Demystifying carbon markets: Why these markets matter and ways you can create effective accounting practices

By Ejituru Okorafor and Tawanda Chadenga, Audit & Assurance Partners, and Xiaochao (Helen) Deng, Audit & Assurance Managing Director, Deloitte & Touche LLP

Talking points

• Carbon markets can play an important role in reducing greenhouse gas (GHG) emissions, recognized as a major contributor to global warming.
• But the obscurity surrounding these markets can make accounting and reporting challenging.
• A few important considerations can allow you to develop effective carbon market accounting and reporting practices now and as these markets evolve to address new regulations (such as the proposed FASB rule changes).

Carbon markets have been around for decades, but they’re still a mystery to many finance and accounting professionals. Despite some uncertainty around their effectiveness, these markets are important and worthy of attention, especially if you’re tasked with carbon market accounting and reporting, which can have its share of challenges. What are some of those challenges? And what should you know to address them? Let’s take a closer look.

What they are and what they can do 

Carbon markets can be an efficient way for companies in GHG-intensive industries to offset their carbon footprint and finance direct emission reduction projects. The first carbon markets were compliance markets driven by governmental regulations. Voluntary carbon markets developed later to enable organizations to voluntarily commit to emission reduction. Both compliance and voluntary markets have helped fuel the demand and supply of environmental products like carbon credits and offsets.

Accounting and reporting complexities

• For producers, the classification and recognition of environmental credits can be complex. An organization’s intent for generating environmental credits often plays an important role in determining how credits are accounted for, valued, and reported. Logistical challenges can arise, particularly in book-and-claim systems where environmental attributes are transferred and/or sold separately from the related physical commodity. 
• Carbon market intermediaries generally develop innovative transaction structures, manage invalidation and credit reduction risks, and help with sales. Their diverse roles, including carbon offset strategy consulting, book-and-claim logistics, verification, and registration, can create revenue recognition challenges. And blockchain technology and tokenization can further complicate matters. Carbon registries can play an important role in helping to promote market integrity, manage invalidation, and lower credit reduction risks.
• Consumers often focus on selecting and acquiring the right credits. They face the challenge of selecting the most suitable credits, a task that can become arduous in less standardized voluntary markets. A leading concern for consumers is understanding the validity, effectiveness, and value of the credits.

Establishing effective accounting and reporting practices

What can you do to manage these challenges and complexities? Developing effective accounting and reporting procedures can go a long way toward controlling and reducing any issues. Here are a few considerations to keep in mind when creating these for evolving carbon markets:

1. Understanding stakeholder preferences: Why is it important for accounting professionals to understand their stakeholders’ environmental preferences? For starters, these preferences often influence the choice of environmental credits a stakeholder produces or procures. These environmental credits can, in turn, affect the recognition and measurement of related assets and liabilities, which is why they should matter to accounting staff.
2. Life cycle of a credit: Understanding the full life cycle of a credit, from production to retirement, and the entity’s role in the credit life cycle is important for accurate accounting and reporting. Producers, for instance, should establish appropriate policies for allocating development costs, including costs related to the development of buffer credits, and revenue recognition policies related to bespoke revenue share arrangements.
3. Processes, systems, and controls: Consider adapting your systems, processes, and controls for environmental credits—balancing the use of existing assets with the need for new investments. Keep in mind that using existing transportation and storage assets in a way that can maximize profits from environmental credits (including through book-and-claim systems) can conflict with the goal of using these assets solely as physical commodities. Careful environmental credit cost-benefit analyses are important in these decisions.
4. Impact of technology: The use of technology, including blockchain, in tracking and verifying credits can add a layer of complexity to the accounting process, particularly for organizations that tokenize carbon credits. The value of tokenized credits may be affected by factors beyond the carbon markets, including the market for cryptocurrencies and fungible tokens. It’s important to consider existing accounting practices and policies for such cryptocurrencies and tokens in developing accounting policies, processes, and internal controls for affected carbon credits.

How Deloitte can advise as you take the next step

You don’t have to tackle these challenges alone. Deloitte professionals understand the complexities of carbon markets and can advise you on next steps in setting up accounting and reporting processes, systems, and controls. Don’t hesitate to reach out to us with questions or for more information. You can also download our Deloitte Insights thought piece on carbon markets for additional insights.

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