Accounting Issueson

Emissions TradingI am a member of the CPA (Australia), and I will

spend the following 15 minutes to talk about theaccounting issues relate to emissions trading.

The 3 areas I would like to concentrate on are:1) Why - Emissions of carbon dioxide (CO2)2) How to reduce CO2 emissions3) The accounting issues

I am a member of the CPA (Australia), and I willspend the following 15 minutes to talk about theaccounting issues relate to emissions trading.

The 3 areas I would like to concentrate on are:1) Why - Emissions of carbon dioxide (CO2)2) How to reduce CO2 emissions3) The accounting issues

Global WarmingIndustrial activities Greenhouse gasses

Results & Solutions• From 1993 to 2003 (10 years), a near doubling in the rate of sea level

rise.

• The United Nations Framework Convention on Climate Change(UNFCCC) – first international treaty to set limit on greenhouse gasemissions (1992).– nonbinding - not impose legal obligations on any nations.

• (1997), UNFCCC took place in Kyoto - Kyoto Protocol.– Goal: Developed countries ↓ emissions of greenhouse gases by

at least 5% of 1990 levels. The year to complete this target is2012.

– Legal obligation? Yes. For example, by ratifying the KyotoProtocol, all member nations of the European Union becameobligated to reduce their GHG emissions.

• From 1993 to 2003 (10 years), a near doubling in the rate of sea levelrise.

• The United Nations Framework Convention on Climate Change(UNFCCC) – first international treaty to set limit on greenhouse gasemissions (1992).– nonbinding - not impose legal obligations on any nations.

• (1997), UNFCCC took place in Kyoto - Kyoto Protocol.– Goal: Developed countries ↓ emissions of greenhouse gases by

at least 5% of 1990 levels. The year to complete this target is2012.

– Legal obligation? Yes. For example, by ratifying the KyotoProtocol, all member nations of the European Union becameobligated to reduce their GHG emissions.

How?Reforestation • How? to remove CO2 from

the atmosphere is to growmore forests.

• How? to purchase & use lowCO2 emission technologies.

• How? to remove CO2 fromthe atmosphere is to growmore forests.

• How? to purchase & use lowCO2 emission technologies.

How?Straight tax option

• Advantage: a straight tax on CO2emissions is immediately enforceableand transparent.

• Disadvantage: some businesses mayhave the market ability to pass the taxto consumers, and not to cut emissions.

• Advantage: a straight tax on CO2emissions is immediately enforceableand transparent.

• Disadvantage: some businesses mayhave the market ability to pass the taxto consumers, and not to cut emissions.

Cap-and-trade option• Cap-and-trade scheme. Companies are told

how much CO2 they can emit (the cap) fora period.

• If the companies produce less than the cap,they have surplus credits for sale.

• If they emit more than their cap, then theycan buy credits from other businesses thatcome in under their cap (the trade).

• Cap-and-trade scheme. Companies are toldhow much CO2 they can emit (the cap) fora period.

• If the companies produce less than the cap,they have surplus credits for sale.

• If they emit more than their cap, then theycan buy credits from other businesses thatcome in under their cap (the trade).

Kyoto Protocol&

Emissions Trading• The Kyoto Protocol endorsed an international

emissions trading mechanism– a member nation can emit more CO2 than its

assigned amount (which, is defined as being 8%above its emissions in 1990) only if the membercountry can simultaneously create the equivalentamount in CO2 reduction activities such asreforestation.

• The Kyoto Protocol endorsed an internationalemissions trading mechanism– a member nation can emit more CO2 than its

assigned amount (which, is defined as being 8%above its emissions in 1990) only if the membercountry can simultaneously create the equivalentamount in CO2 reduction activities such asreforestation.

International Emission Trading –Cap & trade option

• Now, in the international carbon creditmarket, countries can sell their unusedemission allowances to other countrieswith reduction commitments.

• Credits can be bought and sold ininternational carbon credits tradingmarkets at the prevailing market price,such as the Chicago Climate Exchangeand the European Climate Exchange.

• Now, in the international carbon creditmarket, countries can sell their unusedemission allowances to other countrieswith reduction commitments.

• Credits can be bought and sold ininternational carbon credits tradingmarkets at the prevailing market price,such as the Chicago Climate Exchangeand the European Climate Exchange.

One can shop for the best price• These 'carbon credits' are similar to 'taxi licenses'

issued by a local authority that can be traded formoney.

• However, even though the underlying basis ofcalculating a carbon credit is international, just liketaxi licenses, the pricing of carbon credits varies fromcountry to country and state to state.

• In other words, significant arbitrage opportunitiesexist, and 'CO2 emitters' in high cost countries canbuy credits from trading exchanges in low-costcountries.

• These 'carbon credits' are similar to 'taxi licenses'issued by a local authority that can be traded formoney.

• However, even though the underlying basis ofcalculating a carbon credit is international, just liketaxi licenses, the pricing of carbon credits varies fromcountry to country and state to state.

• In other words, significant arbitrage opportunitiesexist, and 'CO2 emitters' in high cost countries canbuy credits from trading exchanges in low-costcountries.

Advantage• Carbon trading refers to the buying and selling of

the right to emit CO2. The basic unit is one metrictonne of CO2 per year.

• Carbon credits trading system gives a monetaryvalue to the cost of polluting the air. This meansthat carbon becomes a cost of doing businessand is seen like other inputs such as rawmaterials.

• Now, the factories can compare the costs buyingthe carbon permits to the costs of purchasing thelow CO2 emission technologies.

• Carbon trading refers to the buying and selling ofthe right to emit CO2. The basic unit is one metrictonne of CO2 per year.

• Carbon credits trading system gives a monetaryvalue to the cost of polluting the air. This meansthat carbon becomes a cost of doing businessand is seen like other inputs such as rawmaterials.

• Now, the factories can compare the costs buyingthe carbon permits to the costs of purchasing thelow CO2 emission technologies.

Implications• For underdeveloped agricultural countries, trees

may no longer be seen as hinder to farming.

• Planting trees for conservation purposes willprovide more long-term benefit to the global carboncycle than will plantings for commercial harvesting,such as trees for logging and pulping.

• In theory - a stronger incentive to prevent forest fire.In practice – no. (The law - how many new treesplanted after 1990, and pre-1990 trees still existingare not considered carbon credit purposes).

• For underdeveloped agricultural countries, treesmay no longer be seen as hinder to farming.

• Planting trees for conservation purposes willprovide more long-term benefit to the global carboncycle than will plantings for commercial harvesting,such as trees for logging and pulping.

• In theory - a stronger incentive to prevent forest fire.In practice – no. (The law - how many new treesplanted after 1990, and pre-1990 trees still existingare not considered carbon credit purposes).

Accounting issuesIs the 'allowance' an asset?• No. The company gets it free from the government.• Yes. It can trade in the market (it has money value).• If yes, should it be treated as an intangible asset

– US: Since emissions rights lack physical substance,they cannot meet the definition of a financial assetunder SFAS 140.

• if it is treated as an intangible asset, should it bemeasured at cost when the business acquired thecarbon allowance through a third party transaction (Itwill meet the reliability test). How about the allowanceget from government?

Is the 'allowance' an asset?• No. The company gets it free from the government.• Yes. It can trade in the market (it has money value).• If yes, should it be treated as an intangible asset

– US: Since emissions rights lack physical substance,they cannot meet the definition of a financial assetunder SFAS 140.

• if it is treated as an intangible asset, should it bemeasured at cost when the business acquired thecarbon allowance through a third party transaction (Itwill meet the reliability test). How about the allowanceget from government?

We can’t find the answer• If we look to the GHG Protocol Corporate

Accounting and Reporting Standard(World Business Council for SustainableDevelopment 2004), a guide for companiesto report their GHG emissions.

• However, the entire standard does notsuggest any accounting treatment forcarbon allowance.

• If we look to the GHG Protocol CorporateAccounting and Reporting Standard(World Business Council for SustainableDevelopment 2004), a guide for companiesto report their GHG emissions.

• However, the entire standard does notsuggest any accounting treatment forcarbon allowance.

In or not in the balance sheetOff-balance sheet approach• The business only accounts for actual emissions by

indicating the amount of insufficient allowances -carbon credits purchase from the market. Theaccountant should debit expenses, and credit cash atmarket price.

In-balance sheet approach• If an entity recognizes the allocated allowances as an

asset, then the accountant may use the amortisingmodel (debit: asset, credit equity reserves) at costprice. Subsequently, the entity amortizes theallowances as it pollutes (debit expense, credit asset).

Off-balance sheet approach• The business only accounts for actual emissions by

indicating the amount of insufficient allowances -carbon credits purchase from the market. Theaccountant should debit expenses, and credit cash atmarket price.

In-balance sheet approach• If an entity recognizes the allocated allowances as an

asset, then the accountant may use the amortisingmodel (debit: asset, credit equity reserves) at costprice. Subsequently, the entity amortizes theallowances as it pollutes (debit expense, credit asset).

Asset & liabilities, offsetting?

Is offsetting of assets and liabilities bepermitted?

• Should an accountant treat carbonallowances (assets) independently tothe obligations (liabilities)? If carbonallowance is an independent asset, thenthe accountant cannot offset of the assetamount with the liabilities.

Is offsetting of assets and liabilities bepermitted?

• Should an accountant treat carbonallowances (assets) independently tothe obligations (liabilities)? If carbonallowance is an independent asset, thenthe accountant cannot offset of the assetamount with the liabilities.

Right to emit CO2The hottest trading item

• Due to the possibility of trading, carboncredits become the world's hottest tradingitem.

• The carbon trading market internationally wasabout US$100 million total value about 10years ago.

• Now it is about US$18 billion. It becomes thefastest growing commodity markets in theworld.

• Due to the possibility of trading, carboncredits become the world's hottest tradingitem.

• The carbon trading market internationally wasabout US$100 million total value about 10years ago.

• Now it is about US$18 billion. It becomes thefastest growing commodity markets in theworld.

Shipping• CO2 emissions from shipping have a serious

impact on global warming.– For example, BP owns 50 tankers, and

researchers at the Institute for Physics andAtmosphere in Wessling, Germany reveal thatannual CO2 emissions from shipping rangebetween 600 and 800m tonnes. (This constitutesabout 5% of the global total). This is nearlydouble Britain's total emissions and more than allAfrican countries combined.

• CO2 emissions from shipping have a seriousimpact on global warming.– For example, BP owns 50 tankers, and

researchers at the Institute for Physics andAtmosphere in Wessling, Germany reveal thatannual CO2 emissions from shipping rangebetween 600 and 800m tonnes. (This constitutesabout 5% of the global total). This is nearlydouble Britain's total emissions and more than allAfrican countries combined.

Shipping• CO2 emissions from ships do not come under the

current Kyoto agreement.

• CO2 emissions from ships would be a likely targetin the next commitment period of the Kyoto Protocol.

• For example, the Norwegian government opinedthat there are no technical obstacles to bringinginternational shipping under a post-Kyoto Protocol.

• Therefore, it would be beneficial for ship owners toget themselves familiar with the emissions tradingscheme under the Kyoto Protocol.

• CO2 emissions from ships do not come under thecurrent Kyoto agreement.

• CO2 emissions from ships would be a likely targetin the next commitment period of the Kyoto Protocol.

• For example, the Norwegian government opinedthat there are no technical obstacles to bringinginternational shipping under a post-Kyoto Protocol.

• Therefore, it would be beneficial for ship owners toget themselves familiar with the emissions tradingscheme under the Kyoto Protocol.