No smoke without allowances

Thomas Edison once remarked: ‘Opportunity is missed by most people because it is dressed in overalls and looks like work.’

For accountants who will be diving into the uncharted water that is the European Union greenhouse gas emissions trading scheme (ETS), the great inventor’s words hold particular resonance.

The ETS has created approximately EUR15bn (£10.3bn) worth of brand new assets and liabilities in company financial reports, which will generate fresh business for accountants. Throw in the work that will flow from advisory services on compliance and you have one big, lucrative opportunity just waiting to be snaffled up.

‘For companies subject to the ETS, the challenge goes beyond accounting and compliance,’ says Richard Gledhill, head of climate change services at Big Four firm PricewaterhouseCoopers.

‘In the new “carbon constrained” world, this issue needs to be embedded in everything a company does, from strategy and investment planning through to tax compliance and risk management. We now have around 150 people worldwide advising on these issues, and business is growing rapidly.’

But those jumping at these new business opportunities will not just be pulling in big cheques for services rendered. They will also be confronted with a maelstrom of technical detail and regulatory uncertainty.

The ETS, which came into effect at the beginning of this year, places a cap on the amount of greenhouse gas emissions companies can release into the atmosphere. Businesses will be allocated emissions allowances, which can be traded if unused. The scheme is mandatory in the EU and will apply to 15,000 installations.

The challenge for accountants auditing and preparing reports on the scheme is that, on top of working with a class of assets that have never existed until now, they will have to apply the equally new IFRS when working on emissions.

Robert Casamento, senior manager of energy markets at Deloitte, says the ETS raises a number of questions about how to reflect the emissions allowances in reports and account for them as they are used.

‘The ETS gives rise to questions as to whether an allowance is an asset or a liability and how to measure and recognise an allowance,’ Casamento explains.

These questions have been explored by IFRIC, a committee of the IASB that presents authoritative interpretations on international standards. But while some clarity has been achieved on the matter there are still issues that remain unclear.

IFRIC decided that emissions allowances should be accounted for as intangible assets, in line with IAS38. Emissions, meanwhile, would be seen as separate contingent liabilities, according to IAS37.

Casamento says the key concern with treating allowances and emissions in this way is that it creates a ‘mixed measurement’ model that will cause volatility in a company’s profit and loss account.

‘Emissions rights are booked in equity as assets, but as emissions are made the loss for the liability for emissions is reflected in the profit and loss account,’ Casamento explains.

‘As emissions are made, a loss in the value of emission rights is recorded against the previous gains in equity, but the gain related to revaluing the liability is still recorded in profit and loss.’

But perhaps an even greater concern than explaining this volatility to investors and companies, is the risk accountants will face in determining the fair value of allowances.

Under IAS20, allowances have to be recorded as government grants. Companies receive the allowances from government for no cost, even though they can trade unused allowances for profit.

A market has been established to trade the allowances, but because the ETS is still new, the market is not active enough to establish what is the fair value for the allowances.

It is also possible that, at certain times of the year, the allowances will not trade at all. If the market is not active, accountants will still have to reflect the allowances in reports at fair value, even though there is no effective means of doing so.

In a research report by FEE, a representative organisation for European accountants, assessing the fair value of allowances was highlighted as a ‘risk consideration’ for auditors and described the task as ‘difficult and complex’.

The result is that accountants will have to assess the value of allowances using unorthodox, untested methods, which has the potential to develop into a tricky conundrum, especially if different valuation methods are used at different companies.

The opportunities are there, but accountants are going to have to lose the cufflinks and pinstripe suits, slip on the overalls and get down to the hard work Mr Edison referred to if they want to take advantage.