What to know about accounting for environmental credits

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, we believe 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 we do not believe that to qualify as an asset, an environmental credit necessarily needs to be actively traded on an exchange, we 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.

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.

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).

We believe 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.

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.

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

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.