FASB project on environmental credit programs

Assets

The Board refined the project scope to include credits that meet all of the following:

• Credits that are enforceable and transferable. In-scope credits can take numerous forms including credits, certificates, allowances and offsets.
• Credits that are acquired (including from related parties), granted by a regulatory agency or designee or internally generated (created).
• Credits that lack physical substance and do not meet the definition of financial assets under US GAAP.
• Credits that are represented to prevent, control, reduce, or remove emissions or other pollution.

The Board confirmed that income tax credits, such as those related to the Inflation Reduction Act, are outside the scope of the project because they are in the scope of other US GAAP.

Liabilities

The Board clarified the following:

• ECOs are in the scope of the project. ECOs arise from existing or enacted laws, statutes or ordinances represented to prevent, control, reduce or remove emissions or other pollution that may be settled with environmental credits. ECOs generally arise from compliance programs.
• Environmental obligations accounted for under ASC 410-30 are not ECOs.
• Constructive obligations for internally established (i.e. voluntary) targets to reduce emissions are not in the scope of the project but may be within the scope of other US GAAP.

Recognition

• A credit would be recognized as an asset when it is probable that it will be used to settle an ECO, sold or traded.
• Costs to obtain all other credits (e.g. as part of a voluntary program) would be expensed when incurred. The costs would not be eligible for capitalization.
• Entities would apply the recognition guidance in ASC 805 to account for credits acquired in a business combination regardless of the acquirer’s intended use.

Initial measurement

• Credits that meet the asset recognition criteria would be measured initially at historical cost – consistent with asset acquisition guidance in ASC 805-50 – unless other US GAAP applies.
• Costs for credits that are granted or created would be limited to transaction costs (e.g. application fees) and could be zero if there are no costs directly associated with obtaining the credits.
• Credits acquired in a business combination would be measured at acquisition date fair value under ASC 805. However, the amounts allocated to a credit for a voluntary program would immediately be expensed.

Subsequent measurement

The measurement model applied would align with how the entity will use the credit (i.e. its intent).

• Credits used to settle an ECO (i.e. compliance environmental credits) would not be remeasured.
• Credits that will be sold or traded (i.e. noncompliance environmental credits) and that are initially measured at historical cost would be assessed for impairment.
• Entities could elect an accounting policy to remeasure eligible noncompliance credits, other than those internally generated or granted, to fair value as part of an eligible class. These credits would include noncompliance credits obtained in an exchange transaction with related parties and through a nonreciprocal transfer that is not a grant from a regulator. Entities would continue to re-measure the credit to fair value until it is derecognized. Entities would apply ASC 250 for changes to the accounting policy election and would not retroactively apply this policy change when moving from historical cost to fair value.

Reassessment

• Each reporting period, entities would reassess whether compliance and noncompliance credits meet the appropriate recognition criteria.
• Credits that are reclassified from compliance credits to noncompliance credits would be assessed for impairment before applying the subsequent remeasurement guidance.
• Subsequent reversal of a previously recognized impairment loss would be prohibited.
• Entities could establish an accounting policy to use a portfolio approach for similar environmental credits to apply the recognition and measurement guidance.

Recognition

• Entities would recognize a liability when activities or events occurring on or before a balance sheet date indicate the existence of an ECO.
• The balance sheet date would be considered to be the end of the compliance period for recognizing an ECO liability (ECO).
• There would be separate recognition requirements for obligations requiring entities to remit a fixed number of credits to a regulator solely because it is existing as a business:
  • An entity would recognize an ECO on the date that it becomes obligated to remit the credits.
  • The entity would recognize an asset at the same time which would be amortized over the compliance period.
• Entities would apply the recognition guidance in ASC 805 to account for an ECO assumed in a business combination.
• Entities would not recognize a liability (and expense) for commitments to purchase credits unless required by other GAAP.

Initial measurement

• The funded portion of an ECO would be measured based on the carrying amount of compliance credits owned by an entity using its best estimate of the credits to be derecognized on settlement. An entity would apply the liability measurement guidance after applying the asset recognition, measurement, and reassessment requirements. 
• The unfunded portion of an ECO would be measured using the fair value at the balance sheet date of the credits necessary to settle the liability at that date with two exceptions: 
  • If the entity intends to remit cash to settle the ECO liability, it would use the cash settlement amount under the compliance program to measure the ECO liability.  
  • If the entity intends to settle the ECO liability using environmental credits obtained through a commitment to purchase a fixed quantity of environmental credits at a fixed price (existing at the balance sheet date), it would use the estimated cost basis of those credits to be obtained through that contract to measure the ECO liability.  
• Entities would not be permitted to elect the fair value option in ASC 825 for measuring an ECO. 
• An ECO assumed in a business combination would be measured under the tentatively-decided requirements of this ECP project. 

Subsequent measurement

An entity would recognize subsequent changes from the initial measurement of an ECO through earnings and present those changes in the same line item as the initial measurement of the ECO.

Derecognition

• ECOs would be derecognized in accordance with existing guidance for extinguishment of liabilities.
• Gains and losses recognized on derecognition would be presented in the same income statement line item as the initial measurement of the ECO.

Interim requirements

The recognition and measurement criteria for an ECO would be applied consistently for annual and interim periods.

Balance sheet presentation

Entities would present all compliance credits and ECOs gross and offsetting would be prohibited. The Board will seek feedback during the public comment process about whether net presentation might be more relevant to user needs.

Balance sheet classification

• An ECO would be classified as current when it is reasonably expected to be settled within one year from the balance sheet date.
• A credit would be classified as current when it is reasonably expected to be sold, traded, or remitted to a regulator to satisfy an ECO within one year from the balance sheet date (or the operating cycle of the business, if longer).
• All other ECOs and credits would be classified as noncurrent.

Statement of cash flows

Cash flows associated with Environmental Credit Programs would be presented in accordance with ASC 230.

The following disclosures would be required for both public and private entities:

• Qualitative and accounting policy disclosures that would include information about an entity’s involvement in ECPs, activities and events that result in an ECO and the types of credits owned.
• Detailed information about an entity’s significant holdings and significant ECOs for each period for which a balance sheet is presented. This disclosure would also be required at interim periods.
• Income statement disclosures (also related to voluntary programs) including revenue and gains/losses from sales of credits and expenses related to credits. This disclosure would also be required at interim periods.
• Statement of cash flow disclosures under ASC 230.
• Fair value disclosures under ASC 820, where applicable.

Requirements

An entity would be required to adopt the ECP model using the modified retrospective approach. Prior periods would not be recast.

On initial application:

• Noncompliance credits would be measured at their carrying amount immediately prior to initial application (i.e. carryover basis).
• Compliance credits would be measured at the lesser of their historical carryover basis and their fair value.
• Credits not recognized as assets (i.e. related to voluntary programs) would be derecognized with an offsetting adjustment to equity.

Additionally:

• Early adoption would be permitted.
• Entities would apply the transition disclosures under ASC 250.
• Adjustments to credits associated with prior business combinations would be recognized in equity.
• An entity would be permitted on transition to continue to include costs of credits that were capitalized as part of another asset (e.g. inventory) before application.