Entity A wants to secure a long-term supply of carbon offsets. In order to obtain a sufficient supply, on 1 January 20X1, entity A enters into a streaming arrangement with entity B in which entity A will make an upfront non-refundable payment of C1 million to entity B and, in return, entity A will obtain the right to receive a fixed number of carbon offsets from entity B in the future.

Entity B will use the upfront payment received by entity A and other investors to fund its initiative (project R) to protect and preserve a tropical rainforest which has high carbon storage capacity.

Entity B will deliver 10,000 carbon offsets annually to entity A for a period of 10 years starting from 1 January 20X5 (C10 per offset). It is anticipated that the price of a carbon offset will exceed C10 per offset by 1 January 20X5.

There are no clauses in the contract that cause any variation of any cash flows over the contract’s term. No further payments are required over the life of the contract as the carbon offsets are delivered.

If entity B is unable to generate sufficient carbon offsets (from project R or any of its other projects), the contract requires entity B to purchase carbon offsets for delivery to entity A. There are no terms in the contract that permit entity A or entity B to settle the contract net in cash.

Entity A does not have past practice of settling similar contracts net in cash or a practice of taking delivery of the underlying in similar contracts and selling it within a short period of time to generate profit from short-term fluctuations in price or dealer’s margin.

Entity A should consider the guidance in FAQ 3.1.1 to determine the relevant accounting standards that apply to its contract with entity B.

Entity A determines that the contract does not give rise to control, joint control or significant influence over entity B or project R, because entity B makes all of the decisions related to project R, and consent from entity A is not required.

Entity A determines that the contract does not result in the purchase of an interest in any of entity B’s assets, because it does not provide entity A with an undivided interest in any of entity B’s projects. As such, by entering into the contract to purchase carbon offsets, entity A has not purchased a tangible or intangible asset. ¹

Entity A determines that the contract does not contain a lease, because it does not provide entity A with the right to receive substantially all of the outputs from any identified asset linked to any of entity B’s projects.

IFRS 9 applies to contracts to buy or sell a non-financial item where the contracts can be settled net in cash or another financial instrument or by exchanging financial instruments in accordance with paragraph 2.6 of IFRS 9 (net settleable contracts). Contracts to buy or sell carbon offsets could be examples of such contracts.

Some net settleable contracts are outside the scope of IFRS 9 where the contract to purchase or sell the carbon offsets was entered into and continues to be for the entity’s expected purchase, sale or usage requirements in accordance with paragraph 2.4 of IFRS 9. This is commonly referred to as the ‘own use’ exception.

Please refer to the examples below with differing assumptions that consider whether the contract is within the scope of IFRS 9 (to be read in conjunction with the background information above).

Assume that entity A has readily access to a liquid spot market for carbon offsets in which transactions take place with sufficient frequency and volume and prices are available on an ongoing basis. ²

As part of a diversification strategy, entity A plans on selling the carbon offsets that it will receive in the liquid spot market, with a trading objective of generating a profit from increases in the price of a carbon offset.

Would the contract described in this example be within the scope of IFRS 9 for entity A?

Entity A readily has access to a liquid spot market for carbon offsets, so the contract to purchase carbon offsets meets the requirement in paragraph 2.6(d) of IFRS 9 (refer to EX 40.83.2 in the PwC Manual of Accounting); that is, the carbon offsets are readily convertible to cash, so the contract with entity B can be settled net in cash.

Since entity A plans on selling the carbon offsets in the liquid spot market with a trading objective, as opposed to securing the carbon offsets to meet its expected sale, purchase or usage requirements, the contract with entity B will not qualify for the ‘own use’ exception. Therefore, the contract will be within the scope of IFRS 9 for entity A.

Entity A has determined that it does not meet the ‘own use’ exception at inception of the contract, so it would not be able to reclassify the contract if circumstances change, subsequent to inception, and the entity assesses that it would subsequently meet the ‘own use’ exception. Please refer to FAQ 40.81.1 in the PwC Manual of Accounting for further details.

The contract does not meet the definition of a derivative in Appendix A to IFRS 9, because the investment of C1 million is fully prepaid at inception. The prepaid amount will be accounted for as if it were a financial asset. Since entity A has the right to receive a fixed number of carbon offsets in the future, and the fair value of credits received will vary, the contract does not meet the solely payments of principal and interest requirements under IFRS 9 as noted in PwC Manual of Accounting FAQ 40.79.1. Therefore, the financial asset is measured at fair value through profit or loss.

Assume that entity A does not have access to a liquid spot market for carbon offsets.

Entity A intends to use the offsets to offset its own emissions to achieve its own net-zero targets. Entity A does not intend to sell the offsets. In other words, the contract was designed by entity A to be used solely for its own usage requirements.

Is the contract described in this example within the scope of IFRS 9 for entity A?

The contract cannot be settled net in cash, because:

Since the contract is not net-settleable, it does not fall within the scope of IFRS 9. Instead, the prepaid amount should be accounted for as a non-financial asset – that is, a prepayment representing the right to receive carbon offsets.

Even if, at inception, the contract is not within the scope of IFRS 9, it should still be assessed to identify if there are any separable embedded derivatives that should be accounted for under IFRS 9. In this example, because there are no non-closely related embedded derivatives in the contract between entity A and entity B, there are no separable embedded derivatives in the contract.

Assume that entity A readily has access to a liquid spot market for carbon offsets in which transactions take place with sufficient frequency and volume and prices are readily available on an ongoing basis. ³

Entity A intends to use the offsets to offset its own emissions to achieve its own net-zero targets. Entity A does not intend to sell the offsets. In other words, the contract was designed by entity A to be used solely for its own usage requirements.

Is the contract described in this example within the scope of IFRS 9 for entity A?

Entity A readily has access to a liquid spot market for carbon offsets, so the contract to purchase carbon offsets meets the requirement in paragraph 2.6(d) of IFRS 9; that is, the carbon offsets are readily convertible to cash, so the contract with entity B can be settled net in cash.

However, since entity A intends to use all of the offsets solely to offset its own emissions to achieve its own net-zero targets and does not intend to sell any offsets, entity A concludes that the purchases are in accordance with its expected usage requirements. In this case, entity A can apply the ‘own use’ exception. Accordingly, the contract is not within the scope of IFRS 9 at inception. Instead, the prepaid amount should be accounted for as a non-financial asset – that is, a prepayment representing the right to receive carbon offsets.

If, subsequent to inception, circumstances change and the contract no longer continues to be held for ‘own use’, the contract will subsequently be within the scope of IFRS 9. Refer to FAQ 40.84.7 in the PwC Manual of Accounting for further details.

Embedded derivatives would be considered in a similar manner to the discussion in Example B.