The Financial Accounting Standards Board (FASB) on May 25 added a project to its technical agenda on environmental credits. The unanimous decision came two months after the Securities and Exchange Commission (SEC) proposed new climate-related disclosure requirements that include company business strategies for use of energy credits.
This is an evolving area where there is diversity in practice in accounting, and there are new incentives and credits for companies to invest in certain areas that lead to ambiguity. Companies and their auditors are challenged by the lack of accounting guidance, and companies’ decisions to enter these transactions can also be affected.
“We see multiple approaches in practice for accounting for receipt or generation of these credits, predominantly but not exclusively in the energy space,” said Graham Dyer, partner in Grant Thornton’s Accounting Principles Group.
“For companies making net-zero and other emission commitments, environmental credits are often a key driver of their strategy, and these credits are a catalyst for growth and innovation,” said Julie Santoro, audit partner in KPMG’s Department of Professional Practice. “The growth in the voluntary credits market is driven by companies looking for new ways to reduce their emissions.”
FASB’s project will include recognition, measurement, accounting presentation, and disclosure, which Santoro sees as a signal the organization is going back to basics to figure out the right accounting.
“As the reporting and requirements in this space mature, it’s important to remember disclosures are not just about compliance but also about providing comparable, reliable, and decision-useful information to investors,” she said. “Having data insights to reduce carbon footprints helps companies gain competitive advantage and trust from stakeholders.”
What credits apply
FASB’s project potentially includes renewable energy credits/certificates (RECs), which are certificates regulators offer energy providers when they deliver solar or hydroelectric energy to a power grid; carbon offset credits; renewable identification numbers (RINs); and credits created under compliance programs. Tax credits and tax incentives are not in the scope of the project because accounting standards to apply already exist.
“FASB’s decision to take on this developing area now, before the issue becomes too pervasive, is an important step in providing transparency and clarity that investors, auditors, and other stakeholders are craving.”
Julie Santoro, Partner, KPMG
“It will be interesting to see where the final standard comes out on scope, but my sense is many of the prominent incentive programs are likely to be captured,” Dyer said.
The project applies to participants in programs that result in creation of environmental credits and nongovernmental creators of credits. Credits are in two categories: regulatory (e.g., RECs) that track compliance and voluntary (e.g., carbon offsets). FASB is preliminarily looking at credits that are legally enforceable and can be traded.
“Different people use different terminology to refer to the same thing,” Santoro said. “Regulatory credits are most common, but voluntary credits are growing exponentially.”
“Governments use credits in an effort to both encourage and deter behaviors,” Dyer said. “Some of the difficulty with the standard setting in this project is whether these are the same thing.”
Current accounting model
Accounting decisions for credits affect whether to expense or capitalize amounts when entering into an energy credit transaction and whether to record a liability for the obligation to meet compliance targets. There is no specific framework to apply in U.S. generally accepted accounting principles (GAAP) today, which is why FASB believes there is need for a change so there is consistent accounting for similar programs.
Some companies expense the credits upon initial recognition, while others capitalize them as either inventory or intangible assets that are subsequently amortized. Under the current standards being applied, amounts are typically recorded at cost and not at fair value.
“Accounting today without an official framework is based on the company’s intent,” Santoro said. “Questions are, ‘Do I recognize an asset? If I do, what type of asset is it? If I have an obligation to meet compliance targets, does that create a liability?’ In practice, we are seeing companies treating credits they will use themselves as intangible assets and as inventory if they are selling them.”
“In our experience, most entities apply either an intangible asset or an inventory-type model, generally based on the method they use to acquire the credits,” Dyer said. “For example, RINs are generated when ethanol is blended with gasoline in the production process. It is common for entities that acquire RINs through their refining of gasoline to apply an inventory method because the credits are an outcome of their production process.”
Under an inventory method, some part of the production cost is allocated to RINs. Also under this model, companies record cost of goods sold as excess RINs are sold, and the RINs held in inventory are subject to subsequent lower of cost or market analysis and impairment assessments.
“Companies that acquire credits from third parties may apply an intangible asset model,” Dyer said. He shared the example of a real estate developer who must either acquire and set aside land for natural habitats or acquire credits from other entities. “The developer would capitalize any acquired credits as an intangible asset as part of the cost of the real estate development project,” he said.
Liabilities could potentially arise related to environmental credits. “An entity who refines oil into gasoline and does blend enough ethanol into the gas it produces to satisfy its obligation to the government may need to acquire credits in the open market from an entity with excess credits,” Dyer said. “They may have to make mark-to-market adjustments to the liability as the price of the credits changes until they have enough credits to satisfy the obligation.”
Another accounting issue Santoro noted is whether, and how, to account for voluntary credits companies generate, like a forest, and whether there should be separate accounting for the credit from the underlying infrastructure.
There can also be recognition issues for sellers of credits. Companies generating excess credits might sell them to companies with credit deficiencies.
Reaction to the project
Both Santoro and Dyer have seen positive reaction to FASB’s decision to address this project and reduce the diversity in accounting practice.
“FASB’s decision to take on this developing area now, before the issue becomes too pervasive, is an important step in providing transparency and clarity that investors, auditors, and other stakeholders are craving,” Santoro said. “FASB taking on this project is timely, because as the SEC’s proposal increases pressure for more business strategy disclosures, there will be further scrutiny of the accounting.”
Although initial reaction seems to be positive, any time there is a change there will be a cost-benefit analysis. “Because accounting practices have already been developed for entities currently accounting for these credits, whatever FASB does will require changes and a cost to adopt,” Dyer said.
What companies should do now
Although FASB is just beginning to develop its plan for this project, companies who use these credits today should watch the developments.
“It is a good opportunity for companies to understand their current accounting for these credits,” Santoro said. “They may not be material yet, but voluntary markets are evolving.”
“I think this is a project worth paying attention to as it becomes more common for companies to engage in these activities,” Dyer said. “These programs are not new, and these issues have been around for 15 to 20 years, but my sense is they have become more common and will continue to be as the topic of ESG is emphasized and reported on. I would not be surprised to see these sorts of programs proliferate.”