Accounting for Emission Allowances: An Issue in Need of Standards
Elfrink, John, Ellison, Mitch, The CPA Journal
On June 6, 2008, the U.S. Senate failed to support a motion to end the debate on the LiebermanWarner Climate Security Act of 2008, effectively killing the bill. The legislation would have directed the Environmental Protection Agency (EPA) to establish a program to reduce greenhouse gas (GHG) emissions. A critical component of the bill was a provision to set up a cap-and-trade system mat would rely upon the market to facilitate the reduction of GHG emissions by U.S. industries. Despite the bill's defeat, many Washington insiders believe that such a system to control GHG-and carbon dioxide emissions, in particular-is inevitable in the near future. Both John McCain and Barack Obama expressed support for such a system during their presidential campaigns, and it is likely the new Congress will favor it.
Cap-and-trade systems are currently used in other countries and were successfully employed in the United States to help reduce acid rain in the 1990s. To serve these systems, several trading exchanges have emerged, catering to markets in Chicago, New York, and the largest, London. "Observers believe that the [U.S.] market is now worth at least $100 million. Privately, those same observers talk about a $4 billion carbon-trading market once federal caps are approved" (John Goff, "Carbon Trading," CFO Magazine, January 2008). In Europe, where virtually every country has signed the Kyoto Protocol, the cap-and-trade market is worth tens of billions of euros ('Trouble-Entry Accounting," PricewaterhouseCoopers, May 2007). The current and potential volume of activity in this area will impact the financial reports of many companies and warrants standardized financial reporting. Current participants in cap-and-trade systems have little official guidance on relevant accounting issues.
A cap-and-trade system allows emitters to either reduce pollution and increase profit (or reduce expenses), or continue to pollute at excessive levels and pay a price. In theory, the system is self-balanc- ing, allowing underpolluters to offset exces- sive polluters so that a set level of emis- sions is not exceeded. At the center of these schemes are emission allowances (EA). EAs are essentially licenses to emit a spec- ified amount of pollutants over a specific time period. A government entity issues the EAs and limits the authorized permits to match a desired level of emissions. The EAs are given, sold, or auctioned to polluters. On reconciliation days, pol- luters must possess sufficient EAs to cover their emissions, purchase additional EAs from the marketplace, or pay a fine. Companies with excess EAs can sell or trade their excess credits. The govern- ment can reduce the available EAs over time and, thus, gradually reduce the amount of GHG in the atmosphere until the desired level is reached. The proceeds from the governmental sales of EAs, as well as the fines levied, could be earmarked for environmental projects.
Current and past usage of EAs raises several financial accounting issues. On a fundamental level, U.S. GAAP accounts for EAs on a historical cost basis, while International Financial Reporting Standards (IFRS) supports a fair value approach. More specific issues include the following:
* If EAs are recorded as assets, how are they valued and classified?
* How do the EAs and GHG emissions affect the profit and loss statement?
* When and how are liabilities reported?
* When and how are government grants recognized?
* Is revaluation of the related assets and liabilities appropriate?
* How does a participant account for sales of EAs?
* How do cap-and-trade events affect the statement of cash flows?
Unfortunately, official guidance on these issues is shallow and underdeveloped, and accounting for EAs in practice lacks consistency. A 2007 survey by PricewaterhouseCoopers and the International Emissions Trading Association found six major treatments and numerous variations used by the 26 firms in the study ('TroubleEntry Accounting - Revisited," PricewaterhouseCoopers, September 2007). …