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Reporting entities use various models to account for emission allowances. The FASB has previously expressed its belief that the classification of emission allowances as intangible assets is preferable. In practice, utilities and power companies typically classify allowances as inventory (whether held for use or sale) or intangible assets (held for use). Absent authoritative guidance, we believe either classification is acceptable, provided the classification is applied consistently, is reasonable based on the intended use of the allowances, and is properly disclosed. However, we would generally not expect allowances held for sale to be classified as intangible assets because the activity of selling (i.e., goods held for sale in the ordinary course of business) is consistent with the definition of inventory. Therefore, a company that changes its policy would be required to demonstrate that the new classification is preferable based on their intended use, consistent with our discussion on renewable energy credits in UP 7.3. The accounting model applied will impact financial statement presentation and the impairment model used in subsequent accounting (see UP 6.5).

6.2.1 Classification

To determine how to classify emission allowances, reporting entities need to consider the definitions of inventory and intangible assets.

6.2.1.1 Inventory

ASC 330-10-20 defines inventory.

Partial definition from ASC 330-10-20

Inventory: The aggregate of those items of tangible personal property that have any of the following characteristics:
a. Held for sale in the ordinary course of business
b. In process of production for such sale
c. To be currently consumed in the production of goods or services to be available for sale.

Some entities, such as trading organizations, may be engaged in buying and selling emission allowances in the normal course of business. Others, such as utilities or power companies, may use allowances to meet compliance requirements associated with the production of electricity. In both cases, the key elements of the inventory definition are met.

6.2.1.2 Intangible assets

Emission allowances held for use may also meet the definition of intangible assets provided by ASC 350.

Partial definition from ASC 350-10-20

Intangible Assets: Assets (not including financial assets) that lack physical substance.

Emission allowances evidence the authorization to pollute, based on the number of allowances that are allocated by a government entity or otherwise obtained. In addition, emission allowances lack physical substance. Emission allowances are not financial assets because cash is not delivered when they are used; instead, the emission allowance itself is delivered to demonstrate compliance with established regulations. Therefore, they meet the definition of an intangible asset.
Question 6-1
Is it acceptable to classify emission allowances as part of generation plant?
PwC response
Yes, but only in limited circumstances. As a result of prior acquisitions of emission allowances in a plant acquisition or business combination, some reporting entities may have recorded emission allowances as part of the overall property, plant, and equipment balance. Such presentation is acceptable for existing allowances, provided that management’s intent is to use the emission allowances in production.
However, property, plant, and equipment generally consists of long-term assets used to create and distribute products and services of a reporting entity. Emission allowances facilitate a reporting entity’s ability to satisfy emissions requirements related to the production of electricity and the allowances are not used in the physical generation of the electricity. Therefore, we believe the accounting for newly-acquired allowances should follow either an inventory or intangible asset model.
Emission allowances recorded as part of plant are depreciated over the useful life of the related plant asset.
Question 6-2
Does an emission allowance meet the definition of a derivative?
PwC response
No. An emission allowance itself does not meet the definition of a derivative because it does not contain an underlying. An underlying is a price or index that interacts with a notional amount in a contract to determine the settlement amount; an underlying is not the asset or liability itself. Therefore, an emission allowance itself does not contain an underlying and is not accounted for as a derivative.
However, as discussed in UP 6.3.2.1, contracts for the purchase or sale of emission allowances (e.g., forwards, futures, or options) may meet the definition of a derivative. In addition, as discussed in UP 6.6, a compliance obligation which requires a reporting entity to deliver emission allowances in the future may contain an embedded derivative.
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