IAS 20 Accounting for emissions trading schemes, emission allowances, certified emission reductions and emission rights will become more important for entities’ financial reporting purposes.
Emissions trading schemes and certified emission reductions
EU member states have set limits on carbon dioxide emissions from energy-intensive companies under the EU emissions trading scheme. The scheme works on a ‘cap and trade’ basis, and each EU member state is required to set an emissions cap covering all installations covered by the scheme.
Even after the less specific Copenhagen Accord, the EU cap and trade scheme is still considered to be a model for other governments seeking to reduce emissions.
Additionally, several non-Kyoto carbon markets exist. These include the New South Wales Greenhouse Gas Abatement Scheme, and the Regional Greenhouse Gas Initiative and the Western Climate Initiative in the United States and Canada.
Accounting for emissions trading schemes
The emission rights permit an entity to emit pollutants up to a specified level.
The emission rights are given or sold by the government to the emitter for a defined compliance period. Schemes in which the emission rights are trade-able allow an entity to do one of the following:
- emit fewer pollutants than it has allowances for and sell the excess allowances;
- emit pollutants to the level that it holds allowances for; or
- emit pollutants above the level that it holds allowances for and either purchase additional allowances or pay a fine.
IFRIC 3, Emission Rights, was published in December 2004 to provide guidance on how to account for cap and trade emission schemes. The interpretation proved controversial and was withdrawn in June 2005 because of concerns over the consequences of the required accounting. As a result, there is no specific comprehensive accounting for cap and trade schemes or other emission allowances
The guidance in IFRIC 3 remains valid, but entities are free to apply variations, provided that the requirements of all relevant IFRSs are met. Several approaches have emerged in practice under IFRS. The scheme can result in the recognition of assets (allowances), expense of emissions, a liability (obligation to submit allowances) and, potentially, a government grant.
The allowances are intangible assets – often presented as part of inventory – and are recognised at cost if separately acquired. Allowances received free of charge from the government are recognised either at fair value, with a corresponding deferred income (liability), or at cost (nil), as allowed by IAS 20, Government Grants.
The allowances recognised are not amortised, provided residual value is at least equal to carrying value. The allowances are recognised in the income statement, because they are delivered to the government in settlement of the liability for emissions on a ‘units of production’ basis.
If initial recognition at fair value under IAS 20 is elected, the government grant is amortised to the income statement on a straight-line basis over the compliance period. An alternative to the straight-line basis can be used if it is a better reflection of the consumption of the economic benefits of the government grant.
The entity may choose to apply the revaluation model in IAS 38, Intangible Assets, for the subsequent measurement of the emissions allowances. The revaluation model requires the carrying amount of the allowances to be restated to fair value at each balance sheet date, with changes to fair value recognised directly in equity (except for impairment, which is recognised in the income statement).
A provision is recognised for the obligation to deliver allowances or pay a fine to the extent that pollutants have been emitted because an obligation is created by the emission of the greenhouse gas. The provision is commonly measured at the cost of the certificates acquired, including those acquired for nil cost (for example, under government grants) or the contracted purchase price for planned purchases of certificates.
The allowances reduce the provision where they are used to satisfy the entity’s obligations through delivery to the government at the end of the scheme year. However, the carrying amount of the allowances cannot reduce the liability balance until the allowances are delivered.
Certified emission reductions
For fast-growing countries and countries in transition that are not subject to a Kyoto target on emissions reduction, another scheme exists under the Kyoto Protocol. Entities in these countries can generate certified emission reductions. Entities can acquire certified emission reductions from existing projects, although new certified emission reduction projects are not currently accepted in the EU. IAS 20 Accounting for emissions trading schemes
Certified emission reductions represent a unit of greenhouse gas reduction that has been generated and certified by the United Nations under the Clean Development Mechanism provisions of the Kyoto Protocol. The Clean Development Mechanism allows industrialised countries that are committed to reducing their greenhouse gas emissions under the Kyoto protocol to earn emission reduction credits towards Kyoto targets through investment in ‘green’ projects. Examples of projects include reforestation schemes and investment in clean energy technologies. IAS 20 Accounting for emissions trading schemes
Once received, the certified emission reductions have value because they are exchangeable for EU Emission Trading Scheme allowances, and hence can be used to meet obligations under that particular scheme. IAS 20 Accounting for emissions trading schemes
An entity that acquires certified emission reductions accounts for these following the Emission Trading Scheme cost model; they are accounted for at cost, at initial recognition, and subsequently in accordance with the accounting policy chosen by the entity. No specific accounting guidance under IFRS covers the generation of certified emission reductions. Entities that generate certified emission reductions should develop an appropriate accounting policy.
Most entities that need certified emission reductions are likely to acquire them from third parties and account for them as separately acquired assets. The key question that drives the accounting for self-generated certified emission reductions is, ‘What is the nature of the certified emission reductions?’. The answer to this question lies in the specific circumstances of the entity’s core business and processes. If the certified emission reductions generated are held for sale in the entity’s ordinary course of business, certified emission reductions are within the scope of IAS 2, Inventories. If they are not held for sale, they should be considered as identifiable non-monetary assets without physical substance (that is, intangible assets – often presented as part of inventory).
The accounting for certified emission reductions is also driven by the applicability of IAS 20, Government Grants and Disclosure of Government Assistance. If certified emission reductions are granted by a government, the accounting would be as follows:
- Recognition when there is a reasonable assurance that the entity will comply with the conditions attached to the certified emission reductions and the grant will be received. IAS 20 Accounting for emissions trading schemes
- Initial measurement at nominal amount or fair value, depending on the policy choice.
- Subsequent measurement depends on the classification of certified emission reductions and should follow the relevant standard (that is, IAS 2, Inventory, IAS 38, Intangible Assets, or IFRS 5, Non-current Assets Held for Sale and Discontinued Operations).
IFRIC 21, Levies, sets out the accounting for an obligation to pay a levy that is not income tax. The interpretation addresses the accounting for a liability to pay a levy recognised in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets, and the liability to pay a levy whose timing and amount is certain; it does not address the related asset or expense. IAS 20 Accounting for emissions trading schemes
Entities are not required to apply IFRIC 21 to emissions trading schemes (application is optional), due to a scope exception in the guidance.
The interpretation is likely to result in later recognition of some liabilities, particularly in connection with levies that are triggered by circumstances on a specific date. IFRIC 21 is effective as of 1 January 2014 and applies retrospectively. IAS 20 Accounting for emissions trading schemes
Accounting for emissions allowances can be judgmental and is currently not (yet) addressed by authoritative guidance in IFRS. This section provides interpretive guidance on the accounting for emission allowances. IAS 20 Accounting for emissions trading schemes
Accounting considerations for emission allowances
Certain atmospheric gases (e.g., carbon dioxide, methane, nitrous oxide) are called greenhouse gases because they are believed to contribute to the retention of outgoing energy, trapping heat somewhat like the glass panels of a greenhouse. Various governments have created programs to incent entities to reduce the level of emissions in manufacturing facilities and the pollution generated from automotive vehicles. Companies may participate in emission reduction programs to reduce the emission of greenhouse gases, such as by setting emission limits or modifying the emission source.
A government may establish a target limit for the amount of emissions during a period. The term “emission allowance” refers to a trade-able instrument that conveys a right to emit a unit of pollution. Participants may be allocated emission allowances free of charge, or they may be required to purchase allowances from the government (e.g., through government auctions) or other participants. The allowance gives a participant the right to emit a specified amount of gases. Within the automotive industry, the government forces automotive manufactures to reduce the impact of emissions through increased miles per gallon and/or increased production or sale of zero or low emission vehicles (e.g., electric or hybrid vehicles). IAS 20 Accounting for emissions trading schemes
Emission allowances are treated as a separate unit of account when received from the government or purchased from third parties. Entities use emission allowances in various ways, some entities buy and sell emission allowances in the normal course of business, while others use allowances to meet compliance requirements associated with production. IAS 20 Accounting for emissions trading schemes
There are various complexities related to the accounting for emissions allowances, including but not limited to:
- Reporting entities use various models to account for emission allowances (generally as an intangible asset or inventory) IAS 20 Accounting for emissions trading schemes
- Initial recognition of emission allowances can be at zero cost (i.e., if received from the government) or at fair value IAS 20 Accounting for emissions trading schemes
- Emission allowances purchased and sold on an open market are subject to costing policies (e.g., LIFO, FIFO, average cost) and may be subject to derivative accounting IAS 20 Accounting for emissions trading schemes
See also: The IFRS Foundation