Accounting for Sustainability: Carbon credits and offsets
Second article in the series ‘Accounting for Sustainability’
Introduction
Carbon offsets and credits can represent significant assets or liabilities, making accounting essential to accurately reflect an entity’s financial position and financial performance. Without this transparency, how will stakeholders receive a reliable and faithful representation of an entity’s sustainability efforts and financial position?
Our second publication in the Accounting for Sustainability series explores the question of how to account for carbon credits and offsets within financial statements. To address this, it is essential first to understand the various types of carbon credits, the distinct markets in which they operate, and the participants involved - ranging from project developers and traders to buyers. Second, it is essential to understand the various actions that can be taken with carbon offsets and credits including buying, trading, selling, and retiring them. With this foundational knowledge established, the publication then explores the accounting treatment of carbon offsets and carbon credits from the perspective of project developers, intermediaries, and end-users.
Understanding the market dynamics of carbon credits and offsets
To fully understand the accounting implications, it is important to distinguish between carbon credits and carbon offsets, as they serve different purposes and operate in different markets.
Having distinguished between carbon credits and offsets, it is important to understand the two main markets in which they operate: the compliance market and the voluntary market. The compliance market is governed by regulations such as the EU Emissions Trading System (EU ETS), where companies are legally required to hold carbon credits, emissions allowances, that limit their greenhouse gas emissions. This market is mandatory and strictly regulated, with penalties for non-compliance.
In contrast, the voluntary market allows organisations and individuals to purchase carbon offsets to meet self-imposed emission reduction goals. These offsets fund projects that reduce or remove emissions, such as reforestation or renewable energy. While participation is optional, the voluntary market gains credibility through third-party verification.
Carbon credits and offsets each represent the reduction or removal of one metric tonne of CO2 equivalent1. To guarantee that carbon offsets purchased from a project are used only once, electronic registries maintain records of each specific offset2.
Lastly, it is important to understand the various participants involved in the lifecycle of carbon credits and offsets. The process begins with the project developer, who generates carbon offsets by implementing projects such as renewable energy installations, carbon removal initiatives, or reforestation efforts. The project developer registers the project with a recognised carbon offset registry and maintains detailed records quantifying the emission reductions achieved. These reductions are then validated and verified by independent third-party certification bodies.
Once generated, carbon credits become transferable and tradable instruments within the registry. Intermediaries facilitate the transfer of credits from project developers to end-users. Intermediaries can be carbon brokers, private carbon trading platforms, or carbon exchanges, providing the infrastructure for the market transactions.
When an end user decides to claim the emission reductions, they must instruct the registry to retire the carbon offsets. Retirement ensures that the credits cannot be sold or used again, effectively removing them from circulation and allowing the end user to report the offset as a genuine reduction in their carbon footprint.
Together, these participants make up a system that supports the generation, trading, and retirement of carbon credits and offsets, allowing participation in compliance and voluntary markets.
Reporting for carbon credits and offsets
While there is often no explicit accounting standard for carbon credits and offsets, IFRS provides relevant guidance. The accounting treatment of carbon offsets and carbon credits depends heavily on the role of the entity within the carbon market, whether as a project developer who generates the carbon offsets, an intermediary who transfers the carbon offsets, or an end-user who retires the carbon offsets against its own emissions. The following outlines the relevant IFRS Accounting Standards applicable to each participant:
Stay Tuned
Accurate accounting for carbon offsets and credits is essential to fully capture the entity’s environmental commitments alongside its financial standing. As the Accounting for Sustainability series continues, we explore how the IASB allows entities to account for their net zero pledges and power purchase agreements (PPAs) in the light of recent updates to the IFRS Accounting Standards.
Additional contributors:
- Dr. Ramona Achermann, Assistant Manager, Sustainability Services
- Emilie Lundsgaard Jensen, Senior Consultant, Sustainability Services
