The Chartered Accountant • Journal of ICAI November 2021 • Vol. 70 • No. 5 • pp. 76–83 (Journal pp. 588–595)
ACCOUNTING STANDARDS • SUSTAINABILITY REPORTING

Carbon Accounting Practices in Select European Companies

Neelam Yadav (Research Scholar) & Prof. Shurveer S. Bhanawat (Professor)

1. Introduction: The Carbon Market Challenge & Reporting Void

Carbon markets expansion has produced a mass of challenges for the corporations, societies, nations – of which, accounting for carbon emissions is perhaps the least implicit area for the corporation. Experts of carbon trading in Europe are still working on an agreement on how to record carbon emission rights in the financial statements whereas, companies emitting carbon emissions in the United States have just started to struggle with the accounting issues of an already multifaceted and unknown market. (ACCA, 2010)1

Accounting standard setters globally have made forethoughts on this emergent topic but still, there is an absence of accounting standards to manage carbon emissions accounting. There are no specific guidelines on how to account for carbon emission allowances by companies in their financial statements. One report of (CNBC, February 2019)2 shows that “half of European Union companies have no carbon reduction plan despite admitting climate change risks and these European companies do not show a clear picture of any disclosure of carbon accounting treatment in their financial reports”.

Emissions in the European Union (EU):

European Union (10.76%) is the third-largest carbon emitter in the world after China and the USA. But EU is consciously aware about mitigating CO2 emissions in the world. Seventeen emission trading schemes are running in the EU right now. Hence, the companies in the EU are facing problems on accounting treatment of carbon because no authoritative accounting standard exists at present. Without any accounting standards that specify how to account for carbon emission allowances, it is hard to compare the financial statements of companies.

In general, there are multiple ways to account for carbon emission allowances. According to the different interpretations of general principles of accounting (International Financial Reporting Standards, IFRS), some companies classify emission rights as intangible assets, others as inventory assets and some others as R&D, but the fact is that there is no common standard for different institutional contexts. This article attempts to explore accounting practices of carbon allowances followed by companies in the EU through examination of their financial statements.

2. Standardization of Carbon Accounting at International and National Level

Global Standard-Setting Milestones

1. EITF & IFRIC-3 (2003–2005):

In 2003, the Emerging Issues Task Force (EITF)1 brought carbon accounting onto the agenda, but it was removed in a very short time. Due to the lack of mandatory regulations, many companies developed their accounting policies related to carbon emissions during this period. Consequently in 2004, the IFRS Interpretations Committee (IFRIC)2 published IFRIC-3 on 2/12/2004, effective from 1/3/2005, which had been withdrawn in June 2005.

In IFRIC 3 Emission Rights, emission rights (allowance) are recognized as intangible assets and measured in accordance with IAS-38 Intangible Assets. If the government issues allowances for less than fair value, the difference between the amount paid and fair value of allowance is accounted as government grant in accordance with IAS-20 Accounting for Government Grants and Disclosure of Government Assistance. As a participant produces emissions, a provision for its obligation is recognized to deliver allowances in accordance with IAS-37 Provisions, Contingent Liabilities and Contingent Assets.

Recognition under IFRIC-3: Allowances – Intangible asset – fair value at initial recording creates without payments – it recognized a grant which is deferred revenue in the financial statement. Recognition of a provision for its obligation to deliver allowances as emissions are produced and to measure them at fair value. The grant is gradually transferred from deferred revenue to income at its initial value.

Reason for IFRIC-3 Withdrawal:

IFRIC-3 withdrawal occurred because of the Mixed Presentation Model (gains and losses derived from the valuation of liabilities are reported in the income statement, while the gains and losses derived from any revaluation of the emission allowances were recognized under equity in the balance sheet) and the Mixed Measurement Model (either at cost or fair value). After these mismatches, very few companies subject to such schemes have applied IFRIC 3 voluntarily.

Instead, a range of approaches have developed in practice which can be broadly grouped into either the net liability approach or the government grant approach. In Europe, there has, however, been a strong trend towards the net liability approach. In the net liability approach, emission permits granted are recorded at their nominal amount (i.e., nil if granted for nil consideration) and the entity only recognizes a liability once actual emissions exceed the permits granted and are still held. Under this approach, emission permits purchased are accounted for as any other purchased intangible asset.

2. FASB & IASB Joint Project (2007–2015):

After this period of time in 2007, FASB3 and IASB4 started a joint project. IASB began a project about emission trading schemes along with FASB in December 2007. This project aims to develop comprehensive guidance in accounting for emission traded schemes and revise existing relevant standards like IAS-38, IAS-39, IAS-20, IAS-2, and IAS-8.

In order to tentatively suggest accounting treatment, after May 2010, IASB tentatively decided that an entity should recognize the allowances received free of charge from the government as assets and measure them initially at fair value. Another tentatively decided that an entity recognizes a liability that represents its promise to pay allowances throughout the commitment period irrespective of whether the entity has already emitted.

In December 2012, IASB formally reactivated the project as an IASB-only research project and deferred joint work with FASB. In 2015, the project was renamed from “Emission trading schemes” to “Pollutant pricing mechanisms” to address a variety of schemes that use emissions allowances to manage the emission of pollutants.

3. US FERC Accounting Guidance (2007):

FERC (Federal Energy Regulatory Commission)5 of the US has issued GHG accounting guidance: there is no accounting standard or interpretation in US GAAP Suggested Accounting Treatment (2007). Emission allowance should be classified as inventory, measured on a historical cost basis (that is, they should be valued at their original cost, in most cases zero), with recognition of costs as emissions are made (that is, as the allowances are consumed) on a weighted average cost basis.

4. Status Under IFRS Framework:

There are several IFRS guidelines on the recognition, measurement, and disclosure of financial elements connected to environmental matters. However, there is not a single standard focused exclusively on environmental issues and their associated effects on the firms’ accounts.

3. Indian Standard-Setting: ICAI Guidance Note on Self-Generated CERs (2012)

At the national level, The Institute of Chartered Accountants of India (ICAI)6, issued a Guidance Note on ‘Accounting for Self-generated Certified Emission Reductions (CERs)’ in 2012. There is no specific Accounting Standard or interpretation provided by the International Accounting Standard Board (IASB) in relation to the accounting for Certified Emissions Reductions (CERs). There are, however, existing Accounting Standards (AS) that deal with the principles that should govern accounting for Certified Emissions Reductions (CERs). In this note, ICAI provides guidelines on how to account for carbon credits generated under the Clean Development Mechanism, i.e., CERs, which can be considered as assets of the generating entity.

ICAI Guidance Framework for Self-Generated CERs:

  • CERs is an Asset: The Framework for the Preparation and Presentation of Financial Statements, issued by the Institute of Chartered Accountants of India, defines an ‘asset’ as follows: “An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.” CER is an asset as per the definition. (UNFCCC)7 – Approved CER as an Asset, under approval process – Contingent assets AS 29 (provisions, contingent liabilities, and contingent assets).
  • Recognition of CERs: “An asset is recognized in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably.” CER should be recognized on certification by UNFCCC at nominal cost (consultant fees and cash payment to UNFCCC towards administrative cost).
  • Type of Assets: CER is an intangible asset as per AS 26: “an intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services for rental to others, or for administrative purposes.” (Ind AS 38). However, other requirements of AS 26 such as an intangible asset should include assets that are developed by the entity. Development should be recognized only if, its intention to complete the IA and use or sell it. CER is an intangible asset.
  • Accounted as Inventories: Intangible assets held for the purpose of sale in the ordinary course of business are excluded from the scope of AS 26 and therefore are to be accounted for as per AS-2, Valuation of Inventories. Therefore, even though CERs are intangible assets these should be accounted for as per the requirements of AS 2.
  • Measurement of CERs: Since CERs are inventories for an entity that generates the CERs, therefore, the valuation principles as prescribed in AS 2 should be followed for CERs. CERs should be measured at cost or net realizable value, whichever is lower.
  • Income Recognition: Since CERs are recognized as inventories, the entity should apply AS-9 to recognize revenue in respect of sales of CER.
  • Disclosure Requirements: An entity should disclose the following information relating to CERs in the financial statements:
    1. No. of CERs held as inventory and the basis of valuation.
    2. No. of CERs under certification.
    3. Depreciation and operating and maintenance costs of emission reduction equipment expensed during the year.

4. Research Methodology & Sample Distribution

The objectives of the present research study are:

  • To study carbon accounting practices in select European companies.
  • To identify various heads under which CO2 Emission Allowances are recorded.

Research Methodology: For the study, annual reports of 25 companies were analyzed through content analysis technique. The present study covers one year’s data from 2017-18. In order to achieve the objective of the present research work, sample units have been selected on the basis of the ACCA8 (The Association of Chartered Certified Accountants, 2010) report including convenience sampling and data availability. 25 units are selected from the European Union (EU) countries from different sectors i.e., Combustion, Iron, Steel, and Refining.

Table 1: Name of the Sample Countries and Sectors

S. No. Country No. of Companies Percentage (%) Sector
1. Luxembourg 01 4% Combustion; Iron and Steel
2. Portugal 01 4% Combustion
3. Poland 03 12% Combustion
4. France 01 4% Combustion
5. United Kingdom 03 12% Refining and Combustion
6. Germany 04 16% Combustion, Iron and Steel
7. Czech Republic 01 4% Combustion
8. Spain 01 4% Combustion
9. Slovakia 01 4% Iron and steel
10. Netherlands 03 12% Combustion
11. Austria 01 4% Combustion
12. Italy 02 8% Refining
13. Finland 01 4% Iron and steel
14. Greece 02 8% Combustion
Total 25 100% –

5. Carbon Accounting Practices in European Companies: Empirical Findings

This section discusses carbon accounting mechanisms followed by European Union Companies which are summarized in Table 2 and Table 3 at a glance. These carbon accounting treatments have been compiled from reference companies. The table shows that sample companies of the study adopted various accounting treatments for carbon emission allowances and the different forms of presentation of carbon emission allowances in their financial statements.

Table 2: Accounting Practices for Carbon Emission Allowances

S. No. Accounting Treatment of Carbon No. of Companies Percentage (%) Measured
At Cost At Fair Value
1. Intangible Assets 08 32% 08 –
2. Inventories 05 20% 05 –
3. (Both Intangible Assets, Inventories) 04 16% 04 –
02 02
4. Other assets 01 04% 01 –
5. No Disclosure 07 28% – –
Total 25 100% –

Table 3: The Different Forms of Presentation of Carbon Emission Allowances in Financial Statements

S. No. Accounting Treatment of Carbon No. of Companies Percentage (%)
1. Provisions 11 44%
2. Derivatives 13 52%
3. CO2 allowances show in cash flow from operating activities. 03 12%
4. Sales of CO2 allowances show in sales revenue. 02 08%
5. CO2 shows in trade payable and other liabilities. 03 12%
6. CO2 emission rights are allocated to the company free of charge. 07 28%
7. Show CO2 emission rights as Non-amortizable assets. 01 04%
8. Cost related to purchasing of emission rights shows under other operating expenses. 01 04%
9. Changes in CO2 emission allowances show in working capital (current assets, Inventories). 01 04%

6. Analysis and Discussions

The empirical results show which accounting treatments have been followed across different sectors in the sample:

  • Intangible Assets (32%): Out of 25 companies, 8 companies (32%) have followed accounting treatment for carbon emission allowances (CEA) as intangible assets. Out of 8 companies, some companies held carbon emission allowances for “own use” are booked as intangible assets at cost price and some companies purchase carbon emission allowances (CEA) from the market for their use they are showing as an intangible asset. All 8 companies show CEA as intangible assets at cost price. Out of this 08, 07 companies are showing CEA as an amortizable intangible asset and only 01 company accounted for CEA as a non-amortizable intangible asset.
  • Inventories (20%): Out of 25 companies, 05 companies (20%) show carbon emission allowances as inventories in their financial statements. Inventory is the goods and materials that a business holds for the ultimate goal of resale or trading purposes. When sample units hold Carbon Emission Allowances for a trading purpose then they accounted for CEA as inventories in books of accounts. All 05 companies show CEA as inventories at cost and net realizable value whichever is lower. An interesting fact is that out of 25 companies, only 05 companies treated CEA as an inventories in the head of current assets in the balance sheet but only 01 company shows changes in CEA as current assets in the working capital. It shows diversified accounting treatment followed by sample companies in the EU.
  • Both Intangible Assets and Inventories (16%): Out of 25 companies, only 04 companies (16%) show carbon emission allowances as both intangible assets and inventories in books of accounts when the company used CEA as its own used to show as intangible assets and when held for trading purposes accounted as inventories. In these 04 companies, all show CEA as an intangible asset at cost price and all 04 companies show CEA as an inventories but 02 companies show at a cost price and 02 companies show at fair value.
  • Other Assets (4%): Out of 25 companies, only 01 (04%) company show CEA as other assets (other than intangible assets and inventories).
  • No Disclosure Shock (28%): It’s a very interesting fact that out of 25 sample companies, a huge amount of companies – 07 (28%) companies – do not follow any accounting treatment for CEA. It’s very shocking but true these 07 companies are large energy sector companies in European Union countries but they have not disclosed any accounting treatment for carbon emission allowances.
  • Provisions (44%): A provision is an amount set aside from a company’s profits to cover an expected liability or a decrease in the value of an asset, even though the specific amount might be unknown. A provision is not a form of savings; instead, it is a recognition of an upcoming liability. Out of 25 sample units, only 11 (44%) units create a provision for carbon emission allowances / GHG (greenhouse gases) and disclosed detailed information regarding carbon emission allowances provisions.
  • Derivatives & Commodity Trading (52%): 13 companies out of 25 (52% of sample units) trade carbon emission allowances through derivatives market and show CEA as a commodity. A derivative is a contract between two parties that derives its value/price from an underlying asset. The most common types of derivatives are futures, options, forwards, and swaps. These companies treat CEA as a financial instrument.
  • Cash Flow from Operating Activities (12%): Out of 25 companies, only 03 (12%) companies show carbon emission allowances (CEA) in cash flow from operating activities. 05 companies show CEA as inventories and other than this, 04 companies show CEA as both intangible and inventories. But out of this 09 total companies, only 03 companies show CEA in cash flow from Operating Activities.
  • Revenue Disclosure Disconnect (8% vs. 36%): In this table out of 25 companies, 09 (36%) of companies treated carbon emission allowances as an inventory for the trading of CEA. But the interesting fact is that only 02 (8%) companies show sales of carbon emission allowances in sales revenue. Other remaining companies used CEA for trading purposes but the purchase and sales of CEA cannot be disclosed in their financial statements.
  • Trade Payables & Other Liabilities (12%): Out of 25, only 03 (12%) companies treated CEA as a trade payable and other liabilities.
  • Free Government Allocations (28%): Only 07 (28%) of companies disclose information about the fact that they are getting CEA free of charge from the government and other authorities. All 07 companies disclosed that they get free of charge carbon emission allowances and show as intangible assets at nominal value or nil value. Other remaining companies are also getting CEA free of charge but they cannot disclose it in their financial statements.
  • Operating Expenses (4%): Only 01 (04%) company disclosed “Cost related to purchasing of emission rights in other operating expenses”. Other companies have not disclosed information regarding this.

7. Concluding Remarks & Framework Synthesis

Carbon trading practices in Europe are still working on an agreement on how to record carbon allowances in the financial statements. The result of the study concluded that divergent accounting treatment of carbon emission allowances has been followed by sample companies of European Union countries. All over the world, there is no single set of accounting standards for carbon emission allowances, so a large number of companies have not disclosed any information about carbon trading and some of the companies disclosed information about CEA but in a much-diversified manner. Without consistent accounting practices for carbon emission, it can be hard to compare the financial statements of companies.

Sufficiency of Existing Accounting Standards:

At present, there is no need for any new accounting standards for carbon allowances, the existing accounting standards are sufficient to deal with accounting issues of carbon allowances. Some accounting bodies previously (IASB and IFRIC) have given guidance to CEA treated as an intangible asset (they are allocated free of charge or purchased) under IAS 38. Other carbon allowances that are allocated for less than fair value should be measured initially at fair value, any difference between the amount paid and fair value should be identified as a government grant and accounted under IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance). For accounting of liabilities, the liability should be recognized in the accounts as the emissions are made, and that this obligation should be treated as a “Provision” and covered by IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets). Only proper guidance for how, when, and which existing standards are followed for carbon accounting treatment for companies all over the world and also companies in the European Union are required.

References & Statutory Footnotes

  1. Lovell, H., Aguiar, T. S., Bebbington, J., & Gonzalez, C. L. (2010). Accounting for Carbon. The Association of Chartered Certified Accountants. International Emissions Trading Association.
  2. CNBC Report (19 February 2019): Half of European Union companies have no carbon reduction plan despite admitting climate risks. Available at: https://www.cnbc.com/2019/02/19/half-of-european-companies-have-no-carbon-reductionplan-report-finds.html
  3. The Institute of Chartered Accountants of India (ICAI) (2012). Guidance Note on ‘Accounting for Self-generated Certified Emission Reductions (CERs)’. Retrieved October 01, 2019.
  4. The Emerging Issues Task Force (EITF) is an organization formed by the Financial Accounting Standards Board (FASB) in 1984 to identify, discuss and resolve financial accounting issues with an aim to improve financial reporting.
  5. IFRIC Interpretations are developed by the IFRS Interpretations Committee (previously International Financial Reporting Interpretations Committee IFRIC) and Interpretations are issued after approval by the International Accounting Standards Board (IASB). IFRIC Interpretations issued IFRIC-3 Emission Rights.
  6. The Financial Accounting Standards Board (FASB) is an independent non-profit organization formed in 1973 responsible for establishing financial accounting standards in the United States following US GAAP.
  7. The International Accounting Standards Board (IASB) was founded on April 1, 2001, as the successor to the IASC, serving as the independent standard-setting body of the IFRS Foundation.
  8. The Federal Energy Regulatory Commission (FERC) founded on October 1, 1977, regulates transmission and wholesale electricity/gas in the US and issued GHG accounting guidance in 2007.
  9. The United Nations Framework Convention on Climate Change (UNFCCC) adopted on 9 May 1992 at the Rio Earth Summit, entered into force on 21 March 1994, aiming to stabilize greenhouse gas concentrations (197 Parties).
  10. Association of Chartered Certified Accountants (ACCA) founded in 1904, headquartered in London with administrative office in Glasgow, offers the global Chartered Certified Accountant qualification.