Here’s another fact pattern recently discussed by Canada’s IFRS Accounting Standards Discussion Group:

• A Company owns and manages forests for the primary purpose of harvesting trees for timber. The Company determined that by reducing its harvest levels by 10 per cent, it could develop carbon credits and sell them in the voluntary market for a greater return than the foregone amount of harvested timber. The Company therefore developed a project to reduce harvest levels on designated lands to generate carbon credits. The Company will also continue some harvesting activities on these lands.
• The project has been verified and registered on a voluntary registry. The Minimum Project Term is 40 years, and the Crediting Period is the first 10 years. This means that the Company must maintain the carbon-stocking level associated with verified and issued carbon credits for 40 years by limiting its harvesting activities. This ensures a level of “permanence” for the related carbon stocks. 

The fact pattern lists a series of specific activities for which the company is responsible over the 40-year term. For purposes of the analysis, the group assumed the sales of the carbon credits to be material to the Company and to be an output of the Company’s ordinary activities in exchange for consideration in the scope of IFRS 15, and assumed the third parties purchasing the carbon credits to meet the IFRS 15 definition of customers. Against that backdrop, the group discussed what constitutes a “performance obligation” in this scenario for the purposes of the standard. You might argue it’s simply the sale of the carbon credits, or else that the performance obligation constitutes both the sale of the credits and the carrying out of the related activities over 40 years, or that the two things constitute distinct performance obligations. Or maybe all of those views have merit and the company applies its judgment to determine what policy best reflects the economics of a particular transaction.

Most members of the group took the first view, that the performance obligation is confined to the sale of the carbon credits. It’s key that in the fact pattern, there are no further obligations outlined in the contract with the customer beyond the transfer of a specific serialized carbon credit in exchange for cash consideration; there’s no further reporting to the customer, and any reversal of carbon credits sold doesn’t impact the customer who purchased them. The 40-year activities, in this light, represent an obligation not from the Company to the customer, but rather to the registry to obtain and maintain accreditation for the project (some group members analogized with long-term debt covenants or conditions attached to government grant conditions, which are generally considered to be compliance matters rather than performance obligations to customers). Any penalty or other liability arising from a failure to carry out those tasks would be to the registry, not to the customer.

That all assumes the carbon credits relate to past carbon capture; some group members indicated they would see it differently if the value of the carbon credits arises to any degree from future carbon capture, and a couple of the members were more inclined to identify the carrying out of the 40-year activities as a performance obligation, emphasizing the importance of long-term carbon storage. The meeting notes observe:

• A few Group members considered what would happen if, after the customer retired the credits, the Company were to harvest the trees that were meant to store the carbon associated with the retired credits for 40 years. In this case, the customer may be under pressure to take some form of action in order to still be able to meet its GHG emissions reduction goals. This could include purchasing more carbon credits or possibly pursuing legal action against the Company. The Group members thought that the carbon credits would be less valuable to the customer in this case. Some Group members thought that this would be a separate issue from revenue recognition (e.g., impairment)…

For many group members identifying a single performance obligation, it follows that point-in-time revenue recognition would be appropriate, when the sales contract with the customer is concluded and control of the carbon credits passes from the company. The notes record one member’s comment though that “if the carbon credits contained an inherent promise for future carbon capture, it may not be appropriate to recognize revenue until that carbon capture occurs.” It does seem to me that there’s something intuitively a bit strange (even unseemly) about selling carbon credits based on a 40-year plan and then recognizing revenue for them immediately. But that’s not to take issue with the technical analysis – maybe it’s more of a quasi-moral qualm on my part. Anyway, the group noted this as a rapidly emerging area, which it will continue to monitor, perhaps discussing similar issues in the future as other fact patterns emerge.

The opinions expressed are solely those of the author.