Accounting for voluntary purchases of carbon credits

Currently, there is no specific guidance or requirements within IFRS® Accounting Standards dealing with the accounting for voluntary purchases of carbon credits. With the global push towards ‘net zero by 2050’, many New Zealand entities making ‘net zero’ and other commitments are purchasing New Zealand carbon credits (called New Zealand Units (NZUs)) to reduce the overall levels of their reported greenhouse gas (GHG) emissions. This article addresses the accounting for voluntary purchases of NZUs.

How should the voluntary purchase of NZUs be accounted for?

Entities will have to consider the hierarchy in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors and develop an appropriate accounting policy. They must refer to the following:

  • Firstly, the requirements of IFRS® Accounting Standards dealing with similar and related issues
  • Secondly, the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Conceptual Framework for Financial Reporting
  • Thirdly, the most recent pronouncements of other standard setters that use a similar conceptual framework to develop accounting standards and other accounting literature (if these do not conflict with the above sources).

Judgement is required in determining the appropriate accounting policy, and if it is material to the entity, the entity should consider disclosing the accounting policy in its financial statements.

How are NZUs generated?

When developing an accounting policy for the purchase of NZUs, it is useful to understand what they are and how they are developed:

  • The New Zealand Government has established the New Zealand Emissions Trading Scheme (NZ ETS) as a tool for reducing greenhouse gas emissions to help meet international obligations under the Paris Agreement, and the 2050 target and emissions budgets for New Zealand. 
  • The Government sets and reduces the number of units supplied into the NZ ETS over time through the NZ ETS settings regulations, which limits the quantity that businesses participating in the NZ ETS can emit.  
  • The ETS covers the following sectors: 
    • Industrial processes (such as manufacturing steel or aluminium)
    • Liquid fossil fuels, (such as petrol, diesel and aviation fuel)
    • Stationary energy, (includes fossil fuels used for heat and electricity generation)
    • Waste (operating landfills) 
    • Synthetic gases (synthetic greenhouse gases for use in refrigeration or air conditioning systems)
    • Forestry. 
  • These industries must measure and report on their greenhouse gas emissions and surrender one NZU for each one tonne of carbon dioxide equivalent (CO­2-e) emissions they emit.
  • The Government sells NZUs directly to the market through auctioning and the price is based on supply and demand.
  • There is also a NZ ETS secondary market where most NZUs are traded.  The secondary market platforms are run independently and are not the responsibility of the New Zealand Government.
  • Entities can thus acquire NZUs directly from the Government via the NZ ETS auctions or may buy and sell NZUs via the secondary market platforms with other participants.

Inventory or intangible assets?

Entities voluntarily buying NZUs to reduce reported GHG emissions can generally recognise NZUs as an asset because they are a resource controlled by the entity. That is, NZUs can be sold for cash in the secondary carbon market. But what type of asset is it?

Inventory
(IAS 2 Inventories)

  

Intangible asset
(IAS 38 Intangible Assets)

If
↓

  

If
↓
  1. Held for sale in the ordinary course of business, or
  2. Supplies to be consumed in the production process (e.g. to produce carbon-neutral products).
  

Identifiable non-monetary asset without physical substance and:

  1. Probable that the expected future economic benefits will flow to the entity
  2. The cost of the asset can be measured reliably
  3. Does not meet the ‘inventory’ definition.

Broker-traders would classify NZUs as inventories because they are held for sale to others in the ordinary course of business. Entities aiming to reduce the carbon footprint of their products could also classify NZUs as inventories, as they are supplies to be consumed in the production process.

Otherwise, NZUs are classified as intangible assets. This is because:

  • They are identifiable non-monetary assets without physical substance
  • It is probable that future economic benefits will flow to the entity in the form of cash proceeds when the NZU is sold, and
  • The cost, being the amount paid, can be measured reliably.

This could occur when NZUs are held for investment purposes, including surrendering against excess emissions obligations in a mandatory scheme such as the NZ ETS.

Measurement

Purchased NZUs are initially recognised at cost, regardless of whether classified as inventory or an intangible asset, and subsequently, as follows:

Inventory – Broker-trader1

Inventory – Not broker-trader

Intangible asset

At either:

  • Lower of cost and net realisable value, or
  • Fair value less costs to sell (FVLCTS) – IAS 2.3(b).

If measuring at FVLCTS, fair value movements are recognised in profit or loss.

At lower of cost and net realisable value.

Either:

  • At cost less accumulated impairment losses2, or
  • Using revaluation model2 (can only be used if there is an active market for NZUs (refer below)).

If using the revaluation model, fair value movements are recognised in other comprehensive income (OCI), and not reclassified to profit or loss on disposal.

1 Broker-traders are those who buy or sell commodities for others or on their own account. NZUs are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margins.

2 No amortisation is recognised, with consumption of economic benefits when the NZU is derecognised.

 

Need help?

Accounting for carbon credits can be complex, and judgement is required. Please contact our Financial Reporting Advisory team if you need assistance.

For more on the above, please contact your local BDO representative.

This article has been based on an article that originally appeared on BDO Australia, read the original article here.