How Are Carbon Certificates Accounted for under IFRS (International Financial Reporting Standards)?

There is no clear, specific standard on how carbon certificates should be accounted for under IFRS (International Financial Reporting Standards). However, several approaches to accounting for carbon certificates have developed within the framework of existing IFRS standards. These approaches may vary depending on how carbon certificates are acquired, used and sold.

1. Overview of accounting for carbon certificates

Carbon certificates (emission allowances and carbon credits) are rights that help entities cover or offset their carbon emissions. Entities may buy or sell these certificates to meet regulatory obligations or achieve sustainability targets.

Under IFRS, carbon certificates and contracts based on them can be accounted for in three main ways:

1. Intangible asset (IAS 38 – Intangible Assets)

2. Inventory (IAS 2 – Inventories)

3. Financial instrument (IFRS 9 – Financial Instruments)

2. Accounting approaches under IFRS standards

A. Accounting as an intangible asset (IAS 38)

• If the entity buys carbon certificates to meet its own emission obligations, they may be classified as intangible assets.

• They are initially recognised at cost.

• The revaluation model may be applied, but only if an active market exists.

• Certificates are generally not amortised until they are used or sold; if there is an indication of impairment, an impairment test must be performed (IAS 36 – Impairment of Assets).

Example entry:

(Dr) Intangible asset (carbon certificate)   XX
    (Cr) Cash / Payables                         XX

B. Accounting as inventory (IAS 2)

• If carbon certificates are bought for trading purposes (for example, a broker buying and selling them), it may be appropriate to account for them as inventory.

• They are initially recognised at cost.

• Inventories are measured at the lower of cost and net realisable value.

Example entry:

(Dr) Inventories (carbon certificates)   XX
    (Cr) Cash / Payables                     XX

When a sale takes place:

(Dr) Cash / Receivables             XX
    (Cr) Revenue                         XX
(Dr) Cost of sales                  XX
    (Cr) Inventories                     XX

C. Accounting as a financial instrument (IFRS 9)

• Carbon certificates themselves generally do not meet the definition of a financial asset. However, forward and derivative contracts based on these certificates that can be settled net in cash are accounted for under IFRS 9.

• These contracts are recognised at fair value, and periodic changes in value are recognised in profit or loss.

Example entry:

(Dr) Derivative financial asset (carbon certificate contract)   XX
    (Cr) Cash / Payables                                            XX

Remeasurement (increase in value):

(Dr) Derivative financial asset (carbon certificate contract)   XX
    (Cr) Fair value gain                                            XX

3. Use and sale of carbon certificates

A. Use of carbon certificates (for regulatory purposes)

• For an entity subject to an emissions trading scheme, an obligation arises as it emits, and an expense and a provision are recognised for that obligation. At the end of the period, the certificates are surrendered to the regulator to settle the obligation.

As emissions are made:

(Dr) Emission expense                        XX
    (Cr) Emission obligation (provision)          XX

When the certificates are surrendered:

(Dr) Emission obligation (provision)         XX
    (Cr) Carbon certificate (intangible asset)    XX

B. Sale of carbon certificates

• If carbon certificates held as intangible assets are sold, the difference between the sale proceeds and the carrying amount is recognised as a gain or loss. (Sales of certificates held as inventory are recognised as revenue and cost of sales, as shown above.)

(Dr) Cash / Receivables                        XX
    (Cr) Carbon certificate (intangible asset)     XX
    (Cr) Gain on sale of carbon certificates       XX

4. Accounting for government allocations, incentives and penalties

Emission allowances allocated free of charge by the government are non-monetary government grants and, under IAS 20 (Government Grants), may be recognised at fair value or at a nominal (zero) amount. If recognised at fair value:

(Dr) Carbon certificate (intangible asset)     XX
    (Cr) Deferred government grant income          XX

If entities receive monetary incentives to reduce carbon emissions, these are also accounted for under IAS 20:

(Dr) Grant receivables               XX
    (Cr) Government grant income          XX

If the entity pays a penalty for carbon emissions:

(Dr) Emission penalty expense        XX
    (Cr) Cash / Payables                  XX

Conclusion

• How carbon certificates are accounted for depends on the purpose for which the entity holds them.

• Depending on that purpose, they may be classified as an intangible asset (IAS 38) or inventory (IAS 2); derivative contracts based on them fall within the scope of IFRS 9.

• Emission obligations are recognised as an expense and a provision as emissions are made, and are settled by surrendering certificates.