflow
c) 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 balance
sheet 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 giving
misleading indications of the likelihood of income arising.

Illustrative Problem:

XXX Company is an oil transportation and refinery company. On year

2005, one of the pipe leaked. The management formed an assessment team
to determine if there’s a contamination in the land. The team incurred
200,000 and the assessment shows that the land area was contaminated. It
is estimated that it would cost 25,000,000 to clean up the contamination and
it is probable that the company would be obligated by the government to
clean up the area.

Journal Entries:

To record the cost of assessment

Operating Expense 200,000
Cash 200,000

To record the setting up of a provision

Environmental Expense 25,000,000
Provisions for Environmental Damages 25,000,000

To record the actual clean-up

Provisions for Environmental Damages 25,000,000
Cash 25,000,000


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 resources
include minerals, oil, natural gas and similar non-regenerative resources.
The term “exploration for and evaluation of mineral resources” is
defined as the search for mineral resources after the entity has obtained
legal rights to explore in a specific area as well as the determination of the
technical feasibility and commercial viability of extracting the mineral
The expenditures incurred by an entity in connection with the
exploration for the evaluation f the mineral resources before the technical
feasibility and viability of extracting a mineral resource are known as
exploration and evaluation expenditures

Exploration and evaluation expenditures

Exploration and evaluation expenditures include the following:
1. Acquisition of the rights to explore
2. Topographical, geological, geochemical, and geophysical studies
3. Exploratory drilling
4. Trenching
5. Sampling
6. Activities in relation to evaluating the technical feasibility and
commercial viability of extracting a mineral resource.
7. General and administrative costs directly attributable to the
exploration and evaluation activities.
Expenditures related to development of mineral resources, for
example, preparation for commercial production, such as building roads and
tunnels, cannot be recognized as exploration and evaluation expenditures.

Exploration and evaluation asset

The exploration and evaluation expenditures may qualify as
exploration and evaluation asset. However, the standard does not provide a
clear-cut guidance for the recognition of the exploration and evaluation
Accordingly, an entity must develop its own accounting policy for
the recognition of such asset. As a matter of fact, the standard permits an
entity to continue to apply its previous accounting policy provided that the
resulting information is relevant and reliable.

Measurement and classification

If the entity's accounting policy results in the recognition of an
exploration and evaluation asset, such asset shall be measured initially at
cost. After the initial recognition, an entity shall apply either the cost model
or revaluation model.
Exploration and evaluation asset is classified either tangible asset or
an intangible asset. For example, vehicles and drilling rigs would be
classified as tangible assets and drilling rights would be classified as
intangible assets.

The standard provides that the exploration and evaluation asset shall be
assessed for impairment when facts and circumstances suggest that the
carrying amount may exceed recoverable amount. Facts and circumstances
that may indicate impairment include:
a. The period for which the entity has the right to explore in a specific area
has expired and is not expected to be renewed.
b. Substantive expenditure for exploration and evaluation is neither
budgeted nor planned.
c. The exploration and evaluation activities have not led to the discovery of
commercially viable quantity of mineral resource and the entity has
decided to discontinue such activities.
d. Sufficient data indicate that the carrying amount of the exploration and
evaluation asset is unlikely to be recovered in full successful development
or by sale.

Wasting Assets
Wasting 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 and
silver, and timber.
Wasting assets are so called because they are physically consumed
and once consumed, they cannot be replaced anymore. If ever, they can be
replaced only by the process of nature. Natural resources cannot be
produced by man. Thus, wasting assets are characterized by two main
a. they are physically consumed.
b. they are irreplaceable.

Cost of Wasting asset

Entities follow a wide variety of practices in accounting for an extractive
industry. At present, there is no comprehensive standard that is applicable to
the extractive or mining industry. In general, the cost of wasting asset or
mineral resource can be divided into four categories, namely:
a. Acquisition cost
b. Exploration cost
c. Development cost
d. Estimated restoration cost

Acquisition cost
Acquisition cost is 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
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 be
included in the natural resource account or may be set up in a separate
account and the remaining cost should be charged to the natural resource
account. Actually, the land value is the residual value of a wasting asset for
purpose of computing depletion. Thus, this should be deducted from the total
acquisition cost to get the depletable cost.

Exploration cost
As stated earlier, exploration cost is the expenditure incurred before
the technical feasibility and commercial viability of extracting a mineral
resource are demonstrated.
Simply stated, the exploration cost is the cost incurred in an attempt to
locate the natural resource that can economically be extracted or exploited.
The exploration may result in either success or failure. Accordingly, the
exploration cost may be accounted for the following two methods, namely
“successful effort method” and “full cost method”.
Under the “successful effort” method, only the exploration cost directly
related to the discovery of commercially producible natural resource is
capitalized as cost of the resource property. The exploration cost related to
“dry well” or unsuccessful discovery is expensed in the period incurred.
Under the “full cost” method, all exploration costs, whether successful
or unsuccessful, are capitalized as cost of the successful resource discovery.
This is on the theory that any exploration cost is “wild goose chase”
and therefore necessary before any commercially producible and profitable
resource can be found. The cost of drilling dry wells is part of the cost of
locating productive wells.
Both methods are used in practice. Most large and successful oil
entities follow the successful effort methods. The full cost method is popular
among small oil entities.

Development cost
Development 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 equipment
is 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 of

Restoration cost
The resource property may sold after extracting activities are
complete. The amount to be derived from such sale represents the residual
value of the resource property.
To prepare the property for sale, however, restoration cost mat\y be
necessary to bring the property to its original state. Such restoration cost
may be added to the cost of the resource property or “netted” against the
expected residual value of the resource property.

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

Depletion, as an accounting procedure, is a systematic allocation of the

depletable cost of wasting asset over the period the natural resource is
extracted or produced.
In essence, however, depletion is recognized as cost of the material
used in production and thus becomes the finished product of the extractive
entity since the wasting asset is conceived as the total cost of the materials
available for production.

Depletion method
Normally, 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
unit is then multiplied by the units extracted during the year to arrive at the
depletion for the period.

For instance, a wasting asset entity has acquired the right to use a property
to explore a natural resource. The acquisition cost is P3, 000,000, and
development 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 1,000,000

units. 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, then
the depletion for the year is P2, 500,000, computed by multiplying the
production of 250,000 units by the rate of P10. The entry to record the
depletion is:
Depletion 2,500,000
Accumulated depletion 2,500,000

In the income statement, the depletion is classified as part of the cost

of production or cost of sales. If the statement of financial position is
prepared at the end of the first year, the wasting asset would be shown as
separate line item as follows:

Resource deposit, at cost 10,000,000

Less: accumulated depletion 2,500,000
Book value 7,500,000

Another method of computing depletion is the straight line method.

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

Revision of depletion rate

Not frequently, the original estimate of the resource deposit has to be
changed either because new information is available or because production
process has become more sophisticated.
The revision of the original estimate of the recoverable resource
deposit gives rise to the same faced in accounting for change in estimate
concerning the useful life of property, plant and equipment.
Changes in estimate are to be handled currently and prospectively, if
necessary. Accordingly, the procedure is to revise the depletion rate on a
prospective basis, that is, by dividing the remaining depletable cost of
wasting asset by the revised estimate of the productive output.

For instance, assume that, in the preceding example, additional

development costs of P3, 750,000 are incurred in the second year, and
recoverable deposits are estimated to be 1,250,000 units at the beginning of
the second year is computed as follows:
Original cost of wasting asset 10,000,000
Additional development cost in 2 year
Total 13,750,000
Less: Accumulated depletion 2,500,000
Remaining 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 the
depletion for the period is:
Depletion (300 000 units x P9) 2,700,000
Accumulated depletion 2,700,000
Depreciation of mining property
Again, tangible equipment such as transportation equipment, heavy
machinery, mine shaft and other equipment used in the mining operations
shall be reported in separate accounts and depreciated following normal
depreciation polices.
Generally, the depreciation of equipment used in mining operations is
based 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 life
using straight line method.

For instance, assume that the natural resource deposit is estimated to
contain 450,000 units. Heavy equipment necessary to extract the deposits is
acquired 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 the
deposit will be exhausted in approximately 15 years (450,000 units divided
by 30,000 units), whichever is longer than the 10-year life of the equipment.

The equipment then should be depreciated over 10 years following the

straight line method giving an annual depreciation of P900, 000 (P9, 000,000
divided 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, which
is shorter than 10-year life of the equipment.
Depreciation then on the equipment shall be based on the life of the
deposit following the output method of depreciation. The depreciation for the
first year is computed as follows:

Depreciation per unit (9,000,000/ 450,000 units) = P20

Depreciation (50,000 units extracted x P20) = P1, 000,000

When the output method is used in depreciating mining property, in
the event of shutdown, such method cannot be used. In this case, the
depreciation in the year of shutdown is based on the remaining life of the
equipment following the straight line method.
In other words, the remaining book value of the equipment is divided
by the remaining life of the equipment to arrive at the deprecation in the
year of shutdown.

Thus, in the preceding example, if there is a shutdown in the second

year, the depreciation is determined as follows:
Equipment, at cost 9,000,000
Less: 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 computed

following the output method. But in this case, a new depreciation rate per
unit is computed by dividing the remaining book value of the equipment by
the remaining or revised estimate of the deposit.
Thus, if the third year, operations are resumed and 60,000 units are
extracted, the depreciation on the equipment is computed as follows:

Equipment, at cost 9,000,000

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

Original estimate of deposit 450,000 units

Less: extracted in 1st year 50,000 units
Remaining 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 doctrine

Under 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 doctrine

Under this doctrine, a wasting asset corporation or an entity engaged
in the extraction of a natural resource can legally return shareholders during
the 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 accumulated
The amount paid in excess of the retained earnings is accounted for a
liquidating dividend or return of capital.
The wasting asset doctrine is therefore an exception to the trust fund

For instance, assume that a wasting asset corporation shows the following
accounts, among others:
Wasting asset, at cost 1,000,000
Accumulated depletion 100,000
Retained earnings 200,000

The maximum dividends that can declared by the wasting asset

corporation would be P300, 000, the retained earnings balance of P200, 000
plus the accumulated depletion balance of P100, 000. If the same is declared
as dividends, the entry is:

Retained earnings 200,000

Capital liquidated 100,000
Dividends payable 300,000

The dividend of P100, 000 in excess of the retained earnings balance is

actually a liquidating dividend and thus accounted for as a return of capital
to the shareholders. Although this dividend is based on the accumulated
depletion balance, the accumulated depletion account is not charged
because the same is not a source of dividend unlike the retained earnings.
The accumulated depletion balance is used only for the purposes of
determining how much capital can be legally returned to shareholders.
The “capital liquidated” account is an equity item. It is a deduction
from the total shareholders.
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 on
the philosophy that to limit dividend declaration to the retained earnings
balance would have the effect of retaining in the business funds which are
not needed because the wasting assets are irreplaceable. The funds then
would 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 the
exploitation or extraction of natural resources.

Complete formula
The complete formula in determining the maximum dividend that can
be declared and paid by a wasting asset corporation is as follows:

Retained earnings xx
Add: Acc. Depletion xx
Total xx
Less: capital liquidated in prior years xx
Unrealized depletion in ending inventory xx
Maximum dividend xx

For instances, assume the following balances in December 31 of the current

Wasting asset, at cost 8,000,000

Accumulated depletion 3,000,000
Share capital 5,000,000
Capital liquidated 500,000
Retained earnings 2,000,000
Depletion for the current year based on
50,000 extracted at P20 per unit 1,000,000
Inventory of resource deposit (5,000 units) 300,000

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

as follows:

Retained earnings 2,000,000

Add: Acc. Depletion 3,000,000
Total 5,000,000
Less: 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, the

entry is:

Retained earnings 2,000,000

Capital liquidated 2,400,000
Dividends payable 4,400,000