The Debate: Accounting for emissions

Guidance muddies the waters

By John Kellas

It’s fortunate that the draft guidance recently issued by the UITF on accounting for emissions rights will apply to relatively few companies.

In my view it’s an example of accounting theory taking precedence over common sense.

Polluting companies are awarded emission allowances for a particular period; these are tradable and have a market value. Where emissions are within the allowance granted, there’s nothing to pay and excess allowances may be sold to others who ‘over-pollute’.

An over-polluter who cannot buy someone else’s spare allowances must pay a fine. Companies may play the market by trading their allowances.

I’m not averse to complexity. But I do believe in simplicity and in accounting as an intuitive tool for business. So I would account for nothing unless excess allowances are sold, giving a profit; or further allowances are required because of over-polluting, leading to a provision and a loss.

Need it be more complex than this?

The UITF’s approach is more theoretical, but is it really better? It proposes that companies should record a government grant for the allowances awarded, at their fair value at the date of award; an asset representing the allowances held, initially recorded at fair value; and a liability for the obligation to deliver allowances for emissions made to date, at the fair value of the relevant allowances at the date of pollution – or penalty, as the case may be – adjusted at each balance sheet date to the then market value of the allowances, or penalty.

Not only will the numerous entries to be generated by the initial, and subsequent, accounting raise the possibility of error. But if the values of allowances change, profits and losses will arise even though the company is polluting within its allowances. Even the UITF itself admits that ‘the achievement of the most appropriate accounting treatment is constrained… by other accounting requirements’.

It’s disappointing that the UITF could have made such a proposal, and it’s time for common sense to prevail over complex rules and over specification in accounting.

• John Kellas is senior technical partner at KPMG.

Draft is on the right track
By Chris Dobson

The accounting for emission rights, as set down by the draft UITF abstract, is heading in the right direction.

The draft advocates a ‘gross’ accounting approach in preference to a ‘net’ approach. This is based on the premise that the allowances granted for the right to emit pollutants are separable assets and should be recognised as such. A liability is then accrued as pollutants are emitted, reflecting the value of allowances required to be returned to the government equivalent to this volume.

At first glance, the gross treatment appears surprising, as it appears the true exposure is the excess of allowances over the obligation to return them or vice versa, in other words, the exposure is only ever ‘net’.

This is true up to a point. If a company holds allowances purely for compliance, the net approach is appropriate. However, this approach is not robust enough to deal with a major aspect of the scheme – the trading of allowances in a liquid market.

For a company that trades them, the allowances represent marketable instruments that can be sold directly for cash and hence are valuable economic resources in their own right.

Therefore, they should be separately recognised.

Moreover, in terms of the liability, the past event is the emission of pollutants, and hence the obligation to return allowances is built up gradually throughout the year.

At any point during the compliance period the holding of allowances and the emission of pollutants are mutually exclusive events. It is only on settlement that the two are linked.

One aspect of the draft requiring further thought is the treatment of changes in the value of allowances.

With the allowances reflected as current asset investments, any appreciation in value is recognised in the statement of total recognised gains and losses. This causes a mismatch with the change in value of the liability as this is recognised in the profit and loss account. Hence, to reflect these separate but related valuation changes in different performance statements is far from ideal.

• Chris Dobson is a technical manager at PricewaterhouseCoopers.