Accounting Regulation and Emissions Trading Schemes - Essay Example

Accounting regulation and Emissions trading schemes Lecturer: Accounting regulation and Emissions trading schemes Introduction Global warming and climate change presents challenges to individuals, businesses, policy makers and industries and industrialised countries have made committed to reduce the greenhouse gas emissions by 8 percent in relations to the 1990 levels as outlined in the Kyoto Protocol of 1997 (Taticchi, Carbone & Albino, 2013). According to Jones & Ratnatunga (2012), the industrialised nations have adopted market-based mechanisms of carbon-emissions reduction such as the Emissions Trading Schemes (ETS) that internalise the externalities through providing a price to the cost of pollution. In this case, economists are faced with a moral dilemma on whether emission rights will actually reduce the levels of emissions and whether the price of the emission rights will force the industries to implement less emitting technologies or industries will simply purchase the rights and continue with the same polluting technologies (Bakker, 2009). According to the International Public Sector Accounting Standards Board (IPSASB) objectives with respect to Emission Trading Schemes (ETS), the development of accounting requirements will enhance the global consistency and comparability of resources and obligations related to ETS in the financial statements of public sector entities (IPSASB, 2013, pg 3). The accounting standards setting boards have responded to climate change through suggesting for measures of ensuring emitting entities disclose their efforts towards combating greenhouse gas emissions. Freestone & Streck (2009) asserts that emission Trading Schemes (ETS) provide a market mechanism where greenhouse gases are transformed to tradable commodity through assigning rare emission rights to the different emitting entities thus enabling companies to implement measures of reducing carbon pollution through using more environment-friendly technologies. The international accounting standards setting need to explore new mechanisms for reflecting the impact of carbon emissions in the financial reports and new mechanisms of demonstrating carbon abatement progress. International Accounting Standards Board (IASB) efforts in setting acceptable accounting guidelines for emission trading schemes have faced numerous hurdles since recognising the emission rights as assets may not be consistent with the Kyoto Protocol and nature of the emission rights (IASB, 2005). Surprisingly, International Financial Reporting Interpretations Committee 3 has been withdrawn since it provides inadequate and distorted picture of the nature of emissions. Some unresolved issues surround the debate on whether the emission rights should be recognised as an asset when emitting entities receive them free of charge or as government grant or should a liability be recognised in these circumstances (Kashyap, 2011). According to mainstream approaches of understanding the ‘nature’ of emission rights, such rights are regarded as private property that have economic benefits and tradability (Zhang-Debreceny, Kaidonis & Moerman, 2009). Environmental ethics requires human beings to take measures of conserving the environment and thus institutions like the accounting profession must face the moral as well as technical challenges that are involved in accounting for sustainability (West, 2003). Social ecology perspective is consistent with environmental ethics since humans must appreciate the intrinsic value of nature and thus accounting regulation must take in to account environmental externalities such as pollution. In this case, mainstream approaches consider the role of accounting as integral to the capital markets while social ecologists are of the view that role of accounting in the society is to represent nature and thus humans are guardians of nature and protect the future generations’ needs thus economy must be long-term. Zhang-Debreceny, Kaidonis & Moerman (2009) argues that accounting recognition of the emission rights as an asset is consistent with the view that emission rights can be traded for monetary benefits, but this view is problematic on the social and environment perspective since human are not expected to possess the right to pollute the environment. In the social ecology perspective, humans are expected to undertake the responsibility to protect and thus business behaviour must aim at internalizing the pollution costs. In this regard, some argue that emission rights may be recognised as liabilities since businesses are expected to fulfill an obligation of purchasing the rights and future benefits are non-monetary since the benefits result from the past transactions (Zhang-Debreceny, Kaidonis & Moerman, 2009). Australia has implemented several initiatives of greenhouse gases disclosure such as the private sector carbon disclosures project and public sector national greenhouse and energy-reporting scheme. Accounting for carbon emissions focuses on the disclosure for the carbon allowances and assumes emission trading scheme exists. IPSASB has initiated a joint project with International Accounting Standards Board that will ensure the auctioning of emission permits and allocation of the allowances at no cost. Types of Emission trading schemes Internationally and domestically, accounting standards setters have not issued guidance on the accounting for emission trading schemes, but different approaches have been supported by the existing generally accepted accounting practices. (Kashyap, 2011). Several industrialised countries have ratified the Kyoto Protocol that provide rise to liabilities for national governments. The issues that surround the accounting for greenhouse gas emissions include whether the Kyoto Protocol Units (KPUs) that are issued to the national governments are to be considered as assets and how to measure such an asset. Another pertinent issue is on whether the obligations under Kyoto Protocol and other treaties should be regarded as liabilities. In addition, the accounting standards setters are faced with the issue on whether the allowances that are issued to participants without charge amount to an expense and liability of the administrator of the scheme and whether revenue will arise when participants surrender some of their allowances. Australian government ratified the Kyoto Protocol in 2007 and announced the introduction of carbon pollution reduction scheme in 2010 that aims at reducing the greenhouse gas emissions (GHG) and combating climate change. Cap and trade scheme The cap and trade scheme entails setting of a cap by the government or central administrator on the amount of emissions and the cap is allocated to the emitting entities by the distribution of the ‘emission allowances’ (Tuerk, 2009). The emission allowances can be traded in a emission trading scheme since they are scarce and valuable. The cap and trade model involves a long term emission abatement goal, a system of permit allocation and issuance, safety valve emission fee and recognition of international carbon offset regimes. The companies are expected to report the direct emissions that arise from their facilities and indirect emissions that arise due to consumption of electricity or steam within the facility (Tuerk 2009). About 1,000 Australian largest companies have joined the cap and trade scheme and the government determines the cap depending on the particular sector of the economy. The businesses are expected to acquire and surrender enough permits to cater for the greenhouse gas emissions each year and the prices for the permits are determined by the existing demand and supply. The companies that directly emit more than 25,000 tonnes of GHG emissions are liable under the Australian scheme (Editors 2008). Baseline and credit scheme The second type of ETS is the baseline and credit scheme whereby a central administer or the government sets up cap in the form of baselines. Baseline and credit schemes differ from cap and trade schemes since they do not have transferable allowances but assign baselines that are regulated by the emission sources (Houghton, 2004). The trading mechanism issue credits to entities that keep their emissions below the baseline during the compliance period and such credits are either traded or transferred or may be kept for future compliance periods. Although cap and trade schemes may sell carbon allowances, the baseline and credit scheme involve free allocation of baselines and only the credits are tradable. An example of baseline and credit scheme that has been implemented in Australia is the New South Wales Greenhouse gas reduction scheme (GGAS) According to International Accounting Standard (IAS) 38, emission allowances are classified as intangible assets and purchased allowances are recognised at cost. Under the net liability approach, the allocated emission allowances are recognised at zero cost due to lack of acquisition costs while under the government grant approach the emission allowances are recognised at fair value. The cost model does not cater for the subsequent increases in the value of the allowances, but the impairments are reflected in write-down. Under the revaluation model, the emission allowances are revalued on regular basis and the revaluation gains are recognised in other incomes while the revaluation losses are recognised in the profit and loss account (Berger, 2012). Accordingly, the accounting for ETS must cater for offsetting liability through reflecting the obligations in the financial statement and identification of an obligating event to identify the recognition date and ensure correct measurement. The International Accounting Standards and general accounting practice has identified two methods of recognition date of the offsetting liability especially for the businesses that receive free emission allowances (Lohmann, 2009). The first is the allocation date when the company receives the free emission allowances and is based on the argument that participating entities will strive to offset its greenhouse gas emissions. The second approach on recognition date of the offsetting liability is when the entity emits thus no liability occurs until the entity has emitted (Bogui, 2008). An appropriate measurement method of the liability is also controversial, but international financial reporting standards requires liabilities to be measured using the best estimate of the expenditure that is required to settle the obligation. In this case, the issue that arises is whether to measure the offsetting liabilities using the market price of emission allowances (fair value approach) or the carrying value of the allowances (cost of replacement). The fair value approach of measuring the offsetting liabilities using the current market prices based on the argument that the fair value actually represents the real expenditure that will be utilised in offsetting the emissions as the entity is not required to remit the allowances (Clark, Leo & Picker, 2012). However, the fair value approach presents challenges since emission allowances are intangible assets and shifts in prices may lead to net loss during the accounting period as emission allowances are not recognised as profits using the revaluation model, but leads to other comprehensive income of the entity (White & Labatt, 2013). According to the cost of settlement approach, the offsetting liability will be measured depending on the book value of held allowances, but the accounting implications of this measurement approach will depend on the measurement approach (Berger, 2012). If the allowances were initially recognised using the net liability approach, the liability will only be accounted for when the actual emissions exceed the initially allocated allowances since they were initially recognised at nil cost. If the allocated allowances were initially accounted as government grant, the emitting entity will account for a liability as soon as the entity emits. IAS 37 provides for the establishment of contingent liabilities and contingent assets using the best estimate of expenditure that will be required to settle the obligation at the end of the disclosure period. Conclusion The Kyoto Protocol requires governments to undertake measures of reducing the greenhouse gas emissions through market-based mechanisms that offer companies incentives to reduce their emissions. The objectives of the IPSASB with respect to emission trading schemes (ETS) is to ensure accosting requirements that enhance global consistency and comparability of resources and obligations related to ETS in the financial reporting statements of the public sector entities. The implementation of ETS enables the public sector entities to acquire and trade emission allowances that are offered through the cap and trade model. Accordingly, the public sector entities can participate in baseline and credit schemes that allow them to trade their emission credits to other entities that exceed their baselines. According to IAS 38, the emission allowances are perceived as intangible assets and purchases are recognised at the cost, but such allowances may be recognised at nil cost under the net liability approach since the public sector entities may receive such as allowances as a government grant. Another global consistency practice in the accounting for the emission allowances is writing down the revaluation losses if such as allowances were obtained at cost and adding the revaluation gains to the other comprehensive incomes. Furthermore, another inconsistency that exists is the date of recognition of the offsetting liability since it may be recognised when the entity acquires the allowances or when the entity actually emits. Accordingly, accounting profession faces hurdles in determining the best measurement of the offsetting liabilities since the fair value approach will experience challenges associated with changes in prices, but general practice requires liabilities to be estimated according to the best estimate of the expenditure that is required to offset the liability under IAS 37. Reference list: Jones, S & Ratnatunga, J. 2012. Contemporary issues in sustainability accounting, assurance and reporting. Bingley: Emerald Group Publications. Freestone, D & Streck, C. 2009. Legal aspects of carbon trading: Kyoto, Copenhagen, and beyond. Oxford: Oxford University Press. Tuerk, A. 2009. Linking emissions trading schemes. London: Earthscan. Houghton, J.T. 2004. Global warming: the complete briefing. Cambridge: Cambridge University Press. IASB (2005). IASB withdraws IFRIC interpretation on emission rights, Press release, July 2005, International Accounting Standards Board. Lohmann, L. 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