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2.1. Definition of an intangible asset

Although relatively new, the carbon offset markets are growing. A certified carbon offset delivered in a transferable or tradeable format to the entity’s registry account can typically be resold for cash. A unit of certified carbon offset will meet the definition of an intangible asset under IAS 38, ‘Intangible Assets’, as “an identifiable non-monetary asset without physical substance”, if it is transferable or tradable. The reasons are:
  • it is a resource controlled by an entity (that is, the entity has the power to obtain the economic benefits that the asset will generate and to restrict the access of others to those benefits) as a result of past events and from which future economic benefits are expected to flow to the entity;
  • it is identifiable as it can be sold, exchanged or transferred individually;
  • it is not cash or a monetary asset; and
  • it has no physical form.

2.2. Classification, recognition and measurement

IAS 38 paragraph 2 states that it should not be applied for intangible assets that are within the scope of another standard. As such, IAS 38 accounting principles apply to carbon offsets only when they do not fall within the scope of another standard. This section considers the accounting implications of falling within the scope of IAS 2 or IAS 38 along with certain other classification and measurement issues.

2.2.1. Inventory accounting

Certified carbon offsets would meet the definition of inventories in IAS 2 under the following circumstances:
  1. they are assets held for sale in the ordinary course of business; or
  2. they are assets in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Inventories are generally measured at the lower of cost and net realisable value in accordance with the measurement requirements of IAS 2. Where the inventory is made up of a large number of similar items, please refer to paragraphs 25.30 - 25.33 of the PwC Manual of Accounting. Also see FAQs 3.2.1 and 3.2.2 for discussion on when carbon offsets purchased might meet the definition of inventory and Section 4.1 for the accounting considerations around their costs of generation.
However, broker-trader entities that consider carbon offsets to be commodities can elect to measure them at fair value less costs to sell with changes in fair value recognised in profit or loss. See FAQ 2.2.1.1 below for further information.
The carbon offsets will not meet the definition of inventory if the entity holds carbon offsets only for investment purposes (that is, capital appreciation) over extended periods of time or sells carbon offsets outside of its ordinary course of business.

2.2.2. Intangible assets accounting

Carbon offsets that do not meet the inventory definition as discussed in the section above will be accounted for as intangible assets under IAS 38, provided they meet the definition and recognition criteria for intangible assets.
Under IAS 38, an intangible asset is recognised “if, and only if:
  1. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
  2. the cost of the asset can be measured reliably.

Purchased carbon offset intangibles that can be resold would meet both criteria. Entities that develop carbon offset intangibles for own use need to demonstrate that the offsets meet the intangibles definition (see Section 2.1) and recognition criteria above.
Carbon offset intangibles meeting the recognition criteria above are initially measured at cost. For each unit of carbon offset, there is generally no consumption of its economic benefits until it is derecognised. As such, each carbon offset would subsequently be carried at cost less any accumulated impairment losses (see FAQ 3.2.4) or, as permitted under IAS 38, measured using the revaluation model if an active market exists for the acquired carbon offsets. Where the quality and prices of certified carbon offsets vary widely, there might be little evidence to support the existence of an active market. See Section 2.3 for the relevant factors to consider.
For carbon offset intangibles measured using the revaluation model, the entity will need to determine an appropriate frequency for revaluing the assets. The timing of when an asset was last revalued is important when the asset is disposed of. This is because any difference between the carrying amount at the last revaluation date (less any subsequent accumulated amortisation or impairment losses) and the proceeds on the date of disposal will be recognised in profit or loss (refer to FAQ 21.88.1 in the PwC Manual of Accounting).

2.2.3. Other accounting considerations

Entities involved in the VCM need to consider the appropriate accounting before obtaining or generating any carbon offsets. The range of possible classifications, as well as their associated measurement, shows the importance of understanding the entity’s business model/purpose for holding the asset. This increases the importance of implementing specific accounting policies, ensuring their consistent application to similar transactions and appropriate disclosures. Where an entity can evidence the existence of clearly distinguished portfolios of similar assets held for different purposes, different treatments might apply within an entity.
Examples of other activities that require careful consideration include:
  • Upfront investment in a Project Developer and the accounting for subsequent returns on the investment. The ‘investor’ and ‘developer’ should consider the appropriate accounting for the upfront payment. See Sections 3.1 and 4.4 for further details.
  • Agreements to acquire/sell carbon offsets in the future. Entities that are acquiring carbon offsets to offset their own emissions and project developers selling self-produced carbon offsets are likely to meet the ‘own use’ exemption under paragraph 2.4 of IFRS 9. However, entities engaged in trading carbon offsets need to consider whether the contracts to acquire and sell such carbon offsets are within the scope of IFRS 9. This would be as a result of the contract having a net settlement feature as explained in paragraph 2.6 of IFRS 9. Entities would, therefore, need to account for the contracts for future purchases and sales at fair value through profit or loss (FVTPL). See Sections 3.1 and 4.4 for further details.
  • Project Developers need to assess the appropriate accounting for their operational activities. For example:
    • Developers need to consider whether costs incurred in the development of carbon capture or other similar projects meet the criteria for capitalisation under IAS 16 or IAS 38. See Section 4.3 for further details
    • Carbon offsets could also result from forestry projects where trees are being held with the sole purpose of generating and selling carbon offsets. In such situations, the accounting for the offsets would depend on first determining the appropriate accounting for the trees, including whether they are in the scope of IAS 41. Some commonly witnessed scenarios are discussed in more detail from Section 4.2.

The role of the entity in the VCM and the intended use of the carbon offsets will also impact the classification of its cash flows in the cash flow statement.

2.3. Fair value

There are further complications for entities that need to reference fair value when they account for carbon offsets. As noted above, this could include carbon offset commodities carried by broker-traders at fair value through profit or loss or carbon offset intangibles measured under the revaluation model.
IFRS 13, ‘Fair Value Measurement’, defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”, and it sets out a framework for determining fair values under IFRS.
Some high level factors to consider are included below:
  • Active market:
Appendix A to IFRS 13 defines an active market as one “in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis”.
A benchmark for evaluating the depth of a market could include active trading days within a given time period. A metric for volume that could also be considered is the average daily turnover ratio. This is calculated by dividing the average daily trading volume by the total amount of outstanding carbon offsets.
IFRS 13 does not define thresholds for frequency (such as active trading days) and volume (such as turnover ratio) to determine if an active market exists. This means that the conclusion requires professional judgement. In assessing whether an active market exists in a region for a particular type of carbon offsets, an entity should also consider whether reliable trading data is available.
In some cases, there might be several markets for a particular type of carbon offsets that meet the definition of an active market and each of those markets might have different prices at the measurement date. In these situations, IFRS 13 requires the entity to determine the principal market for the asset.
The principal market will be the market with the greatest volume and level of activity for the relevant type of carbon offsets that the entity holding the type of carbon offsets can access. IFRS 13 also contains a tiebreaker if there is not a clear principal market (that is, because there are several markets with approximately the same level of activity). In the case of a tie, IFRS 13 defaults to the most advantageous market within the group of active markets that the entity has access to with the highest activity levels.
If no active market exists, any carbon offsets held should not be fair valued. However, the entity may still be required to account for contracts to acquire the carbon offsets in the future at fair value, if such contracts have a net settlement feature and are not for the entity’s ‘own use’ (see Section 3.1). This would require the use of other directly or indirectly observable inputs (level 2 in the fair value hierarchy) or a valuation model (level 3).
  • Valuation techniques:
In many cases, the market approach [IFRS 13 para B5] will be the most appropriate technique for contracts to acquire carbon offsets in the future, because this would be used by a market participant. However, there might be particular facts and circumstances where an entity could demonstrate that a market participant would use a different approach. The cost approach [IFRS 13 para B8] or the income approach [IFRS 13 para B10] is likely to be rare in practice.
In determining an appropriate valuation technique, IFRS 13 indicates that the technique should be appropriate in the circumstances, and it should maximise the use of relevant observable inputs and minimise the use of unobservable inputs.
In general, a valuation model should be applied consistently from period to period. The market for carbon offsets is evolving rapidly and valuation techniques used by market participants are likely to evolve. IFRS 13 permits an entity to change valuation techniques (or change weightings amongst multiple valuation techniques) where the change results in a measurement that is equally, or more, representative of fair value, in the circumstances. The development of new markets, availability of new information or changing market conditions might result in changing valuation techniques.
  • Disclosure:
IFRS 13 contains a number of disclosure requirements. Given that markets for carbon offsets are rapidly evolving, determining the fair value can be complex. IFRS 13 provides advice on the level of detail necessary to satisfy the disclosure requirements, how much aggregation or disaggregation to undertake and whether users of financial statements will need additional information to evaluate the quantitative information disclosed.

2.4. Derecognition

Carbon offsets should be derecognised when they are sold, transferred or retired.
As discussed earlier, when carbon offsets are used to offset a company’s own emissions, the company is required to instruct the registry to ‘retire’ the carbon offsets. In some cases, the carbon offsets are simultaneously purchased and retired. See Section 3 below about the end users’ accounting when carbon offsets are retired.
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