(a) an asset for allowances held – Allowances, whether allocated by government or
purchased, were to be regarded as intangible assets and accounted for under
IAS 38. Allowances issued for less than fair value were to be measured initially at
their fair value;13
(b) a government grant – When allowances are issued for less than fair value, the
difference between the amount paid and fair value was a government grant that
should be accounted for under IAS 20. Initially the grant was to be recognised
as deferred income in the statement of financial position and subsequently
recognised as income on a systematic basis over the compliance period for
which the allowances were issued, regardless of whether the allowances were
held or sold;14
(c) a liability for the obligation to deliver allowances equal to emissions that have been
made – As emissions are made, a liability was to be recognised as a provision that
falls within the scope of IAS 37. The liability was to be measured at the best
estimate of the expenditure required to settle the present obligation at the
reporting date. This would usually be the present market price of the number of
allowances required to cover emissions made up to the reporting date.15
The interpretation also noted that the existence of an emission rights scheme could
represent an indicator of impairment of the related assets, requiring an IAS 36
impairment test to be performed, because the additional costs of compliance could
reduce the cash flows expected to be generated by those assets.16
Those who called for the withdrawal of IFRIC 3 identified a number of accounting
mismatches arising from its application:17
• a measurement mismatch between the assets and liabilities recognised in
accordance with IFRIC 3;
• a mismatch in the location in which the gains and losses on those assets are reported;
and
• a possible timing mismatch because allowances would be recognised when they
are obtained – typically at the start of the year – whereas the emission liability
would be recognised during the year as it is incurred.
In light of these accounting mismatches, it is perhaps no surprise that in practice very
few companies have applied IFRIC 3 on a voluntary basis. Instead companies have
developed a range of different approaches in accounting for cap and trade emission
rights schemes, which are discussed below:
• ‘net liability’ approaches;
• ‘government grants’ approach.
Whatever approach is used, companies should disclose their accounting policies
regarding grants of emission rights, the emission rights themselves, the liability for the
obligation to deliver allowances equal to emissions that have been made and the
presentation in the statement of profit or loss. [IAS 1.117, 121].
1280 Chapter 17
11.2.2
Emissions trading schemes – Net liability approaches
Under the ‘net liability’ approach emission allowances received by way of grant are
recorded at a nominal amount and the entity will only recognise a liability once the
actual emissions exceed the emission rights granted and still held, thereby requiring the
entity to purchase additional allowances in the market or incur a regulatory penalty.
Purchased grants are initially recognised at cost.
We believe that an entity can apply such a ‘net liability’ approach, because in the
absence of specific guidance on the accounting for emission rights, IAS 20 allows non-
monetary government grants and the related asset (in this case the emission rights)
received to be measured at a nominal amount (i.e. nil). [IAS 20.23].
Under IAS 37, a provision can only be recorded if the recognition criteria in the
standard are met, including that the entity has a present obligation as a result of a past
event, it is probable that an outflow of economic resources will be required to settle
the obligation and a reliable estimate can be made, [IAS 37.14], (see Chapter 27). As far
as emissions are concerned, the ‘obligating event’ is the emission itself, therefore a
provision is considered for recognition as emissions are made, but an outflow of
resources is not probable until the reporting entity has made emissions in excess of
any rights held. This means that an entity should not recognise a provision for any
anticipated future shortfall of emission rights, nor should it accrete a provision over
the period of the expected shortfall.
Under IAS 37 the entire obligation to deliver allowances should be measured on the
basis of the best estimate of the expenditure required to settle the present obligation at
the end of the reporting period (see Chapter 27). [IAS 37.36]. Accordingly any provision is
based on the lower of the expected cost to purchase additional allowances in the market
or the amount of any regulatory penalty.
Although it has been criticised for using a nominal value for the rights and a net
approach for measuring the liability, the ‘net liability’ approach appears to have gained
acceptance in practice.
Example 17.18: Application of ‘net liability’ approach
Company A received allowances representing the right to produce 10,000 tonnes of CO2 for the year to
31 December 2018. The expected emissions for the full year are 12,000 tonnes of CO2. At the end of the third
quarter, it has emitted 9,000 tonnes of CO2. The market price of the allowances at the end of the each quarter
is €10/tonne, €12/tonne, €14/tonne and €16/tonne respectively.
Under the ‘net liability’ approach, the provision at the end of the first, second and third quarters would be nil,
because the company has not yet exceeded its emissions target. Only in the fourth quarter is a provision
recognised, for the excess tonnage emitted, at 2,000 tonnes × €16/tonne = €32,000.
In the above example, the company cannot anticipate the future shortfall of
2,000 tonnes before the fourth quarter by accreting the provision over the year, nor can
it recognise on day one the full provision for the 2,000 tonnes expected shortfall. This
is because there is no past obligating event to be recognised until the emissions target
has actually been exceeded.
Some schemes operate over a period of more than one year, such that the entity is
unconditionally entitled to receive allowances for, say, a 3-year period, and it is possible
to carry over unused emission rights from one year to the next. In our view, these
Intangible
assets
1281
circumstances would justify application of the net liability approach for the entire
period concerned, not just the reporting period for which emission rights have been
transferred to the entity. When applying the net liability approach, an entity may choose
an accounting policy that measures deficits on the basis of:
• an annual allocation of emission rights; or
• an allocation that covers the entire first period of the scheme (e.g. 3 years)
provided that the entity is unconditionally entitled to all the allowances for the first
period concerned.
For such schemes, the entity must apply the chosen method consistently at every
reporting date. If the entity chooses the annual allocation basis, a deficit
is measured on
that basis and there can be no carrying over of rights from one year to the next or back
to the previous year.
In Example 17.18 above, the entity had an expected shortfall of 2,000 tonnes. Suppose
that during the year it had purchased emission rights to cover some or all of the expected
shortfall. How should these be accounted for?
Example 17.19: Impact of purchased emission rights on the application of ‘net
liability’ approach
In Example 17.18 above, Company A had an expected shortfall of 2,000 tonnes. The same facts apply, except
that at the end of the second quarter, it purchases emission rights for 1,000 tonnes at €12/tonne, i.e. a cost of
€12,000. It records these rights as an intangible asset at cost. No impairment has been necessary.
In recognising the provision for its excess emissions of 2,000 tonnes at the end of the year, can the entity
apply a method whereby the provision is based on the carrying amount of the emission rights it already owns
(the ‘carrying value method’), with the balance based on the market price at the year end? That is, can the
entity recognise a provision of €28,000, being €12,000 (1,000 tonnes at €12/tonne) plus €16,000
(1,000 tonnes at €16/tonne)?
Because the cost of emissions can only be settled by delivering allowances and the liability
to the government cannot be transferred, it is argued that the cost to the entity of settling
the obligation is represented by the current carrying value of the emission rights held.
Another view is that measurement of the obligation should be determined
independently of considerations as to how settlement may be funded by the entity.
Accordingly, the provision would be measured, as in Example 17.18, at €32,000
(based on the market value of emission rights at the year-end). However, the entity
may consider the emission rights it holds as a reimbursement right under IAS 37,
which is recognised at an amount not exceeding the related provision (see
Chapter 27). [IAS 37.53].
Under this alternative ‘net liability / reimbursement rights’ approach, the entity would
re-measure (to fair value) the emission rights that it holds. So although Company A has
recognised a provision (and an expense) of €32,000, at the same time it would revalue
its purchased emission rights, as a reimbursement right, from €12/tonne to €16/tonne. It
would thus recognise a gain of €4,000 (1,000 tonnes × €4/tonne), resulting in a net
expense of €28,000 in the statement of profit or loss. This is the same as the profit or
loss effect of applying the ‘net liability / carrying value’ approach.
In practice both the ‘net liability’ approach and the ‘net liability / reimbursement rights’
approach have gained acceptance.
1282 Chapter 17
In the extract below, MOL Hungarian Oil and Gas Plc applies a ‘net liability’ approach,
i.e. emission rights granted free of charge are accounted for at their nominal value of
zero and no government grant is recognised. A liability for the obligation to deliver
allowances is only recognised when the level of emissions exceed the level of
allowances granted. MOL Hungarian Oil and Gas Plc measures the liability at the cost
of purchased allowances up to the level of purchased allowances held, and then at the
market price of allowances ruling at the reporting date, with movements in the liability
recognised in operating profit.
Extract 17.12: MOL Hungarian Oil and Gas Plc (2017)
NOTES TO THE FINANCIAL STATEMENTS [extract]
9. PROPERTY, PLANTS AND EQUIPMENT AND INTANGIBLE ASSETS [extract]
B) INTANGIBLE ASSETS [extract]
ACCOUNTING POLICIES [extract]
Free granted quotas are not recorded in the financial statements, while purchased quotas are initially recognised as
intangible assets at cost at the emitting segments subsequently remeasured to fair value through profit or loss.
16. PROVISIONS [extract]
ACCOUNTING POLICIES [extract]
Emission rights
The Group recognizes provision for the estimated CO2 emissions costs when actual emission exceeds the emission
rights granted and still held. When actual emission exceeds the amount of emission rights granted, provision is
recognised for the exceeding emission rights based on the purchase price of allowance concluded in forward contracts
or market quotations at the reporting date.
11.2.3
Emissions trading schemes – Government grant approach
Another approach which has gained acceptance in practice is to recognise the emission
rights granted by the government initially at their fair value and record a corresponding
government grant in the statement of financial position. The government grant element
is subsequently recognised as income in accordance with the requirements of IAS 20.
To that extent, the approach follows that required by IFRIC 3. However, rather than
measuring the liability for the obligation to deliver allowances at the present market
price of those allowances, the liability is measured instead by reference to the amounts
recorded when those rights were first granted.
As with the ‘net liability’ approach, critics have argued that the government grant
approach would not be in line with the ‘best estimate’ determined under IAS 37 as the
amount that an entity would rationally pay to settle the obligation at the reporting date
or to transfer it to a third party at that time. [IAS 37.37].
Repsol initially recognises the emission rights at fair value as a government grant
under IAS 20 and illustrates clearly that the measurement of the liability follows that
of the related emission rights. To the extent that emissions are not covered by
emission rights, the liability is recognised at the fair value of such allowances at the
reporting date.
Intangible
assets
1283
Extract 17.13: REPSOL, S.A. (2017)
NOTES TO THE 2017 CONSOLIDATED FINANCIAL STATEMENTS [extract]
(2) BASIS OF PRESENTATION [extract]
ACTIVITY-SPECIFIC ACCOUNTING POLICIES [extract]
Carbon emission allowances: [extract]
Emission allowances are recognized as an intangible asset and are initially recognized at acquisition cost. Those
received free of charge under the emissions trading system for the period 2013-2020, are initially recognized at the
market price prevailing at the beginning of the year in which they are issued, against deferred income as a grant. As
the corresponding tons of CO2 are issued, the deferred income is reclassified to profit or loss.
They are not amortized as their carrying amount matches their residual value and are subject to an impairment test
based on their recoverable amount, (measured with reference to the price of the benchmark contract in the futures
market provided by the ECX – European Climate Exchange).
The Group records an expense under “Other operating expenses” in the income statement for the CO2 emissions
released during the year, recognizing a provision calculated based on the tons of CO2 emitted, measured at: (i) their
carrying amount in the case of the allowances of which the Group is in possession at year end; and (ii) the closing list
price in the case of allowances of which it is not in possession at year end.
When the emissions allowances for the CO2 t
ons emitted are delivered to the authorities, the intangible assets as well
as their corresponding provision are derecognized from the balance sheet without any effect on the income statement.
When carbon emission allowances are actively managed to take advantage of market trading opportunities (see
Note 29), the trading allowances portfolio is classified as trading inventories.
The fair value on initial recognition of emission rights that are accounted as intangible
assets will be based on the requirements of IFRS 13 which are discussed in Chapter 14.
If there is no active market for emission rights, the selection of appropriate valuation
techniques, inputs to those valuation techniques and the application of the fair value
hierarchy are discussed in Chapter 14.
11.2.4
Amortisation and impairment testing of emission rights
In the case of cap and trade schemes, emission rights that are accounted for as intangible
assets are unlikely to be amortised as their depreciable amount is usually nil. Their
expected residual value at inception will be equal to their fair value. Thereafter,
although their residual value is equal to their market value, there is no consumption of
economic benefit while the emission right is held. The economic benefits are realised
instead by surrendering the rights to settle obligations under the scheme for emissions
made, or by selling rights to another party. It is necessary to perform an IAS 36
impairment test whenever there is an indication of impairment (see Chapter 20). If the
market value of an emission right drops below its carrying amount, this does not
automatically result in an impairment charge because emission rights are likely to be
tested for impairment as part of a larger cash generating unit.
11.2.5
Emission rights acquired in a business combination
At the date of acquisition of a business, an acquirer is required to recognise the
acquiree’s identifiable intangible assets, in this case emission rights, at their fair values.
[IFRS 3.18].
1284 Chapter 17
However, an acquirer should only recognise a provision for actual emissions that have
occurred up to that date. This means that an acquirer cannot apply the ‘net liability’
approach to emission rights acquired in a business combination. Instead, an acquirer
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 253