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What to Know About Accounting For Environmental Credits

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As the popularity of environmental credits grows, so do concerns regarding their financial reporting. This Accounting Spotlight examines environmental credits and key carbon accounting considerations.

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An increasing number of entities in different sectors and industries aim to reduce global greenhouse-gas emissions. While several are taking steps to reduce their own carbon emissions, these efforts may not be sufficient to achieve required or voluntary emission commitments.  

Environmental credits can help entities accomplish their carbon emission reduction targets and goals. The popularity of such credits has grown; however, questions have emerged regarding the accounting and reporting for them since the treatment of environmental credits is not explicitly addressed in US GAAP.  

What are environmental credits? 

In the most basic sense, a carbon credit is a market-based or legal instrument that represents the ownership of one metric ton of carbon dioxide equivalent that can be held, sold, or retired to meet a mandatory emissions cap or a voluntary emissions reduction target.  

Accounting practices under existing GAAP 

Because the treatment of environmental credits is not explicitly addressed in US GAAP, entities have used different approaches, and questions have emerged about how to account and report for them. Below, Deloitte describes certain approaches that exist today in practice as well as observations regarding such approaches. Note that entities should carefully consider all relevant facts and circumstances when selecting an appropriate accounting model to use. They should then apply such model consistently and, if material, disclose their selection. 

Environmental credits as assets 

When accounting for environmental credits, entities should determine whether such credits represent assets. 

Entities must consider all relevant facts and circumstances when assessing whether their acquired or created environmental credits meet the definition of an asset. For instance, Deloitte believes that enhanced marketing, public claims regarding environmental activities, and the potential reduction of the entity’s net emissions do not, by themselves, support the recording of an asset under GAAP. And whereas do not believe that to qualify as an asset, an environmental credit necessarily needs to be actively traded on an exchange and believe that the ability to place the environmental credit on an exchange where it can be bought and sold, resulting in net cash inflows, supports a conclusion that such credit meets the definition of an asset.  

Classification as either inventory or an intangible asset 

In informal and industry-related discussions, the FASB and SEC have indicated that two methods of accounting for emission allowances are acceptable: (1) an inventory model and (2) an intangible asset model.  

In practice, entities generally select an accounting model on the basis of the intended use for the environmental credits. For instance, when an entity plans to actively trade its environmental credits, it often accounts for them under an inventory model. Entities need to consider the facts and circumstances of the underlying arrangements and their business objectives related to environmental credits to determine which accounting model is more appropriate to apply. 

Impairment considerations  

While some entities may subject environmental credits to the appropriate impairment or lower-of-cost or -market evaluation, others may believe that an evaluation of impairment is not necessary. Entities in the latter group may believe that their approach is justified because the intended benefits of the environmental credits do not diminish until the credits are consumed (i.e., used to offset emissions).  

Deloitte considers that under both the inventory and intangible asset models, entities should subject environmental credits to the applicable impairment method. The recognition of impairment adjustments under these models is intended to reflect changes in the utility and expected recoverability of the underlying asset.  

Timing of expense 

Some entities immediately retire environmental credits upon purchase and therefore do not record such credits as assets. Other entities may announce their intention to use or offset their environmental credits but not formally retire them, giving rise to questions regarding the appropriate time at which they should expense assets recorded for environmental credits.  

Deloitte believes that until an environmental credit is retired or sold, it still represents a legal right that can be transferred. 

Liabilities for environmental credits 

Some entities participating in a compliance program record a liability associated with their emissions only if the actual emissions for a given period exceed the environmental credits the entities hold (i.e., an entity would need to acquire more environmental credits to satisfy its obligation). However, some compliance program participants may use a model in which a liability is recorded on the basis of an entity’s total emissions. Under such a model, the “gross” liability associated with an entity’s carbon emissions is based on the cost of acquiring the required allowances, and an asset is recorded for the environmental credits held by the entity on the basis of the acquisition cost of any allowances purchased.  

FASB project on environmental credits 

In response to stakeholder feedback on the invitation to comment and the results of its outreach, the FASB decided in May 2022 to add a project to its technical agenda to address the recognition, measurement, presentation, and disclosure of environmental credits that are legally enforceable and tradable. The project is also expected to address the accounting for users and producers of environmental credits and participants operating in compliance and voluntary programs.  

SEC’s proposed rule on climate-related disclosures  

In March 2022, the SEC issued a proposed rule that would require registrants to disclose in their annual audited financial statements certain climate-related financial impacts and expenditure metrics as well as a discussion of such impacts on their financial estimates and assumptions.  

Entities that use environmental credits, particularly carbon offsets or renewable energy certificates (RECs), in their plans to achieve climate-related goals or targets would have to disclose information about such use.  

Registrants would also be required to disclose how much of their progress toward climate targets or goals has been attributable to these environmental credits. The disclosures would reflect the short- and long-term risks associated with such progress, including the risks that the availability or value of carbon offsets or RECs could be curtailed by regulations or changes in the market. See Deloitte’s March 29, 2022, Heads Up for a comprehensive discussion of the SEC’s proposed rule. 

Learn more about key accounting considerations for environmental credits 

Entities should become aware of the financial reporting considerations for environmental credits as the use of such credits becomes more prevalent.  

Deloitte’s Accounting Spotlight on Accounting and reporting consideration for environmental credits focuses on certain current US accounting practices, regulatory developments, and other accounting issues associated with such credits. 

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.  

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