trouble entry accounting - uncertainty in accounting for the eu emissions trading scheme and...

8/7/2019 Trouble Entry Accounting - Uncertainty in accounting for the EU Emissions Trading Scheme and Certified Emission R

1/49Trouble-entry accounting

Trouble-Entry Accounting Revisited*

Uncertainty in accounting or the EU Emissions Trading Schemeand Certied Emission Reductions

Industries

*connectedthinking pwc

Analysis o the results o the Joint Survey undertaken by PricewaterhouseCoopers and IETA on the accountingapproaches applied in practice and assessment o the key accounting approaches considered suitable under IFRS

Energy, Utilities & Mining


2/49 PricewaterhouseCoopers

Table o contents

Welcome 3

Introduction 4

Overview o the EU Emissions Trading Scheme (ETS), andCertied Emissions Reductions (CERs) 6

Results o the suvey - Accounting or the EU ETS 0

Conclusions 5

Accounting approaches or the EU ETS / illustrative example PwC view 7

Results o the survey - Accounting or CERs 30

Conclusions 39

Accounting approaches or CERs PwC view 4

Challenges o nancial reporting 44

Who took part? 45

Looking ahead 46

Contact us 47

There is a widespread eeling that the EU ETS has made great progress but that the pace o change has notalways been matched by its inrastructure. Carbon nancial accounting is a case in point. The industry is plagued

with diversity o accounting and no uniorm approach seems to be in sight since the International AccountingStandards Board withdrew its accounting interpretation set out in IFRIC 3. The impact o accounting is increasinglyimportant. Companies trading within the EU ETS perceive increasingly how allowances and carbon creditsrepresent a signicant asset. For example, between 008 and 0 some billion allowances* will be issued.

The important question is how these are recorded or accounting purposes. The survey which IETA is doing inconjunction with PwC will be a step in the right direction o bringing in more transparency and understanding onthe real accounting issues within the EU ETS. On this basis IETA and PwC will be in a position to stimulate urtherdebate and action on a uniorm standard.

* Figures from Societe Generale.Andrei Marcu, President and CEO, IETA


3/49

Welcome

The emerging political consensus on climate change has pushed the green agenda rom the debating chamber into theboard room. Indeed, a rat o economic measures at the national and international level has ensured that both public andprivate companies have become increasingly alert to the nancial consequences o climate change and the measuresbeing employed to tackle it.

The European Union Emissions Trading Scheme (EU ETS) has emerged as one o the most signicant measures to dateto tackle climate change since its commencement on st January 005. Overnight it created a pan-European marketworth tens o billions o Euros and created new challenges and opportunities or those companies within scope o thescheme and the regulators overseeing it. By bringing the value o carbon dioxide emissions on to the balance sheet italso created a clear connection between emissions and corporate value.

As markets or carbon dioxide and other emissions emerge and develop in the EU and around the world, the need tocommunicate clearly and unambiguously to stakeholders about how company perormance has been and is expected tobe aected by such initiatives has become paramount.

A direct challenge to meeting this need or clear and eective accounting guidance and transparency was the withdrawalin June 005 o the International Accounting Standard Boards (IASB) interpretation o how to account or the EU ETS(IFRIC 3). The reason or the withdrawal was the mismatch between the valuation o assets and liabilities leadingto articial income volatility. This gave rise to a notable absence o specic guidance on carbon accounting at theinternational level, although there are existing standards within IFRS that deal with the accounting. With the risk oalternative accounting treatments emerging, the comparability requirement o nancial statements between entities asunderpinned by the IASB Framework may be undermined. This in turn could pose clear risks to shareholder value andeective stakeholder decision making.

This risk is increased given the observed volatility in the market prices or the EU allowances since the scheme wasintroduced which has led to volatility in company income statements and in the valuation o carbon assets and liabilitieson balance sheets.

Whilst the EU ETS represents the most signicant o the new carbon abatement measures introduced to meet Kyotoobligations, other measures such as the Clean Development Mechanism (CDM) have also been developed. The CDMallows industrialised countries (also known as Annex countries under the Kyoto protocol) to earn emissions reductionscredits towards Kyoto targets through investment in qualiying and sustainable projects in ast growing countries (alsoknown as host countries o the project). Firms and governments can invest in the CDM by purchasing the outputs othe CDM Certied Emissions Reductions (CERs). Subject to certain limits, the CERs will be convertible into EUAllowances to contribute to meeting carbon emissions obligations.

The withdrawn IFRIC 3 does not apply to the CERs scheme as it is not a cap and trade scheme like the EU ETS, hencethere has not been any specifc guidance issued by the accounting standard setters specifcally aimed at CERs. However,as or EU ETS there are existing standards within IFRS that deal with the accounting both in terms o those CERs that arereceived by the asset owners themselves, and those that are purchased through bilateral trades in the market.

This publication aims to shed some light on some o the accounting approaches being applied in practice, and

provides some useul guidance under IFRS and worked examples showing the impact on the nancial statements.We hope that you nd this publication both revealing and helpul.

Richard Gledhill, PricewaterhouseCoopersGlobal Leader - Climate Change Services

Andrei Marcu, IETAPresident and CEO

. IFRIC 3 stands or the International Financial Reporting Interpretations Committee Interpretation 3 which provided guidanceon the recognition o emissions rights, beore its withdrawal in June 005 by the International Accounting Standards Board (IASB).

3


4/49

Purpose and objectives o this publication

Given the growing importance and impact o carbon abatement measureson nancial reporting, PricewaterhouseCoopers (PwC), in conjunction withthe International Emissions Trading Association (IETA), have conducteda Europe wide survey o the accounting approaches applied by majororganisations which are signicantly aected by the EU ETS. The survey

ocuses on the accounting or the EU ETS, but also covers the accountingor CERs, given the linkage to the EU ETS.

The purpose o the survey and o this publication is to present a synopsiso the accounting approaches applied in practice and to understand thekey themes and issues arising given the absence o specic accountingguidance. The survey and ndings are predominantly based on InternationalFinancial Reporting Standards (IFRS).

This detailed publication is an expanded version o the summary publicationissued by PwC and IETA in May 007.

The key additional areas included over and above the summary version areas ollows:

greater quantitative analysis o the responses to the survey questions.

PwC view o the key accounting approaches or the EU ETS, withreerence to worked examples.

PwC view o the key accounting approaches or sel generated andpurchased CERs.

Results o the survey at a glance

Based on the 6 surveys received, it is possible to identiy six main

approaches in relation to the EU ETS. Only a small minority o respondentshave continued to apply the withdrawn IFRIC 3 as an accounting policy.The most common approach identied was to recognise the grantedallowances at nil value, with the obligation recognised at the carryingvalue o allowances already granted/ purchased, with the balance at theprevailing market price. There was however more variation when theclassication o the EU ETS on the balance sheet is considered, with teendierent approaches identied in total.

In relation to the purchased CERs it is possible to identiy two mainapproaches. All respondents initially recognise the purchased CERs at cost,but in terms o subsequent treatment, 38% revalue the CERs subsequent

to initial recognition, with 6% choosing not to revalue the CERs. Aswith the EU ETS it is possible to identiy more variation when it comes toclassication, with eleven dierent approaches identied in total.

Introduction

44 PricewaterhouseCoopers

The purpose o the surveyand o this publication is topresent a synopsis o theaccounting approachesapplied in practice and tounderstand the key themesand issues arising giventhe absence o specicaccounting guidance.


5/49

It is also noted that nancial institutions and traders tend to avour theapproach o air valuing the CERs and EU ETS certicates received andalso orward purchase/sales contracts through the income statement.Utilities on the other hand have tended to be more compliance ocusedand have less o an appetite or recognising movements in air value othe assets through the income statement and have tended to apply the

own use exemption or cash-fow hedge accounting or orward purchasecontracts.

The emergence o dierent accounting approaches applied to the EU ETSand to CERs poses clear challenges or the users o nancial statements.Decisions concerning the valuation o carbon assets and liabilities havea clear impact on a companys nancial position and nancial results ora given period. Indeed, as one respondent commented; It is dicult tocompare the business perormance between the peers when accountingtreatments are not clear or they vary so greatly.

Respondents also expressed rustration over how much time was requiredto be spent in considering the alternative accounting treatments and in

developing suitable accounting policies in the absence o authoritativeguidance. This was particularly so or groups that report under both IFRSand another GAAP, as time consuming and oten complex adjustmentsmay be required between the two. Furthermore, respondents alsohighlighted how the lack o guidance posed challenges or eectiveoperational and investment decision making due to the impact that theaccounting treatment can have on company and transaction valuations.

Whilst in this publication we do not go so ar as to advocate one particularaccounting approach over another, nor do we opine on the appropriatenesso the approaches within the survey, we do highlight how some o theprinciples o IFRS could be interpreted in the context o the EU ETS and

CERs. From this we have provided a number o approaches that are clearlysupportable under IFRS.

The IASB has stated that work on a project to address the underlyingaccounting or emission trading schemes is due to resume towards theend o 007, by which time a urther round o nancial year ends willhave passed. In the absence o specic guidance, the need or eectivecommunication to stakeholders about the accounting policies adopted andthe impact o the schemes on the nancial position and perormance o thecompany is paramount.

Acknowledgement

We would like to express our gratitude to those who have completed thesurvey and have made this publication possible. All individual responseswill o course be kept strictly condential.

Decisions concerning thevaluation o carbon assetsand liabilities have a clearimpact on a companysnancial position andnancial results or a givenperiod.

Trouble-entry accounting 5



EU Emissions Trading Scheme (EU ETS)

The ratication o the Kyoto Protocol by the EU required total emissionso greenhouse gases within the EU member states to all to 9% o their990 levels in the period between 008 and 0. The introduction o theEU Emissions Trading Scheme (EU ETS) on st January 005 representsa signicant EU policy response to the challenge. Under the scheme, EU

member states have set limits on carbon dioxide emissions rom energyintensive companies approximately 0,000 steel actories, power plants,oil reneries, paper mills, and glass and cement installations.

Phase o the EU ETS commenced on January 005 and runs throughto 3 December 007 and is designed to embed the scheme beore ullimplementation is scheduled in 008 Phase o the EU ETS.

The scheme works on a cap and trade basis and each member state othe EU is required to set an emissions cap covering all installations coveredby the scheme. In this way, organisations within scope o the EU ETS mustmake an economic decision as to whether to introduce abatement measuresto reduce carbon dioxide emissions so as to be within their carbon allocation

under the scheme, or purchase credits on the market rom organisations thathave reduced emissions to a level whereby a surplus is created which canbe traded.

Under the EU ETS, EUmember states have setlimits on carbon dioxideemissions rom energyintensive companies approximately 0,000steel actories, powerplants, oil reneries,paper mills, and glass andcement installations.

Overview o the EU EmissionsTrading Scheme (EU ETS) andCertied Emissions Reductions

(CERs)

. MEMO/03/54 http://ec.europa.eu/environment/climat/emission/linking_en.htm


7/49Trouble-entry accounting 7

Certied Emissions Reductions (CERs)

Under the Kyoto Protocol, emissions reduction projects in ast growingcountries and countries in transition not subject to a Kyoto target onemissions reduction can generate Certied Emissions Reductions(CERs). CERs represent a unit o greenhouse gas reduction that has beengenerated and certied by the United Nations under the Clean Development

Mechanism (CDM) provisions o the Kyoto Protocol. The CDM allowsindustrialised countries that are committed to reducing their greenhousegas emissions under the Kyoto protocol (so-called Annex countries)to earn emissions reductions credits towards Kyoto targets throughinvestment in green projects in ast growing countries and countriesin transition such as China, India and Brazil (so-called host countries).Examples o projects include reorestation schemes and investment inclean energy technologies. Once received, the CERs have value as they willbe exchangeable or EU ETS allowances and hence can be used to meetobligations under that particular scheme.

The CERs are issued by the CDM board and projects that wish to begranted CERs must undergo a rigorous review and approval process. The

ollowing is a summary o some o the main steps:

The proposed project is identied and easibility study completed.

The proposed project must be approved by the CDM executive board,which can take up to 0 months.

Once approved, the project can begin implementation and operation

The project will be periodically reviewed by the CDM executive board toensure that the project is proceeding as expected.

Once the project or particular phase o the project is complete, a return isrequired to be submitted to the CDM board detailing the level o emissionsreductions reached and the number o CERs that are to be issued.

The project and associated emissions reductions are veried by the CDM

executive board.

Receipt o CERs by the generating organisation.

.

.

3.

4.

5.

6.

7.

Overview o the EU Emissions Trading Scheme (EU ETS),and Certied Emissions Reductions (CERs)

CERS represent a unit ogreenhouse gas reductionthat has been generatedand certied by the UnitedNations under the CleanDevelopment Mechanism(CDM) provisions o theKyoto Protocol.



The importance o clear corporate reporting

The increased public ocus on climate change as well as the measuresintroduced by national and international governments to curb emissions hasbrought the issue o carbon accounting to the ore. Phase o the EU ETShas brought the value o carbon onto the nancial statements o companiesor the rst time. The introduction o Phase o the EU ETS in 008 will

urther widen the coverage o the scheme, as well as reduce the overallamount o emissions that can be emitted, based on the EU Kyoto targets.This will urther raise the importance o carbon in terms o corporatereporting.

As we reported in Emission Critical3, carbon will represent an increasingelement o corporate strategy, operations and reporting.

Figure 1: the Carbon Value Cycle

As gure above illustrates, addressing the EU and national governmentcarbon strategies could have signicant impacts on businesses withinthe scope o the various schemes in operation. For example, a companywithin the scope o the EU ETS and subject to a carbon cap, will needto consider how to address these requirements as part o its corporatestrategy.

Macro-Strategy

Co

rp

or

ateStrate

gy

Commun

ica

tions

CorporateReporting

Carbon MarketEU Carbon Allocation

Kyoto Strategy

ValuationFinancial Reporting

Management Reporting

Market Analysis

Production

HedgingPurchasing

TradingM&A

Shareholder ReportingStakeholder Reporting

Regulatory ReportingMedia Reporting

Overview

The increased publicocus on climate changeas well as the measuresintroduced by nationaland internationalgovernments has broughtthe issue o carbonaccounting to the ore.

3. Emission Critical, 004 visit www.pwc.com/energy.



Overview o the EU Emissions Trading Scheme (EU ETS),and Certied Emissions Reductions (CERs)

Internal discussions with production teams will be required or managementto understand whether it is practical or possible to reduce emissions. Forexample, detailed analysis o the carbon market prices will be requiredto assess the potential costs o purchasing carbon credits on the marketversus costs o abatement. Depending on the groups resources, its skillset and risk appetite, it may be appropriate to trade carbon allowances or

speculative gain, or economic hedging purposes or a combination othe two.

As reported in Power Deals 20064, the price o carbon will increasinglygure in deal calculations as companies seek to optimise their uel mixthrough acquisition and disposal.

Opportunistic companies with access to technology may be able toextract value rom companies who have been slow to capitalise on marketopportunities.

The value attached to these activities is expected to be increasinglyrelevant in and material to corporate reporting and this is being recognisedwith increasing ocus being placed on this area. Decisions about how to

represent the impact o carbon in its reporting to management and to theBoard and nancial reporting to the companys shareholder and otherstakeholders could have a signicant impact on corporate strategy anddecision making. Shareholder decisions will increasingly be infuenced bythe nancial considerations o the carbon regulatory schemes.

The groups wider stakeholders such as customers, employees and localcommunities will also look to understand the impact o carbon and thecorporate strategy in place to deal with it.

Increasingly the environmental and economic price o carbon is also beingconsidered on a personal level and is a topic requently commented on by

the press and broadcasting media. Recent months have seen increasedocus by political parties on green issues and the concepts o personalcarbon budgets and green taxation. Such a breadth o ocus on the costo carbon and the key role o the corporate bodies in developing carbonabatement and osetting technologies and methodologies highlights thedesire or and importance o clear communications in this area.

So, with carbon becoming increasingly material to the nancial statementso companies and important to dierent users o nancial statements ordierent reasons, a clear understanding o the accounting or the EU ETSand or CERs is important.

The price o carbon willincreasingly gure in dealcalculations as companiesseek to optimise their uelmix through acquisitionand disposal.

4. Power Deals 006, visit www.pwc.com/energy.



The withdrawal in June 005 o the International Accounting StandardBoards (IASB) interpretation o how to account or the EU ETS (IFRIC 3),means there is no specic authoritative approach to the issue.

Contrary to commonly held views, IFRIC 3 complied ully with the currentInternational Financial Reporting Standards (IFRS). The reason or itswithdrawal was the oten undesirable impact its adoption had on the

income statement, introducing both volatility or those balances re-valuedbased on the prevailing market prices o allowances, and a mismatchbetween movements in the asset and liability as recognised through theincome statement.

The withdrawal o IFRIC 3 did not however invalidate its application. Somecompanies across Europe have decided to continue to adopt it on thegrounds that it remains compliant with existing IFRS. Other companieshowever have sought to adopt alternative approaches to address theshortcomings o IFRIC 3.

Guidance in relation to alternative approaches comes rom IAS 85, thestandard covering Accounting Policies, which states that in the absence o

a Standard or Interpretation that specically applies to a transaction otherevent or condition, management shall use its judgement in developing andapplying an accounting policy that results in inormation that is:

a) Relevant to the economic decision making needs o users; and

b) Reliable, in that the nancial statements:

Represent aithully the nancial position, nancial perormance andcash fows o the entity;

Refect the economic substance o transactions, other events andconditions and not merely the legal orm;

Are neutral, i.e. ree rom bias;

Are prudent; and

Are complete in all material respects.

i.

ii.

iii.

iv.

v.

Survey questionsAccounting or the EU ETS

5. IAS 8 reers to the International Accounting Standard 8 Accounting Policies, Changes in AccountingEstimates and Errors.



In looking to understand how the EU ETS is being accounted or we haveassessed the ollowing key questions in our survey:

At what value are granted allowances initially recognised on thebalance sheet?

Where are granted allowances initially recognised on the balance sheet?

Where are purchased allowances recorded on the balance sheet?

Are granted/purchased allowances subsequently amortised/depreciated?

Are granted/purchased allowances revalued subsequent to initialreceipt/purchase?

Where granted allowances are initially recorded at air value anddeerred income is recognised, how is the deerred income released tothe income statement?

Where granted allowances are recorded at air value and deerredincome is recognised, where in the income statement is the deerred

income released to?

How is the obligation or emissions valued?

In the event granted allowances (that are recorded at nil value) are sold,how is the sale accounted or?

Which line item o the income statement is used to record the sale ogranted allowances?

Furthermore, we also asked respondents to explain the accounting ororward contracts to purchase and sell EU ETS allowances, plus whetherthere are any adjustments to IFRS i the respondent reported under anyother reporting standards.

.

.

3.

4.

5.

6.

7.

8.

9.

0.



Results o the survey

Whereas IFRIC 3 had required companies to recognise granted allowancesat air value, with the corresponding entry recognised as deerred incomeon the balance sheet, only 4% o respondents apply this treatment. Three

quarters o respondents instead apply an alternative which recognisesthe granted allowances at a nil value, as allowed by the standard onaccounting or government grants, IAS 0. This is perhaps not surprising,as this approach can reduce the grossing up impact on the balancesheet and income statement that drew such criticism when IFRIC 3 wasissued. Interestingly, 0% recognise the allowances at air value with thecorresponding entry recognised immediately in the income statement.

Whilst the majority o respondents recognise the allowances at nil value,it is clear that these three approaches lead to very dierent eects onthe balance sheet and the income statement. For example, a decision torecognise granted allowances at air value through the income statement

upon receipt would clearly lead to recognising higher prot up rontcompared to a company that recognised them at nil value.

. At what value are granted allowances initially recognised on the balance sheet?

76%

10%

14%

At nil value

At fair value at date of receipt,

with opposite entry recognised

immediately in income statement

At fair value at date of receipt,

with opposite entry recognised

as deferred income on the

balance sheet

76%o respondentsinitially recognisegranted allowancesat nil value



The majority o respondents, 65%, recognise the granted allowances withinintangible xed assets on the balance sheet, whilst 5% recognise theallowances within inventory. The balance apply alternative approaches that

include other current assets, or not recognising them in the accounts at all.

The deault presumption would be that allowances all into scope o IAS 38Intangible Assets, as they are an identiable non monetary asset withoutphysical substance, and it appears the majority have ollowed this line othinking. However, intangible assets held or sale in the ordinary courseo business are scoped out o IAS 38 and all into IAS Inventories, hencethis would suggest that the 5% meeting this criteria consider they holdthe granted intangibles or this purpose as opposed to or compliancepurposes. Potentially this is being applied thereore to excess allowancesheld and expected to be sold, although establishing this number at the timeo receipt o the allowances could be challenging.

. Where are granted allowances initially recognised on the balance sheet?

20%Other

65%Intangible fixed assets

0%Tangible fixed assets

15%Inventory

0%Debtors

Accounting or EU ETS allowances

65%o respondentsrecognise thegranted allowancewithin intangiblexed assets




Further variation in accounting practice is evident when considering whereto record purchased allowances on the balance sheet. Once again thereis a clear majority who recognise the purchased allowances as intangible

xed assets. However, % recognise purchased allowances as inventoryand 3% recognise them elsewhere on the balance sheet.

As noted earlier, classiying the allowances as inventory would seemappropriate i the entity is holding them or sale in the ordinary course obusiness. Financial institutions and traders that dont hold any physicalassets and hence do not hold the allowances to meet any complianceobligations could be expected to apply this approach. Looking at the surveyresults, this isnt always the case however with a mix o treatment beingapplied by both the companies with CO emitting assets and those tradingpurely on their own account.

Amongst those who selected Other, a number drew distinctions in theirresponses between allowances that were purchased to cover expecteddecits when compared to orecast emissions and those that were heldor trading. Some respondents noted that allowances held or speculativetrading are classied as either short-term nancing assets or as othercurrent assets. As ETS allowances in themselves are not nancialinstruments or a orm o nance, classication as short-term nancingassets could potentially cause some conusion unless clearly described inthe accounting policies or notes.

3. Where are purchased allowances recorded on the balance sheet?

31%Other



11%Inventory

0%Debtors

58%o respondentsrecognisepurchasedallowanceswithin intangible

xed assets,with the balancerecognising themsomewhere withincurrent assets



There is a clear majority o respondents who adopt an accounting policyo not amortising/ depreciating allowances recognised on the balancesheet. One respondent that had elected to amortise the allowances held

did however draw distinction between granted allowances which were notamortised, and purchased allowances which were amortised. No otherrespondents drew such distinction in their responses.

The policy o amortising the allowances would imply the allowancesare being consumed by the business over the period. However, as theallowances have a residual value, as evidenced by an actively tradedmarket, it would appear that the majority do not recognise the cost oallowances in the income statement until settled or sold, or potentiallythrough an impairment in value i the recoverable amount o the allowancesis below their carrying value.

Looking at the results in detail, o those who amortise the allowances,some, as expected, record the allowances as intangibles, whilst an equalnumber record as other current assets.

4. Are granted/purchased allowances subsequently amortised/ depreciated?

86%

14%Yes, allowances are

amortised / depreciated

No, allowances are not

amortised / depreciated


86%o respondentsdo not applyamortisation/depreciationto allowances

recognised onthe balance sheet




Over three quarters o respondents do not apply a policy o revaluinggranted/purchased allowances ollowing their initial recognition. O theremaining % o respondents that do revalue the allowances, all recognise

the corresponding entry to the revaluation directly in the income statement.Given the volatility o the market price or allowances since the schemebegan in 005, these divergent approaches can lead to very dierent resultsbeing reported depending on the approach applied and the underlyingmarket price o allowances.

O the % who revalue the allowances directly to the income statement,there is a mix o responses in relation to where they recognise theallowances on the balance sheet. Some recognise the allowances asinventory, whilst some as intangibles. This is against expectations asthe standard on intangibles, IAS 38, specically precludes revaluationmovements to be recognised in the income statement (other than or

impairments or reversals o impairments). The standard on inventory, IAS, requires inventory to be measured at the lower o cost and net realisablevalue, hence at ace value revaluation to the income statement does notappear appropriate either. However, there is a reerence in the scopingsection IAS that states the standard does not apply to the measuremento inventories held by commodity broker-traders who measure theirinventories at air value less costs to sell, and that where this policy isapplied, the changes in air value are recognised in the income statement inthe period o the change. Those applying this approach would be expectedthereore to be acting as broker/traders, in other words entities that aretrading on their own account or or another party as opposed to those thathold CO emitting assets and need allowances to settle the obligationsarising. However, we recognise that it is important that the accounting is

considered in relation to each organisations acts and circumstances andthat is beyond the scope o this publication.

5. Are granted/purchased allowances revalued subsequent to initial receipt/purchase?

21%

79%No

0%

Yes, with the opposite entry

recognised in the income statement

86%Yes, with the opposite entryrecognised in reserves

79%o respondentsdo not revaluethe allowancessubsequent toinitial receipt/

purchase



As identied rom question , only 4% o respondents adopt the IFRIC3 approach o recognising granted allowances at air value, with thecorresponding entry recognised as deerred income on the balance sheet.

O those applying this approach, the responses show that there is noconsistent approach used to release the deerred income to the incomestatement. Releasing the deerred income on a systematic basis in linewith the production prole o the asset appears to be the avoured policy,although a quarter apply perhaps a more straight orward approach using astraight line basis.

6. Where granted allowances are initially recorded at air value and deerred incomeis recognised, how is the deerred income released to the income statement?

25%

25%

50%

Reased to income statement

in line with emissions produced

in the period

Reased to income statement

on a straight line basis

Other


50%o respondents whoapply this approachrelease the deerredincome to thebalance sheet in line

with the emissionsproduced in theperiod




A third o respondents release the deerred income through the revenueline, a third through costs o sales and a third through some other line in theincome statement. For those respondents that selected other, the deerred

income is released through other income.

At ace value, recognising the deerred income as revenue is unusual as thestandard on Government Grants, IAS 0, is specic in that grants should berecognised either separately or as a deduction against the related expenseor which the grant has been made available.

The dierent treatments can make comparability o perormance somewhatchallenging. The classication o deerred income release as revenue orcost o sales has no impact on gross margin, however revenue is otena key measure o perormance and comparison. Furthermore, wheregross margin protability is used as a key nancial perormance metric,

comparing gross margins is made more dicult given that some companiesrecord deerred income below gross margin as other income. Thishighlights the need or clear disclosure in nancial reporting.

7. Where granted allowances are recorded at air value and deerred income isrecognised, where in the income statement is the deerred income released to?

O respondentsthat apply this

approach there isno clear consensusas to where in theincome statementthe deerredincome should bereleased to

33%

33%

34%

To cost of sales

To revenue

Other



The results o the survey show that there is a range o valuation treatmentsbeing applied in valuing the obligation associated with the productiono emissions. Most respondents (47%) value the obligation based on

the carrying value o allowances already granted (which may be nil) andpurchased, and then value the balance i applicable at the prevailing marketprice o allowances. A urther 6% apply a similar approach but value thatelement o the obligation hedged by orward purchases o allowances at theunderlying orward contract price. This refects a cost to the company andis indicative o the expected cash fows to be incurred in order to settle theobligation. 6% o respondents simply apply the prevailing market price orthe entire obligation, irrespective o how the company intends to settle it.This is akin to the approach set out in IFRIC 3 prior to its withdrawal.

8. How is the obligation or emissions valued?

The most commonapproach is to value

the obligation basedon the carryingvalue o thoseallowances alreadygranted/purchased,with the balanceo the obligationvalued at theprevailing marketprice

47%

26%

11%

At carrying value for allowances already

granted / purchased, with the balance

valued at the prevailing market price

16%At the prevailing market price ofallowances for the entire obligation

At carrying value for allowances already granted /

purchased and at the relative contract price for

allowances to be purchased under forward

purchase co ntracts, with the balance valued at

the prevailing market price

Other





It is clear that the majority o respondents recognise the gain on thesale directly in the income statement, whilst 7% recognise it as deerredincome released over the remainder o the compliance year. In reality both

approaches may lead to the same result at year-end, although should thenancial year end not to be coterminous with the compliance year-end orshould quarterly or hal yearly reporting be involved, the income statementsor two identical companies but applying the dierent approaches will notbe directly comparable without urther analysis or narrative being providedin the notes.

9. In the event granted allowances that are recorded at nil value are sold, how is thesale accounted or?

Most respondentsrecognise the

gain on disposalimmediately in theincome statement

86%

Gain on disposal recognised

immediately as a credit to

the income statement

7%

7%

Gain on disposal recognised as

deferred income and released to

income statement over the

rest of the complaince year

Other



Most respondents (54%) recognise the sale o granted allowances withincost o sales. This perhaps refects the judgement that the sale does notarise rom the sale o goods or services in the ordinary course o business.

Netting sales proceeds against cost o sales eectively represents areduction in the cost o compliance with the EU ETS. Or putting thisanother way, or the energy utilities in particular, the inherent value o theallowances is one o the variables that drives the economic decision owhether to produce or buy rom the market. This would seem to supportrecognition o any sale o granted allowances against cost o sales. Aquarter o respondents record the sale as other operating income. This mayrefect the intention o separating out the sale so as not to distort what isconsidered to be underlying business perormance. This treatment couldalso be motivated by viewing the sale proceeds as prots on disposal o anasset, which would normally be disclosed under this heading.

Whatever the justication, it remains that a range o dierent approachesappear to be in place, potentially raising the diculty o comparing onecompanys nancial perormance against anothers, gross marginsin particular.

0. Which line item o the income statement is used to record the sale o grantedallowances?

54%Cost of sales

8%

23%

Revenue

Other operating income

15%Other


54%o respondentsrecognise the sale ogranted allowanceswithin cost o sales




Most respondents, 53%, deem the orward purchase/sale contracts tobe within scope o IAS 39 and either air value the contracts through theincome statement, (46%) or air value through reserves under cash fow

hedge accounting (7%). 40% o respondents account or the contracts onan accruals basis on the premise that the orward contracts were enteredinto meet the companys own purchase/sales/requirements (reerred to asown use) and hence exempt rom the scope o IAS 39. 7% o respondentsdo not consider the contracts to be within scope o IAS 39 or otherreasons.

We also asked respondents or their view on the reliability o market priceinormation or allowances. 70% o respondents consider the market to besuciently active so as to provide reliable orward price curves that can beused to air value the allowances and/or orward contracts. The remaindero respondents were unsure about the liquidity o the market, with only 6%

deeming the market to be illiquid.

As or most emerging markets, the market or ETS allowances has beencharacterised by high volatility. As both participants and regulatorsgain more inormation concerning the operation o the scheme and thedemand and supply undamentals, market liquidity should increase andprice volatility decline. Despite the fuctuating prices and initial uncertaintysurrounding national allocations, interestingly most respondents still viewthe market as providing suciently reliable price inormation that allowsreliable valuations o allowances on hand and orward contracts to buy orsell them.

. How are orward contracts to purchase/sell emissions allowances accounted or?

O the totalrespondents to the

survey, 60% haveengaged in orwardpurchase/salearrangements withregards to emissionsallowances.O those, 46%deem the orwardpurchase/salecontracts to bewithin scope oIAS 39 and airvalue the contractsthrough the incomestatement

Fair valued through reserves under

cashflow hedge accounting

7%

7%

46%

Accruals accounted,

as forward contracts are not

considered to be in scope of IAS39

Fair valued through

income statement

40%Treated as 'own use' under

IAS39 and accruals accounted



70% o respondents recognise an obligation by pro-rating the expected

shortall o allowances in the compliance year on a unit o production basisso that the cost o emissions builds up in the income statement in line withproduction. However 5% o respondents only recognise the obligationonce the emissions exceed the equivalent allowances held. Such adierence in approach clearly has implications or interim reporting and willlead to entities with a shortall who do pro-rate the obligation recognisinga liability and cost in the income statement in advance o those that onlyrecognise the obligation once emissions exceed allowances on hand.

. For interim reporting periods, in the event expected emissions will exceedallowances held, how is the obligation or emissions recognised over thecompliance year?

Most respondentsrecognise theobligation basedon pro-rating theorecast shortallor the complianceyear on a unit oproduction basis

An obligation is recognised based

on a pro-rating of the forecast shortfall

for the forecast shortfall for the compliance

year on a per unit of production basis

70%

An obligation is only recognised

once the year to date emissions

exceeds granted allowances on hand

15%

15%

Other





In general, respondents that also report under UK GAAP did not note anysignicant dierences in the accounting or EU ETS rom the treatmentadopted under IFRS.

There were a ew dierences noted or those also reporting under USGAAP. One respondent highlighted that orward contracts are air valuedunder the organisations US GAAP reporting with the other entry recognisedthrough the income statement but are not air valued under IFRS. Anotherpointed out that although the entity reports no GAAP dierence orgranted allowances recorded at nil value, under US GAAP the purchasedallowances recorded as intangible assets are not re-valued at air valuethrough the income statement, although the respondent noted that i theallowances are treated as nancial assets under US GAAP this wouldpermit revaluation. The same respondent highlighted that the issue is howexactly the same asset (i.e. granted allowances and purchased allowances)

have a dierent treatment on the balance sheet. Finally, another respondentnoted that under its national GAAP or statutory accounting (in this case theGerman Commercial Code) there were basically no dierences in the policycompared to IFRS with the exception that the orward contracts to tradeallowances are air valued under IFRS and not under the national GAAP.

We have not considered the merits or otherwise o the observations madein respect o GAAP dierences, and the consideration o GAAPs otherthan IFRS is outside the scope o this publication. What our survey doeshighlight however is that most reporters do not consider there to be manysignicant GAAP adjustments between IFRS and other standards.

Dierences in treatment between IFRS and other GAAP used by respondents

Nearly hal o allrespondents report

under accountingstandards other thanjust IFRS, with mostalso reporting underUS GAAP

UK GAAP 19%

US GAAP

25%

56%

Other GAAP



Conclusions

We have identied that there are six main approaches applied byrespondents to the survey.

. 5% o respondents apply the IFRIC 3 approach. Granted allowancesare recognised at air value when received, and the corresponding entryrecognised in deerred income on the balance sheet. The obligation oremissions is recognised at market price. The allowances may or may not be

re-valued.

a. Recognise the granted allowances at nil value, with the obligationrecognised at the carrying value or allowances already granted/purchased,with the balance valued at the prevailing market price. This is the mostrequent approach being applied - 45% o respondents have adopted thispolicy.

b. This is a slight modication to the approach in a. Granted allowancesare recognised at nil value with the obligation recognised at the carryingvalue or allowances already granted/purchased, then at the relevantcontract price or allowances to be purchased under orward purchasecontracts, with the balance valued at the prevailing market price. Around

5% o respondents apply this policy.3a. 0% o respondents recognise granted allowances at air value with theobligation recognised at the carrying value or allowances already granted/purchased, with the balance valued at the prevailing market price.

3b. This is a slight extension to 3a. 5% o respondents recognise grantedallowances at air value with the obligation recognised at the carrying valueor allowances already granted/ purchased, and at the relevant contractprice or allowances to be purchased under orward purchase contracts,with the balance valued at the prevailing market price. As with 3a, theallowances may or may not be re-valued.

4. 5% o respondents recognise the granted allowances at nil value with

the ull obligation recognised at market value.

5% o respondents have used some other approach to recognising thegranted allowances and the obligation.

In summary, o therespondents wherethe EU ETS is relevant,there is a wide varietyo approaches beingapplied. In act, it hasbeen possible to identiyas many as 5 distinctapproaches beingapplied in practice.Ignoring dierences inclassication however, wehave identied that thereare 6 main approaches,

as ollows:



It is clear rom the responses that the initial negative eedback generatedby IFRIC 3 has translated into only a small minority o respondents applyingthe withdrawn interpretation as an accounting policy; presumably thisis because o the volatility that this approach can create in the incomestatement. It appears that concerns that IFRIC 3 would have lead to amismatch in income has meant that it has not been accepted by many

preparers o nancial statements.The other main approaches are a close variation o each other 60%eectively recognise granted allowances at nil value (as allowed under thestandard on government grants), albeit value the obligation in dierentways. The most common approach or valuing the obligation is to valueit based on the carrying value o allowances on hand. Any additionalobligation is then valued at contracted prices and or market prices. Thisseems to suggest the obligation is valued based on the expected cost tothe company o ultimately settling it. Again however, there are variations tothe accounting policies in use.

It is also noted that nancial institutions and traders tend to avour theapproach o air valuing the EU ETS certicates received and also orwardpurchase/sales contracts through the income statement. Utilities on theother hand have tended to be more compliance ocused and have less oan appetite or recognising movements in air value o the assets throughthe income statement and have tended to apply the own use exemption orcash-fow hedge accounting or orward purchase contracts.

In preparing the report we have not distinguished between the sizes o thedierent entities responding or the extent o the impact o ETS or CERs onthe business and its reported nancial results. It can be presumed howeverthat the more signicant the scheme to the entity and the larger thevolume o certicates granted, purchased or sold, the more signicant theimpact will be o applying the dierent approaches outlined above. It maybe that certain o the approaches being applied by some o the smaller,or less aected entities would be reconsidered by the directors o thesecompanies in the event the materiality on nancial reporting was moresignicant.

Nonetheless, the application o dierent policies clearly serves todemonstrate the importance o clear accounting policies in the nancialstatements and clear communication to key stakeholders.

The application odierent policies clearlyserves to demonstratethe importance o clearaccounting policies in thenancial statements andclear communication tokey stakeholders.

Conclusions



Full market value

approach (IFRIC 3) Cost of settlement approach

Alternative

Approach 1

Alternative

Approach 2

Initial recognition

- Granted

allowances

Recognise when able

to exercise control;

corresponding entryto government grant,

at market value at

date o grant.

Recognise when able


corresponding entryto government grant,

at market value at

date o grant.

Recognise when able


recognise at cost,which or granted

allowances is a

nominal amount

(e.g. nil).

Initial recognition

- Purchased

allowances

Recognise when able

to exercise control,

at cost.

Recognise when able


at cost.

Recognise when able


at cost.

Subsequent

treatment o

allowances

Allowances are

subsequently held

at cost or re-valued

amount, subject

to review or

impairment.

Allowances are

subsequently held

at cost or re-valued

amount, subject

to review or

impairment.

Allowances are

subsequently held

at cost, subject

to review or

impairment.

Treatment o

deerred income

Government grant

amortised on a

systematic and

rational basis over

compliance period.

Government grant

amortised on a

systematic and

rational basis over

compliance period.

Not applicable.

Recognition o

liability

Recognise liability

when incurred.

Recognise liability

when incurred.

Recognise liability

when incurred.

Measurement o

liability

Liability is re-

measured ully based

on the market value

o allowances at each

period end, whetherthe allowances are

on hand or would be

purchased rom the

market.

Re-measure liability

at each period end.

For allowances

held, re-measure to

carrying amount othose allowances

(i.e. market value at

date o recognition i

cost model is used;

market value at

date o revaluation

i revaluation model

is used) on either a

FIFO or weighted

average basis. A

liability relating

to any excess

emission would be

re-measured at the

market value at the

period end.

Re-measure liability

at each period end.

For allowances on

hand, at the carrying

amount o thoseallowances (nil or

cost) on a FIFO or

weighted average

basis. A liability

relating to any excess

emission would be

re-measured at the

market value at the

period end.

The withdrawal o IFRIC3 means that under thehierarchy or selectingaccounting policies inIAS 8 Accounting policies,changes in accountingestimates and errors,other accounting modelsare acceptable (as long asthey are consistent withunderlying IFRS).

The main accountingapproaches whichPricewaterhouseCoopersconsider to be acceptableare summarised in theollowing table.

Accounting approaches or theEU ETS PwC view

(Note: this summary does not deal with the accounting or emissions allowances by broker/traders).



Illustrative example

To illustrate the impact on the nancial statements o these threeaccounting approaches consider the ollowing scenario:

Companies A, B and C all have nancial year ends o3 December 006

Each receives 50 granted allowances at the start o the year

The market price at grant date was 0 per allowance

Each company requires 00 allowances to cover its obligation orthe 006 compliance year to be settled in February 007

The market price at 3 December 006 was 5 per allowance

Accounting policies adopted

Company A has adopted the Alternative Approach

Company B has adopted the Alternative Approach

Company C has adopted the ull market value approach (IFRIC 3)

Alternative approach Alternative approach IFRIC 3

Figures in Company A Company B Company C

Income statement

Release o deerred income 3000 3000

Emissions cost -450 -50 -5000

Net result -50 -50 -000

Balance sheet

Intangible assets 3000 3000

Liability -450 -50 -5000Net assets -50 -50 -000

Current year result -50 -50 -000

Revaluation reserve - - -

Shareholders unds -50 -50 -000

i) 50 allowances received measured

at market value at grant date 0 per

allowance (50* 0 =3,000)

ii) liability based on allowances held measured

at carrying amount, and liability related to

excess emission market value at period end

[(50*0) + (50*5) = 4,50]

iii) 50 shortall in obligation measured at market

value at period end 5 per allowance

iv) 00 obligation measured at market value at

period end 5 per allowance

The nancial results show that companies A and B have identical net results. However, company A eectively has a grossed up balancesheet in comparison with Company B.

Company C has applied the IFRIC 3 approach and has a very dierent net result and balance sheet.

It is important to note that each entity, making the same level o emissions and holding the same number o allowances will ultimately berequired to make up the same shortall in allowances. In the example each company will have to fnance the shortall o allowances, which ithe price o allowances remained constant would cost each company ,50. For company C, the decision to value the entire obligation at the

prevailing market price o allowances means that there is a mismatch in the timing o recognition, with the ollowing year recognising a creditto the income statement o 750 as the liability is settled. This highlights the volatility in earnings that can arise with the use o this method.

Further dierences in results could arise when considering when the shortall is recognised. One approach could be to recognise theexpected shortall, and associated cost and liability, over the nancial year. Others, meanwhile, recognise the cost and liability only when theemissions obligation exceeds the assets held. Hence, or two identical companies receiving the same number o allowances and making thesame level o emissions, whilst the liability at the year-end would be identical, the position at the hal year or at each quarter would o coursebe very dierent between the two approaches.

There is an additional consideration or entities using Alternatives and , as the measurement o the obligation or which allowances areheld will depend on whether the carrying amount o allowances is allocated to the obligation on a FIFO or on a weighted average basis. Thisis a particular issue where the balance sheet date is not at the end o the compliance period (or example, an interim balance sheet date, or anancial year-end which is not the same as the compliance period end).

Entities using the FIFO method should measure the obligation at the carrying amount per unit o emissions, up to the number o allowances(i any) held at the balance sheet date, and at the expected cost (the market price at the balance sheet date) per unit or the shortall (i any)at the balance sheet date.

Entities using the weighted average method should measure the obligation using the weighted average cost per unit o emission expected

to be incurred or the compliance period as a whole. To do this, the entity determines the expected total emissions or the complianceperiod and compares this with the number o allowance units granted by the government and/or purchased and still held by the entity orthat compliance period, to determine the expected shortall (i any) in allowances held or the compliance period. The weighted averagecost per unit o emission or the compliance period is the carrying amount o the allowances held (which may be nil or those granted or nilconsideration) plus the cost o meeting the expected shortall (using the market price at the balance sheet date), divided by the expectedtotal number o units o emission or the compliance period. In other words:

Organisations that choose to actively manage their emissions asset and liability ace urther accounting decisions. For example, consideran organisation that reports quarterly and sells all o its 007 allowances in March 007. Some would claim that the income rom the saleshould be recognised immediately as a credit to the income statement. This would o course be partially oset by a debit to the incomestatement to refect emissions in the year to date not covered by any allowances held. However there is a mismatch between recognising thevalue o months allowances against the cost o three months o emissions. Alternatively, some would claim that the credit to the incomestatement be deerred and released over the remainder o the compliance year.

Dierences in accounting treatment concerning recognition o emissions obligations and allowances could thereore have a signicantimpact on nancial reporting, particularly where the organisation reports quarterly or hal-yearly results or has a nancial year which is notco-terminus with the compliance year.

Carrying amount o allowances held + Cost omeeting expected shortall

Expected total units o emissionor the compliance period

= Weighted average cost per unito emission or the complianceperiod

Table : The companies nancial results and balance sheet or the 006 year-end

(i)

(ii) (iii)

(i)

(ii) (iii)

(i)

(i)

(iv)

(iv)



The ollowing sets outthe main considerationswhen accounting ororward purchase/sales oemissions allowances.

Is a orward purchase or sale contract or EU emissions allowances withinthe scope o IAS 39?

IAS 39 Financial Instruments: recognition and measurement applies to contracts to buy

or sell a non-nancial item where the contracts can be settled net in cash or another

nancial instrument or by exchanging nancial instruments. Contracts to buy or sell EU

emissions allowances could be examples o such contracts.

The deault presumption is that such contracts, i they can be net settled, would be

held at air value with movements in air value being recognised through the income

statement. However the contract may be outside the scope o IAS 39 where the

contract to purchase or sell the emissions allowance was entered into and continues

to be or the entitys expected purchase, sale or usage requirements. This is commonly

reerred to as the own use exemption.

An example o own use in this context would be a orward contract to purchase

emissions allowances that the entity enters into and continues to hold to meet a shortall

in the entitys emissions obligation, i.e. where granted allowances and/or purchased

allowances held by the entity are less than the expected number o allowances required

to meet the entitys obligation or a specic period.

The host contracts that do not meet the net settlement criteria are outside the scope o

IAS 39, although such contracts should still be reviewed or the existence o embeddedderivatives.

For those contracts deemed in scope o IAS 39, an alternative treatment to air

valuing the contracts through the income statement may be to apply cash-fow hedge

accounting, whereby the change in the air value o the contract is recognised within

equity. The adoption o this approach requires strict application criteria within IAS 39 to

be met and documented at the outset o the hedge.

Accounting or orwardpurchases / sales o emissionsallowances



Results o the survey Accounting or CERs

Unlike the accounting or the EU ETS there has never been any specicaccounting guidance or interpretation provided by the IASB in relationto the accounting or Certied Emissions Reductions (CERs). There areexisting standards within IFRS that deal with the accounting, however alack o specic guidance urthers the scope or judgement to be applied bymanagement in determining a suitable accounting approach.

We asked the ollowing questions in our survey:

How are purchased CERs initially recognised on the balance sheet?

How are sel generated CERs (i.e. issued in respect o qualiyingassets held) accounted or on thebalance sheet?

Are the sel generated/purchased CERs amortised?

Are granted/purchased CERs re-valued subsequent to initial receipt/purchase?

How are sel generated CERs accounted or in the income statement?

How are the orward contracts to purchase/sell CERs accounted or?

Do you consider there is a suciently active market in CERs to providereliable orward price curves that can be used to air value the CERs/orward contracts?

.

.

3.

4.

5.

6.

7.



The results o the survey indicate that a broad range o classicationsare used in practice. 38% o respondents classiy the purchased CERsas intangible xed assets and 38% classiy them as inventory. 4% o

respondents classiy them in other areas o the balance sheet, such asother current assets or as trading securities or short term nancing assets.

. How are purchased CERs initially recognised on the balance sheet?

Consistent withthe classication

o ETS allowances,respondents tendto classiy thepurchased CERs aseither intangible xedassets, inventoryor some other linewithin current assets

24%Other



38%Inventory

0%Debtors



The results showed that 9% o respondents recognise the CERs asinventory upon generation, at an allocated cost o production. 3% orespondents record the CERs as intangible xed assets, measured at air

value at date o receipt.

Interestingly, 9% o respondents adopt a policy o not recognising thesel-generated CERs until they are sold or used in the business. This couldsuggest that the business sees no underlying value attached to the CERsand expects no uture economic benets to fow to the entity, at least untilit can be proved otherwise. The eect o this, in the short-term at least,would be to understate the balance sheet, and potentially also the incomestatement, in comparison to an identical entity that recognises the CERs asassets at air value upon generation.

Some respondents separated out the treatment or CERs that are held to

meet emissions obligations, holding them as intangibles, whereas thoseCERs that are held or trading are classied as nancing assets.

. How are sel generated CERs (i.e. issued in respect o qualiying assets held)accounted or on the balance sheet?

A smaller numbero respondents

held sel generatedCERs - hal as manyas those who hadpurchased CERshad generated theminternally throughrenewable energyor other carbonreduction schemes.From the responsesreceived thereappears no commonbalance sheetclassication o selgenerated CERs

29%Other

29%Not recognised until

CERs are used/sold

0%As inventory, at fair value

at date of receipt

29%

13%

As inventory, at an

allocated cost of production

As intangible fixed assets,

at fair value at date of receipt

Accounting or CERs



As is consistent with the treatment o EU ETS allowances, mostrespondents do not amortise/ depreciate the CERs. This perhaps refectsthe view that the CERs have a residual value that approximates book value

or potentially that the CERs are expected to be used/sold within the currentnancial year o the entity.

3. Are the sel generated/purchased CERs amortised/ depreciated?

75%

25%Yes

No

75%o respondentsdo not amortise/depreciate CERs




The survey showed that the majority, 6%, o respondents do not applya policy o revaluing the CERs subsequent to initial receipt/purchase.The balance, 38%, revalue the CERs through the income statement. O

these, a number classiy the CERs as intangible assets and recognisethe revaluation movements through the income statement. There are norespondents that recognise the revaluation movements in reserves.

It is noteworthy that the majority o respondents, as is shown later in thispublication, do not consider there to be an active market or CERs, whichmay urther explain the decision by 6% o respondents not to revaluethe CERs.

4. Are granted/purchased CERs revalued subsequent to initial receipt/purchase?

No 62%

Yes, entry recognised

in income statement

0%

38%

Yes, entry

recognised in reserves

62%o respondentsdo not revalue theCERs subsequentto initial receipt/purchase



The results o the survey show a variety o responses. 67% o respondentsimmediately credit the income statement at the point o receipt o theCERs. Around 7% initially record the CERs as a government grant with the

dierence between air value and production cost recognised as deerredincome on the balance sheet, which is released to the income statementwhen the CERs are used or sold. The balance o respondents credit theincome statement with the ull selling price when sold.

5. How are sel generated CERs accounted or in the income statement?

There is a lack oconsensus as to how

the sel-generatedCERs should beaccounted or in theincome statement

17%

16%

Initially treated as a government grant,

with the difference between fair value and

production cost recognised as 'deferred

income', and released to

income statement when sold/used

Immediately credited to income

statement at point of receipt of CERs

Other

67%




Accounting or CERs

64% o respondents to the survey had participated in orward selling/purchasing agreements or CERs.

The decision as to how to account or these orward contracts varies.37% o respondents deem the orward contracts to be within scope oIAS 39 and apply a policy o air valuing the contracts through the incomestatement. 50% o respondents account or the contracts on an accrualsbasis. On the whole this is because they deem the orward contracts tobe outside the scope o IAS 39 on the basis that they are exempt rom thestandard and they are entered into and continue to be held or the entitiesown purchase and sales requirements.

The dierent approaches used may well be justied given the acts andcircumstances o the organisation, but as the accounting is so dierent ithighlights the need or clear disclosure and suciently detailed accounting

policies in nancial reporting.

6. How are the orward contracts to purchase/sell CERs accounted or?

13%Other

19%

31%

Accruals accounted as forward

contracts are not considered to

be in scope of IAS39

Treated as own use under

IAS39 and accruals accounted

0%

37%

Fair valued through reserves

under cashflow hedge accounting

Fair valued through income statement

The majority orespondentsdeem the orwardcontracts to bewithin scope oIAS 39



Whilst 37% o respondents air value the orward purchase and salescontracts through the income statement, only 0% o respondents deemthere to be a suciently active market or CERs to provide reliable price

curves or valuation purposes, with 53% considering the market not tobe suciently active. This would suggest valuations are being based onvaluation techniques and in-house curve estimates. In contrast to themarket or EU ETS allowances, where 70% o respondents consider themarket to be suciently active to provide reliable price curve data, the vastmajority o those holding or trading CERs consider the market or CERs notto have reached a similar level o maturity and liquidity. This is perhaps notsurprising as the various administrative steps allowing CERs to be ungiblewith EU ETS allowances have not yet been completed. In time, it wouldbe expected that the price o CERs, at least in the secondary market, willshadow the market price o the more actively traded EU ETS allowances.

7. Do you consider there is a suciently active market in CERs to provide reliableorward price curves that can be used to air value the CERs/orward contracts?

Most respondentsdo not consider

there to be asuciently activemarket or CERs soas to provide reliableorward price curves

No 53%

Yes

0%

20%

27%Not sure




Accounting or CERs

In general, respondents reported that there were not many signicantdierences between their reporting under IFRS and under some other set ostandards. Some respondents noted that air value rules may be dierent,

or example one noted that under Irish GAAP the orward contracts tobuy/sell CERs are not air valued as they are under IFRS. Another notedthat whilst there are currently no dierences between the IFRS and USGAAP accounting treatment or CERs, this could change in relation to theaccounting or orward contracts to procure primary CERs. The respondentnoted that i these orward contracts to buy primary CERs (i.e. direct romthe generator) qualiy or mark to market accounting under IAS 39, theymay not qualiy as a derivative under FAS 33 which requires nancialinstruments to have one or more notional amount - primary CERs may nothave a notional amount i the contract is to purchase all CERs generatedrom a particular project.

As or the EU ETS accounting, we have not considered the merits orotherwise o the observations made in respect o GAAP dierences andthe consideration o GAAPs other than IFRS is outside the scope o thispublication. Again, our survey highlights that most reporters do not considerthere to be many signicant GAAP adjustments between IFRS and otherstandards, however the dierences that were raised seemed to be dierentacross dierent respondents.

Dierences in treatment between IFRS and other GAAPs used by respondents

Other GAAP 27%

UK GAAP

0%

13%

60%US GAAP

As is consistentwith the responsesto EU ETS, mostrespondentsthat report underanother seto accountingstandards do sounder US GAAP



Conclusions

In summary, o the respondents where accounting or CERs is relevant, it ispossible to identiy a number o dierent approaches being applied. Ignoringdierences in classication, the survey results can be broken down into approaches in accounting or purchased CERs. All initially recognise thepurchased CERs at cost, but in terms o subsequent measurement:

6% o respondents do not revalue the CERs subsequent to initialrecognition.

38% o respondents revalue the CERs subsequent to initial recognition.O these, 0% recognise the CERs on the balance sheet withinintangibles, 40% recognise the CERs within inventory and 40% withinanother heading in current assets.

Amongst those surveyed, most obtain CERs rom the developer or in thesecondary market. There were however 6 respondents to our survey that ownqualiying assets and thereore need to account or sel-generated CERs. Othese, there are no clear accounting approaches emerging in practice or howto do this.

The approaches adopted or sel generated CERs varied greatly. Whilst mostrespondents credit the income statement at the point o receipt o the CERs,there are dierences in how they are recognised in the balance sheet orexample, one recognises the sel-generated CERs within inventory at anallocated cost o production, whilst other respondents do not recognise theCERs on the balance sheet until the CERs are used/sold.

Another o the respondents recognises the sel-generated CERs as intangiblesand as a government grant, measured as the dierence between their airvalue and their production cost, with the grant being released to the incomestatement when the CERs are sold or used.

Nonetheless, the application o dierent policies to the treatment o CERs, aswith the EU ETS above, underlines the importance o clear accounting policiesin the nancial statements and clear communication to key stakeholders.

.

.

In summary, o therespondents whereaccounting or CERs isrelevant, it is possibleto identiy a number odierent approachesbeing applied.



The ollowing key questions are considered:

Are the CERs assets?

What is the nature o the CERs?

For entities receiving sel generated CERS under the CDM scheme (the

generator), the key accounting questions are:

When should sel generated CERs be recognised by the generator?

What value should be ascribed to CERs that have been recognised- at initial measurement?

What value should be ascribed to CERs that have been recognised- at subsequent measurement?

What are the requirements around amortisation and impairment?

Presentation in the income statement?

For entities purchasing CERs, the accounting questions are:

When should purchased CERs be recognised?

At what value should purchased CERs be recognised at initialmeasurement and at subsequent measurement?

What are the requirements around amortisation and impairment?

We then consider whether orward contracts to purchase or sell CERs arein scope o IAS 39: Financial Instruments: Recognition and Measurement.

Are CERs assets?

CERs meet the denition o an asset per the IASB Framework; the CERrepresents a resource controlled by the entity arising as a result o past

events or example, the production o green energy or the completiono a reorestation project. Furthermore, uture economic benets in theorm o cash or cash equivalents would be expected to fow to the entityas a consequence o the sale o the CER by the generator/intermediatepurchaser or its use to oset against emissions obligations in the case opurchase by a nal consumer.

What is the nature o the CERs?

CERs are intangible assets they are identiable non-monetary assetswithout physical substance (IAS 38 Intangible Assets).

IAS 38 however does not permit such assets to be treated under the

terms o this standard i they are within scope o another accountingstandard, such as Inventories (IAS ). CERs will be within scope oIAS when they are held or sale in the ordinary course o business.Sel generated CERs held by the generating entity could in certaincircumstances meet the IAS denition.

The key accountingapproaches thatPricewaterhouseCoopersconsider to be suitableunder IFRS are set out inthe ollowing pages. Thisaddresses both entitiesthat receive CERs roma qualiying asset underthe CDM scheme (selgenerated CERs), andor entities that purchaseCERs.

Accounting approaches or CERs PwC view



Accounting orsel generated CERs

Based on the assumption that the sel generated CERs are granted by a Government as dened in IAS 0, thestandard on accounting or government grants, the two key approaches we consider suitable under IFRS are setout below. Approach A accounts or the CERs under IAS Inventories. Approach B accounts or the CERsunder IAS 38 Intangible Assets.

A) Treat as a government grant with CERs

recognised as inventory under IAS

B) Treat as a government grant with CERs

recognised as an intangible under IAS 38

When should CERs be

recognised?

CERs are produced over the course o the project.However they are not received by the producingentity until the project and the associated emissionsreductions meet the conditions o the grant and areveried by the CDM executive board.

CERs should thereore only be recognised once there isreasonable assurance that the CERs will be received (i.e.reasonable assurance that the conditions attaching tothe attribution o the CERs are met) these conditionsmay be met as the entity produces the green product(i.e upon generation) or may require ullment o otherconditions attached to receiving the CERs.

CERs should meet the denition o intangible assets:identiability, control over the resources and utureeconomic benets criteria should be met.

CERs should be recognised:

When there is a reasonable assurance that the entitywill comply with the conditions attached to the CERsand the grants will be received; and

I the cost o the CER can be measured reliably andit is probable that the expected uture economicbenets that are attributable to the CER will fow tothe entity.

As approach A, this may mean the CERs are recognisedupon generation or at a later point in time.

What value should be

ascribed to CERs that

have been recognised -

at initial measurement?

IAS 0 Accounting or Government Grants and

Disclosure o Government Assistance, provides twochoices in terms o initial measurement:

Fair value CERs should be recognised at air

value and a government grant recognised or the

dierence between nominal amount and air value.

Nominal amount production costs should be

allocated on a rational and consistent basis

between production cost o the green product irelevant and costs o production o the CERs.

As approach A

What value should be

ascribed to CERs that

have been recognised- subsequent

measurement

Subsequently, the CER inventory should be valued atthe lower o cost and net realisable value.

I CERs do not meet the denition o non-current assetsheld or sale then they should be held at cost less anyamortisation and impairment, i there is no active market.Where there is an active market or CERs, IAS 38 permitsvaluing them either at cost less any amortisation andimpairment or at air value. Increases and decreases inthe carrying amount o the CERs should be recognised asrequired by IAS 38.85 and IAS 38.86.

Where CERs meet the denition o non-current assetsheld or sale per IFRS 5 (CERs should be immediatelyavailable or sale in their present condition and the sale ishighly probable), the ollowing treatment applies:

Treatment per IAS 38 should continue to apply upuntil the date at which CERs meet IFRS 5 criteria.Impairment test under IAS 36 should be perormed.

Subsequently, CERs should be held at the lower otheir carrying amount and air value less costs to sell.

(Note: I CERs are not granted by a Government as dened in IAS 0 then this table will not apply)



A) Treat as government grant with CERs

recognised as inventory under IAS

B) Treat as a government grant with CERs

recognised as an intangible under IAS 38

Amortisation and

impairment

N/a - CER inventory should be valued at the lower ocost and net realisable value.

CERS are deemed to have a useul lie. Under IAS 38,indenite lie applies where there is no oreseeable limit tothe period over which the asset is expected to generatenet cash infows or the entity - this is not applicable orCERs, where the benets will be obtained at the date theyare sold, or submitted to settle the entitys obligation underthe EU ETS.

In principle, IAS 38 requires assets with a useul lie to beamortised, however:

Where there is an active market or CERs noamortisation will be recognised because the residualvalue will be the same as cost and hence thedepreciable amount will be zero.

Where there is no active market, CERs are assumedto have no residual value and amortisation would inprinciple be applied.The amortisation method shouldrefect the expected pattern o consumption o theuture economic benets. Since the uture economicbenets will arise at the date o disposal (ie utilisationo the CER to settle a liability under the EU ETS ), theCER would be amortised at this date.

I CERS are under the scope o IFRS 5 then there isno amortisation

The CERs should be tested or impairment under IAS 36Impairment o Assets.

When should income

associated with CERs

be recognised?

When the grant is measured at nominal amount, noincome can be recognised beore the date o theactual sale o the CERs.

When the grant is recognised at air value, the grant isrecognised as other income but at initial recognition.

Consequently there is a timing dierence orecognition o income i CERs are recognised atnominal amount or at air value under IAS 0.

As Approach A

Presentation in the

income statement

CERs initial recognition is recorded as other income.

At disposal date, the sale o CERs is also recognisedas other income.

An alternative presentation is:

At initial recognition, the company reduces thecost o sales to refect the negative cost o thebi-product (i.e. the CER),

At disposal date, the company recognises

revenue or the amount o the sale, and cost osales or the carrying amount o the CER.

CERs initial r

trouble entry accounting - uncertainty in accounting for the eu emissions trading scheme and...

Documents