References

• IAS 20 Accounting for Government Grants and Disclosure of Government Assistance (reformatted 1994)
• IAS 37 IAS 37 Provisions, Contingent Liabilities and Contingent Assets (1998)
• IAS 38 IAS 38 Intangible Assets (1998)

History

• Draft Interpretation D1 Emission Rights is IFRIC's first draft Interpretation.
• IFRIC D1 was issued 15 May 2003
• Comment Deadline 14 July 2003
• Click for Press Release on IFRIC D1 (PDF 29k).
• IFRIC 3 Emission Rights issued 2 December 2004
• Effective for annual periods beginning on or after 1 March 2005
• Click for Press Release on IFRIC 3 (PDF 38k).
• Discussed at the IFRIC June 2005 Meeting
• Discussed at the IASB June 2005 Meeting at which time IFRIC 3 was Withdrawn.

In the light of the Kyoto agreement, several governments have, or are in the process of developing, schemes to encourage reductions in greenhouse gas emissions. The Interpretation focuses on the accounting to be adopted by participants in a 'cap and trade' scheme, although some of its requirements might be relevant to other schemes that are also designed to encourage reduced levels of emissions and share some of the features of a cap and trade scheme.

Typically in cap and trade schemes, a government (or government agency) issues rights (allowances) to participating entities to emit a specified level of emissions. (The government may issue the allowances free of charge or the participant may be required to pay for them). Participants in the scheme are able to buy and sell allowances and therefore, in many schemes, there is an active market for the allowances. At the end of a specified period, participants are required to deliver allowances equal to their actual emissions.

The Interpretation specifies that:

• rights (allowances) are intangible assets that should be recognised in the financial statements in accordance with IAS 38 Intangible Assets.
• when allowances are issued to a participant by government (or government agency) for less than their fair value, the difference between the amount paid (if any) and their fair value is a government grant that is accounted for in accordance IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.
• as a participant produces emissions, it recognises a provision for its obligation to deliver allowances in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. This provision is normally measured at the market value of the allowances needed to settle it.

Discussion at the June 2005 IFRIC Meeting

In June 2005 the IFRIC discussed two papers:

• A proposed amendment to IAS 38 Intangible Assets that would create an additional category of intangibles measured at fair value through profit and loss, and
• A proposal from EFRAG as to how hedge accounting could be used to resolve the mis-match issues created by IFRIC 3.

At its February 2005 meeting the IFRIC had agreed to prepare a limited amendment to IAS 38, despite the preference of some members for the revaluation model contained in that standard to be completely revisited. It was noted that the effect of the proposed amendment was to move the gains and losses into the same place (profit and loss); however the timing might still have a mismatch because of the at the beginning of the period an asset exists, for which fair value gains and losses must be recognised, however the corresponding liability builds up over the period.

EFRAG presented a paper proposing to include emission rights within a hedge accounting model, that would use the principles of cash flow hedging to deal with this issue. There was support from a number of IFRIC members; however, many expressed reluctance to take the project further until the IASB had been explicitly consulted as whether they considered this an appropriate project to pursue.

It was noted that the amendment to IAS 38 in itself is insufficient to alleviate the concerns raised by EFRAG, but is not incompatible with the EFRAG proposals. Accordingly, the amendment to IAS 38 would solve part of the problem for entities that do not pursue hedge accounting. It was noted that if the hedging proposal was used, it would be difficult to mandate hedging (as entities could fail eligibility for hedging on a number of criteria, particularly forecast usage), and therefore this might open up more options. It was agreed that in principle hedge accounting should be required where certain facts and circumstances exist, with a default treatment being required if an entity fails to meet the hedge accounting requirements. The IFRIC agreed that the staff should continue with the proposal to amend IAS 38, subject to satisfying themselves that the amendment is necessary irrespective of whether the hedging methodology is introduced, and that the result of such an amendment is not to back IFRIC into a corner such that their options for introducing the hedging rules are limited. Staff agreed to check with the financial instrument team whether it was appropriate to use cash flow hedging during the period when the entity has only the allowances, and fair value hedging after the emissions have been made.

The IFRIC noted that there are other issues, such as the appropriate initial recognition date, however did not seek to resolve these issues at this time.

Discussion at the June 2005 IASB Meeting - Withdrawal of IFRIC 3

At the June 2005 IASB meeting, the IFRIC staff introduced the topic by outlining the development of IFRIC 3 and the subsequent developments within the European Union, including the fact that EFRAG Recommended (PDF 303k) that IFRIC 3 not be endorsed for use in the EU. There followed a long and vigorous debate during which several alternative treatments were proposed.

Board Members acknowledged that IFRIC 3 had expressed a correct and appropriate interpretation of existing standards. Board Members expressed similar reservations over the effects of that Interpretation to those that had been expressed by IFRIC members at the time it was finalised but observed that they, like IFRIC, had been under the impression at the time that an Interpretation was needed urgently because of the imminent start of the EU 'cap and trade' scheme. However, it was apparent that this urgency was no longer there. Consequently, the Board decided to take the time to conduct a broader assessment of the nature of the various volatilities resulting from the application of IFRIC 3 to a 'cap and trade' scheme and to consider whether and how it might be appropriate to amend existing standards to reduce or eliminate some of those volatilities.

The Board voted to withdraw IFRIC 3 with a public explanation of its plans to conduct such wider assessment (12 in favour; 1 opposed; 1 abstained). How this withdrawal is to be effected will be decided at the July IASB meeting.

In July 2005 the Board issued a Public Statement on Withdrawal of IFRIC 3 (PDF 42k).

Discussion at the July 2005 IASB Meeting

During discussion of the Board's agenda plan, it was indicated that the Board itends to issue an exposure draft in the first half of 2006. Whether the approach will be amendment of IAS 38 or of IAS 39 remains to be decided.