Advantages and Disadvantages of Standardized Accounting of Carbon Trading

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The emissions of greenhouse gases called carbon that is directly or indirectly attributed to human activities alter the global atmosphere and may lead to climate changes (Australian Bureau of Statistics 2005). This is why greenhouse gas emissions together with urban air quality became the most concerning issues of the past quarter of a century (Environment Australia & Csiro 2002). To deal with climate change issues, the Intergovernmental Panel on Climate Change (IPCC) was established by the World Meteorological Organization and the United Nations Environmental Programme in 1988 (Lyster, Lipman & Franklin 2007).

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This organization assesses the risk of climate change created by human activities. Kyoto protocol was negotiated at the instance of UNFCCC ratifying Annexure I countries to reduce their emission below 1990 level and certain developing countries not to reduce their emission over the same time frame. The principle used in the framework is that of contraction and convergence. Based on this principle those who emit at an above-average rate may have to reduce emission and conversely those emitting below that average rate may have to increase emission. Any country which does not achieve its target is required to provide for a reduction of 1.3 tonnes for each tonne of carbon that exceeds the target.

This has resulted in carbon trading to cope with their targeted achievements. The Clean Development Mechanism (or CDM registered Certified Emission Reduction) (Bonyhady and Christoff 2007) allows industrialized countries to offer their pollution by buying ‘certified emission reduction credits generated by low carbon schemes in the developing countries. Naturally, carbon trading involving high-level finances needs standardization in its accounting treatment and the effective advantages and disadvantages of such accounting standardization need in-depth analysis.

The importance of standardization of carbon accounting cannot be underestimated because “climate change issues will impact financial statements in a variety of areas, including strategic capital investments and compliance and risk management costs” (Labatt & White, 2007, 129). There are three layers of accounting and reporting of Global Climate Change (GCC). The first is the financial accounting for carbon emission allowances (Metz and Intergovernmental Panel on Climate Change 2007).

The second is the accounting and reporting of risks associated with GCC. Finally, there is the accounting and reporting of the uncertainty associated with GCC. Standardization of accounting procedures will affect the organizations that are actively involved in carbon trading and will not allow polluters to buy their way out of more costly carbon-cutting measures. Carbon trading on reaching its zenith will attain the stock exchange-like market and then the importance of standardized accounting for such market transactions requires no further supporting arguments if recent recession-like situations are to be avoided.

There are endless implications of changing climate over the functioning of economies. There are certain phases in the functioning of any economy that receives greater weight for accounting purposes. For example, production of goods, transportation of those goods, and disposal or trading in goods are those economic functions that may be directly affected by climate change (Parry & Intergovernmental Panel on Climate Change 2007). Above all, these functions also directly affect the financial metrics this is why “without a uniform and coherent accounting system, consumers will face distorted figures” (Cottier, Nartova & Bigdeli, 2009, 134).

Carbon trading has certain short-term financial implications that arise from the cost of allocated or purchased allowances. Carbon allowances allocation is an annual feature. As per regulations, actual emission is effected in equal installments (Yamin 2005). Excess allowances are traded to meet the shortfall attained by countries or organizations. This raises the question of accounting recognition of such allowances as assets and obligations to deliver allowances as liabilities (Weetman 2006).

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For carbon allowances to be considered as an asset, they have to meet certain criteria. These criteria explain the principles of considering allowances as an asset. The principles can be seen in that, obtaining allowances through auctions, by bidding the quantity in tones of the emissions reduced, it will be expected that there will be fewer allowances than usual. Accordingly, these principles, the documentation of the received allowances, and the fact that they have “a market value greater than zero” (Andersen 2002, 8) are sufficient to consider carbon allowance as an asset.

This means that standardization of accounting will not only bring uniformity but also provide a measurement in achieving the allocated target.

The valuation of granted allowances is another area that earnestly seeks standardization. Fair market valuation may rule the accounting procedures, but valuing the allowances at cost by the companies purchasing the allocation is also no less important (Hester & Harrison 2003). There is a need to standardize procedures for valuing the allowance because the recognition of allowances as assets and liabilities with different valuation bases will bring in volatility in the financial results of companies. Standardization will also bring in universal treatment of expired allowances.

Accounting is very important to any activity that affects the normal life of humanity, and carbon emissions are going to change our normal living as well as business and working styles (Lin, Smith, Fawekes, Robinson & Chaplin 2007). The coal industry is a principal source of greenhouse gas emissions (Weiss, Thurbon & Mathews 2007); a great pressure to reduce greenhouse emissions will be placed namely on the coal sector because in any country energy consumption comes mostly from coal (Mercer 2000). In that context, the world will see the introduction of a “robust price for carbon appearing and progressively over the next few years carbon accounting will be part of accounting because there will literary be a price corresponding to the carbon emissions associated with a project” (Luff 2008, 108).

An important feature of standardized accounting is its direct relation to the fair valuation approach which is used for valuing the opening asset base (Pardina, Rapti & Groom 2008). As stated by Weeman (2006), IASB standards “have moved towards a fair value approach to valuation rather than a deprival value approach” (386). The rules for carbon accounting still have to be finalized (Hamilton 2001), but one thing which is clear so far is that a fully standardized carbon accounting is beneficial for any country. It will not only encourage fair value reporting but also keep financial statements afresh with environmental technological advances’ impacts on financial reporting.

The standardization will indeed focus on marginal analysis and abstract from dynamics and uncertainties, but these analyses resulting from standardization of accounting are not suitable for the issues and problems of GCC. The severity of potential impacts of GCC cannot be measured under presently framed accounting rules. Cost/ benefit analysis will always come in way of achieving the targets for the benefit of humanity. The eradication of basic human problems cannot be achieved by strict commercialization attained based on standardized accounting.

Though standardization initiated under IFRIC 3 rightly treats the allowances as intangible assets, amortization of deferred credit to profit and loss is debatable. Each picture has two sides but the uniformity attained under standardization would be a welcome idea.

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Andersen, A 2002, Accounting for carbon under the UK emissions Trading Schemes. Web.

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Cottier, T, Nartova, O & Bigdeli SO 2009, International Trade Regulations and the Mitigation of Climate Change, Cambridge University Press, Cambridge.

Environment Australia and Csiro 2002, Australia, state of the environment 2001: theme reports, CSIRO Publishing, Melbourne.

Hamilton, C 2001, Running from the storm: the development of climate change policy in Australia, UNSW Press, Sydney.

Hester, RE & Harrison, RM 2003, Sustainability and environmental impact of renewable energy sources, Royal Society of Chemistry, London.

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Labat, S & White RR 2007, Carbon Finance: The Financial Implications of Climate Change, John Wiley & Sons, New York.

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Mercer, D 2000, A question of balance: natural resources conflict issues in Australia, Federation Press, Sydney.

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Weis, L, Thurbon, E & Mathews, J 2007, National Insecurity: The Howard Government’s Betrayal of Australia, N.S.W., Crows Nest.

Yamin, F 2005, Climate change and carbon markets: a handbook of emission reduction mechanisms, Earthscan, London.

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BusinessEssay. "Advantages and Disadvantages of Standardized Accounting of Carbon Trading." February 11, 2022.