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Lack of accepted standards in emissions accounting

Question:

Discuss about the Role of Emissions in Climate Change Policy.

Currently, there are no universally accepted standards of accounting for emission allowances in organizations. There is no accepted method of measuring and recognizing emission allowances and this has created a misunderstanding on the standards for accounting for this item in the financial report. However, this has not prevented organizations from trading and developing carbon markets. Many countries especially in Europe, South Korea, and Australia have made significant steps in trying to set uniform emission allowance measurement standards for companies in their countries (Skjrseth & Eikeland, 2013). The definitions given by the Global accounting standards body indicates that carbon allowances should be treated as assets since they are resource being controlled by the organization and they have economic value.  A proposal for revision on the regulation of financial instrumentsrecognizes emissions as part of an organizations instruments of finance.(Fusaro & James, 2013). When it comes to accounting, allowances from emissions are not treated as financial instruments..

The report discusses the emission allowances and provides justification for the discussions that follows. The report evaluates the measurement of emission allowances and the journal entries for this transaction are entered to illustrate how the instruments are accounted for. The final section of the report discusses the consequences of allowances issued on emissions on the financial statements which includes the balance sheet, income statement and the statement of cash flow.

The first reason European Commission has established that “classification of the emission allowances for accounting reasons depends on the criteria set by recognized accounting standards body only”(Perkins, 2011). Since no accounting standards body has been able to put in place strategies to account for the emission allowances in financial reports.

The U.S GAAP has established uniform systems of accounting which provides guidance to companies to account for emission allowance. It provides that emission allowances should be reported at historical cost and are classified as inventory in the balance sheet. Allowances that are being bought are recorded at the buying price while those received from EPA are recorded at zero price. Weighted average cost method is recommended and the calculations should be done on a monthly.

The financial Accounting Standards Board (FASB) works hand in hand International Accounting Standards Board (IASB) to solve the issue of accounting for carbon emission schemes (Antes, Hansju?rgens, & Letmathe, 2006). In USA certain companies mostly in the power and energy industries which are viewed as contributing greatly to pollution are needed to engage in established programs on emissions. The absence of a clearly defined strategy and methods for measuring the emission credits has resulted to the rise of the following practices in various industries; renewable energy certificates, emission offsets and credit on emissions.

Measurement of Emission Allowances

In a survey conducted in USA for publicly registered companies with yearly revenues of between $1.1 billion and $100 billion between Jan 2009 and September 2009(Taticchi,Carbone& Albino, 2013). Of all the companies registered in this program, more than 29 companies indicated that they had an accounting policy related to emission credits.

One of the models used in accounting for carbon emission allowances is intangible assets accounting model. The company’s measure emission credits and allowances issued to them and bought in the market by comparing with the cost of emissions. If a company is therefore issued with emission credits, it has a nominal zero cost. When a company buys carbon credits, it has costs associated with them which are the buying price of the carbon credits (Watchman, 2008). Under this technique, it is possible to value emission credits that have been issued at a fair value immediately they are received. Emission credits are subject to impairment under the intangible assets model impairment model and the assets that are fixed model to the point of amortization of the carbon credits (Newell, Boykoff & Boyd, 2012).

The carbon credits can also be accounted for under the inventory model. Under this model, the emission credits are measured using the weighted-average cost. Emission credits issued by relevant bodies in charge of carbon credits have zero costs attached to them. Weighted average cost of carbon emissions for a particularly period of time is valued by estimating the cost of fuel. Under this model, the emission allowances are ranked as inventory in a company’s balance sheet and in the cash flow statements, they are classified as operating activities.

The emission credits are also accounted as liability and gain recognition. In this, a company does nor recognize the obligation to deliver carbon credits to concerned bodies until the real level of carbon emissions for a particular period is more than the credit recorded on the balance sheet. A gain is usually recognized in the period in which the credits have been sold. Some companies however defers the income if the emissions were given for a future vintage year and they happen to be sold in the current year (Chen, Liu& Hua, 2013). The gain in this case is considered as not realized since the company may fail to cover its emissions in the future vintage year due to the credits sold in the previous year.

In accounting vintage year changes, all emissions have years of vintage allocated to them. Allowances that have not be used are transferred to future years. This practice is common because government agencies I charge of issuing emission allowances issue for many years simultaneously and hence need to exchange allowances between the years.

Analysis of the consequences of allowances issued on emissions on financial statements

Details

Debit

Credit

Allowances    

 10

Income differed         

10

If a company receives 1000 tonnes of emission allowances, then the total value of emission allowance is (1000×10) =$10,000. This amount will be credited as income as emissions allowance.

If the government offers companies in an industry a grant of 3.5 tonnes. It will be recorded as follows;

Details

Debit

Credit

Deferred earning in form of gov grant

 2.5

Income Statement      

2.5

The company recognizes income from the government grant that is equal to the cost of emissions and hence (2.5×1.2)

Details

Debit

Credit

Record on income statement (expense)

4

Liability due to emission

4

The company recognizes responsibility for emission and credits it on the income statement.

Settling of obligation

Details

Debit

Credit

liability on emissions

20

Emission allowance

20

Settlement of the liability due to carbon pollution and delivery of allowances during the financial period indicated

Details

Debit

credit

Issued allowances

20

Differed income from sale of allowance

20

End of 2014 year with a price of $14

Details

Debit

Credit

Allowances

2

Equity (revaluation surplus)

2

If a company recognizes increase in the value of emission allowances it has by1,000 and the price per ton has increased to $14 from $12 then:`

Details

Debit

Credit

Transferred income

2.5

Record on statement of income

2.5

The company should recognize as income the government grant when the cost of emissions is calculated and it exceeds the grant (Brebbia, Longhurst & Popov, 2011).

Details

Debit

Credit

Expense emissions

6

Emission burden(liability)

6

The company recognizes the burden for emission (4,000 ton /4 x 1= 1000 ton x €12

=€12000). The burden on emission in this case is calculated at fair value.

The recording of emission allowances affects financial statement in various ways. The first reason why they affect financial statements is that they may bring a new aspect in the recording of financial information. The following is an evaluation of the consequences of emission allowances on specific financial records:

Currently held emission allowances should be recorded as assets on the balance sheet. This is because a company expects to derive future benefits from holding an allowance since it will enable the company to produce high amount of GHG in the production of goods and services (Bostan, 2009). Furthermore, a company may decide to sell the allowance and generate cash which is an asset for the business.

A purchase of emission allowance by a company should be recorded as an allowance asset. It increases the allowance asset and reduces the cash asset on the balance sheet. If it is on credit, it increases accounts payable. When a company uses the emission allowance by emitting the quantity of emission authorized, the allowance asset should be decreased to indicate a reduction in an asset. A corresponding allowance expense should be recorded to decrease net income in the income statement of the company. This is listed as the cost of pollution in most income statements of companies. Companies should make adjustments at the end of the year to the carrying value allowance asset accounts to bring it to the market value. Increase in price in the market, the “Allowance asset” account should be increased by the change in price(Daniel Lieberman, 2010).The equity account named “Unrealized gain on Allowances” of the company should also be increased by same amount (Bonham & Ernst & Young. 2008). When a company emits more carbon than its current allowance held. It should be recorded as an accrued expense which is a liability for the business. The company will then need to pay a fine or purchase additional carbon credits.

Methods for Accounting for Emission Allowances

Conclusion

The report evaluates and describes the subject of emissions allowances. Emissions allowances is becoming popular means of ensuring environmental sustainability through the counting of carbon foot prints which can then be sold to other producers. This report evaluates the accounting methods used to account for emissions among various companies in different countries. There are no universally accepted standards on accounting for emission allowances and therefore the standards and accounting practices in this regard. Some of the common and most popular methods used by companies vary from country and a company has a choice on which accounting methods to use in this regard. One of the models used in accounting for carbon emission allowances is intangible assets accounting model. The company’s measure emission credits and allowances issued to them and acquired in the market at cost and this cost is assumed to be the value of the emissions for that accounting period. The report analyzes the journal entries resulting from accounting for emissions and uses examples to illustrate how the item is recorded in the financial statement. The consequences of the emission allowances on the financial records is that they increase the “emissions allowance account” when they are bought and in turn decrease the cash account or accounts receivables. If emissions by a company exceed the emission allowance that a company holds, it will record it as “emission allowance” payable. This is a liability for the company and needs to be paid at a future date.

References

Antes, R., Hansju?rgens, B., & Letmathe, P. (2006). Emissions trading and business. Heidelberg: Physica-Verlag.

Burritt, R. (2011). Environmental management accounting and supply chain management . Dordrecht: Springer.

Bonham, M., & Ernst & Young. (2008). International GAAP 2008: Generally accepted accounting practice under International financial reporting standards. Chichester, West Sussex, England: J. Wiley & Sons.

Bostan, I. (2009). Consideration Concerning Finanacial Statement in the Context Globalization. SSRN Electronic Journal. https://dx.doi.org/10.2139/ssrn.1324954

Daniel Lieberman, M. (2010). Accounting for Climate Change. Springer Netherlands.

Fusaro, P. C., & James, T. (2013). Energy and emissions markets: Collision or convergence. Hoboken, N.J: Wiley.

International Conference on Modelling, Monitoring and Management of Air Pollution, Brebbia, C. A., Longhurst, J. W. S., & Popov, V. (2011). Air pollution XIX. Southampton, UK: WIT Press.

International Conference on Low-carbon Transportation and Logistics, and Green Buildings, Chen, F., Liu, Y., & Hua, G. (2013). LTLGB 2012: Proceedings of International Conference on Low-carbon Transportation and Logistics, Green Buildings, Beijing, China, October 12-13, 2012. Berlin: Springer.

Jones, S., & Ratnatunga, J. (2012). Contemporary issues in sustainability accounting, assurance and reporting. Bingley: Emerald Group Pub.

Newell, P., Boykoff, M., & Boyd, E. (2012). The New Carbon Economy: Constitution, Governance and Contestation. New York, NY: John Wiley & Sons.

Perkins, H. (2011). The Role of Emissions in Climate Change Policy. Hauppauge: Nova Science Publishers, Inc.

Skjrseth, J. B., & Eikeland, P. O. (2013). Governing European industry by emissions trading: Resistance, innovation or responsibility?. Farnham: Ashgate.

Taticchi, P., Carbone, P., & Albino, V. (2013). Corporate sustainability. Berlin: Springer

Veith, S. (2010). The EU emission trading scheme: Aspects of statehood, regulation, and accouting. Frankfurt am Main: Peter Lang.

Watchman, P. (2008). Climate change. London: Globe Law and Business.

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