Accounting for going green: How businesses are achieving net zero emissions and the financial reporting implications

April 07, 2022

Governments around the world, including Canada, have signed on to the Paris Agreement to limit global warming to 1.5⁰ and to achieve net-zero emissions by 2050 or earlier. Businesses have also set similar targets in order to contribute to the fight against climate change.

These commitments (and other environment, social, and governance (ESG) targets) are driven by the growing physical risks of climate change in the form of droughts, wildfires, and high temperatures as well as transitional risks as new regulations and expectations emerge from governments, investors, and consumers.

These types of pledges are rapidly becoming the norm and should be a wake-up call for businesses that are not yet on the path to fighting climate change or implementing ESG priorities.

Stakeholders are pressuring companies to move beyond setting targets and goals; they expect tangible progress toward those goals with transparent reporting and accountability from corporate leadership.

In this article, we look at how businesses are ‘going green’ and the resulting accounting and financial reporting implications.

What does achieving net zero mean?

In a business context, reaching net zero means that the amount of carbon that goes into the environment, due to activities in the value chain, is equal to the amount being sequestered. This can be achieved by tree planting, employing carbon capture technologies, or even buying carbon credits, where applicable, through programs like cap-and-trade systems or voluntary markets.

How can businesses achieve net zero?

The net-zero concept represents many value-creation opportunities, while building a more sustainable economy. However, moving from goal setting to an actionable strategy can be difficult. Achieving net zero or other ESG-related goals can be a daunting task and there is no one-size-fits-all approach.

“There are many ways that businesses can lower carbon emissions, everything from changing a product mix to switching to electric vehicles to updating facilities,” said Armand Capisciolto, National Accounting Standards Partner at BDO Canada. “But we’re also seeing more and more financial solutions being developed that actually create market incentives for companies to reach their lower-carbon targets,” he added.

For example:

  • Cap and trade
  • Virtual power purchase agreements (VPPAs)
  • Carbon offset credits
  • Sustainability-linked bonds

Are emerging solutions that have been effective in incentivizing companies to lower emissions. See below for a summary of each:

Cap and trade

  • Under cap-and-trade systems, regulators place caps on the amount of greenhouse gasses businesses can emit. If a business exceeds those, it can buy allowances from other companies that came under their own limits. The cap is reduced over time so that total emissions fall 
  • Here are two examples of some of the largest cap-and-trade systems in the world:
    • The European Union ETS: Emitters covered under the ETS reduced emissions by about 35% between 2005 and 2019
    • California & Quebec: These cap-and-trade programs became linked in 2014 creating the largest carbon market in North America 

VPPAs

  • VPPAs have emerged as an effective means of rapidly decarbonizing corporate energy consumption at scale
  • A VPPA is a long-term contract—typically 10 to 20 years—between a developer of renewable energy project and an interested energy buyer
  • VPPAs secure large amounts of carbon-free electricity at scale and help insulate companies against rising electricity costs over time by locking in a fixed price, while providing the developer with long term fixed cash flows, which reduces the risk of developing such projects

Carbon offset credits

  • Carbon offset credits can be purchased by polluters (individuals or businesses) from carbon-reduction projects such as wind farms in order to offset their own emissions
  • These are typically purchased to offset emissions that cannot be eliminated
  • Renewable Energy Certificates (RECs) certify that one megawatt-hour (MWh) of electricity was generated from a renewable energy source and was fed into the grid. The RECs earned may be sold to other entities that are polluting as a carbon credit to offset their emissions.

Sustainability-linked bonds

  • Sustainability-linked bonds require a company to meet an overall ESG target, such as reducing emissions
  • Generally speaking, the bond terms offer companies lower interest rates for meeting goals, but rates increase if the target is not achieved

The need for transparency and accounting standards

The carbon-reducing solutions outlined above are relatively new or ground-breaking and, consequently, there is no specific accounting standard that addresses all the issues that can arise from these arrangements. Because of increasing public calls for greater transparency around sustainability initiatives, companies must be able to communicate clearly about their emissions-cutting efforts and the impact such actions have on their bottom lines. However, a lack of accounting standards creates an uneven playing field and opens the door for potential green washing.

“How these programs are accounted for in financial statements can vary from contract to contract, if you’re the buyer or seller, or if a program is mandated by the government or initiated by the business,” said Braham Moondi, Partner at BDO Canada. “Currently, no clear guidance exists and judgements will need to be made. In fact, the best practice for getting the accounting right is reaching out to an accounting advisor who has expertise in this area.”

The ability to measure for carbon emissions and reduce their impact has become a key factor in business decision-making. Not only would standardization help businesses communicate more effectively with stakeholders, it would also help them evaluate their efforts against others in the industry and identify opportunities to make an even greater impact.

Getting the accounting right is important for transparency and measuring success, but it’s also important for improving access to capital, building trust with stakeholders, accessing government incentives, and attracting and retaining talent. talent. Learn more about how to activate ESG initiatives and the impact to your bottom line here.

Standardization is coming

Globally accepted sustainability standards are being developed. On Nov. 3 2021, at COP26, the UN global summit to address climate change, the International Financial Reporting Standards Foundation (IFRS Foundation) announced the formation of the International Sustainability Standards Board (ISSB).

The IFRS Foundation has created accounting standards used in more than 140 jurisdictions, through the International Accounting Standards Board (IASB). With the creation of the ISSB, the Foundation is aiming to bring a much needed, globally comparable standard for reporting on ESG matters to the financial markets. In addition, the IASB recently undertook an agenda consultation and they received feedback that they should undertake projects on climate related risks and pollutant pricing mechanisms. Learn more about incorporating ESG into your financial reporting here.

How BDO can help

ESG progress depends in part on the development and implementation of better, more transparent information.

BDO’s team of experts understand the best practices in your industry and will work with you to identify opportunities to implement, measure, and account for your ESG initiatives. If your business is setting ESG targets and is entering into financial transactions to achieve lower carbon emissions, reach out to a BDO advisor today.

Armand Capisciolto
National Accounting Standards Partner
BDO Canada
 
Braham Moondi
Partner, Accounting & Assurance
BDO Canada
 
Mary Mathews
Partner, Accounting Advisory Service
BDO Canada

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