Emissions allowances

How do emissions trading systems work?

A government caps total emissions and issues allowances, some free to certain industries and the rest by auction. Each year, a covered company must surrender allowances equal to its verified emissions. Allowances can be traded, so companies that emit less can sell their surplus and those that emit more must buy. The EU system has been running since 2005 and covers power, industry and aviation, with free allocation being phased out for sectors covered by the EU's carbon border adjustment mechanism. See power and utilities accounting.

What is the net liability approach?

Allowances received free from the government are recognised at nil, a permitted option for non-monetary government grants under IAS 20. Purchased allowances are recognised at cost, as intangible assets under IAS 38 or as inventory, and are not amortised because they are consumed by surrender. A provision is recognised under IAS 37 as the company emits, because emitting is the obligating event. It is measured first at the carrying amount of the allowances the company holds to settle it, nil for free ones and cost for purchased ones, and only the shortfall at the current market price. The result is that the expense reflects the cost of the allowances the company actually used.

Emissions allowances: a combined heat and power plant's year

A combined heat and power plant receives 800,000 free allowances, mainly for the heat it supplies, since electricity generation itself rarely receives free allocation in the EU. It buys 150,000 allowances at €70 and emits 1,000,000 tonnes. At the year end, the market price is €80, and the plant still needs 50,000 allowances.

The plant's carbon expense is €14.5 million, far less than the €80 million market value of its emissions, because most were covered by free allowances. The purchased allowances, carried at €10.5 million, are used to settle the provision when surrendered.

What is the alternative gross approach?

IFRIC 3, issued in 2004, required free allowances to be recognised at fair value as intangible assets with matching deferred grant income, and the liability for emissions to be measured at the market value of allowances needed. Because the assets could be held at cost while the liability moved with the market, profit became volatile, and IFRIC 3 was withdrawn in 2005. Some companies still use a gross approach, and it is acceptable as a policy if applied consistently, but it is less common.

What about forward purchases and traders?

Allowances can be settled net, because they are traded on exchanges, so a forward contract to buy allowances is a derivative unless it is held for the company's own compliance needs, the own-use exemption. Companies that trade allowances to profit from price changes may hold them as inventory measured at fair value less costs to sell, as commodity broker-traders. See energy contracts and own use.

What should be disclosed?

The policy chosen, the allowances held and their carrying amount, the provision, and the sensitivity of the company's carbon costs to prices and to changes in free allocation. The IASB considered a project on pollutant pricing mechanisms but in January 2025 deferred the decision to its next agenda consultation. See renewable energy certificates, which face the same gap.

How does US GAAP compare?

ASU 2026-02, which creates Topic 818, applies to public companies from fiscal years beginning after 15 December 2027. Compliance allowances are recorded at cost and not remeasured, and the obligation is measured at the carrying amount of allowances held plus the fair value of any shortfall, an approach close to the net liability approach under IFRS.

This guide is general information. It is not tax or legal advice for your situation.