Emissions Allowances Essay

Custom Student Mr. Teacher ENG 1001-04 5 July 2016

Emissions Allowances

Polluter Corp, has recently spent $3 million to purchase emission allowances, with a vintage year of 2012, in order to meet the need for additional EAs in the fiscal years 2010-2014. They will also need to sell EAs, with a vintage year of 2016, in order to offset the costs of the purchase. It is to my understanding that the need for EAs arose because of the significant amount of greenhouse gases emitted by the Company’s antiquated manufacturing facilities. In order to remedy this situation, plans were made to upgrade the facilities in 2014.

The reduced gas emissions that the upgraded facilities are expected to provide will render EAs with vintage years beyond 2014, useless, as they would no longer be needed to meet the gas emission standards. Consequently, the Company took action as explained above. Issues: Polluter Corp entered into two separate transactions in the fiscal year 2010, which must be appropriately classified on the statement of cash flows. Each transaction can be recorded as an operating, investing, or financing activity on the statement of cash flows. Financing activities consist of obtaining cash from issuing debt and repaying the amounts borrowed.

This also includes equity transactions, such as obtaining cash from stockholders, the purchase of treasury stock, and paying shareholders. Investing activities include the purchase or disposal of property, plant, and equipment as well as other productive assets, which are held for use in the production of goods or services. Investing activities also include the lending of money and collecting of loans. Operating activities consist of all transactions that are not classified as investing or financing. In general, this includes any activities involving the production and sale of goods or services that generate revenue.

Operating activities also include transactions that affect net income . After thorough research, it is apparent that Emissions Allowances are an unusual asset, whose recording and classification can occur in various ways. In order to determine how the asset will be classified on the statement of cash flows, it is important to decide what type of asset this will be and whether or not it is held or used in the production of good and services. If Emissions Allowances were being recorded as inventory, they would be classified as an operating activity on the statement of cash flows.

Additionally, the amortization of an intangible asset affects net income, and would therefore be an operating activity. This aligns with the requirements of operating activities because their impact on cost of goods sold will affect net income. Unless the Emissions Allowances are recorded as derivatives, the purchase or sale of Emissions Allowances would not be recorded as a financing activity because it does not involve the issuing or repayment of debt, nor does it include any transaction that would impact the equity accounts such as dividends or stocks.

Polluter Corp specifically states that the purchase and sale of Emissions Allowances are being recorded as intangible assets. Under this model, their inflows and outflows must be classified as an investing activity. This aligns with the requirements of investing activities, which include productive assets. Emissions Allowances are necessary in Polluter Corp’s manufacturing processes; therefore, they are considered an asset that is needed for production. Conclusion: As stated previously, Emissions Allowances are considered intangible assets that are used directly in the production of household cleaning products.

During the production process, the role of the EAs is to offset the pollutants and greenhouse gasses that are being released into the environment. If Polluter Corp used up all of its Emissions Allowances and did not have the ability to purchase more, production would have to be put on hold. Since production cannot go on without Emissions Allowances, it can be argued that these assets are in fact part of the production process. This leads us to the conclusion that the purchase and sale of Emissions Allowances are to be categorized as an investing activity on the statement of cash flows. Research and Analysis:

To aid us in our decision making process in the matter of determining the appropriate classifications in the statement of cash flows for the purchase and sale of EAs, we primarily used the Accounting Standards Codification First and foremost, we established that EAs are to be treated as intangible assets, as specifically stated by Polluter Corp, and supported by the Accounting Standards Codification. In the SAB Topic 10. F, under section S99-1 – Summary of Decisions Reached to Date (As of November 18, 2010), it states that the Boards decided “purchased and allocated allowances should be recognized as assets.

” This specific decision was in reference to emission trading schemes and tradable rights. Furthermore, the same section of the codification referred to above states that, “some entities follow an intangible asset model for emission allowances. ” In December 2004, the International Financial Reporting Interpretations Committee (IFRIC) released IFRIC 3, Emission Rights, which stated that allowances are intangible assets and should be measured at fair value when received from the government.

Secondly, we referred again to the Accounting Standards Codification in section 230-10, subsection 45-11 through 45-17, to discern which was the appropriate classification in the statement of cash flows for the two transactions made by Polluter Corp. According to sub-section 45-12, receipts from the sales of property, plant, equipment and other productive assets, fall under the Investing Activities in the cash flow statement. Sub-section 45-13 also states that cash outflows for investing activities are “payments at the time of purchase or soon before or after purchase to acquire property, plant, and equipment, and other productive assets”.

By definition, a productive asset is an asset used to operate the business. EAs are used by Polluter Corp in order to continue operating and producing goods, which means they can be defined as productive assets that fall under the category of investing activities. We established earlier that EA transactions are to be treated as transactions of intangible assets and conclude that neither of the transactions should be classified as operating activities, as supported by sub-sections 45-16 and 45-17.

The only category of operating activities that EAs might fall under is ‘payments made to settle an asset retirement obligation’, however; we established that EAs are intangible assets, which consequently, do not have costs related to future disposal. With that being said, a transaction related to EAs does not fall under the category of ‘payments made to settle for an asset retirement obligation’. In addition, FASB Statement no.

143 which addresses this issue of asset retirement obligation states that it addresses “the retirement of tangible long-lived assets and the associated asset retirement cost” and therefore only applies to tangible long-lived assets, not intangible assets like EAs. We can also conclude that EA transactions are not classified as a financing activity according to sub- sections 45-14 to 45-15. According to our research as presented above, we can safely conclude that the appropriate classifications for the purchases of 2012 EAs from Clean Air Corp. , and the sales of 2016 EAs to dirty Chemical Corp.

are investing activities. Summary and Recommendations: Emissions Allowances are intangible assets that must be appropriately classified in the statement of cash flows as either an operating, investing, or financing activity. EA’s are not classified as financing activities because they do not involve the issuing or repayment of debt or any transaction that would impact the equity accounts such as dividends or stocks. It can be argued that Emissions Allowances are not part of the production process and are solely used to counterbalance harmful chemicals released into the environment as a result of operating. However, as

previously stated, the absence of EAs would put a halt to production altogether, which means that these intangible assets are productive assets that should be classified as investing activities. Polluter Corp will record all transactions pertaining to Emissions Allowances as investing activities on the statement of cash flows. They will have a cash outflow when purchasing $3 million in Emissions Allowances and a cash inflow when selling $2 million in Emissions Allowances. Polluter Corp anticipates the need for additional EAs in fiscal years 2010-2014 and believes that they will have excess EA’s after 2014 due to their upgrade in facilities.

These upgrades will cost them an estimated $15 million, however; they will decrease greenhouse gas emission to a very low level, which means that they will be able to sell their EAs in order to offset the cost of the upgrade and possibly make a profit on their unused allowances in the future. Financial Accounting Standards Board (FASB). (2012). 230 Statement of Cash Flows. Retrieved from Accounting standards codification TM. Financial Accounting Standards Board (FASB): https://asc. fasb. org/subtopicviewall&trid=2134447

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