Irina Cheburdanidze looks at how businesses are striving to reduce their carbon footprint and addresses the issue of accounting for carbon credits.
The minds of regulators around the world have been firmly focused on climate-related disclosures for some time now, with the first two IFRS Sustainability Disclosure Standards now published. While reduction of carbon has long been considered key to mitigating climate change, a new industry is fast emerging – carbon capture.
Capture and storage
As well as switching to renewable energy, the capture and storage of new and existing carbon dioxide from the atmosphere might be a further solution to rising global temperatures. We may think that this is all about planting more trees or restoring peatland to sequester more carbon, but there’s more to it than that. New technologies are emerging all the time – including the discovery of volcanic microbes that scientists say can absorb CO2 astonishingly quickly.
Despite recent doubts expressed by the United Nations about the unknown environmental and social risks of carbon capture, large corporates have been investing significant funds into this growing industry in anticipation of the creation of a new global carbon market. Acceleration of guidance from accounting and tax authorities could aid viability of these projects, as could further support from the government.
Large corporates have been investing significant funds in anticipation of the creation of a new global carbon market
What are carbon credits?
A carbon credit is defined in IFRS S2 Climate-related Disclosures as “an emissions unit issued by a carbon crediting programme and represents an emission reduction or removal of greenhouse gases. Carbon credits are uniquely serialised, issued, tracked and cancelled by means of an electronic registry”. The provisions around disclosures of these are in place in the Task Force on Climate-Related Financial Disclosures (TCFD) regulations and the new IFRS Sustainability Disclosure Standards. At the moment, carbon credits are not permitted to be directly deducted from greenhouse gas emissions and must be shown separately. Unlike the Financial Accounting Standards Board (FASB) in the US, the International Accounting Standards Board (IASB) and the Financial Reporting Council (FRC) do not currently have active projects on their respective agendas relating to accounting for carbon credits.
Carbon offsetting can be achieved by carbon credits, financing the development of own projects or investing in existing schemes. In the UK, there are only two carbon offset schemes accredited by the UK Environment Agency: the Woodland Carbon Code and the Peatland Code. These issue Woodland Carbon Units (WCUs) and Peatland Carbon Units (PCUs), which respectively represent measurable amounts of CO2 removed from the atmosphere by growing trees or restoring peatland. Entities can also purchase or sell Pending Issuance Units (PIUs), which are effectively a ‘promise to deliver’ WCUs or PCUs in future. Commercially, care needs to be taken when selling a PIU to ensure that the risks associated with the growth of the trees are considered due to a requirement to repurchase under-delivered carbon units at a market price.
Accounting for carbon credits
In a similar way to the blockchain industry, questions arise around how companies should account for carbon credits. For example, what value would one assign to a new commodity that does not have a physical substance and a regulated market? Does such an asset really exist and, if so, how do you account for a sale or purchase of such assets?
Using the example of woodland sequestration, the parties to the transaction may involve a landowner, a project developer and the end user. Landowners may sell or lease their land to a project developer, with the latter responsible for raising finance, obtaining grants, planting trees and maintaining woodland to achieve the required certification. Certified carbon units are then sold to ultimate customers or used internally in pursuit of achieving environmental strategic goals. Landowners may work directly with the regulators and sell carbon units to buyers in a private transaction, via auction or via the UK Land Carbon Registry platform.
What value would one assign to a new commodity that does not have a physical substance and a regulated market?
From the perspective of a landowner or project developer, where the trees are used purely for generation of carbon offsets, it would be appropriate to account for them under IAS 16 Property, Plant and Equipment (or section 17 of FRS 102 The Financial Reporting Standard applicable in the UK and the Republic of Ireland), if control over the trees can be demonstrated using the contractual terms. Payments to establish and develop the trees, together with related borrowing costs, may be included in the cost of these assets subject to satisfying capitalisation criteria. Some projects are financed through government grants, which are permitted to be deducted from the cost of an asset under IFRS (but not under FRS 102).
The resulting carbon units would be classified as inventories if they are held for sale in the ordinary course of business, rather than capital appreciation or own use. These will be measured at the lower of cost, including the depreciation of the trees, and net realisable value. Alternatively, carbon units held for own use may meet the definition of intangible assets, subject to determining future economic benefits, which are measured at cost or under the revaluation model. The revaluation model may be challenging to apply for WCU/PCU due to the requirement for an active market to exist, with frequent transactions taking place and pricing information available to the public.
Revenue recognition will depend on the performance obligations written into a customer contract. PIU sales may involve financial instruments accounting, including fair valuation requirements or discounting. There are many more scenarios that can occur on the carbon credit market that will also require consideration, such as the accounting from a buyer’s or intermediary’s perspective.
Looking to the future
It is likely that generally accepted accounting practice will ultimately find its way into new accounting standards or interpretations as the voluntary carbon capture market continues its growth. Taxation of these transactions is also uncertain, with a HMRC consultation on carbon offsetting of woodlands and peatlands currently in progress, the outcome of which may have a significant impact on the development of the UK market going forward.
Irina Cheburdanidze, Financial Reporting Advisory Services Director, Johnston Carmichael
