We welcome any comments or follow-up questions regarding today’s Round Table topic.

Click here for details on the session.

* UPDATE: The archived video of this Round Table can be found here.

Many accountants have only passing familiarity with Emissions Trading Schemes.  As the FASB project page describes,

Emission trading schemes to reduce greenhouse gas emissions have expanded rapidly in recent years at the state, national, and international levels. Cap and trade schemes are a common emission allowance approach. In a cap and trade scheme, a government (or government agency) typically issues tradable rights (allowances) to emit to participating entities. Participants may buy and sell allowances with others, and liquid markets have developed to facilitate this trading activity. At the end of a compliance period, participants are required to deliver allowances equal to their actual emissions, and they may be required pay a fine or suffer other penalties for emissions in excess of remitted allowances.

In a typical U.S. cap and trade scheme, each individual emissions allowance has a vintage year designation, indicating the first year an allowance may be used. Unused allowances may be carried forward to future years. Allowances with the same vintage year designation are fungible and may be remitted by any party to cover its emissions from any source. In these schemes, vintage year swaps among participants are common, as government agencies typically issue allowances for multiple years at a time. For example, a entity may expect to install equipment to reduce its emissions in 2009 but may need additional allowances in 2008 to cover a projected shortfall. That entity might exchange some of its allowances with a 2010 vintage year designation (when it expects to have reduced emissions) for allowances with a 2008 designation with another entity that has an opposite exposure.

You might know that emissions trading schemes are a hot-button political topic.  (The US House of Representatives has passed a bill providing for a cap-and-trade program, but the Senate has not.  You can see previous FASRI blog post and discussion on the matter here.)  But such schemes also present vexing accounting challenges.  A particular challenge arises when a firm receives an allowance free of charge.  Does this give the firm an asset?  If so, for what amount?  If that amount is not zero, what is the other side of the entry?  A gain?  Or a liability for pollution that has not yet occurred (and is therefore hard to construe as a liability).

Naomi Soderstrom, along with Derek Johnston and Stephan Sefcik, has recently published a paper on the value implications of emissions allowances:

This paper examines the valuation implications of greenhouse gas (GHG) emissions allowances. We posit that the value of a firm’s bank of emission allowances has two components that are likely to be positively valued by the capital market: (1) an asset value component; and (2) a real option value component. Since the necessary data to examine this research hypothesis in the setting of GHG emission allowances is not yet available, we test our conjecture by examining the value relevance of sulfur dioxide (SO2) emission allowances held by US electric utilities. Empirical results reveal that the capital market assigns a positive price to a firm’s bank of SO2 emission allowances, consistent with the argument that emission allowances have, at least, an asset value component that is assigned a positive price by the market. We also find weak evidence
consistent with the market assigning a real option value to the allowance banks.

Naomi will be presenting her research results, but more importantly will be introducing us to the relatively unknown but important emissions trading markets, and indicating directions for future work.  Shayne will weigh in with some standard setting insights and updates.

Details on attending are available here, and of course you can always watch right on the web, at our LIVE page.

* UPDATE: The archived video of this Round Table can be found here.

Another student guest blogger.  See the comment thread for my own remark on this topic, which promises to be very interesting over the coming year.  –RJB

One of FASB’s current projects involves providing guidance to accounting issues such as accounting for Emissions Trading Schemes.  This project is important because many environmental and ecological accounting concepts are ambiguous in nature.  As societal demand grows for more corporate and political environmental accountability, accountants will require increasing guidance on how to account for accounting information associated with economic instruments such as cap and trade schemes.

Such environmental economic instruments have been better explored in the environmental economics literature compared to the environmental accounting literature. This is unfortunate because accounting academicians may be a valuable resource in the development of efficient, effective, and practical economic instruments that aim to address environmental issues.  In order to provide beneficial and tangible economic instruments, environmental economists will need to use economic theory that is consistently grounded in an ecological accounting reality.  This merging of economics and accounting will be more successful if accounting scholars take a more prominent role in analyzing and exploring environmental accounting information systems that yield viable economic results.

If it is acknowledged that accounting scholars are arriving tardy in addressing environmental issues, then it may be helpful for the literature to rigorously discuss accounting’s basic and fundamental role in understanding the accounting ramifications associated with the development of environmental economic instruments such as the cap and trade schemes.  One suggestion is to begin broadly comparing and contrasting accounting’s role in other environmental economic instruments, such as traditional command and control regulatory approaches.  Basic knowledge of different environmental economic instruments can be found in an introductory environmental economics textbook, such as Turner, Pearce, and Bateman’s Environmental Economics.  An older edition (1993) can be purchased cheaply on sites such as Amazon.

There are many research opportunities for accounting researchers to help inform the debate on how best to develop accounting standards aimed at addressing environmental economic instruments such as the cap and trade schemes.