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Accounting Issues on Emissions Trading I am a member of the CPA (Australia), and I will spend the following 15 minutes to talk about the accounting issues relate to emissions trading. The 3 areas I would like to concentrate on are: 1) Why - Emissions of carbon dioxide (CO2) 2) How to reduce CO2 emissions 3) The accounting issues Global Warming Industrial activities Greenhouse gasses Results & Solutions • From 1993 to 2003 (10 years), a near doubling in the rate of sea level rise. • The United Nations Framework Convention on Climate Change (UNFCCC) – first international treaty to set limit on greenhouse gas emissions (1992). – nonbinding - not impose legal obligations on any nations. • (1997), UNFCCC took place in Kyoto - Kyoto Protocol. – Goal: Developed countries ↓ emissions of greenhouse gases by at least 5% of 1990 levels. The year to complete this target is 2012. – Legal obligation? Yes. For example, by ratifying the Kyoto Protocol, all member nations of the European Union became obligated to reduce their GHG emissions. How? Reforestation • How? to remove CO2 from the atmosphere is to grow more forests. • How? to purchase & use low CO2 emission technologies. How? Straight tax option • Advantage: a straight tax on CO2 emissions is immediately enforceable and transparent. • Disadvantage: some businesses may have the market ability to pass the tax to consumers, and not to cut emissions. Cap-and-trade option • Cap-and-trade scheme. Companies are told how much CO2 they can emit (the cap) for a period. • If the companies produce less than the cap, they have surplus credits for sale. • If they emit more than their cap, then they can buy credits from other businesses that come in under their cap (the trade). Kyoto Protocol & Emissions Trading • The Kyoto Protocol endorsed an international emissions trading mechanism – a member nation can emit more CO2 than its assigned amount (which, is defined as being 8% above its emissions in 1990) only if the member country can simultaneously create the equivalent amount in CO2 reduction activities such as reforestation. International Emission Trading – Cap & trade option • Now, in the international carbon credit market, countries can sell their unused emission allowances to other countries with reduction commitments. • Credits can be bought and sold in international carbon credits trading markets at the prevailing market price, such as the Chicago Climate Exchange and the European Climate Exchange. One can shop for the best price • These 'carbon credits' are similar to 'taxi licenses' issued by a local authority that can be traded for money. • However, even though the underlying basis of calculating a carbon credit is international, just like taxi licenses, the pricing of carbon credits varies from country to country and state to state. • In other words, significant arbitrage opportunities exist, and 'CO2 emitters' in high cost countries can buy credits from trading exchanges in low-cost countries. Advantage • Carbon trading refers to the buying and selling of the right to emit CO2. The basic unit is one metric tonne of CO2 per year. • Carbon credits trading system gives a monetary value to the cost of polluting the air. This means that carbon becomes a cost of doing business and is seen like other inputs such as raw materials. • Now, the factories can compare the costs buying the carbon permits to the costs of purchasing the low CO2 emission technologies. Implications • For underdeveloped agricultural countries, trees may no longer be seen as hinder to farming. • Planting trees for conservation purposes will provide more long-term benefit to the global carbon cycle than will plantings for commercial harvesting, such as trees for logging and pulping. • In theory - a stronger incentive to prevent forest fire. In practice – no. (The law - how many new trees planted after 1990, and pre-1990 trees still existing are not considered carbon credit purposes). Accounting issues Is the 'allowance' an asset? • No. The company gets it free from the government. • Yes. It can trade in the market (it has money value). • If yes, should it be treated as an intangible asset – US: Since emissions rights lack physical substance, they cannot meet the definition of a financial asset under SFAS 140. • if it is treated as an intangible asset, should it be measured at cost when the business acquired the carbon allowance through a third party transaction (It will meet the reliability test). How about the allowance get from government? We can’t find the answer • If we look to the GHG Protocol Corporate Accounting and Reporting Standard (World Business Council for Sustainable Development 2004), a guide for companies to report their GHG emissions. • However, the entire standard does not suggest any accounting treatment for carbon allowance. In or not in the balance sheet Off-balance sheet approach • The business only accounts for actual emissions by indicating the amount of insufficient allowances carbon credits purchase from the market. The accountant should debit expenses, and credit cash at market price. In-balance sheet approach • If an entity recognizes the allocated allowances as an asset, then the accountant may use the amortising model (debit: asset, credit equity reserves) at cost price. Subsequently, the entity amortizes the allowances as it pollutes (debit expense, credit asset). Asset & liabilities, offsetting? Is offsetting of assets and liabilities be permitted? • Should an accountant treat carbon allowances (assets) independently to the obligations (liabilities)? If carbon allowance is an independent asset, then the accountant cannot offset of the asset amount with the liabilities. Right to emit CO2 The hottest trading item • Due to the possibility of trading, carbon credits become the world's hottest trading item. • The carbon trading market internationally was about US$100 million total value about 10 years ago. • Now it is about US$18 billion. It becomes the fastest growing commodity markets in the world. Shipping • CO2 emissions from shipping have a serious impact on global warming. – For example, BP owns 50 tankers, and researchers at the Institute for Physics and Atmosphere in Wessling, Germany reveal that annual CO2 emissions from shipping range between 600 and 800m tonnes. (This constitutes about 5% of the global total). This is nearly double Britain's total emissions and more than all African countries combined. Shipping • CO2 emissions from ships do not come under the current Kyoto agreement. • CO2 emissions from ships would be a likely target in the next commitment period of the Kyoto Protocol. • For example, the Norwegian government opined that there are no technical obstacles to bringing international shipping under a post-Kyoto Protocol. • Therefore, it would be beneficial for ship owners to get themselves familiar with the emissions trading scheme under the Kyoto Protocol.