The Australian Emissions Trading Scheme due to start no later than 2012 presents challenges for financial reporters, write Mark Shying and Jessie Wong.
Draft laws that would require business to report their emissions to the Australian government by 2009 were introduced into parliament on 15 August 2007. This information is expected to assist in the design of the government's Australian Emissions Trading Scheme (AETS).
One month earlier the government released its long-awaited climate change policy, which endorsed the key design features of the AETS set out in The Report of the Task Group on Emissions Trading (the report) released on 31 May 2007.
An AETS based on the 'cap-and-trade' model is to commence no later than 2012. The AETS is the central plank of the government's policy platform to reduce domestic greenhouse gas emissions at the least cost.
It is complemented by a series of measures the government asserts would 'ensure Australia leads the world in our domestic approach to reducing greenhouse gas emissions, and is a key player in effective international responses to climate change'.
At the same time, the Australian Labor Party has adopted policies on carbon emissions that similarly embrace a cap-and-trade model but with an earlier start date of no later than 2010.
In addition, the Australian Securities Exchange has announced plans to facilitate emissions trading in a futures market for carbon emission permits at the earliest opportunity. It is against this background that CPA Australia has urged the accounting and auditing standard setters to include on their work programs the topic of emissions.
Features of the AETS
The government has accepted the conclusions in the report in relation to key design features of the AETS.
CPA Australia considers that some of these key features are of particular importance to financial reporting and auditing they being, that the AETS should include a mixture of free allocation and auctioning of single-year dated emissions permits and a 'safety valve' emissions fee.
The mixture of free allocation and auctioning of single-year dated emissions permits should:
provide an up-front, once-and-for-all, free allocation of annual permits, each dated for a given year, as compensation for existing businesses identified as likely to suffer a disproportionate loss in asset value due to the introduction of a carbon price. (The report noted these permits could have a range of dates that could extend well beyond 2020)
ameliorate, through free allocation, the carbon-related exposures of existing and new investments in trade-exposed, emissions-intensive industries while key international competitors do not face similar carbon constraints, but which also provides ongoing incentives for abatement and adoption of industry best practice. (The report noted allocations to these firms could continue for as long as other key nations did not impose comparable carbon constraints on their firms. Permits would be provided to these firms for five years at a time, conditional on actual levels of production; decisions about whether to continue free provision of permits would be made as part of periodic reviews of the operation of the scheme. Residual permits for the period 2011 to 2030 would be progressively auctioned)
allow for the periodic auctioning of remaining permits. (The report noted this would involve a small number of future-dated beyond 2020 permits, in order to promote the establishment of liquid forward markets.)
The AETS should also include a 'safety valve' emissions fee designed to limit unanticipated costs to the economy and to business, particularly in the early years of the scheme, while ensuring an ongoing incentive to abate. (The report noted there may be times when firms cannot acquire sufficient permits due to limited market liquidity or when the cost of doing so would be regarded by government as excessive.)
The emissions fee is consistent with the objective of limiting emissions at least cost. 'Banking' - or carrying forward - dated emission permits for use against future emissions liabilities is another. Linking with other schemes to maximise opportunities for both Australian and non-Australian emitters, giving access to least-cost abatement opportunities globally is also consistent with this objective.
Reporting considerations
CPA Australia is of the view that prior to the operation of the emissions trading scheme, action by the accounting standard setter is necessary to ensure the financial reporting by the pollution emitters to which the scheme applies is understandable, relevant, reliable and comparable.
We have identified some issues that potentially may result in financial reporting that are not consistent with these objectives. CPA Australia considers the differentiation of issues (as below) is a useful framework for progressing the accounting standards literature concerning emissions in both the short and medium term.
Issues giving possible rise to divergent reporting practices under the current accounting standards
Does a cap-and-trade scheme give rise to a net position? If yes, an emitter who pollutes to the extent of its permit has neither an asset nor liability. Is this financial reporting consistent with the objectives of reporting?
If no, does the emitter have an asset and a liability, deferred income and/or income, or some other accounting?
If there is an asset, what is it? A right to pollute or an instrument that must be delivered in order to settle the obligation that arises from emissions, or something else?
Issues that need to be addressed as part of a coordinated approach
Intangible asset revalued to fair value
If the asset is a right to pollute, or an instrument that must be delivered in order to settle the obligation that arises from emissions, then it is likely to be an intangible asset. The report acknowledges there may be times when the market is not liquid.
AASB 138 Intangible Assets only allows revaluation to fair value when the market is active (that is, it satisfies each of the following conditions: the items traded in the market are homogenous, willing buyers and sellers can normally be found at any time, and prices are available to the public).
Accordingly, it may be difficult for emitters to revalue the intangible asset (particularly in the early years of the scheme).
Accounting mismatch of assets and liabilities
Even if revaluation to fair value can be used, AASB 138 requires that the changes in fair value not go to profit and loss (they go direct to the equity section of the balance sheet).
In contrast it is likely that the AASB 137 Provisions, Contingent Liabilities and Contingent Assets would apply to the liability. AASB 137 requires the liability to be measured at current value, with changes in current value to profit and loss.
Accordingly, there will be an accounting mismatch between assets and liabilities when the asset is measured at cost and the liability at current value. Similarly, there will be an accounting mismatch when assets are measured at fair value with changes to equity (as is the requirement of AASB 138 when intangible assets are revalued) and liabilities measured at current value with changes to profit and loss.
In summary, the accounting standards are introducing volatility into the financial reports that is not consistent with the underlying economic position of the emitter.
Upon establishment of a framework for recognition, measurement and disclosure of emissions-related information, CPA Australia is of the further view that there is more work to be done.
As is the case with information relating to the financial position and performance of an entity for which users have long required assurance, emissions data should similarly be subjected to assessment by an independent, external party.
The importance of having in place a professional accepted assurance framework for emissions data well in advance of the implementation of the AETS is explained below. The advantages associated with ensuring that the Australian assurance framework for application to emissions data is internationally aligned are also highlighted.
Early in its recommendations, the report alludes to the need for emissions data to be assured. Specifically, it states that the (proposed) AETS is 'premised on the assumption that trading could commence in 2011 and that a purpose-built mechanism to monitor, report and verify emissions data would already be in operation'. Interpreting this recommendation, a system for verifying emission data is therefore required to be in place before the trading scheme takes effect in the next three to four years.
CPA Australia has urged the auditing standard setter to commence work in this area without delay, as a limited time frame exists in which to establish a workable assurance framework and ensure practitioners are appropriately trained.
The report further asserted that Australia assumes a direct interest in promoting links between comparable schemes. Any Australian domestic trading scheme should be designed to enhance the scope for links, both formal and informal, with as many different systems as possible. The report recommends a basic approach, that of promoting links where there is assurance of the integrity of the partner system and the linking mechanism.
Without doubt, a key element influencing the acceptance of the AETS in other jurisdictions is the ability for users to rely on information output from the scheme. The assurance function has long been established in the marketplace to be best placed to perform this role.
International developments and considerations
Internationally, national standard setters have reported progress on several fronts.
For example, the Dutch institute, Royal NIVRA, has recently issued an assurance standard on sustainability reporting.
The German institute, IDW, has approved a standard, 'Generally Accepted Assurance Standard for the Audit or Review of Sustainability Reports'.
As more national standard setters undertake to develop separate pronouncements in this area, there is a risk that divergent practices will evolve. This is detrimental to the ability of emissions trading schemes across jurisdictions to link in with other similar initiatives.
In Australia, although not a widespread practice, selected entities have elected to include sustainability-related information as part of their annual reporting to external stakeholders. Such reporting would include emissions data.
As recommended in the report, a global approach to managing sustainability-related issues is of utmost importance in achieving the objectives of requiring the reporting of greenhouse gas emissions and implementing any emissions trading scheme in the first place.
The Financial Reporting Council's mandate is for Australian auditing and assurance standards to use international standards issued by the International Auditing and Assurance Standards Board (IAASB) as a base.
Given this, it is perhaps efficient for Australia to dedicate its resources to supporting the IAASB in its development of a new standard or adaptation of its existing standards for purposes of establishing a framework for providing assurance on emissions disclosures.
In doing so, it is important to bear in mind that the recent introduction of the National Greenhouse and Energy Reporting Bill 2007, together with the government's commitment to an emission trading scheme by 2012, requires the IAASB to adopt a suitable timetable.
Financial reporting should be understandable, relevant, reliable and comparable. The introduction of the AETS presents some challenges for financial reporting. CPA Australia considers it important that the Australian accounting standard setter work cooperatively with others to ensure financial reporting of emissions-related information is consistent with those objectives.
One key to the success of the AETS is confidence in emissions disclosures. An independent and robust verification of emissions data will help achieve this. It is therefore critical that Australia continues to engage actively with the international community and pursues the development of a professionally accepted assurance framework for emissions disclosures in time for adoption and implementation in Australia.
About the authors
Mark Shying is CPA Australia's senior policy adviser financial reporting and governance. Jessie Wong is CPA Australia's policy adviser financial reporting and governance
