Accounting for Renewable Energy Credits

A Renewable Energy Credit (REC) is a tradable instrument representing proof that one megawatt-hour (MWh) of electricity was generated from a renewable source and delivered to the power grid. Companies purchase RECs to meet state-mandated renewable energy targets or to voluntarily support green energy production for their sustainability goals.

The main challenge in accounting for RECs is the lack of specific guidance from the Financial Accounting Standards Board (FASB). This has forced companies to apply existing accounting principles for other assets by analogy. This approach has led to diverse practices and a lack of comparability for investors.

Initial Recognition and Measurement of RECs

The initial recognition of a Renewable Energy Credit (REC) involves recording it on a company’s books for the first time. The valuation is determined by how the REC was acquired. If it is not probable that the REC will be used to settle a regulatory obligation or be sold, the acquisition costs are expensed as incurred.

RECs Acquired Through Generation

When a company generates its own RECs from a renewable source it owns, the initial cost recorded is often zero. Accounting principles do not allow for the allocation of the facility’s operating costs to the REC, as it is considered to have no separable cost from the electricity produced.

However, any direct, incremental fees paid for the certification or registration of the REC can be capitalized. This means the initial value of a self-generated REC is the sum of these direct transaction costs.

RECs Acquired Through Purchase

When a company purchases RECs on the open market, they are recorded at their acquisition cost. This includes the purchase price plus any directly attributable transaction costs, such as broker commissions. For example, if a company buys 1,000 RECs at $5 each and pays a $200 transaction fee, the total cost capitalized is $5,200. This cost basis is carried forward until the RECs are sold or retired.

Balance Sheet Classification and Subsequent Measurement

After a REC is recorded, a company must classify it on the balance sheet and account for changes in its value over time. The classification is based on the company’s purpose for holding the REC, which dictates the accounting model to be applied. Companies adopt one of two models by analogy: the inventory model or the intangible asset model.

This choice is an accounting policy that must be applied consistently and directly impacts the financial statements. A change in management’s intent for the REC can affect its subsequent measurement.

The Inventory Model

Companies that acquire RECs with the intention of selling them in the ordinary course of business account for them as inventory. This model is for energy traders, brokers, or generators who treat RECs as a product. Under this approach, RECs are classified as “Inventory” on the balance sheet.

After being recorded at cost, this inventory is measured at the lower of cost or net realizable value (NRV). NRV is the estimated selling price less any costs to sell. If the market price of the RECs falls below their original cost, the company must write down the inventory’s value and recognize a loss on the income statement.

The Intangible Asset Model

When a company holds RECs for its own use, such as for regulatory compliance or voluntary environmental claims, the intangible asset model is used. The RECs are classified as intangible assets on the balance sheet, either as current or non-current assets depending on when they will be retired.

RECs are treated as indefinite-lived intangible assets, meaning they are not amortized. Instead, they are tested for impairment at least annually. Impairment occurs if the REC’s fair value falls below its carrying amount, requiring the company to write down its value and recognize an impairment loss.

Derecognition of Renewable Energy Credits

Derecognition is the process of removing a REC from the balance sheet when it is sold or retired for internal use. The accounting treatment depends on the REC’s carrying value at the time of the event. This results in recognizing revenue, a gain, a loss, or an expense on the income statement.

Accounting for the Sale of a REC

When a REC is sold, the asset is removed from the balance sheet at its carrying value. The difference between the sale proceeds and the carrying value is recognized as a gain or loss on the income statement. For example, selling a REC with a $4 carrying value for $5 results in a $1 gain. This is presented in “Other Income/Expense” unless the company’s primary business is trading RECs, in which case it is part of revenue.

Accounting for the Retirement of a REC

When a company uses a REC for compliance or a voluntary commitment, it is retired and can no longer be traded. Upon retirement, the REC’s carrying value is removed from the balance sheet and recognized as an expense on the income statement.

The classification of this expense depends on the reason for retirement. If retired for a regulatory obligation, the expense is often classified as “Operating Expense.” If linked to producing a specific product, its cost might be allocated to “Cost of Goods Sold.” For instance, if a REC with a carrying value of $4 is retired for compliance, the company would record a $4 operating expense.

Financial Statement Presentation and Disclosures

On the balance sheet, RECs are presented as assets based on the chosen accounting model. Under the inventory model, they appear as “Inventory.” If the intangible asset model is used, they are listed under “Intangible assets” as either current or non-current.

On the income statement, selling RECs results in “Revenue” or a “Gain or loss on sale of RECs.” When RECs are retired, their value is recognized as an expense, such as “Operating Expenses” or “Cost of Goods Sold.”

Disclosures

Financial statement footnotes must provide clear disclosures. A company should disclose the accounting policy elected for its RECs, specifying whether it uses the inventory or intangible asset model and explaining the rationale for its choice.

The footnotes should also quantify the impact of REC activities. This includes disclosing the total carrying amount of RECs held at the balance sheet date. The company must also disclose the amounts of any gains, losses, or expenses recognized during the period from the sale or retirement of RECs.