APPENDIX
A WORKED EXAMPLE OF AN ETS IN A NATIONAL ACCOUNTING FRAMEWORK
This example shows the difference between the split asset approach, recommended by the SNA, and the financial asset approach, favoured by the ABS, in recording tradeable emissions permits in a national accounts framework. The four significant economic phenomena involved, (sale of permits, taxable emission of pollution, market trading, and surrender of permits) are represented. The example is unrealistic in that it separates the phenomena in time, whereas all are expected to occur simultaneously once the scheme has been operating for some time. The example is structured as follows:
- Period 1: Government auctions tradeable permits to financial corporations for $100 (10 units of CO2, price of $10 per unit).
- Period 2: Liable non-financial corporations emit 10 units of CO2; the market price of CO2 is now $11.
- Period 3: Market price is now $10.50 per unit; liable non-financial corporations buy permits from financial corporations, and surrender them to government.
Period 1: Government auctions tradeable permits to financial corporations for $100 (10 units of CO
2, price of $10 per unit)
Under both the split asset approach and the financial asset approach, a sale of permits (for example via an auction) creates transactions to be recorded in the financial account and balance sheet only. In this example it is assumed that financial corporations buy permits as an investment, and not for surrender against a future emission liability.
The financial account transactions are:
- Financial corporations pay cash (reduction in financial asset) to government (increase in financial asset).
- Under the split asset approach, the permits bought will be recorded as tax prepayments: an account receivable (increase in financial asset) of financial corporations and an account payable (increase in liability) of government.
- Under the financial asset approach, the permits bought (increase in financial asset) will be recorded as debt security assets of financial corporations and an increase in debt security liabilities of government, except for GFS(footnote 1) .
- In all cases the transactions will be recorded at sale price of $100 (10 units of CO2, price of $10 per unit)(footnote 2) .
- The transactions will result in changes in the composition of financial corporation and government balance sheets.
- No change in net worth of either groups of transactor arises from the exchange of financial assets and liabilities.
The only difference between the split asset approach and the financial asset approach for period 1 is the classification of the financial asset/liability: tax prepayment (split asset approach) or debt security (financial asset approach).
Period 2: Non-financial corporations emit 10 units of CO
2; the market price of CO
2 is now $11
Emissions by liable entities, assumed to be only non-financial corporations, incur an accrued tax liability as they occur. These accruals are recorded as an expense of non-financial corporations and as revenue of government in the income and use of income accounts under both the split asset and the financial asset approaches. Under this scenario, the accruals are assumed to be unpaid at the end of the period, giving rise to a new account payable liability (of non-financial corporations) and account receivable (of government) through financial account transactions which result in changes of balance sheet position. However, the value of these accruals and unpaid accounts will differ depending on the approach taken. In this scenario it is assumed that the market value of the carbon units represented by the permits issued in period 1 has risen 10% to $11 by the end of period 2.
Under the split asset approach:
- the tax accruals will be valued at issue (period 1) price of $100 (10 units of CO2, price of $10 per unit);
- the unpaid value of the accrual will create a new account payable / receivable asset (of government) and liability (of non-financial corporations) in the financial account also valued in period 1 prices;
- the difference between the period 1 price and the period 2 price of $10 (10 units of CO2, $1 per unit) will create a new non-produced non-financial asset for the holders of permits, in this case the financial corporations that purchased them at auction in period 1; and
- this new asset does not emerge as a transaction (there has been no exchange of value) but as an entry in the other change in volume account of financial corporations, and as an additional non-produced non-financial asset on their balance sheet at the end of period 2, valued at $10.
Under the financial asset approach:
- the tax accruals will be valued at current market prices (period 2) at $110 (10 units of CO2, price of $11 per unit);
- the unpaid value of the accrual will also be $110 for non-financial corporations accounts payable and government accounts receivable in the financial account and balance sheets;
- the difference between period 1 and period 2 permit values of $10 (10 units of CO2, $1 per unit), will be recorded in the revaluation account for both permit asset holders, in this case financial corporations, and permit issuer, government; and
- both the revaluation account entries and the changed balance sheet entries will be classified as debt securities(footnote 3) .
It is in the period 2 scenario that the essential differences between the split asset and financial asset become evident:
- the tax accrual for non-financial corporations under this scenario is different to the extent of market price variation of CO2, in this case $10, which is also the difference in change in net worth for non-financial corporations and government under the two treatments;
- the market price variation of permits is treated differently, as a revaluation of a debt security(footnote 4) under the financial asset approach, and as the emergence of a new non-produced non-financial asset in the other change in volume account under the split asset approach; and
- Government debt is recorded at market price under the financial asset approach and at historic cost under the split asset approach.
Period 3: The market price is now $10.50 per unit; non-financial corporations buy permits from financial corporations and surrender them to government
The liable non-financial corporations that emitted in period 2 have to surrender permits to discharge their unpaid tax liability. They will have to buy these permits from permit holders, financial corporations, at market prices. At the end of period 3, the market price has fallen to $10.50 per CO
2 unit. The surrender of the permit not only acquits the account payable liability of non-financial corporations to government but also liquidates the liability government has to recognise permits that were created at sale in period 1.
Under the split asset approach:
- the decrease in the market value of permits in period 3 of $5 (10 units of CO2, $0.50 per unit) will be recorded as a disappearance of non-produced non-financial assets in the other changes of volume account for asset holders (financial corporations);
- the sale of permits by financial corporations to non-financial corporations will result in an exchange of cash of $105 (decrease for non-financial corporations, increase for financial corporations) and an exchange of permits (increase for non-financial corporations, decrease for financial corporations);
- however, the exchange of permits will be recorded in two parts: $100 in the financial account in accounts receivable assets for the historic cost component, and $5 in the capital account for the exchange of the non-produced non-financial asset that represents the market price variation since period 1 in this approach;
- the surrender of the permits by non-financial corporations to government is likewise recorded in two steps. The financial account records an exchange of permits in the financial account, decrease in accounts receivable (non-financial corporations) and accounts payable (government) at historic cost ($100) of the permits. The market price variation since period 1, $5, is recorded as a disappearance of the non-produced non-financial asset of non-financial corporations in the other changes of volume account. The surrender effectively cancels the permit and they disappear from balance sheets; and
- the surrender of the permits liquidates the tax accrual (account payable) liability of non-financial corporations created by emission in period 2 valued at $100 and the tax accrual (account receivable) of government. In effect, the tax prepayment created in period 1 offsets the period 2 tax accrual on delivery of the permits in period 3, even though the permits may be surrendered by a different entity to the period 1 purchaser.
Under the financial asset approach:
- the decrease in the market value of permits in period 3 of $5 (10 units of CO2, $0.50 per unit) will be recorded as a revaluation of debt securities in the revaluation account for asset holders (financial corporations) and the liability issuer (Government);
- the sale of permits by financial corporations to non-financial corporations will result in financial account entries for an exchange of cash of $105 (decrease for non-financial corporations, increase for financial corporations) and an exchange of permits (increase in debt security assets for non-financial corporations, decrease in debt security assets for financial corporations) also valued at $105, at period 3 prices;
- the surrender of the permits by non-financial corporations to government is recorded as an exchange of permits in the financial account, decrease in debt security assets (non-financial corporations) and decrease in debt security liabilities (government) at period 3 prices ($105). The surrender effectively cancels the permits (both asset and liability are held by government), and they disappear from balance sheets; and
- the surrender of the permits liquidates the tax accrual (account payable) liability of non-financial corporations created by emission in period 2 now valued at $105 and the tax accrual (account receivable) of government. In effect, the debt security created in period 1 offsets the period 2 tax accrual on delivery of the permits in period 3 valued at period 3 prices even though the permits may be surrendered by a different entity to the period 1 purchaser.
The market trading and surrender phenomena illustrated in period 3 show how the split asset approach received its name. The non-produced non-financial asset absorbs all market price variations allowing the surrender transactions to be valued at historic cost by government, with non-government participants recording capital gains and losses. It should be noted that under certain market conditions the non-produced non-financial asset could have a negative value. The ABS argues that this isolation of government from the impacts of market pricing of CO
2 by these artificial means is contrary to the fundamental principles of both the design of ETS schemes and to the principles of SNA.
Extension of the accounting treatments illustrated for ETS to free permits, internationally traded permits and similar schemes, such as RECs and the CFI, will show that under the split asset approach, all permits or certificates for which cash was not received by government on issue will not be reflected in government accounts as they will only be recognised as non-produced non-financial assets. For example, a free permit issued in period 1 of the above example will have zero historic cost but will have a market value on issue. The ABS argues that historic cost is an unrealistic representation of these schemes to the extent that government will accept such permits and certificates to acquit emissions liabilities of liable entities, or require mandatory purchase of credits by liable entities, such as in the RECs scheme, and that liable entities will incur market based costs to acquit their liabilities.
A worked example of an ETS in a national accounting framework
1 In GFS, these entries will be classified as accounts payable / receivable (see discussion in Section 5.2).
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2 To simplify the example all transactions are assumed to occur at end of period. Transactional prices applicable through the period should be used; in practice this is likely to be proxied by using average prices for the period.
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3 In GFS, these entries will be classified as accounts payable / receivable (see discussion in Section 5.2).
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4 In GFS, these entries will be classified as accounts payable / receivable (see discussion in Section 5.2).
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