Environmental credits: Understanding new FASB guidance

0:00Thought Leadership from PwC's National Office. Hello, and welcome to PwC's accounting podcast. I'm Heather Horn. In today's episode, we're talking about a new accounting standard on environmental credits and the related environmental credit obligations. Historically, there's been diversity in practice and how companies account for these. And the new guidance establishes a consistent framework for recognizing, measuring, presenting and disclosing these assets and liabilities. Environmental credit markets and compliance programs continue to evolve both in regulatory and voluntary settings. So even if this guidance isn't applicable to you today, it's something you should keep on your radar.

0:48Joining me for this conversation, I'm happy to welcome to the podcast, Mike Pratt, a partner, and Logan Redland, a director in our national office. They've both been closely following this project, including helping to draft our comment letter and engaging with the FASB, clients, and engagement teams on this topic. Mike, Logan, welcome. Thanks for having us. Thank you. All right. So let's jump straight into things, maybe starting with the basics. So Mike, I'll turn to you first. Can you provide some background on why the FASB issued this new standard? Yeah. So there was no specific US GAAP guidance for environmental credits or related obligations.

1:23As you mentioned, as a result of that, there was significant diversity in practice. When Logan and I were researching this project, we did outreach with a number of companies across a number of industries. And we found that some companies were applying an inventory model. Some were treating them as intangible assets. Some were expensing them as they acquired them. Others were applying a fair value model. So really all over the board. There were companies that were internally generating credits, and some of them were allocating costs to those and putting them on the balance sheet. and others doing pretty much the same thing business-wise, we're not doing that.

1:58And then in terms of timing of expense recognition for environmental obligations, some companies were following what you would call an accrue-as-you-go approach and others were following a shortfall method, which we'll talk about here in a little bit. So tremendous diversity in practice. One of the things we heard repeatedly when we talked to companies was that their environmental credit activity at the time just wasn't material. And that really played out in the disclosures we saw in financial statements and footnotes. What companies were disclosing, if anything, was really tailored towards what they were doing.

2:33Maybe they had a significant purchase in a period or significant expense, but really a lack of transparency and a lack of comparability in disclosures. When we think about where environmental credits have been going in recent years, we've seen a tremendous growth in companies using these credits. And so the FASB was certainly aware of that as they were working on this project. A lot of companies are publicly committed to net zero goals. And so they're acquiring a lot of credits to help them meet those commitments. We have seen some pullback in regulatory programs in recent years. And so even though there has been some pullback in some of those programs, for example, the EPA recently rescinded its greenhouse gas endangerment finding, I think the growth in the voluntary use of credits has far outweighed some of the pullback in those programs.

3:21And certainly not to be surprised, investors have been asking for more transparency and comparability in this space. Yeah, I mean, I think one of the things that's so interesting on this topic will probably two things. One is the fact that there's so many different types of programs and purposes, voluntary and regulatory, I think creates the challenge. And that's also interesting to think about how this intersects with companies' sustainability reporting. So we'll get into that and what this all is going to mean in the podcast. So with that, what, at a high level, does the new ASU require in terms of the accounting?

3:56Sure. So the standard establishes when a company should recognize environmental credit assets, as well as how to measure them, both initially and on an ongoing basis. It also establishes when a company should recognize environmental credit obligations and how to measure those as well. It then provides specific presentation and disclosure requirements, which we'll get into here later. A key concept in this standard is that it is based on the company's intent and it uses a probability threshold. So, for example, if a company intends to use an environmental credit to settle an environmental credit obligation or it intends to transfer it in an exchange transaction, for example, to sell it, and it's probable they will do so, then the credit can be recorded as an asset.

4:38Otherwise, it must be expensed. So a key point here is that two different companies with the same type of environmental credit might account for that differently depending on what the intended use is. Um, also environmental credit assets and environmental credit obligations must be presented gross on the balance sheet. They can't be netted. Uh, but the accounting can be linked when there's an asset that's probable of being used to settle an obligation, in which case the measurement of the liability will be based on the measurement of the asset. Yeah, and I think one thing that is worth highlighting here is this intent model.

5:09And it's interesting. I've been in some other discussions on this. And I think people miss it a bit the first time that really that counting here is going to be based on how you intend to use them. And that's definitely something that the FASB received a lot of feedback on. And so I just want to reiterate that in particular, if you have credits that are intended for voluntary purposes. So, for example, those would be ones that you're acquiring for your net zero or other types of emission reduction programs. Then those are going to need to be expensed in general for accounting purposes, even though we're seeing those reported in sustainability reporting.

5:46And so that is going to cause for companies reporting under U.S. Gap potential disconnect with their sustainability statements. And I think, again, this is really important for those companies that have voluntary purposes, less so obviously for companies that are purchasing these for regulatory purposes or trading because then there's a different approach taken. So with that clarity, and again, I think that's one of the most interesting aspects of this statement. And I think for some companies can be source of frustration now that you're going to see this separation. Logan, why don't we clarify the scope of the standard and particularly which assets are included in this guidance?

6:26Yeah, so on the asset side, a environmental credit would need to meet certain criteria in order to be in the scope of this guidance. So it needs to lack physical substance. It cannot be a financial asset. It needs to represent rights that are associated with preventing, controlling, reducing or removing emissions or other pollution. It needs to be separately transferable. There doesn't necessarily need to be an active market, but it needs to be legally separately transferable. And then it cannot be an income tax credit because we do see income tax credits that relate to environmental activities.

7:02So those would not be in scope. And then, so it doesn't matter what the credits are actually called. We see certificates, we see allowances, we see carbon offsets. So those are all different kind of names of things that may be in the scope of this guidance, but you need to go through that criteria. So this is just the definition of an environmental credit. It doesn't mean that the credit actually will be recorded as an asset, but in order to be able to potentially record it as an asset, it's one to first need to meet this criteria. Yeah, so maybe a couple of common examples in this space. One would be an emission allowance.

7:37So emission allowances are remitted by companies that produce emissions, whether it's for manufacturing, power generation, or whatever, but they remit emission allowances to a regulator under some sort of regulatory program. So those are fairly common. Another example would be renewable energy credits. And as we talked about earlier, there's a lot of companies that are buying those for voluntary purposes and retiring those to meet voluntary net zero goals. And both of these examples, both of those environmental credits meet the definition of an environmental credit in the standard. However, but to Logan's point, it depends on how the company is going to use those credits to determine if they actually can recognize them as an asset.

8:20So even the same company can have the same types of credits, but may account for them differently depending on what they intend to do with them. All right. So it's going to be really important for companies to work with the operations side. I feel like this is a broken record on all of our podcasts to understand what they're purchasing and how they're being used. Maybe the other point I'd make here is that although this is U.S. Gap, a lot of companies playing U.S. Gap have international operations. And so these types of credits could go by a lot of different names around the world. So I think key point here, though, is just making sure no matter what the credit is called, that you're doing this evaluation.

8:56So you make sure you're following the right accounting model. Logan, one of the things that added complexity to all of this is the fact that for certain companies, they are going to have a liability. So that's either for emissions, which I think Mike talked about, or a lot of utilities will have that they have to reduce the amount of emissions from the power generation. So how do companies account for that? First of all, what even qualifies as environmental liability? And then what's that counting? Yeah, so this guidance also addresses what it calls environmental credit obligations. So it can get a little confusing when you're talking about environmental credits, environmental credit obligations.

9:36So we often abbreviate it ECO on the obligation side. So in order to be within the scope of this guidance and consider it an environmental credit obligation, it needs to be related to a regulatory compliance obligation, which must be in order to prevent, control, reduce, or remove emissions or other pollution. And then the key point where this makes the connection back to the asset side is that you have to be able to settle the obligation with an environmental credit. But that's not required, though. Some programs, you can do cash as well. But you still have the option of either satisfying the obligation with the credit or paying cash.

10:21And so those obligations would be in the scope of this guidance. Yes, going back to the previous examples I talked about, with the emission allowances, those programs are typically required by a regulator. And so those would fall into the environmental credit obligation part of this guidance. Um, there's also certain requirements into those programs where a company doesn't have to, um, submit credits or pay cash unless they exceed a certain threshold. And so those would fall into this, this ASU as well. Those are fairly common. Uh, and then contrast that to the renewable energy credit example I gave where a company's acquiring those for, for voluntary net zero goals.

11:00Those would not qualify under this program, even if a company publicly commits to a net zero obligation as it's not promulgated by a regulator. All right. So it's very important there is to understand them where your commitments are coming from. I guess, Logan, anything else we should highlight on the scope? Um, there's a couple explicit scope outs of, uh, ASC 818, which is, that's the, the new guidance that's set up by the standard, um, is if, uh, if you have a environmental remediation obligation that is in the scope of ASC 41030, you would follow, you'd still follow that guidance. You wouldn't be here in the new environmental credit guidance.

11:41I had mentioned before income tax credits, so those would follow, um, other guidance. And then there's also some scope outs, where if an arrangement is within the scope of 818, they clearly say you wouldn't follow other guidance. So government assistance, that's some new guidance in ASC 832. You would not apply government assistance. You would apply this standard. And then same for not-for-profit contributions. Again, you'd follow this standard. You wouldn't follow not-for-profit. Yeah. And I think that's really important, particularly the point on government assistance, because one of the big debates before we had this standard was whether or not if a government agency is giving you these credits, if they should be accounted for as some type of government assistance.

12:26So this clarification is definitely important. And I guess settled that debate from that perspective. So let's move on then to recognition and measurement. And Mike, first, again, focusing on the asset side, when would a company recognize an environmental credit as an asset? Yeah, so an asset is recognized if it meets the definition of an environmental credit, as Logan just went over. And it's probable collectively that it will either be used to settle an environmental credit obligation, it will be transferred in an exchange transaction, i.e. sold, or it will be used in a non-reciprocal transfer.

13:01So, for example, if a subsidiary earns or generates a credit and dividends it to a parent or an investor. A couple of key points. The probability threshold we're using here is around 75%. That's used elsewhere in US GAAP. The assessment is collective, meaning you don't have to specifically determine it's going to be used to settle an obligation or transfer it in an exchange transaction. It just has to be probable you'll use it for one of those things. And so companies can purchase credits and record assets in anticipation of future obligations. So it's very common for companies to buy, you know, two, three or more years worth of credits to satisfy their obligations and just retire them as they need to.

13:41And so that practice is fine, as long as they still think it's probable they'll use those for future obligations. And then, so again, getting back to credits that are used for voluntary purposes, those meet the definition of an environmental credit. It's just where they won't meet asset recognition here is when you get into the probability assessment that they're going to be used for one of those specific purposes to recognize it as an asset. Okay, that's super helpful, Mike. So can we rewind a moment, though, to this non-reciprocal transfer? And we're talking, so then a subsidiary that's potentially like, for example, dividending to the parent or investor.

14:17So in that case, then you're saying that the subsidiary would be able to recognize an asset. However, then the parent or whoever it's transferring it to would also need to do that assessment. So potentially, then at that point, it would wind up being expensed. Yeah, yeah. So good question. So think about it, a subsidiary may not have an obligation in and of itself, but it might earn a credit, but the parent may have an obligation. And so, yeah, it could dividend the credit up to the parent and the parent could use it, but both entities would probably need to go through that evaluation. And hopefully within the consolidated group, they would meet the definition.

14:52Okay. Or then if not, the consolidated group would either expense or record the asset, depending on the ultimate purpose there. Okay. All right. That's helpful. And then back to your point about the assessment being collective, when you say collective, you're not necessarily talking about a group of credits. You're more so talking about that it will either be used to satisfy an obligation or be traded. So are you evaluating a group of credits or are you evaluating each credit? Yeah. So also a good question. I guess I meant collective in two contexts. So the first one is you don't have to go through and look at every single credit and make a determination on its own.

15:33You can bucket them and say, Hey, look, if I have a thousand credits, I don't know exactly today what I'm going to do with every single one of them, but I do think it's probable I'm going to use all thousand of those. And therefore it meets the definition. Again, you don't have to go through for every credit and say, I'm going to use this one specifically to settle an obligation or I'm going to sell it. But I do know that I'm going to use all of them and to do, to do one of those things. And so collectively, you know, which one of those things? I don't know today, but it will meet one of them.

16:02Okay, that's helpful. But I probably could lead in then into measurements. So Logan, if we determine that you are able to recognize the credit, then how would you perform your initial measurement? So the initial measurement is also going to depend on how you obtain the credit. So if you're obtaining the credit because you're internally generating the credit or it's being granted to you by a regulator, you would measure that credit at its transaction costs only, which we expect to be minor. And in some cases, there won't actually be transaction costs. So it would be recorded at zero. It still would be an asset, which matters for some of the subsequent accounting, but it would be recorded at zero.

16:49And then an important point here is you would not allocate any production costs. So for example, example, today, you have, we talked about an inventory model, some companies who are generating the credits are allocating those production costs to these credits as well, you would no longer be doing that. You anticipated my question that I jotted down as soon as you said the first point. And then all other credits would be measured at the cost to obtain that credit. If there is that there may be other applicable guidance for those credits. So for example, if you obtain them from a customer. You may be looking to ASC 606 to figure out how to allocate those costs.

17:28So you'd still look to that other guidance to help with measurement, but yeah, you'd be recording those at cost. And then another thing you need to do at this time is assess classification of these credits, which will be important for subsequent measurement, your disclosures, and when we get to measuring the environmental credit obligation. So you're either going to have compliance credits, and those are when it's probable that you're going to use them to settle an environmental credit obligation, and then everything else would be a non-compliance credit. Yeah, so for internally generated credits, this guidance in the ASU will likely be different from what some companies are doing today.

18:08So we saw companies who their primary business model was to generate credits and then sell them, and that's how they generated their revenue. Now, some of those companies took an approach of taking their production costs, allocating them to credits under an inventory model, whereas others that did pretty much the same thing didn't take that approach. And so, again, we've seen diversity. This is going to hit on that diversity in practice, but it will require companies, some companies, to change what they're doing. This was one of the areas that had the most debate when the FASB deliberated on this.

18:39And by a four to three vote, they decided not to allow costs to be allocated to internally generated credits. So, Mike, it's really an interesting point, because if you think about a company that's like a solar farm or a wind farm, and they're generating power and they're generating credits, less so probably today than it was previously. But the renewable energy credit is often a lot of the value that they're generating. And so what we're saying is, that doesn't matter, all those costs are going to go to the power. And then the renewable energy credit, basically, if they're planning to sell it goes on their balance sheet at zero, and then or effectively zero, and then they're going to have a gain at whatever point in time that they make the sale?

19:23There were a few comment letters that touched on this question of allocating consideration in a bundled transaction. The FASB responded not by putting new guidance in this ASU, but rather in the basis for conclusions section, they stated they felt this question was already addressed by the guidance in ASC 80550 on asset acquisitions, which essentially says the cost of a bundle of assets acquired shall be allocated to the individual assets based on their relative fair values. All right. So that's helpful context, Mike. And it's interesting to hear that that was a large point of discussion and then where they landed.

19:53It'll be interesting as well to see what that means in practice as companies start implementing this. So Logan, then if we go on to subsequent measurement, how does that work? Yeah, so then this is where the classification, one area where that comes into play. So your compliance credits are not going to be remeasured. So you would have just recorded them initially, and then subsequently they'll remain at that carrying amount. But then for non-compliance credits, you're going to assess them at each reporting period for impairment. So they'll be recorded at cost less any impairment. You can't reverse any impairments in future periods if the value goes back up.

20:32There is an available accounting policy election for these non-compliance credits. Those are only available for credits that are not internally generated or received from a regulator. So it's a fair value election where each period you'd be marking it up or down. I think most people who will use that election are the ones who are trading and selling these credits. And then classification will be reassessed at each reporting date. If it does change, then you'll assess for impairment prior to moving classification. So, for example, we talked about maybe someone buys a big chunk of credits and they know they're going to either use them themselves.

21:16to satisfy an obligation or they're going to sell any excess, you'd still be in this classification. You'd be figuring out, okay, what, you know, is it probable that I'm, which ones am I going to use for the obligation? Those ones I'm not remeasuring. The other ones that I'm going to sell, I will be, you know, assessing for impairment at least. And so in future periods, maybe at first you think 50 % of them you're going to use for your obligation. And then later now it's 60%. So now you need to move, you know, that extra amount into compliance credits. So it's possible you're kind of changing between these buckets in future periods and you have to reassess that classification each period.

21:58All right. It's definitely a complex model. And it's going to be a lot for companies that have these credits to go through that counting. I guess maybe before we go on to the obligations, Mike, you've mentioned a few points where there's a lot of debate from the FASB. I think one question that's interesting is why they developed this whole new model instead of just following either the intangible model or the inventory model that companies were previously using. Did they talk about that at all in the project or they just moved straight into a new model without really having debate about the applicability of one of the existing models?

22:33Yeah, so there was consideration under the different models. I think under the inventory model and kind of getting back to what I talked about in terms of internally generated credits, I think there was just a view that the subjectivity that goes into allocating cost to credits, it's complex, it's time consuming, and they didn't think that the benefit outweighed the cost. And so they didn't really pursue that. They did speak to intangible assets as well. But some of the board members kind of likened this to advertising costs and just didn't like the idea of, you know, having some of these viewed as assets in that regard.

23:13And so they did debate these different models. But in the end, they kind of picked something that I view. It's a bit of an amalgamation of these different models. Yeah, and it's interesting you said that cost doesn't outweigh the benefit, given that we know at least some people that would have been the ones doing this allocation raised that issue. But anyway, obviously, there's a lot to consider because these are relatively unique type of asset. So I think now that we've talked about these assets and the way they're recognized, let's move on to the liability side. And so, Mike, let me turn to you.

23:45And when would you be recognizing an obligation related to environmental credits? Yeah, so an obligation is recognized when the events have occurred on or before the reporting date, and the standard requires that a company assume the reporting date is the end of the compliance period. So if I think about a company that's a calendar year end, they get to the end of the second quarter, June 30th, they need to look at emissions or whatever activity generates the obligation through June 30th, and that's what their obligation should represent. It should only be based on past activities and it shouldn't forecast any future emissions.

24:20So even if a company knows that at the halfway point they're going to double, triple, quadruple their emissions, they shouldn't account for that obligation until they've actually incurred and done those activities. I mentioned threshold programs earlier, diversity in practice in there currently. And so this standard addresses that head on and basically says that no obligation should be recognized until the threshold is exceeded. And then the obligation would represent whatever the incremental obligation is above that threshold. Again, not considering any expected future reductions. When we were doing our outreach, we did learn that there are certain programs like the CAFE credits that certain auto manufacturers have to comply with.

25:01They actually do have the ability where if they produce a bunch of low gas mileage cars in the first half of the year, they can actually offset or perhaps even eliminate their obligation if they produce a bunch of high mileage cars in the second half of the year or electric vehicles that have no emissions. and the FASB is aware of those programs, but still they didn't feel that the obligation at any given point in time should reflect future activities. And so it's based on past activities as of that point in time. So then Mike, the threshold programs, if you have one of these programs with a threshold and let's say, you know, halfway through the year, you're going to exceed it.

25:37You're still seeing that in the first half of the year, no expense will be recognized. And then all the expense is recognized in the second half of the year. Yes. That's the way the model is written. And then was this another point of debate that the FASB talked about? Again, you gave the example of the cars, and I know this also can factor in for a lot of utilities, that maybe there's seasonality to the way they're producing. Yeah. So there was discussion around this, but in terms of the threshold program, and they recognized there was diversity in practice, but in the end, they all kind of felt that an obligation wasn't triggered until a threshold had been exceeded.

26:12And so they didn't think the accounting should really start until then. Okay. So then Logan, if we move on, once you recognize the obligation, how should it be measured? So here again, there's two kind of classifications that impact different measurements. So one is you're going to figure out if the obligation is funded. And to do that, you'll look at whether or not you have the credits already on your balance sheet that you will then use to, you expect to use to satisfy that obligation. So where that's the case, it's a funded ECO and you'll just measure the liability to be the same as the asset.

26:52And so this is where also the guidance has you do your accounting on the asset side first, and then you get to the liability. And then that's where you'll know, okay, I did record these assets. I'm going to, here's what I measured them at. And now my liability is going to equal the asset. And so back to what Mike said early on, even though they're going to offset each other, you still need to report gross. So you'll still have the asset and the liability, but they'll be equal and in effect net each other out. Well, and that's very consistent with normal offsetting rules because obviously it's with a different party.

27:29So that makes sense. Yeah. And they debated that too. And that was their rationale that you have other places in GAAP that report gross in those circumstances. And then you'll have anything else will be an unfunded environmental credit obligation. And to measure those, you're going to be recording them at fair value each period. And that's the fair value of the assets you would have to acquire to satisfy the obligation. There are two exceptions. So if the program that you're subject to allows you to settle in cash as an alternative, and that's what you expect to do, then you can use the cash value.

28:09And then also if you already have existing contracts, so for unconditional purchase commitments or rights, and there's a contractual value to purchase those credits, then you can use that value instead. So then Logan, what would happen then for Or de-recognition. So then once you've actually either remitted the credits to satisfy the obligation or paid the cash, then that's when you would de-recognize the obligation. All right. And then obviously the fair value is going to add some volatility. So was this another point of discussion in the deliberations? Yeah. I mean, they recognized that but thought it should be at fair value.

28:49Yeah. And I actually think a lot of companies were using a similar model already in some ways. So, yeah, I think except, though, the point that Mike made about not considering, you know, we are sort of future action. Yes. So you might have in fair value kind of considered, you know, all the bigger picture. But yeah. Well, yeah. You say utilities or otherwise. I feel like some companies at least were using a similar type of model already. But yeah, and then at least they gave those specific instances where if you do have that additional contract or you can pay cash, then you can. Yeah, take that into account.

29:28All right. Very interesting. So anything else then that we should take into account from an accounting perspective? Yeah, there's a few other areas where there's some specific guidance. So one of those is if you have a business combination. So if you're acquiring any environmental credit assets or the obligation in a business combination, there's some specific guidance. just at a high level on the asset side, you're going to recognize all of those environmental credits at fair value. And that's regardless of that probability threshold. That's regardless of your intended use. But then on day two, you would then apply the model we talked about.

30:04So it's possible you're recording some assets at fair value. And then on day two, you say you're going to use it, for example, for voluntary purposes and you'd expense those on day two. and then on the obligation side you're mostly following the the model that we talked about the only nuance here is that on the when you're determining whether the obligation is funded or unfunded you're only looking at the assets that you're acquiring the environmental credit assets that you're acquiring so it's possible maybe you already have you know credits that you own that you're going to use to satisfy those obligations but you can't take those into consideration in the acquisition accounting you would on in the future in day two accounting Okay, that's helpful.

30:45Anything else, Mike? Yeah, so one other area worth noting is in relation to ASC 815 for derivatives and hedging. The ASU specifically scopes out environmental credit obligations from ASC 815 in case there are any companies worried about maybe having embedded derivatives in environmental credit obligations. No need to worry. That's specifically scoped out. However, they did keep environmental credits themselves in play in terms of 815. So while credits themselves typically don't meet the definition of a derivative, a forward contract to buy credits in the future could meet the definition of a derivative.

31:21Generally speaking, credits aren't readily convertible to cash, but there could be certain types of credits in certain markets where maybe companies do view them to be really convertible to cash and these markets continue to evolve. So I would recommend companies just keep an eye on the space as these markets evolve. So, Mike, just to confirm then, from an obligation point of view, I think previously there was sometimes a view that there was an embedded derivative, like an embedded obligation to acquire these assets in the future. So what you're saying is explicitly now, you can just follow this model, you don't have to worry.

31:56I mean, it's already partly fair valued anyway, it's just interesting, but I think this is helpful clarification from the FASB. Yeah, correct. All right, how about presentation disclosure? Yeah. So in terms of presentation on the balance sheet, I think we mentioned earlier, it requires gross presentation. So you can't net assets with liabilities. And both the assets and the liabilities have to be presented both current and non-current on the balance sheet. And then when it comes to disclosures, there's a whole slew of disclosures, most of them annual. So you have to talk about the types of credits you have, how you obtain them, what the intended use is, your accounting policies, if there are any significant estimates involved, what those are.

32:41As you talked about earlier, impairment derecognition impacts have to be disclosed. For companies that apply the fair value option, there would be fair value disclosures under ASC 820. And there are also detailed disclosures for environmental credit obligations to break down between funded and unfunded obligations. So a lot more transparency should come from these requirements. All right. But again, it will go to companies' materiality. So if the program isn't material for that company, then you would scale these disclosures appropriately. But for companies with big or material activities, then this will add a lot of transparency.

33:20Yeah, correct. Okay, that's helpful. So maybe last point we should touch on is effective date and transition. Logan, what can you share? Yeah, so for effective date, early adoption is permitted. If you're not going to early adopt, then public business entities would be required to adopt for annual periods beginning after December 15th, 2027. So for a calendar year end, that's beginning in 2028. So like a year and a half ish from now. Yep. Okay. And then that would apply for interim periods within that year, so 2028. And then all other companies would be one year later. In terms of transition, on the asset side, you'd be reassessing all your credits to determine whether they meet the recognition criteria at the adoption date.

34:06If they don't, then you would be de-recognizing any of those credits. So for example, if you had the voluntary credits that you had capitalized, you'd have to expense those or they'd go through a cumulative effect of just adjustment and retained earnings actually. And then on the, you'd be also determining whether they're compliance or non-compliance credits. The compliance credits are just going to be measured at the carrying value that you already had them at on your books at adoption. Or if it's a non-compliance credit, it's the lower of your fair value or carrying value. Or if you make that fair value election policy election, you could record them at fair value.

34:45And then there's an additional election. If you're a company that has internally generated or granted credits, you can elect to measure all those at their transaction costs, if any. So if you had it at a higher, so we talked about like that inventory model, companies may have it at the higher value because they allocated production costs. You have a policy where you could record them at the lower value at the transaction costs. So, Logan, before you go on to the liability, so then when you said that compliance credits, you'd measure care and value. So even if your prior model was something different, you could just carry that value over and then apply this basically prospectively to new credits.

35:25Yeah. Okay, that's helpful. And then, but you're saying you don't. New guidance to new credits. Yeah, the new guidance to new credits, although you could elect to also apply the internally generated guidance to your existing credits. Okay, so that's helpful. And then how about from a liability side? So then just after, so you would have done all that on the asset side to figure out the value of your credits or your assets or if you had any of them. And then you would follow the funded, unfunded model that we had talked about to measure your obligation. And then it would be applied. So this would be applied retrospectively through a cumulative effect adjustment, opening retained earnings.

36:07And you're not going to be recasting any prior period numbers at the date of adoption. All right. That's helpful. So a little less work from an adoption point of view. So obviously there's a lot of changes and a lot of complexity that I highly recommend people take a look at the in-depth to make sure they understand the particular fact pattern for their particular programs. But Mike, it might be helpful to just give some highlights of as you're talking to clients what you're recommending they do now. Sure. So first I recommend they just identify where their current accounting defers from ASC 818.

36:42As we talked about earlier, given the lack of gap existing prior to this ASU and diversity in practice, most companies are going to have to change their accounting to some degree to adopt the standard. Presumably, companies have an inventory of their existing credits and have a handle on what their obligations are already for whatever their accounting is currently. But they will have to go through and evaluate all their credits for intent and assess probability. The other thing I would just ensure that management, investors and stakeholders are aware of the impact of the new standard because it could impact the financials in an unexpected way.

37:16So we talked about internally generated credits. And so that could change the timing of when expenses hit the income statement. And then, Heather, you also mentioned how the use of voluntary credits, there may be a disconnect between financial reporting and sustainability reporting in terms of when the costs of these credits get recognized relative to when they're actually reflected in sustainability reporting. As I mentioned earlier as well, many of the companies we talked to kind of said that their credit activity really wasn't material at this point in time. But I would encourage companies to think strategically where they might be in a few years as they adopt this standard and make sure they're thinking about the accounting policies and things that make sense for a future period where maybe the credits are more material to them than they are today.

38:00I'd be remiss if I didn't mention systems for tracking credits. I wouldn't be surprised to learn if a large number of companies are tracking these manually on spreadsheets. And that may be fine for the purposes of their accounting today. But it may not be fit for purpose as they have to go through and determine are they compliance credits or noncompliance credits? Are they voluntary? They have to do probability assessments, maybe fair value measurements. They need to break down their liability between funded and unfunded. And so there's just a lot more disclosure requirements. And so I would recommend companies look at those disclosure requirements and compare it to the information that they can get from their tracking system today and see if it's really fit for purpose or if they need to make some improvements there.

38:45And then the last thing I would just mention is process and controls. Again, given the lack of disclosures we saw historically, this is probably going to drive more disclosures in more companies' financials. And so you'll just want to make sure that processes and controls are up to snuff in a new disclosure that perhaps you didn't have before. All right, it's very helpful. And I was reflecting as we were speaking, it's very interesting, because I think, Mike, you and I are both coming from a background of having dealt with these programs for a long time, both from, you know, our utilities, the clients that would have had the obligations, maybe already also generating credits, buying credits.

39:21And then I think, Logan, you have come at this without that type of background, but more dealing from a sustainability and other perspective. And so I 100 % agree with all Mike's recommendations. I'm just curious if there's anything that you would add or change coming again from sort of a bit of a different direction, maybe less focus on the obligation side and more on companies with voluntary programs. Well, I think definitely the cross coordination, if you've got different people, you know, involved in the sustainability reporting and financial reporting and making sure that they on the sustainability side understand, you know, that these are being expensed and the disconnect for, you know, communicating to the right stakeholders.

40:03And then in your disclosures, I think also being consistent, you know, how you're describing them and all that. You're going to have this, you know, information. If you're a public company, right, you'll have the public information out there. And, you know, the being consistent is important. All right. Good advice. Thank you. And I think maybe the only thing I'd add from listening to both of you is that we mentioned a few times materiality and that for some companies right now, this may not be material. And I think we've all seen where things start. It's not material and become material. And that's where often then there can be potential issues.

40:37So definitely recommend if you have these programs, even if they're not material, that at least from a financial reporting, you get your hands around what they are and what your future plans are so you can measure them. Oh, sorry. I wasn't trying to interrupt you. No, that's okay. I was also going to say you talked about if you have the compliance, you know, if you have these programs and whether they become material, but also like the laws, you know, may change in the future. And so monitoring the regulations, where they go, and then, you know, it could become material or become something new to you in the future, depending on the direction that goes.

41:12I completely agree. I think that's a great point. And I also do want to echo your point on the fact that now having public information, potentially your financial statements, maybe other information in your sustainability statements, just trying to make sure you can reconcile and explain that because connectivity between the financial statements and sustainability statement is one of the sort of foundational concepts in at least both ESRS and IFRS sustainability disclosure standards. All right. So definitely a lot to think about, gentlemen. It's always a pleasure to talk to you. Thanks so much for joining me.

41:44Thanks for having us. That's our show for today. Tune in next week for more fresh episodes. So that you never miss any of our audio content, follow the PwC Accounting Podcast wherever you listen to your podcasts. And to stay up to date on all our latest accounting and reporting news, sign up for our newsletter at viewpoint.pwc.com. From Thought Leadership at PwC, I'm Heather Horn. Thanks for tuning in.

42:37www.pcc.com slash structure for further details. This podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors, including accountants and lawyers.