Embedding ESG in Cost Accounting: A Simulation Framework for Financial Reporting and Transparency

Environmental, Social, and Governance (ESG) reporting has shifted from voluntary disclosure to a regulatory imperative and cornerstone of corporate transparency. Traditional cost accounting systems, which emphasize direct, indirect, and overhead costs, often ignore externalities like carbon emissions, social equity investments, and governance overhead. This study investigates how embedding ESG-driven cost allocations reshapes financial reporting and managerial decisions in manufacturing firms. Using a simulated dataset spanning three divisions (Energy, Materials, Consumer), we compare outcomes under conventional accounting and an ESG-adjusted framework that includes carbon pricing equivalents, compliance costs, worker and governance programs. Our results show that ESG adjustments increase reported costs by approximately 20-30% and reduce operating margins by 5-7 percentage points, while significantly improving transparency across environmental, social, and governance metrics. Sensitivity analyses (varying carbon pricing) indicate that margin declines are robust to plausible environmental cost changes, though divisions with higher emissions are most affected. This research contributes to sustainability accounting by operationalizing ESG into cost allocation mechanics rather than treating it as supplementary disclosure. It provides a practical model for managers, regulators, and investors seeking to balance profitability with long-term accountability and risk mitigation.