Environmental Accounting (#288)
/In this podcast episode, we discuss environmental accounting. Key points made are noted below.
The concept is in two parts. One is the reporting of greenhouse gas emissions, and the second part is the accounting for emissions-related fees paid by businesses.
Reporting of Greenhouse Gas Emissions
Now in the first case, there really isn’t any mandated greenhouse gas disclosure that goes into the financial statement footnotes. But, you’ll still see a lot of public companies putting out disclosures in their annual reports or in entirely separate reports. These disclosures talk about their greenhouse gas emissions and what they’re doing about it. So if these reporting requirements aren’t coming from the Financial Accounting Standards Board or the International Accounting Standards Board, then who’s doing it?
The answer is the Greenhouse Gas Protocol. It’s a nonprofit that’s come up with a really good reporting system. You can download it for free as a PDF by going to ghgprotocol.org and clicking on their Corporate Standard link. A big part of this reporting is based on what they call measurement boundaries. The most narrow definition of a company’s carbon emissions is called scope 1, which is direct emissions by the business. So if you’re running a diesel tractor on your farm, the emissions from that tractor fall within scope 1. Or, if you have your own fleet of delivery trucks, their emissions are also listed within scope 1. After that is scope 2, which is purchased indirect emissions – in other words, the emissions of the power plant relating to the electricity that you bought from it. According to the protocol, any business reporting its greenhouse gas emissions should do so for both scope 1 and scope 2.
In addition, the protocol also lists a scope 3, which is indirect emissions from third parties. For example, this can include the emissions related to airline travel by employees, or the carbon emissions from the cars of your employees when they commute to and from work. This is a lot more difficult to calculate, so the protocol leaves this as an optional reporting area.
Calculation of Greenhouse Gas Emissions
What about actually calculating your greenhouse gas emissions? The protocol lists a lot of ways to do that. The easiest approach for most firms is the indirect approach, where, for example, you track down the documented emissions of a similar building to the one your business is occupying, adjust for the square footage, and there you go – instant emissions information. But the protocol has more detailed tools on their website, in the form of downloadable spreadsheets that list more specific emissions data for all kinds of things, like different fuels and types of vehicles.
For example, you can use the company’s utility bills to figure out the amount of power purchased from your power company, figure out what type of energy source they’re using, like coal or natural gas, and then derive the emissions from a spreadsheet on the Protocol website. It’s not easy, and you’re bound to miss something on the first try, but this is a decent way to figure out your emissions number.
Bu this is not just a nice reporting system. You can actually use it to save money, too. Emissions come from the release of energy, and energy is expensive. So by cutting emissions, you’re also cutting energy usage, which in turn reduces your cost of energy, and increases profits.
Greenwashing
So, that was the upside of emissions reporting. There’s also a downside, which is called greenwashing. This is when management deliberately messes with the data to make the company look more green than it really is. For example, by outsourcing your manufacturing operations, the company is using less energy within the scope 1 category – which everyone reports. The operations were moved to a third party, which falls into category 3 – which almost no one reports. And yes, people actually do that.
Accounting for Emission-Related Fees
Now, there’s also an accounting aspect to environmental reporting. Some governments operate a cap and trade system. This is a system for controlling emissions. It sets an upper limit on the amount that can be emitted by a business – but – it allows for additional capacity to be purchased from some other business that hasn’t used its full allowance.
In a lot of cases, the initial allowance is granted to a business by the government for free, and each year, the government makes that allowance a little bit smaller, which puts pressure on the business to reduce its emissions. One way it might buy additional capacity is to get it from an operation that commits to planting a certain number of trees every year, which sequesters carbon.
The accounting that’s used for this arrangement in Europe is called the net liability approach. What they do is record the emissions allowance at its acquisition amount – which is usually nothing. Then they only record a liability when the actual emissions liability exceeds the amount of the allowances held by the company. If there is an emissions liability, then they record it as an intangible asset. Then they clear it off the books at the end of the year, when they report their actual emissions and the offsetting allowances to the government.
So for example, you’ve run the numbers for your scope 1 and scope 2 reporting, and you realize that you’re going to come up short by 1,000 tons of carbon emissions. So, you buy the emissions credits from wherever you can buy them for the least amount – maybe it’s a forest planting operation in Romania – and it costs you $10,000 for the credits. That’s recorded as an intangible asset, and it’s charged off at the end of the period. That’s a pretty easy accounting system, so of course I approve. When in doubt, keep it simple.
IFRIC 3 Reporting
Now, a much more complicated system was proposed by the International Accounting Standards Board back in 2005. It’s called IFRIC 3. Which sounds like a Viking war leader, but it’s actually the name of the committee, which is the International Financial Reporting Interpretations Committee. They suggested that those allowances granted by the government be measured at their fair value, which would result in the recognition of a gain. That’s because getting them for free from the government is definitely less than what the allowances would trade for on the open market. And, they wanted businesses to recognize a provision each month for a company’s emissions-related liability, which would be measured at the market value of the allowances needed to settle it.
I won’t get into a complicated example to show how all that works, since – luckily – the standard was never approved, and nobody does it this way. It’s a good example of presenting a theoretical approach that looks good on paper, but it’s difficult to implement – sort of like our new lease accounting standard.
Donation Suggestion
And here’s a recommendation for you. My wife and I pay the National Forest Foundation to plant 6,000 trees every year, which they do for a dollar a tree. That sequesters about 3,000 tons of carbon over the life of those trees. We’re going to keep doing that for as many years as we can, since global warming is the defining issue of our times – the coronavirus is bad, but that will go away when a vaccine is rolled out. That’s not the case for global warming, which is not going away. If you want to donate to the national forest foundation, their website is nationalforests.org.