The trading of carbon-related instruments in carbon markets across the world has become increasingly popular as companies work to address their carbon emissions and reduce their carbon footprint. But what are these instruments, and how are they accounted for in financial statements?
A research report by ACCA and the Adam Smith Business School at the University of Glasgow, published in April, the Reality of Accounting for Carbon-related Instruments, takes a detailed look at carbon-related instruments and their accounting treatment. ACCA has now explored this research further and supplemented it with real-life examples in two articles that examine the reasons why companies are choosing to use carbon-related instruments and the implications for employees and customers; and what companies need to consider when thinking about accounting for and reporting of these instruments.
Too many instruments
The research highlights the ‘plethora of different instruments which may vary both in substance and intended use’ that have emerged across the world in recent years. Carbon-related instruments have a significant value attached; while some companies have been allocated instruments from governments at no cost, these will become less available over time, and the cost of purchased carbon-related instruments is expected to increase significantly.
Twenty-one percent of respondents believe that offsetting is never acceptable
The average price of allowances in the EU Emissions Trading System increased from €24.61 in 2020 to €83.66 in 2023, for example, and Bloomberg estimates that the price of carbon credits could reach US$238 per tonne in 2050, which would value the market at US$1.1 trillion annually.
Companies engage with carbon-related instruments for a variety of reasons. Many (predominantly in the EU, where carbon markets are more mature and regulation is more established) are propelled by compliance, but the report warns that ‘the absence of a single uniform global scheme for each type of carbon market potentially raises regulatory concerns and affects the level of transparency and integrity of carbon-related instruments’.
Some companies voluntarily use carbon-related instruments to offset emissions that cannot yet be reduced (thereby demonstrating their commitment), while others (notably aviation companies) work collectively as a sector to reduce emissions on a voluntary basis.
Stakeholder scepticism
However, the report also highlights that companies need to be mindful of stakeholders’ scepticism. An online public sentiment survey carried out as part of the research found that 21% of respondents believe that offsetting carbon emissions is never acceptable business practice, while almost half say it should be used only as a last resort. And most respondents were also unwilling to pay more for goods or services that include the costs of carbon credits to offset emissions.
The annual reports of 300 companies in 10 sub-sectors worldwide were examined as part of the research. Only 28% of these companies disclose their participation in a carbon market in their annual report, even though all operate in sectors with high carbon emissions. Even fewer disclose information about their engagement with voluntary carbon credits or the use of internal carbon pricing.
Reporting differences
Of the 300 companies examined, 121 (40%) refer to carbon-related instruments in their financial statements. But analysis is complicated by the lack of a uniform reporting approach.
It is difficult to tell whether companies have applied a consistent accounting treatment
On a basic level, a wide variety of terms are used to describe carbon-related instruments, from ‘allowances’ to ‘carbon certificates’; researchers found at least 11 different terms being used in the companies’ annual reports, often without a definition attached. The tax and accounting treatment is also unclear; a globally adopted set of principles for the taxation of carbon-related instruments would help both multinationals and tax authorities, says the report.
The report notes that absence of an IFRS Standard that applies to carbon-related instruments has led to a variety of accounting treatments being applied in practice. As a result, it is difficult to tell whether companies have applied a consistent accounting treatment to the same instrument, even when the circumstances are alike. Some companies may participate in more than one carbon scheme, adding to the reporting problems.
ACCA’s analysis of the reporting challenges of carbon-related instruments includes a suggested workflow to help determine the most appropriate accounting treatment for carbon-related instruments. This helps finance professionals decide whether an instrument is an asset or an expense, for example, and whether impairment should apply.
An overarching term for these instruments would serve as a helpful stepping stone
The report calls for globally applicable guidance for the consistent accounting and reporting of carbon-related instruments, which should cover scope, when and how to recognise the instrument, measurement, and disclosure. An overarching term for these instruments – such as ‘carbon-related instruments’, as used in ACCA’s report – would serve as a helpful stepping stone to developing accounting guidance, it adds.
In the meantime, preparers are urged to take proactive measures to clarify how and why they use carbon-related instruments, including a clear statement of their accounting policies and the nature, function and intended use of carbon-related instruments.
More information
Watch on demand ACCA’s halfday conference on sustainability, including a session on accounting for carbon-related instruments
See ACCA’s sustainability reporting hub for more resources
