Many accountants must now think about reporting emissions in financial statements. If they work for companies that participate in emissions-trading schemes, have made firm commitments on renewable energy or net zero, or are participating in carbon markets, then reporting these activities in the financial statements is essential. But it may not be straightforward.
The cap-and-trade Emissions Trading Schemes (ETS) is one of the most common and well-established types of schemes. Here, companies in carbon-intensive industries must deliver certificates to cover their emissions. These certificates could be granted by governments, purchased through auctions, or in some cases, bought on secondary markets.
These schemes have been in existence in some areas for almost 20 years; now we are seeing a rapid rise in their prevalence globally. As of March 2022, there were 25 different ETS covering 17% of global greenhouse gas (GHG) emissions1. This had increased from 21 schemes and only 9% of GHG emissions in March 2020, and only 5% in 20052. Since March this year, a further 22 schemes are under consideration or development.
As well as new schemes being introduced, we are also seeing an expansion of the industries covered by existing schemes. Many cover the power and industrial sectors, though it is becoming increasingly common for other sectors such as buildings, transport and domestic aviation to be included.
There are two key questions in determining the accounting treatment:
- How should certificates held be recognised and measured on the balance sheet?
- What liability should be recognised as emissions occur?
There is no specific guidance for these schemes under IFRS® Accounting Standards, and as a result, the existing guidance on, for example, intangible assets, inventories, provisions and government grants, is applied.
How are certificates recognised and measured?
Many would agree that certificates held are an asset: they could be sold to generate future economic benefits or could be delivered to satisfy obligations. What is less clear is the nature of that asset: are they an intangible asset or inventory? An argument can be made for either treatment, and that choice will depend on the policy decision companies make, and the purpose of holding those certificates.
Once recognised, the certificate asset must be measured. These certificates could be traded on a market where there is a readily ascertainable market price. If recognised as an intangible, this would allow subsequent measurement at cost or fair value under the Standards. However, some companies will be granted certificates for free: how are they accounted for?
The Standards do not specifically address this and there could be choices for companies. If free certificates are measured at the nominal amount – zero –they will not feature on the balance sheet. Conversely, if free certificates are measured at fair value, then this would be the amount at which either inventory or an intangible asset is originally recognised.
If certificates are purchased and accounted for as inventory, the price will not be the same for every certificate bought. When they are therefore subsequently sold or delivered a decision must be made on what cost is derecognised. This could mean a policy choice between using first in, first out (FIFO) or weighted-average.
What liability should be recognised as emissions occur?
For companies operating under an ETS, the emission of GHGs creates an obligation to deliver certificates covering the emissions made. Assuming there are no alternatives for the settlement of an obligation for emitted pollutants other than the delivery of emissions certificates, a provision will need to be made.
If a company has sufficient certificates available and is held to meet the obligation, the best estimate of the provision required would be based on the carrying amount of certificates available. To the extent that GHG emissions exceed the number of certificates available, market value would normally be used to measure the provision for the excess. The opposite side of the entry for the excess provision would generally be a charge in profit or loss.
The impact of these requirements could be that for a company receiving free certificates and accounting for them at the nominal amount of zero, in the early part of a compliance period, no provision is required (whilst emissions build to the level of the free certificates). Later, provisions may be recorded once actual emissions exceed the level of free certificates.
As accountants, we are going to have to be comfortable with reporting emissions in the financial statements. There are a lot of choices to be made on how to report and an increasing number of companies are impacted directly by these schemes. Understanding the options and the impact on reporting is essential and being able to explain these effects to investors and users is becoming increasingly important.
1 ICAP Emissions Trading Worldwide Status Report 2022
2 ICAP Emissions Trading Worldwide Status Report 2020