FASB Issues Proposal on Environmental Credits

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Background

Navigating the scope, recognition, measurement, presentation, and disclosure of environmental credit programs has been a significant challenge for institutions as GAAP lacks related accounting guidance. Due to the growing number of entities across various industries engaging in environmental credit programs and arrangements related to climate change initiatives and environmental, social, and governance matters, the FASB added a project to its agenda in May 2022. The proposal on environmental credit programs aims to provide clear and comprehensive guidance to ensure consistent and transparent financial reporting.

Breaking it down

What is an environmental credit?

An environmental credit is an enforceable right that can be acquired, granted by a regulatory agency, or earned by reducing greenhouse gas emissions, increasing environmental conservation, or using renewable energy sources. An environmental credit can also serve as a permit for emissions, granting an entity the authorization to generate a specific quantity of emissions. These rights can be bought, sold, or traded.

To be classified as an environmental credit, the credit must:

• Lack physical substance – not be considered a financial asset under GAAP
• Represent the prevention, control, reduction, or removal of emissions or pollutants
• Be separately transferable in an exchange transaction
• Not be classified as an income tax credit to be used to settle an entity’s income tax liability

The scope of the proposal includes credits that are acquired (including from related parties), granted by a regulatory agency or designee, or internally generated (created).

Crowe observation: The scope of this project excludes tax credits or incentives that are within the scope of ASC 740, “Income Taxes.” When a company receives the benefit of a credit or an incentive based solely on its income or income tax liability, the accounting for the credit would be within the scope of ASC 740. In addition, equity investments in income tax credit structures, such as investments in low-income-housing tax partnerships or renewable energy tax structures, would be outside of the scope of this project.

What is an environmental credit obligation?

ECOs are regulatory compliance obligations that arise from existing or enacted laws, statutes, or ordinances represented to prevent, control, reduce, or remove emissions or other pollution that may be settled with environmental credits. Obligations within the scope of Subtopic 410-30, “Environmental Obligations,” are not environmental credit obligations.

Asset recognition and measurement

In recognizing and measuring environmental credits, the proposal aims to capture the flow of funds, emphasizing cash flow rather than environmental emission limitations. Determining how to account for an environmental credit involves several considerations.

Initial asset recognition and measurement

Under the proposal, in order for an environmental credit to be considered an asset, it must be probable that the credit will be used to settle an ECO or transferred in an exchange transaction. If these conditions are not met, the environmental credit is not recorded as an asset and should be expensed as incurred unless the credits are required to be accounted for as part of the cost of another asset in accordance with other guidance under GAAP. Environmental credits that are probable to be used to settle an ECO or are expected to be sold or traded are initially recorded as an asset at acquisition cost. If granted by a regulator or internally generated, the assets would be recorded at cost, limited to transaction cost. Furthermore, any credits acquired in a business combination would be reported at fair value – using the guidance in ASC 805, “Business Combinations,” regardless of the intended use. If it is probable that an environmental credit will be used to satisfy an environmental credit obligation, the asset would be categorized as a compliance credit. If the credit is not probable to be used to satisfy an environmental credit obligation, the asset would be categorized as a noncompliance credit.

Crowe observation: The master glossary defines a future event as “probable” if it is likely to occur. In practice, “probable” is considered to a be a high threshold to which the event would be deemed to have a 70% or greater likelihood of occurrence.

The following flowchart provides an overview of the asset recognition and measurement guidance.

Subsequent asset measurement

Similar environmental credits recognized as assets are subsequently measured using one of the following cost methods: 1) average cost; 2) first in, first out; or 3) specific identification. Determining subsequent asset measurement is dependent on whether an environmental credit is a compliance credit or noncompliance credit. Noncompliance credits expected to be sold or traded would be subsequently measured at historical cost less impairment. Impairment should be analyzed at the end of each reporting period and is to be recognized when the carrying value of the noncompliance credit exceeds its fair value. Impairment losses are irreversible. On the other hand, compliance credits are not subsequently remeasured if the environmental credit remains probable to settle an ECO. However, if it becomes improbable that the environmental credit will be used to settle an ECO, the asset should be derecognized and reflected in earnings. If the compliance credit’s underlying value of the liability changes, the change in the asset value corresponding to the obligation to settle the ECO also would adjust accordingly.

The proposal would require a reevaluation each reporting period of the compliance and noncompliance credits classification. In the event compliance credits are reclassed to noncompliance credits, an impairment assessment would be required.

Crowe observation: Because the intent of compliance credits is to settle ECOs, generally an entity would not realize any gain or loss on the settlement. As such, the board decided to not propose subsequent remeasurement at fair value through earnings for compliance credits.

For noncompliance credits, an entity is permitted to make a fair value accounting policy election, with changes in fair value recognized in earnings. Credits generated by an entity are ineligible for fair value election. This election is irrevocable, and an entity must remeasure the asset until derecognition.

The proposal would allow entities to use a portfolio approach for the recognition and measurement of similar environmental credits as an accounting policy election. If this approach is used, the entity will need to apply this accounting policy consistently.

Lastly, an environmental credit that was previously derecognized or never recognized as an asset should not be recognized as an asset at a later time.

Liability recognition and measurement

Under the proposal, an entity would be required to recognize a liability when events occurring on or before the balance sheet date indicate the existence of an ECO. For entities existing as a business that must remit a fixed number of credits to a regulator at a specific date, the proposal includes specific recognition requirements. These entities would recognize an ECO liability on the date the entity is obligated to remit the credits. On this date, an entity also would recognize an asset, which should be amortized over the compliance period. The balance sheet date is considered the end of the compliance period for recognizing such liabilities.

The proposal states that entities would not recognize liabilities for commitments to purchase environmental credits unless required by other specific guidance in GAAP.

According to the proposal, ECO liabilities would be measured as follows:

• Funded portion. The funded portion of an ECO refers to the portion of the liability where the entity possesses the credits used to settle ECOs. This portion should be measured at the carrying amount of the credits at the balance sheet’s date.
• Unfunded portion. The unfunded portion represents the residual. This portion should be measured at the fair value of the credits needed to settle the ECO unless the entity intends to settle the ECO using cash. In the case of cash settlement, the liability should be measured based on the costs incurred to obtain the credits. If the settlement is planned through an existing commitment to purchase a fixed quantity of credits at a fixed price or an unconditional right to receive credits as part of a compliance program, the liability is measured based on the estimated cost basis of the credits to be obtained.

The following flowchart provides an overview of ECOs recognition and measurement guidance.

The proposal would prohibit entities from electing the fair value option, in Topic 825, for ECOs.

As outlined in the proposal, any subsequent measurement of an ECO liability should follow the initial measurement requirements as of each balance sheet date. Any changes in the ECO liability, including any derecognition gain or loss, should be presented in the same line item on the income statement as the initial measurement.

Presentation and disclosure

Balance sheet presentation

The proposal would require entities to present all environmental credits and ECOs on the balance sheet on a gross basis. The board has decided to prohibit an entity from netting environmental assets and liabilities.

Environmental credits slated for sale, trade, or remittance within the year would be classified as current assets; if not, they would be considered noncurrent assets. Conversely, ECOs due within a year would be considered current liabilities, while those not expected to be settled within a year would be categorized as long-term liabilities.

Income statement presentation

Changes in an ECO should be presented in the income statement in a manner consistent with the recognition and initial measurement of that liability.

Upon derecognition of an ECO, any resulting gain or loss should be presented in the income statement in a manner consistent with the recognition and initial measurement of that liability.

Disclosure

The proposal requires annual disclosure of the types of environmental credits and obligations, information about an entity’s involvement in environmental credit programs, and events or activities that give rise to ECOs or ECOs owned by the entity. The program information disclosed also should include the types of environmental credits accepted by those programs and the nature and timing of settlements as well as the entity’s method for subsequently remeasuring both environmental credits recognized as assets and the unfunded portion of ECOs. Significant estimates and judgments that are applied also should be disclosed.

The proposal also would require the reporting entities to disclose the following at both annual and interim periods:

• For significant environmental credit holdings and significant ECO liabilities, a description of the holding, classification, and program (including jurisdiction) as applicable
• Cash paid for environmental credits acquired during the reporting period, regardless of whether those credits were recognized as assets

Balance sheet requirements include:

• The carrying amounts as of the balance sheet date of all environmental credits (compliance and noncompliance) and obligations (disaggregated between funded and unfunded) that are individually significant. Aggregate carrying amount disclosure would be required for all credits and obligations not deemed individually significant.
• For a classified balance sheet, the current and noncurrent balances of compliance environmental credits, noncompliance environmental credits, the funded portion of ECO liabilities, and the unfunded portion of ECO liabilities. An entity also would be required to disclose where those amounts are presented in the consolidated balance sheet (if not separately presented).

Income statement requirements include:

• Sales of environmental credits:
  • Revenues from sales of environmental credits in contracts with customers and the carrying amount of those environmental credits at the date of sale
  • Gains and losses from sales of environmental credits with noncustomers and the carrying amount of those environmental credits at the date of sale
  • Total revenue (or gains) from sales of environmental credits that were never recognized as assets or were previously derecognized because it was not probable that those environmental credits would be sold or used to settle an ECO
• Costs of environmental credits:
  • Total expense recognized for ECOs, disaggregated by accruals for emissions during the reporting period and remeasurement of ECOs previously recognized
  • Total expense recognized for environmental credits not initially recognized or subsequently derecognized because it was not probable that those credits would be sold or used to settle an ECO
  • Total impairment expense recognized, the nature of the environmental credits that make up that expense, and a description of the facts and circumstances causing the impairment
  • The appliable income statement line items or items that include the amounts previously noted

Crowe observation: The board received significant stakeholder feedback strongly supporting the need for enhanced disclosures about an entity’s involvement in environmental credit programs and the financial impacts to the entity’s financial position, results of operations, and cash flows.

Transition and effective date

Entities would adopt the proposal using a modified retrospective approach, recording a cumulative effect adjustment to equity (or net assets) at the date of adoption. While an effective date has not yet been set, the proposal would allow for early adoption. If an entity early adopts in an interim period, it would be required to apply the proposal as of the beginning of the year in which the interim period is included.

Next steps

Comments on the proposal are due April 15, 2025.

FASB materials reprinted with permission. Copyright 2025 by Financial Accounting Foundation, Norwalk, Connecticut. Copyright 1974-1980 by American Institute of Certified Public Accountants.