Defining Issues | February 2024

Insight

FASB project on environmental credit programs

The FASB’s latest discussion focuses on the model to account for environmental credit obligations.

Nick Burgmeier

Nick Burgmeier

Partner, Dept. of Professional Practice, KPMG US

+1 212-909-5455

Louise Santacruz

Louise Santacruz

Executive Director, Dept. of Professional Practice, KPMG US

+1 212-909-5090

As more companies enter into commitments to reduce their carbon emissions or invest in renewable energy, how to account for carbon offsets, allowances and credits is becoming more pressing. The complexity and variety of arrangements is giving rise to questions about how US GAAP applies, often involving more than one standard.

Applicability

  • FASB project: Accounting for Environmental Credit Programs
  • Companies that acquire, are granted or create environmental credits

Relevant dates

On January 31, 2024, the FASB continued its discussions about accounting for environmental credit programs.  

Key impacts

The accounting for environmental credits (credits) is both an emerging issue and one that has been on the radar of standard-setters for decades. Emissions trading arrangements are not new, but for companies making net-zero or other emissions commitments, offsets and credits are often a key driver of their strategy. These arrangements were historically established to help companies comply with governmental or regulatory emissions mandates. Now they are also a catalyst of growth and innovation, incentivizing companies to develop and implement the latest renewable technology. These growing and largely self-imposed strategic commitments have caused the related accounting issues to reemerge as a high priority.

Although several standard-setting projects have been attempted, there are currently no accounting requirements under US GAAP specific to carbon offsets, allowances or credits. Consequently, practice has become diverse as companies seek to interpret and apply current accounting guidance to arrangements that are often complex and evolving.

After meeting in October 2023 to refine its project scope and discuss recognition and measurement criteria for environmental credits, the FASB met on January 31, 2024, to discuss the accounting model for environmental credit obligations (ECO) and general presentation and classification matters. The FASB noted throughout the meeting the importance of developing criteria that are operable and decision-useful to investors.

The following are key highlights from the tentative decisions reached on the project to date.

Project scope

Assets

The Board refined the project scope to include credits that meet all of the following:

  • Credits that are enforceable and transferable. In-scope credits can take numerous forms including credits, certificates, allowances and offsets
  • Credits that are acquired (including from related parties), granted by a regulatory agency or designee or internally generated (created)
  • Credits that lack physical substance and do not meet the definition of financial assets under US GAAP
  • Credits that are represented to prevent, control, reduce, or remove emissions or other pollution

The Board confirmed that income tax credits, such as those related to the Inflation Reduction Act, are outside the scope of the project because they are in the scope of other US GAAP.

Liabilities

The Board clarified the following:

  • Environmental credit obligations (ECOs) are in the scope of the project. ECOs arise from existing or enacted laws, statutes or ordinances represented to prevent, control, reduce or remove emissions or other pollution that may be settled with environmental credits. ECOs generally arise from compliance programs
  • Environmental obligations accounted for under ASC 410-30 are not ECOs
  • Constructive obligations for internally established (i.e. voluntary) targets to reduce emissions are not in the scope of the project but may be within the scope of other US GAAP

Asset recognition and measurement criteria

Recognition

  • A credit would be recognized as an asset when it is probable that it will be used to settle an ECO, sold or traded.
  • Costs to obtain all other credits (e.g. as part of a voluntary program) would be expensed when incurred. The costs would not be eligible for capitalization.

Initial measurement

  • Credits that meet the asset recognition criteria would be measured initially at historical cost – consistent with asset acquisition guidance in ASC 805-50 – unless other US GAAP applies.
  • Costs for credits that are granted or created would be limited to transaction costs (e.g. application fees) and could be zero if there are no costs directly associated with obtaining the credits.

Subsequent measurement

The measurement model applied would align with how the entity will use the credit (i.e. its intent).

  • Credits used to settle an ECO (i.e. compliance environmental credits) would not be remeasured.
  • Credits that will be sold or traded (i.e. noncompliance environmental credits) and that are initially measured at historical cost would be assessed for impairment. However, the Board requested further outreach around whether to require or permit a fair value model for credits intended to be traded.

Reassessment

  • Each reporting period, entities would reassess whether compliance and noncompliance credits meet the appropriate recognition criteria.
  • Credits that are reclassified from compliance credits to noncompliance credits would be assessed for impairment before applying the subsequent remeasurement guidance.
  • Subsequent reversal of a previously recognized impairment loss would be prohibited.
  • Entities could establish an accounting policy to use a portfolio approach for similar environmental credits to apply the recognition and measurement guidance.

Liability recognition and measurement criteria

Recognition

  • Entities would recognize a liability when activities or events occurring on or before a balance sheet date indicate the existence of an ECO.
  • The balance sheet date should be considered to be the end of the compliance period for recognizing an ECO liability (ECO).
  • There would be separate recognition requirements for obligations requiring entities to remit a fixed number of credits to a regulator solely because they exist as a business:
    • An entity would recognize an ECO on the date that it becomes obligated to remit the credits.
    • The entity would recognize an asset at the same time which would be amortized over the compliance period.

Initial measurement

  • The funded portion of an ECO would be measured based on the carrying amount of compliance credits owned by an entity using its best estimate of the credits to be derecognized on settlement. An entity would apply the liability measurement guidance after applying the asset recognition, measurement, and reassessment requirements.
  • The unfunded portion of an ECO would be measured using the fair value at the balance sheet date of the credits necessary to settle the liability at that date with two exceptions:
    • If the entity intends to remit cash to settle the ECO liability, it would use the cash settlement amount under the compliance program to measure the ECO liability.
    • If the entity intends to settle the ECO liability using environmental credits obtained through a commitment to purchase a fixed quantity of environmental credits at a fixed price (existing at the balance sheet date), using the estimated cost basis of those credits to be obtained through that contract.
  • Entities would not be permitted to elect the fair value option in ASC 825 for measuring an ECO.

Subsequent measurement

An entity would recognize subsequent changes from the initial measurement of an ECO through earnings and present those changes in the same line item as the initial measurement of the ECO.

Derecognition

  • ECOs should be derecognized in accordance with existing guidance for extinguishment of liabilities.
  • Gains and losses recognized on derecognition would be presented in the same income statement line item as the initial measurement of the ECO.

Interim requirements

The recognition and measurement criteria for an ECO should be applied consistently for annual and interim periods.

Presentation and classification

Balance sheet presentation

Entities would present all compliance credits and ECO gross and offsetting would be prohibited.  The Board will seek feedback during the public comment process about whether net presentation might be more relevant to user needs.

Balance sheet classification

  • An ECO would be classified as current when it is reasonably expected to be settled within one year from the balance sheet date.
  • A credit would be classified as current when it is reasonably expected to be sold, traded, or remitted to a regulator to satisfy an ECO within one year from the balance sheet date (or the operating cycle of the business, if longer).
  • All other ECOs and credits would be classified as noncurrent.

Statement of cash flows

Cash flows associated with Environmental Credit Programs would be presented in accordance with ASC 230.

 

Additional decisions

At the January 31, 2024 meeting, the Board also tentatively decided that:

  • Recognized environmental credits and ECOs would not be evaluated under derivatives guidance.
  • An entity should recognize nonrefundable deposits for environmental credits that are not probable of being used to settle an ECO or transferred as an expense.

Next Steps

The Board will continue discussions at a later meeting including on remaining sweep issues, disclosure and transition.

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