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Determining the scope of the FASB's environmental credit project

The Financial Accounting Standards Board (FASB) added an environmental credits project to its technical agenda on May 25. The decision came two months after the Securities and Exchange Commission (SEC) proposed new climate-related disclosure requirements, including company business strategies for using energy credits.

This is a developing area with a wide range of accounting practices, as well as new incentives and credits for businesses to invest in certain areas that cause ambiguity. The lack of accounting guidance poses a challenge to businesses and their auditors, and it can have an impact on business decisions to engage in these transactions.

"We see multiple approaches in practice for accounting for receipt or generation of these credits, predominantly but not exclusively in the energy space," said Graham Dyer, a partner in Grant Thornton's Accounting Principles Group.

"For companies making net-zero and other emission commitments, environmental credits are often a key driver of their strategy, and these credits are a catalyst for growth and innovation," said Julie Santoro, audit partner in KPMG's Department of Professional Practice. "The growth in the voluntary credits market is driven by companies looking for new ways to reduce their emissions."

The FASB's project will cover recognition, measurement, accounting presentation, and disclosure, which Santoro sees as a sign that the organization is getting back to basics in order to figure out the best accounting practices.

"As the reporting and requirements in this space mature, it’s important to remember disclosures are not just about compliance but also about providing comparable, reliable, and decision-useful information to investors," she said. "Having data insights to reduce carbon footprints helps companies gain competitive advantage and trust from stakeholders."

Renewable energy credits/certificates (RECs), which are certificates regulators offer energy providers when they deliver solar or hydroelectric energy to a power grid; carbon offset credits; renewable identification numbers (RINs); and credits created under compliance programs are all possible components of FASB's project. Because accounting standards to apply already exist, tax credits and tax incentives are not included in the project's scope.

,"It will be interesting to see where the final standard comes out on scope," Dyer said, "but my sense is many of the prominent incentive programs are likely to be captured."

Participants in programs that result in the creation of environmental credits, as well as nongovernmental credit creators, are covered by the project. There are two types of credits: regulatory (e.g., RECs) and voluntary (e.g., LEED credits) (e.g., carbon offsets). FASB is looking at credits that are legally enforceable and can be traded as a starting point.

Santoro explained, "Different people use different terminology to refer to the same thing. R egulatory credits are most common, but voluntary credits are growing exponentially."

"Governments use credits in an effort to both encourage and deter behaviors," Dyer explained. "Some of the difficulty with the standard setting in this project is whether these are the same thing."

When entering into an energy credit transaction, accounting decisions for credits affect whether to expense or capitalize amounts and whether to record a liability for the obligation to meet compliance targets. There is currently no specific framework to apply in US generally accepted accounting principles (GAAP), which is why FASB believes that a change is necessary to ensure that similar programs are accounted for consistently.

Some companies expense credits when they are first recognized, while others capitalize them as inventory or intangible assets and amortize them later. Amounts are typically recorded at cost rather than fair value under current accounting standards.

"Accounting today without an official framework is based on the company’s intent," Santoro explained. "Questions are, ‘Do I recognize an asset? If I do, what type of asset is it? If I have an obligation to meet compliance targets, does that create a liability?’ In practice, we are seeing companies treating credits they will use themselves as intangible assets and as inventory if they are selling them ."

"In our experience, most entities apply either an intangible asset or an inventory-type model, generally based on the method they use to acquire the credits," Dyer explained. "For example, RINs are generated when ethanol is blended with gasoline in the production process. It is common for entities that acquire RINs through their refining of gasoline to apply an inventory method because the credits are an outcome of their production process ."

RINs are allocated a portion of the production cost when using the inventory method. Companies also record cost of goods sold as excess RINs are sold, and RINs held in inventory are subject to subsequent lower of cost or market analysis and impairment assessments under this model.

"Companies that acquire credits from third parties may apply an intangible asset model," Dyer said. He used the example of a real estate developer who has to either buy and set aside land for natural habitats or get credits from other sources. "The developer would capitalize any acquired credits as an intangible asset as part of the cost of the real estate development project," he explained.

Liabilities could arise as a result of environmental credits. "An entity who refines oil into gasoline and does blend enough ethanol into the gas it produces to satisfy its obligation to the government may need to acquire credits in the open market from an entity with excess credits," Dyer explained. "They may have to make mark-to-market adjustments to the liability as the price of the credits changes until they have enough credits to satisfy the obligation."

Another accounting issue raised by Santoro is whether and how to account for voluntary credits that businesses generate, such as forest credits, and whether the credit should be separated from the underlying infrastructure.

There may also be issues with credit sellers' recognition. Companies that generate excess credits may sell them to companies that have credit problems.

Both Santoro and Dyer have received positive feedback from the FASB's decision to take on this project and reduce accounting practice diversity.

"FASB’s decision to take on this developing area now, before the issue becomes too pervasive, is an important step in providing transparency and clarity that investors, auditors, and other stakeholders are craving," Santoro said. "FASB taking on this project is timely, because as the SEC’s proposal increases pressure for more business strategy disclosures, there will be further scrutiny of the accounting."

Although the initial reaction appears to be positive, any change will be subjected to a cost-benefit analysis. "Because accounting practices have already been developed for entities currently accounting for these credits," Dyer explained, "whatever FASB does will require changes and a cost to adopt."

Although the FASB is still developing its plan for this project, companies that currently use these credits should keep an eye on developments.

Santoro said, "“It is a good opportunity for companies to understand their current accounting for these credits. They may not be material yet, but voluntary markets are evolving."

"I think this is a project worth paying attention to as it becomes more common for companies to engage in these activities," Dyer said. "These programs are not new, and these issues have been around for 15 to 20 years, but my sense is they have become more common and will continue to be as the topic of ESG is emphasized and reported on. I would not be surprised to see these sorts of programs proliferate."


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