Carbon offsets can be produced by a variety of activities that reduce greenhouse gas emissions or increase carbon sequestration. In most cases, these activities are undertaken as discrete ‘projects’. A carbon offset project, for example, may involve:
  • renewable energy development (displacing fossil-fuel emissions from conventional power plants);
  • the capture and destruction of high-potency GHGs like methane, N2O, or HFCs; or
  • forestation or restoration of forests (trees planted to absorb carbon).

The Project Developer should carefully analyse the accounting considerations for the costs incurred for the underlying project that generates carbon offsets and their contracts to deliver carbon offsets in the future.

4.1. Costs incurred to generate carbon offsets

Project Developers may incur significant costs developing the appropriate technology and building assets that will enable carbon offset to take place and carbon offsets to be earned/generated. Please refer to Section 4.3 for accounting considerations for research and development and other costs.
The project activities often involve the use of certain physical assets, for example trees. Accounting for the underlying assets generating carbon offsets can be complex. Please refer to Section 4.2 for accounting for trees held to generate carbon offsets.

4.2. Accounting for trees held to generate carbon offsets

Project Developers that plant trees to absorb carbon to generate carbon offsets need to consider the accounting treatment for the trees. Considering the nature and intended use of the trees, entities need to determine whether the trees are
  1. biological assets that should be accounted for in accordance with IAS 41; or
  2. bearer plants that should be accounted for in accordance with IAS 16; or
  3. assets not related to agricultural activity.

Trees meet the definition of a biological asset under IAS 41. Trees that relate to agricultural activity (except those that meet the definition of a bearer plant) should be accounted for in accordance with the requirements of IAS 41. IAS 41 defines agricultural activity as “the management by an entity of the biological transformation and harvest of biological assets for sale or for conversion into agricultural produce or into additional biological assets”. Agricultural produce is defined as “the harvested produce of the entity’s biological assets”.

4.3. Carbon sequestration and other projects

4.3.1 Carbon sequestration - introduction

Carbon sequestration is the process of capturing and storing atmospheric carbon dioxide. It is recognised as a key method for reducing the carbon in the earth’s atmosphere with the goal of reducing global climate change.
Carbon sequestration can happen in two basic forms: biologically or geologically. Biological carbon sequestration happens when carbon is stored in living plants. Geological carbon sequestration is technological and happens when carbon is stored in underground geological formations or rocks or depleted oil and gas reservoirs, deep unmineable coal beds, retired salt mines and so on.
An increasing number of entities are investing in developing technologies that would enable carbon capture and storage (CCS) at a massive scale. The majority of these projects are currently in research and development phases. The regulatory policies governing such projects vary between countries and the associated commercial models are still a work in progress in many cases. These factors introduce complexity and involve significant judgement in determining if the research and development costs incurred on such projects meet the capitalisation criteria under IAS 38 and/or IAS 16.
In the following sections, we discuss the accounting considerations related to the following topics:
  • the application of IAS 38 to research and development expenditure incurred in respect of a CCS project; and
  • the application of IAS 20 for accounting for government grants provided to a CCS project.

4.3.2 Research and development expenditure

The process of generating an intangible asset is generally divided into a research phase and a development phase. This applies to CCS projects where significant costs are incurred before the start of the construction of physical infrastructure. These costs are incurred on activities such as studies evaluating suitable technologies, producing conceptual project designs, pigging, seismic surveys, establishing technical, commercial and economic feasibility and evaluating potential locations for development. Whether these costs can be capitalised as intangible assets can involve significant judgement in determining if the activities amount to development and meet the criteria outlined in IAS 38.
IAS 38 defines research as the “original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding”. Paragraph 54 of IAS 38 stipulates that ‘expenditure on research (or the research phase of an internal project) should be recognised as an expense when it is incurred’. Two examples of research activities provided in IAS 38 are:
  • ‘activities aimed at obtaining new knowledge; and
  • the search for, evaluation and final selection of, applications of research findings or other knowledge.’

In contrast, paragraph 57 of IAS 38 provides that an intangible asset arising from development (or from the development phase of an internal project) should be recognised provided certain criteria are met. Development is defined as “the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use”.

4.3.3 The application of IAS 20 for accounting for government grants provided to a CCS project

Given the ever-increasing focus on reducing and mitigating carbon emissions, many governments are assisting the development of CCS and other green projects in one form or another. The nature and extent of government support may vary across jurisdictions and projects.
Entities need to assess whether the government support is a government grant or another form of government assistance based on the definition and scope of IAS 20. The distinction is important because the accounting requirements of IAS 20 only apply to government grants. In particular, the definition of government grants excludes the following forms of government assistance:
  • Assistance to which no value can reasonably be assigned.
  • Transactions with the government that cannot be distinguished from the normal trading transactions of the entity.

Paragraph 2 of IAS 20 also excludes grants related to income tax, biological assets measured at its fair value less costs to sell or government participation in the ownership of an entity from the scope of IAS 20.
The nature of government support in respect of CCS projects varies and a detailed analysis based on specific facts and circumstances will be required to determine the nature of support and, therefore, the applicable accounting standard and appropriate accounting treatment.
For example, the UK government’s Net Zero Strategy sets out policies and proposals for decarbonising all sectors of the UK economy by 2050. The nature of government assistance committed for CCS and other industries includes legislative changes, direct revenue support, contracts for differences schemes, dispatchable power agreements and so on. Each of these schemes would require an assessment based on their specific terms and conditions to determine the appropriate accounting treatment.
Legislative changes for example, that only provide indirect support to a particular industry would typically be outside the scope of IAS 20. This is on the basis that the definition of government assistance under the standard does not include “benefits provided only indirectly through actions affecting general trading conditions, such as the provision of infrastructure in development areas or the imposition of trading constraints on competitors”.
Governments also sometimes provide assistance through tax incentive schemes and entities need to analyse the requirements and terms of each tax offset or incentive to determine the applicable accounting standard.

4.4. Contracts to deliver carbon offsets in the future

Like the issues discussed under Section 3.1 from the investors’ perspective, Project Developers entering into contracts to deliver carbon offsets in the future should also carefully assess the contract to determine whether the nature of the arrangement is financial (equity, loan, a FVTPL financial instrument including derivatives), or non-financial (a lease, an executory carbon offsets sales contract (including a prepayment) or a sale of an intangible asset).
If the contract falls into IFRS 15 and an initial payment is received from the customer, the Project Developer will also need to assess whether a significant financing component exists.
Where contracts fall into IFRS 15 and include goods or services other than the carbon offsets (for example renewable electricity), the delivery of the carbon offsets will be considered a separate performance obligation. The PwC In depth on Accounting for Green/Renewable Power Purchase Agreements from the Buyer’s Perspective discussed the accounting considerations from the Renewable Energy Credits (REC) purchaser’s perspective. Similar considerations apply from Project Developer’s perspective.
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