Comments by John Kidd, Partner, Melbourne as originally published in Australian Institute of Company Directors, The Boardroom Report Vol, 5 Issue 5, April 2007

There is growing consensus about the connection between carbon emissions and climate change, yet there is virtually no agreement on how ‘going green’ should be recorded in a company’s financial accounts. It seems that it will only be a matter of time before some form of carbon credit trading scheme will be introduced in Australia. The impact of this will vary from industry-to-industry and from company-to-company, but all directors should be assessing the size of their company’s ‘carbon footprint’ and developing policies to adapt to this new business environment.

According to John Kidd, partner, Financial Instrument Advisory Service at Deloitte Touche Tohmatsu: “Directors should be primarily concerned about high level policy issues such as the size of the company’s carbon footprint and what actions the company will take to reduce this. There are two aspects to this – one is the emotional issue of being a good corporate citizen and engaging with employees and customers, given that as people like to work for, and buy from, companies with a responsible climate policy.

“The second aspect is the more pragmatic economic impact assessment. There is little doubt that carbon trading will be introduced in some form in the next few years as both major political parties are trying to outdo each other in this area,” says Kidd.

Consequently, it is important for directors to understand what this new business environment will look like and what risks and opportunities it will generate.

The big change will come when carbon credit schemes are introduced. Initially, all companies are given the same allocation of carbon credits. If your carbon generation exceeds your allocation you will need to buy more – or pay a fine – and if you have too many credits these can be sold.

Kidd advises directors to take the time to understand the new regulatory environment in advance, rather than doing nothing and having to react to it. He also suggests that directors should be taking action to influence the regulatory environment by lobbying for or against particular policy initiatives.

“For some companies in the service industries, their carbon output will be relatively low while companies in the energy generating sector will have a much greater impact. Until you measure some of these things, you cannot really talk about action plans,” Kidd observes.

“Consider various options and their costs. Remember, there are more than financial impacts on these decisions. There are also the political aspects, such as on your company’s reputation as a good corporate citizen, as well as the signal it gives to industry analysts regarding the company’s long-term sustainability. It is important to take a stance on the climate issue – it is simply something that cannot be ignored.”

But what impact will a carbon trading scheme have on the bottom line? Accounting for greenhouse gas emissions remains a challenge and, as yet, there is no clear guidance from accounting standards setters. The International Financial Reporting Interpretations Committee (IFRIC) initially took on this task and issued IFRIC 3, Emission Rights. Unfortunately, considerable pressure from both the business community and European politicians (who objected to the financial statement consequences of applying the interpretation) led to its withdrawal by the International Accounting Standards Board (IASB) within a year of it being issued.

Kidd says: “Given that it often takes two to three years for agreement to be reached on new accounting standards, companies will need to develop their own policy on this issue in the next few years. In the absence of an accounting standard, the board should sign-off on this subjective issue and be comfortable that it understands the implications that the chosen accounting policy will have on the company’s balance sheet and profit and loss statement, as against possible alternative treatments.”

A company’s choice of accounting treatment of its greenhouse gas emissions will have an impact on the different components of its financial reports – that is, its balance sheet and profit or loss statement. It will also have significant implications not only for financial performance reported in the profit or loss account, but also – in a reverse engineering sense – on how a company may decide to manage its participation in any emissions trading scheme. At the very least, directors should ensure that their company’s accounting policy on this issue is explained clearly to the market to ensure that the impact of emission rights accounting on financial performance is understood.