BY CHEN VOON HOE AND WONG TIEN CHI
TAKEAWAYS
As nations and businesses around the world commit to the race to net zero, stakeholders – including investors, customers and regulators – are compelling companies to measure, manage and report their greenhouse gas emissions. Coupled with the continuing development of the voluntary carbon market, companies in Singapore may be considering acquiring carbon credits to offset their emissions. As such, companies need to understand the accounting implications of purchasing or investing in carbon credits. Considering that carbon emission is generally not a visible item in the financial statement, how then will its offset be accounted for?
Externalities like environmental and social costs are generally not reported in financial accounting. Carbon emission tends to not be accounted for in the financial statement, as the boundary of traditional financial statements is framed with respect to economic values. In the context of Singapore, where carbon tax is imposed only on large emitters, while the cost of carbon tax may be passed on to consumers via higher product prices, the price of carbon emission remains invisible in the financial reporting of most companies in Singapore.
In order that companies are accountable for their emissions, the reporting of carbon emissions separately in sustainability reports is expected, or even mandated, for public companies in many countries including Singapore. With the growing scrutiny over emissions metrics and targets, companies may have to incur decarbonisation expenditure such as investments in green technology, earlier retirement of brown assets, procurement of sustainable materials, as well as the use of carbon credits to offset their remaining emissions. In the last two decades, carbon markets have developed around the world, with the key goal to attribute a price to emissions and to reflect such costs in the financial results of companies – either mandatorily or voluntarily.
Financial accounting standards have not kept pace with the development of carbon markets. In December 2004, the International Accounting Standards Board (IASB) issued IFRIC 3 to provide guidance on how to account for emission rights issued under emission trading schemes (ETS). However, IFRIC 3 was short-lived and was withdrawn in July 2005. The “Pollutant Pricing Mechanisms” project has remained inactive in IASB’s research pipeline. In the recent IASB’s Third Agenda Consultation, many respondents rated the project as high priority. Acknowledging that developing specific requirements for pollutant pricing mechanisms would be complex, IASB decided to add the project to its reserve list, such that the project could be added to its work plan (from 2022 to 2026) if additional capacity becomes available.
The absence of specific accounting standards for carbon credits creates various challenges. As can be gleaned from the PwC/IETA surveys in 2007 and 2021, there is considerable diversity in the accounting approaches to emission rights (or carbon credits). This is partly because carbon credits can be purchased, granted or self-generated. Accounting can also vary depending on the uses for the carbon credits. In fact, companies should already consider the accounting treatment when they are entering into contracts to acquire carbon credits, as accounting for these contracts is often more complex than accounting for the underlying carbon credits.
There are many ways for companies to acquire carbon credits. Starting at the top of the value chain, companies may directly invest in carbon offset projects to lock in a long-term supply of carbon credits. Investors should carefully evaluate the agreements with the project developers as they may constitute joint arrangement, lease over the underlying nature-based assets or other forms of investment structures. Alternatively, sourcing carbon credits from brokers or carbon exchanges may be more accessible to companies. If the carbon credits are to be delivered only at a future date, the purchase contract may in substance be a forward contract. Depending on whether the underlying carbon credits are for “own use”1, the forward contract may have to be fair valued as derivatives under SFRS(I) 9. Different contract terms and different business models may lead to different accounting outcomes.
Upon receipt of the carbon credits on delivery date, companies should then consider whether the costs should be capitalised or expensed. As defined under the SFRS(I) Conceptual Framework for Financial Reporting, an asset is a present economic resource controlled by the entity as a result of past events. This would be the case if the entity has the right to resell the carbon credits or use them to extinguish liabilities in the future. Buying entities should understand the characteristics of the carbon credits, such as whether they are certified and transferrable, to determine if the carbon credits received should be recognised as assets or expensed.
If a carbon credit meets the definition of an asset, ensuing questions arise over its classification and measurement. While carbon credits generally meet the definition of intangible assets under SFRS(I) 1-38 due to their non-monetary nature and non-physical form, they would be accounted for under another standard if within the scope of that other standard. For example, a company that buys carbon credits to sell in its ordinary course of business should account for its carbon credits as inventories under SFRS(I) 1-2. In contrast, if a company uses carbon credits to offset its own emissions and/or carbon tax, it should account for the carbon credits as intangible assets under SFRS(I) 1-38. Depending on whether there is an active market for the relevant carbon credits, either the cost model or the fair value model may apply. Therefore, companies could present and measure carbon credits differently due to different uses and liquidity of the carbon markets.
We may note from the above that there are numerous factors to consider. Companies should use their judgement in developing and applying accounting policies that are relevant and reliable pursuant to SFRS(I) 1-8 requirements.
While this article focuses on the financial accounting for carbon credits, it is important to note the interaction between financial accounting and reporting of emissions in sustainability reports.
In financial accounting, carbon credit should be expensed in the same period when it is retired or when it no longer meets the definition of asset; for the purpose of sustainability reporting, companies should also consider whether the carbon credit is reported as an emission offset in the same period. We can also observe that the Greenhouse Gas Protocol Corporate Accounting and Reporting Standard (GHG Protocol) adopts certain key financial accounting concepts – for example, the consolidation scope for emissions may follow the assessment for control and consolidation under international financial accounting standards. With the establishment of the International Sustainability Standards Board (ISSB) under the IFRS Foundation, we can expect increasing connectivity between the ISSB’s Sustainability Disclosure Standards and the IFRS Accounting Standards.
Afterall, financial statements and sustainability reports are separate but related parts of a company’s report on enterprise value. As the interest and use of carbon credits and other decarbonisation strategies are set to grow, companies should seek to understand the impact to their sustainability metrics as well as to their financial reporting.
Chen Voon Hoe is Accounting and Financial Reporting Advisory Leader, PwC Singapore, and Wong Tien Chi is Senior Manager, Carbon Credit Accounting Specialist, PwC Singapore.
1 With reference to paragraph 2.4 of SFRS(I) 9, “own use” contracts refer to those entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements.
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