Carbon offsets and credits under IFRS庐 Accounting Standards
Net-zero strategies and emissions reduction commitments bring carbon offsets and credits to the forefront of global accounting issues.
From the IFRS Institute 鈥� March 2, 2023
As more companies enter into commitments to reduce their carbon emissions or invest in renewable energy, questions about how to account for carbon offsets and credits are becoming more pressing. The complexity and variety of arrangements in rapidly developing voluntary markets is giving rise to questions about how IFRS Accounting Standards apply, often involving more than one standard. Here, we level set on these offsets and credits, and provide some of the key accounting considerations for voluntary markets relevant under IFRS Accounting Standards; plus a comparison to US GAAP.
The accounting for carbon offsets and credits is both an emerging issue and one that has been on the radar of global standard-setters for decades. Mandatory emissions trading schemes are not new, but for companies making net-zero or other emissions commitments, voluntary offsets and credits are often a key driver of their strategy. Where these schemes were historically established to help companies comply with governmental emissions mandates, they are now also a catalyst of growth and innovation, incentivizing companies to develop and implement the latest renewable technology. These schemes vary greatly and their number is growing. This has caused the related accounting issues to reemerge as a high priority.
Although several standard-setting projects have been attempted, there are currently no accounting requirements under IFRS Accounting Standards (or US GAAP) specific to carbon offsets or credits. International Accounting Standards聽Board聽(IASB庐)聽attempts聽over the years were either not finalized or withdrawn. And unlike the Financial Accounting Standards Board (FASB) in the US, the IASB currently has no active project on its agenda1Thus diversity in practice exists as companies seek to apply current accounting guidance to arrangements that are often complex and innovative.
Offsets vs credits vs allowances
Before considering the proper accounting, it is important to understand the nature of the item being accounted for. Terms are often conflated or undefined 鈥� e.g. carbon offsets, renewable energy credits or certificates (RECs), emissions permits or allowances, certified emissions reductions (CERs), environmental credits 鈥� and the respective ESG reporting proposals of the International Sustainability Standards Board (ISSB), SEC and the European Financial Reporting Advisory Group (EFRAG) were not aligned.2聽It remains to be seen whether there will be alignment in the final standards.3
Historically, the most recognizable term in discussing greenhouse gas (GHG) emissions under IFRS Accounting Standards has been 鈥榚missions allowances鈥� in the context of emissions trading schemes (ETSs). One example is a cap and trade scheme in which a company receives allowances that in effect allow it to emit a certain amount of CO2; established markets exist in which companies can sell surplus allowances and/or purchase additional allowances to make up for a deficit. The world鈥檚 largest cap and trade scheme is in the EU and covers just over a third of the EU鈥檚 GHG emissions. ETSs operate in the US at the state level (e.g. the California Cap-and-Trade Program).
Rather than the above compliance markets, this article is focused on the voluntary markets that are rapidly developing. In these markets, companies are buying and/or selling carbon offsets or credits as part of their own strategy related to reducing GHG emissions and not as the result of an underlying legal obligation.
In the context of reducing GHG emissions, the ISSB proposed using the general term 鈥榗arbon offset鈥�, which it defined as: 鈥淎n emissions unit issued by a carbon crediting聽programme聽that represents an emission reduction or removal of a greenhouse gas emission. Carbon offsets are uniquely聽serialised,聽issued, tracked and cancelled by means of an electronic registry.鈥�4
- Examples of emissions reductions include using wind, solar and geothermal energy sources as alternatives to natural gas or coal power plants.
- Examples of GHG removals include planting forests to absorb GHG emissions and sequestering carbon in underground storage.
Reflecting the lack of consistency in practice, as part of its redeliberations the ISSB has decided to use 鈥榗arbon credits鈥� as the general term, noting feedback that 鈥榦ffset鈥� better described 鈥渢he application of a carbon credit to an entity鈥檚 net emissions.鈥�5聽Therefore, the remainder of this article refers to the acquisition or sale of carbon credits.
Accounting for carbon credits
In the absence of specific guidance on the accounting for carbon credits, and because of the complexity and variety of arrangements beginning to emerge, a critical initial step is to understand the company鈥檚 facts and circumstances, and the specific terms and conditions of the credits. There is no one-size-fits-all accounting answer, and a contractual reference to a carbon credit can mean a variety of things 鈥� from a separable asset that can be traded to a 鈥榞reen鈥� credential or attribute.
Before analyzing specific fact patterns, a general question often asked is whether carbon credits even meet the definition of a separate asset. An asset is a present economic resource (i.e. a right that has the potential to produce economic benefits) controlled by the company as a result of past events.6
In some cases, it will be obvious that a carbon credit is a separate asset 鈥� e.g. a company enters into a transaction to acquire a carbon credit that can be traded on an exchange. In other cases, the answer may be different because the carbon credits are part of a larger transaction or they are immediately retired such that the economic benefits have been consumed, for example.
Below we consider two scenarios where the potential unit of account is the individual carbon credit; we look at key questions and the accounting implications. This commentary is intended to help you get started in thinking about the accounting that might apply 鈥� it is not intended to be exhaustive or determinative.
Scenario 1 鈥撀燗cquirer鈥檚聽perspective: company purchases carbon credits
The primary objective in asking the questions below (not exhaustive) is to determine whether the company has acquired a聽separate asset; and, if it has, the nature of that asset. These exploratory questions are not intended to be linear and answers may overlap; they also consider only initial recognition. Further, the questions assume financial instruments are聽not聽involved, including potential derivatives 鈥� e.g. as would be the case for a virtual power purchase agreement.
| Example questions | Commentary |
|---|---|
| How does the arrangement work? | This is the gateway question to understanding the arrangement and also the nature of the carbon credits. Answering this question includes understanding whether and how the company lays claim to the carbon credits, and how practically it can benefit. As noted in discussing聽terminology, a 鈥榗arbon credit鈥� might mean a variety of things. |
| Are the carbon credits part of a larger contract? | The carbon credits may be part of a larger contract for which understanding the overall substance of the arrangement is relevant to the accounting. For example, analysis of the facts and circumstances may lead to a conclusion that the carbon credits simply credentialize a larger asset acquired as a 鈥榞reen鈥� widget (i.e. an attribute of that asset), and therefore there is no separate asset to recognize for the carbon credits. |
| What are the terms and conditions of the carbon credits? Can they be traded or exchanged? | Carbon credits that can be transferred to a third party likely indicate that the company has obtained a separate asset versus the credit being an attribute of another asset (e.g. a 鈥榞reen鈥� widget). However, the analysis may be less clear if the credits cannot be transferred but the company can use them in some other way as part of its emissions reduction strategy. Further, if the company does not have title or other contractual rights to the carbon credits, and cannot sell or otherwise exchange them, perhaps the carbon credits are actually part of the cost of another asset because they are like 鈥榞reen鈥� credentials and simply a characteristic of that other asset. |
| What will the carbon credits be used for? | The following observations apply if it is determined that the carbon credits are a separate unit of account. If the carbon credits will be聽held for sale聽(or incorporated into goods for sale), this likely indicates that classification as inventory (or an inventory cost) under IAS 27聽is most appropriate. If the carbon credits will be held for own use, classification as an intangible asset under IAS 388聽may be appropriate. If the carbon credits will be retired immediately as part of the company鈥檚 GHG emissions strategy, this may indicate that immediate recognition in profit or loss is appropriate. |
| Is there a time lag between payment and receipt of the carbon credits? | In many cases, there may be a time lag between initiating a transaction to buy carbon credits and actually receiving them. Any such time lag should be carefully considered to determine its impact on initial recognition. |
| Can the company claim the benefit of the carbon credits in its GHG accounting? | Understanding whether the company will be able to use the carbon credits as an offset against its GHG emissions can help to determine exactly what the company receives. For example, proposed IFRS S2 would require a company to disclose information about the intended use of carbon offsets (now credits5) in achieving emissions targets. Could the company include these carbon credits as part of its strategy? |
| What does the company鈥檚 CDP9聽questionnaire say? | If the company completes a CDP (or similar) questionnaire, the answers therein can be compared to information about the arrangement coming from other sources; this may be especially instructive if the questionnaire is completed outside the finance function. Evaluating a transaction in the context of a company鈥檚 strategy and intent around climate change can be helpful (but not determinative) in considering the accounting. |
Scenario 2 鈥� Vendor perspective: company incorporates carbon credits into revenue arrangements
As just two examples, carbon credits might be incorporated into a revenue contract by transferring them to the customer when they purchase a 鈥榳idget鈥� or by retiring carbon credits on a customer鈥檚 behalf. In other cases, the carbon credits might in some way simply credentialize or certify the 鈥榳idgets鈥� sold.
In applying IFRS 1510, the primary objective in asking the questions below (not exhaustive) is to determine whether the company has a separate performance obligation related to the carbon credits. If the answer to that question is 鈥榶es鈥�, the company allocates a portion of the transaction price to the carbon credits or related service (assuming control does not transfer at the same time), and recognizes revenue when the performance obligation is satisfied. There may also be an impact on revenue recognition disclosures (e.g. disaggregation of revenue).
These exploratory questions are not intended to be linear and answers may overlap.
| Example questions | Commentary |
|---|---|
| How does the arrangement work?聽 | This is the gateway question to understanding the arrangement and also the nature of the carbon credits or related service (e.g. retiring carbon credits). In particular, as noted in discussing聽terminology, a 鈥榗arbon credit鈥� might mean a variety of things. |
| What exactly does the customer get and what can it do with it? | Understanding how the customer benefits from the carbon credits is necessary in determining whether they are capable of being distinct (i.e. the customer can benefit) and distinct in the context of the arrangement (separately identifiable). If these conditions are met, the vendor has a separate performance obligation in relation to the carbon credits. |
| Is there a separate market for the carbon credits? | Understanding whether the vendor sells the carbon credits on their own, whether the customer could purchase them separately from another vendor, and whether the customer could sell or exchange them separately in a transaction with other parties can help identify whether there is a separate performance obligation in the arrangement. |
| When is control of the carbon credits transferred to the customer? | The determination of when the transfer of control occurs requires an analysis of the specific facts of the customer arrangement and the related carbon credits. Indicators of control transfer may differ between stand-alone carbon credit sales and arrangements in which carbon credits are bundled and sold with the widget. The following are example questions to ask: When does the customer have a present obligation to pay for the credits? Are the credits pre-certified and if so, does the jurisdiction recognize title over pre-certified credits? If not, when is title transferred to the customer? How substantive is the certification process? What are the significant risks and rewards related to the credits (e.g. market price risk, certification risk) and when do they transfer? Are there any customer acceptance provisions? |
| Are carbon credits retired as part of the arrangement? How does the mechanism work? | If carbon credits are retired on behalf of the customer, that might indicate that a separate service is being provided to the customer. However, before concluding, understand exactly how the retirement mechanism works and how such retirement benefits the customer. This will help determine whether the customer is in fact the beneficiary of the carbon credits rather than it being a notional accreditation that credentializes the widget in some way. |
| Is the vendor acting as an agent by providing a service of retiring or buying and retiring carbon credits on behalf of the customer? | This is another way of investigating whether the company is performing a service for the customer (in addition to the sale of the widget). |
| Can the customer claim the benefit of the carbon credits in its GHG accounting? | Understanding whether the customer will be able to use the carbon credits as an offset against its GHG emissions can help to determine exactly what the customer receives. |
| Does the vendor have a 鈥榞reen鈥� commitment related to the revenue contract? | In some cases, the revenue arrangement might trigger a separate action for the vendor 鈥� e.g. if it has agreed to undertake certain 鈥榞reen鈥� actions (such as sponsor a tree planting) for each widget sold. |
Comparison to US GAAP
Similar to IFRS Accounting Standards, there is no US GAAP specific to carbon credits, although the FASB does have a project on its agenda (see below). The above questions are equally relevant in determining the appropriate US GAAP accounting.
- Acquirer鈥檚 perspective.聽Although there are differences between the standards (ASC 330 for inventory and ASC 350-20 for intangible assets), the types of questions to ask would apply equally under US GAAP.
- Vendor perspective.聽IFRS 15 is largely converged with ASC 60611聽and we would not expect significant聽differences in the analysis.
See 乐鱼（Leyu）体育官网 Handbook,聽, for a closer look at differences between IFRS Accounting Standards and US GAAP.
The possibility of future accounting guidance
Under IFRS Accounting Standards, the IASB has a project on pollutant pricing mechanisms (e.g. emission trading schemes) on its newly created reserve list. Although identified as a high priority, the IASB concluded there were higher priority projects in the pipeline and the project will only be added to the work plan if capacity becomes available before its next five-year agenda consultation in 2026.
In May 2022, the FASB added to its active agenda a project on accounting for聽. The Board acknowledged that the current proliferation of markets that trade environmental credits has made the need to provide accounting guidance to program participants a priority. The objective of the Board鈥檚 new project is to address the recognition, measurement, presentation and disclosure requirements for participants in compliance and voluntary programs that create environmental credits. The project also includes financial reporting requirements for nongovernmental entities that create environmental credits. We anticipate the Board will continue discussions on this project in coming months.
Key Takeaways:
There is a growing voluntary market for carbon credits, with arrangements becoming more complex. At the same time, there is no specific accounting guidance and no consistent terminology that helps identify the nature of a carbon credit in a given situation. Therefore, it is critical to understand the substance of an arrangement as a precursor to determining the appropriate accounting.
Our advice: ask lots of questions and document your analysis carefully. And start the conversation now with your auditors and other accounting advisors.
Footnotes:
1The IASB has a聽project聽on pollutant pricing mechanisms on its 鈥榬eserve list鈥�.
2ISSB proposed IFRS S2,聽; SEC proposal,聽; EFRAG proposed ESRS E1,聽
3Draft ESRS E1,聽, was published in November 2022; the ISSB and SEC continue redeliberating their respective proposals.
4Definition in proposed IFRS S2,聽
5ISSB redeliberations in October 2022; ISSB staff paper,聽
6Conceptual Framework for Financial Reporting, paras 4.3 to 4.25
7IAS 2, Inventories
8IAS 38, Intangible Assets
9Formerly, Carbon Disclosure Project
10IFRS 15, Revenue from Contracts with Customers
11ASC 606, Revenue from Contracts with Customers
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