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When it comes to trading in carbon emissions, Europe is right up there with the best, which makes its chaotic accounting for emissions allowances all the more disturbing

This article was first published in the April 2011 UK edition of Accounting and Business magazine.

Europe is ahead of the pack when it comes to developing a carbon emissions trading scheme, but a startling report produced jointly by ACCA and the International Emissions Trading Association (IETA) has highlighted a serious problem: nobody is entirely sure how to account for carbon.

The study, led by Dr Heather Lovell of the University of Edinburgh, calls on accounting standard setters to issue clear guidance on how to handle carbon emissions allowances. And fast. The clock is ticking towards 2013, when the next phase of Europe’s Emissions Trading Scheme (ETS) begins. After that time, companies will be able to auction carbon credits, making their value more relevant to investors.

Major companies have been granted emissions allowances since the ETS was launched in 2005, but there is no uniformity in how these should be treated in the books. Around 42% view allowances as intangible assets, meaning they appear in company accounts ‘at cost’. If allowances are obtained at no cost, they are shown to have nil value. Companies that buy allowances record them at the purchase price.

Others account for emissions allowances at fair value, treating the difference between cost and fair value as a government grant and presenting this as deferred income on balance sheets.

One of the authors of the report, Carlos Larrinaga-Gonzales of the University of Burgos in Spain, says most companies do not disclose any information on depreciation or revaluation of emissions allowances. He says large emitters should work together, and with auditors, to harmonise accounting practices by the end of this year.

Reason to worry

Speaking at an event in the European Parliament in Brussels, organised by ACCA, IETA and Hanover Communications, Henry Derwent, president and CEO of IETA, said the report was shocking: ‘Frankly, given how far we’ve got in Europe it’s horrifying to see such disparity. If we want carbon to have a significant value, then CFOs and auditors need to be as worried about this position as the professional accountants who have done this report.’

There are other problems, too. Péter Olajos, Hungary’s deputy state secretary for climate change, said clarity was needed on how to handle cross-border trading. There are also technical issues around taxation and VAT, which must be worked through in a uniform way.

‘Europe needs to answer these questions,’ Olajos said at the event, entitled Hot Air or Real Value: Accounting for Carbon in the EU ETS. ‘Any accounting rules set here will give direction to the rest of the world as the ETS is the largest carbon market in the world. What will happen if a major carbon market player becomes insolvent?

Accounting bodies can help us prepare for these events before they arise. Accounting is part of the bedrock of the system – it’s invisible yet crucial. The public won’t take any notice of carbon trading until there is a major accounting mess that causes serious damage. We all have an interest in making sure that doesn’t happen.’

Chris Lenon, group strategic adviser for tax policy at Rio Tinto, said that if policymakers wanted to decarbonise industry, there needed to be a long-term framework. He believes that guidelines on accounting, tax and VAT must be ready by 2013.

Yvon Slingenberg, head of the European Commission unit charged with implementing ETS, said her focus now was on establishing a system for auctioning allowances. She called on accounting bodies to set voluntary standards for how carbon is treated, as her department had neither the resources nor the expertise.

‘I must admit to being a bit puzzled by how some companies account for carbon at present,’ Slingenberg said. ‘Even allowances received for free have a value. I was quite surprised to see some of these accounted for as nil.’

Cost of inaction

The complexities of whether allowances should be marked to market or valued at their purchase price are leading some firms to shy away from opportunities in emissions trading, according to Louis Redshaw, head of environmental markets at Barclays Capital. He said the carbon emissions market was expected to grow every year, at least until 2020, and clarity on accounting standards would help firms capitalise on this growth.

A more transparent treatment of emissions allowances would guide investors’ decisions, according to Belgian MEP Philippe Lamberts, who hosted the event organised by ACCA and Hanover. It would, he said, be a step towards ‘sustainability accounting’.

This view was echoed by Alan McGill, partner in PwC’s sustainability and climate change practice. He also warned that organisations were not keen on adding more pages to their annual reports and financial statements and that there were 106 ways of counting for carbon worldwide and this was impractical.

‘We need to see a new form of reporting evolving as part of the holistic performance of an organisation in terms of sustainability,’ McGill said. ‘It should allow comparability so that companies can be benchmarked against one another.’

McGill added that organisations would have to invest in systems and training for financial staff to ensure they were prepared for this new wave in carbon accounting. With 2013 looming, the message from Brussels is that the accounting profession will have a key role to play in ensuring the success of the EU ETS – something policymakers have a long-term stake in.

Gary Finnegan, journalist

What gets measured gets done

Philippe Lamberts MEP sees carbon accounting as the first step towards measuring the sustainability of companies. This, he believes, will help the market assess the environmental liabilities of an organisation and provide a fuller picture of its long-term prospects.

An engineer by training and a leading light in the Belgian Green Party, Lamberts is a numbers man. ‘What gets measured gets done,’ he told Accounting and Business. ‘If we don’t start measuring emissions in a serious way, they basically don’t count in commercial decisions. This is what accounting for the ETS is all about: making sure business leaders take account of carbon. It’s easy to say sustainability is important, but we need to put figures on it.’

Lamberts believes market discipline can help steer industry onto a low-carbon path, but he wants the market regulated by ‘elected politicians acting in the public good’. His instinct is to eschew self-regulation, blaming the economic crisis on laissez-faire financial watchdogs, but he is also a realist.

Dealing with the fallout from the crisis will keep key arms of the European policy apparatus busy for the foreseeable future, leaving much of the heavy lifting in streamlining accounting practices to professional bodies.

‘We have a real bottleneck,’ he said. ‘The climate crisis has been crowded out by the financial crisis, adding to the workload of European Commission officials in charge of taxation, financial regulation and the internal market. So we are relying on accounting bodies to make proposals. They have the expertise to put forward solutions we can work with.’

Despite advocating emissions trading, the outspoken MEP is concerned the market could be distorted by speculators and wants strict rules to guard against speculators. ‘I would urge accounting standard setters to design a model that incentivises long-term thinking rather than the short-term approach which contributed to the present financial crisis,’ he said.

Last updated: 14 Jul 2014