Accounting for Carbon Emission Allowances in the European Union: In Search of Consistency

Abstract

With the commencement of Phase III of the European Union Emissions Trading System (EU ETS) in 2013, it is projected that approximately one-half of emission allowances will be acquired through auctioning and the provision of free allocations to installations will be substantially tightened. As a result, it is likely that many companies will hold purchased (as opposed to freely allocated or gratis) allowances and will have more significant liabilities under the scheme. The accounting treatment of emission allowances has therefore become more relevant and the lack of uniformity in practice that resulted after the withdrawal of IFRIC 3 is now a more pressing concern. This study uses content analysis to examine disclosed accounting policies of companies with significant emission liabilities under the EU ETS and identifies three more common approaches adopted to date. These can be generally described as the following: (i) a net liability approach, based on the classification of allowances as intangibles but only showing an emission liability when it exceeds the free allocation; (ii) an approach broadly based on IFRIC 3 (recognising the free allocation at fair value and a corresponding gross liability under the EU ETS); and (iii) an approach based on inventory classification, with free allocations given at nil value. The diversity in these treatments highlights the need for guidance from the International Accounting Standards Board.

Notes

1 In addition to the EU, emissions trading systems are currently operating in Australia, New Zealand, the US state of California, the Canadian province of Quebec, and within regions of Japan whilst schemes are under development in the Republic of Korea and China. The Regional Greenhouse Gas Initiative also operates with respect to the power sector in nine east coast US states.

2 The details of each EU Member State's corporate taxation regime will vary but a common starting point for establishing taxable profits across the EU is the company's accounting profits. See EC (2011). With regard to taxation, the taxation treatment of allowances was the subject of a detailed study published by Copenhagen Economics (2010).

3 A significant source on the EU ETS is the European Community website, which includes not only access to the primary documents but also a discussion of the operation of the trading system. Available at http://ec.europa.eu/clima/policies/ets/index_en.htm. Academic commentary is also widely available. See, e.g. Ellerman et al. (2010).

4 According to EC data, in Phase II, on average Germany had planned to auction 9% of the country allocation whilst the UK planned for 7% auctioning. Lower-scale auctioning had also been planned by the Netherlands, Austria, Ireland, and Hungary. See EC (2012).

5 Phase III of the EU ETS will see the end to allocations to electricity generators except in limited circumstances, an overall reduction in allocations (reducing to 80% and being further reduced annually with a goal of 30% free allocation by 2020) and a shift in the determination of allocations to an EU-wide process based on carbon leakage criteria and benchmarks (EU, 2009). The initial list of sectors considered at risk of carbon leakage was agreed to at the EU level in late 2009 (EU, 2010).

6 The revaluation model may be applied to emission allowances under the EU ETS as there is an active market whereby the fair value of allowances can be determined. IAS 38, para. 75.

7 IFRS (2013). See also Meeting Summary, IASB/FASB September 2010, and Meeting Summary, IASB/FASB November 2010.

8 In all but four cases, the 2011 annual financial reports were located. In those four cases, only the 2010 reports were available at the time that the study was undertaken so these reports were used. A list of the companies included in the sample is available upon request.

9 The Warwick and Ng study did not address this issue.