Certain atmospheric gases (e.g., carbon dioxide, methane, nitrous oxide) are called greenhouse gases (GHGs) because they are believed to contribute to the retention of outgoing energy, trapping heat somewhat like the glass panels of a greenhouse. Various governments have created programs to incentivize entities to reduce the level of emissions in manufacturing facilities and the pollution generated from automotive vehicles. Companies may participate in emission reduction programs to reduce the emission of GHGs, such as by setting emission limits or modifying the emission source.

A government may establish a target limit for the amount of emissions during a period. The term “emission allowance” refers to a tradeable instrument that conveys a right to emit a unit of pollution. Participants may be allocated emission allowances free of charge, or they may be required to purchase allowances from the government (e.g., through government auctions) or other participants. The allowance gives a participant the right to emit a specified amount of gases. Within the automotive industry, the government forces automotive manufactures to reduce the impact of emissions through increased miles per gallon capabilities or through the increased production and sale of zero or low emission vehicles (e.g., electric or hybrid vehicles).

Emission allowances are treated as a separate unit of account when received from the government or purchased from third parties. Entities use emission allowances in various ways, some entities buy and sell emission allowances in the normal course of business to profit from market price changes, whereas others use emission allowances to meet compliance requirements associated with production.

Because of a lack of authoritative guidance, there are various complexities related to the accounting for emissions allowances including but not limited to:

See UP 6 for guidance on the accounting models for emissions allowances.