Katetutor A1

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Limited Drives Sustainability Improvement

Jon Bartley

North Carolina State University

Frank Buckless

North Carolina State University

Y.S. Al Chen

North Carolina State University

Stephen Harvey

Bacardi Limited

Scott Showalter

North Carolina State University

Gilroy Zuckerman

North Carolina State University

ABSTRACT

This study describes an application of the principles of activity based flexible budgeting

advanced by Bacardi Limited to produce indices of improvement for sustainability

performance measurement. Examples are used to demonstrate this is an effective tool for

top management to promote their strategic initiatives, manage sustainability efforts,

evaluate sustainability performance, and communicate sustainability results to

stakeholders.

Key Words: Strategy, sustainability, sustainability reporting, flexible budgeting,

performance evaluation

Introduction

The 21 st century business leaders have learned the importance of leveraging a genuine

commitment to sustainability to help their companies grow their leadership in key

markets. They see the need to build an integrated global sustainability effort based on

rigorous measurement standards that both produce accountability and profitability. This

movement is very visible through the efforts of the International Integrated Reporting

Council (IIRC). The aim of the IIRC is to create a globally accepted framework to bring

“together material information about an organization’s business model, strategy,

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governance, performance and prospects in a way that reflects the commercial, social and

environmental context within it operates.”1

A parallel initiative, the Sustainability Accounting Standards Board (SASB), was

founded in July 2011. The purpose of the SASB is to establish “industry-based

sustainability standards for the recognition and disclosure of material environmental,

social and governance impacts by companies traded on U.S. exchanges.”2 Although still

in the launch phase, the SASB’s standards are intended to be industry specific and clearly

communicate the priority of material sustainability issues enabling corporations to show

how material sustainability issues impact operations.3

Further, the idea of “natural capital” has been gaining traction among global businesses.

“Natural capital is the stock of capital derived from natural resources such as biological

diversity and ecosystems, in addition to geological resources such as fossil fuels and

mineral deposits. It provides the ecosystem products and services that underpin our

economy and provide inputs or indirect benefits to business.”4 For example, in a 2012

survey report issued by KPMG, Fauna Flora International, and the Association of

Chartered Certified Accountants found that more than half of CFOs and CEOs have

included natural capital concerns in their company’s business-risk evaluations. Further,

49% identified natural capital as a “material issue” for their business and linked it directly

to “operational, regulatory, reputational and financial risks.” However, few companies

have modified their accounting systems to include the measurement of natural capital.5

It is widely recognized that “sustainability reporting is not likely to go away —

companies have invested too much reputational capital in telling stories and providing

detailed information, and stakeholders have come to view them as a minimum

requirement of a company’s sustainability commitment. But as integrated reporting

ramps up, sustainability reports will need to provide more detailed performance data

relevant to broader stakeholders, insight into what is driving changes in metrics, and

deeper explanations of management responses to social, resource, and pollution

challenges.”6 A best practice of sustainability development and reporting is to integrate sustainability into the organization’s strategy, not as a standalone program. Where this

all comes together is through an organization’s strategy. According to Deloitte, “in this

environment, boards need to ensure that their organization views corporate sustainability

as more than just good corporate citizenship; it must be integral component of its overall

strategy. Sustainability initiatives can strengthen an organization’s reputation,

competitiveness, the moral of employees, and its ability to attract capital.”7

1 Integrated Reporting, The Pilot Programme 2012 Yearbook, “Capturing the experiences of global

businesses and investors”, September 2012

.http://www.sasb.org/sasb/Sustainability Accounting Standards Board, 2

3 Ibid.

4 KPMG, Fauna & Flora International, ACCA, “Is natural capital a material issue”, 2012.

5 Ibid.

6 GreenBiz.Com, “State of Green Business 2013”, 2013.

7 Deloitte, “The Sustainable Board”, 2011.

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In this article, we describe an activity-based flexible budget methodology for measuring

the improvement in sustainability performance developed by Bacardi Limited. With this

innovative application of activity-based metrics to sustainability performance

measurement, companies can more accurately measure and report the progress they make

in (1) meeting key sustainability objectives for management internally and (2) corporate

responsibility reporting. The methodology can be readily understood by management,

and it provides an important tool for C-suite executives to promote sustainability best

practices to their employees and to communicate the results of their organization’s

sustainability results to their stakeholders.

Bacardi Limited

Family-owned Bacardi Limited is one of the world’s largest spirits companies. Bacardi

Limited is headquartered in Hamilton, Bermuda (U.S. headquarters in Coral Gables, FL),

and operates in 16 countries on four continents. Some of their leading brands include

Bacardi Rum, Grey Goose Vodka, Dewar’s Scotch and Bombay Sapphire Gin.

During the past decade, Bacardi Limited began setting aggressive operating goals for

quality, environmental impact, and health and safety. Bacardi Limited is an active

member of the Beverage Industry Environmental Roundtable, a consortium of global,

leading beverage companies and suppliers focused on resource protection, energy

efficiency and climate change mitigation. In 2009, Bacardi Limited achieved ISO 9001,

ISO 14001 and OHSAS 18001 certifications with all of its production facilities. The

company has published Corporate Responsibility Reports since fiscal year 2008, and in

2011 its report followed the Global Reporting Initiative G3 framework at a self-declared

application level B. Bacardi Limited makes environmental, health and safety objectives

integral to the operations of every site through the use of Key Performance Indicators

(KPIs).

In 2008, Bacardi Limited began applying an innovative measurement methodology to

three environmental aspects: water consumption, energy consumption, and greenhouse

gas (GHG) emissions. The methodology advances the company-wide strategy through an

application of the principles of activity based flexible budgeting to produce indices of

improvement (efficiency metrics) for sustainability performance KPIs based on physical

quantities. The new methodology was a response to concerns that aggregate measures

such as total annual tons of greenhouse gases emitted do not capture the actual rates of

improvement. For example, a shift in production mix from high volume rum (a relatively

low GHG emitter) to single malt Scotch whisky (a relatively high GHG emitter) could

cause total greenhouse gas emissions to increase even if emissions per unit of both Scotch

and rum were reduced. The new methodology allows calculation of efficiency metrics

that can be aggregated across product lines to provide company-wide measures of

efficiency improvement (Aggregate Performance Indices or APIs) that are not distorted

by shifts in either product mix or volume. Bacardi Limited uses the efficiency metrics

internally for decision support, and as key performance indicators (KPIs) in its strategic

plan. The resulting APIs for the sustainability aspects (greenhouse gas emissions, energy

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consumption and water consumption) are highlighted along with absolute measures of

sustainability performance in the company’s Corporate Responsibility Reports.

Bacardi Limited’s application of activity-based metrics to sustainability performance has

transformed the way Bacardi measures progress in meeting its key sustainability

objectives, and it represents an innovative best practice for management and for external

reporting. In the reminder of this article, we describe the activity-based flexible budget

methodology developed by Bacardi Limited for measuring the improvement in

sustainability aspects.

Flexible Budgeting for Performance Evaluation

Financial and non-financial budgeting impact all areas of a company’s value chain, from

research and development to customer services. Budgets have been used effectively as

an incentive for employees and management to focus on maximizing value-added

activities and minimizing non-value-added activities. Budgeting, thus, can be used as an

effective tool to convey management’s sustainability initiatives and goals, manage its

sustainability-related efforts, evaluate sustainability performance, and achieve its

sustainability goals over time.

Traditionally, a financial flexible budget is developed in detail for dollar amounts of

budgeted revenues, costs, and profits at all feasible levels of activities. Flexible budgets

adjust the expected amounts for total revenues, costs, and profits based on different

activity levels. A master budget, by contrast, is developed for one level of anticipated

activity. For control and performance evaluation purposes, the actual activity level is

used to derive the flexible budget. A review of the environmental management

accounting literature (e.g., Blackburn 2007; IFAC, 2011; IFAC, 2005; EPA, 1995)

indicates that there has been a focus on applying sophisticated managerial accounting

methodologies to obtain enhanced cost information to support sustainability management,

but there is little, if any, evidence that methodologies such as activity based analyses and

flexible budgeting have been applied to measures of key physical environmental and

social variables.

Table 1 gives a simple example of how flexible budgeting would be used for non-

financial measures; consider the following manufacturing firm that experiences an

increase in production volume. The company requires four units of input A for each unit

of output B. In planning for the next reporting period the company schedules 1,000 of B

for production. The master budget would indicate 4,000 units of A to be used in

production. Assume at the end of the period, 5,000 units of A were actually used to

produce B. If we simply compare the 5,000 units of A actually used with the 4,000 units

of A budgeted, we might jump to the conclusion that A was wasted. If we investigate

and learn that the actual production of B was 1,250 (not 1,000), we would calculate a

flexible budget amount for A equal to be 5,000 units, the amount that we actually used in

production. Thus, the efficiency of the use of input A was unchanged from the budgeted

(planned) amount.

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Table 1: Flexible Budgeting Example

Master Budget Flexible Budget Actual Results

Planned Level of Activity Actual Level of Activity

1,000 units of output B 1,250 units of output B

Units of A 4,000 5,000 5,000

The flexible budget is based on ex post (after-the-fact) knowledge of the actual activity

level. In practice, managers prefer analyzing the differences between plans and actual

results on the actual activity levels. The flexible budget is the product of the estimated

input per unit and the actual output activity level achieved. The flexible budget, thus,

provides the correct basis for comparison between actual and expected units, given the

actual activity. And, as we demonstrate in the next example, flexible budgeting can adjust

for changes in product mix as well as volume.

Flexible Budget Application: Aggregated Performance Index (API)

The example that follows is a hypothetical application of Bacardi Limited’s innovative

application of flexible budgeting to sustainability performance measures for a global

manufacturer of high-end carpets, Zapet, Inc. This company also provides interior design

consulting services. This example demonstrates that the Bacardi methodology can be

applied to both manufacturing and non-manufacturing businesses. Bartley, Buckless,

Chen, Harvey, Showalter and Zuckerman (2013) also provides a detailed example

applied to the beverage industry.

Zapet begins by measuring the relationship between the amount of an aspect (a

sustainability KPI) relative to the activity level in a base year. For example, they may

measure CO2 emissions at a manufacturing plant in 2012 and find that it emitted 57,600

units of CO2 while producing 30,000 thousand square yards of carpet (K-Sq.yd). Thus,

for 2012, the rate of emissions would be 1.92 units of CO2 for each one thousand square

yards of carpet. At the end of 2013, they combine the actual level of activity; let’s say

39,900 K-Sq.yd, with the rate from the base year. The resulting flexible budget for 2013

is 76,608 units of CO2 (1.92 units x 39,900 K-Sq.yd). This means that if there is no

change in the efficiency, 76,608 units of CO2 are expected to be emitted at the higher

level of activity.

Zapet then compares the actual amount of CO2 emitted during 2013; let’s say 59,700

units, to the flexible budget amount of 76,608 units. In accounting, we would look at this

difference of 16,908 CO2 units (76,608 – 59,700) and identify the amount as a favorable

flexible budget variance. Zapet, instead, extends the analysis by converting the ratio to an

index number. The resulting index is 78 (59,700 units/76,608 units x 100). The

interpretation is that there has been a 22% (100 – 78) improvement in the efficiency of

CO2 emissions at its carpet manufacturing plant.

Zapet repeats this process for each activity area of the company, e.g., interior design

consulting and offices. Table 2 provides a hypothetical example for five activity areas.

The next challenge that Zapet faces is how to provide a meaningful aggregation of

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sustainability aspects across segments with different activity measures, e.g., thousands of

Sq.yd carpet versus number of people. Zapet resolves this by continuing with the flexible

budgeting approach. For example, the amounts of CO2 emissions projected by the

flexible budget for 2013 are summed to a total of 135,657 units. This is the total

emissions expected for all segments combined assuming no efficiency improvement

relative to the base year. Similarly, the actual amount of total emissions across all

segments for 2013 is calculated as 119,700 units. An overall index weighted by activity

level is calculated by taking the ratio of 119,700 units to 135,657 units and multiplying

by 100 yielding an index of 88.2 (see Table 2). The interpretation is that, aggregating

over all segments, there has been 11.8% improvement in the efficiency of CO2 emissions.

The Aggregate Performance Index illustrated here provides a more sophisticated

description of aggregate sustainability performance than simple totals of the sustainability

aspects (i.e., KPI totals). However, the API is a corollary rather than a substitute for KPI

totals. Management should seek to optimize API efficiency measures as a means to the

ultimate reduction of total sustainability impacts.

Table 2: Bacardi Limited’s Aggregated Performance Index (API): Using Flexible

Budgeting to Aggregate Performance for the CO2 Aspect across Segments

Flexible

Budget Category

Activity Unit Activity

Level CO2e

Efficiency

Rate

Activity

Level CO2e CO2e Index

Carpet Manufacturing K-Sq.yd 30,000 57,600 1.92 39,900 59,700 76,608 78

Interior Design Consulting # of Jobs 8,000 4,080 0.51 6,860 3,600 3,499 103

Transportation Mtons 4,000 34,800 8.70 4,500 38,000 39,150 97

Offices No. of People 8,000 9,000 1.13 8,200 10,100 9,225 109

Corporate Travel - Non

Consulting No. of People 8,000 7,000 0.88 8,200 8,300 7,175 116

API =

112,480 119,700 135,657 88.2

Base Year Current Year

Product Mix and Variation

The five business activities have widely differing GHG efficiencies, but Table 2 shows

that an overall efficiency index may be calculated without arbitrary distortions by

changes in product mix. Not only can the company evaluate its overall GHG

performance but also by activity area.

Note that Zapet has increased its carpet production due to the increase in demand for its

products. One would think intuitively that its GHG footprint will increase proportionally

with its production level as those in the areas of Offices and Corporate Travel – Non-

consulting. However, the Carpet Manufacturing team has embarked on several important

initiatives to improve its GHG performance in the current year. The results of their effort

will not be captured by the change in the absolute CO2 emission (from 57,600 units to

59,700 units) because it has been masked by the increase in its production level. The API

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method helps reveal the underlying GHG performance improvement by showing a 22%

improvement compared to the base year while experiencing the increase in market

demand for carpet products. Similarly the API index for the Transportation area shows

that the division has improved its GHG efficiency while increasing its volume (Mtons of

product shipped) at the same time.

By observing the change in the absolute units CO2 emission, Interior Design Consulting

would appear to make improvement in its GHG performance by reducing 480 units in the

current year (that is 4,080 – 3,600). Note that the change is driven primarily by the

reduction of its business activity level (from 8,000 jobs to 6,860 jobs). The API index

captures the drop in the business level and reveals that GHG performance actually

deteriorated in the current year.

Finally the API methodology helps the business executives understand the overall

sustainability performance for the company as a whole and the contribution made by

individual areas in improving the company’s sustainability efforts. The Carpet

Manufacturing and Transportation areas, for example, are the key contributors of GHG

performance improvement in the current year. They together help the company achieved

11.8% improvement in GHG efficiency. On the other hand, the Interior Design

Consulting, Offices, and Corporate Travel – Non-consulting areas experienced a decline

in performance.

Conclusion

Sustainability efforts should be integrated into the strategies of companies. Companies

need to be able to establish goals and measure and report results against those goals. The

methodology used to measure and report results needs to accurately describe the aspects

of sustainability performance that are subject to management control, and do so in a

manner that is meaningful and easy to understand. That is where API enters the picture.

Most companies report the results of their sustainability efforts in gross numbers such as

the reduction in greenhouse gasses, number of gallons of water saved, or tons of waste

recycled, but other than knowing a reduction in absolute numbers, it is difficult to

determine whether results are better or worse. This is especially true for a company in

an expansion or acquisition mode. While the company may be making progress with its

sustainability goals, the progress is being masked by other strategic actions. Through an

easily understood index, API provides the opportunity to clearly and objectively measure

and report the results obtained from the sustainability efforts – not only individually, but

as an integrated element of the company’s strategy.

References

Bartley, J. Buckless, F., Chen,Y.S., Harvey, S.K., Showalter, S., and Zuckerman, G.

2012. Flexible Budgeting meets Sustainability at Bacardi Limited. Strategic

Finance, pages 28-34, December 2012.

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Blackburn, W. 2007. The Sustainability Handbook. Earthscan, London, UK.

Deloitte, “The Sustainable Board”, 2011.

Dutta, S., R. Lawson, and D. Marcinko. 2010. A System of Cost Variances to Evaluate

Sustainability Efforts, Journal of Corporate Accounting & Finance, Volume 21,

Issue 3, pages 47–52, March/April.

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Implications of Management Theory, Corporate Social Responsibility and

Environmental Management, 18: n/a doi: 1002/csr.259.

Gray, R. 2006. Does sustainability reporting improve corporate behaviour? Wrong

question? Right time? Accounting and Business Research (0001-4788), p. 65.

GreenBiz.Com, “State of Green Business 2013”, 2013.

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corporate sustainability reports: Evidence that quality matters, Sustainability

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Integrated Reporting, The Pilot Programme 2012 Yearbook, “Capturing The Experiences

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Sustainability Accounting Standards Board, http://www.sasb.org/sasb/

About the Author

Jon Bartley, Ph.D., CPA is a professor of accounting and former Dean of the Poole

College of Management at North Carolina State University. His research and teaching

interests include enterprise risk management, sustainability performance measurement,

and XBRL. He has published in the Journal of Accountancy, Accounting Horizons,

Management Accounting, and other professional and academic journals.

Frank Buckless, Ph.D is KPMG Professor and department head of accounting at the

Poole College of Management at North Carolina State University. His research and

teaching interests have focused on sustainability, auditing, managerial and educational

issues. He has published in such journals as The Accounting Review, Advances in Public

Interest Accounting, The CPA Journal, Strategic Finance, Issues in Accounting

Education, and the Journal of Accounting Education.

Y.S. Al Chen, Ph.D., CPA, CMA, CFM is a professor of accounting at North Carolina

State University. His research and teaching interests include sustainability performance

measurement, environment cost management and XBRL. He has published in the

Journal of Accountancy, Strategic Finance, Accounting Horizons, Engineering

Economist and other professional and academic journals.

Stephen Harvey, P.E. has served as the global director of environment, health and safety

for Bacardi Limited for the past six years. Steve Harvey, M.S., M.B.A., P.E., has served

for the past six years as the global director of environment, health and safety for Bacardi

Ltd. Prior to that he has held the position of senior environmental executive for several

major multinational corporations engaged in mining, chemicals, energy, industrial

equipment and military defense systems. His experience includes management systems

for compliance, measurement and assessment, and performance improvement in

environmental and sustainability performance.

Scott Showalter, CPA, CGMA, CGFM is a professor of practice at the Poole College of

Management at North Carolina State University. Scott was a national partner with

KPMG and the lead partner within KPMG to develop the firm’s sustainability service

line. Since joining the faculty, Scott Showalter has developed and integrated

sustainability reporting into his graduate and undergraduate classes.

Gilroy Zuckerman, Ph.D. is an associate professor of accounting and former Associate

Dean of Academic Affairs of the Poole College of Management at North Carolina State

University. His research and teaching interests include environment cost management

and cost management strategies for public universities. He has published in the

Accounting Review, International Journal of Accounting, Journal of Applied Business

Research, Engineering Economist and other professional and academic journals.

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