Part 9: Accounting and valuation matters
There is no authoritative guidance on how to account for emissions trading schemes by either participants or governments. Previously, the International Financial Reporting Interpretations Committee (IFRIC) issued Emission Rights (IFRIC 3), but this was withdrawn by the International Accounting Standards Board (IASB) in July 2005. At that time, the IASB affirmed that IFRIC 3 Emission Rights was an appropriate interpretation of the relevant existing International Financial Reporting Standards (IFRSs), but also acknowledged that it led to unsatisfactory measurement and reporting mismatches.
The IASB was working on a project to produce authoritative guidance on accounting for emissions trading schemes. However, the project has been deferred to allow the IASB to focus on other projects. It is unclear when the IASB will complete its work in this area. The International Public Sector Accounting Standards Board (IPSASB) is currently considering whether to include on its work programme a project to develop guidance on accounting for emissions trading schemes. In the meantime, public entities (and the private sector) in New Zealand will have to account for their ETS transactions without specific guidance.
For the public sector, the accounting issues can be split into those that are relevant to the Government as the administrator of the ETS, and those that are relevant to public entities as participants in the ETS. Below, we set out our current views on these accounting issues. These views may be subject to change should authoritative guidance be issued by the IASB, the IPSASB, or the New Zealand standard setter.
9.1 Accounting for the ETS by the Government
In summary, the Treasury has adopted the following approach for accounting for the Government’s ETS transactions.
From the Government’s perspective, NZUs can be considered a medium of exchange backed by the Government (like currency). Alternatively, they can be considered intangible assets at the time that they are issued by the Government. NZUs have a market value and the issue of NZUs without charge to participants is an expense to the Government and creates a liability, which, at a minimum, represents an obligation to swap the NZUs for Kyoto AAUs if the participant asks for this.43
For NZUs issued as one-off compensation (such as the pre-1990 forestry allocation), the timing of the expense will be at the point that the participant has provided all relevant information to the Government to show that they have met the criteria and rules for the issue of NZUs and are entitled to them under the ETS.
For NZUs issued for carbon sequestration (such as post-1989 forestry) or as annual compensation for ETS costs (such as the industrial allocation), the timing of the expense will generally be as the carbon is sequestered (based on forecasts) or as the emissions compensated by the industrial allocation occur.
When ETS participants surrender NZUs to the Government to satisfy ETS obligations, receipt of the NZUs is revenue for the Government and reduces the ETS liability.
The timing of the revenue recognition will be based on when the activity giving rise to the emissions and ETS liability occurs. If it is not possible to reliably forecast some emissions, then revenue recognition will be delayed until an emissions return is received and the Government has assessed the obligation to surrender NZUs. Under the ETS, the actual surrender of NZUs to the Government may occur later.
For both the issue and surrender of NZUs, the revenue and expense transactions are measured at the fair value of the NZUs at the time of the transaction. In practice, it will not be practical to determine a fair value every day, and a monthly (or similar) price is likely to be used as a reasonable proxy to the daily fair value.
On each balance date, the Government’s ETS liability is revalued based on the current carbon price.
The Auditor-General has considered and agreed that the above approach is appropriate and meets the requirements of the New Zealand equivalents to International Financial Reporting Standards (NZ IFRS). The approach was used in the 2010 Financial Statements of the Government although, at that time, the Government had issued NZUs only to post-1989 foresters and no ETS revenue had yet been recognised. For the 2011 Financial Statements of the Government, other sectors will be active in the ETS, and participants will also have started surrendering NZUs to the Government to meet their obligations under the ETS.
9.2 Accounting for the ETS by public sector participants
Accounting for the ETS by public sector participants is expected to be broadly the same as the accounting that will be applied by private sector participants. Those entities that are classified as profit-oriented entities44 under NZ IFRS are required to comply with NZ IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, whereas entities classified as public benefit entities must not. However, we do not expect this to cause significant divergence in accounting practice for ETS transactions between these two types of entities.
At this stage, we have seen little in the way of real-life examples of ETS accounting by participants, as only the forestry sector was participating in the scheme before 1 July 2010.
There are a number of alternative accounting approaches that entities in other jurisdictions have adopted for accounting for emissions trading schemes. These provide some insight into the likely accounting approaches that entities will adopt in New Zealand. However, the New Zealand ETS has some significant differences from some of the major overseas emissions trading schemes. In particular, many participants in the New Zealand ETS do not get an allocation of free NZUs and many entities that do get an allocation of free NZUs are not participants in the ETS. In addition, there is little overseas precedent on how to account for forestry in an emissions trading scheme.
NZUs are intangible assets and the accounting issues are based on when to recognise receipt of the intangible asset, at what value to measure the asset initially and subsequently, when to recognise a liability to surrender NZUs to the Crown, and at what value to measure this liability.
One overseas accounting approach for an entity that makes emissions and receives an allocation of free carbon units is to recognise the free units received as intangible assets and revenue measured at fair value, with the revenue recognition spread over the compliance period. Actual emissions give rise to expenses and a surrender obligation liability (measured at the current carbon price) as the emissions arise. This accounting is consistent with the withdrawn IFRIC 3.
The perceived problem of IFRIC 3 was in relation to subsequent measurement of the intangible asset and surrender obligation liability. The liability was required to be re-measured based on current carbon prices at each balance date, with the change in value going to the income statement. The revaluation of intangible assets (the carbon units) to fair value is an accounting option, the alternative being to keep the carbon units at their initial recognition amount (subject to review for impairment). If the revaluation option was chosen, the revaluation movement would go to a revaluation reserve (in other comprehensive income) rather than to the income statement. Therefore, as carbon unit prices change, there is potentially a mismatch of accounting treatments, with changes in the asset value going to a reserve and changes in the liability value going to the income statement.
The most common alternative accounting option to the IFRIC 3 approach is to account for carbon units at their cost (which, for free credits from the Government, is nil) and to measure the surrender obligation liability and emissions expense at the carrying amount of carbon units on hand (which may be nil if the cost was nil), plus the fair value of any additional units required to cover excess emissions. This approach avoids the income statement mismatch noted above.
Because there are possible alternative accounting approaches for ETS transactions, it is important that entities disclose the accounting policies that they have adopted in relation to the ETS.
Entities that are part of the government reporting group will need to comply with the Treasury’s accounting requirements for reporting ETS transactions for consolidation into the Government’s financial statements.
Below, we consider likely accounting approaches for different scenarios under the New Zealand ETS.
For a participant that does not receive any free allocation of NZUs, our view is that an expense and surrender obligation liability should be recognised as the "emissions" occur – which is as the participant carries out the activity that leads to the ETS surrender obligation. For example, for a council operating a landfill, this will be as waste is put into the landfill. The expense and liability should be measured at the best estimate of the expenditure required to settle the obligation, which is likely to be the quantity of emissions at the market price of NZUs. The liability will need to be re-measured based on updated NZU pricing at balance date.
For a participant that receives an annual industrial allocation of free NZUs, the international approaches discussed above are more directly relevant and there are accounting options to choose. These include:
- whether to recognise the free NZUs and associated revenue at cost of nil or at the fair value of the NZUs; and
- whether to recognise the surrender obligation and expense at the fair value of the full obligation amount or at the carrying amount of NZUs on hand (which could be nil for free NZUs) plus the fair value of the excess NZUs required to meet the obligation.
Entities also need to decide on an accounting policy for subsequent measurement of any NZUs on hand at balance date. The two options are the cost model and the revaluation model. Under the cost model, the NZUs will continue to be measured at their initial recognition amount (which could be nil for free NZUs). Under the revaluation model, the NZUs will be revalued to fair value at each balance date with the movement going to a revaluation reserve.
Under NZ IFRS, the revaluation model for intangible assets can be applied only if there is an active market for the asset. NZ IFRS have specific requirements to be met before a market is considered active. There are currently different views as to whether the NZU market is an active market. Considering the NZU market and other international markets for carbon units together, we will accept public entities assessing the market as active and adopting the revaluation model for NZUs.
9.2.2 Post-1989 forestry
For post-1989 forestry, the accounting is slightly different because it must deal with carbon sequestration and then emissions as trees are harvested. The NZUs are received after carbon has been sequestered and we would expect an asset and revenue to be recognised once an emissions return has been filed and an entitlement to NZUs is confirmed by the Crown. Again, there are accounting options to consider. In particular, whether to recognise the free NZUs and associated revenue at cost of nil or at the fair value of the NZUs received.
As trees are harvested (or carbon stocks decrease through events such as fire or storm), a liability and expense should be recognised for the NZUs to be surrendered to the Crown. If the entity has NZUs on hand at the time of harvest, then there is an option to recognise the liability and expense at the fair value of the full surrender obligation amount or at the carrying amount of NZUs on hand (which could be nil for free NZUs) plus the fair value of the excess NZUs required to meet the obligation.
However, the post-1989 forestry accounting is further complicated by the requirement to measure the forest asset at fair value. Currently, there is no authoritative guidance on how forestry valuations should take into account the ETS. We understand that MAF has commissioned the New Zealand Institute of Forestry to develop guidance material in this area, although the timeframe for this is unclear.
In most cases, we would expect a forest’s fair value to be determined by forecasting the future cash inflows and outflows from the forest. This valuation should therefore incorporate expectations of future NZU entitlements, as well as the obligation to return NZUs to the Crown on forest harvest. To the extent that actual NZUs are received during an accounting period, that entitlement should be removed from the forest valuation calculation.
There are other accounting approaches that could be adopted for post-1989 forestry. Some have suggested that, on receipt of NZUs for forest growth, the accounting should be to recognise the NZUs as an asset and a corresponding liability for the return of the NZUs to the Crown on forest harvest. Our view is that, if such a liability was recognised, it would need to be discounted for the time period until the forest is expected to be harvested. In establishing such a liability, it is also necessary to consider future harvest and replanting patterns and the extent to which any NZUs received may be considered risk-free (that is, unlikely to be required to be surrendered to the Crown under the forecast harvesting and re-planting plan).
If a separate liability to surrender units on harvest is established, then it is important that this is excluded from the forest valuation calculation to avoid double counting.
Where a post-1989 forester has received NZUs for forest growth and has accounted for the future surrender liability within the forest valuation rather than as a separate liability, our view is that the amount of NZUs received and the requirement to return them on forest harvest should be disclosed as a contingent liability that will crystallise on forest harvest.
For guidance on measurement of NZUs at subsequent balance dates, see section 9.2.1.
Recipients of one-off allocations (pre-1990 forestry and fisheries)
For those public entities that are entitled to a one-off allocation of free NZUs as compensation for loss in value (pre-1990 foresters) or future expense increases (fishing quota owners), we would generally expect an asset and revenue to be recognised when an entitlement to NZUs was confirmed by the Crown.
As discussed above, there is a choice between recognising the asset at cost (nil) or fair value on receipt. For those entities intending to sell their allocation soon after receipt, a pragmatic solution may be to recognise initially at nil and then recognise revenue at the transaction price when the units are sold.
For pre-1990 foresters, the allocation will be received in two parts, with the second part to be transferred in 2013. Our view is that the entitlement to both parts can be recognised once the Crown has made its formal allocation decision, as legislative change will be required to amend the allocation of the second part.
For guidance on measurement of NZUs at subsequent balance dates, see section 9.2.1.
Pre-1990 foresters will need to consider the valuation implications for their forests and forest land. The ETS is not expected to significantly affect the value of the actual forest because no NZUs will be received for forest growth and no NZUs need to be surrendered on harvest (as long as the forest is replanted). However, the ETS is likely to have reduced the value of some land on which pre-1990 forests stand, because the ETS imposes a financial penalty on deforestation and land use change.
It may be appropriate for a pre-1990 forester to disclose in their financial statements that certain land contains pre-1990 forest and that, under the ETS, they will incur financial penalties should the land be deforested.
43: During the transitional period to 31 May 2013, only NZUs received for forestry removal activities or under the forestry allocation plan are permitted to be exchanged for AAUs.
44: NZ IFRS defines “public benefit entities” as “reporting entities whose primary objective is to provide goods or services for community or social benefit and where any equity has been provided with a view to supporting that primary objective rather than for a financial return to equity holders”. Profit-oriented entities are all entities other than public benefit entities.