Carbon Pricing Mechanism and Accounting System - Coursework Example

Title : Name : Student ID : Subject : Date : Table of Contents Table of Contents 2 Executive summary Carbon pricing mechanism in Australia will be introduced on July 1, 2012 under The Clean Energy Act 2011, which was passed by parliament on November 8, 2011 to compel companies emitting carbon dioxide or its equivalent to pay every ton of emitted pollutants. The first phase is referred to as fixed price phase, which begins on July 1, 2012 to June 30, 2015. Second phase is referred to a flexible phase, which starts July 1, 2015 onwards. Companies can be directly or indirectly liable depending on where the emissions they emit occur. Directly liable companies are those that emit in their production facilities and indirectly liable companies emit the pollutants away from their premises. There are about 500 directly liable companies in Australia. The liable companies will purchase permits (carbon units) for every ton of carbon dioxide equivalent they emit from the government and surrender it to the government. Indirect companies can receive free permits if they meet set conditions. Furthermore, permits can either be surrendered to the government or traded in the market. Permits can be valued and revalued at cost (nominal) or fair value. Carbon pricing mechanism impacts both the balance sheet and income statement. However, there is no strict guideline on how to account for carbon taxes in Australia because it is a new concept under development by relevant agencies. Carbon Pricing Mechanism and Accounting System 1.0 Introduction Introduction of carbon pricing mechanism in Australia on July 1, 2012 will impact significantly on accounting systems of the affected companies or entities. Carbon tax is likely to induce uncertainty in the economy because economic players will have to factor in impact of the carbon tax. Porteous (2008 pp. 102) affirms that carbon tax can easily be understood by all consumers and producers of energy. To legalize carbon taxation, The Clean Energy Act 2011 was passed by parliament on November 8, 2011 to regulate carbon taxation in Australia. Under The Clean Energy Act 2011, every ton of carbon dioxide produced is subjected to tax. The act commences on July 1, 2012 and shall cover both carbon and non-carbon (carbon equivalent) pollution emitters. Carbon pricing mechanisms occur when entities burn fuel that produces carbon dioxide or its equivalents. Carbon tax does not cover combustion of certain fossil fuels, including combustion of biomass, biogas or biofuel. It does not also include agricultural emissions, legacy wastes emissions, closed landfills facility emission, fugitive emissions from underground mines that have been decommissioned as well as emissions from specific synthetic green house gases. The liable companies will purchase permits (carbon units) for every ton of carbon dioxide equivalent they emit from the government and surrender it to the government. The business entities must comply with associated costs, regulatory and administrative requirements of emitting carbon dioxide or its equivalents. The purchase of emission permits, which are also referred to as carbon units are treated equally to trading stocks based on rolling balance approach. Entities likely to be impacted negatively by the introduction of carbon pricing mechanism are those entities that are not able to pass on tax to consumers and those that have entered into long-term contracts. However, business entities may benefit from grants and support packages to help in transition to the carbon pricing mechanism regime. For example, if a small business has less than $2 million turnover, they would receive tax write-off of $6,500 if they purchase new assets beginning July 1, 2012. Carbon pricing mechanism would impact on cash flow, income statements and balance sheet of the affected entities 2.0 Carbon Pricing Mechanism Phases Companies or business entities that emit green house gases are required to pay for emitting pollutants under the Australian Carbon Pricing Mechanism. As a result, Australian Government publicly announced its intention to introduce carbon tax (Carbon Pricing Mechanism) in February 2011. Carbon tax will be introduced in two phases. First Phase is referred to as fixed price phase, which starts from July 1, 2012 to June 30, 2015. The first phase stipulates that all entities that emit over 25,000 tons of carbon dioxide equivalents (CO2-e) will have to pay $23 for a permit for every additional ton of CO2-e emitted beyond the 25,000 tons of CO2-e. The price of every additional CO2-e would be increased by 2.5% in real terms every year until June 30, 2015. The second phase is flexible price phase, which will be based on Emission Trading Scheme (ETS), which will begin on July 1, 2015. ETS refers to cap and trade scheme. Under the second phase, the government role is to set a limit (cap1) and the market mechanisms are allowed to set the price of permits. In the beginning of the second phase, $15 would be paid to players who emit less than the threshold and $20 charged on permit for every ton of CO2-e released beyond the threshold set by the government. The price paid to less emitters and tax charged on additional emission will increase by 4% and 5% per year. 3.0 Liable Companies 3.1 Directly affected entities The companies that are directly emit carbon dioxide or their equivalents as they carry out their day to day operations within their facilities as well as emissions from burn of fuel. Such companies undertake electricity generation, fumigations, fuel usage for transporting their inputs and those that undertake industrial processes. According to KPMG (2011 pp.1), carbon pricing mechanism will directly impact five hundred business entities in Australia. Of the five hundred companies, hundred and ninety (190), one hundred (100) and sixty (60) are entities of waste disposal; coal mining and other mining; and electricity generation companies respectively. In addition, there will be sixty (60), fifty (50) and forty (40) industrial processes, fossils fuel and natural gas retailers companies respectively. The above companies are liable if they produced pollutants above the threshold2 and are required to report additional emissions to the concern authorities. Companies that are directly affected are also exposed to scope two emissions just like indirectly liable companies. Carbon dioxide or equivalent emission units are calculated by multiplying the amount of fuel consumed by the emission factors, which are set for different types of electric generators and sources. Direct emitters are not eligible for free permit and measure their emission liability at their fair value. Therefore, they must purchase all permits. A directly liable entity record in the balance sheet the price of permits they acquire as assets. The permits are then revalued at fair value to cater for impairments. Gains or losses from sales proceeds are captured in the profit and loss account. 3.2 Indirectly affected entities The emissions of indirectly affected companies occur outside their premises. These are companies that emit carbon dioxides or its equivalents from the energy they purchased for consumption. In addition, the companies are in no direct obligations to purchase permit. However, they are affected because they absorb costs passed on by direct generators. These companies are affected only through compensation calculations. They are required to report emissions beyond threshold of 25,000 tons of carbon or its equivalents. The quantity of carbon dioxide or its equivalent emitted is calculated by multiplying the amount of fuel or energy consumed by the emission factors that has been set for different types of electricity and fuel generators and sources. Other business entities may also be affected indirectly depending on the level of processing the product or service and whether the service or product is completed in Australia or in other countries. Indirect payers also include builders, indirectly through cost of energy consumed and materials used. An indirectly liable entity record in the balance sheet the price of permits they acquire as assets either free or purchased permits. The permits are then revalued at fair value to cater for impairments. Gains or losses from sales proceeds are captured in the profit and loss account 3.3 Permits This further divided into free and purchased permits Australian government introduced assistance programs in form of free permits (carbon units) or cash to help entities in transition to carbon pricing regime. Free permits are considered government assistance in form of grants. Guidelines for recording government grants are provided by AASB 120, the specific guidelines indicates how to account for government grants and disclosure of assistance from the government. For free permits to be recognized, liable entities must comply with conditions attached and the entity must receive the said free permits. Under the first phase of carbon pricing mechanism, all conditions to receive the free carbon must be fulfilled by August 15, of the compliance year and free permits would be allocated by September 1 of the compliance year. However, if the number of free permits to be allocated is not known before the date of receipts, the free permits are to be recognized on the date it is received. Free permits When a business entity receives a free permit, they are deemed assessed upfront on permit value. According to taxation rules, the value of a permit is deemed at market value if: i. The permit is transferred between related or associated parties under a non-arms-length ii. Tax payer receives it as part of support or assistance arrangement The permit was issued the carbon Farming Initiative and it is an Australian Carbon credit. AASB 120 allows government grants received to be valued at zero or at their fair value Therefore, the entity can choose to value them based on either nominal or fair value. When the amount of free permits is measured under the fair value, the value remains constant. However, if it is measured under nominal value on grounds that they are intangible assets, they are revalued at fair value through equity if an active market exists for the free permits during the first phase. If the entity has sufficient free permits to pay all its emission obligations, expected emission liability will be zero. If free permits are insufficient, the entity can measure its emission liability within the year to the point where CO2-e exceed free permits and beyond the free permits, excess emissions are measure at fair value. On the other hand the entity may estimate the average cost of each permit while considering number of free permits and additional permits it may have to pay to meet its emission obligations (KPMG 20122, p. 5). 4.0 Emissions Liability Starting 1 July, 2012 the liabilities of CO2-e entities will be recognized as provided by the requirements of AASB 137, that guides recognition of contingent assets, and liabilities as well as provisions. If entities emits more than 35000 tons of CO2-e, they will have to settle three-quarter (75%) of their estimated obligation by July 15 in the year of compliance and settle the remaining by February 1 of the following year. However, entities that emit CO2-e below 35,000 tons, they are required to settle their obligation by February 1 of the following year. Under the Clean Energy Act 2011, entities must surrender their permits to meet requirements of their emission liability. Entities with insufficient permits must purchase them from the government or other entity or pay a shortfall charge. However, paying shortfall charge is more expensive than surrendering units. Within the fixed period, all permits purchased from the government must be surrendered immediately. In general, the basis of measuring the free permits influences the measurement of the emission liability. If the entity chooses to measure free permits using the fair value, then the emission liability is also measured using the fair value. Measuring using the nominal value 5.0 General Accounting System Carbon pricing mechanism would impact on cash flow, income statements and balance sheet of the affected entities. However, According to KPMG (2012 pp. 3), there is no specific literature addressing carbon accounting locally or internationally. Therefore, Australia just like any other countries discusses accounting of carbon pricing mechanisms at the local (domestic) accounting standard board level. Lack of specific accounting guidance makes it logical to borrow guidelines from the ASSB 108, which covers changes in accounting estimates and errors. 5.1 Impact on Income Statement Carbon pricing definitely impact on the income statement through revenues generated when the permits are sold, taxes imposed, tax write-off, penalties and other costs associated with carbon pricing mechanism. Cost of purchasing permits will be tax deductible but the deduction would be deferred until when the permit is surrendered to the government or sold to other entities. The expense incurred to hold a permit is deductible the year the liable entity start to earn the permit. However, deduction would be denied if there are penalties (including shortfall charges), which are imposed under The Clean Energy Act 2011. The permits may be surrendered to the government or sold to another entity through the buy-back arrangement existing the fixed price period. If the permit is sold instead of being surrendered, the monies generated from sale will be included in the revenue account in the year under which the permit was sold. In addition, when an entity is compensated for emission liability in a given year, the free permits are recognized as income over that particular compliance year. Compensation resulting from increased cost of electricity caused by Energy Intensive Trade Exposed activities such as smelter , the free permits are recognized as income to the entity while at the same time additional electricity cost are recognized as expense. When the assets value such as brown coal generators is eroded, if the grant or support is intended to support the erosion of the value of the assets, then the fair value of the free permits are recognized when the value of the assets decreases as an expense in the income statement (KPMG 20122 p. 5). This takes the form of impairment write off or depreciation because the assets economic life is shortened. If nominal value approach is used by the entity to measure the free permits, the government grant is not recognized in the income statement of the entity. The time to recognize free permits in the income statement depends on use of free permits by the entity. If the emitter surrenders the free permit to fulfill its obligations in accordance with carbon pricing mechanism, the free permits are recognized as lower carbon emission expense indirectly in the income statement. For other entities, free permits are recognized as income when they are sold to the government or other entity. In this regard, monetization of free permits would be recognized on systematic basis only if the entity sells the permits progressively during the compliance year. CPA Australia (2012 pp. 1) reveals that AASB 112 recognize income taxes to include all taxes on taxable profits and that the carbon tax has no profit concept because it is more of a production tax. Therefore, it does not impact on income tax of the entity. GOA3 (2012) affirms that the supply of permits under The Clean Energy Act 2012 will be free from GST tax to avoid distortion of prices of the permit prices and protects the entity form denial of input tax credits. 5.2 Impact on Balance Sheet Permits are recognized as new assets to the entity or a new carbon emission liability as emissions occur. Free permits are valued at zero value or at fair value at reporting date or at date of initial recognition. The permits4 that are acquired become an asset to the business in the year in which it was acquired. To make accounting easier, AASB5 (2011) recommends that permits need to be classified based on nature of permit as well as the type of the asset. AASB considers permits as assets regardless of purchase or being received as compensation. Permits are considered resources to be controlled by the liable entity. The permits have future economic benefits in the sense that it can be used to settle emission financial obligations or converted into cash when it is returned to the government for a refund when threshold has not been surpassed. 5.0 Recommendations 1. The entity must comply with conditions set by the company to qualify for free permits. 2. The entity need to adopt fair value as the basis of its valuation 3. The entity need to purchase permits at all times and ensure that the purchased permits are sufficient to protect the company form paying penalties or short charges, which add costs to the company. 4. Surrendered permit to the government or sell it as soon as possible to minimize the holding cost of the permits because long holding defers tax relief associated with permit expenses. 6.0 References AASB 2011. Meeting 26 October 2011. Available at: http://www.aasb.gov.au [Accessed 5 June 2012]. KPMG. 2012. Reporting Update, 12RU-003 Available at: http://www.kpmg.com/AU/en/IssuesAndInsights/ArticlesPublications/Flash-Reports/Documents/12ru-003.pdf [Accessed 5 June 2012]. AG 2012. Clean Energy Act 2011 - C2011A00131. Available at: http://www.comlaw.gov.au/Details/C2011A00131[Accessed 5 June 2012]. CPA Australia. 2012. Fact Sheet: Carbon Price and Financial Reporting. Available at: http://www.cpaaustralia.com.au/cps/rde/xbcr/cpa-site/carbon-price-and-financial-reporting.pdf[Accessed 5 June 2012]. KPMG. 20121. Managing the implication of price of a price on carbon. Available at: http://www.kpmg.com/AU/en/IssuesAndInsights/ArticlesPublications/Climate-Change-Carbon-Price/Documents/managing-the-commercial-implications-of-a-price-on-carbon-v3.pdf [Accessed 5 June 2012]. Porteous, A., 2008. Dictionary of Environmental Science and Technology. 4th ed. New Jersey: John Wiley & Sons. Read More