CPA Canada’s IFRS Discussion Group recently turned its attention to cap and trade programs, setting out the issue as follows:
- Many governments around the world have, or are in the process of developing, programs to encourage corporations and individuals to reduce emissions of pollutants. The Government of Ontario introduced a Cap and Trade program as of January 1, 2017 whereby participants are allocated emission rights or allowances equal to a maximum level of allowable emissions. Entities are permitted to trade those allowances. Below is a brief overview of Ontario’s Cap and Trade program:
- The program introduces caps on the amount of greenhouse gas emissions that Ontario’s largest polluters may emit, with the cap being lowered over time. Mandatory participants include large final emitters and specified larger natural gas distributers, fuel suppliers, and electricity importers. Voluntary participants may also partake in the program.
- Participants must submit allowances or credits equal to actual emissions for each compliance period. If the emissions exceed the cap, the participant must buy allowances or credits for compliance purposes. Excess allowances and credits can be sold into the market.
- The cap is the maximum number of allowances that the government creates each year. Capped participants can get allowances either through government grants, at a government auction or purchasing from other participants in a secondary market.
- Credits are compliance instruments granted for early reductions or for reductions, removals, or avoidance of carbon dioxide equivalent emissions achieved by those who are not capped participants.
- The program is expected to link with programs in Quebec and California to enable trading of allowances and credits among the three jurisdictions.
IFRS doesn’t specifically address such programs – an old IFRIC interpretation on emission rights, IFRIC 3, was withdrawn in 2005. According to the group’s discussion, several approaches can be observed in practice. Here are some of their key characteristics:
- IFRIC 3 approach Cap and trade allowances (i.e., purchased or allocated) are recorded as intangible assets and accounted under IAS 38. Allocated allowances received are considered government grants and accounted at fair value under the IAS 20 model. The grant is recognized as deferred income and recognized into income on a systematic basis over the compliance period. Purchased allowances are initially measured at cost. If there is an active market, the purchased allowances can be subsequently remeasured at fair value if the entity chooses to apply to the revaluation model in IAS 38 (NB it appears questionable whether such an active market has been created to date). Otherwise, the purchased allowances are carried at cost, subject to impairment if indicators exist. A liability for the obligation to deliver allowances equal to the emissions produced is accounted for under IAS 37. The liability is measured at the best estimate of the expenditure required to settle the present obligation at the reporting date.
- Government grant approach The asset is measured in the same way as above. However, the liability is measured by reference to the amounts recorded when the rights were initially granted, without necessarily remeasuring the present obligation.
- Net liability approaches Allocated allowances received are considered non-monetary grants under IAS 20, and therefore, recorded at nominal amount. The liability is again measured by reference to the amounts recorded when the rights were initially granted.
The different approaches should all generate the same aggregate bottom line impact over time, but might entail material differences to both the balance sheet and income statement during intervening periods (a recent CPA Canada publication illustrates this in more detail and also provides additional background commentary). The group discussed various specific questions arising from the different approaches, while noting that it’s too early to tell exactly what range of policies may be observed in practice.
One imagines that the first approach set out above, of following the former IFRIC 3, will sound most appealing to many readers at first glance, in that it seems to provide the most transparent representation of the various components of the arrangement. Even as the IASB withdrew IFRIC 3, it assessed it to be an appropriate interpretation of existing IFRS for accounting for the emission trading schemes within its scope; however, the board also acknowledged IFRIC 3 had created unsatisfactory measurement and reporting mismatches between assets and liabilities arising from emission trading schemes. The current IASB research pipeline contains a project on pollutant pricing mechanisms, which would include such schemes; however, the board isn’t currently planning any more work on this until the revised conceptual framework is further along.
All of this won’t be directly relevant to too many preparers and users at the current time. However, there’s some value even in asserting that IFRS has grappled with such issues in the past and will do again, and in hoping that over time this might extend into more conceptually ambitious engagement with climate change, even if (as an initial step at least) only as a supplement to the core financial statements…
The opinions expressed are solely those of the author