A PDF of the below Comment Letter can be downloaded here »
Mr. Jackson M. Day
Technical Director
Financial Accounting Standards Board
801 Main Avenue, PO Box 5116
Norwalk, CT 06856-5116
Re: File Reference No. 2024-ED910
Dear Mr. Day,
This letter is submitted by Financial Executives International’s (FEI) Committee on Corporate Reporting (CCR) in response to the Financial Accounting Standards Board’s (FASB or Board) Proposed Accounting Standards Update—Environmental Credits and Environmental Credit Obligations (Topic 818) (Exposure Draft or proposed Update).
FEI is a leading international organization comprised of members who hold positions as Chief Financial Officers, Chief Accounting Officers, Controllers, Treasurers, and Tax Executives at companies in every major industry. CCR is FEI’s technical committee of approximately 50 Chief Accounting Officers and Corporate Controllers from Fortune 100 and other large public companies, representing more than $16 trillion in market capitalization. CCR reviews and responds to pronouncements, proposed rules and regulations, pending legislation, and other documents issued by domestic and international regulators and organizations such as the U.S. SEC, PCAOB, FASB, and IASB.
This letter represents the views of CCR and not necessarily the views of FEI or its members individually.
Executive Summary
We commend the Board for proposing authoritative guidance on environmental credits and environmental credit obligations. As companies continue to become subject to additional regulation related to emissions, we believe the proposed Update will provide clarity and drive consistency in the accounting for environmental credits and environmental credit obligations.
In our letter, we offer broad support for most of the amendments in the proposed Update, which we believe are generally clear and operable. CCR generally agrees with the proposed scope and definitions of environmental credits and environmental credit obligations. CCR also generally supports the proposed amendments on the recognition, measurement, and derecognition of environmental credits, but believes the Board could provide additional clarity on when to derecognize an environmental credit asset. Additionally, while CCR companies generally support the proposed amendments on the recognition, measurement, and derecognition of environmental credit obligation (ECO) liabilities, certain companies – primarily manufacturers with compliance programs that consider a company’s activities over a period of time – have concerns around the requirement to consider the end of the reporting period to be the end of the compliance period. These companies believe the proposed amendments will result in a significant increase in liabilities that will ultimately reverse, creating earnings volatility that is not consistent with current accounting practice.
CCR supports the Board’s objective of providing investors with decision-useful information through the clear and transparent presentation and disclosure of environmental credit assets and ECO liabilities. We strongly believe netting environmental credit assets and ECO obligations on a program-by-program basis will offer a more meaningful view to investors than the proposed gross presentation, as a net presentation better depicts the future net cash flows associated with a company’s regulatory compliance programs. The net presentation is also consistent with current practice at most companies. Additionally, based on feedback from our investor relations teams – and the fact that we generally do not receive inquiries from analysts or investors requesting this information – we do not believe the granularity of the proposed disclosures would provide significant incremental benefit to investors. In addition, we believe the proposed disclosures may result in the disclosure of proprietary information. Accordingly, our letter includes specific recommendations to streamline the proposed quantitative disclosure requirements.
We believe the proposed transition method is operable and support the option to elect early adoption. CCR is not opposed to the Board permitting companies to apply a full retrospective approach; however, we do not believe a full retrospective approach should be required. We believe it would be beneficial to provide preparers between 18 and 24 months to implement after a final standard is issued.
Master Glossary
We appreciate the Board’s efforts to update the Master Glossary to clarify the distinction between compliance environmental credits and noncompliance environmental credits. However, we believe further clarification is needed to differentiate between noncompliance environmental credits and voluntary environmental credits. The current definition of noncompliance environmental credits combined with the absence of a definition for voluntary environmental credits may lead to confusion and inconsistent application of these terms. For example, one interpretation of the definition of noncompliance environmental credits could be that these types of credits are inclusive of voluntary credits. In addition, the term noncompliance environmental credit has a different meaning for legal purposes, which is inclusive of voluntary credits.
To promote clarity and consistency, we recommend the Board (1) replace the term noncompliance environmental credit with the term environmental credit held for sale (or trade), as held for sale is already used in other parts of GAAP and widely understood across the preparer and user communities, (2) update the definition of environmental credit held for sale (or trade), and (3) add a definition for a voluntary environmental credit as follows:
Noncompliance Environmental Credit Held for Sale (or Trade): An environmental credit recognized as an asset in accordance with Topic 818 that is not a compliance environmental credit. Environmental credits held for sale (or trade) do not include voluntary environmental credits because voluntary environmental credits are not recognized as assets in accordance with Topic 818.
Voluntary Environmental Credit: An environmental credit that is not recognized as an asset in accordance with Topic 818 and is used to meet voluntary environmental initiatives.
Recognition, Measurement, and Derecognition of Environmental Credits
CCR generally supports the proposed amendments related to the recognition, measurement, and derecognition of environmental credits and believes they are clear and operable. Specifically, we agree that an entity should only recognize an environmental credit as an asset if it is probable that the environmental credit will be used by the entity to settle an environmental credit obligation or be transferred by the entity in an exchange transaction. We also agree that most environmental credit assets should be measured at cost and appreciate the Board providing companies with the option to subsequently measure certain environmental credit assets at fair value.
However, we believe the Board could provide additional clarity on when to derecognize an environmental credit asset. The proposed Update indicates entities should account for the derecognition of an environmental credit asset in accordance with Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets (unless a scope exception from that Subtopic applies). As discussed in paragraph BC70 of the Basis for Conclusions, the Board expects the proposed guidance would typically result in the derecognition of compliance environmental credits upon remittance to a regulator or its designee(s). However, CCR companies have observed that, in practice, regulators may not issue a formal report documenting a company’s compliance with the program until well after the end of the compliance period and when the environmental credits are remitted – sometimes years later. As a result, we suggest the Board consider clarifying in the Basis for Conclusions that (1) this formal report should be assessed similar to a customer acceptance clause in paragraph 606-10-55-86 of Topic 606 on revenue from contracts with customers and (2) a company can typically determine program compliance objectively, making the regulator’s report a formality that does not impact the timing of derecognition.
We also recommend the FASB consider clarifying when to derecognize environmental credit assets upon partial settlement of an obligation. For example, companies with compliance programs based on a company’s activities over a period of time often remit credits to the government that only partially cover the company’s obligation, along with a plan to generate the remaining credits necessary to settle the full obligation in the future. In these situations, it is unclear whether a company should derecognize the credits remitted upon partial settlement or wait to derecognize all credits when the entire obligation is settled. Furthermore, the actual credits used to fully settle the obligation often change between when a company communicates its settlement plan to the regulator and final settlement. Further guidance on this point would help promote consistency in practice.
Recognition, Measurement, and Derecognition of ECO Liabilities
Many CCR companies support the proposed recognition, measurement, and derecognition requirements for ECO liabilities. However, certain companies – primarily manufacturers with compliance programs based on a company’s activities over time – are concerned that the proposed amendments will result in a substantial increase in liabilities that will ultimately reverse based on a company’s future activities. Specifically, the proposed Update would require a company to recognize and measure an ECO liability as if the reporting date were the end of the regulatory compliance period, without factoring in any expected future activities that could reduce or eliminate its ECO liability.
CCR acknowledges that the proposed amendments are consistent with certain other GAAP. For example, Topic 740 on income taxes does not permit companies to anticipate changes in future tax rates or laws or consider expected future net operating losses when measuring an entity’s income tax liability. While we appreciate the consistency, the compliance period for ECO liabilities could span multiple years, differing from the annual compliance period for income taxes. Furthermore, there are other examples within GAAP where companies are required to consider future events or activities when measuring liabilities. For example, Topic 740 requires companies to compute an estimated annual effective tax rate in interim periods that reflects anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives. In addition, as discussed in Chapter 4 of the Conceptual Framework, “sometimes the nature of [certain] obligations is that the outcome of the present obligation, not the existence of the obligation itself, is determined by some future event. The consequences of the uncertain outcome may affect how the present obligation is measured.” By requiring companies to recognize and measure an ECO liability without considering any expected future activities, the proposed amendments could introduce significant earnings volatility not experienced today. This is particularly concerning for companies subject to programs that measure compliance based on a company’s activities over a period of time and/or in circumstances where an entity’s only compliance option is to internally generate credits in future periods.
In Example 2 – Case A, an automotive manufacturer selling vehicles in the United States is subject to a compliance program represented to control greenhouse gas emissions by establishing minimum levels of average fuel economy standards for vehicles sold. The compliance period begins on January 1, 20X4, and ends on December 31, 20X7. The entity is obligated to remit 1 environmental credit per vehicle for each mile per gallon that the average fuel economy of all of its vehicles sold within a designated model year is less than 32 miles per gallon. The regulator grants the entity 1 environmental credit per vehicle for every mile per gallon that the average fuel economy of all vehicles sold exceeds 32 miles per gallon. For the 3 months ended March 31, 20X4, the entity sold 100,000 20X4 model year vehicles with an average fuel economy of 30 miles per gallon. Under the proposed amendments, when measuring its March 31, 20X4 ECO liability, the entity would assume March 31, 20X4 (the reporting date) is the end of the compliance period and record a liability assuming it would be obligated to remit 200,000 environmental credits ((32 miles per gallon – 30 miles per gallon) x 100,000 cars x 1 credit).
However, assume the entity expected to launch a more fuel-efficient car in the period ended June 30, 20X4 and ultimately sells 800,000 20X4 model vehicles with an average fuel economy of 36 miles per gallon. The entire liability (and related expense) recorded in the period ended March 31, 20X4 would be reversed in a future period because the average fuel economy of all vehicles with a 20X4 model year would be above 32 miles per gallon.
To avoid this volatility, we suggest the Board allow companies to include forecasted future activities when recognizing and calculating its estimated ECO liability at each reporting date, similar to estimates of variable consideration (including payments to customers) in Topic 606.
In addition to volatility, certain CCR companies have operability concerns around measuring ECO liabilities. Under the proposed Update, a company would calculate its ECO liability by adding (1) the funded portion – measured at the carrying amount of compliance environmental credits expected to be derecognized upon settlement of the liability and (2) the unfunded portion – measured at (a) the fair value of the environmental credits necessary to settle the remaining portion of the liability at the reporting date or (b) a cash settlement amount. Certain compliance programs do not provide a cash settlement option, and credits may not always be available for purchase. In these scenarios, it would be difficult to measure the unfunded portion of the ECO liability, and as noted in the prior paragraph, the entity’s only avenue to compliance is to generate credits in the future that can be carried back. Such situations may be best addressed by disclosure as opposed to recognition of an ECO liability.
Presentation
CCR appreciates the Board providing specific presentation guidance for environmental credit assets and ECO liabilities; however, we believe environmental credit assets and ECO liabilities should be netted on a program-by-program basis. First, we believe this presentation will be more meaningful to investors as it better depicts the future net cash flows associated with a company’s regulatory compliance programs. Second, we believe this presentation would be consistent with the requirement to present the net funded status of a pension obligation. Third, this presentation would be more consistent with how many companies present non-voluntary environmental credits today.
Disclosure
CCR is aligned with the Board’s objective to provide decision-useful information to investors through clear and transparent disclosures. We also appreciate the inclusion of example disclosures in the proposed Update to illustrate the quantitative disclosure requirements; however, we believe the Board can achieve its objective without requiring all of the quantitative disclosures outlined in the proposed Update. Based on feedback from our investor relations teams, we do not believe the proposed level of granularity would provide a significant incremental benefit to investors and in some cases may result in the disclosure of competitively sensitive information. Furthermore, the detailed quantitative disclosures may obscure the most relevant information for users, hindering users’ ability to assess the entity's overall exposure and performance related to environmental credits. In addition, CCR companies do not typically receive questions from investors or analysts on environmental credits. Therefore, we encourage the Board to refine the quantitative disclosure requirements as outlined below. We recommend a more aggregated approach, focusing on key qualitative disclosures that can supplement amounts recognized on the balance sheet and income statement. We also recommend performing additional outreach with the investor community to understand whether the benefit to users may outweigh the cost, including the operational challenges for preparers in obtaining and disclosing this information.
Program-Level Balance Sheet Disclosures
The proposed Update requires companies to disclose a description, the carrying amount, and the classification (compliance or noncompliance) of each significant environment credit asset holding as well as a description and carrying amount (disaggregated between the funded and unfunded portion) for each significant ECO liability. We suggest the Board remove the detailed quantitative disclosures by program and instead require companies to qualitatively describe each significant environmental credit program, including a statement indicating the general magnitude of the program in comparison to the company’s other environmental credit programs. To understand an entity’s obligations and cash flows, we believe providing information on a total company basis segregated (1) between current and non-current assets and liabilities, (2) between compliance and noncompliance credit assets, and (3) between funded and unfunded liabilities is sufficient. This will also avoid potentially disclosing competitively sensitive information about a company’s plans for compliance with a particular program.
Income Statement Disclosures
The proposed Update requires companies to disclose information about revenues and gains and losses from sales of environmental credits in interim and annual reporting periods. The proposed Update also requires companies to separately disclose the total expense recognized in each interim and annual period for (1) environmental credits not initially recognized as an asset or subsequently derecognized, (2) impairment of environmental credit assets, (3) ECO liability accruals for emissions occurring during the reporting period, (4) remeasurement of ECO liabilities previously recognized, and (5) total amortization expense related to assets recorded related to an obligation to remit a fixed number of environmental credits solely because the entity exists as of a specific date in accordance with paragraph 818-30-25-2.
First, we recommend the Board remove the requirements related to revenues and gains and losses on the sale of environmental credits to avoid competitive harm. Specifically, requiring the disclosure of both sales and expense information could inappropriately provide users and competitors with margin information.
Next, we recommend the Board remove the individual expense requirements listed above and instead allow companies to disclose one aggregated amount representing the total expense recognized for environmental credits, where the total expense amount excludes expenses related to voluntary environmental credits. This approach will streamline reporting for investors and allow investors to clearly identify expenses related to mandatory compliance programs versus voluntary initiatives. Furthermore, as stated above, CCR companies rarely receive questions from investors or analysts about expenses incurred for environmental credits.
We believe these modifications to the disclosure approach will enhance operability for companies in several ways. First, separately identifying and disclosing expenses related to environmental credit assets and ECO liabilities may be challenging – particularly for companies with compliance programs that consider a company’s activities over a period of time. These companies may experience significant fluctuations in the funded and unfunded portions of the ECO liability, making consistent and meaningful disclosure difficult. Next, certain companies enter into bundled power purchase agreements (PPAs) or virtual PPAs (VPPAs) that include voluntary environmental credits, which would require estimation to accurately separate and disclose (1) expenses related to energy and (2) expenses related to voluntary environmental credits. Furthermore, under a VPPA, while the company obtains environmental credits generated by the counterparty, it does not actually receive energy directly from the counterparty. This may make it even more difficult to determine the expense specifically related to voluntary environmental credits. As a result, requiring companies to disclose expenses related to voluntary environmental credits could introduce significant judgement and variability, making it difficult for users to compare across entities. In addition, the cost of gathering and reporting this information – especially for companies with large portfolios of PPAs – would likely outweigh the benefits to users as both energy and voluntary environmental credits are typically expensed at or around the same time.
Cash Flow Disclosures
We suggest the Board remove the requirement to disclose the cash paid for environmental credits during the reporting period as we do not believe it would provide meaningful insight into a company’s performance. Companies may acquire environmental credits in different ways, (e.g., one-time purchases, bundled transactions, long-term contracts, etc.) and as a result, we do not believe this disclosure would provide comparable, decision-useful information for investors
Please refer to the Appendix for an example of the quantitative disclosures illustrating CCR’s suggestions above.
Additions to Disaggregation of Income Statement Expenses Requirements
The proposed Update would require companies to disclose expenses related to environmental credits within a table for each relevant expense caption required by paragraph 220-40-50-21 Topic 220, Disaggregation of Income Statement Expenses (DISE). Certain CCR companies may capitalize the costs of environmental credits into inventory or otherwise allocate the costs across various business units or line items. Consistent with the discussion of inventory and other cost allocations in CCR’s comment letter on the FASB’s DISE proposal, tracing the costs of environmental credits to specific line items will be challenging for some companies and will require the use of estimates. To improve operability, we suggest the FASB only require companies to separately disclose expenses related to environmental credits within a table if the amounts are only included in one expense caption that is also a relevant expense caption in accordance with paragraph 220-40-50-22.
Alternatively, if the FASB determines this suggestion does not align with the principles of Topic 220, we suggest the FASB remove the proposed amendments in Topic 818 that would require companies to disclose the income statement line items that include the expenses.
Effective Date and Transition
We support allowing entities to apply the amendments in the proposed Update retrospectively through a cumulative-effect adjustment to the opening balance of retained earnings as of the beginning of the annual reporting period of adoption. CCR also agrees that companies should have the option to elect early adoption.
CCR does not object to the Board permitting companies to apply a full retrospective approach, which would require recasting prior period results. However, we do not believe a full retrospective approach should be required as many CCR companies identified significant operability concerns related to recasting prior period results. For example, it could be difficult for certain companies to accumulate historical data related to prior compliance programs. In addition, it could be challenging for companies to determine the fair value of unfunded liabilities as of past reporting dates. Furthermore, meaningful comparability between periods may be limited if the Board affirms the proposed amendments to require companies to recognize and measure an ECO liability without considering any expected future activities, which may create earnings volatility between periods.
We believe it would be beneficial to provide preparers between 18 and 24 months to implement after a final standard is issued. While many companies do not expect significant changes to their accounting for environmental credits upon implementation, companies will need time to identify their population of environmental credit programs, assess the new guidance, document conclusions, and make changes to or design and implement new policies, processes, and internal controls. At this time, most companies do not anticipate a need for significant system updates to comply with the proposed Update. However, some companies may still require system modifications, especially if the FASB chooses to finalize the granular quantitative disclosure requirements as proposed. Additional time is also needed given the expected concurrent implementation of other standards.
Conclusion
We appreciate this opportunity to provide feedback on the proposed Update related to environmental credits and environmental credit obligations. We thank the Board for its consideration of our comments and welcome further discussion with the Board or staff at your convenience.
Sincerely,
Alice L. Jolla
Chair, Committee on Corporate Reporting
Financial Executives International