Accounting and trading issues regarding carbon

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Carbon is believed to be something significant to firm's financial and non-financial performance. Carbon and global climate change are related and are both under concerned.The respond to the threat of GCC included the development of scientific knowledge and policies regarding GCC. It can also be said that ecological concerns are now translating into economic phenomena which will affect the accounting theories and brought a lots of issues. This article is a consequence of the special debating forum regarding the concerns mentioned.

First, this article introduces the high level scientific and policy regarding the carbon issues. It then covers the impacts of carbon trading on accounting and reporting activities. Besides, Accounting is involved in a variety of ways associated with GCC. For example, valuation of assets, for instance the granted pollutions right.On the other hand, it included valuation of liabilities such as obligation to buy additional rights to cover the emission of carbon. Next, this article also discuss on the new area of research on the relationship between risk and uncertainties associated with GCC.

Global Climate Change : An Introduction to the Science

Global Climate Change (GCC) is mainly caused by the greenhouse effects. A portion of energy from the sun will be absorbed by the surface of the earth and the rest will be reflected back into atmosphere and this is known as infrared radiation. The proportion of infrared radiation remained within the atmosphere will caused greenhouse effects and the average surface temperature also will be higher than it should be. Combination of several atmosphere gases with carbon dioxide, hydro fluorocarbons also creates greenhouse effects.

GCC is an impact of anthropogenic. Industrial resolution used fossil fuels in order to increase the quality of life. But, unfortunately, it had brought negative results to humans as fossils fuels contain carbon. The usage of carbon will leads to the greenhouse gases (GHG) creation. As the better life can be obtained from utilizing fossils fuels, the more fossils fuels will be used and this will lead to GCC from the effects of GHG released which will influence ecological, social and economic. Changing concentration of GHGs made ecosystems hard to adapt as it changed too fast. Consequently, it will damage human populations. GCC also brings to economic losses.

Greenhouse gases (GHG) has been increased if compared to pre-industrial level of 280ppm in 1750 to current levels of 430ppm. These increases also increase the average global temperature. As human realized that the increasing will leads to 'dangerous' climate change, thus, it led to substantive policy action.

In December 2007, Kyoto protocol was forced after the agreement and negotiation made. Kyoto protocol require ratifying Annex I countries to reduce their emissions of a specified GHG basket by an average of 5% below 1990 levels. Meanwhile, developing countries are not included. Contraction and convergence is a principle that for those who exceeds the average rate have to reduce the emissions and for those who below the average rate can increase their emissions. The Kyoto framework is a system that restricts each country with certain level of emissions for the first commitment period. If the country not able to hit the target, then, in future, they have to provide a reduction of 1.3 tones for each tones of carbon they exceeded. There are several number of policy mechanism being used such as emissions trading, obligation to meet targets for renewable energy production and so on. Stern (2006) suggests that a combination of carbon pricing, support for low carbon innovation and action on behavior change will be all required to meeting the target.

In carbon market, participants are allocated a sum of allowance for emission which is lower than what they currently emit. Participants will take action towards their accounts or buy the emission rights from others in order to achieve the allowable emission. The European Union Emission Trading Scheme (EU ETS) had been establish in the year 2005 to support the goal of reducing emissions to a level which is 8% lower than 1990 levels. Under this scheme, they able to trade the allowances as they wish and what they need. This has brought to financial implications after the announcement of The World Bank that there is a total of $50 billion for clean development mechanism and $13.6 billion in joint implementation process in the year of 2007. Thus, this paper will be continued with the study on the implication for accounting and reporting of carbon

Implication for Accounting and Reporting of Carbon

From the preceding section, number of implications could be drawn. First, a scientific consensus is emerging that GCC is an issue that requires urgent attention. Second, the fast moving of public policy domain with legal and fiscal regimes developing that require actions that will affect those who buy goods and services as well as those who supply them. Three main aspects that can be viewed: the financial accounting of carbon emission allowances, accounting and reporting for the risk associated with GCC and accounting and reporting for the uncertainty associated with GCC.

Financial Accounting of Carbon Emission Allowance Units

Carbon trading creates short-term financial implications for companies which arise from purchase allowances or cost of allocated. For instance, European Union Allowances (EUAs), the free allowances receive annually in the EU ETS to emit one tone of carbon dioxide equivalents during a specified period. At the end of each year, firstly, organizations compulsory match their actual emissions with a sufficient amount of EUAs and CERs. After that, surrender these to the national registry. Organizations are allowed to trade their excess granted allowances and required to get extra allowances if their emissions are higher than their allowances.

A penalty of €100/EUA for each unit uncovered by purchased allowances. Entities still need to purchase carbon emission rights to offset those uncovered emissions as well. This means that it is a double penalty for failure to either keeping within emissions levels or failing to buy emissions to cover excess emissions.

Carbon emission trading schemes raise the issues of whether should recognize EUAs as assets and how to recognize it, as well as the recognition of the obligation to deliver allowances as liabilities. Two aspects have centred the debate on the accounting for EUAs. First, considering in the initial allocation, majority of EUAs are free for the companies affected and total emission rights contained within the EU ETS, only a small amount are purchased. It is debatable for the valuation of granted allowances and given the volume of EUAs for some companies, has a potential significant impact in their account. Second, different valuation criteria on the recognition of assets and liabilities will create a variety of effects in some companies. These two aspects, together lead to lobbying for the recognition and reporting of the net position with respect to emission allowances. According to this view, only purchased allowances would influence the balance sheet.

Wambsganss and Sanford (1996) say that it is not inconsistent if not to recognize granted allowances but recognized purchased allowances on the balance sheet and as expense when they are used to compensate for pollution emissions. Granted allowances been recommended by them to treated as donated assets, a uniform accounting will been provided for all allowances, no matter they are granted or purchased. In additional, they also argued that would alleviate the associated externalities when charging the cost of all allowances to profit and loss for pollution emissions.

The International Accounting Standards Board (IASB) followed Wambsgabss and Staford's view. On the other hand, negative endorsement advice has been issued by the European Financial Reporting Advisory Group (EFRAG). Where reporting mismatches produced and would result in an artificial volatility of results in companies. Example of mismatches is when assets are measured at cost and related liability at fair value, and allowance revaluation gains are recognized directly in equity while expenses relating to the liability are recognized in profit and loss.

Resulting in the withdrawal of IFRIC 3 in June 2005, IASB changed its mind and decided that accounting for emission allowances was not an urgent matter. But, in December 2007, the IASB changed its mind again and added this issue to the IFRS agenda considering the development of emission trading schemes and the above mentioned diversity in practice.

Accounting and Reporting for the Risk Associated with GCC

GCC is significant to suggest that the presently conventional accounting and reporting should transcend to reflect the risk associated with GCC. It is to help decision makers to understand what will be the possible impacts of GCC on corporate performance and prospects. For Gibson, she indicates that an ecological approach seems to be more informative than economic approach to emission problem. On the other context, it can be said that the non-financial reporting is acquired in providing the information about the impact of GCC on organizations and their adaptation to GCC.

The emphasis in analyzing the accounting and reporting of GCC will on the risk and uncertainty that associated to GCC. Before discussing in more details, it is necessary to understand how to differentiate risk and uncertainty. Risk is about the existence of a probability distribution of gains and losses while Uncertainty is about the existence of different probability distribution of gains and losses (outcomes).

According to Stern, the pricing of carbon have modest impact in economy than the impact of price increase in oil and gases. It shown in example that when the carbon price increases from $26/bl to $100/bl, the unchanged oil price is still $196/tCO2 , which is still larger than the carbon price. Although its impact is relatively modest, the carbon pricing is likely to be unevenly distributed between countries, sectors and companies. Thus, those countries, sectors and companies that are more rely on energy-intensive goods may be severely affected by GCC. This is supported by Lund studies where he found that the effects will be disproportionately larger (more than 10% of production value) to the energy-intensive industries.

There are two main forms of risk from GCC that faced by the organizations, which are regulatory risks and competitive risks. For regulatory risks, it arises from the different policy instruments regarding carbon trading that developed at national and supra-national. The scenario shown is that most of the allowances are still granted allowances and it still not involve all the sectors although the carbon trading schemes are increasing. If and when the objective to mitigate carbon emission been translated into policy, there is possibility that the government decide to auction allowances, restricts the numbers or to involve new sectors. This is where the regulatory risks arisen. Besides that, there is another source of regulatory risks indicated by World Bank which is regarding the delays in the registration of JI/CDM credits.

For competitive risks, it stems from the probability that carbon-intensive products and services will become obsolete in a carbon constrained future if compared with low emission technologies and products. So, it seems to be more significantly important than the risk of loss of competitiveness that caused by the introduction of carbon markets or taxes.

Investors, policy makers and general public need non-financial accounting and reporting regarding GCG emissions. They need that information to assist them to evaluate the carbon intensity of the products and service besides estimate the regulatory and competitive risks. They also need information about the way the organizations manage the GCG emissions. The Carbon Disclosure Project (CDP) and GHG Protocol initiatives show that risk management and corporate social responsibility are contribute increment in addressing GCC risk. As the GHG reporting financial and environmental risks are more aligned than normally it is, it leads to new research arena.

The first further research is to investigate the interplay between how organizations address carbon emission and how their carbon position and management is disclosed. There are still many problems on the meaningfulness of the information although the development of carbon reporting mechanisms is fast.

The second further research is to evaluate the value relevance of disclosures about carbon exposure and carbon management. In addition, it also to empirically test the hypotheses that organizations face GCC risks and carbon trading scheme risk. Johnston et al. found that investors viewed emission allowance as assets. They also realized that there is market reaction when a firm buys emission rights. In addition, they also notice that the reporting regime for carbon market in USA is not well developed. All of the findings imply that investors need the information that can accurately evaluate the risks faced by the organizations, not a good financial reporting disclosure.

Accounting and Reporting for the Uncertainty Associated with GCC

For this section, there are several issues raised by different authors as stated below:

Stern (2006)

Stern disagree the method of standard economics which focusing on marginal analysis and abstract from dynamics and uncertainty are not suitable for the issues raised by GCC.

Stern says that the effect of GCC will not linear to the increased warming. This uncertainty of GCC brings up some ethical issues and flavors the adoption of precautionary approaches mentioned by Aslaksen and Myhr.

Aslaksen and Myhr (2007)

These authors developed the precautionary approaches to make decisions for environmental risk according to two intertwined principle which are scepticism about scientific approaches and the social aspects of uncertainty. This will pursue different stakeholders to incude their view in making decisions.

For the scientific scepticism , Aslaksen and Myhr suggest that precautionary approaches requires the consideration of long term adverse outcome, awareness of ethical methods and having a humble attitude towards technological improvements.

For the social dimension, it point out that the economic, social and scientific contexts are intertwined and new institutions for participatory processes are required to enhance the connection between stakeholders.

Besides that, Aslaksen and Myhr also point out the way the evaluator views the environmental risk by referring to the risk window.

The consequences of the precautionary approaches are crucial for accountants and accounting and reporting method. Firstly, all the account for the uncertainty associated with GCC should practice a participatory approach. Secondly, technical facts and social issues are impossible to measure or compare in value and this will leads to the potential problems involved in the standardization of carbon accounting and carbon reporting.

Cohen et al. (1998)

Cohen suggested the use of integrated assessment models to reach an intersection between more objectives, global and science-driven approaches to GCC and more normative, local and problem-drive approaches of sustainable development. This integrated assessment models may include wider social issues, be contextual and need the understanding of different people.

Considering the framework suggested by Cohen et al. (1998) and Aslaksen and Myhr (2007), research on accounting and reporting of climate change by involving the uncertainty should develop models in two different ways to deal with the uncertainty.

Firstly, it should look into how carbon accounting and accountability develop by using a research engagement model. This would need to scrutinize the point of view of stakeholders and organization who can bring alternative 'risk window' and who are often not included from the risk evaluation.

Secondly, accounting research should continue in line with the Gray's proposal for normative-oriented research and participate in the process of designing the carbon accounts.

Concluding Comments

This article is an attempt to outline the science behind the concern of GCC and the policy development as a result of the scientific debate on GCC. Accounting and reporting for GCC debate in indeed crucial as it will bring some big challenges on accounting and reporting. In fact, GCC is a global challenge for humankind in many aspects.

Thus, the challenge brought out a variety of actions to tackle GCC, depending on the implications. For example, for carbon markets, the implications on accounting and reporting are significant enough for a accounting academics research.

It can be argued that the implications for carbon emissions should be broader and not only focusing at accounting field by introducing the difference between risk and uncertainties. It is debated that the research should concern more on new social account to deal with uncertainties. This special debate forum is only the starting of the issue of GCC's implication, there are still a lot of issues to be discussed.