The Financial Accounting Standards Board's (FASB) proposed accounting guidance for carbon offset credits and other climate-related financial instruments still requires several revisions to avoid harming the environmental credit market. This view comes from the Environmental Defense Fund (EDF), an environmental advocacy organization.

EDF is one of 37 organizations that submitted comment letters during the public comment period for this standards update. Other participants include the Big Four accounting firms, General Motors, Ford Motor Company, and another environmental advocacy organization, the Center for Environmental Accountability.

According to an FASB spokesperson, the scope of environmental credits and obligations covered by the new rules includes: emission allowances from cap-and-trade programs, Corporate Average Fuel Economy (CAFE) credits, renewable identification numbers, and renewable energy certificates generated by state renewable portfolio standards. The update, formally named "Topic 818," aims to provide specific guidance in areas currently not effectively addressed by Generally Accepted Accounting Principles (GAAP).

Several comment letters, including EDF's, praised this specification. EDF's letter opened by commending FASB for providing "much-needed and beneficial industry-specific" accounting guidance that will promote "improvements in financial reporting clarity and consistency."

However, EDF also pointed out several aspects of the proposed rules that need revision. For example, the proposal requires companies purchasing environmental credits to fulfill voluntary sustainability commitments to expense the purchase cost immediately, whereas EDF argues that non-refundable advance payments made for future credit purchases should be recorded as prepayments and reclassified as intangible assets upon receipt of the credits.

EDF noted in its letter that its proposed revisions have multiple benefits, including that the intangible asset approach would better align with International Financial Reporting Standards (IFRS). Additionally, this approach would highlight on the balance sheet companies' proactive investments in future sustainability commitments.

Furthermore, the intangible asset presentation and disclosure model would "eliminate potential unintended economic and behavioral consequences of the immediate expense recognition approach, which could discourage companies from supporting sustainability projects that generate such environmental credits, thereby potentially undermining the economic foundation of the environmental credit market." This opinion was raised by Holly Pearen, EDF's lead counsel for carbon pricing, in an April 9 letter to FASB.

EDF also recommended that the proposed standard allow companies generating environmental credits for sale to use an inventory accounting model, enabling them to capitalize development costs of credit-generating projects as part of inventory costs and expense them upon sale of the credits. The current proposal requires such companies to follow the intangible asset accounting model, which does not permit capitalization of development costs.

Additionally, the Center for Environmental Accountability warned in its April 15 letter that, except for credits measurable under government-created cap-and-trade programs, "environmental credits may be misleading in representing specific environmental attributes. FASB should avoid supporting projects that encourage misleading representations bordering on fraud."

Therefore, the Center argued that the rules should only treat environmental credits purchased under compliance programs created by federal and state law as assets. Furthermore, the Center for Environmental Accountability noted that the Trump administration's shift in U.S. federal climate policy requires extra caution in defining terms within the new rules.

For example, the letter mentioned that, given the U.S. withdrawal from the Paris Agreement under the Trump administration, the update does not clarify whether FASB would allow U.S. companies to treat credits from the EU Emissions Trading System or credits traded under Article 6 of the Paris Agreement as accounting assets.

Marc Marie, chairman of the Center for Environmental Accountability, wrote in the letter: "FASB should proceed cautiously in considering how to incorporate environmental credits into GAAP. Because GAAP is referenced by many regulatory programs, any changes beyond modest modifications could create substantial legal issues for these regimes."

The business community also expressed concerns about the rules. For example, Ford Motor Company stated in its April 15 comment letter that the automaker agrees with most of the proposed update but believes certain disclosure requirements could raise "competitive concerns," and the liability measurement requirement that does not allow considering future "mitigation actions" when estimating obligation values "would likely result in income statement volatility."

An FASB spokesperson said the board will discuss all received comments at future meetings. FASB added the environmental credits topic to its high-priority technical agenda in May 2022.