Carbon offsets and credits under IFRS® Accounting Standards

From the IFRS Institute – March 2, 2023

As more companies enter into commitments to reduce their carbon emissions or invest in renewable energy, questions about how to account for carbon offsets and credits are becoming more pressing. The complexity and variety of arrangements in rapidly developing voluntary markets is giving rise to questions about how IFRS Accounting Standards apply, often involving more than one standard. Here, we level set on these offsets and credits, and provide some of the key accounting considerations for voluntary markets relevant under IFRS Accounting Standards; plus a comparison to US GAAP.

The accounting for carbon offsets and credits is both an emerging issue and one that has been on the radar of global standard-setters for decades. Mandatory emissions trading schemes are not new, but for companies making net-zero or other emissions commitments, voluntary offsets and credits are often a key driver of their strategy. Where these schemes were historically established to help companies comply with governmental emissions mandates, they are now also a catalyst of growth and innovation, incentivizing companies to develop and implement the latest renewable technology. These schemes vary greatly and their number is growing. This has caused the related accounting issues to reemerge as a high priority.

Although several standard-setting projects have been attempted, there are currently no accounting requirements under IFRS Accounting Standards (or US GAAP) specific to carbon offsets or credits. International Accounting Standards Board (IASB^®) attempts over the years were either not finalized or withdrawn. And unlike the Financial Accounting Standards Board (FASB) in the US, the IASB currently has no active project on its agenda.¹ Thus diversity in practice exists as companies seek to apply current accounting guidance to arrangements that are often complex and innovative.

Offsets vs credits vs allowances

Before considering the proper accounting, it is important to understand the nature of the item being accounted for. Terms are often conflated or undefined – e.g. carbon offsets, renewable energy credits or certificates (RECs), emissions permits or allowances, certified emissions reductions (CERs), environmental credits – and the respective ESG reporting proposals of the International Sustainability Standards Board (ISSB), SEC and the European Financial Reporting Advisory Group (EFRAG) were not aligned.² It remains to be seen whether there will be alignment in the final standards.³

Historically, the most recognizable term in discussing greenhouse gas (GHG) emissions under IFRS Accounting Standards has been ‘emissions allowances’ in the context of emissions trading schemes (ETSs). One example is a cap and trade scheme in which a company receives allowances that in effect allow it to emit a certain amount of CO₂; established markets exist in which companies can sell surplus allowances and/or purchase additional allowances to make up for a deficit. The world’s largest cap and trade scheme is in the EU and covers just over a third of the EU’s GHG emissions. ETSs operate in the US at the state level (e.g. the California Cap-and-Trade Program).

Rather than the above compliance markets, this article is focused on the voluntary markets that are rapidly developing. In these markets, companies are buying and/or selling carbon offsets or credits as part of their own strategy related to reducing GHG emissions and not as the result of an underlying legal obligation.

In the context of reducing GHG emissions, the ISSB proposed using the general term ‘carbon offset’, which it defined as: “An emissions unit issued by a carbon crediting programme that represents an emission reduction or removal of a greenhouse gas emission. Carbon offsets are uniquely serialised, issued, tracked and cancelled by means of an electronic registry.”⁴

• Examples of emissions reductions include using wind, solar and geothermal energy sources as alternatives to natural gas or coal power plants.
• Examples of GHG removals include planting forests to absorb GHG emissions and sequestering carbon in underground storage.

Reflecting the lack of consistency in practice, as part of its redeliberations the ISSB has decided to use ‘carbon credits’ as the general term, noting feedback that ‘offset’ better described “the application of a carbon credit to an entity’s net emissions.”⁵ Therefore, the remainder of this article refers to the acquisition or sale of carbon credits.

Accounting for carbon credits

In the absence of specific guidance on the accounting for carbon credits, and because of the complexity and variety of arrangements beginning to emerge, a critical initial step is to understand the company’s facts and circumstances, and the specific terms and conditions of the credits. There is no one-size-fits-all accounting answer, and a contractual reference to a carbon credit can mean a variety of things – from a separable asset that can be traded to a ‘green’ credential or attribute.

Before analyzing specific fact patterns, a general question often asked is whether carbon credits even meet the definition of a separate asset. An asset is a present economic resource (i.e. a right that has the potential to produce economic benefits) controlled by the company as a result of past events.⁶

In some cases, it will be obvious that a carbon credit is a separate asset – e.g. a company enters into a transaction to acquire a carbon credit that can be traded on an exchange. In other cases, the answer may be different because the carbon credits are part of a larger transaction or they are immediately retired such that the economic benefits have been consumed, for example.

Below we consider two scenarios where the potential unit of account is the individual carbon credit; we look at key questions and the accounting implications. This commentary is intended to help you get started in thinking about the accounting that might apply – it is not intended to be exhaustive or determinative.

Scenario 1 – Acquirer’s perspective: company purchases carbon credits

The primary objective in asking the questions below (not exhaustive) is to determine whether the company has acquired a separate asset; and, if it has, the nature of that asset. These exploratory questions are not intended to be linear and answers may overlap; they also consider only initial recognition. Further, the questions assume financial instruments are not involved, including potential derivatives – e.g. as would be the case for a virtual power purchase agreement.

Scenario 2 – Vendor perspective: company incorporates carbon credits into revenue arrangements

As just two examples, carbon credits might be incorporated into a revenue contract by transferring them to the customer when they purchase a ‘widget’ or by retiring carbon credits on a customer’s behalf. In other cases, the carbon credits might in some way simply credentialize or certify the ‘widgets’ sold.

In applying IFRS 15¹⁰, the primary objective in asking the questions below (not exhaustive) is to determine whether the company has a separate performance obligation related to the carbon credits. If the answer to that question is ‘yes’, the company allocates a portion of the transaction price to the carbon credits or related service (assuming control does not transfer at the same time), and recognizes revenue when the performance obligation is satisfied. There may also be an impact on revenue recognition disclosures (e.g. disaggregation of revenue).

These exploratory questions are not intended to be linear and answers may overlap.

Comparison to US GAAP

Similar to IFRS Accounting Standards, there is no US GAAP specific to carbon credits, although the FASB does have a project on its agenda (see below). The above questions are equally relevant in determining the appropriate US GAAP accounting.

• Acquirer’s perspective. Although there are differences between the standards (ASC 330 for inventory and ASC 350-20 for intangible assets), the types of questions to ask would apply equally under US GAAP.
• Vendor perspective. IFRS 15 is largely converged with ASC 606¹¹ and we would not expect significant differences in the analysis.

See KPMG Handbook, IFRS compared to US GAAP, for a closer look at differences between IFRS Accounting Standards and US GAAP.

The possibility of future accounting guidance

Under IFRS Accounting Standards, the IASB has a project on pollutant pricing mechanisms (e.g. emission trading schemes) on its newly created reserve list. Although identified as a high priority, the IASB concluded there were higher priority projects in the pipeline and the project will only be added to the work plan if capacity becomes available before its next five-year agenda consultation in 2026.

In May 2022, the FASB added to its active agenda a project on accounting for environmental credit programs. The Board acknowledged that the current proliferation of markets that trade environmental credits has made the need to provide accounting guidance to program participants a priority. The objective of the Board’s new project is to address the recognition, measurement, presentation and disclosure requirements for participants in compliance and voluntary programs that create environmental credits. The project also includes financial reporting requirements for nongovernmental entities that create environmental credits. We anticipate the Board will continue discussions on this project in coming months.