[GHG Network] Taxation regimes

James Anderson James.Anderson at sd3.co.uk
Thu Apr 5 16:53:07 EDT 2007 

Not on CERs but for EU allowances:
 
 
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	 Financial Accounting 

	
	 	 	

Accounting treatment of EU Allowances


As some 2 billion allowances will be issued to European companies next
year - potentially representing a 10-fold value in terms of euros - a
very important question is how they will be recorded for accounting
purposes.

Key issues
In May 2003 the International Financial Reporting Interpretations
Committee (IFRIC) which is a part of the International Accounting
Standards Board (IASB) issued a draft interpretation (D1 Emission
Rights). D1 focused on the following key issues:

*	Does an emissions allowance scheme give rise to (i) a net asset
or liability or (ii) an asset (for allowances held) and a liability,
deferred income and/or income? 
*	If a separate asset is recognized, what is the nature of that
asset? 
*	If a separate liability, deferred income and/or income is
recognized, what is the nature of that item and how is it measured? 
*	When should a potential penalty, which will be incurred if a
participant fails to deliver sufficient allowances to cover its actual
emissions, be recognized, and how should it be measured? 

Current Situation
The interpretation proposed that:

* Allowances held are Intangible assets (IAS38) and should be recorded
at fair (market) value. 
* The difference between the market value of Allowances and the amount
participants pay for them is recognised as a Government Grant (IAS20).
(Member states will allocate the majority of Allowances free to
participants).
* A liability for the obligation to deliver allowances equal to
emissions that have been made with gains and losses recognised in income
The interpretation also treats assets (i.e., allowances) independently
to the liabilities (i.e., obligations). Accordingly, netting off (i.e.,
offsetting) of the asset and liability is not permitted.

Over 40 comment letters were received from various sources. Respondents
welcomed IFRIC's attempts to provide guidance on this issue; however,
only a few respondents fully supported the proposed approach.

The main concerns were:

* Artificial volatility in the income statement. Many respondents were
concerned about this.  It arises because; 
(i) the allowances are not required to be re-measured to reflect changes
in their value and 
(ii) the release of the government grant to income is by reference to
the initial value of the allowances.  In contrast, the liability that
arises as the entity emits is measured by reference to the current
market value of the allowances.  Even if the entity elects to measures
the allowances subsequently at market value, a mismatch arises because
some gains and losses are reported in the income statement and others in
equity.

* Whether it was appropriate for the IFRIC to issue an Interpretation at
this time. Given the infancy of the EU ETS and the fact that projects on
the Board's active agenda, including the potential withdrawal of IAS 20,
some respondents suggested that IFRIC should wait and see how the market
would develop prior to issuing any accounting guidance.

Other concerns centred on the fact that many respondents felt the
proposals failed to reflect the economic substance of an emission
trading scheme. Some respondents therefore proposed alternative
accounting solutions or amendments to the IFRIC's proposals. These
included:

* A net model, under which an entity does not recognise allocated
allowances, and accounts for actual emissions only when it holds
insufficient allowances to cover those emissions. 
* Accounting for the allowances as an item of inventory.
* Accounting for the allowances as financial assets and measuring them
at fair value with gains and losses recognised in income. 
* Classifying the allowances as a derivative and accounting for them as
a cash flow hedge. 
* Specifying disclosure requirements.
* Providing guidance on how to account for allowances and obligations if
there is no active market.

After considering the responses (incl. alternative treatments), the
IFRIC confirmed its belief that the proposals set out in D1 are the most
appropriate interpretation of existing International Financial Reporting
Standards (IFRS).

The IFRIC did note, however, the key concern regarding the lack of
symmetry in the accounting.  It therefore recommended that the IASB
amend IAS 38 Intangible Assets to create a new category of intangible
asset.  The purpose of the amendment would be to require allowances (and
any similar intangible assets) to be measured at fair value with all
changes in value recognised in the income statement (a treatment not
allowed under the present version of IAS 38). 

The IASB agreed to amend IAS 38, but given the importance of IAS 20 as a
reference for D1, the Board decided to accelerate its work on amending
IAS 20 before the IFRIC finalised D1.

As at July 2004, the IASB has decided to amend IAS 20 by replacing its
main recognition requirements with the requirements relating to
agricultural grants in IAS 41 Agriculture.  The IFRIC will now need to
reconsider the treatment of the government grant in D1; in particular,
whether it should be treated as a conditional or an unconditional grant.


The IASB has suggested that the IFRIC re-expose its draft interpretation
at the same time as the IASB exposes its amendments to IAS 20 and IAS
38. Documents outlining these changes are expected later this year.
Given this timing, it remains unclear when any final Interpretation
would become mandatory. However, many companies may choose to adopt
early the final Interpretation because they may believe it provides a
more "true and fair" presentation of their results.

Implications
Some of the more practical issues a company will face:

*	Fair value accounting (i.e., pricing of the allowances). Pricing
allowances may be difficult to determine without a liquid market: Also,
the suggested approach of adopting mark-to-market accounting could have
a significant impact on a company's profit and loss. The volatility in
prices would need to be reflected in the income statement; as such
profit and loss figures could be subject to disturbances with severe
price spikes (that could easily happen in a thin market). 
	
*	Taxation. Many countries approach to tax depends on the
financial accounting treatment. Companies should be aware of the
accounting and associated tax issues before embarking on any
trading/compliance strategies.
	
*	Impairment of assets. 
	

IETA's Accounting Working Group is monitoring the development of the
accounting treatment of EU allowances. For more information, please
contact: Martina Priebe <mailto:priebe at ieta.org> . 

This update contains information courtesy off Deloitte & Touche


________________________________

From: discuss-bounces at ghgnetwork.org
[mailto:discuss-bounces at ghgnetwork.org] On Behalf Of Lancaster,
Christine
Sent: 05 April 2007 14:45
To: Russell, Charles; hdginzo; Michael Gillenwater [moderator]; Stanford
Mwakasonda
Cc: discuss at ghgnetwork.org; DRevet at unfccc.int
Subject: Re: [GHG Network] Taxation regimes


Does anyone have information on taxation regimes or accounting
procedures relating to CERs in any developing country?
 

 

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