Introduction
In response to growing environmental initiatives and the lack of standardized accounting for environmental credits and obligations, the Financial Accounting Standards Board (FASB) proposed a new accounting standard in 2024: Environmental Credits and Environmental Credit Obligations (ASU 2024-ED910). The proposal seeks to enhance consistency and transparency in financial reporting related to environmental credits and obligations, an increasingly material area for businesses, especially in the energy and manufacturing sectors.
This article explores the status of the proposed standard, key themes from the public comment letters, practical implications for companies, and what businesses should anticipate as the FASB moves toward finalizing the rule.
Background: Why a New Standard Was Needed
Historically, U.S. GAAP has lacked explicit guidance on how to account for environmental credits, such as emissions allowances, renewable energy certificates (RECs), and carbon offsets. This void led to diverse practices:
- Some companies treated credits as inventory.
- Others treated them as intangible assets.
- Some expensed the cost immediately.
Such inconsistencies made it difficult for investors and other stakeholders to compare financial statements and assess the financial impact of environmental credit programs.
Recognizing this problem, the FASB initiated a project to create a comprehensive framework addressing:
- Recognition and derecognition of environmental credits.
- Measurement at initial and subsequent stages.
- Presentation on the balance sheet and income statement.
- Disclosure requirements.
The proposal specifically impacts industries heavily involved in compliance and voluntary carbon markets, particularly energy, industrials, and utilities.
Overview of the Proposal
The ASU proposes a detailed framework for accounting for environmental credits as follows:
- Recognition: Credits are recognized as assets when it is probable they will be used to settle an environmental credit obligation (ECO) or sold.
- Measurement: Initially measured at cost, unless the environmental credits are received through a grant from a regulator or internally generated by an entity, in which case they would be measured at the amount of transaction costs incurred to obtain those environmental credits, if any.
- Subsequent Measurement:
- Compliance credits – Environmental credits that an entity is probable of using to settle an environmental credit obligation would be subsequently measured at cost and not tested for impairment at each reporting period.
- Noncompliance credits – Noncompliance environmental credits are subsequently measured at cost and tested for impairment at the end of each reporting period. Impairment expense would be recognized when the carrying value of a noncompliance environmental credit exceeds its fair value, measured as the excess of the carrying value over fair value.
- Derecognition: Credits are derecognized when used or sold.
- Fair Value Election: Companies would be permitted to elect an accounting policy to measure certain classes of noncompliance environmental credits at fair value, with subsequent changes recognized through earnings.
- Presentation: Companies would be required to present compliance environmental credit assets separately from environmental credit obligation liabilities on their balance sheets.
- Disclosure: Entities must provide robust qualitative and quantitative disclosures about environmental credits and related obligations, including:
- In each interim and annual reporting period, information about significant environmental credit holdings, cash paid for environmental credits, revenues and gains and losses from sales of environmental credits, expenses for environmental credits not initially recognized (or subsequently derecognized because an entity intends to use those environmental credits for voluntary purposes), and impairment expense.
- Applicable fair value disclosures for noncompliance environmental credits measured at fair value in accordance with its accounting policy.
- In annual reporting periods, qualitative information about how a company obtains and uses environmental credits, significant estimates and judgments, and methods used in applying the environmental credit accounting requirements.
The proposed ASU includes the following guidance for environmental credit obligations:
- Recognition: An entity would be required to recognize an environmental credit obligation liability when events (for example, emissions) occurring on or before the reporting date result in an environmental credit obligation.
- Measurement: An entity would be required to initially and subsequently measure an environmental credit obligation liability using the carrying amount of the compliance environmental credits that the entity holds and expects to use to settle that obligation at the reporting date (referred to as the funded portion of the liability). If an entity has insufficient compliance environmental credits at the reporting date to satisfy the liability, that unfunded portion would be initially and subsequently measured at the fair value of the environmental credits necessary to settle the unfunded portion at the reporting date, with certain exceptions.
- Derecognition: An environmental credit obligation liability would be derecognized when an entity remits the necessary environmental credits to a regulator.
- Disclosure: Companies would be required to disclose the following in interim and annual reporting periods:
- information about significant environmental credit obligation liabilities,
- the current and noncurrent amounts of the funded and unfunded portions of environmental credit obligation liabilities (if not separately presented on a classified balance sheet), and
- expenses related to environmental credit obligation liabilities, disaggregated between accruals for emissions occurring and liability remeasurements during the reporting period.
- applicable fair value disclosures for the unfunded portion of environmental credit obligation liabilities.
For each annual reporting period, an entity would disclose the following information about its environmental credit obligations:
- A description of regulatory compliance programs that the entity is subject to, including the nature, settlement provisions, types of environmental credits accepted as settlement, and activities that result in environmental credit obligations in those programs
- How the unfunded portion of an environmental credit obligation liability is measured.
Proposed Effective Dates
- Public Companies: Fiscal years beginning after January 1, 2026.
- Nonpublic Companies: Fiscal years beginning after January 1, 2027.
- Early Adoption: Permitted.
Transition Requirements
- Modified retrospective approach
- Companies apply the new guidance to all environmental credit assets and obligations existing at the beginning of the year of adoption
- Companies would continue to include the cost of environmental credits capitalized as part of another asset (for example, manufactured inventory) before the date of initial application as part of the carrying amount of that other asset.
Key Concerns Raised by Commenters
The FASB received 37 comment letters on the proposal, reflecting a wide range of stakeholders—preparers, auditors, industry groups, and standard-setting bodies. Common themes emerged:
1. Intent-Based Recognition Model
- Concern: Commenters argued that the proposal’s “probable use” threshold introduces subjectivity and inconsistency.
- Issue: Management judgment regarding the future use or sale of credits may vary significantly, undermining comparability.
- Suggested Improvement: Many recommended that all purchased credits should be recognized as assets at cost upon acquisition, with a straightforward impairment model thereafter.
2. Measurement and Impairment Testing
- Concern: Differentiating compliance credits (not subject to impairment) from noncompliance credits (subject to impairment) creates complexity.
- Issue: Some stakeholders questioned why a distinction was necessary, arguing that all environmental credits could lose value.
- Operational Challenge: Performing frequent impairment assessments, particularly for companies holding large portfolios of noncompliance credits, could be burdensome.
3. Disclosure Requirements
- Concern: The proposed disclosures are extensive and potentially burdensome, especially for companies active in multiple environmental credit markets.
- Issue: Stakeholders questioned whether all proposed disclosures truly provide decision-useful information.
- Suggested Improvement: Streamline disclosures to focus on material credits and obligations, reducing compliance costs while preserving transparency.
4. Interaction with Existing GAAP
- Concern: Commenters requested clarification on how the new standard interacts with:
- ASC 330 (Inventory)
- ASC 350 (Intangible Assets)
- Issue: Without clear guidance, preparers risk applying inconsistent accounting policies across different types of environmental assets.
5. Transition and Effective Date
- Concern: While the proposal favors a modified retrospective approach, commenters asked for additional practical expedients to ease the transition.
- Implementation Timeline: Many requested that the effective date be delayed by one year to allow companies sufficient time to build necessary systems and controls.
Practical Implications for Companies
Companies, particularly those in energy and heavy industry, must prepare for a significant shift in how environmental credits are accounted for and disclosed.
Key Actions for CFOs and Controllers:
- Inventory Assessment: Begin cataloging existing environmental credits.
- Policy Development: Establish clear accounting policies aligned with the proposed guidance.
- System Updates: Ensure that accounting systems can track environmental credits separately and assess impairment when needed.
- Training and Education: Finance teams will need training on the nuances of the new standard.
- Stakeholder Communication: Prepare to explain changes in financial reporting to investors, auditors, and boards.
Conclusion: Looking Ahead
The FASB’s proposed ASU on environmental credits and obligations represents a pivotal step in standardizing the accounting for a critical, emerging asset class. While broad support exists for the overall goals of consistency and transparency, significant operational and conceptual issues remain.
The ultimate shape of the standard will depend heavily on how the FASB addresses stakeholder concerns during redeliberations in mid-to-late 2025. Regardless of final modifications, companies that proactively assess their environmental credit activities and strengthen internal tracking and reporting capabilities will be better positioned for success.
Environmental credits are becoming central to corporate strategy, and how companies report these credits will increasingly influence investor perceptions and regulatory compliance. Preparation today will drive resilience and competitive advantage tomorrow.
