Accounting for environmental assets

Are there any Monk fans out there? What does he always say about his mystery solving ability? “It’s a blessing…and a curse.” Somedays it feel that way for me working at a large non-profit. Being on the cutting edge, it’s a blessing but its also a challenge to identify the right accounting treatment for activities which lack authoritative guidance. When I began researching accounting for environmental assets with my coworkers, I spent some time identifying with Monk.

So what is an environmental asset and how does it relate to non-profits? An environmental asset is an emission allowance or carbon offset credit (a generic term meaning that a value has been assigned to a reduction or offset of greenhouse gas emissions.[1]) Three scenarios come to mind for how non-profits may be involved with environmental assets:

1. When an organization receives donated carbon credits for sale to market participants.
2. When an organization internally generates carbon credits from its programmatic activities and certifies the credits for sale to market participants.
3. When organization operations become subject to carbon emission quotas in the US or internationally.

The debate continues around the public policy governing carbon emission programs as well as the accounting guidance for environmental assets. Several different market solutions have been proposed for carbon emission programs which would result in environmental assets and/or liabilities. As discussed in the August 2008 Journal of Business & Economics Research article, the proposed market solutions include:

1. Use of fees on polluting inputs,
2. System of quotas, whereby companies with the opportunity to reduce carbon emissions could sell their unused, excess quota of carbon savings,
3. Establishment of output efficiencies which would be monitored and compared to a baseline carbon use, and
4. Carbon offsets

 

Carbon Offsets:
Accounting treatment of donated carbon credits and internally generated carbon credits generally relate to the fourth proposed market solution, carbon offsets. Carbon offsets have to be regulated and certified because of their intangible nature. The carbon credit’s value exists because of the trust that exists in the system which validates the credit’s existence and value as a commodity. Verification is key for accountants, auditors, and the public at large if carbon credits are reported as assets in a company’s financial statement.

While the accounting for Emission Trading Programs and initial carbon offset recognition is currently under debate by the FASB, other discussions and white papers provide some guidance about accounting treatment.

The different treatment options under consideration are impacted by the method with which the carbon credits are acquired, whether by internal creation, purchase or donation to the organization. The different accounting treatment options also consider the intended use of the credits – will they be used for an organization’s own compliance purposes or sold to market participants? The accounting options under debate provide for a vast difference in the impact to the bottom line (2). Simply stated, the main differences in the accounting treatment for carbon credits is whether they are treated as inventory or intangible assets, and whether they are marked to market or held at cost.

Carbon credits acquired from a donation could be recognized at fair value, and those acquired as a purchase could be valued at cost. When carbon credits are internally generated, accounting for them as inventory would result in balance sheet recognition. Alternatively, accounting for internally generated carbon credits as intangible assets results in a series of expenditures on the statement of activities and virtually no balance sheet recognition. Any adjustments to either inventory or an intangible subsequent to initial recognition may be necessary because the carbon credits are either 1) held for sale and therefore adjusted to fair value on a recurring basis, or 2) intended for use and therefore expensed or amortized over a systematic basis.

 

Emission allowances:
According to PriceWaterhouseCoopers (PWC), the IASB has determined that emission allowances received free of charge by the government for use in operations would create an asset and liability upon receipt of the allowances, recognized at fair value(3). Because the FASB has yet to issue guidance, PWC recommends that all allowances granted free of charge or internally developed be recognized at $0, and only purchased emission allowances be recognized at fair value. Similar to carbon credits, emission allowances used by an organization could be expensed or amortized over a systematic basis.

 

What next?
Until authoritative guidance is issued, an organization should keep in mind several key considerations when establishing a policy for accounting for environmental assets(4):

1. Develop an accounting policy based on thoughtful analysis as to the use of the environmental assets by the organization and with consideration of how future events may impact financial results. The policy must be applied consistently; therefore decisions made now may impact future reporting.
2. Monitor issues that may arise during the accounting period (e.g., expense recognition, impairment, accounting for shortfalls of allowances or credits, vintage-year swaps, and revenue recognition for excess sales) to ensure appropriate consideration and resolution.
3. Present and disclose environmental assets in line with accounting policy and intended use (based on materiality)
4. Evaluate instruments for derivative accounting. Forward, future, swap or option contracts may qualify as derivative instruments.
5. Remember to account for renewable energy credits, whether they are generated through production, purchased on the market, or embedded within a power purchase agreement.

Finally keep an eye on the FASB’s updates to watch for new guidance about how to account for carbon credits and emission allowances.

Additional Resources:
PWC Whitepaper on Environmental Assets

References:
1. Wikepedia
2. November 2009 article – Financial Accounting for Forest Carbon Offsets and Assets
3. PriceWaterhouseCoopers Stay Informed* Utilities and Power