November 2009 | A house is a house, a share is a share, and an pile of corn is a pile of corn. Companies that own these can note them in their books and turn their books over to accountants, who can convert them into measurable assets, which can make it easier to understand the company's value, risk exposure, and overall strategy.
Various entities such as the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have come up with uniform accounting principles like the Generally Accepted Accounting Principles (GAAP) and the International Accounting Standards (IAS) that help companies around the world put their books into similar order so that everyone can understand them.
Unfortunately, neither entity has come up with uniform accounting principles for forest carbon credits, and that makes it nearly impossible to fairly compare financial statements across entities such as project developers.
Entities also struggle with the time and resources required to determine the most appropriate accounting treatment, and this difficulty is exacerbated when an organization follows both GAAP and IAS. Until accounting guidance is issued, difficulty regarding information transparency and comparability will persist.
In May 2007, PricewaterhouseCoopers (PwC) and the International Emissions Trading Association (IETA) released a survey of 26 major European organizations affected by the EU Emissions Trading Scheme (ETS).
The survey looked at the accounting approaches for ETS allowances and Certified Emission Reductions (CERs), both acquired and self-generated. Although the study relates to the EU compliance market, its findings may provide insight for the voluntary market. Specifically, findings on self-generated emissions reductions may reflect similar trends and issues as those encountered by entities in the voluntary forestry carbon market.
The survey found that on the balance sheet, 29% of participants accounted for self-generated CERs as inventory upon generation, at an allocated cost of production; 13% recorded the CERs as intangible fixed assets, at fair value; 29% did not recognize the CERs until they were used/sold; and 29% used other treatments. The decision not to recognize CERs until they are used/sold may suggest that the organization anticipates no future economic benefits from the offsets. For the purpose of this paper, however, we assume classification of offsets as assets. This may be consistent with existing guidance.
According to IASB, an asset "is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity". FASB similarly defines an asset as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events".
Whether the offset is sold pre-verification or ex-post, money exchanges hands in return for offset ownership rights. A buyer may bank and later sell forestry offsets or use them to settle compliance or pre-compliance emissions obligations. Accordingly, forestry offsets may qualify as assets for financial accounting purposes because they are entity controlled and provide future economic benefits.
Despite the lack of clear rules, various accounting methods applicable to offsets are present in existing standards under IAS and U.S. GAAP. With the assumption that forestry offsets are classified as assets, we focus on the two remaining accounting treatments found in the survey: inventory and intangible assets. In determining the appropriate accounting for forestry carbon offsets, considering their character is imperative. The use of the offsets determines their nature, which in turn dictates how they should be classified in the financial statements.
Forestry carbon offsets can be classified in the financial statements as either inventory or intangible assets. The offsets can be held at fair value, net realizable value, or cost. Fair value and net realizable value are based on market prices; however, without an active market for the offsets, it may be prudent to record them at cost. This value is either what an entity purchases its offsets for or the cost the entity incurs to manufacture the offsets. If an entity self generates offsets, it may use cost accounting to arrive at a unit cost regardless of classification as inventory or intangible assets. This unit cost is the amount recorded on the balance sheet and eventually expensed on the income statement when the offsets are sold.
Talitha Haller is a short-term associate with the Social Carbon Company in Brazil. She graduated from the Ross School of Business at the University of Michigan with a Master of Accounting and a BBA. She can be reached at email@example.com.
Gabriel Thoumi is a consultant with Forest Carbon Offsets, LLC a global forestry carbon offset project development firm. He is a graduate from the University of Michigan with an MBA, MSc, and a Graduate Certificate in Real Estate Development. The views expressed in this article represent Gabriel's professional opinions. He can be reached at firstname.lastname@example.org.
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