Accounting for environmental agreements

Background

UK environmental policy aims to protect nature, combat climate change, and promote sustainable development. Key legal frameworks include the Environment Act 2021, Nutrient Neutrality, and Biodiversity Net Gain (BNG).

Nutrient Neutrality requires new developments to avoid increasing nutrient pollution in protected habitats. BNG, mandatory since February 2024, requires developers to enhance biodiversity of land by at least 10% compared to pre-development levels. This can be achieved through onsite habitat creation or agreements with landowners.

BNG agreements generate measurable environmental units, which developers can acquire to meet legal or policy obligations. Common mechanisms for securing units include the following.

• Section 106 agreements – legal planning obligations binding landowners to habitat management and monitoring plans, enabling creation of environmental units which can then be sold to developers.
• Conservation covenants – legal agreements between landowners and government-designated responsible bodies to manage land for conservation.
• Leases – allowing developers to use third-party land to secure environmental units, with legal commitments for habitat enhancement, monitoring and reporting.

BNG agreements typically require a 30-year commitment. Nutrient neutrality agreements usually last the lifetime of the development – often 80 to 125 years – depending on catchment, mitigation method, and legal structure.

Types of environmental units

Environmental agreements generate various environmental units, each serving distinct policy goals.

• Biodiversity units – quantified habitat improvements, often created through wildflower meadows and woodland planting, used to meet BNG requirements.
• Nutrient credits – reduction of nitrogen/phosphorus runoff, typically via wetland creation to trap and filter nutrients before reaching watercourses.
• Carbon credits – capture of CO₂ to support net zero targets, commonly achieved through tree planting or peatland restoration.
• Water quality credits – improvements to water bodies, used by developers and water companies, often via wetland restoration to filter nutrients and slow runoff.

Credits may be stacked or bundled on the same parcel of land.

This is a complex area with a range of environmental credit schemes, involving varied agreements. This raises questions about how such transactions should be reported in the financial statements.

Revenue recognition

Despite agreements often spanning more than 30 years, substantial upfront receipts are common. The following discussion is broadly relevant to all the types of environmental units described above but with varying degrees of applicability depending on the nature of the underlying agreement and performance obligations. The timing of income recognition is crucial: if these receipts relate to immediate performance obligations, they may trigger early tax liabilities. Conversely, if recognition of the income is deferred over the life of the agreement, it can materially alter the tax profile and financial reporting. Getting this classification right is therefore essential to managing both tax compliance and the financial impact.

Under UK GAAP, income is recognised when earned, not when received. FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland is introducing a five-step revenue recognition model (aligned with IFRS 15 Revenue from Contracts with Customers), effective for periods starting on or after 1 January 2026 with early adoption permitted.

Five-step revenue recognition model

1. Identify the contract – must be legally enforceable, defining rights and obligations eg, conservation covenant, Section 106 agreement, lease, unit sale contract or service contract.
2. Identify the performance obligations – review habitat management and monitoring plans to assess:
   - one-off habitat creation obligations;
   - ongoing management, monitoring, or reporting requirements;
   - penalties or clawbacks for unmet performance criteria;
   - spread of obligations over time; and
   - conditions (eg, planning permission) that could delay recognition.
3. Determine the transaction price - consider lump sums, staged payments, annual fees and the timing of, and conditions attached to, each payment.
4. Allocate the transaction price to performance obligations - while specific obligations and associated timeframes should be outlined within the habitat and monitoring plan, it may be challenging to reliably estimate future obligations.
5. Recognise revenue – based on fulfilment of performance obligations – apply discounting to reflect time value of money.

Case examples demonstrate that agreements without financial clawbacks tend to result in greater upfront income recognition. In contrast, where clawback provisions are included, a larger proportion of income may be deferred. In more extreme cases, income has only been recognised up to a “reasonable level of costs already incurred,” reflecting a more cautious accounting approach.

With each of these agreements, the “devil is in the detail”, as each contract will differ in terms of management requirements, performance criteria, timescales and clawbacks. In most cases though, it is common to see a mix of upfront revenue recognition reflecting the habitat creation and when the establishment criteria have been met with a spreading of income over time, reflecting ongoing management requirements.

Asset Classification and Disclosures

Even when receipts are recognised as income, related balance sheet items and disclosures must be considered. Key areas include the following.

• Land and Property - is the land now investment property (eg, leased or non-operational)? Consider capital costs of habitat creation.
• Environmental Credits - may be classified as intangible assets (if held for investment) or trading stock (if sold as part of a trade).
• Fair Value Adjustments - consider if encumbered by long term covenants.
• Deferred Income Liabilities - reflecting future income recognition.
• Provisions - review for restoration obligations or penalties for non-performance.

FRS 102 also requires disclosure of:

• significant commitments affecting future performance;
• revenue recognition policies;
• contingent liabilities (eg, penalties or clawbacks if performance not met); and
• professional judgement used in the classification and recognition of receipts. 

Given the level of uncertainty around the accounting for environmental agreements, entities subject to such agreements are encouraged to include a specific accounting policy, outlining key judgements, estimations and any areas of risk.

For large and medium-sized companies, the Companies Act 2006 requires strategic report disclosures on the company’s principal risks and uncertainties, the long-term consequences of board decisions, and its environmental impact.

No standardisation

There is no standard approach to the accounting or tax treatment of environmental agreements. Each contract will vary in duration, performance obligations, financial clawbacks, and management requirements.

With limited guidance and no established case law yet, interpretation involves significant judgement and carries considerable risk. Even seemingly minor contractual adjustments can materially affect both the accounting and tax treatment.

Early engagement with legal, tax and land professionals is essential to structure agreements that align with commercial goals, optimise tax efficiency and reduce exposure to future disputes. 

Kate Hardy, Director at Albert Goodman