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Accounting for Carbon Credit

Updated on: May 3rd, 2022

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6 min read

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A Carbon Credit is equal to one ton of carbon dioxide expelled in the atmosphere. The concept came into existence as a result of increasing awareness on the need for pollution control. It became formal after the agreement among 141 nations known as KYOTO PROTOCOL. Carbon Credits are the certificates awarded to the countries taking active participation in reducing the emissions that cause global warming.

As per the KYOTO PROTOCOL, developing as well as the least developed countries are not bound by the emissions they produce. For the developed nation, to meet the assigned reduction targets, allowances have been issued equal to the number of emissions allowed. For attaining these objectives, three market-based mechanisms have been provided by the Kyoto protocol:

Joint Implementation

Developed nations with the very high cost of domestic Green House Gases (GHG) reduction, have an option of the joint implementation. They can set up a project in another developed country which has a relatively lower cost. In this way, a developed country can earn carbon credits that can be applied during excessive emission targets.

Clean Development Mechanism

Developed nations can take up GHG reduction project activity in a developing nation. The cost of GHG reduction is usually much lower, and the developed country would be given carbon credit for meeting emission reduction targets.

International Emission Trading

A developed country with emission reduction targets could trade in the international carbon credit market. Developed countries exceeding the emission limits can buy the carbon credit for those whose actual emissions are less than the emission limit. Carbon Credits can be exchanged between businesses in the international market at the prevailing market price.

How is carbon accounting done for them?

For Carbon Emission Reduction (CER) to be an asset, it should be controlled by the generating entity. Since CER arise as a result of past events, and from which future economic benefits are expected to flow to the generating entity. According to AS 26 “INTANGIBLE ASSETS”, an intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rentals to others, or for administrative purposes.”

Carbon Emission Reduction (CER) is an ‘INTANGIBLE ASSET’. It is a non-monetary asset without a physical form and expected to generate future economic benefits. However, they aren’t held for use in production or supply of goods and services and neither used in administrative purposes or for rent to others. Instead, CER is generated by the generating entity and held for sale. Accounting for Self-Generated CER in the ordinary course of business are excluded from the scope of AS 26. Therefore, they are to be accounted as per Accounting Standard (AS) 2 VALUATION OF INVENTORIES.

Inventories are assets when they are held for sale in the ordinary course of business, and used in production for such sale or in the form of materials or supplies to be consumed in the production process or in the rendering of services. Thus the CER should be accounted as per requirements of AS 2. Thus CER is to be valued at the lower of cost or net realizable value. Cost of inventories should comprise of all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location or condition including:

  • Research costs arising from exploring alternative ways to reduce emissions,
  • Costs incurred in developing the selected alternative process,
  • Cost of prepare the Project Design Documents,
  • Fees of registering with the United Nations Framework Convention on Climate Change (UNFCCC) as it is mandatory to register without which CRE doesn’t come into existence and thus shall not be an asset.

Net Realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale, where estimates of net realizable value are based on the most reliable evidence at the time the estimates are made as to the amount the inventories are expected to realize. Income from the sale of CRE is to be recognized in accordance with the Accounting Standard (AS) 9 REVENUE RECOGNITION as the CRE is now an inventory. For the generation of CRE, the generating entity may create certain intangible and tangible assets.

For example, for reducing emissions, an entity may carry out some research and development which may result in the creation of an intangible asset and thus should apply AS 26. In some cases, an entity may use a tangible asset to reduce emissions such as incinerators. In respect of such assets, the provisions of AS 10 (Revised) will apply. It may be acquired for safety or environmental reasons. The acquisition, although not directly increasing the future economic benefits but may be necessary to obtain from its other assets. Such items qualify for recognition as assets because they enable an enterprise to derive future economic benefits. An entity should present certified emission rights as part of Inventories, in the balance sheet separately from other categories of Inventories such as Raw Materials, Work in Process, Finished Products and others.

An entity should disclose the following information in financial statements:

  • Number of CRE held as inventory and basis of valuation.
  • Number of CRE under certification.
  • Depreciation and operating maintenance costs of Emission Reduction Equipment expensed during the year.

Conclusion

Carbon Trading is a useful tool to earn extra benefits both for developing countries and non-developed countries. Clean Development Mechanism also offers an effective source of economic as well as technological development for developing countries with environmental sustenance. Although India is the largest beneficiary of carbon trading, it still does not have a proper policy for the trading of carbons in the market.

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