The trading of instruments such as carbon allowances, carbon credits and carbon quotas through mandatory or voluntary carbon markets has become prevalent in recent years as companies work to reduce their emissions and footprints.
A new report by ACCA and the Adam Smith Business School takes a close look at these instruments from an accounting perspective, assessing current corporate reporting and accounting practices for carbon-related instruments and highlighting the challenges for users who are looking for clarity and consistent information.
Only 28% of companies disclosed participation in the narrative section of their annual report
Worldwide, the carbon credit market is growing at an estimated 25% a year and is expected to be worth US$15.7bn by 2024. The report, Reality of accounting for carbon-related instruments, sets out the challenges that are leading to confusion and a lack of clarity when it comes to accounting for carbon-related instruments, including:
- the variety of terms used when companies refer to their carbon-related instruments within financial statements, coupled with vague or absent definitions of these terms
- the absence of clear guidance on how companies should account for these instruments; IFRS S2, Climate-related Disclosures, requires companies to provide information on the use of relevant instruments, but there is no specific guidance on the actual accounting treatment
- the increasing market price of carbon-related instruments; the average price of the EU’s Emissions Trading Scheme allowances, for example, has risen from €24.61 in 2020 to €83.66 in 2023.
Lack of disclosure
The report is based on analysis of the narrative and financial statements of the annual reports of 300 companies operating in sectors with high carbon emissions.
Companies used a wide range of terms to describe carbon-related instruments
The research found that only 84 of the 300 companies in the sample (28%) disclosed their participation in a carbon market in the narrative section of their annual report; 86 explicitly said they did not participate; and the remaining 130 were silent on the matter.
The companies that did disclose their participation in carbon markets tended to be larger entities, and those in the airline, conventional electricity, iron and steel and chemical sectors. Only 50 companies disclosed their participation in both the narrative and financial statements of the annual report.
An added complication is that companies used a wide range of terms to describe carbon-related instruments. Some terms were clear while others, such as ‘carbon certificates’, were more open to interpretation. The report points out that the variety of terms used to describe carbon-related instruments, sometimes within the same company, ‘add an extra layer of difficulty’ for users trying to understand the accounting treatments and financial implications of the underlying instruments.
Companies have been left to develop their own policies
When it comes to the financial statements, the report also found that of the 121 companies that referred to carbon-related instruments in their financial statements, less than half (51) disclosed the associated amounts, and 11 did not disclose the accounting treatment applied to them.
No standardisation
The lack of an IFRS Standard that specifically applies to carbon-related instruments, says the report, means that there is no standardised accounting treatment and companies have been left to develop their own policies. The result is a wide range of treatments, with some recognising the instruments as ‘intangible assets’ and others as ‘inventories’, ‘financial assets’ or ‘other assets’.
Measurement of carbon-related instruments was another source of confusion, with the report speculating that ‘the chosen approach appears to be influenced by how these instruments were acquired and their intended use’.
Of the 54 companies that recognised their instruments as intangible assets, for example, 44 used a historical cost measurement, four used fair value and six did not disclose their measurement approach. And of the 35 companies that accounted for their instruments as inventories, 14 used historical cost and another 14 used fair value.
More auditor effort
According to the report, ‘relatively few auditors’ reports discussed issues about carbon-related instruments’, and those that did tended to discuss issues relating to the exercise of judgment or uncertainties arising following the use of assumptions, such as measurement, impairment testing and changes in accounting policy. It adds that ‘auditors may need to spend more effort auditing financial statements of companies that engage with such instruments’.
The report calls for globally applicable guidance for consistent accounting treatment
The report concludes that the carbon marketplace is in ‘a dynamic state of growth’, and that the lack of standardisation globally ‘raises regulatory concerns and affects the level of transparency and integrity of carbon-related instruments for users’. A subsequent lack of consistency in accounting for these instruments, it adds, could impair the comparability of financial statements.
Globally applicable guidance for consistent accounting treatment of these instruments, the report concludes, will help determine when and how to recognise them, the appropriate measurement approaches and relevant disclosures. It makes a number of recommendations for preparers, auditors, regulators, policymakers and users, including:
- Preparers should clearly state their accounting policies for the recognition and measurement of carbon-related instruments.
- Auditors should lend their expertise to support the development of globally applicable guidance for consistent accounting treatment of these instruments.
- Preparers should collaborate with their peers to promote best practice and the consistency of accounting treatments.
- Users should familiarise themselves with carbon markets and carbon-related instruments to better understand how and why companies use them.
More information
Register to attend the session on accounting for carbon-related instruments at ACCA’s sustainability half-day conference, live on 29 April or on demand
Look out for ACCA’s upcoming series of articles to supplement key findings from the research, with anecdotes and examples of organisations’ perspectives; implications on the organisation and its value chain; and considerations for accounting treatments
