Accounting for Tomorrow's Pollution Control

By Ewer, Sid R.; Nance, Jon R. et al. | Journal of Accountancy, July 1992 | Go to article overview

Accounting for Tomorrow's Pollution Control

Ewer, Sid R., Nance, Jon R., Hamlin, Sarah J., Journal of Accountancy

When the Clean Air Act was signed by President Bush in 1990, many accountants with no professional interest in the electric utility industry-the target of that environmental law--examined the legislation carefully. They were interested because they suspected the law's unusual procedures for attacking industrial pollution would be precursors of environmental laws that will have a major impact on their clients or employers.

The provision of specific interest to accountants was the government's authorization to grant airpollution emission rights--in effect, a limited license to pollute-- and the eventual creation of a market in which these rights can be sold or traded. (For details on the law's schedule, see the sidebar on page 71.) In fact, several states, including California and Washington, have already implemented similar regulations affecting local industry, and the United Nations is now considering implementing some type of worldwide pollution allowance system.

As a result, the law opens a Pandora's box of accounting problems for industry nationwide. The major question faced by utility accountants today, and probably other accountants tomorrow, is, How should these emission rights, which in many ways resemble securities, property and inventory, be accounted for? For example, are they assets? What should their cost basis be? Can they be amortized?

To date, there are no definitive answers to these questions. This article, however, explores some of the complexities the law raises and offers some solutions. Also, the article may inspire fresh thinking on what surely will be a topic many accountants will have to address in the years ahead.

To understand the accounting issues, accountants must first understand this background on air pollution and its regulation.


Sulfur dioxide emission, a by-product of electric-generating utilities that burn fossil fuels (coal and oil), has been a target of federal regulators for decades. The first Clean Air Act, passed in 1970, set pollution standards, but they were applied with only moderate regard for their economic consequences. Some utilities were forced to make very costly plant modifications that did not yield equivalent benefits to air quality. Others could have improved air quality at modest cost, but the law gave them no incentive to do so. Consequently, many utilities missed deadlines for air-quality improvements, and sulfur dioxide emitted by electric utilities was nearly as high in 1985 as it was the year the law was passed.

The Environmental Protection Agency (EPA) always has regulated sulfur dioxide emission by setting emission standards. The 1990 law, which begins to go into effect in 1993, continues that process. Utilities currently operating will be granted rights to release sulfur dioxide emissions, but only in amounts based on those of the period from 1985 to 1987. New power plants will not be granted such rights. The goal is to reduce total emissions for all U.S. power plants to about two-thirds of their 1985-87 level.

The law bundles emission rights into units called "allowances," which are authorizations to emit one ton of sulfur dioxide in a given year. The law also directs the EPA to establish a market and a bank for the allowances. An allowance may not be used before the authorized year but may be carried forward to a later year.

The EPA goal is to hold back 2.8% of those allowances in order to develop the bank. Beginning in 1993, it will sell some of these allowances directly, and in 1993, in addition to its direct sale, the EPA will auction allowances to the highest bidder. Auction and sale proceeds will be distributed pro rata to the existing companies from which allowances were withheld. Qualifying sources also may trade allowances directly.

The auction and direct sale

* Will allow new companies to produce electricity using fossil fuels. …

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