What to disclose about carbon credits in your financial stat

What to disclose about carbon credits in your financial statements

Currently, there is no specific guidance or requirements within IFRS® Accounting Standards and New Zealand equivalents to International Financial Reporting Standards (NZ IFRS) (or Public Benefit Entity Accounting standards (PBE Standards) for Public Benefit Entities (PBEs)) dealing with the accounting for carbon credits.

With the global push towards ‘net zero by 2050’, many New Zealand entities making ‘net zero’ and other commitments are voluntarily purchasing New Zealand carbon credits (called New Zealand Units (NZUs)) to reduce the overall levels of their reported greenhouse gas (GHG) emissions. Others receive NZUs through their participation in the New Zealand Emissions Trading Scheme (NZ ETS) and then either hold or on-sell them to those who wish to voluntarily offset their GHG emissions, or to entities required to surrender NZUs under the NZ ETS.

While our previous article explains how to develop appropriate accounting policies applying the hierarchy in NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (or PBE IPSAS 3 Accounting Policies, Changes in Accounting Estimates and Errors for PBEs), the question remains: What information should entities disclose in their financial statements about carbon credits?

We recommend entities include the following disclosures from existing NZ IFRS (PBEs: PBE Standards) to enhance a user’s understanding of the effect of carbon credits on an entity’s financial statements:

Accounting policies
Judgements and major sources of estimation uncertainties
Specific disclosures – NZ IAS 2, NZ IAS 38, NZ IAS 36 and NZ IFRS 13 (PBEs: PBE IPSAS 12, PBE IPSAS 31, PBE IPSAS 21 and PBE IPSAS 26)
Impact on financial performance, financial position and cash flows.

In addition, entities should ensure connectivity between the financial statements and the broader annual report (the Directors’ Report and/or Chairperson’s Report and (if provided) the Sustainability Report). Entities should use and disclose consistent assumptions when making estimations for measuring carbon credits, including for impairment testing and determining fair values (if a fair value measurement basis is being used).

Accounting policies

NZ IAS 1 Presentation of Financial Statements requires disclosure of all material accounting policy information. Accounting policy information is likely to be considered material if the policy was developed in accordance with the hierarchy in NZ IAS 8. (For PBEs: PBE IPSAS 1 Presentation of Financial Statements requires disclosure of all significant accounting policy information).

Given there is no specific guidance in NZ IFRS Standards (or in PBE Standards for PBEs) about how to account for carbon credits, entities developing a policy to account for voluntary purchases of carbon credits or for those received from participation under the NZ ETS should, therefore, disclose their accounting policy for acquiring carbon credits. Entities selling carbon credits should also disclose how they account for such disposals.

We recommend entities include the following disclosures for each type of carbon credit, although other details may be appropriate to suit the entity’s specific circumstances:

The nature and terms of the scheme to enable users to understand the risks and opportunities

Whether they were acquired voluntarily or received through participation under the NZ ETS.

The table below shows the different types of accounting policy information required for voluntary purchases of carbon credits and those acquired from conducting carbon abatement activities.

Accounting policy information	Voluntary purchases	Received through participation under the NZ ETS
Type of asset	Accounted for as inventories or intangible assets.	Accounted for as inventories or intangible assets.
Initial recognition – inventories and intangible assets	The measurement basis on initial recognition is cost.	Acquired for Nil consideration from the government and accounted for as a government grant (specify which method has been applied for initial measurement): Approach 1 – recognise asset and government grant at fair value Approach 2 – recognise asset and government grant at nominal amount (Nil). (For PBEs: The grant of any NZUs under the NZ ETS would likely be accounted for as non-exchange revenue under PBE IPSAS 23 Revenue from Non-Exchange Transactions.)
Inventories
Subsequent measurement - inventories	This is usually at the lower of cost and net realisable value, but broker-traders have a choice to measure at fair value less costs to sell.	This is usually at the lower of cost (amount recognised on initial recognition), and net realisable value, but broker-traders have a choice to measure at fair value less costs to sell.
Subsequent measurement – government grants	N/A	Government grants must be recognised as income in profit or loss on a systematic basis over the periods in which the entity recognises as expenses, the related costs for which the grants are intended to compensate.¹ ¹: This is likely to be recognised in profit or loss in the period when the NZU is issued. This is because they are for the purpose of giving immediate financial support to the entity, with no future related costs to be incurred. (For PBEs: N/A. The grant of any NZUs under the NZ ETS would likely be accounted for as non-exchange revenue under PBE IPSAS 23 Revenue from Non-Exchange Transactions.)
Disposals of inventories	Recognised as revenue in accordance with NZ IFRS 15 Revenue from Contracts with Customers together with the related cost of sales (carbon credits). (For PBEs: recognised as revenue from sale of goods under PBE IPSAS 9 Revenue from Exchange Transactions.)	Recognised as revenue in accordance with NZ IFRS 15 Revenue from Contracts with Customers together with the related cost of sales (carbon credits). (For PBEs: recognised as revenue from sale of goods under PBE IPSAS 9 Revenue from Exchange Transactions.)
Cash flows from purchases (acquisitions) and disposals of carbon credits recognised as inventories	Presented as operating cash flows in the cash flow statement.	Disposal proceeds are presented as operating cash flows in the cash flow statement. Acquisitions for Nil consideration are non-cash items and not presented in the cash flow statement.
Intangibles
Subsequent measurement - intangibles	This is usually at cost less impairment losses written off in profit or loss. However, entities can apply the revaluation model in rare instances where there is an active market, in which case fair value movements are recognised in other comprehensive income.	This is usually at cost (amount recognised on initial recognition) less impairment losses written off in profit or loss. However, entities can apply the revaluation model in rare instances where there is an active market, in which case fair value movements are recognised in other comprehensive income.
Subsequent measurement – government grants	N/A	Government grants must be recognised as income in profit or loss on a systematic basis over the periods in which the entity recognises as expenses, the related costs for which the grants are intended to compensate.² ²: This is likely to be recognised in profit or loss in the period when the NZU is issued. This is because they are for the purpose of giving immediate financial support to the entity, with no future related costs to be incurred. (For PBEs: N/A. The grant of any NZUs under the NZ ETS would likely be accounted for as non-exchange revenue under PBE IPSAS 23 Revenue from Non-Exchange Transactions.)
Disposals of intangibles	Recognised as a net gain or loss on disposal, being the difference between the gross disposal proceeds and the carrying amount of the carbon credit asset at the date of disposal. If the revaluation model is used, fair value movements recognised in other comprehensive income are transferred to retained earnings because they cannot be reclassified to profit or loss.	Recognised as a net gain or loss on disposal, being the difference between the gross disposal proceeds and the carrying amount of the carbon credit asset at the date of disposal. If the revaluation model is used, fair value movements recognised in other comprehensive income (PBEs: other comprehensive revenue and expense) are transferred to retained earnings because they cannot be reclassified to profit or lossn (PBEs: surplus or deficit).
Cash flows from purchases (acquisitions) and disposals of carbon credits recognised as intangibles	Presented as investing cash flows in the cash flow statement.	Disposal proceeds presented as investing cash flows in the cash flow statement. Acquisitions for Nil consideration are non-cash items and not presented in the cash flow statement.

Judgements and major sources of estimation uncertainties

Entities should disclose the basis of judgements made to classify carbon credits as either inventories or intangibles (NZ IAS 1.122) (PBEs: PBE IPSAS 1.137).
They should also disclose the sources of any estimation uncertainty at the end of the reporting period that have a risk of a material adjustment to the carrying amount of assets within the next financial year (NZ IAS 1.125) (PBEs: PBE IPSAS 1.132). Examples where we may see estimation uncertainty include:

Broker-traders recognising carbon credit inventories at fair value less costs to sell at the end of each reporting period
Determining net realisable value of carbon credits recognised as inventories
Determining the recoverable amount of carbon credits recognised as intangibles (using the cost model)
Determining fair value for intangibles subsequently measured using the revaluation model.

If not required elsewhere by specific disclosures, we encourage entities to disclose key assumptions used to determine estimates, including sensitivity analyses.

Specific disclosures – NZ IAS 2, NZ IAS 38, NZ IAS 36 and NZ IFRS 13
(PBEs: PBE IPSAS 12, PBE IPSAS 31, PBE IPSAS 21 and PBE IPSAS 26)

If material, entities should include disclosures from all relevant NZ IFRS Accounting Standards used to develop the accounting policy for carbon credits.

Inventories or intangibles

Inventories (NZ IAS 2 Inventories)
(PBEs: PBE IPSAS 12 Inventories)

Intangibles (NZ IAS 38 Intangible Assets)
(PBEs: PBE IPSAS 31 Intangible Assets)

Cost formula used (e.g. FIFO, weighted average, etc.).
Carrying amount of inventories held at fair value less costs to sell (for broker-traders only).
Amount of inventories recognised as an expense during the year (cost of sales).
Amounts of write-downs and reversals of write-downs recognised in profit or loss (PBEs : surplus or deficit).
Carrying amount of inventories pledged as security for liabilities.

(Certain RDR disclosure exemptions are available for Tier 2 reporters – please refer to relevant standard)

That no amortisation is recognised because economic benefits are consumed when the NZU is derecognised.
Detailed reconciliation of movements from the beginning to the end of the period.
For carbon credits acquired by way of government grant and initially measured at fair value:
- Fair value initially recognised
- Carrying amount
- Whether they are recognised after recognition using the cost or fair value model.
Existence and carrying amounts of intangible assets whose title is restricted.
Carrying amounts of intangible assets pledged as security for liabilities.
Additional disclosures where carbon credits are subsequently measured at revalued amounts.

(Certain RDR disclosure exemptions are available for Tier 2 reporters – please refer to relevant standard)

Impairment

Carbon credits recognised as intangible assets are also subject to the impairment requirements contained in NZ IAS 36 Impairment of Assets (PBEs: PBE IPSAS 21 Impairment of Non-Cash-Generating Assets and PBE IPSAS 26 Impairment of Cash-Generating Assets). The recoverable amount is determined as the higher of value in use and fair value less costs of disposal. Fair value less costs of disposal can be determined for an individual carbon credit asset. However, value in use would need to be assessed for a cash-generating unit (CGU) to which the carbon credits belong (i.e. the business operation against which the carbon credits will be redeemed). NZ IAS 36 (PBE IPSAS 21 and PBE IPSAS 26) contains extensive disclosures in this regard. (There are certain RDR disclosure exemptions available for Tier 2 reporters.)

Fair values

NZ IFRS 13 Fair Value Measurement contains detailed disclosure requirements where fair values recognised in the financial statements are material. This would apply to instances where carbon credits are measured at fair value less costs to sell because the entity is a broker-trader. These entities should consider if the inputs used to measure the fair value of carbon credits are derived from sources other than observable prices in an active market (i.e. not Level 1). If so, they may need to categorise the fair value using Level 2 or Level 3 assumptions in the NZ IFRS 13 fair value hierarchy and include relevant NZ IFRS 13 disclosures.

Impact on financial performance, financial position and cash flows

While the accounting policies should explain how carbon credits are measured, the financial statements should clearly explain how carbon credits impacted the financial performance, financial position, and cash flows for the period. This should be done by indicating which lines in the financial statements are materially affected by carbon credits. For example:

Statement of financial position

The statement of financial position or notes should clearly distinguish the carrying amount of carbon credits held as inventories or intangibles from the balance of other inventories or intangibles.
The detailed reconciliation of intangibles should include a separate column (category) for carbon credits.

Profit or loss (PBEs: Surplus or deficit)

The amount of inventories recognised as an expense during the period (cost of sales) for carbon credits should be disclosed separately from expenses recognised during the period for other types of inventories.
The amount of write-downs or reversals of write-downs recognised in profit or loss (PBEs: Surplus or deficit) should separately show how much related to carbon credits.
Disaggregated revenue disclosure under NZ IFRS 15 (PBEs: PBE IPSAS 9) should quantify sale proceeds from carbon credits separately from other goods and services.
The net gain/loss on disposal of carbon credits classified as intangibles should be separately disclosed.

Cash flow statement

For voluntary carbon credits, the cash flow statement should separately show:
- In operating activities, the cash outflows and inflows for the purchase and sale of carbon credits that are recognised as inventories.
- In investing activities, the cash outflows and inflows for the purchase and sale of carbon credits that are recognised as intangibles.
For carbon credits acquired from participation in the NZ ETS:
- The operating section of the cash flow section should separately present the cash inflows from the sale of carbon credits classified as inventories.
- The investing section should separately present cash inflows from the disposal of carbon credits classified as intangibles.

Note: There will be no cash outflows as carbon credits are acquired for $Nil consideration in this instance. This should be disclosed as a non-cash transaction.

Need help?

Accounting for carbon credits is a new and evolving area and can be complex, with judgement required to establish an appropriate accounting policy. Please contact our Financial Reporting Advisory team if you need assistance.

For more on the above, please contact your local BDO representative.

This article has been based on an article that originally appeared on BDO Australia, read the original article here.