Running Head: CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 1

Corporate Accounting for Emission Allowances

SAMEER SHARMA

3212322
CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 2

Contents

Introduction......................................................................................................................................3

Determination of the relevant issues of accounting, related with the emission trading schemes

and allowances of emission.............................................................................................................3

Illustrate the nature behind the allowances of emission and offer proper justifications on the

nature...............................................................................................................................................4

Determining how the allowances of emission are being measured at initial period and henceforth.

Illustrate the journal entries for the same........................................................................................5

Illustrate the varied consequences faced by financial statements of company, because of the

allowances of emission..................................................................................................................10

Conclusion.....................................................................................................................................11

References......................................................................................................................................12

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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 3

Introduction

This particular research study illustrates about the accounting treatment in respect of the

allowances for emission and relevant effects associated with the financial statements. The report

describes the appropriate treatments for the allowances, which are important for the

implementation of the ETS.

Determination of the relevant issues of accounting, related with the

emission trading schemes and allowances of emission

The principles for accounting for the emission allowances are based on existing

principles for financial reporting. There is no formula for accounting, standards for carbon

emission trading. The section illustrates the key issues for conceptual frame promulgated by

international accounting (Mookdee, 2013).

The main framework is the IASB and AASB for the preparation of financial statements.

As per their framework, financial statements are prepared for meeting the uncommon needs of

users. The accrual basis of accounting and the going concern underpins the conceptual

framework as they all are needed to conform the concepts. The four main principles to be

followed are: understandability, relevance, reliability and comparability. All these requirements

applies equally to carbon emission companies for whom, development of allowance certification

is the main product. Green house gas protocol is the only set of GHG accounting standards,

which applies specific principles and qualitative characteristics towards the GHG accounting,

which requires that the inventory figure is a faithful one and fair one, to a companys GHG

emission (Fornaro, Winkelman, & Goldstein, 2009). There is some overlap in the concepts of

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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 4

accounting principle of GHG and that of financial accounting standards board. The carbon

emission companies does not explicitly defines faithfulness, but the FASB focuses on

faithfulness as a means that the information of finance must show what it results. Completeness,

neutrality and freedom from errors are the main issues, which are being faced by the trading

schemes of emission and allowances of emission (Dellaportas, 2014).

Illustrate the nature behind the allowances of emission and offer

proper justifications on the nature

Allowance and famous scheme of cap trading generally employs a mechanism of trading

with the help of issuance of tradable instrument that are considered as allowances for emissions

at the initial period of compliance. As per the scheme, the participants have to remit the

allowances to the government in an amount, which is equal to amount of emission produced. In

the beginning of the compliance period, through the designated scheme, participants either

receives the allocated allowances free of charge or they purchases such allowances through

scheme auctions (Emissions-euets, 2012). The main issue was the precise characteristics of the

emission allowance. The characteristic of the emission allowance can be easily judged as a

property right and can be recognized as an asset because: companies can revive emission

allowances by (Jegou & Rubini, 2011):

receiving allocations if they are free of cost, from government

buying them from government, at fixed or market price
buying them from market

The interpretation committees conclude that an allowance, which is purchased as an asset

should be recognized that way only. The characteristics which were noticeable for regarding

them as asset were: they exist in electronic form, they can be easily transferred in electronic
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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 5

manner with the help of registry system and lastly they possess some kind of economic value

also, as it can be utilized for avoiding fine (Lovell, Aguiar, Bebbington, & Larrinaga-Gonzalez,

2010).

Determining how the allowances of emission are being measured at initial

period and henceforth. Illustrate the journal entries for the same

The financial accounting standard has not yet reached to a conclusion on the initial

identification and aspects related with the measurement of the emission of allowances. The

measurement criteria includes following key criterias:

Emission allowances are considered as intangible assets, which are to be accounted under

the International accounting standards. The international accounting standard number 38, allows

the uses a choice in between the historic costing model and costing method of revaluation

(Kashyap, Rahman, & Steenkamp, 2013)

Allowances, which are purchased, are generally registered at on cost value. Allowances

received from the government at no cost, or for a cost that is less than the fair value, are

generally posted in journals at fair value only. Allowances that are identified under such

methodology are subjected to impairment tests at periodic intervals. In case the companies

selects international accounting standard number 38, then increase in the fair value is certainly

assured in equities of shareholders and at the same time a decrease in the fair value will also be

seen in the financial statement to the level that they extent the surpluses of revaluation . The

difference that is seen in the paid price of allowance, which is received from government and the

fair value, is essential to comply with the guidelines laid down by internal accounting standard

board. Such differences in the allowance measurement are considered as deferred income. This

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deferred income is a liability for a company and is systematically termed as revenue over the

period of compliance, which is irrespective of the fact that whether the allowances are being

retained or are being sold. (Fornaro, Winkelman, & Goldstein, 2009). The determination of the

liabilities and the expenses for the emission considers following the rules of international

accounting standards 37. The liabilities of the same are measured as current obligation required

for the satisfaction of the actual emission created through the balance sheet.

The net income calculation, which is considered for emission allowance, is not permitted

under law. After a lot of discussion, it was decided by the international accounting, standard

board that allowances will be initially and subsequently measured at fair values. Allowances for

emissions are considered as intangible assets for the companies. Management should either

chose the cost model or revaluation model for accounting policies (Andor & Fazekas, 2010).

Cost Model: After the initial identification, allowances of emission are generally carried

at a subsequent amount of fair values, at the dates related with the revaluation and lessening the

same with the impaired accumulated losses. The fair values should be calculated in accordance

with the active market reference. Rules and regulations are to be determined at regular basis, so

that in the balance sheet calculation, the amount of assets should not vary the amount of fair

value. The accruing amount of the modification of the revalued allowances can be accounted

based on the gross or through net method. Such gross methods recount the accumulated

amortization proportionally to the change in the gross value. The objective of impairment is to

ensure that the assets of entity carry not more than the recoverable amount.

Below are the journal entries for cap and trade emission reduction program (Ertimur, Francis,

Gonzales, & Schipper, 2014)

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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 7

S. No. Particulars Dr. Cr.

1. Receiving allocation of No entry No entry

allowances from the government
for free of cost

Surrendering of allowances to the Carried value of

2. government for covering allowance + fair
emissions: value of excess
emission - carrying
Dr. Expenses of Emission value of
obligation*
(Surrendered
quantity/ Total
Quantity)
Carried value of
Cr. Obligations allowance + fair
to surrender value of excess
emission - carrying
value of
obligation*
(Surrendered
quantity/ Total
Quantity)
Re-measuring the emission Carried value of
obligation to current value: allowance + fair
value of excess
Dr. Surrendered allowance emission- carrying
obligation value of
obligation*
(Surrendered
quantity/ Total
Quantity)
Surrendered
Cr. Emission quantity *(Carried
Allowances value of
allowance/
quantity of
allowance)

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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 8

Cr. Profit ad
loss
Difference
Purchase of Acquired Quantity *
3. allowances from the Fair value
third party:
Acquired Quantity
* Fair value
Selling Allowance to Sold Quantity * Fair
4. the Third Party: value

Sold quantity
*(Carried value of
allowance/ quantity
of allowance)

Difference

Allowance surrendering for not covering Surrendered quantity

5. emission : *(Carried value of
allowance/ quantity
Dr. P&L of allowance)

Surrendered quantity
Cr. Allowance *(Carried value of
allowance/ quantity
of allowance)

6. Allowance purchased from the Acquired *fair value

government Auction:

Dr. Allowance Acquired *fair value

Cr. Cash

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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 9

Reversing previous deduction: Acquired quantity

7. *(Carried value of
Dr. Allowance allowance/ quantity
of allowance)
Cr. Obligation
Acquired quantity
*(Carried value of
allowance/ quantity
of allowance)

Recognizing obligation of emission on Carried value of

8. the basis of annual emission in quarters: allowance + fair
value of excess
Dr. Expense emission - carrying
value of obligation
Cr. Obligation for Carried value of
surrendering allowance + fair
value of excess
emission- carrying
value of obligation

Recognizing re-measurement: Carried value of

9 allowance - total fair
Dr. P&L value
Carried value of
Cr. Allowance allowance - total fair
value

Re- measuring the emission obligation Carried forward

10 on the basis of the carry forward value of amount of allowance
allowance: + excess emission
amount at fair value -
Dr. Expenses related with allowance Obligation value

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CORPORATE ACCOUNTING FOR EMISSION ALLOWANCES 10

Carried forward
amount of allowance
Cr. Obligation related with + excess emission
allowance surrendered amount at fair value -
Obligation value

Government grant: Not available

11

Not available Not available

Illustrate the varied consequences faced by financial statements of company, because of the

allowances of emission.

Till today, the allowance program has not gained uniform success in representing the use

of the allowances of emission on the financial statements of company. These financial statements

comprises of cash flows of company, balance sheet of company and profit statements of

company. The emission allowance program will gain more effectiveness only when the

representation of allowances on the financial statement becomes standardization, because the

company forces that the carbon emission trading system should be transparent in nature. .

Financial statements of company are considered a breakthrough for the outsiders for evaluating

the performance of the company (PWC, 2008). Financial statements of company impacts the

understanding of outsiders that how they will be valuing the company which can ultimately

affect the prices of the stocks, loan ability and ability of engagement. For illustrating the

requirement of uniformity in account of emission allowances, it can be said that it does affects

the financial statements largely. We can consider for instance, two companies that are having

excess allowances for selling. If first company identifies allowance as asset while second one
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merely mentions the extra allowance to financial statements, then the first company will appear

to possess more strong in financial terms in comparison to the second company. Such kind of

discrepancies occurs mainly because of the valuation, which is done in ineffective manner.

Financial statements are very useful when they are presented accurately. Companies should make

year-end adjustments for carrying forward the values related with the asset to its fair value. As

the prices of allowance will, enhance in the emission process over the value of previous year,

then in such case the asset allowance value will also increase with the nominal difference in

between the pricing values. This increase will also bring a corresponding increase in the equity

accounts. Such adjustments ensure recording allowances at fair values. As the methodology

behind accountancy, calls out for the quantification of the allowances calculation in financial

statements, therefore such incidents forces companies to internalize the cost of GHG emission

(IFRS, 2014). The accuracy behind the calculation of accounting information is essential and

important for upholding the integrity process of global finance system and therefore companies

need to possess non-voluntary standards of accounting for better establishments. Though the

current regulations of SEC describe the procedures for locating, descriptions and risk assessment,

they need to specify the standards of measurement methodology. Voluntary regimes of reporting

offer some regulations and practice guidelines related with the methods of accounting, but

unfortunately it has not been much successful in developing uniform standards required

(Souchik, 2012).

Conclusion

The regulations related with the scheme of allowances for emission will turn out to be

effective only when the companies are going to pen down the entries of such allowances on the

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asset side of the balance sheet of company. In addition to this, the pollution in excess of

allowances should be entered in the accrued expense column. Determining and presenting the

financial statements of company according to the methods discussed above, wall make company

look more accountable for the purpose of investment. In such proposal cases, allowance s related

with emission might affect the net income of the company. This kind of methodology forces

companies to internalize the cost of pollution.

References

Andor, A., & Fazekas, D. (2010). Accounting Aspects of Emission Trading. Academia.

Dellaportas, S. G. (2014). Accounting for carbons. Retrieved from https://www.google.co.in/url?

sa=t&rct=j&q=&esrc=s&source=web&cd=8&cad=rja&uact=8&ved=0ahUKEwikuLH3t

cXMAhWEGZQKHYJDBxMQFghKMAc&url=https%3A%2F

%2Fwww.charteredaccountants.com.au%2F~%2Fmedia%2FFiles%2FIndustry

%2520topics%2FReporting%2FClimate%2520Change%2FAc

Emissions-euets. (2012). The legal nature of emission allowances as a property rights. Retrieved

emissions-euets, from http://www.emissions-euets.com/emissions-trading/1-

emissionstrading/149-the-legal-nature-of-emission-allowances-as-a-property-rights

Ertimur, Y., Francis, J., Gonzales, A., & Schipper, K. (2014). Financial Reporting for Cap-and-

Trade Emissions Reduction Programs. Duke University.

Fornaro, J. M., Winkelman, K. A., & Goldstein, D. (2009). Accounting for Emissions. Retrieved

from Journalofaccountancy.com:

http://www.journalofaccountancy.com/issues/2009/jul/20081312.html

IFRS. (2014). Measurement of liabilities under IAS 37 within the context of. IFRS.

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Jegou, I., & Rubini, L. (2011). The Allocation of Emission Allowances Free of Charge: Legal

and Economic Considerations. ICTSD .

Kashyap, V., Rahman, A., & Steenkamp, N. (2013). Accounting for Carbon Emission

Allowances An Exploratory Study . Massey Univesity.

Lovell, D. H., Aguiar, D. T., Bebbington, P. J., & Larrinaga-Gonzalez, D. C. (2010). Accounting

for Carbon. ACCA.

Mookdee, T. (2013). Accounting for Carbon Emission Trading: An Australian Perspective.

RMIT University.

PWC. (2008). How your company can prepare to manage carbon as an asset*. PWC.

Souchik, L. E. (2012). Accounting for Emissions Trading: How Allowances Appear on Financial

Statements Could Influence the Effectiveness of Programs to Curb Pollution. Boston

College Environmental Affairs Law Review.

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