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Environmental credits: Understanding new FASB guidance · PwC's accounting podcast

• 0:00
  SPEAKER_01: Thought Leadership from PWC's National Office.
• 0:07
  SPEAKER_03: Hello, and welcome to PWC's Accounting Podcast.
• 0:11
  SPEAKER_03: I'm Heather Horn.
• 0:12
  SPEAKER_03: In today's episode, we're talking about a new accounting standard on environmental credits and the related environmental credit obligations.
• 0:20
  SPEAKER_03: Historically, there's been diversity in practice in how companies account for these.
• 0:24
  SPEAKER_03: And the new guidance establishes a consistent framework for recognizing, measuring, presenting, and disclosing these assets and liabilities.
• 0:33
  SPEAKER_03: Environmental credit markets and compliance programs continue to evolve both in regulatory and voluntary settings.
• 0:40
  SPEAKER_03: So even if this guidance isn't applicable to today, it's something you should keep on your radar.
• 0:48
  SPEAKER_03: Joining me for this conversation, I'm happy to welcome to the podcast Mike Pratt, a partner, and Logan Redlin, a director in our national office.
• 0:56
  SPEAKER_03: They've both been closely following this project, including helping to draft our comment letter and engaging with the FASBE clients and engagement teams on this topic.
• 1:05
  SPEAKER_03: Mike, Logan, welcome.
• 1:07
  SPEAKER_00: Thanks for having us.
• 1:07
  SPEAKER_00: Thank you.
• 1:08
  SPEAKER_03: All right.
• 1:09
  SPEAKER_03: So let's jump straight into things, maybe starting with the basics.
• 1:12
  SPEAKER_03: So, Mike, I'll turn to you first.
• 1:14
  SPEAKER_03: Can you provide some background on why the FASBE issued this new standard?
• 1:18
  SPEAKER_02: Yeah, so there was no specific U.S.
• 1:20
  SPEAKER_02: GAAP guidance for environmental credits or related obligations.
• 1:23
  SPEAKER_02: As you mentioned, as a result of that, there was significant diversity in practice.
• 1:27
  SPEAKER_02: Um, when Logan and I were researching this project, we did outreach with a number of companies across a number of industries, and we found that some companies were applying an inventory model, some were treating them as intangible assets, some were expensing them as they acquired them, others were applying a fair value model, so really all over the board.
• 1:47
  SPEAKER_02: Um, there were companies that were internally generating credits, and some of them were allocating costs to those and putting them on the balance sheet, and others doing pretty much the same thing business-wise, where we're not doing that.
• 1:58
  SPEAKER_02: Um, and then in terms of timing of expense recognition for environmental obligations, uh, some companies were following what you would call an accrue as you go approach, and others were following a shortfall method, which we'll we'll talk about here in a little bit.
• 2:12
  SPEAKER_02: So tremendous diversity in practice.
• 2:14
  SPEAKER_02: Um, one of the things we heard repeatedly when we talked to companies was that their environmental credit activity at the time just wasn't material.
• 2:23
  SPEAKER_02: And that really played out in the disclosures we saw in financial statements and footnotes.
• 2:28
  SPEAKER_02: Um, what companies were disclosing, if anything, uh, was really tailored towards what they were doing.
• 2:33
  SPEAKER_02: Maybe they had a significant purchase in a period or significant expense, uh, but really a lack of transparency and a lack of comparability in disclosures.
• 2:42
  SPEAKER_02: Um, when we think about where environmental credits have been going in recent years, we've seen a tremendous growth in companies using these credits.
• 2:49
  SPEAKER_02: And so the FASB was certainly aware of that as they were working on this project.
• 2:53
  SPEAKER_02: Uh, a lot of companies are publicly committed to net zero goals, and so they're acquiring a lot of credits to help them uh meet those commitments.
• 3:01
  SPEAKER_02: We have seen some pullback certain regulatory programs in recent years, and so even though there has been some of the some pullback in some of those programs, uh, for example, the EPA recently uh rescinded its greenhouse gas endangerment finding, um, I think the growth in the voluntary use of credits has has far outweighed some of the pullback in those programs.
• 3:21
  SPEAKER_02: Um and certainly not to be uh surprised, uh, in uh investors have been asking for more transparency and comparability in this space.
• 3:30
  SPEAKER_03: Yeah, I mean, I think one of the things that's so interesting on this topic, well, probably two things.
• 3:34
  SPEAKER_03: One is the fact that there's so many different types of programs and purposes, voluntary and regulatory, I think creates the challenge.
• 3:41
  SPEAKER_03: And that's also interesting to think about how this intersects with company sustainability reporting.
• 3:46
  SPEAKER_03: So we'll get into that and what this law is going to mean uh in the podcast.
• 3:50
  SPEAKER_03: So, with that, what at a high level does the new ASU uh require in terms of that counting?
• 3:57
  SPEAKER_02: Sure.
• 3:57
  SPEAKER_02: So the standard uh establishes when a company should recognize environmental credit assets uh as well as how to measure them, both initially and on an ongoing basis.
• 4:07
  SPEAKER_02: It also establishes when a company should recognize environmental credit obligations and how to measure those as well.
• 4:12
  SPEAKER_02: Uh it then provides specific presentation and disclosure requirements, which we'll get into here later.
• 4:18
  SPEAKER_02: A key concept in this standard is that it is based on the company's intent and it uses a probability threshold.
• 4:24
  SPEAKER_02: So, for example, if a company intends to use an environmental credit to settle an environmental credit obligation, or it intends to transfer it in an exchange transaction, for example, to sell it, and it's probable they will do so, then the credit can be recorded as an asset.
• 4:38
  SPEAKER_02: Otherwise, it must be expensed.
• 4:40
  SPEAKER_02: So a key point here is that two different companies with the same type of environmental credit might account for that frontly depending on what the intended use is.
• 4:47
  SPEAKER_02: Um also environmental credit assets and environmental credit obligations must be presented gross on the balance sheet.
• 4:53
  SPEAKER_02: They can't be netted.
• 4:54
  SPEAKER_02: Uh, but the accounting can be linked when there's uh an asset that's probable of being used to settle an obligation, in which case the measurement of the liability will be based on the measurement of the asset.
• 5:05
  SPEAKER_03: Yeah, and I think one thing that is worth highlighting here um is this intent model.
• 5:09
  SPEAKER_03: And it's interesting.
• 5:10
  SPEAKER_03: I've been in some other discussions on this, and I think it it people miss it a bit the first time that really that counting here is going to be based on how you intend to use them.
• 5:20
  SPEAKER_03: And that's definitely something that the FASP received a lot of feedback on.
• 5:24
  SPEAKER_03: And so just want to reiterate that in particular, if you have credits that are intended for voluntary purposes, so for example, those would be ones that you're acquiring for your net zero or other types of emission reduction programs, then those are going to need to be expensed in general for accounting purposes, even though we're seeing those reported in sustainability reporting.
• 5:46
  SPEAKER_03: And so that is going to cause for companies reporting under US GAAP, potential disconnect with their sustainability statements.
• 5:54
  SPEAKER_03: And I think again, this is really important for those companies that have voluntary purposes, um, less so obviously for companies that are purchasing these for regulatory purposes or trading, because then there's a different approach taken.
• 6:08
  SPEAKER_03: So, with that clarity, and again, I think that's one of the most interesting aspects of this statement.
• 6:13
  SPEAKER_03: And I think for some companies can be source of frustration now that you're going to see this separation.
• 6:18
  SPEAKER_03: Um, Logan, why don't we clarify the scope of the standard and particularly which assets are included in this guidance?
• 6:26
  SPEAKER_00: Yeah, so on the asset side, a environmental credit would need to meet certain criteria uh in order to be in the scope of this guidance.
• 6:34
  SPEAKER_00: So it needs to lack physical substance, it cannot be a financial asset, it needs to represent rights that are associated with preventing, controlling, reducing, or removing emissions or other pollution.
• 6:45
  SPEAKER_00: It needs to be separately transferable.
• 6:47
  SPEAKER_00: It doesn't, there doesn't necessarily need to be an active market, but it needs to be uh legally separately transferable.
• 6:53
  SPEAKER_00: And then uh it cannot be an income tax credit because we do see income tax credits that um relate to you know environmental um activities.
• 7:02
  SPEAKER_00: So uh those would not be in scope.
• 7:04
  SPEAKER_00: And then uh, so it doesn't matter what the uh credits are actually called.
• 7:09
  SPEAKER_00: You know, we see certificates, we see allowances, we see carbon offsets.
• 7:13
  SPEAKER_00: So those are all different kind of names of things that may be in the scope of uh this guidance, um, but you need to go through that criteria.
• 7:20
  SPEAKER_00: So this is just the definition of an environmental credit.
• 7:23
  SPEAKER_00: It doesn't mean that the credit actually will be recorded as an asset, but in order to be able to potentially record it as an asset, it's when to first need to meet this criteria.
• 7:32
  SPEAKER_02: Yeah, so maybe a couple of common examples in this space.
• 7:35
  SPEAKER_02: Um, one would be an emission allowance.
• 7:37
  SPEAKER_02: So emission allowances are uh remitted by companies that produce emissions, whether it's for manufacturing, power generation, or or whatever, but they uh remit emission allowances to uh to a regulator under some sort of regulatory program.
• 7:50
  SPEAKER_02: So those are fairly common.
• 7:52
  SPEAKER_02: Uh another example would be uh renewable energy credits.
• 7:56
  SPEAKER_02: And uh, as we talked about earlier, there's a lot of companies that are buying those for voluntary purposes and retiring those to meet uh voluntary net zero goals.
• 8:05
  SPEAKER_02: And both of these examples, both of those environmental credits uh meet the definition of an environmental credit in the standard.
• 8:11
  SPEAKER_02: However, but to Logan's point, it depends on how the company is going to use those credits to determine if they actually can recognize them uh as an asset.
• 8:20
  SPEAKER_02: So even the same company can have the same types of credits, but may account for them differently depending on what they intend to do with them.
• 8:26
  SPEAKER_03: All right, so it's gonna be really important for companies to work with the operations side.
• 8:31
  SPEAKER_03: I feel like this is a broken rough guard on all of our podcasts to understand what they're purchasing and how they're being used.
• 8:37
  SPEAKER_03: Maybe the other point I'd make here is that although this is US SCAP, a lot of companies applying US SCAP have international operations.
• 8:45
  SPEAKER_03: And so these types of credits could go by a lot of different names around the world.
• 8:50
  SPEAKER_03: So I think key point here though is just making sure no matter what the credit is called, that you're doing this evaluation.
• 8:56
  SPEAKER_03: So you make sure you're following the right accounting model.
• 8:59
  SPEAKER_03: Um, Logan, one of the things though that added complexity to all of this is the fact that for certain companies, they are going to have a liability.
• 9:06
  SPEAKER_03: So that's either for emissions, which I think Mike talked about, or uh a lot of utilities will have that they have to reduce the amount of emissions from the power generation.
• 9:17
  SPEAKER_03: So, how do companies account for that?
• 9:20
  SPEAKER_03: Well, first of all, what even qualifies as uh environmental liability and then what's that counting?
• 9:25
  SPEAKER_00: Uh yeah, so the this guidance also addresses what it calls uh environmental credit obligations.
• 9:31
  SPEAKER_00: Um so it can get a little confusing when you're talking about environmental credits, environmental credit obligations.
• 9:36
  SPEAKER_00: So um we often uh abbreviate it ECO on the obligation side.
• 9:41
  SPEAKER_00: Um so in order to be a uh it within the scope of this guidance and and uh consider an environmental credit obligation, it needs to be related to a regulatory compliance obligation, which uh must be in order to prevent, control, reduce, or remove emissions or other pollution.
• 9:59
  SPEAKER_00: And then the key point where this makes the connection back to the asset side is that you have to be able to um settle the obligation with an environmental credit.
• 10:09
  SPEAKER_00: Uh it that's not required though.
• 10:12
  SPEAKER_00: Some programs you can do cash uh as well.
• 10:15
  SPEAKER_00: So um, but but you still have the option of either satisfying the obligation with the credit or paying cash.
• 10:20
  SPEAKER_00: And so those obligations would be uh in the scope of this guidance.
• 10:26
  SPEAKER_02: Yeah.
• 10:26
  SPEAKER_02: So going back to the previous examples I talked about uh with the emission allowances, those programs are typically required by a regulator.
• 10:33
  SPEAKER_02: And so those would fall into the environmental credit obligation uh part of this guidance.
• 10:39
  SPEAKER_02: Um there's also certain requirements into those programs where a company doesn't have to um submit credits or pay cash unless they exceed a certain threshold.
• 10:48
  SPEAKER_02: And so those would fall into this ASU as well.
• 10:51
  SPEAKER_02: Those are fairly common.
• 10:53
  SPEAKER_02: Uh and then contrast that to the renewable energy credit example I gave where a company's acquiring those for voluntary net zero goals, those would uh not qualify under this program, even if a company publicly commits to a net zero obligation um as it's not promulgated by a regulator.
• 11:10
  SPEAKER_03: All right.
• 11:10
  SPEAKER_03: So it's very important there is to understand then where your commitments are coming from.
• 11:15
  SPEAKER_03: I guess uh Logan, anything else we should highlight on the scope?
• 11:19
  SPEAKER_00: Um there's a couple explicit scope out of uh ASC 818, which is that's the the new guidance that's set up uh by the standard.
• 11:28
  SPEAKER_00: Um, is if uh if you have an environmental remediation obligation that is in the scope of ASC 41030, you would follow, you'd still follow that guidance.
• 11:38
  SPEAKER_00: Uh, you wouldn't be here in the new environmental credit guidance.
• 11:41
  SPEAKER_00: I had mentioned before income tax credits, so those would follow um other guidance.
• 11:45
  SPEAKER_00: And then there's also some scope outs uh where if an arrangement is within the scope of 818, uh, they clearly say you wouldn't follow other guidance.
• 11:54
  SPEAKER_00: So uh government assistance, that's uh some new guidance in ASC 832.
• 11:59
  SPEAKER_00: You you would not apply government assistance, you would apply this standard.
• 12:03
  SPEAKER_00: And then same for not-for-profit uh contributions, those would uh again, you'd follow this standard, you wouldn't follow not-for-profit.
• 12:11
  SPEAKER_03: Yeah, and I think that's really important, particularly the point on government assistance, because one of the big debates before we had this standard was whether or not if a government agency is giving you these credits, if they should be accounted for as some type of government assistance.
• 12:26
  SPEAKER_03: So this clarification is is definitely important, and I guess settled that debate from that perspective.
• 12:32
  SPEAKER_03: So let's move on then to recognition and measurement.
• 12:34
  SPEAKER_03: And Mike, first again, focusing on the asset side, uh, when would a company recognize an environmental credit as an asset?
• 12:42
  SPEAKER_02: Yeah, so an asset is recognized if it meets the definition of an environmental credit, as Logan just went over, uh, and it's probable collectively that it will either be used to settle an environmental credit obligation, it will be transferred in an exchange transaction, i.e.
• 12:58
  SPEAKER_02: sold, uh, or it will be used in a non-reciprocal transfer.
• 13:01
  SPEAKER_02: So, for example, if a subsidiary earns or generates a credit and dividends it to a parent or an investor.
• 13:08
  SPEAKER_02: Uh, a couple of key points.
• 13:10
  SPEAKER_02: Um, the probability threshold we're using here is around 75%.
• 13:13
  SPEAKER_02: That's used elsewhere in US GAAP.
• 13:16
  SPEAKER_02: Uh, the assessment is collective, meaning you don't have to specifically determine it's going to be used to settle an obligation or transfer to an exchange transaction.
• 13:24
  SPEAKER_02: It just has to be probable you'll use it for one of those things.
• 13:28
  SPEAKER_02: And so companies can purchase credits and record assets in anticipation of future obligations.
• 13:33
  SPEAKER_02: So it's very common for companies to buy, you know, two, three or more years worth of credits to satisfy their obligations and just uh retire them as they need to.
• 13:42
  SPEAKER_02: And so that practice is fine as long as they still think it's probable, they'll use those for future obligations.
• 13:47
  SPEAKER_02: Um, and and then so again, getting back to credits that are used for voluntary purposes, those meet the definition of an environmental credit.
• 13:54
  SPEAKER_02: It's just where uh they won't meet asset recognition.
• 13:58
  SPEAKER_02: Here is when you get into the probability assessment that they're going to be used for one of those specific purposes to recognize it as an asset.
• 14:04
  SPEAKER_03: Okay, that's super helpful, Mike.
• 14:06
  SPEAKER_03: So can we rewind a moment though to this non-reciprocal transfer?
• 14:10
  SPEAKER_03: And we're talking, so then a subsidiary that's potentially like, for example, dividending to the parent or investor.
• 14:17
  SPEAKER_03: So in that case, then you're saying that the subsidiary would be able to recognize an asset.
• 14:23
  SPEAKER_03: However, then the parent or whoever it's transferring it to would also need to do that assessment.
• 14:27
  SPEAKER_03: So potentially then at that point it would wind up being expensed.
• 14:32
  SPEAKER_02: Yeah, yeah.
• 14:33
  SPEAKER_02: So good question.
• 14:34
  SPEAKER_02: So think about it, a subsidiary may not have an obligation in and of itself, but it might earn a credit, but the parent may have an obligation.
• 14:41
  SPEAKER_02: And so, yeah, it could dividend uh the credit up to the parent and the parent could use it, but both entities would probably need to go through that evaluation.
• 14:48
  SPEAKER_02: Um, and hopefully within the consolidated group, they would they would meet the definition.
• 14:52
  SPEAKER_03: Okay, or then it's not they the consolidated group would either expense or record the asset depending on the ultimate purpose there.
• 14:59
  SPEAKER_03: Okay.
• 15:00
  SPEAKER_03: Correct.
• 15:00
  SPEAKER_03: Yep.
• 15:00
  SPEAKER_03: All right, that's helpful.
• 15:01
  SPEAKER_03: And then back to your point about the assessment being collective.
• 15:05
  SPEAKER_03: When you say collective, you're not necessarily talking about a group of credits, you're more so talking about that it will either be used to satisfy an obligation or be traded.
• 15:16
  SPEAKER_03: Or is it so are you evaluating a group of credits or are you evaluating each credit?
• 15:22
  SPEAKER_02: Yeah.
• 15:22
  SPEAKER_02: So, so also a good question.
• 15:24
  SPEAKER_02: Um, I guess I meant collective in two contexts.
• 15:27
  SPEAKER_02: So the first one is um you don't have to go through and look at every single credit and make a determination on its own.
• 15:33
  SPEAKER_02: You can bucket them and say, hey, look, if I have a thousand credits, I don't know exactly today what I'm gonna do with every single one of them, but I do think it's probable I'm gonna use all thousand of those, and therefore it meets the definition.
• 15:45
  SPEAKER_02: Uh again, you don't have to go through for every credit and say, I'm gonna use this one specifically to settle an obligation or I'm gonna sell it, but I do know that I'm going to use all of them and to do to do one of those things.
• 15:57
  SPEAKER_02: And so collectively, I, you know, which one of those things I don't know today, but it will meet one of them.
• 16:01
  SPEAKER_03: Okay, that's helpful.
• 16:02
  SPEAKER_03: But I probably could lead in then into um measurements.
• 16:06
  SPEAKER_03: So, Logan, if we determine that you you are able to recognize the credit, then how would you perform your initial measurement?
• 16:15
  SPEAKER_00: Um, so the initial measurement is also gonna going to depend on how you uh obtain the credit.
• 16:21
  SPEAKER_00: Um, so uh if if you're obtaining the credit because you're internally generating uh the credit or you're or it's being granted to you by a regulator, you would measure that credit at its transaction costs only, uh which we expect to be minor.
• 16:35
  SPEAKER_00: And in some some cases, there won't actually be transaction costs.
• 16:39
  SPEAKER_00: So it would be recorded at zip at zero.
• 16:41
  SPEAKER_00: It still would be an asset, uh, which matters for some of the um some of the subsequent accounting, but um it would be recorded at zero.
• 16:49
  SPEAKER_00: And then uh an important point here is you would not allocate any production uh production costs.
• 16:54
  SPEAKER_00: So, for example, today you have um we talked about an inventory model.
• 16:59
  SPEAKER_00: Some companies who are generating the credits are allocating those production costs uh to these credits as well.
• 17:04
  SPEAKER_00: You would no longer be doing that.
• 17:05
  SPEAKER_03: You anticipated my question that I jotted down as soon as you said the first point.
• 17:11
  SPEAKER_00: And then all other credits uh would be measured at the cost to obtain that credit.
• 17:16
  SPEAKER_00: Uh, if there is, there may be other applicable guidance uh for those credits.
• 17:21
  SPEAKER_00: So, for example, if you obtain them through a from a customer, uh, you may be looking to ASC 606 to figure out how to allocate those costs.
• 17:29
  SPEAKER_00: So you'd still look to that other guidance um to help with measurement, but um, but yeah, you'd be recording those at cost.
• 17:36
  SPEAKER_00: And then another thing you need to do at this time is assess classification of these credits, which will be important for uh subsequent measurement, your disclosures, and when we get to measuring the environmental credit obligation.
• 17:49
  SPEAKER_00: So you're either going to have compliance credits, and those are when it's probable that you're going to use them to settle an environmental credit obligation, and then everything else would be a non-compliance credit.
• 18:01
  SPEAKER_02: Yeah.
• 18:01
  SPEAKER_02: So for internally generated credits, this guidance in the ASU uh will likely be different from what some companies are doing today.
• 18:08
  SPEAKER_02: So we saw companies who uh their primary business model was to generate credits and then sell them, and that's how they generated their revenue.
• 18:15
  SPEAKER_02: Now, some of those companies took an approach of taking their production costs, allocating them to credits under an inventory model, whereas others that did pretty much the same thing didn't take that approach.
• 18:25
  SPEAKER_02: Um and so again, we've seen diversity.
• 18:28
  SPEAKER_02: This is going to uh hit on that diversity in practice, but we'll it will require companies, some companies to change what they're doing.
• 18:34
  SPEAKER_02: This was one of the areas that had uh the most debate when the FASB deliberated on this.
• 18:39
  SPEAKER_02: And uh by a four to three vote, they decided not to allow costs to be allocated to internally generated credits.
• 18:45
  SPEAKER_03: So, Mike, it's really an interesting point because if you think about a company that's like a solar farm or a wind farm and they're generating power and they're generating credits, less so probably today than it was previously.
• 18:59
  SPEAKER_03: But the renewable energy credit is often a lot of the value that they're generating.
• 19:04
  SPEAKER_03: And so what we're saying is that doesn't matter.
• 19:08
  SPEAKER_03: All those costs are going to go to the power, and then the renewable energy credit basically, if they're planning to sell it, goes on their balance sheet at zero and then, or effectively zero, and then they're gonna have a gain at whatever point in time that they make the sale.
• 19:23
  SPEAKER_02: There were a few comment letters that touched on this question of allocating consideration in a bundled transaction.
• 19:28
  SPEAKER_02: The FASB responded not by putting new guidance in this ASU, but rather in the basis for conclusions section, they stated they felt this question was already addressed by the guidance in ASC 8050 on asset acquisitions, which essentially says the cost of a bundle of assets acquired shall be allocated to the individual assets based on their relative fair values.
• 19:46
  SPEAKER_03: All right, so that's helpful context, Mike.
• 19:48
  SPEAKER_03: And it's interesting to hear that that was a large point of discussion and then where they landed.
• 19:54
  SPEAKER_03: It'll be interesting as well to see what that means in practice as companies start implementing this.
• 19:58
  SPEAKER_03: So, Logan, then if we go on to subsequent measurement, how does that work?
• 20:03
  SPEAKER_00: Yeah, so then this is where the classification, uh, one area where that comes into play.
• 20:07
  SPEAKER_00: So your compliance credits are not going to be remeasured.
• 20:11
  SPEAKER_00: So you would have just recorded them initially and then subsequently they'll remain at carrying at that carrying amount.
• 20:17
  SPEAKER_00: Uh, but then for non-compliance credits, you're going to assess them at each reporting period for impairment.
• 20:24
  SPEAKER_00: So they'll be recorded at cost less any impairment.
• 20:27
  SPEAKER_00: Uh, you can't reverse any impairments in future periods if the value goes back up.
• 20:32
  SPEAKER_00: Um, there is an available accounting policy election for uh these non-compliance credits.
• 20:39
  SPEAKER_00: Those are only available for credits that are not internally generated or um received from a regulator.
• 20:47
  SPEAKER_00: Uh so it's a fair value election where each period you'd be marking it um, you know, up or down.
• 20:52
  SPEAKER_00: I think most people who will use that election are the ones who are trading, you know, buying and selling these credits.
• 20:58
  SPEAKER_00: Um, and then classification will be reassessed at each reporting date.
• 21:02
  SPEAKER_00: If it does change, then you'll assess for impairment prior to you know moving classification.
• 21:08
  SPEAKER_00: So for example, um, you know, we we talked about, you know, maybe someone buys like a big chunk of credits and they know they're gonna either use them themselves uh to satisfy an obligation or they're going to sell any excess.
• 21:20
  SPEAKER_00: Um, you'd still be uh in this classification, you'd be figuring out, okay, what, you know, is it probable that I'm which ones am I gonna use for the obligation?
• 21:29
  SPEAKER_00: Those ones I'm not remeasuring.
• 21:31
  SPEAKER_00: The other ones that I'm going to sell, I will be reassessing for impairment at least.
• 21:36
  SPEAKER_00: Um, and so it in future periods, maybe at first you think 50% of them you're gonna use for uh your obligation, and then later now it's 60%.
• 21:45
  SPEAKER_00: So now you need to move you know that extra amount into compliance credits.
• 21:50
  SPEAKER_00: So it's possible you're kind of changing between these buckets uh in in future periods, and you have to reassess that classification each period.
• 21:58
  SPEAKER_03: All right.
• 21:59
  SPEAKER_03: It's very definitely.
• 22:00
  SPEAKER_03: A complex model, and it's gonna be a lot for companies that have these credits to go through that counting.
• 22:05
  SPEAKER_03: I guess maybe before we go on to the obligations, Mike, you've mentioned a few points where there's a lot of debate from the FASB.
• 22:12
  SPEAKER_03: I think one question that's interesting is why they developed this whole new model instead of just following either the intangible model or the inventory model that companies were previously using.
• 22:23
  SPEAKER_03: Did they talk about that at all in the project or they just moved straight into a new model without really having debate about the applicability of one of the existing models?
• 22:33
  SPEAKER_02: Yeah, so there was consideration under the different models.
• 22:36
  SPEAKER_02: I think under the inventory model, uh, and kind of getting back to what I talked about in terms of internally generated credits, uh, I think there was just a view that the subjectivity that goes into um allocating cost to credits, um, it's complex, it's time consuming, and they didn't think that the benefit outweighed the cost.
• 22:55
  SPEAKER_02: And so um they didn't really pursue that.
• 22:58
  SPEAKER_02: Um, they did speak to intangible assets as well, but some of the board members kind of likened this to advertising costs um and and just didn't like the idea of um, you know, having some of these uh viewed as viewed as assets in that regard.
• 23:13
  SPEAKER_02: And so um they did they did debate these different models, but in the end, they kind of picked something that I view.
• 23:18
  SPEAKER_02: It's it's a bit of an amalgamation of of these different models.
• 23:22
  SPEAKER_03: Yeah, and it's interesting you said the cost doesn't outweigh the benefit, given that we know at least some people that would have been the ones doing this allocation uh raise that issue.
• 23:30
  SPEAKER_03: But anyway, obviously there's a lot to consider because these are relatively unique type of asset.
• 23:36
  SPEAKER_03: So I think now that we've talked about these assets and the way they're recognized, let's move on to the liability side.
• 23:44
  SPEAKER_03: And so, Mike, let me turn to you.
• 23:45
  SPEAKER_03: And when would you be recognizing an obligation related to environmental credits?
• 23:51
  SPEAKER_02: Yeah, so an obligation is recognized when the events have occurred on or before the reporting date.
• 23:56
  SPEAKER_02: And the standard requires that a company assume the reporting date is the end of the compliance period.
• 24:01
  SPEAKER_02: So if I think about a company that's a calendar year end, they get to the end of the second quarter, June 30th, they need to look at emissions or whatever activity generates the obligation through June 30th, and that's what their obligation should represent.
• 24:14
  SPEAKER_02: Um, it should only be based on past activities and it shouldn't forecast any future uh emissions.
• 24:20
  SPEAKER_02: So even if a company knows that at the halfway point they're gonna double, triple, quadruple their emissions, they shouldn't account for that obligation until they've actually incurred and done those activities.
• 24:31
  SPEAKER_02: Um I mentioned threshold programs earlier, diversity and practice in there currently.
• 24:35
  SPEAKER_02: And so this standard addresses that head on and basically says that no obligation should be recognized until the threshold is exceeded, and then the obligation would represent whatever the incremental obligation is above that threshold.
• 24:50
  SPEAKER_02: Um, again, not considering any expected future reductions.
• 24:54
  SPEAKER_02: When we were doing our outreach, we did learn that there are certain programs like the CAFE credits uh that certain auto manufacturers have to comply with.
• 25:02
  SPEAKER_02: They actually do have the ability where if they uh produce a bunch of low gas mileage cars in the first half of the year, they can actually offset or perhaps even eliminate their obligation if they produce a bunch of high mileage uh cars in the second half of the year or electric vehicles that have no emissions.
• 25:17
  SPEAKER_02: And the FASB is aware of those programs, but still they didn't feel that the obligation at any given point in time should reflect future activities.
• 25:24
  SPEAKER_02: And so it it's based on past activities as of that point in time.
• 25:28
  SPEAKER_03: So then, Mike, the threshold programs, if you have one of these programs with a threshold, and let's say you know halfway through the year you're going to exceed it, you're still seeing that in the first half of the year no expense would be recognized, and then all the expense is recognized in the second half of the year.
• 25:44
  SPEAKER_02: Yes, that's the way the model is written.
• 25:46
  SPEAKER_03: And then was this another point of debate that the Fauspe talked about?
• 25:50
  SPEAKER_03: Again, you gave the example of the cars, and I know this also can factor in for a lot of utilities that maybe there's seasonality to their um, the way they're producing.
• 26:00
  SPEAKER_02: Yeah, so there was discussion around this, um, but in terms of the threshold program, and they recognized there was diversity in practice, but in the end, they all kind of felt that an obligation wasn't triggered until a threshold had been exceeded.
• 26:12
  SPEAKER_02: And so they didn't think the accounting should really start until then.
• 26:16
  SPEAKER_03: Okay.
• 26:16
  SPEAKER_03: So then Logan, if we move on, once you recognize uh the obligation, how should it be measured?
• 26:23
  SPEAKER_00: Um, so here again, there's two um kind of classifications that impact uh different measurements.
• 26:29
  SPEAKER_00: So one is uh you're gonna figure out if the obligation is funded.
• 26:34
  SPEAKER_00: And to do that, you'll look at whether or not you have the credits that already on your balance sheet that you will then use to uh you expect to use to satisfy that obligation.
• 26:44
  SPEAKER_00: So where that where that's the case, it's a funded uh ECO, and you'll just measure the liability to be the same as the asset.
• 26:52
  SPEAKER_00: Um and so this is where also the guidance has you um do your accounting on the asset side first, and then you get to the liability, and then that's where you'll know, okay, I did record these assets.
• 27:03
  SPEAKER_00: I'm gonna, here's what I measured them at, and now my liability is gonna equal the asset.
• 27:08
  SPEAKER_00: And so uh back to what um Mike said early on, uh you even though they're gonna offset each other, um, you still need to report gross.
• 27:16
  SPEAKER_00: So you'll still have you know the growth, the asset and the liability, but they'll be equal and in effect, you know, net each other out.
• 27:22
  SPEAKER_03: Well, and that's very consistent with normal offsetting rules because obviously it's from a with a different party.
• 27:29
  SPEAKER_03: So that makes sense.
• 27:30
  SPEAKER_03: Yeah.
• 27:31
  SPEAKER_00: Yeah.
• 27:31
  SPEAKER_00: And that was their they they debated that too.
• 27:33
  SPEAKER_00: And that was their rationale that you have other places in GAP that uh report gross um in those circumstances.
• 27:39
  SPEAKER_00: And then uh you'll have uh anything else will be an unfunded uh environmental credit obligation.
• 27:45
  SPEAKER_00: And to measure those, you're gonna be uh recording them at fair value each period.
• 27:50
  SPEAKER_00: And that's the fair value of the assets you would have to acquire to satisfy the obligation.
• 27:56
  SPEAKER_00: Uh there are two exceptions.
• 27:58
  SPEAKER_00: So if the program that you're subject to allows you to settle in cash as an alternative, and that's what you expect to do, then you can use the cash uh value.
• 28:09
  SPEAKER_00: Uh and then also if you already have existing contracts, so for unconditional uh purchase commitments or rights, and there's like a contractual value to purchase those credits, then you can use that value instead.
• 28:23
  SPEAKER_03: So then, Logan, what would happen then for derecognition?
• 28:27
  SPEAKER_00: So then you'll uh once you've actually either remitted the credits to satisfy the obligation or paid the cash, um, then that's when you would de-recognize the obligation.
• 28:37
  SPEAKER_03: All right.
• 28:37
  SPEAKER_03: And then obviously the fair value is going to add some volatility.
• 28:40
  SPEAKER_03: So was this another point of discussion in the deliberations?
• 28:45
  SPEAKER_00: Yeah, I mean, they recognized that, but thought it should be at fair value.
• 28:49
  SPEAKER_03: Yeah, and I actually think a lot of companies are using were using a similar model already in some ways.
• 28:55
  SPEAKER_00: So Yeah, I think except though the point that um Mike made about um not considering, you know, your sort of future action.
• 29:03
  SPEAKER_00: Yes.
• 29:03
  SPEAKER_00: So you might have in fair value kind of considered, you know, all the kind of bigger picture.
• 29:09
  SPEAKER_00: But yeah.
• 29:10
  SPEAKER_03: Well, yeah, you say utilities or otherwise.
• 29:13
  SPEAKER_03: Um, I feel like some companies at least were using the similar type of model already, but yeah.
• 29:19
  SPEAKER_00: And and then at least they gave those specific instances where if you do have that traditional, you know, contract or you can pay cash, then you can yeah, take that into account.
• 29:28
  SPEAKER_03: All right, very interesting.
• 29:29
  SPEAKER_03: So anything else then that we should take into account from an accounting perspective?
• 29:33
  SPEAKER_00: Yeah, there's a few other areas where there's some uh specific guidance.
• 29:37
  SPEAKER_00: So one of those is if you have a business combination.
• 29:40
  SPEAKER_00: So if you're acquiring any environmental credit assets or the obligation in a business combination, there's some specific guidance.
• 29:47
  SPEAKER_00: Um, just at a high level uh on the asset side, you're gonna recognize all of those environmental credits at fair value.
• 29:55
  SPEAKER_00: And that's regardless of that probability threshold.
• 29:58
  SPEAKER_00: So that's regardless of your intended use.
• 30:00
  SPEAKER_00: Um, but then on day two, you would then apply the model we talked about.
• 30:04
  SPEAKER_00: So it's possible you're recording um some at assets of fair value.
• 30:08
  SPEAKER_00: And then on day two, you say you're gonna use it, for example, for voluntary purposes, then you'd expense those on day two.
• 30:15
  SPEAKER_00: Um, and then on the obligation side, you're mostly following the model that we talked about.
• 30:21
  SPEAKER_00: The only nuance here is that on the uh when you're determining whether the obligation is funded or unfunded, you're only looking at the assets that you're acquiring, the environmental credit assets that you're acquiring.
• 30:32
  SPEAKER_00: So it's possible maybe you already have you know credits that you own that you're gonna use to satisfy those obligations, but you can't take those into consideration um in the acquisition accounting.
• 30:41
  SPEAKER_00: You would on in the future in day two accounting.
• 30:44
  SPEAKER_03: Okay.
• 30:44
  SPEAKER_03: That's helpful.
• 30:45
  SPEAKER_03: Anything else, Mike?
• 30:47
  SPEAKER_02: Yeah, so one other area worth noting is in relation to ASC 815 for derivatives and hedging.
• 30:52
  SPEAKER_02: Um, the ASU specifically scopes out environmental credit obligations from ASC 815 in case there are any companies worried about maybe having embedded derivatives in environmental credit obligations, no need to worry.
• 31:04
  SPEAKER_02: That's specifically scoped out.
• 31:06
  SPEAKER_02: Uh, however, they did keep environmental credits um themselves in play in terms of 815.
• 31:12
  SPEAKER_02: So while credits themselves typically don't meet the definition of a derivative, a forward contract to buy credits in the future could meet the definition of a derivative.
• 31:20
  SPEAKER_02: Um, generally speaking, credits aren't readily convertible to cash, but um there could be certain types of credits in certain markets where maybe companies do view them to be readily convertible to cash, and these markets continue to evolve.
• 31:33
  SPEAKER_02: So I would uh recommend companies just keep keep an eye on the space as these markets evolve.
• 31:38
  SPEAKER_03: So, Mike, just to confirm then, from an obligation point of view, I think previously there was sometimes the view that there was an embedded derivative, um, like an embedded obligation to acquire uh these assets in the future.
• 31:51
  SPEAKER_03: So what you're saying is explicitly now, you can just follow this model.
• 31:55
  SPEAKER_03: You don't have to worry.
• 31:56
  SPEAKER_03: I mean, it's already partly fair valued anyway.
• 31:59
  SPEAKER_03: It's just interesting, but I think this is helpful clarification from the FASB.
• 32:04
  SPEAKER_02: Yeah, correct.
• 32:05
  SPEAKER_03: All right, how about presentation and disclosure?
• 32:07
  SPEAKER_02: Yeah, so um, in terms of presentation uh on the balance sheet, uh I think we mentioned earlier it requires gross presentation, so you can't net assets with liabilities.
• 32:17
  SPEAKER_02: And uh both the assets and the liabilities have to be presented, both current and non-current uh on the balance sheet.
• 32:24
  SPEAKER_02: And then when it comes to disclosures, there's uh there's a whole slew of disclosures, uh, most of them annual.
• 32:30
  SPEAKER_02: So you have to talk about the types of credits you have, how you obtained them, uh, what the intended use is, your accounting policies, if there are any significant estimates involved, what those are.
• 32:41
  SPEAKER_02: Um, as you talked about earlier, impairment derecognition impacts have to be disclosed.
• 32:46
  SPEAKER_02: Uh, for companies that apply the fair value option, there would be fair value disclosures under ASC 820.
• 32:52
  SPEAKER_02: And there are also detailed disclosures for environmental credit obligations to break down uh between funded and unfunded obligations.
• 33:00
  SPEAKER_02: So uh a lot more transparency uh should come from these requirements.
• 33:05
  SPEAKER_03: All right, but again, it will go to companies' materialities.
• 33:08
  SPEAKER_03: So if the program isn't material for that company, then you would scale these disclosures appropriately.
• 33:15
  SPEAKER_03: But for companies with big um or material activities, then this will add a lot of transparency.
• 33:21
  SPEAKER_02: Yeah, correct.
• 33:21
  SPEAKER_03: Okay, that's helpful.
• 33:23
  SPEAKER_03: So maybe last point we should touch on is effective date and transition.
• 33:27
  SPEAKER_03: Logan, what can you share?
• 33:29
  SPEAKER_00: Um, yeah, so for effective date, early adoption is permitted.
• 33:32
  SPEAKER_00: Uh, if you're not going to early adopt, then public business entities would be required to adopt for annual periods beginning after December 15th, 2027.
• 33:41
  SPEAKER_00: So for a calendar year end, that's beginning in 2028.
• 33:44
  SPEAKER_03: So like a year and a half-ish from now.
• 33:46
  SPEAKER_00: Yep.
• 33:47
  SPEAKER_00: Okay.
• 33:47
  SPEAKER_00: And then that would apply for interim uh periods within that year.
• 33:51
  SPEAKER_00: So 2028.
• 33:52
  SPEAKER_00: And then all other companies would be one year later.
• 33:56
  SPEAKER_00: In terms of transition on the asset side, you'd be reassessing all your credits uh to determine whether they meet the recognition criteria at the adoption date.
• 34:06
  SPEAKER_00: If they don't, then you would be derecognizing any of those credits.
• 34:09
  SPEAKER_00: So for example, if you had uh if you had the voluntary credits that you had capitalized, uh you'd have to expense those, uh, or they'd go they'd go through a cumulative effect of just adjustment in retained earnings, actually.
• 34:21
  SPEAKER_00: Um and then on the you'd be also determining whether they're compliance or non-compliance credits.
• 34:27
  SPEAKER_00: The compliance credits are just going to be measured at the carrying value that you you already had them at on your books at adoption, or if it's a non-compliance credit, it's the lower of your fair value or carrying value.
• 34:39
  SPEAKER_00: Or if you make that fair value election policy election, um, you could record them at fair value.
• 34:45
  SPEAKER_00: Uh and then there's an additional election.
• 34:47
  SPEAKER_00: If you're a company that has internally generated or granted uh credits, you can elect to measure all those at their transaction costs, if any.
• 34:58
  SPEAKER_00: So if if you had it at a higher, so we talked about like that inventory model, companies may have it at the higher value because they allocated production costs.
• 35:06
  SPEAKER_00: You have a policy where you could record them at the lower value at the transaction costs.
• 35:11
  SPEAKER_03: So, Logan, before you go on to the liabilities, so then when you said that compliance credits, you'd measure it carrying value.
• 35:16
  SPEAKER_03: So even if your prior model was something different, you could just carry that value over and then apply this basically prospectively to new credits.
• 35:25
  SPEAKER_03: Yeah.
• 35:26
  SPEAKER_03: Okay.
• 35:26
  SPEAKER_03: That's helpful.
• 35:26
  SPEAKER_00: And then, but you're saying you don't have new guidance to new credits.
• 35:29
  SPEAKER_03: Yeah, the new guidance to new credits, although you could elect to also apply the internally generated guidance to your existing credits.
• 35:38
  SPEAKER_03: Okay.
• 35:39
  SPEAKER_03: So that's helpful.
• 35:40
  SPEAKER_03: And then how about from a liability side?
• 35:43
  SPEAKER_00: Um, so then just uh after, so you would have done all that on the asset side uh to figure out your the value of your credits or your assets if or if you had any of them.
• 35:53
  SPEAKER_00: And then you would follow the the funded, unfunded model that we had talked about to measure your uh obligation.
• 36:00
  SPEAKER_00: And then it would be applied, so this would be applied retrospectively through accumulative effect adjustment, opening retained earnings, and you're not going to be recasting any uh prior period uh numbers uh at the date of adoption.
• 36:13
  SPEAKER_03: All right, that's helpful.
• 36:14
  SPEAKER_03: So a little less work from an adoption point of view.
• 36:17
  SPEAKER_03: So obviously, there's a lot of changes and a lot of complexity that I highly recommend people take a look at the in-depth of to make sure they understand the particular fact pattern for their particular programs.
• 36:28
  SPEAKER_03: But Mike, it might be helpful to uh just give some highlights of as you're talking to clients, what you're recommending they do now.
• 36:37
  SPEAKER_02: Sure.
• 36:37
  SPEAKER_02: Uh so first I recommend they just identify where their current accounting differs from ASC818.
• 36:43
  SPEAKER_02: As we talked about earlier, given the lack of gap existing prior to this ASU and diversity in practice, most companies are going to have to change their accounting to some degree to adopt the standard.
• 36:53
  SPEAKER_02: Presumably, companies have an inventory of their existing credits and have a handle on what their obligations are already for whatever their accounting is currently, uh, but they will have to go through and evaluate all their credits for intent and assess probability.
• 37:06
  SPEAKER_02: Um, the other thing I would just ensure that management, investors, and stakeholders are aware of the impact of the new standard because it could uh impact the financials in unexpected ways.
• 37:16
  SPEAKER_02: So we talked about internally generated credits, and so that could change the timing of when expenses hit the income statement.
• 37:22
  SPEAKER_02: Um and then Heather, you also mentioned how uh the use of voluntary credits, there may be a disconnect between financial reporting and sustainability reporting in terms of when the costs of these credits uh get recognized relative to when they're actually reflected in sustainability reporting.
• 37:37
  SPEAKER_02: Um, as I mentioned earlier as well, uh many of the companies we talked to kind of said that their credit activity really wasn't material at this point in time, but I would encourage companies to think strategically where they might be in a few years as they adopt the standard and make sure they're thinking about the accounting policies and things that make sense for uh a future period where maybe the credits are more material to them than they are today.
• 37:59
  SPEAKER_02: Um, I'd be remiss if I didn't mention systems for tracking credits.
• 38:03
  SPEAKER_02: I wouldn't be surprised to learn if a large number of companies are tracking these manually on spreadsheets.
• 38:08
  SPEAKER_02: Uh, and that may be fine for the purposes of their accounting today, uh, but it may not be fit for purpose as they have to go through and determine are they compliance credits or non-compliance credits?
• 38:19
  SPEAKER_02: Are they voluntary?
• 38:20
  SPEAKER_02: Um, they have to do probability assessments, maybe fair value measurements.
• 38:24
  SPEAKER_02: They need to break down their liability between funded and unfunded.
• 38:29
  SPEAKER_02: Uh, and so there's just a a lot more um disclosure requirements.
• 38:33
  SPEAKER_02: And so I would recommend companies look at those disclosure requirements and compare it to the information that they can get from their tracking system today and see if it's really fit for purpose or if they need to uh make some improvements there.
• 38:45
  SPEAKER_02: And then the last thing I would just mention is process and controls.
• 38:48
  SPEAKER_02: Uh again, given the lack of disclosures we saw historically, this is probably going to drive more disclosures and more companies' financials.
• 38:56
  SPEAKER_02: Uh, and so you'll just want to make sure that processes and controls are up to snuff in a in a new disclosure that perhaps you didn't have before.
• 39:03
  SPEAKER_03: All right, it's very helpful.
• 39:04
  SPEAKER_03: And I was reflecting as we were speaking, it's very interesting because I think, Mike, you and I are both coming from a background of having dealt with these programs for a long time, both from uh, you know, our utilities clients that would have had the obligations, maybe already also generating credits, buying credits.
• 39:21
  SPEAKER_03: And then I think Logan, you're you have come at this um without that type of background, but more dealing from a sustainability and other perspective.
• 39:29
  SPEAKER_03: And so I 100% agree with all Mike's recommendations.
• 39:32
  SPEAKER_03: I'm just curious if there's anything that you would add or change coming again from sort of a bit of a different direction, maybe less focused on the obligation side and more on companies with voluntary programs.
• 39:44
  SPEAKER_00: Um, well, I think definitely uh the cross coordination, if you've got different people, you know, involved in the sustainability reporting and financial reporting and making sure that they on the sustainability under side understand, you know, that these are being expensed and the the disconnect uh for you know communicating to the right stakeholders.
• 40:03
  SPEAKER_00: And then in your disclosures, I think also uh being consistent, you know, how you're describing them and and all that.
• 40:10
  SPEAKER_00: You're gonna have this, you know, information.
• 40:11
  SPEAKER_00: If you're a public company, right, you'll have the public information out there and uh, you know, the being consistent is important.
• 40:17
  SPEAKER_03: All right.
• 40:18
  SPEAKER_03: Good advice.
• 40:18
  SPEAKER_03: Thank you.
• 40:19
  SPEAKER_03: And I think maybe the only thing I'd add from listening to both of you is that we mentioned a few times materiality, and that for some companies right now, this may not be material.
• 40:28
  SPEAKER_03: And I think we've all seen where things start, it's not material and become material, and that's where often then there can be potential issues.
• 40:37
  SPEAKER_03: So definitely recommend if you have these programs, even if they're not material, that at least from a financial reporting, you get your hands around uh what what they are and what your future plans are so you can measure them.
• 40:49
  SPEAKER_00: Oh sorry, I was I wasn't trying to interrupt you.
• 40:51
  SPEAKER_03: No, that's okay.
• 40:52
  SPEAKER_00: I was gonna I was also gonna say you you talked about if you have the compliance, you know, if you have these programs and whether they become material, but also like the laws, you know, may change in the future.
• 41:01
  SPEAKER_00: And so monitoring the regulations, where they go, and then uh, you know, it could become material or become something new to you uh in the future, depending on where the direction that goes.
• 41:12
  SPEAKER_03: I completely agree.
• 41:13
  SPEAKER_03: I think that's a great point.
• 41:14
  SPEAKER_03: And I also do want to echo your point, your point on the fact that now having public information potentially in your financial statements, maybe other information in your sustainability statements, just trying to make sure you can reconcile and explain that because connectivity between the financial statements and sustainability statement is one of the sort of uh foundational concepts in at least both ESRS and the IFRS sustainability disclosure standards.
• 41:39
  SPEAKER_03: All right, so definitely a lot to think about, gentlemen.
• 41:41
  SPEAKER_03: It's always a pleasure to talk to you.
• 41:42
  SPEAKER_03: Thanks so much for joining me.
• 41:43
  SPEAKER_00: Thanks for having us.
• 41:44
  SPEAKER_00: Thanks.
• 41:46
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• 42:08
  SPEAKER_03: From Thought Leadership at PwC, I'm Heather Horn.
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