Discussion at the December 2007 IASB Meeting
IASB staff presented an agenda proposal to re-activate the project to provide guidance on how to account for emission trading schemes. Staff noted that emission trading schemes were becoming increasingly common and that subsequent to the withdrawal of IFRIC 3, there was no clear accounting guidance on how to account for such schemes.
The staff paper presented to the Board for the agenda decision included the following table outlining the main approaches that are being accepted in practice to account for emissions trading schemes:
| | Approach 1 | Approach 2 | Approach 3 |
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| Initial recognition - Allocated allowances |
Recognise and measure at market value at date of issue; corresponding entry to government grant. |
Recognise and measure at cost, which for granted allowances is nil. |
| Initial recognition - Purchased allowances |
Recognise and measure at cost. |
| Subsequent treatment of allowances |
Allowances are subsequently measured at cost or market value, subject to review for impairment. |
Allowances are subsequently measured at cost, subject to review for impairment. |
| Subsequent treatment of government grant |
Government grant amortised on a systematic and rational basis over compliance period. |
Not applicable. |
| Recognition of liability |
Recognise liability when incurred (ie as emissions are produced). |
Recognise liability when incurred (ie as emissions are produced). However, the way in which the liability is measured (see below) means that often no liability is shown in the statement of financial position until emissions produced exceed allowances allocated to entity. |
| Measurement of liability |
Liability is measured based on the market value of allowances at each period end that would be required to cover actual emissions, regardless of whether the allowances are on hand or would be purchased from the market. |
Liability is measured based on:
the carrying amount of allowances on hand at each period end to be used to cover actual emissions (ie market value at date of recognition if cost model is used; market value at date of revaluation if revaluation model is used) on either a FIFO or weighted average basis; plus
the market value of allowances at each period end that would be required to cover any excess emissions (ie actual emissions in excess of allowances on hand). |
Liability is measured based on:
the carrying amount of allowances on hand at each period end to be used to cover actual emissions (nil or cost) on a FIFO or weighted average basis; plus
the market value of allowances at each period end that would be required to cover any excess emissions (ie actual emissions in excess of allowances on hand. |
Staff also noted that the FASB has added a similar project to its agenda. One Board member questioned whether the project would deal only with emission trading schemes, and any government grants related to such schemes, or whether the IAS 20 project should also be reactivated.
The IASB research director put forward the recommendation to restart work on the emission trading schemes project. The IASB research director did not believe that the scope of the work should extend to a review of IAS 20. It was suggested by one Board member that the project could be split into two phases:
- Phase 1 could deal with emissions trading schemes
- Phase 2 could deal with a revised IAS 20.
Staff did not support this proposal.
Another Board member queried why there was diversity in practice when the IAS 8 hierarchy was in place and IFRIC 3 exists (although not effective). It was noted that it is important that the project defines what an emission right is.
The staff proposed that the scope of the project should only address emission trading rights, including any government grants associated with such emission trading rights, but not address government grants more generally. The Board voted (10 in favour) to proceed with this project.
Discussion at the May 2008 IASB Meeting
(The FASB staff joined the meeting by video link for this session.)
Background and objective
The purpose of this session was to clarify the scope of the joint project with the FASB on emissions trading schemes. The Board activated the work on this project in December 2007 and this was the first time it was discussed at the Board since then.
The staff highlighted the following:
- Presently, there is no authoritative accounting literature in either IFRSs or US GAAP that addresses these issues. In June 2005, the IASB withdrew IFRIC 3 Emissions Rights, which addressed the accounting for the rights and obligations arising from participation in the European Union's Emissions Trading Scheme (EU ETS).
- Clarification of the scope of the project is a key issue because it will have the following implications:
- The accounting questions that will need to be answered (and therefore the staff's direction of research) depend on the scope of the project.
- Neither Board has clearly defined the scope (in light of the variety of schemes that exist) when it added the project to its agenda.
- An opportunity exists to align each Board's respective scope.
- There is a wide range of emissions trading schemes. In common, they are all aimed at reducing the damage to the environment. The theory behind emissions trading relies on the creation of value through the allocation of a right to emit. This target is normally below actual physical levels of emissions currently being made by entities. Hence, an artificial scarcity is created, which in turn creates a value for the holders of such rights. Emissions trading schemes are believed to reduce emissions in a manner that is cost effective and efficient.
In general, an emissions target is set and distributed (either through an auction or through allocation) among those that qualify. The emissions target creates a 'cap' or a 'baseline' target of total emissions allowed during a particular period.
Scope alternatives and Board decisions
Based on the staff's research, three possible scopes for the project have been identified:
Alternative A: Government mandated cap and trade schemes only (narrow scope).
Alternative B: All emissions trading schemes and tradable rights (broad scope).
Alternative C: A scope between the narrow scope and broad scope
The Board supported Alternative B mainly for the following reasons:
- Constituents, particularly financial statement preparers, are asking for guidance is this area.
- There is currently no authoritative literature in IFRSs or US GAAP that addresses the subject; consequently, preparers are uncertain about the proper accounting and diversity has developed in practice.
- The lack of authoritative guidance might produce diversity between different schemes and/or tradable rights.
- A consequence of a limited-scope project might be that preparers and auditors bombard the Board with questions about how to account for schemes or tradable rights that were excluded from the scope of the project.
- The number and types of emissions trading schemes continue to increase over time as more and more citizens, entities, and governments all around the world grow increasingly concerned about the environment.
The Board then discussed the definition of emissions trading scheme. The staff proposed the following definition:
'An emissions trading scheme is an arrangement designed to improve the environment, in which participating entities may be required to remit to an administrator a quantity of tradable rights that is linked to their direct or indirect effects on the environment.'
Broadly speaking the Board agreed with the proposed definition. However, Board members proposed to change the wording slightly to clarify that such a scheme does not improve but rather reduces the impact on the environment. Further editorial comments will be provided offline.
Finally, the Board agreed with the staff's recommendation not to constrain itself to existing authoritative literature when developing possible accounting models, but only to ensure that the accounting model developed will comply with the Framework.
Discussion at the March 2009 IASB Meeting
The Board was presented with, but did not discuss, a paper that explained the mechanisms in an emissions trading scheme. The staff had prepared this paper as useful background for the Board in deciding on an approach for the initial accounting of an allocation of tradable offsets in a 'cap and trade' scheme.
Accounting for issued tradable offsets in the context of a cap and trade scheme
The Board discussed the initial accounting for instruments that may be used to offset an emissions obligation ('tradable offsets') that have been issued to an entity free of charge in an emissions cap and trade scheme.
Is there and asset and, if so, what is its initial measurement?
The Board agreed that a tradable offset met the definition of an asset in the IASB Framework in that they are a resource controlled by the receiving entity that provide future economic benefits. The entity can use issued offsets in settling emissions obligations or it can sell issued offsets on the open market for cash. Issued offsets held result from a past event (the receipt of tradable offsets) and are a present resource.
The Board considered whether the tradable offsets should be measured at cost (nominal amount) or fair value and concluded that measuring the tradable offsets on initial recognition fair value provides more transparent and decision-useful financial information than cost.
How to account for the credit
The Board considered three possible approaches:
A: Non-reciprocal transfer model
This model considers whether an entity incurs a present obligation when it is issued offsets. The staff noted that this most likely results in a gain upon initial recognition of issued offsets. Only if a claw-back attaches to issued offsets and the Board concluded that this to give rise to a present obligation might entities recognise a liability, reducing (or perhaps eliminating) the gain. The staff noted that they had spoken with a wide variety of interested parties, including large emitters, other standard setters, auditors, analysts, ratings agencies, and investors. They generally believe that recognizing a gain on initial recognition of issued offsets does not provide useful information.
B: Performance obligation model
Under this model, when an entity is issued offsets, it has a performance obligation that it must fulfil in order to realise income from the offsets. Effectively, the entity enters into an agreement with the scheme administrator. The entity agrees to reduce its emissions below the level represented by the allocation of tradable offsets. That is, the offsets exist only as a result of the agreement with the scheme administrator. The agreement establishes a performance obligation. The performance obligation model does not result in a gain on initial recognition of issued offsets.
C: Compensation model
The compensation model takes the view that the issuance of tradable offsets is not a non-reciprocal transfer from the scheme administrator to an entity. Instead, the compensation approach considers the issuance of tradable offsets in the context of the whole package of requirements imposed by an emissions trading scheme. The model adjusts for a measurement mismatch that arises as a result of different measurement bases.
In the discussion that followed, none of the Board members supported the Compensation model.
The Board was finely balanced between the non-reciprocal transfer model (6 in favour) and the performance obligation model (6 in favour). One Board member put forward a model somewhere between the two.
Those who favoured the non-reciprocal transfer model noted that, when the tradable offsets were issued (presumed to be prior to the emission year), there was no obligation that meets the definition of a liability in IFRS. One member noted that the IFRIC had debated this issue for several meetings as it developed IFRIC 3, had come to an appropriate answer under the existing IFRS requirement, and the Board had not supported them.
Those who supported the performance obligation model did so for a variety of reasons-not all of them consistent. Some saw tradable offsets as a sort of conditional government grant (cf IAS 41); others supported the performance obligation approach because they liked the answer, even though it did not fit nicely with the Framework or existing IFRS.
The conclusion of the debate was not clear, but the Board will need to address the issue at a subsequent meeting given the lack of consensus.
Discussion at the November 2009 IASB Meeting
Accountng for items in a voluntary scheme
The staff introduced the session by explaining that the staff was asking for direction rather than decisions from the Boards. The staff paper presented at the meeting described the items that an entity exchanges when it becomes a member of a scheme with voluntary participation, and it discussed which items met the element definitions in the Boards' frameworks.
The Boards were not invited to discuss the criteria for recognition, measurement, or presentation of the elements in a voluntary scheme.
The discussion used the following simple example:
On 1 January 2010 an entity becomes a member of a voluntary scheme with a one year commitment period, starting on 1 January 2010. The entity is entitled to an allocation of 100 allowances. The allowances that result from the allocation are issued on 1 January 2010.
In exchange for membership in the scheme and the right to an allocation, the entity promises to pay one allowance for each unit of emissions occurring during the commitment period.
The entity estimates it will emit 110 units of emissions during the commitment period. That means the entity expects that its demand for allowances will exceed its allocation of 100 allowances by 10 units. The entity plans to make up the expected shortfall by acquiring allowances on the market.
The staff analysed the example by reference to each of the Boards' conceptual frameworks and relevant accounting standards. The staff presented two views as to what created the obligating event in a voluntary scheme:
- View 1: The entity's actual emissions create the obligating event. A member of a voluntary scheme does not incur a present obligation until it has emitted. Until emissions have occurred, the member can avoid the outflow of allowances by its future actions.
- View 2: The membership contract signed by the entity creates the obligating event. The entity incurs a present obligation as result of becoming a member of a scheme. As of signing the membership contract, the obligation to pay allowances is unconditional. Only the amount of allowances due under the membership contract is uncertain.
Applying the two views to the base example, the staff suggested that:
- Under View 1, an entity would have a scheme liability on 1 January 2010 only if, and to the extent that, the entity had emitted on 1 January 2010.
- Under View 2, an entity would have a liability on 1 January 2010 that reflects the promise to pay allowances throughout the commitment period. The entity estimates it would pay 110 allowances for the one year commitment period. The liability exists irrespective of whether the entity had already emitted.
IASB and FASB members individually expressed support for both Views. Some saw View 1 as the only view that was consistent with IFRS, US GAAP, and the frameworks. Supporters of View 2 thought that the information provided was more useful to users of the financial statements. Some supporters of View 2 expressed levels of discomfort with how the staff had applied existing standards in supporting their conclusions and suggested alternative ways of achieving the same conclusions. A third alternative was put forward by an IASB member and received some support from a FASB member. Under this third alternative, the analysis should be based on the net position: on Day 1 the entity would estimate the liability or asset based on 'expected emissions less allowances'. Another IASB member, while admitting instinctive support for View 1, suggested that the transaction was similar to a conditional government grant (IAS 20.8).
The IASB Chairman asked for indications of support for the two views as a way of giving direction to the staff. In the 'directional' vote that followed, a majority of both the FASB and IASB supported View 2.
Responding to this direction, the staff noted that the Boards would now have to face the question of justifying how an entity could have an obligation (for the consequences of emitting pollutants) prior to creating the emissions that give rise to that obligation.
The Boards will consider that question, along with recognition, measurement, and presentation issues at a subsequent date.
Discussion at the December 2009 IASB Meeting
Accounting for the right to future instalments
The Board discussed a paper that was prepared for the November joint meeting, but that was not discussed due to time constraints, relating to the accounting for the right to receive allowances in an emissions cap and trade scheme before the related allowances have been issued. The staff explained that the right to future instalments is a prevalent feature in most emission trading schemes and that the right to receive future instalments is typically contingent on an eligible entity continuing its emitting operations. The question that arises is whether an entity should recognise the right to future instalments as an asset.
The Board considered the following alternatives:
- View 1 - An entity does not control a resource until the contingencies related to the right to receive allowances are resolved.
- View 2 - An entity controls a resource when the entity holds a right that will result in the entity receiving allowances if the entity takes specified actions (typically continuing to emit at a specified level). That right is regarded as an option and the entity exercises it by undertaking the specified actions.
As part of the deliberations of the alternatives, several Board members questioned the logic underlying the second alternative, especially regarding what the exercise price of the option and nature of the corresponding liability would be. One Board member expressed difficulty in understanding how an option could be exercised by just continuing in business.
Several Board members expressed concern about considering whether there is an asset to be recognised without first considering whether the entity has an obligation under the scheme. There should also be symmetry in the treatment of the related asset and liability.
One Board member suggested that the staff should consider the situation in the US where farmers are paid not to farm in order to maintain the price of corn. This analogy could help provide guidance in accounting for emission trading schemes. Several other Board members supported this analogy and agreed that the issue should be considered as a whole, together with the question whether an obligation has arisen.
When asked whether there would be a difference in accounting when the emission trading scheme is a statutory/mandatory scheme as opposed to a voluntary scheme, the Board unanimously agreed that there should be no difference.
February 2010: Deloitte paper on 'cap and trade programs'
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Deloitte's Climate Change and Sustainability Services team has published a paper on Cap and Trade Programs for Greenhouse Gas. Concern for the potential implications of climate change is leading governments to consider policies and programs designed to reduce greenhouse gas (GHG) emissions. Cap and trade programs are one option that is considered to be
effective in creating a financial incentive for emissions reductions for large emitters in industrial sectors. The purpose of the paper is to present the key characteristics of greenhouse gas emissions cap and trade programs. A knowledge of cap and trade mechanisms is essential to understanding the impact on business, including carbon management, accounting, and tax implications.
| The IASB's Emissions Trading Schemes Project |
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The IASB has on its agenda a project on Emissions Trading Schemes. The goal of that project, being conducted jointly with the US FASB, is to develop comprehensive guidance on the accounting for emissions trading schemes. The Board has decided tentatively that if an entity receives emission allowances free of charge from the government:
- The entity should recognise the allowances as assets and measure them initially at fair value.
- Because the entity incurs an obligation to reduce its emissions below the level represented by those allowances (ie its cap), the entity should recognise a liability that represents its promise to pay allowances throughout the commitment period. The liability exists irrespective of whether the entity has already emitted.
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Click to download Cap and Trade Programs for Greenhouse Gas (PDF 1,123k).
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