An Investigation into Recent Trends and Challenges of Accounting 'Climate Instruments'

By Rathee, Sudeep; Kapil, Sheeba | Journal of Services Research, April-September 2015 | Go to article overview

An Investigation into Recent Trends and Challenges of Accounting 'Climate Instruments'


Rathee, Sudeep, Kapil, Sheeba, Journal of Services Research


INTRODUCTION

The main aim of this paper is to analyse the accounting policies and the challenges that arise for firms and investors in reporting, measurement and disclosure of 'climate mitigation assets' or 'climate instruments'. The evolving climate policy is debating a marketbased approach of adopting 'climate instruments' for mitigating the greenhouse gas emissions through carbon markets and promote sustainable energy practices through tradable Renewable Energy (Green) Certificates (RECs) (Linares et al., 2008; EC Directive, 2009; Massetti and Tavoni, 2012; Goulder, 2013; World Bank, 2013; UNEP, 2011). As we know, the tradable climate instruments under the carbon markets - emissions credits - are meant to control firm-level carbon pollution and are available in form of - i) government allocated emissions 'rights' (also known as allowances) and remittance 'obligations' under a 'cap-and-trade' scheme (Böhringer and Lange, 2013); and ii) certificates or 'rights' issued by a regulator to acknowledge verifiable emissions reductions under a 'baseline-and-credit' mechanism (Garcia and Roberts, 2008). Similarly, to promote investment in clean energy, other type of 'climate instruments' - Renewable energy certificates (RECs) - are granted by market regulators to renewable energy producers (Couture and Gagnon, 2010).

These schemes have a penalty and a trading structure to force a climate-friendly behaviour among participating firms. So, the market value of emissions credits is due to trading by firms that need to submit credits equal to their emissions in a period (Bennett, 2010). In case of RECs, the renewable energy producer can sell them to power distributors and energy consumers who have a compliance need to have a specific amount of power sourced from renewable energy resources (Couture and Gagnon, 2010).

Several of these schemes allow portfolio investors to invest directly in these 'climate instruments' or they may allocate capital to debt and equity security of firms that hold emissions credits and/or RECs. Depending on market conditions and asset characteristics, they can thus benefit from capital appreciation and portfolio diversification. However, the investment decision to allocate capital to later - carbon credit or REC holding firms - depends on financial analysis of the firm's disclosures of information on these 'climate instrument'.

The existing studies on climate trading have been mainly conducted on trading behaviour and opportunities for investments in carbon credits (Bennett, 2010; Clark and Knox-Hayes, 2011; Goulder, 2013). As accounting statements are the main source of reporting financial information on any material event, this paper examines the evidence present on the accounting treatment of such 'climate instruments'. It further analyses the existing state of guidance provided by accounting standard boards and the specific accounting practice being followed by firms to report these assets.

The paper, in the end identifies the challenges faced by firms and private investors in applying these accounting practices. The main research objectives, hence, crystal down to:

a) analyse the existing guidance provided by leading accounting standard setting boards on emissions credits and RECs;

b) review the surveys on current practice in accounting of emissions credits by firms;

c) examine the various views and accounting interpretations of emissions credits; and

d) identify the challenges faced by firms and investors due to anomalies in accounting of climate instruments;

The research concludes that the accounting standard boards in countries across Europe, America and Asia have attempted to provide specific guidance for treatment of these 'climate instruments' in financial statements, yet, so far there exists no such formal accounting policy. Analysis of various surveys suggests that due to this accounting impasse, there are wide disparities in reporting, measurement and disclosure practices of the firms on these 'climate instrument'. …

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