ACCA IETA Accounting for Carbon 2010

8/8/2019 ACCA IETA Accounting for Carbon 2010

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Acct Ca

rac t 122

ACCA working in partnership with IETA





Acct Ca

Dr Heather Lovell

Dr Thereza Sales de Aguiar

Proessor Jan Bebbington

Dr Carlos Larrinaga-Gonzalez

Certied Accountants Educational Trust (London)



ISBN: 978-1-85908-469-4

© The Association o Chartered Certied Accountants, 2010

ACCA’s international research programme generates high-prole, high-quality, cutting-edge research. All researchreports rom this programme are subject to a rigorous peer-review process, and are independently reviewed by twoexperts o international standing, one academic and one proessional in practice.

The Council o the Association o Chartered Certied Accountants consider this study to be a worthwhile contribution todiscussion but do not necessarily share the views expressed, which are those o the authors alone. No responsibility orloss occasioned to any person acting or reraining rom acting as a result o any material in this publication can beaccepted by the authors or publisher. Published by Certied Accountants Educational Trust or the Association oChartered Certied Accountants, 29 Lincoln’s Inn Fields, London WC2A 3EE.





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5ACCOUNTING FOR CARBON EXECUTIVE SUMMARY

most notably a shit towards auctioning o emissionallowances, rather than giving them out at no charge. Thischange will have implications or nancial reporting.

The mAin reseArCh Aims And objeCTives

The project had ve aims.

To survey the treatment o carbon emission allowances•

within the nancial statements o large EU ETS emittersin order to establish a baseline understanding ocurrent accounting practices.

To assess awareness and knowledge o the IASB/FASB•

Emissions Trading Schemes project, and to evaluate itslikely eect on current and uture choices o nancialaccounting approach.

To establish an understanding o opinions on how to•

resolve the absence o accounting guidance oremission allowances.

To explore the theoretical implications o the research•

ndings.

To disseminate the research ndings to a range o•

policy and academic audiences in order to illuminatethe political and institutional challenges andopportunities that exist or governing the nancialaccounting treatment and reporting o emissionallowances.

There is a practical, policy need or the research (becauseo the lack o comprehensive up-to-date inormation aboutnancial accounting practices in the EU ETS, in what hasbeen a ast-moving area), and it has important conceptualaspects because carbon nancial accounting is in itsormative stages. Rules and practices are still ‘hot’ orunsettled, and there is a signicant opportunity toinvestigate how new accounting rules and practices arise.

A key objective o this ACCA research project, conducted inpartnership with the International Emissions TradingAssociation (IETA), is to open up the debate on carbonnancial accounting to a wider international audience.

meThod

We adopted a two-stage approach to surveying theaccounting choices o corporate players in the EU ETS: asurvey o nancial statement disclosures, and a series otelephone interviews. For the nancial statement survey,we conducted a desk-based review and analysis ostatements o the largest emitters within the EU ETS orthe year 2008, in order to establish their accountingtreatment o carbon emissions. The choice o thecompanies surveyed was dictated by a desire to capturedisclosure data or at least 25% o all EU ETS carbon

emissions. This 25% cut-o point ensured that we includedin our survey the emission allowance accounting practiceso the main polluters, because emissions are most likely tobe material to their accounts. We selected 68 installations

inTroduCTion

This report investigates how large emitters in the EuropeanUnion Emissions Trading System (EU ETS) are accounting

or emission allowances. The research involved a detailedsurvey o the nancial statements o the largestgreenhouse gas (GHG) emitters in the EU ETS (26companies). This was ollowed by telephone interviewswith accountants at ve o these companies to explore indetail why accounting practices vary. Since the EU ETScommenced in 2005 there have been no rm rules abouthow to account or emission allowances, and this uncertainsituation has allowed a range o accounting models toourish. The survey corroborates previous research (PwCand IETA 2007), revealing that a diversity o emissionallowance accounting practices are being used in Europe.

The research is relevant or commercial reasons.Specically, the value o emission allowances traded in theEU ETS is large – worth US$92 billion/€63 billion in 2008– which suggests that carbon accounting should provideinormation about the impact o climate change policies(especially those concerning carbon reductions) oncorporations active in this market. Moreover, in theabsence o international accounting guidance there iscurrently no uniorm nancial accounting treatment oremission allowances. The ndings suggest thatcomparable inormation about the relative perormance orms in the EU ETS cannot be discerned rom carbon-related disclosures. This situation is unsatisactory orindividual corporations as well as actual and potential

users o nancial report inormation.

In 2008, the Emissions Trading Schemes project wasrelaunched by the International Accounting StandardsBoard (IASB), in conjunction with the US FinancialAccounting Standards Board (FASB). The remit o theIASB/FASB project includes the accounting o all tradableemissions rights and obligations arising under emissionstrading schemes, as well as the accounting or activitiesundertaken in contemplation o receiving tradable rights inuture periods. Recommendations on accountingtreatment in this area will have the greatest impact oncompanies in Europe because o the EU ETS, and this isthe main reason why our study ocuses on current

disclosure practices o rms that are subject to the EUETS. Further, with the globalisation o carbon markets onthe horizon, the method o carbon accounting in the EUETS will have increasing international relevance.

To date, nancial accounting has been the ratheroverlooked bedrock o carbon markets, and deserves moreattention in international negotiations and elsewhere. Incontrast with other issues in carbon markets, where therehas been both government involvement and extensivepublic debate, decision making in carbon nancialaccounting appears to be taking place among a muchsmaller group o well-connected experts. Because the

IASB/FASB Emissions Trading Schemes project is due topublish an Exposure Drat in late 2011, the research istimely. Moreover, signicant changes to emissions tradingin Europe are expected in Phase 3 o the EU ETS (2013–20),

exct a



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rom the European Commission’s Community IndependentTransaction Log (CITL), which equate to those responsibleor approximately 26% o the EU ETS total veried emissionsin 2008. The companies owning the installations were then

identied via Internet searches, with 26 organisationscollectively owning these 68 installations. During stage twoo the research, all 26 companies were invited or a shortollow-up telephone interview (o 15 to 30 minutes’duration) to explore in more detail why they adopted theaccounting practices they did; rom where they sought andobtained advice and inormation in this area; their opinionson possible uture changes to EU ETS accounting; and therole o accounting standard setters in this context. Fiveinterviews were conducted, a response rate o 19%.

The reseArCh indings

The main nding rom the research is that large emittersin the EU ETS are using a diversity o accounting practicesto account or emission allowances: there is no uniormityo treatment (see Table).

Additional key ndings are as ollows.

Companies’ accounting practices or revealing their

overall position on emission allowances (as net assets orliabilities) vary hugely, with no discernible pattern inaccounting treatment.

A large proportion o surveyed companies (42%, or 11

out o 26 companies) treat emission allowances as

intangible assets. This means that the allowances aremeasured in company accounts ‘at cost’. I allowanceswere obtained by the company at no cost they areshown, thereore, as having nil value but i emissionallowances were purchased they have a cost associatedwith them in the accounts.

O the companies surveyed, 31% (eight companies) are

accounting or granted carbon allowances at nil value(on the basis that allowances are granted at no charge).Only 15% (or our companies) are accounting oremission allowances initially at air value with thedierence between air value and cost recognised as agovernmental grant and presented as deerred incomeon the balance sheet.

Most o the companies are measuring their obligation to

surrender allowances on a ‘cost with the balance atmarket value’ basis (58%, or 15 companies). That is,valuation is based on the carrying value o thoseallowances already granted or purchased (as this is atcost, a gure usually close to zero), while (i applicable)valuing at the market value the allowances that stillneed to be purchased to cover actual emissions.

Most o the companies do not disclose any inormation

on amortisation/depreciation (69%, or 18 companies)

or revaluation o emission allowances (50%, or 13companies).

Inormation on Certied Emission Reductions (CERs)

was not provided by most companies (77%, or 20companies).

Interviews with accountants conrmed that they nd it

difcult to account or emission allowances andrevealed a guidance role or auditors in the absence oan international accounting standard. In addition,interviews provided evidence that accountants wouldgenerally welcome the prospect o internationalaccounting guidance in this area (expected, at the timeo writing, in late 2011).

sa t: eu eTs t tt’faca t

Emission allowance accounting Disclosure summary*

Granted allowances – initial

recognition

Intangible assets – 42%

No disclosure – 27%

Purchased allowances – initial

recognition



CERS - ini tial recognit ion No disclosure – 77%

Granted allowances –

measurement on initial

recognition

Nil value – 31%


Fair value – 15%

Amortization/Depreciation o

emission allowances


Re-valuation o emission

allowances


Measurement o liabilities Cost with balance at market value

– 58%


* all percentages shown are percentages o the total survey responses

(26 companies) – they are not the % results o only those companies that

are disclosing.

As the table above illustrates, there are diverse accounting

treatments o emission allowances in the EU ETS. Thissituation has arisen because o a lack o accountingguidance rom standard setters in the period 2005–10.Companies in the EU ETS are currently ree to choose theirpreerred accounting method or emission allowances (aslong as it is accepted by their auditor). This exibilitybrings both advantages and disadvantages. The advantageis that companies can choose the accounting method thatsuits their business best and/or that is easiest andsimplest or them to apply. The disadvantages are thatcomparison between companies is not possible, and thatcompanies may need to spend a great deal o time andresources adopting dierent accounting models or

emission allowances in order to satisy dierent regulators,parent companies, and auditors.



7ACCOUNTING FOR CARBON EXECUTIVE SUMMARY

The diversity in accounting practice means that thecompany accounts o large EU ETS emitters cannot inmost cases be directly compared, despite the possibilitythat emission allowances will be material to the accounts.

With a shit to auctioning o allowances in Phase 3 o theEU ETS there are likely to be accounting implications: notleast that companies will no longer be able to account orassets and liabilities at nil value (because allowances willno longer be given out at no charge, but will need to bepaid or). Our interviews reveal that companies appear notto be thinking ahead about this issue.

Our interviews also establish that most companies appearready to welcome rm guidance rom the accountingstandard setters, to reduce complexity or them and toallow them to be airly compared with their peers. Even so,rather surprisingly in light o this, ew companies havebeen tracking the progress o the IASB/FASB EmissionsTrading Schemes project, and they have had little (i any)direct engagement with IASB or FASB.

There are networks where companies discuss emissionallowance accounting issues (eg the International EnergyAccounting Forum), but participation among intervieweesis variable, with some companies having no suchdiscussions with their peers and instead relying heavily ontheir auditor or advice. In the continuing absence ointernational accounting standards, the role o auditors hasbeen important, with most companies interviewed seekinginormation and reassurance rom auditors about theiraccounting model, and auditors playing a role in

establishing best practice through issuing guidance (KPMG2008).

In terms o the theoretical contribution o the research, thisstudy makes a signicant contribution to an emergingbody o work on carbon accounting, especially in adding toits empirical depth. It conrms that there is nothing yethabitual about carbon accounting practices (in contrast tomuch o accounting, which is ‘black-boxed’ and routine),thereby making it an interesting and inormative casestudy. Emission allowances are hard to classiy: they are atype o ‘incommensurable’ because there are multiplepotential uses o carbon credits – as a commodity, acurrency, a nancial instrument and so on – and

accounting practitioners in the EU ETS are trying to dealwith this complexity. Through this struggle to dene andmanage emission allowances, EU ETS accountants areplaying a role (albeit currently a rather quiet, hidden one)in inuencing how the problem o climate change isunderstood and governed.

reseArCh impliCATions And poliCy reCommendATions

We recommend that accounting standard setters issue

clear guidance on emission allowance accounting as soonas is practical (note that the timetable has already slippedrom the expectation o an Exposure Drat in 2009 to late2011). For large emitters in the EU ETS, emissionallowances may already be material to their accounts, andtheir signicance will increase with a shit to auctioning oallowances in EU ETS Phase 3 (commencing in 2013). Alevel playing eld is required to allow air and transparentcomparison o EU ETS company accounts.

We recommend that large emitters in the EU ETS workmore with each other, and with auditors and othertechnical accounting experts, to try to harmoniseaccounting practices in the run up to the issue o dratguidance by IASB/FASB in late 2011. This could, orexample, be through the existing Emission Rights projectled by the International Energy Accounting Forum, orthrough the establishment o new working groups,networks and projects by appropriate organisations (suchas IETA, ACCA, or others). We also recommend that thesegroups engage wherever possible with IASB and FASB tokeep abreast o new developments in the debate onemissions trading accounting.

Large corporate emitters in the EU ETS and auditors bothhave the potential to eect positive change in howaccounting or emission allowances is done, but timing is

crucial. It is the next ew years (2010–13) that will be mostimportant because o the expected issuance o IASB/FASBguidance, and the shit to auctioning o emissionallowances in the EU ETS.

Accountancy can be a way o making things appearuncontroversial and non-political, but the technicaldebates about accountancy rules and standardssometimes involve intense power struggles. Increasingawareness o the nancial bottom-line signicance oemission allowance accounting – and the current level odisparity in corporate reporting – might useully serve topersuade a wider audience o academics (andpolicymakers) that nancial accounting is a worthwhile andrich area o study.

Recognising that carbon markets have been created bygovernments and other institutions, and that these creationscan be altered, opens up the possibilities or changing howthey work, including their nancial accounting ‘bedrock’.

We recommend that academic research on carbonaccounting (nancial or otherwise) is continued, as there ismuch to explore, and now is an excellent time to havevaluable policy input.



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This report investigates how large corporate emitters inthe European Union Emissions Trading System (hereater,EU ETS) are accounting or carbon1 credits. Examiningaccounting approaches in this area is important because

the nancial implications arising rom the EU ETS may bematerial in nature and amount. The value o carbon creditstraded in this market is large: worth US$92 billion/€63billion in 2008 (World Bank 2009). In addition, becauseEU ETS is a major mechanism or carbon reductions, theway in which we account or its impact will provideinormation rom which we may assess the impact oclimate change policies (especially those concerningcarbon reductions) on corporations in this market.Currently, in the absence o international accountingguidance, there is no uniorm nancial accountingtreatment or emissions allowances, and previous surveyshave indicated a diversity o approaches (PwC and IETA2007). Our ndings suggest that comparable inormationabout the relative perormance o rms in this marketcannot be distinguished rom carbon-related disclosures, asituation that is unsatisactory or individual corporationsas well as actual and potential users o nancial reportinormation.

The research consisted o a survey o nancial accountingdisclosures o the largest greenhouse gas (GHG) emittersin the EU ETS (26 companies) as well as ollow-uptelephone interviews with accountants in these companies(ve interviews were conducted) to explore why particularaccounting practices have been adopted. The ndings othe research are twoold. First, there is a signicant

diversity in how companies are accounting or emissionallowances across the EU ETS (and dierent approachesresult in materially dierent disclosures in the nancialstatements). Second, that companies would welcomeguidance rom standard setters so that air comparisonscan be made between organisations, and in order thattheir accounting choices are made simpler.2

Since the withdrawal o the international accountingguidance – ‘Interpretation 3: Emission Rights’ (known as‘IFRIC-3’) rom the International Financial ReportingInterpretations Committee – in 2005, there has been noormal accounting recommendation as to how to accountor EU ETS obligations. Companies, thereore, have a

degree o choice in how they account or emission

1. The term ‘carbon’ is typically used as a shorthand way o reerring to

greenhouse gases (GHGs), o which carbon dioxide is the main one

produced by human activity. The GHGs incorporated within the EU ETS

are: carbon dioxide, methane, nitrous oxide, peruorocarbons,

hydrouorocarbons and sulphur hexauoride. They are measured in terms

o carbon dioxide equivalence, and hence the shorthand o ‘carbon’ is

used.

2. It was expected that the International Accounting Standards Board

(hereater IASB) and the US Financial Accounting Standards Board

(hereater FASB) were going to issue drat guidance in this area late in

2010. Unortunately, the date or this has been set back by over a year,

with late 2011 now being the date or issuance o drat guidance and 2012

being the earliest date that a nal standard could now be expected.

Regardless o timing, this research will eed into the work o these, and

other, standard setters.

allowances, both in dening what kind o asset an emissionallowance is (intangible asset or inventory) and in how it isvalued (at cost or air value) (see ACCA 2009; Deloitte2009; Ernst and Young 2010). Further, it is worth noting

that the choice o asset classication is not necessarilylinked to valuation or measurement. Two key questions orthis research were thereore: ‘How are emission allowancesclassied?’ and ‘How are emission allowances measured?’

In summary, the research produced the ollowing ndings.

A large proportion o surveyed companies (42%, or 11•

o the 26 companies) treat emission allowances asintangible assets. This means that the allowances aremeasured in company accounts ‘at cost’. I allowanceswere obtained by the company at no charge they areshown, thereore, as having nil value, but i emissionallowances are purchased they have a cost associatedwith them in the accounts (Ernst and Young 2010).

O the companies surveyed, 31% (eight companies) are•

accounting or granted carbon allowances at nil value(on the basis that allowances are granted at no charge).Only 15% (or our companies) are accounting oremission allowances initially at air value, with thedierence between air value and cost recognised as agovernmental grant and presented as deerred incomeon the balance sheet.

Most o the companies are measuring their obligation•

to surrender allowances on a ‘cost with the balance at

market value’ basis. That is, valuation is based on thecarrying value o those allowances already granted orpurchased (as this is at cost, a gure usually close tozero), while (i applicable) valuing at the market valuethe allowances that still need to be purchased to coveractual emissions (58%, or 15 o the companies).3

Most o the companies do not disclose any inormation•

on amortisation/depreciation (69%, or 18 companies)or revaluation o emission allowances (50%, or 13companies).

Inormation on Certied Emission Reductions (CERs)•

was not provided by most o the companies (77%, or20 companies).

Interviews with accountants conrmed that they nd it•

difcult to account or emission allowances andrevealed a guidance role or auditors in the absence oan international accounting standard. In addition,interviews provided evidence that accountants wouldgenerally welcome the prospect o internationalaccounting guidance in this area (with drat guidanceexpected at the time o writing in late 2011).

3. This is an accounting practice not permitted under the withdrawn

IFRIC-3, which recommended that assets (the allowances) should be

treated independently to the liabilities arising under the EU ETS.

1. itct



9ACCOUNTING FOR CARBON 1. INTRODUCTION

bACkground

The desire to mitigate the probable maniestations oclimate change is partly expressed through the

construction o markets in which carbon credits arecreated and exchanged; carbon credits are dened instandard units o GHGs. Dierences in the rules andpractices within these markets can alter theirenvironmental and economic impacts and, as a result,assessing the eectiveness o these markets is importantin understanding the eectiveness o mitigation measuresin general. Moreover, how well markets work dependsupon inormation provided by market participants.

This report does not address the ‘physical’ monitoring andreporting by the installations and veriying by EU memberstates o GHG emissions in the context o EU ETS. Rather,it ocuses on a crucial area o carbon rules and practiceswithin the EU ETS – and one that is key to the eectivenesso the carbon markets – namely the treatment o EuropeanEmission Allowances (EUAs,4 henceorth reerred to as‘emission allowances’5) in nancial statements. Since thewithdrawal o the international accounting guidance (IFRIC3) in 2005, there has been no ormal accountingrecommendation as to how to account or EU ETSobligations, and a diversity o practices has emerged as aresult (see PwC and IETA 2007).

In 2008, the Emissions Trading Schemes project wasre-launched by the IASB, this time in conjunction with itsUS counterpart, the FASB. The remit o the IASB/FASB

project includes providing guidance on accounting ortradable emissions rights and obligations arising underemissions trading schemes, as well as the accounting oactivities undertaken in contemplation o receivingtradable rights in uture periods. Recommendations likelyto emerge rom this process will have the greatest impacton companies in Europe because o the existence and sizeo the EU ETS. For this reason, our study ocuses oncurrent disclosure practices o rms that are alreadysubject to the EU ETS. Further, as more carbon marketsemerge in the near uture (as well as the prospect oglobalised carbon markets), the way in which carbon isaccounted or in the EU ETS will have increasinginternational relevance.

It is necessary to provide inormation about the impact ocarbon markets in the nancial statements o companiesor the eective operation o capital markets. In contrastwith other issues in carbon markets where there has been

4. A EUA equates to one tonne o CO2

(either in the orm o CO2or a CO

2

equivalent measure o GHGs).

5. Note that there is some overlap between the terms ‘emission

allowance’ and ‘carbon credit’. Carbon credit is a more general term that

covers either a reduction in emissions, or an oset. For simplicity in this

report we use the term ‘emission allowance’, as emission allowances (GHG

reductions, not osets) represent the large majority o transactions in the

EU ETS. Nonetheless, where appropriate we also use the more general

term ‘carbon credit’.

both government involvement and extensive public debate,such as voluntary osetting (Kollmuss et al. 2008; Lovell etal. 2009), choices that aect nancial accountingdisclosures appear to be taking place among a much

smaller group o experts. As a result, one o the objectiveso this project is to open up the debate about how toaccount or emissions allowances to involve a wideraudience. It is why this work has been supported by apartnership between the International Emissions TradingAssociation (IETA) and ACCA. The IASB/FASB EmissionsTrading Schemes project is due to publish its DratExposure in late 2011, which means that the research isalso timely.

Aims

The project had ve aims.

1. To survey the treatment o carbon emission allowanceswithin the nancial statements o large EU ETS emittersin order to establish a baseline understanding ocurrent accounting practices.

2. To assess awareness and knowledge o the IASB/FASBEmissions Trading Schemes project, and to evaluate itsprobable eect on current and uture choices onancial accounting approach.

3. To establish an understanding o opinions on how toresolve the absence o accounting guidance oremission allowances.

4. To explore the theoretical implications o the researchndings.

5. To disseminate the research ndings to a range opolicy and academic audiences in order to illuminatethe political and institutional challenges andopportunities that exist or governing the nancialaccounting treatment and reporting o emissionallowances.

Besides a practical and policy need or the research (orexample, because o the lack o comprehensive up-to-dateinormation about nancial accounting practices o rmsin the EU ETS), there are also important conceptualaspects to address. Rules and practices are still ‘hot’ orunsettled (Lohmann 2009) and, hence, this settingprovides an opportunity to explore the process by whichnew accounting principles and practices come into being.Several theoretical rameworks could be used tounderstand what is going on, including: theories oaccounting and society, theories o measurement andcalculation, and economic sociology approaches. Conceptsand ideas rom these three broad areas o literature areused as lenses to explore the political and institutionalchallenges o governing the nancial reporting oemissions allowances and to assess whether there is

anything particularly new or dierent about the treatmento carbon in nancial statements (see Chapter 3). Thesethree literatures have been chosen because they arejudged to be most relevant and to provide the best insights



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into the issues that are emerging in emission allowanceaccounting. Chapter 3 has been purposeully designed as astand-alone chapter, and readers rom a non-academicbackground may wish to skip or skim-read this chapter.

meThod

A two-stage approach to surveying the accounting choiceso corporate players in the EU ETS has been adopted: asurvey o nancial statement disclosures, and a series otelephone interviews.

sta : faca tattA desk-based review and analysis o the 2008 nancialstatements o the largest emitters within the EU ETS wasconducted in order to establish their accounting treatmento carbon emissions (2008 was the most recent year orwhich veried emissions data were available). The choice othe companies surveyed was dictated by a desire tocapture disclosure data or at least 25% o all EU ETScarbon emissions. This 25% cut-o point ensured that weincluded in our survey the emission allowance accountingpractices o the main polluters, or whom emissions aremost likely to be material to their accounts. The EuropeanCommission’s Community Independent Transaction Log(CITL) was used to identiy installations (that is, individualactories/power stations) that emitted the largest amounto carbon. Given that the CITL provides only details oinstallations, and not company data, a matching oinstallations to organisations was undertaken. Thereore,68 installations were selected rom the CITL, which equate

to those responsible or approximately 26% o the EU ETStotal veried emissions in 2008. The companies owningthe installations were then identied by Internet searches,revealing that 26 organisations collectively owned these 68installations (the companies surveyed are listed in Table 1.1).

Analysis o the accounting disclosures made in thenancial statements o these 26 companies was guided,with some modications, by the questions (see Appendix)used or the EU ETS survey undertaken by IETA andPricewaterhouseCoopers (PwC and IETA 2007). Inconducting the survey, particular attention was paid to the‘Notes to the nancial statements’, which detailed theaccounting policy ollowed and in some cases alsoprovided a justication or the accounting choices made.

Ta 1.1: eu eTs ca’ faca t

Company name EU ETS sector(s)

Acelormittal Combustion; Iron and Steel

BEH Other

British Energy Combustion

CEZ Combustion

Drax Combustion

East Energia Combustion

EDF Combustion

EDP Combustion

Edson Combustion

Endesa Combustion

Enel Combustion

EON Combustion

Essent Combustion

Grosskratwerk Combustion

Iberdrola Combustion

Nuon Combustion

PPC Combustion

PGE Combustion

Ruukki Iron and Steel

RWE Combustion

Saras Rening

Shell Rening

Tata Steel Coke ovens; Iron and Steel

Tauron Combustion

Thyssenkrupp Iron and Steel

US Steel Košice sro Iron and Steel



11ACCOUNTING FOR CARBON 1. INTRODUCTION

To support stage one o the survey, a literature review anddocumentary analysis was undertaken to provide a briehistory and overview o accounting standard-setting oremissions trading (see Chapter 2). A review o the relevant

academic literature in this area has also been conducted(see Chapter 3).

Some issues arose as stage one o the researchprogressed, particularly the ollowing.

A small number o installations initially selected rom•

the CITL list could not be linked to nancial statements,either because the annual report could not be ound orbecause it was in a language not spoken by theresearch team. To resolve this issue, the nextinstallation rom the CITL list was selected to ensurethat the 25% target o EU ETS emissions or the surveysample was obtained.

We initially planned to use Carbon Disclosure Project•

(CDP) reports as a point o comparison with thenancial statements. We ound, however, that the CDPreports had less detailed inormation than nancialreports and permission to use CDP data could only beobtained i this ACCA–IETA report would not be sold atsome uture date – a matter that, as researchers, we didnot control.

We experienced some difculties in categorising the•

accounting treatment o emission allowances. Forexample, in our initial analysis a large number o

accounting practices were grouped as ‘other’ (using thePWC–IETA template – see Appendix). This problem wasresolved by undertaking more detailed analysis oaccounting practices, but in some cases we stillstruggled to create a categorisation that could copewith the diversity o accounting practices.

A small number o companies in our sample (our)•

disclosed no inormation on emission allowanceaccounting in their nancial statements. This wasunexpected, given the anticipated signicance o theirexposure to the EU ETS. Because these organisationsare large multinational companies it may be, however,that emission allowances are not material to theiraccounts. This is an issue we were unable to clariybecause o the absence o any inormation about thenancial ramications o their EU ETS position. Weemailed these our companies directly to requestinormation about their accounting treatment oemission allowances. This approach yieldedinormation rom one company.

sta t: t tThe second stage o the work built upon the rst, andconsisted o a series o telephone interviews.

Representatives rom all 26 companies surveyed in stageone o the research were invited or a short ollow-uptelephone interview (o 15 to 30 minutes’ duration) toexplore in more detail why they had adopted theaccounting practices they used; rom where they soughtand obtained advice and inormation in this area; theiropinions on possible uture changes to EU ETS accounting;and the role o accounting standard setters in this context.Initial requests were sent to their investor relationsdepartment, or they were contacted via IETA: thesepreliminary contacts were ollowed up (as necessary) by atelephone call and/or a urther email. The questions wereemailed to interviewees in advance o the interview and thesame questions were asked in all interviews. It was hopedthat a minimum o ten companies would agree toparticipate in a telephone interview, but only ve interviews(19% o companies) were secured. The main reason given(by six companies) or reusing to participate in the surveywas because o concerns about commercial condentiality.This suggests that the accounting treatment o emissionallowances and their impact on corporations is signicant.

The interviews that were conducted were digitally recorded(with each interviewee’s permission) and transcribed.Coding o transcripts was undertaken using the qualitativesotware package ‘Atlas’ and an inductive approach tocoding.

This introductory chapter has discussed the rationale orthe research, its aims and the methods used. In the nextchapter we provide some more detailed background to thestudy, including an overview o the EU ETS and a summaryo how international accounting standard setters have thusar sought to deal with emission allowances.



12

In this chapter the European Union Emissions TradingSystem (EU ETS) is introduced, and the accountingtreatments or emission allowances proposed by standardsetters are discussed. The chapter seeks to provide an

outline o the policy and political context o the study,covering issues such as the launch and subsequentwithdrawal o IFRIC 3 (emission allowance accountingguidance) in 2005, dierences in emission allowanceaccounting between Europe and the United States, and anupdate on the IASB/FASB Emissions Trading Schemesproject. Through this necessarily partial overview o thehistory o accounting standard setting or emissionstrading, it is hoped that a avour is conveyed o thetechnical complexity and ambiguity o the treatment oemissions allowances in nancial accounting, and o theact that to date standard setting in this area has been amessy and uncertain process.

The europeAn union emission TrAding sysTem(eu eTs)

The EU ETS has been operational since January 2005, andis the largest multi-country, multi-sector GHG emissiontrading system worldwide. It represents a major plank othe EU’s emission reduction target (which is or a 20%reduction rom 1990 levels by 2020). The scheme requireseach member state to set a cap on emissions, andallowances (termed EUAs) are then allocated (and, iappropriate, subsequently traded) up to the amount oallowances issued. Thus ar, the large majority o emissionallowances (c.95%) have been granted to companies ree

o charge by governments. Installations are covered by theEU ETS i they are deemed to be ‘major emitters’ andthese include combustion plants, oil reneries, coke ovens,iron and steel plants, and actories making cement, glass,lime, brick, ceramics, pulp and paper. Currently, over11,500 installations across Europe are governed by the EUETS and collectively they represent approximately 50% oEurope’s emissions o carbon dioxide (and 40% oEurope’s total GHG emissions).

The EU ETS has been split into three compliance periods:

Phase 1 (which ran rom 2005–7 and which was•

purposely designed as a learning phase)

Phase 2 (which runs rom 2008–12 and which is•

currently in place), and

Phase 3 (which will run rom 2013–20).•

Installations must surrender (by 30 April o each year)allowances equal to their emissions during the previouscalendar year. In Phase 2 there is a penalty o €100 orevery tonne o emissions that does not have matchingallowances.

To date, most emission allowances (approximately 95%)have been allocated to installations ree o charge. This hashad an eect on accounting practices, with allowancestypically being shown in accounts at nil value (on the basis

o their cost). In Phase 3 o the scheme, however, a shit tomore auctioning o allowances is planned (under ECDirective 2009/29/EC) with 70% o allowances beingauctioned by 2020 (and at least 50% rom 2013). This willhave a knock-on eect on accounting practices (a pointreturned to in Chapter 5).

The auctioning o allowances will be organised and carriedout individually by EU member states, and the amountauctioned will vary rom sector to sector. For instance,electricity generators will have ull auctioning rom 2013(albeit with some scope to opt out). In other all industrysectors auctioning will be phased in more gradually:starting at 20% in 2013 and increasing to 70% by 2020(Europa 2008; EC Directive 2009/29/EC 2009).

The EU allows credits rom the United Nations KyotoProtocol ‘Flexible Mechanisms’ (that is, the CleanDevelopment Mechanism (CDM) and Joint Implementation(JI)) to be used by companies to meet EU ETS compliancetargets, albeit that an upper limit or the use o thesecredits has been set. The European Commission has ruledthat Kyoto credits can orm a maximum o 50% o EU-wideemission reductions in the period 2008–20 (equal toabout 1.6 billion credits). For existing installation operatorsthis means that in Phase 2 (the current phase) a maximumo about 11% o allowances surrendered can be covered by

Kyoto credits (Europa 2008).

Emission allowances are sold and purchased or dierentreasons, including the need to have, at the surrenderingdate, the number o allowances that match the actualemissions o an installation; allowances can also be assetsheld or trading. The EU ETS, thereore, has generated amarket or emission allowances. Prices o EUAs have beenvolatile in the period between 2008 and 2010. Forexample, in July 2008 an EUA was priced at €28 euros onthe spot market, yet by February 2009 this price had allento €8 euros. The current trading band or EUAs (in May2010) is at about €10–€15.

The all in EUA prices in early 2009 can be linked to therecession, with a number o emission allowances beingsold because o declining industrial output (and thereorereduced GHG emissions). In addition, as could beexpected, companies were short o cash at this time andlooking or additional unds. Indeed, there is evidence thatallowances were sold to provide short-term unds (Capoorand Ambrossi 2009). The ability or EUAs to provide asource o unds was also acilitated by the process bywhich allowances are allocated each year. Specically,while installations must surrender their allowances by the

2. e ta a faca acct



13ACCOUNTING FOR CARBON 2. EMISSIONS TRADING AND FINANCIAL ACCOUNTING

end o April the year ater the compliance period, they areissued with allowances in February o the calendar yearcorresponding to the compliance period. This means thateven i a company sold 2008 allowances to raise cash, it

could still use its 2009 allowances (issued in February2009) i it had a shortall o allowances at April 2009.Clearly EUAs are an asset to an organisation and are usedto oset emissions as well as having a nancial use (in thisexample, through the regulation o cash ows).

Ta 2.1: T atat aac t eu eTs ca

Company name Currency/units

Assets emission

allowances (I) Assets total (II) % (I/II)

Liabilities

emission

allowances (III)

Liabilities total

(IV) % (III/IV)

BEH

000s BGN

(Bulgarian Levs) 38,585 3,488,399 1.11%

CEZ

000,000s CZK

(Czech koruna) 1,523 473,175 0.32% 1,033 287,765 0.36%

Drax

000,000s

pounds 26 2,107 1.25% 158 1,414 11.20%

East Energia 000s euros 9,074 638,089 1.42%

EDF 000,000s euros 552 200,288 0.28% 397 175,446 0.23%

EDP 000s euros 385,096 35,709,095 1.08% 496,425 27,162,186 1.83%

Edson 000,000s euros 15 15,093 0.10%

Endesa 000,000s euros 568 58,546 0.97% 518 37,782 1.37%

Enel 000,000s euros 10 106,912 0.01%

EON 000,000s euros 1,094 71,763 1.52%

Essent 000,000s euros 450 12,991 3.46% 20 7,738 0.26%

Grosskratwerk 000s euros 19,040 574,496 3.31% 19 460,354 0.004%

IBERDROLA 000s euros 520,821 85,837,029 0.61% 484,042 59,331,301 0.82%

PCC 000s euros 108,073 8,972,857 1.20%

PGE

000s PLN (Polish

zloty) 9,931 47,192,261 0.02% 391,271 17,016,683 2.30%

RWE 000,000s euros 1,216 93,430 1.30% 1,396 80,290 1.74%

Saras 000s euros 83,175 3,236,258 2.57% 5,135 1,925,205 0.27%

US Steel Košice,

s.r.o. 000 euros 165,794 2,134,112 7.77% 137,633 953,166 14.44%

Average 1.75% 2.41%

In addition, the value o emission allowances may be large(and at times material in accounting terms) where thecompany is a large emitter. For example, in 2008 theEndesa Group (an electricity generation and supply

company) had to surrender allowances to cover 30 milliontonnes o emissions, which were valued at €518 million(representing 1.37% o total liabilities).6 Table 2.1 givesurther examples o the materiality o emission allowancesto EU ETS companies.7

6. See page 43 o Endesa’s 2008 Consolidated Financial Statement.

7. Note that Table 2.1 contains inormation or 18 o the total 26

companies surveyed. This is because 10 companies did not disclose

sufcient inormation on their assets and liabilities to allow comparisons.



14

At present, the accounting treatment or allowances asassets and liabilities varies signicantly betweencompanies, because dierent types o accountingclassication and measurement can be used (see Chapter

4), thus making direct comparison between companiesdifcult. The aim o Table 2.1 is to illustrate how emissionallowances may, in general terms, aect nancialstatements. The table contains inormation on emissionallowances classied as Assets and Liabilities on 31December 2008 (with the exception o East Energia, whoseyear end is 31 March 2008). The materiality percentagesshown in Table 2.1 are likely to be an underestimate oactual materiality (typically considered to be in the orderto 5–10% o total net assets/liabilities, but with signicantvariation according to proessional judgement on a case-by-case basis). This is because Table 2.1 expressesmateriality as a percentage o carbon allowances over totalassets. In act, most assets in these companies havelie-cycles o 40 years, and yet carbon has a liecycle oonly one year. An alternative method o calculation (whichmay bear a closer t with the true value and materiality ocarbon assets to a company, revealing them to be muchhigher) would be to calculate the value o carbon as apercentage o operating prot. So, although the materialitypercentages in Table 2.1 seem small, we have used aconservative methodology, which is likely to haveunderestimated their signicance. Further, i there aresome companies in a sector that disclose substantialcarbon assets and liabilities, while other similar companiesdisclose nothing, then this diversity is material, because itis misleading to the users o the reports. This so-called

‘issue materiality’ is evident rom our ndings.

ACCounTing or emission AllowAnCes

According to IASB rules, in cases where no accountingstandards apply, paragraph 10 o IAS 8 Accounting

Policies, Changes in Accounting Estimates and Errors shouldbe ollowed. This requires that management should use itsjudgement in developing and applying an accountingpolicy that results in inormation that is relevant andreliable, in consultation with the rm’s auditors. The resulto this would be that the issues involved in accounting oremission allowances would be governed by a number oexisting international nancial accounting standards,

including: International Accounting Standard (IAS) 2Inventories; IAS 20 Accounting or Government Grants andDisclosure o Government Assistance; IAS 37 Provisions,

Contingent Liabilities and Contingent Assets; IAS 38Intangible Assets; and IAS 39 Financial Instruments:Recognition and Measurement . The array o potentiallyrelevant standards arises owing to the multiple sources o,and uses or, emission allowances. Allowances may bedirectly linked to operational concerns (that is, they maybe held in order to comply with the EU ETS rules) as wellas or trading purposes (that is, they are bought and soldat dierent prices in order to generate prots).

The various possible uses o allowances leads to ambiguityabout what sort o ‘thing’ an emission allowance is inaccounting terms: is it a commodity or a nancialinstrument? Should it be recognised as an asset even i it

is acquired at zero cost? Such questions pervade technicaldiscussions by standard setters and accountingpractitioners (see, or example, IASB 2009). Moreover,because nancial accounting guidance or emissions is stillin a state o ux, uncertainty has ourished since the starto the EU ETS in 2005.

An especially tricky issue or accounting standard settersis that although individuals and organisations legitimatelyuse carbon credits (including emissions allowances) indierent ways (or example, to comply with regulation, tooset their emissions voluntarily and to trade on themarket) allowances are not linked to any specic use. So,or example, a company operating under the EU ETS couldinitially attribute an emission allowance to production (andthus ollow one set o accounting practices), but thensubsequently change policy and trade it with the aim oregulating cash-ow. This combination o the potential oemission allowances or multiple use and theirinterchangeability makes it challenging to issue one set oguidance under a single international accounting standard.

The difculty or management in knowing exactly whyallowances are held at any one time helps to explain theemergence o an ‘activity-based’ model o accounting(which appears to have been adopted by accountantssince the withdrawal o IFRIC 3 – see Chapter 4). Indeed, in

its comprehensive guidance in this area the accountingrm KPMG suggests a type o activity-based model (KPMG2008), which recommends that accountants ollowdierent accounting principles depending on the type oorganisation they are accounting or, and hence the type oactivity that is being undertaken. KPMG’s classication(2008) o organisations according to their dominantactivity includes: emitters, creators o green energy,traders/aggregators, and investors/consultants.

The IASB, in contrast, is not predisposed to avour an‘activity-based’ approach to accounting or emissionallowances as it does not sit easily with its own principles-based approach to standard setting (see discussion

below). The rationale is that, even though emissionallowances are used in dierent ways, this should notaect the accounting treatment because the allowancesare all EUAs/CERs. In other words, the IASB view is thateven i emission allowances are assigned temporally byusers to a particular purpose, their use can potentiallychange at any moment and, consequently, they should betreated by accountants consistently in a single, uniormway.




The iriC 3 debACle

Steps are currently being taken, principally by the IASBand the FASB, to attempt to resolve the uncertainty

surrounding the accounting o emission allowances. Theremainder o this chapter ocuses on the history o IASBand FASB guidance on emissions trading and the currentstatus o the IASB/FASB Emissions Trading Schemesproject (relaunched in 2008).

In the run up to the advent o the EU ETS, accountingguidance was issued by the IASB via its InternationalFinancial Reporting Interpretations Committee (IFRIC):IFRIC Interpretation 3: Emission Rights (known as ‘IFRIC 3’)was published in December 2004. IFRIC 3 recommendedthat assets (specically EUAs) should be treatedindependently rom liabilities arising under the EU ETS.Accordingly, the measurement o liabilities on the basis othe carrying value o allowances (assets) in this area wasnot permitted. More specically, IFRIC 3 gave guidance tothe eect that EUAs should be treated as intangible assets(regardless o whether they have been allocated ree ocharge or purchased) and thereore all under theaccounting treatment and disclosure remit o IAS 38.Further, allowances that are allocated or less than airvalue (recalling that EUAs have historically been allocatedree o charge, although this is set to change in Phase 3 othe EU ETS) should be measured initially at their air value(that is, at market price), and the dierence between theamount paid and air value should be identied as agovernment grant and thereore accounted or under IAS

20 ( Accounting or Government Grants and Disclosure o Government Assistance). This ‘grant’ should initially beclassied as deerred income in the balance sheet, andsubsequently recognised as income over the complianceperiod.

In terms o assessing and accounting or liabilities, IFRIC 3judged that a liability to provide EUAs should berecognised in the accounts as the emissions are made,and that this obligation should be treated as a ‘provision’and hence covered by IAS 37 (Provisions, Contingent

Liabilities and Contingent Assets). The liability should againbe measured at air value (that is, the best estimate o theexpenditure required to settle the present obligation at the

balance sheet date).

The amount o controversy that IFRIC 3’srecommendations generated was striking and led to itseventual withdrawal. There was negative reaction rom EUETS participants, especially by utilities and large industryemitters. The European Financial Reporting AdvisoryGroup (EFRAG) issued a particularly negative endorsementadvice, which carried considerable weight (Bebbington

and Larrinaga-Gonzalez 2008). The main objectionsincluded one against the IFRIC 3 recommendation thatgains and losses derived rom the valuation o liabilities bereported in the Income Statement, while the gains and

losses derived rom any revaluation o the emissionallowances were recognised under Equity in the balancesheet (this is what is known as a ‘mixed presentationmodel’). Additionally, the nature o dierent assets, somemeasured on recognition at cost and others at air value(known as a ‘mixed measurement model’) also causedconcerns (Bebbington and Larrinaga-Gonzalez 2008;Cook 2009; MacKenzie 2009). These mismatches ledEFRAG to consider that the IFRIC 3 recommendationswould lead to articial volatility in company results,considering that only a small amount o the total emissionsrights contained within the EU ETS is purchased. Given thenegative endorsement advice rom EFRAG, as well as theviews o the European Commission, the IASB withdrewIFRIC 3 in June 2005.

In the period since then there has been no internationalguidance on how to account or emission allowances and adiversity o practices has emerged (PwC and IETA 2007;McGready 2008; Cook 2009; MacKenzie 2009). Asdiscussed in detail in Chapter 4, the majority o EU ETScompanies have been practising a ‘cost with balance atmarket value’ approach (which IFRIC 3 specicallyprohibited) where allowances are measured at nil value(because they are acquired or no charge), and the liabilityto surrender allowances is similarly measured at nil value(again, because the allowances do not cost the company

anything), with any shortall or excess in allowances beingvalued at market price.

Having noted a lack o international accounting regulationin this area it is relevant to acknowledge that someEuropean countries have issued guidance through nationalaccounting regulations. For instance, in Spain regulationrequires a broadly IFRIC 3 approach. The point whereIFRIC 3 and the Spanish approach depart rom each otheris with respect to accounting or provisions: in Spainprovisions are not valued at air value but at the carryingvalue o the allowances (an approach taken in order toavoid volatility).



16

dierenCes beTween europe And The uniTedsTATes

Accounting or emission allowances has ollowed dierent

trajectories in Europe and the United States (US). Indeed,approaches to emissions trading schemes dier betweenthe two jurisdictions (carbon markets in the US have beenmuch slower to emerge than in Europe, and there isnothing yet comparable in size and scope to the EU ETS).The distinction between Europe and the US is relevantbecause the accounting standard setters’ EmissionsTrading Schemes project involves a collaboration betweenthe IASB and the FASB. As a result, views rom the US willaect the content o the Emissions Trading SchemesExposure Drat when it ultimately emerges in the secondhal o 2011.

In the US, the sulphur dioxide emissions trading scheme(which commenced in 1995) led to the need or USaccounting guidance (Johnston et al. 2008; MacKenzie2009). The Federal Energy Regulatory Commission (FERC)has been the most inuential organisation in determiningthe accounting treatment in this area because utilities havebeen most directly aected by sulphur dioxide regulation,and FERC is the organisation that directly regulates energyutilities in the US – its remit includes surveillance o theiraccounting practices (Deloitte 2007). Indeed, FERC is theonly US organisation to date that has issued any emissionallowance accounting guidance: there is no accountingstandard or interpretation on accounting or GHGemissions within US Generally Accepted Accounting

Principles (US GAAP) (Ernst and Young 2010). Moreover,there is no distinction between accounting or dierenttypes o emission allowances in the US (whether they besulphur dioxide, nitrous oxides or carbon dioxide): theaccounting rules (such as exist) are the same or all typeso emissions.

The recommendation in the FERC Uniorm System oAccounts is that emission allowances should be classiedas inventory, measured on a historical cost basis (that is,they should be valued at their original cost, in most caseszero), with recognition o costs as emissions are made(that is, as the allowances are ‘consumed’) on a weighted-average cost basis (Deloitte 2007). Although FASB claims

that most companies in the US are accounting oremission allowances as inventory, research by Ernst andYoung has shown a more mixed approach, with manycompanies recognising them as intangible assets (Ernstand Young 2010). US companies, such as utilities thatrequire emission allowances or compliance (and hencesee them as an essential part o the production process),tend to ollow the inventory accounting model, whereascompanies that have more varied business activities (orexample, producing credits rom projects in developingcountries, trading credits) tend to ollow the intangible

asset model (Deloitte 2007). Under both the inventory andintangible assets accounting models, the company doesnot typically recognise an obligation to deliver emissionallowances to the regulator until the actual level o

emissions or the year exceeds the number o allowanceson the balance sheet (Ernst and Young 2010). Thisprocedure is thereore similar to the EU ETS companyapproach o valuing at cost, with the balance measured atmarket price. In practice, this means that only the shortallin allowances is disclosed in the nancial statements.

It was not until late 2003 that the FASB Emerging IssuesTask Force (EITF) attempted to address the question oaccounting or emission allowances (in Issue No. 03–14,titled ‘Participants’ Accounting or Emissions Allowancesunder a ‘Cap and Trade’ Program’) (FASB 2010). Theproposal, however, was not taken orward because oconcerns that the accounting recommendations mighthave implications beyond cap and trade schemes (orexample, or the accounting o government licences andpermits) and because some EITF members did notperceive that there was any diversity in emission allowanceaccounting practice (Deloitte 2007).

The accounting o emission allowances did not, however,totally disappear rom the FASB agenda. In late 2004,FASB Statement No. 153 Exchanges o Nonmonetary Assets raised questions about whether ‘vintage year’ emissionallowance swaps should be accounted or at air value oron the basis o the recorded amount. ‘Vintage year’emission allowance swaps are the trades between

companies o similar emission allowances. In a typical UScap and trade carbon market, each individual emissionallowance has an assigned vintage year, indicating the rstyear in which that allowance may be used. Allowances withthe same vintage year designation can be traded orswapped. Vintage-year swaps among companies arecommon, because government agencies typically issueallowances or multiple years at a time. So the issue orFASB was whether or not vintage-year swaps should beaccounted or at air value, in keeping with FASBStatement No. 153 Exchanges o Nonmonetary Assets,where assets classied as inventory would generally bemeasured at air value i exchanged. In 2006, the FASBTechnical Application and Implementation Activities

Committee approved a recommendation or the FASBBoard to add a project to its agenda to address the natureo emission allowances and clariy the accounting methodin relation to vintage-year swaps. The external reviewingprocess conducted by FASB revealed a strong opinionamong industry and accounting rms that the issue ovintage-year swaps touched on wider issues aboutemissions trading accounting, which itsel indicated a needor a more holistic and systematic review. This externaleedback eventually led to the establishment o the jointIASB/FASB Emissions Trading Schemes project in 2008.




The 2008 iAsb/Asb emissions TrAding sChemesprojeCT

The joint IASB/FASB Emissions Trading Schemes project

aims to resolve accounting uncertainty by issuing clearguidance. Originally scheduled to publish an ExposureDrat in late 2009 and then in late 2010, the project hasnow been urther delayed and the Exposure Drat isexpected in the second hal o 2011, with the aim opublishing an International Financial Reporting Standard(IFRS) by the end o 2012 (IASB 2010).

The IASB/FASB project has a broader remit than theormer IASB project. In particular, the project covers notjust the EU ETS but seeks to produce a standard thatwould be suitable or accounting o all tradable emissionsrights and obligations arising under any existing orproposed Emissions Trading Schemes worldwide, therebyanticipating that there will be a growth o emissionstrading schemes across the globe.

To date, IASB and FASB have made relatively modestprogress in reaching decisions on emissions trading. Forexample, the IASB Board decided in March 2009 thatemission allowances are assets (even i received ree ocharge rom government) and that they should thereorebe measured initially at air value (resolving the so-called‘Day One recognition problem’). In contrast, FASB has notyet reached agreement on the issue o initial recognitionand asset status, suggesting that it will or does have somedifculty with the IASB position. According to one source,

the reason why FASB has yet to reach a decision on theissue o ‘Day 1 recognition’ appears to be that the FASBBoard’s preerence is to look at accounting or emissionsin its entirety (that is, to view emissions trading schemes ina more holistic manner). In this context, it could be arguedthat emission allowances are not really a ‘gain’ to incomebecause the company has to return them at the end o theyear. In essence, FASB is hesitant to recognise in nancialstatements that a gain has been made on receipt o anallowance, where that allowance is given out at no charge.Moreover, there are also concerns about the politicalimplications o adopting such an accounting treatment, inlight o criticism o corporate prot-making rom EmissionsTrading Schemes (Lohmann 2006; Harvey and Fidler

2007).

This dierence in approach between IASB and FASB alsoowes much to the more undamental divide in theirorganisational cultures and practices. Key to this is the‘principles-based’ method o standard-setting avoured bythe IASB (a preerence or ollowing a set o overarchingguidelines in order to evaluate each specic accountingcase) compared with the more ‘rules-based’ approachavoured by the FASB (where new rules might bedeveloped or each specic accounting case depending onits individual characteristics, which may or may not t withother rules or overarching guidance; a preerence or an

‘activity-based’ accounting model, as discussed above).While this tension is by no means exclusive to theEmissions Trading Schemes project, it does appear to behampering decision making in this specic context.

summAry

In this chapter, the EU ETS has been introduced, and theissues arising in setting accounting standards or emission

allowances in Europe and the US outlined. It is evident thatthere is a shortage o specic accounting guidance oremission allowances. Eorts have been made to addressthe situation but, thus ar, mostly in a rather haphazardand piecemeal way: at least until we see the nal outcomeo the joint IASB/FASB Emissions Trading Schemes projectin late 2012. In the next chapter, we take a step back romthese intricate nancial accounting issues to considerrelevant academic theories that give insights to the issueo emission allowance accounting.



18

Conceptualising accounting or emission allowancespotentially cuts across a number o dierent theories andbodies o research. There are a range o relevant literaturesto draw upon which oer useul insights into how and why

accountants might be accounting or emission allowances.In this chapter concepts and ideas rom three broad areaso literature (namely theories o accounting and society,theories o measurement and calculation, and theories abouthybrid markets) are used rst as lenses to introduce andexamine the political and institutional challenges o governingthe nancial reporting o carbon, and secondly to assesswhether there is anything particularly novel or dierentabout the treatment o carbon in nancial statements.

The review undertaken here is necessarily brie: it is notthe authors’ intention to provide a ull summary o theliterature, but rather to consider how this material mightprovide insights into accounting or emission allowances inthe EU ETS.

Theories o ACCounTing And soCieTy

Scholars examining the relationship between accountingand society argue that accounting is not only relevantwithin the boundaries o a particular rm but plays aconstitutive role in social processes more generally(Hopwood and Miller 1994). This proposition suggests thatwe should be interested in how the accounting proessionis responding to increasing societal concerns aboutclimate change as well as the role that accounting plays inshaping and inuencing how we make sense o, and deal

with, climate change. As Miller (1994) suggests,‘accounting could not and should not be studied as anorganizational practice in isolation rom the wider socialand institutional context in which it operates’. In otherwords, social processes shape, and are shaped by,accounting. As this rationale equally applies to the issue oaccounting and climate change (or examples o work onthis theme see: Bebbington and Larrinaga-Gonzalez 2008;Cook 2009; Lohmann 2009; MacKenzie 2009), then thiscurrent report builds on and urther develops this existingresearch, particularly in relation to strengthening itsempirical base.

An approach to understanding the nancial accounting ocarbon that takes heed o ideas rom the accounting andsociety literature would position accounting as closelyconnected to wider societal debates about not just theenvironment, but also (or example) the relationshipbetween markets and governments and the role o science.Further, it would view accounting as having the capacity toshape society itsel, as Miller (1994) explains:

accounting is, above all, an attempt to intervene, to act upon individuals, entities and processes to transormthem and to achieve specic ends. From such a

perspective, accounting is no longer to be regarded as aneutral device that merely documents and reports ‘the

acts’ o economic activity. Accounting can now be seenas a set o practices that aects the type o world we livein, the type o social reality we inhabit, the way in whichwe understand choices.

In theory, accounting (according to proessional codes oconduct) is supposed to reect ‘economic reality’ andsocietal preerences and practices, but can in practice endup inuencing them (Miller 1994; Power 1999). The

accounting and society literature is valuable, thereore, asa counter to the implicit assumption within the non-accounting academic literature on climate change policy,politics and markets that accounting is rule-based.

Indeed, scholars have drawn attention to the oten subtleways that power is expressed in decisions about detailed,technical accounting rules and principles (Miller 1994;Miller and O’Leary 1994; Thompson 1994). Accountingcan be a way o making things appear ‘anti-political’(Barry 2005) and seemingly uncontroversial, but thetechnical debates about accounting principles andstandards sometimes involve intense power struggles. Withaccounting or emission allowances still in its ormativestages (and with many critical decisions to be made) closeattention to current governance processes and decisionmaking (standard setting in particular) is likely to yieldtheoretical and policy insights. Further, becauseaccounting rules and principles (once decided) will have apotentially material inuence on company nancialstatements (namely, prot measures, disclosures, assetsand liabilities), they are likely to be, increasingly, a site oconict.

Theories o meAsuremenT And CAlCulATion

When a more indirect approach to understanding carbon

accounting is taken, there are insights to be gained rombroader political science and science and technologystudies literature about measurement, classication,quantication and commensuration on topics as diverse asmedicine and atmospheric science (Alonso and Starr1984; Espeland and Stevens 1998; Bowker and Leigh Star2000) as well as accounting (Robson 1992; MacKenzie2006).

This literature provides an analysis o how diversephenomena are ‘made the same’, examining the role thatclassications and standards play, who does that work,and what happens to cases that do not t into standardcategories that have been constructed. For instance, intheir analysis o health service and race classications,Bowker and Leigh Star (2000) demonstrate how systemso measurement are typically paid little attention on aday-to-day basis:

Good, useable systems disappear almost by denition.The easier they are to use, the harder they are to see. Aswell, most o the time, the bigger they are, the harder

they are to see. (Bowker and Leigh Star 2000)

With nancial accounting being one such pervasive ‘bigsystem’ (a ‘metadevice’, to use the language o MacKenzie2009) it provides an interesting case through which to

examine the distinctiveness o climate change as aproblem. There is as yet nothing habitual about accountingpractices in this area, in contrast to much otheraccounting, which is relatively ingrained, ‘black-boxed’ and

3. Ccta acct aac



19ACCOUNTING FOR CARBON 3. CONCEPTUALISING ACCOUNTING FOR EMISSION ALLOWANCES

routine (MacKenzie 2006). As a result, there is anopportunity to conduct empirical research in this areabecause o the continuing uncertainty about how tomeasure and account or carbon, and the visibility o the

systems o measurement and classication that areactively under construction.

One topic rom this broader literature that is particularlyrelevant or analysis o accounting or emission allowancesis analysis o so-called ‘incommensurables’. Bowker andLeigh Star (2000), or instance, suggest concentratingcritical analysis on cases that do not t in(incommensurables) because these phenomena highlightunresolved tensions. Emission allowances do not t neatlyunder any existing accounting standard, and hence arehard to classiy, thereby making them a type o‘incommensurable’. The difculties presented inaccounting or emission allowances have their origins inthe multiple potential uses o allowances: as a commodity,a currency, a nancial instrument and so on. This situation,in turn, has arisen rom political decisions to adopt amarket-based trading mechanism or implementinginternational climate change policy. As Espeland andStevens (1998) explain ‘claims about incommensurablesare likely to arise at the borderlands between institutions,where what counts as an ideal or normal mode o valuingis uncertain’; and, urther, that ‘commensuration is noticedmost when it creates relations among things that seemundamentally dierent’ (Stevens 1998). MacKenzie(2009) makes precisely this point with regard toaccounting or carbon, outlining how markets in rights to

emit GHGes can only exist i a variety o dierent thingsare somehow ‘made the same’. He uses the example ohow the Clean Development Mechanism allows thedestruction o one tonne o an industrial waste gas,triuoromethane, or HFC-23, in a acility in China to beconverted into rights to emit up to 11,700 tonnes o carbondioxide in a power or heat generation plant in Europe(MacKenzie 2009). The assumptions used to create thisequivalence can be challenged on a number o levels, andwe can useully add to existing scholarship in this area byshowing how these tensions play out in practice in thenancial accounting o carbon within the EU ETS.

Theorising hybrid mArkeTs

The third set o ideas that is relevant or our investigationhere is about how economic and nancial markets arecreated. An interdisciplinary approach to the study omarkets asserts that markets are not just economic ornancial entities but comprise a mix o people, technology,objects and things. This conception o a market drawsrom economic sociology (White 1981; Fligstein 1996;Callon 1998; Barry 2005; Hardie and Mackenzie 2007;Pryke 2007; MacKenzie 2008). Pryke (2007), or example,assesses the emergence o weather-based nancial tradinginstruments since the late 1990s, using what he terms a‘cultural economy’ approach to nance. Likewise, Hardie

and MacKenzie (2007) examine the workings o hedgeunds, showing how the market or such investments isconstructed and shaped by a mix o people andtechnologies.

Work in economic sociology is concerned with howeconomic markets are separated rom everyday relationsand made into a recognisable, working mechanism oexchange (Callon 1998; Munro and Smith 2008). In this

context, examining the microstructures o markets orcarbon ocuses attention on the intricate networks opeople and ‘things’ that constitute the carbon economy,thereby explaining why abstract models rarely t thespecics o particular times and places. Economicsociology approaches recognise the myriad tensions andthe hard work that goes into sustaining, or example, globalcarbon markets every minute o every day. Theseapproaches also recognise that markets have to be made,and that attention as to how particular arrangements opeople and ‘things’ come into being as markets isimportant (Lovell and Smith 2010).

One o the core arguments in this literature is that it is amix o people, objects and technologies (what Callon(1998) terms ‘agencements’) that determines what amarket is and how it evolves. Although this might soundsel-evident, such a raming serves as a useul counter toarguments (ound in carbon markets and beyond) that‘the market’ itsel has agency (an ability to act as morethan the sum o its parts). In reality, the carbon market,like other markets, is no more or less than the complexnetwork made up o various elements that it comprises. Oparticular interest in the context o this report are thetechnical accounting rules and procedures that areessential to carbon market operation. Moreover, theseaccounting rules and procedures oten lie outside the

typical rame o reerence o many key actors in thecarbon market.

Perhaps the key aid to understanding what is happening inaccounting or emission allowances in the EU ETS is Callonand Muniesa’s work (2005) on the constitution o marketsas ‘calculative collective devices’. This work is importantbecause it makes the point that calculation is distributedwidely across the various elements o a market: that is, it isnot eected through a single price mechanism or eventhrough some orm o human agency alone. So it is notsurprising that quantities such as liabilities and assetsarising rom carbon regulatory regimes are hard to pindown: they are things that circulate and transorm as they

do so (Buenza et al. 2006), they are practices enacted ora range o dierence ends (Munro and Smith 2008), andindeed they are stories that, as Velthius (2005) shows,concern rather more than simply money. Such ideas,thereore, draw attention to the importance ointerrogating in detail the variety o market devices (suchas nancial accounting) that make calculation possible(Callon et al. 2007).

Another key insight o the ‘hybrid markets’ literatureconcerns the potential or markets to be actively shapedand governed by various actors. For a new market such ascarbon (a clear example o something created, in this

instance mostly by public institutions and governments) itis important to appreciate the implications o its publicsector origin. Callon (quoted in Barry and Slater 2005)



20

neatly explains the value o seeing markets as bothgovernable and experimental when he suggests: ‘whatsociology and anthropology could bring to the [markets]debate is precisely a recognition o the experimental

character o markets and market organisation and theneed to debate the consequences o experimentation. It isa collective learning process’.

The value o these ideas about markets or carbon is inilluminating the experimental nature o a relatively recentlyconstructed environmental market – that or carbon – thatrests on the commodication o atmospheric gases, andits consequent reliance on sound, workable systems omeasurement and classication, not least nancialaccounting. Further, these ideas about markets open upthe possibility or change in how carbon nancialaccounting is carried out, not just in terms o newaccounting standards (policy and governance) but also inthe possibility o changing accounting technologies,developing new accounting working groups and so on.

A concern o Callon’s (see Barry and Slater 2005)regarding carbon markets is that the ‘raming’ o thecarbon market is premature. Market actors (includingpolicymakers and politicians) have been trying to establishboundaries and rules beore really understanding theissues at stake, or truly appreciating the novelty o carbonas a commodity. As Lohmann (2009) echoes in hisinsightul analysis o dierences between carbon and othertypes o commodity (in this case, wheat):

tensions can be expected to arise whenever a novelcommodity is being created that depends fundamentally

on the development of new accounting procedures .However, the raming o an amalgam carbon commodity

also aced many entanglements and overows that wereunamiliar to the bulk o 19th- and 20th-century trading

systems, and that arguably were not susceptible to

treatment in a straightorward way by any amount or degree o regulation. (Lohmann 2009, emphasis added)

Lohmann emphasises here the integral (and, to date,rather overlooked) role o accounting as the oundation ocarbon markets and wider climate change mitigationactivities.

summAry

In this brie review o literature, we have highlighted severalideas drawn rom work in the areas o economic sociology,

society and accounting, and commensuration that addinsights to the case o nancial accounting in the EU ETS.In particular, taken together, this literature suggests theollowing inerences.

There is nothing yet habitual about accounting or•

emission allowances, in contrast to much existingaccounting practice, which is relatively ingrained,‘black-boxed’ and routine. This makes the study oaccounting or emission allowances an interesting casestudy on the nature o accounting.

Emission allowances do not t neatly under any•

existing accounting standard because there aremultiple potential uses o the emission allowance (orexample, as a commodity, a currency and a nancialinstrument). Emission allowances are, hence, hard toclassiy, they are a type o ‘incommensurable’.

Accounting and society are closely linked: accountants•

are playing a role in inuencing how the problem oclimate change is comprehended and governedthrough the construction o accounting rules andprinciples in this area.

Accounting can sometimes make ‘things’ appear•

uncontroversial and a-political or even non-political, but

the technical debates about accounting rules,principles and standards involve intense powerstruggles. Given that emission allowances are likely tobecome more nancially material over time, suchpower struggles are to be expected, especially becausethe accounting choices will aect the nancialstatements o large corporations.

Recognition that carbon markets have been created by•

governments and other institutions opens uppossibilities or changing how they work, includingalterations in their nancial accounting ‘bedrock’.



21ACCOUNTING FOR CARBON 4. SURVEY OF ACCOUNTING PRACTICES

This chapter presents results rom the research project,drawing on the nancial statements survey undertakenand interviews conducted to shed more light on thereasons why certain accounting practices have been

adopted by EU ETS participants. The chapter is structuredaround our areas: (i) a summary o key ndings (ii) adescription o how assets are accounted or (iii) anequivalent review o the accounting treatments adopted orliabilities, and (iv) additional insights that can be drawnrom the interviews.

summAry o key indings

The main nding o this research is that large emitterswithin the EU ETS are using a diversity o accountingpractices to account or emission allowances. In particular,this has the ollowing aspects.

Most o the companies surveyed are not ollowing•

‘IFRIC 3’, the original international accounting guidanceissued in 2004 (and subsequently withdrawn in 2005).

A large proportion o the companies (42%, or 11 o the•

26) recognise emission allowances as intangible assets.

O the surveyed companies, 31% (eight companies)•

initially recognise allowances at nil value on therationale that they are issued at no charge. Only 15% othe sample (our companies) are ollowing the IFRIC 3drat guidance to recognise emission allowancesinitially at air value, with the dierence between air

value and cost o allowances classied as agovernmental grant (deerred income) on the balancesheet.

Most o the companies do not disclose any inormation•

on amortisation/depreciation o assets (69%, or 18companies), or on revaluation, o emission allowances(50%, or 13 companies).

Likewise, the majority o the companies (77%, or 20•

companies) do not disclose any inormation onCertied Emission Reductions (‘CERs’ which can beused interchangeably with EUAs).8

Companies’ accounting practices or revealing their•

overall position on emission allowances (as net assetsor liabilities) vary hugely, with no discernible pattern inaccounting treatment.

8. This nding is hard to interpret. It may be that companies have CERs

and are not making disclosures about them, or they may not be holding

any such certicates. It is not possible to veriy which situation pertains

here.

Interviews with accountants conrmed that they nd it•

difcult to account or emission allowances, andrevealed that there is a potential guidance role orauditors in the absence o an international accounting

standard. Moreover, interviews provided evidence thataccountants would generally welcome the prospect ointernational accounting guidance in this area.

Table 4.1 summarises these ndings.

Ta 4.1 sa eu eTs t tt’faca t

Emiss ion al lowance accounting Disclosure summary*Granted allowances – initialrecognition



Purchased allowances – initialrecognition



CERS – initial recognition No disclosure – 77%

Granted allowances –measurement on initialrecognition

Nil value – 31%


Fair value – 15%

Amortisation/Depreciation oemission allowances


Re-valuation o emissionallowances


Measurement o liabilities Cost with balance at marketvalue – 58%


*All percentages shown in Table 4.1 are percentages o the total survey

responses (26 companies) – they are not the percentage results o only

those companies that are disclosing.

4. s acct actc



22

TreATmenT o AsseTs

Figures 4.1 and 4.2 provide data on the initial recognitiono emission allowances in the surveyed companies’

nancial statements. This treatment does not varysignicantly whether allowances are granted ree o chargeor purchased. Figure 4.1 illustrates that just under hal thesurveyed companies classiy granted allowances (that is,those distributed by government, in the main or no chargein Phases 1 and 2 o the EU ETS) as intangible assets.Non-disclosure in this area was high, however, with almosta third (27%) o the surveyed companies not providing anyinormation in this area. Figure 4.2 indicates that orpurchased allowances (either EUAs or CERs) accountingpractices ollow a similar pattern to those or allocatedallowances: the most requent categorisation o theseassets is ‘intangible’. At the same time, there is also asignicant amount o non-disclosure in this area. The‘activity-based’ model category in Figure 4.2 reers tothree companies in our survey that held allowances ormore than one reason. For example, each o thesecompanies had allowances that were intended to ull theentity’s own emissions obligations as well as allowancesthat were held or trading purposes. For these companies,the accounting treatment adopted depended on thepurpose or which the allowances were held.

Note that there are some categories in the gures that are‘zero’, ie no companies ollowed this type o accountingtreatment. These categories were in our original analysistemplate (see Appendix) and have been included (despite

the lack o adoption) because they are nevertheless judgedto be valid methods o accounting treatment. I nocompanies are practising them, then this is still a relevantnding.

I we compare our survey results with the accountingtreatment recommended by the withdrawn IFRIC 3 thereare points o both dierence and similarity. The mainsimilarity is that companies are recognising emission

allowances as intangible assets, as recommended byIFRIC 3 (and, thereore, one would expect their treatmentto all under IAS 38: Intangible Assets). Nonetheless, asFigures 4.1 and 4.2 clearly show, not all companies areadopting this approach. Rather, there is diversity intreatment, with many companies having no disclosurewhile others are classiying allowances as inventory, orusing an alternative accounting practice.

The ollow-up interviews with accountants give goodinsight into the reasons or this diversity. In particular, it isviewed as arising rom the lack o guidance romaccounting standard setters since the withdrawal oIFRIC 3 in 2005. Indeed, as one interviewee commented(when asked why they believed we had ound the patterno disclosure we had):

I think because o the lack o clarity, well there is no real

guidance or how to record this in the balance sheet andP and L [prot and loss]. Because IFRIC 3 was withdrawn

some time ago…there is the chance to choose your own

balance sheet item, either under the intangible or inventory. (Head o nance, large European energycompany)

Intangible assets

No disclosure

Other

Inventory

Tangible assets

Debtors

11

7

6

2

0

0

Number of companies

4.1: gat aac – ta ct

2

Intangible assets

No disclosure

Inventory

Activity-based model

Other

Tangible assets

Debtors

Number of companies

11

7

3

3

0

0

4.2: pca aac – ta ct




Another interviewee explained how choice o accountingtreatment or assets (again, given the absence o any rmguidance) is based on practicalities: that is, they choosethe method that is the simplest and easiest:

I think rom our perspective, especially the point o

granted allowances, and in this case we are ocusing onintangible assets...I think it is the easiest way to disclose

it because IAS 38 [Intangible Assets] is nice to apply.(Accounting policy specialist, large European energycompany)

Figure 4.3 gives urther detail on the extent odierentiation in nancial statements between CERs(credits rom the Clean Development Mechanism) andEUAs (emission allowances obtained rom the EU ETSitsel). The large majority o the companies surveyed(77%) either do not make a distinction between thesetypes o carbon credit, or do not hold both sorts oallowance (identied here as ‘No disclosure’). For the ewthat do provide disclosure on CERs, there is no obviouscommon treatment choice.

Accounting or CERs was explored urther in interviews.For one interviewee (whose business includes thegeneration o CERs rom renewable energy projects indeveloping countries) there was uncertainty about how toaccount or CERs and, in particular, whether or not thedierent uses o CERs in the EU ETS (either or trading orcompliance) should be reected in company nancialstatements. This individual stated that:

From our perspective…the CERs issue is important. Or it gets more important now, but it hasn’t been o major

importance in the last one, two or three years, because

we are just starting the business. So it is rather low involume…so I think rom a materiality perspective it wasn’t necessary or us to make a lot o disclosure about

accounting or CERs yet. But it gets more important...andwe are just discussing with our auditors and with other companies about how to account or CERs. When the CER

business expands then I think we will publish more, how we do it and give a sense o volume too…There’s aneconomic dierence between the CERs which are used

or a business purpose and generated and sold [traded] ,and the CERs which might be used or compliancereasons…thereore we want to make [a] dierence in

accounting or these two purposes. (Accounting policyspecialist, large European energy company)

At the moment these dierences in the use and origins oCERs and EUAs are not being reected in nancialstatements, as evidenced in Figure 4.3. This may wellchange in the uture, with growth in the volumes o CERsgenerated and traded.

Figure 4.4 shows that eight companies (or 31% o thesample) measure granted allowances at nil value. Only ourcompanies ollow the treatment suggested in thewithdrawn IFRIC 3 recommendations, which is to measureallowances at air value at date o receipt, with this amountbeing treated as deerred income on the balance sheet.Again, there is diversity in accounting practices, with ahigh proportion o companies not disclosing any data (sixo 26 companies, or 23% o the sample), and a high

proportion ollowing a mix o dierent accounting practices(identied here as ‘Other’ and representing eight o the 26surveyed companies, or 31% o the sample).

No disclosure

Other

Inventory

Intangible assets

Tangible assets

Debtors

20

3

2

1

0

0

Number of companies

4.3: Cer – ta ct

Other

At nil value

No disclosure

At air value at date oreceipt, with opposite entry

recognised as deferred income on the balance sheet

At air value at date oreceipt, with opposite entryrecognised immediately in

income statement

8

8

6

4

0

Number of companies

4.4: gat aac – at tact



24

Figure 4.5 illustrates how companies measure emissionallowances ater initial recognition. Once again there islittle disclosure in this area. In the main, the lack odisclosure is due to the choice o initial valuation o

emission allowances. I allowances are valued at nil (andthey were by a signicant proportion o companies: eighto the 26 companies, translating to 31% o the sample)then amortisation/depreciation is not possible. Indeed, oneinterviewee noted this.

When the granted allowances are recorded at a nil value,

there is nothing to depreciate…when it is not necessary to disclose parties don’t want to give an insight in their positions.9 (Head o nance, large European energycompany)

Another interviewee questioned more undamentallywhether it made sense to view emission allowances asbeing depreciated. This individual implied that emissionallowances should be recognised as inventory and chargedas a production cost, rather than recognising them asintangibles:

But is it really a depreciation? It all depends what these

allowances are used or…the biggest portion is grantedby the government, your shortall you can buy on themarket…. So when you produce electricity you are also

producing carbon dioxide. And at the end o the year youhave to deliver the allowances to the government again.So I don’t know i it is really a depreciation. It is not a

depreciation in the P & L [prot and loss] , it is part o

your cost price. (Accounting policy specialist, largeEuropean energy company)

9. This quote also suggests that there is a tendency to avoid disclosure i

at all possible.

Again, this quote highlights the degree o uncertaintyabout accounting or emission allowances, including whattype o ‘thing’ an EUA actually is (a point returned to in thediscussion below). It seems that the question o

amortisation/depreciation has not been settled in practice,because more undamental denitional problems are stillunresolved. Although IFRIC 3 was based on theassumption that emission allowances represent a right toemit and thus are intangible assets, this may or may notbe the nal conclusion o the IASB and FASB EmissionsTrading Schemes project.

Revaluation o emission allowances in nancial statementsis required when the market values o these assets change.The survey ndings in this area again reveal low levels odisclosure, with hal the companies having no disclosure inthis area (see Figure 4.6). For those that do disclose, mostcompanies (11, or 42%) revalue and recognise this changein the income statement.

In summary, emission allowance assets are accounted orin the companies o the EU ETS in a variety o dierentways, and non-disclosure is common. EUAs are typicallyclassied as intangible assets, and are usually measured atnil value. CERs are generally not distinguished rom EUAsin company accounts, i there is disclosure o them at all.Practices o depreciation and revaluation o emissionallowances are also difcult to discern as non-disclosure ishigh.

No disclosure

No, allowances are not amortised/depreciated

No, allowances are amortised/depreciated

18

5

3

Number of companies

4.5: Atat/cat

No disclosure

Yes, with revaluationtaken to the

income statement

Other

Yes, with revaluationtaken to the reserves

No revaluation

13

11

1

1

0

Number of companies

4.6: raat aac




TreATmenT o liAbiliTies

Figure 4.7 describes how companies are accounting oremission allowance liabilities. Once again, a signicant

number o companies make no disclosure in this area (sixo the 26 companies, or 23% o the sample). Mostcompanies (15 companies, or 58% o the sample) valuethe obligation based on the carrying value (cost) oallowances already granted/purchased (which, in practice,tends to be zero), with the balance valued at the prevailingmarket price. Four companies ollow a slightly amendedversion o this accounting practice, with emissionallowances purchased under orward contract pricesshown at the contract price. These accounting practiceswere not permitted under IFRIC 3. IFRIC 3 recommendedthat assets (the allowances) should be treatedindependently o liabilities, as ollows.

A liability should be recognised as emissions are made,•

and the liability should be categorised as a ‘provision’and, hence, should be treated in accordance with IAS37 (Provisions, Contingent Liabilities and ContingentAssets).

The liability should be measured at air value (that is,•

the best estimate o the expenditure required to settlethe present obligation at the balance sheet date),independently o the cost o the allowances alreadyowned by the company.

The interviews gave urther insights into why mostcompanies have ollowed the ‘cost with balance at marketvalue’ approach. As in the case o assets, the absence orm rules appears to have resulted in the adoption o the

easiest accounting policy. Moreover, this accountingapproach was avoured as it does not require ulldisclosure o assets and liabilities. The choice reectedhere is, however, tied into the practice wherebygovernments have granted allowances at no charge in theearly Phases (1 & 2) o the EU ETS. Eectively, measuringallowances ‘at cost’ means assigning them a nil valuebecause they are not paid or. It ollows that liabilities canthereore also be measured at cost (that is, at nil value). Asone interviewee explains, accounting or emissionallowances in this way helps companies to keep assets andliabilities to a minimum.

With [emission] allowances we ocus on an approach tokeep the balance sheet on both sides rather low. And i we ocus on intangible assets we can value the

allowances at cost and the corresponding provision alsoat cost. So this is rather low. And we are only accounting or the shortall at air value, or at the best estimate…I

think this is the easiest way in the end. (Accountingpolicy specialist, large European energy company)

With a shit in Phase 3 o the EU ETS towards auctioning oallowances (see Chapter 2) there may be an impetus or achange in accounting practices in this area. In particular, itis likely that this will lead to uller recognition o bothassets and liabilities. Rather surprisingly, however, none o

the companies interviewed was clear about theimplications o auctioning or emission allowanceaccounting, as one interviewee demonstrated.

So ater [the year] 2012, yes, then there will be anauction by the government…so that can change the[accounting] approach, [but] nobody knows…Is there an

auction or each year, or or a period o ve years? Again,is there banking and borrowing in that period? These aremore the practical outcomes that you have to transer in,

accounting-wise. (Head o nance, large Europeanenergy company)

A second rationale given or the lack o disclosure oliabilities relates to companies’ desire or secrecy. Thispreerence or keeping inormation undisclosed arisesbecause emission allowances are viewed as beingpolitically high prole and because ull disclosure mightreveal something about the company strategy towardsholding allowances. Another interviewee explained theirperception as to why there was a lack o disclosure.

Actually, I think, one o the reasons is also that companies

do not want others to know whether they have an excesso credits, or have a lack o credits.

At carrying value or allowances

already granted/purchased, withthe balance valued at theprevailing market price

No disclosure

At carrying value or allowancesalready granted/purchased and at

the relative contract price orallowances to be purchased under

orward purchase contracts, withthe balance valued at the

prevailing market price

At the prevailing market price oallowances or the entire

obligation

15

6

4

1

Number of companies

4.7: mat at



26

When asked i this was a strategic concern, the sameinterviewee replied:

Yes. And also now because these allocations are made by

the government o the country or each [sector/company]and this is additional inormation that is not provided…

that is not publicly available…The [company] calculationo the liability actually depends on the actual emissions

and they may dier rom the initially reported data. Somaybe that is another reason. (General manager oaccounting and consolidation, European iron and steelcompany)

In summary, as with emission allowance assets, there isdiversity in the accounting treatment o liabilities, and aconsiderable level o non-disclosure. Most o the samplecompanies (58%) value the obligation on the basis o thecost o allowances already granted/purchased, which isusually close to zero, with the shortall o allowances orthe year measured at the market value. In practice, thismeans that the only liability recognition in the nancialstatements is or shortalls in allowances.

inTerview AnAlysis: AddiTionAl indings

Several issues arise rom the research interviews, aboveand beyond ndings rom the nancial report survey, andthese are discussed briey here. They include:

the accounting implications o having an unclear•

denition o an emission allowance

the role o auditors in this area•

uture expectations o companies with respect to•

accounting standards.

df a aacSeveral interviewees comment on the difculties indening and classiying emission allowances (see Chapter3). Crucially, links were made between these moreconceptual issues (or example, questioning i an EUA is anancial instrument or a property right) and accountingpractices. As one interviewee commented:

It is not clear or us, but...also or tax lawyers, what is thenature, the essence o the emission granted? Thequestion is: are we dealing with a right, or a security, or

an inventory?…We are not sure…It is [thereore] not possible to clearly dene which is the proper presentationin the nancial statement…

The individual continued:

Given the act that it is not clear...we continue to apply our approach in terms o nil, no recognition or theallowances. (Head o accounting principles andstandards, large European energy company)

For this interviewee, part o the explanation or the lowlevel o disclosure o EUAs in nancial statements is theabsence o a clear denition o the nature o emissionallowances. Interestingly, the solution to this problem is

seen as coming rom the European Commission.Specically, the interviewee suggested that:

We believe that the European Community [SIC] has to

dene, to clearly dene, the nature o the emission[allowance]. Because, in my opinion, the standard setter [does not have a]…duty…to identiy what is a legal point

o view or a tax point o view. They are not legal setters…But the accounting approach cannot arise beore theidentication o the legal nature. (Head o accountingprinciples and standards, large European energycompany).

Discussions about the denition and classication oemission allowances are indeed progressing in theEuropean Commission (see Bank o England 2009), andare under review by the IASB and FASB as part o theirEmissions Trading Schemes project. The resolution o thismatter is likely to inuence the accounting treatmentsadopted.

T atMost interviewees indicated that they sought guidancerom their auditors on approaches to accounting oremission allowances and suggested that auditors play akey role in acilitating the convergence o accountingpractices in the absence o an international standard. In

this respect, auditors appear to be acting as a type ointermediary, collating inormation rom dierentcompanies and recommending best practices. Forexample, an interviewee stated:

One o the sources that we use when deciding theaccounting treatment is our auditor’s interpretation,because we have access to their databases – their

interpretations o the accounting standards and alsopreerred accounting treatments…their interpretationsinclude several options, and we choose one o them…The

reason is that they have access to dierent companies,dierent entities that may have such kind o transactions,

and we do not have any relationship to any other companies other than trading relations. So this is one source o how we can get inormation [on] how other companies are doing this [accounting or emissionallowances]. (General manager o accounting andconsolidation, European iron and steel company)

Another interviewee conrmed this reliance on advice romauditors, but indicated also that they engage in directdiscussions with other companies, noting that:

We are in constant discussion with our auditors and they

are also ocusing on what all the industry practices are.We are also sharing inormation, well, on an inormal level,

with other companies in this sector, on how they account or [emission allowances]. (Accounting policy specialist,large European energy company)




The International Energy Accounting Forum (IEAF) wasmentioned by two interviewees as an example o the kindo network where inormation on emission allowancesaccounting practices is shared. Indeed, there is an active

discussion on emission allowances accounting by IEAF(see IEAF 2010). It is evident that more inormal discussionalso takes place at a company-to-company level.

T xctat ca t ct t accttaaMost companies interviewed would welcome new jointguidance on emission allowances rom the IASB and FASB.The opinion was expressed that it was preerable to haveclarity on how to account or emission allowances as thiswould make it easier or companies because they wouldnot have to ollow a range o dierent guidance (orexample, guidance at national and international levels) andbecause it would enable air comparison betweencompanies. Two interviewees provided contrastingcomments on this issue.

Every year we end up in a dierent situation and it isdierent rom what we had beore and cannot nd any guidance. So really, we would appreciate something that

is complex and covers all kind o transactions that may arise. (General manager o accounting andconsolidation, European iron and steel company)

In contrast, another interviewee was less ocused onreceiving guidance rom IASB and FASB, stating:

Well, to be honest, I am very sceptical about theseorganisations…We started in 2005 [with the EU ETS], so

there is a ve-year gap. Honestly, I don’t care now…Sothe question [is], will [it] be helpul? Well, maybe we haveto change something, but it will be or external reporting,

it will not help in our management reporting whatsoever.

They are late, the whole process rom the rst drat untila nal approved standard, that takes years and years.

They are not acting very ast. (Head o nance, largeEuropean energy company)

Very ew o those interviewed were actively tracking the

decision making o the IASB/FASB Emissions TradingSchemes project, mostly owing to a lack o time andresources to do so, but or some it was related to theperceived irrelevance o standards. This nding indicatesthere may be some problems or the IASB and FASB ingaining support or their proposals, and possibly in gainingsufcient eedback and industry response to the EmissionsTrading Schemes Exposure Drat when it is ultimatelyissued.

summAry

In summary, in this chapter we have presented andanalysed results rom our nancial statements survey and

telephone interviews. A third o the companies surveyed(eight o 26) are initially accounting or carbon assets at nilvalue on the rationale that allowances are issued at nocharge. This may change in the uture because in Phase 3o the EU ETS there is a shit towards EUAs being paid orby companies. A large proportion o companies (58%) arevaluing the obligation on the basis o the cost oallowances already granted/purchased, and measuring thebalance at the market value, a practice that impliesaccounting only or their shortall in allowances. Interviewswith accountants revealed a role or auditors in guidingaccounting treatment in the absence o internationalaccounting standards, and provided evidence that theseinterviewees would welcome timely internationalaccounting guidance rom IASB and FASB.

A key nding is that large emitters within the EU ETS areusing a diversity o accounting practices to account oremission allowances: there is no uniormity o treatment,and the incidence o non-disclosure is high. The act thatsome companies have not disclosed their emissionallowances may be explained by their relatively lowmateriality (see Table 2.1). Nonetheless, it is important tohighlight that our survey has shown that some companiespresented incomplete inormation on emissionsallowances: or example, recognising allowances on thebalance sheet as intangible assets, but with no detail about

whether allowances are (or are not) amortised. Our resultsindicate there is a lack o standardisation in practice onemission allowance disclosure, not only with regard to howto account or allowances, but also regarding what shouldbe considered the minimum o inormation provided inorder or users to understand the treatment o allowancesin dierent parts o nancial statements.





29ACCOUNTING FOR CARBON 5. SUMMARY AND CONCLUSIONS

eu eTs emiTTers

Companies in the EU ETS are currently ree to choose theirpreerred accounting method or emission allowances (as

long as it is accepted by their auditor). This exibilitybrings both advantages and disadvantages. Theadvantages are that companies can choose the accountingmethod that suits their business best and that is easiestand simplest or them to apply. The disadvantages are thatcomparability between companies is not possible, and thatcompanies may need to invest time and resources inseeking inormation about, and adopting dierentaccounting models or, emission allowances in order tosatisy dierent regulators/parent companies/newauditors, and yet still ace uncertainty as to theappropriateness o the method adopted.

With most companies in the EU ETS ollowing a ‘cost withbalance at market value’ approach that amounts to justaccounting or their net position (15 o the 26 companies,or 58% o the sample) it is not currently possible toascertain rom company accounts the ull extent ocompanies’ emission allowance assets and liabilities. As aresult, users o nancial statements are unable to assesshow much o companies’ risk is derived rom carbonemissions and carbon markets.

With a shit to auctioning allowances in Phase 3 o the EUETS there are likely to be knock-on accountingimplications, not least that companies will no longer beable to account or assets and liabilities at nil value

(because allowances will no longer be allocated at nocharge). Companies appear not to be thinking ahead aboutthis issue. Although auctioning will alleviate the accountingproblem o the initial valuation o allowances, there is likelyto be scope or dierences between the price at auctioningand air value, because o market volatility in the price oEUAs.

There are some industry networks in which companiesdiscuss emission allowance accounting issues butparticipation is variable, with some companies having nosuch discussions with their peers, and relying heavily ontheir auditor or advice.

We recommend the launching o inormation networks, toinclude large emitters in the EU ETS, technicalaccountants, and industry experts, which could serve toexchange inormation to try to harmonise accountingpractices in the run up to the issuance o guidance byIASB/FASB, and to engage with any standard-settingprocess they ollow.

ACCounTing Theory

Our empirical research adds to an emerging body o workon accounting or carbon (Bebbington and Larrinaga-

Gonzalez 2008; Lohmann 2009; MacKenzie 2009) andconrms that, as yet, there is nothing habitual aboutaccounting practices in this area. This creates possibilitiesor an interesting case study or the understanding oaccounting rules and practices in the making.

Emission allowances are hard to classiy. They are a typeo ‘incommensurable’ because there are multiple potentialuses o allowances (as a commodity, a currency and anancial instrument) and accounting practitioners in theEU ETS are trying to deal with this complexity.

Through their struggle to dene and manage emissionallowances, EU ETS accountants are playing a role ininuencing how the problem o climate change iscomprehended and governed, albeit at the moment in arather narrowly dened technical arena.

With a scheduled shit to auctioning o emissionallowances in the EU ETS, and orthcoming guidance romstandard setters, nancial accounting in this area is likelyto be increasingly controversial, and may attract attentionrom beyond accounting networks and thereby widen therange o parties who will be involved in creating carbonmarkets. The inclusion o a wider range o stakeholdersinto accounting debates is to be broadly welcomed, as itwill raise the prole o these issues, and will acilitate

greater eedback rom users o nancial reports.

Recognising that carbon markets have been created bygovernments and other institutions opens up thepossibilities or changing how they work, including theirnancial accounting ‘bedrock’. Large corporate emitters inthe EU ETS and auditors both have the possibility oeecting change in how accounting or emissionallowances is done, but timing is crucial. It is the next ewyears (2010–13) that will be most important because othe shit to auctioning o allowances, and the expectedissuance o IASB/FASB guidance in this area.

Academic research on accounting or emission allowancesraises questions that are not only technical but alsoconceptual in nature. The study o the particular issuesthat emerge in accounting or emission allowancesdemonstrates uncertainty about its outcome and as suchcan help us to understand accounting principles andpractices in the making.



30

poliCy reCommendATions

In summary, our policy recommendations are as ollows.

We recommend that accounting standard setters issueclear guidance on emission allowance accounting as soonas is practical (noting that the timetable has alreadyslipped rom an Exposure Drat that was due in 2009 toone now due in late 2011). As time goes on, theimportance o resolving this area will grow as EU ETSemission allowances will be auctioned in EU ETS Phase 3(which commences in 2013). A level playing eld oraccounting treatment and disclosure is required to allowair and transparent comparison o EU ETS nancialstatements.

We recommend the launching o inormation networks, toinclude large emitters in the EU ETS, technicalaccountants, and industry experts, which could serve toexchange inormation to try to harmonise accountingpractices in the run up to the issuance o guidance byIASB/FASB, and to engage with any standard-settingprocess they ollow.

We recommend that academic research on carbonaccounting (nancial or otherwise) is continued, as there ismuch to explore, and now is an excellent time to havevaluable policy input.

issues or urTher reseArCh

The research could be urthered in the ollowing ways.

Financial accounting treatments adopted in other•

Emissions Trading Schemes (or example, in the USstate trading schemes) could be investigated as theydevelop so as to have a comparison to the EU ETS.

A wider EU ETS survey could be carried out,•

incorporating more companies active in the EU ETS,including smaller emitters, and a greater range oindustry sectors.

The existence and desirability o national variations•

emerging among member states o the EU could beinvestigated, with regard to rules and practices oaccounting or emission allowances (and in the absenceo an international standard).

The relationship between the legal denition o an•

emission allowance and accounting standard settingcould be investigated. Specically, will the legaldenition being developed by the European Communityaect accounting regulations or emission allowances?And, i so, how?

An in-depth examination could be made o the•

accounting implications o a shit to auctioning oallowances proposed in Phase 3, with an evaluation owhether or not companies and auditors are preparing

or this change.

A more detailed empirical investigation o how•

companies, auditors and standard setters share bestpractice on emission allowance accounting could becarried out. For example, are emission allowanceaccounting standards emerging rom what was bestpractice in the period 2005–10, or are they beingdeveloped by IASB and FASB largely in isolation romcurrent practice?



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33ACCOUNTING FOR CARBON APPENDIX: QUESTIONS AND CATEGORIES FOR ANALYSIS

1 Where are granted allowances init ially recognised on the balance sheet?

1.a Debtors

1.b Inventory

1.c Tangible xed assets

1.d Intangible xed assets

1.e Other

2 Where are purchased allowances recorded on the balance sheet?

2.a Debtors

2.b Inventory



2.e Activity-based model

2. Other

3 How are purchased CERs initially recognised on the balance sheet?

3.a Debtors

3.b Inventory



3.e Other

4 At what value are granted allowances initially recognised on the balance sheet?

4.a At air value at the date o receipt, with opposite entry recognised as deerred income on the balance sheet

4.b At air value at date o receipt, with opposite entry recognised immediately in income statement

4.c At nil value

4.d Other

5 Are granted/purchased allowances subsequently amortised/depreciated?

5.a Yes, al lowances are amortised / depreciated

5.b No, allowances are not amortised / depreciated

5.c No disclosure

6 Are granted/purchased allowances revalued subsequent to initial receipt/purchase?

6.a No

6.b Yes, with revaluation taken to the income statement

6.c Yes, with revaluat ion taken to reserves

6.d Other

7 How is the obligation for emissions valued?

7.a At the prevailing market price o allowances or the entire obligation

7.b At carrying value or allowances already granted / purchased, with the balance valued at the prevailing market price

7.c

At carrying value or allowances already granted / purchased and at the relative contract price or allowances to be purchased under

orward purchase contracts, with the balance valued at the prevailing market price

7.d No obligation is recognised unless there is a shortall, with the balance valued at the prevailing market price

7.e

No obligation is recognised unless there is a shortall, at the relative contract price or allowances to be purchased under orward purchase

contracts, with the balance valued at the prevailing market price

7. Other

Source: Taken (with slight modications) rom the PricewaterhouseCoopers and International Emissions Trading Association survey, as described in PWC

and IETA (2007).

Ax: Qt a cat aa



34





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