Carbon Credit

Pollution is one of the risk factor which affect human lives as well as industrial health. Burning of
fossil fuels is a major source of industrial Greenhouse Gas (GHG) emission. Different industries
like cement, power, steel, textile, fertilizers, ceramics and others emit certain gases like carbon
dioxide, methane, nitrous oxide, carbons, etc., these gases are also called GHG gases and have an
adverse impact on the environment particularly on the Ozon layer. About 142 countries agreed to
reduce the emission of GHG in their respective country and signed international agreement in the
Kyoto Protocol to reduce the emission of GHG. This commitment of different countries created
the market for carbon credit.

Kyoto Protocol and Origin of Carbon Credit Trading

The Kyoto Protocol signed by about 142 countries in February 2005 specify that countries to
initiate the efforts to reduce the emission of GHGs in their respective countries. These efforts

will help in reducing the harmful impact on Ozon Layer. The countries agreed to reduce the GHG
emission by 5.2% and bring it below the level of 1990 by 2012. The penalty for non-compliance
in the first phase is Euro 40 per ton of carbon dioxide equivalent and in the second phase the
amount of penalty to be hiked to Euro 100 per ton of carbon dioxide. The first phase to continue
till 2007 and second phase to start from 2008 onwards.
This treaty and commitment by different countries created the market for the trading of carbon
credit. The companies and governments that reduce GHG gas level can sell their emission credit
to companies and governments that are close to exceeding the emission limit or have exceeded the
emissions limit. The reduced level of emission is to be counted as carbon credit measurable as tons
of carbon emission allowance. Thus, a new segment for trading carbon credit has been evolved.
Carbon credit created by the industry by conserving the environment is required to obtain the
certificate of creating carbon credit. The certification is to be given by the agency authorized by
government to carry out the validation of carbon credit accumulated by the industries.
Carbon Accounting

Carbon accounting covers two important aspects related to carbon credit for a business
organization. First part is the physical carbon accounting which aims at quantifying physical units
of greenhouse emissions to the atmosphere, and second financial carbon accounting which looks
at giving carbon a financial market value.
Physical carbon accounting helps companies to estimate quantum (volume) of carbon emitted by
them in the atmosphere, this is called as greenhouse gas inventory. Then a measurement of carbon
emission reduction done by the company is done. If company is having net positive greenhouse
gas inventory (carbon emission reduction is more as compared to greenhouse gas inventory) then
this is recorded as ‘carbon credit’ – as an asset, technically known as GHG credit. This GHG
credit can be sold by the company. On the contrary to this if a company has negative greenhouse
gas inventory then it is recorded as a liability to be paid off or set off by purchasing GHG credits
from market.
Financial carbon accounting is a mechanism to assign monetary value (cost) to GHG credit
obtained by the company and record that in the books of accounts. Subsequently when this GHG
credit is sold in the market the resulting cash inflow is called GHG credit revenue. The difference
between GHG credit revenue and cost of GHG credit is termed as profit earned on GHG credit.
Carbon Accounting Concepts
With respect to carbon accounting below mentioned accounting concepts are applicable :
Cost concept : This implies that the company should record all the relevant direct and indirect costs
attributable to reduce carbon emission by the company. If company is purchasing GHG credits to
offset negative inventory of greenhouse gas inventory (a situation when carbon emitted by the
company is more as compared to the limits permitted to it) then all the costs incurred to purchase
GHG credit should be shown as cost of GHG carbon credit.
Matching concept : All the costs relevant for the current financial year is to be matched for the
revenue for the year so as to arrive at correct profit.
GHG Credit Valuation Concept : GHG credit are initially recorded as an asset in the books of
accounts following cost concept as explained above. At the end of the financial year the closing
balance of GHG credit is shown as a current asset in the balance sheet. These GHG credits can be
used in two different manners in the next financial year. First, use these GHG credits to offset next
years greenhouse gas inventory, Second sell these GHG credits in the market. Since these are
recognized as current asset therefore these are to be shown in the balance sheet at lower of the cost
of market value (LCM) on the balance sheet date. If market value of GHG credit on the date of
balance sheet is less as compared to the cost of GHG credit then the difference is added to the cost
of GHG credits consumed during the year.
In summary it can be said that for carbon accounting or accounting for greenhouse gases routine
accounting principles are applicable. Therefore, it is like accounting for another inventory item by
the company using standard accounting concepts applicable in the organization.