FRS 102 has no section on emissions allowances or carbon credits, so each business must set its own accounting policy under paragraph 10.4, building on the sections for intangible assets, government grants, provisions and inventories. In practice the choices are how to classify allowances held, whether free allowances are recognised at fair value or at nil, and how to measure the obligation to surrender allowances for emissions already made. Whatever policy is chosen must be applied consistently and the judgements disclosed.
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What exactly is being accounted for?
Two different things are often called carbon credits.
- Compliance allowances. The UK Emissions Trading Scheme came into effect on 1 January 2021 and works on a cap and trade principle. It currently applies to energy intensive industry and power generation installations, aviation and maritime activity. Operators receive free allowances, buy them at auction or on the secondary market, or both. By 31 March each year they submit a verified emissions report for the previous scheme year, and by 30 April they must surrender enough allowances to cover those emissions. Government guidance says free allocation to installations is provided on or before 28 February each year, and can be recalculated if activity levels change, with any over allocation returned.
- Voluntary carbon credits. These are bought by businesses outside a compliance scheme, typically to retire against their own emissions in support of a public claim. There is no legal obligation to surrender them.
Reporting of emissions is a separate regime; see streamlined energy and carbon reporting. The separate import levy is covered in the UK carbon border adjustment mechanism.
Why is there no specific rule?
Neither FRS 102 nor IFRS has a standard on pollutant pricing mechanisms. The IASB considered in January 2025 whether to add a project on them to its work plan and decided, by 13 of its 14 members, to defer that decision to its next agenda consultation. Under FRS 102, paragraph 10.4 requires management to develop a policy giving relevant and reliable information that reflects economic substance. Paragraph 10.5 directs it to FRS requirements dealing with similar and related issues and to the concepts in Section 2, and paragraph 10.6 allows it to consider IFRS.
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How can allowances bought for compliance be accounted for?
An allowance is a right without physical substance that can be traded, so the most direct analogy is an intangible asset under Section 18. A purchased allowance is a separately acquired intangible, so the probability test is treated as met (paragraph 18.7) and it is recorded at cost (paragraph 18.10).
Applying Section 18 needs care, because allowances are surrendered rather than used up over time. Paragraph 18.19 requires a finite useful life, but paragraph 18.23 allows a residual value other than zero where there is an active market from which it can be determined. Where residual value is close to carrying amount, little or no amortisation arises, and the asset is instead tested for impairment under Section 27 if the market price falls. On surrender, the allowance is derecognised against the obligation.
A business that buys and sells allowances in the ordinary course of business is in a different position. Section 18 does not apply to intangibles held for sale in the ordinary course of business (paragraph 18.1); those are inventories under Section 13. Paragraph 13.3 permits measurement at fair value less costs to sell only where the business operates in an active market and the inventory is a store of readily realisable value.
How are free allowances treated?
Free allocation is a form of government assistance. If free allowances are recognised as intangible assets, paragraph 18.12 says the cost of an intangible acquired by way of a grant is its fair value at the date the grant is received or receivable, in accordance with Section 24. The matching grant is then recognised under the performance model or the accrual model chosen for that class of grant (paragraph 24.4), and paragraph 24.3A requires reasonable assurance that conditions will be met and the grant received. Under the accrual model, a grant relating to revenue is recognised over the periods in which the related costs are recognised (paragraph 24.5D), which matches it to the emissions charge. The two models are compared in FRS 102 Section 24: government grants.
A simpler policy would record free allowances at nil and recognise a liability only for emissions not covered by allowances held. That gives a lower balance sheet total. Because FRS 102 does not address it directly and paragraph 18.12 deals with intangibles received as grants, a business choosing it needs to be satisfied that it meets paragraph 10.4 and should explain the judgement.
When is the obligation to surrender recognised?
The obligation arises as the business emits, not when allowances are surrendered the following April. Paragraph 21.4 requires a provision where there is a present obligation from a past event, an outflow is probable and the amount can be estimated reliably. Emitting under the scheme creates a legal obligation that cannot be avoided by future actions, as paragraph 21.6 requires.
Paragraph 21.7 measures a provision at the best estimate of the amount the business would rationally pay to settle the obligation at the reporting date. A business that already holds allowances to cover its emissions could measure that part by reference to the allowances held, and price any shortfall at the cost of buying allowances at the reporting date. The provision and the allowances held should be shown gross, not netted; see offsetting assets and liabilities.
How do the two approaches compare?
Illustration only. An installation needs 10,000 allowances to cover its emissions for the year to 31 December. It received 7,000 free allowances when the market price was £42, bought 2,000 at £40, and the price at the year end is £45. It applies the accrual model to the grant.
| Item | Fair value approach £ | Nil approach £ |
|---|---|---|
| Free allowances recognised | 294,000 | Nil |
| Purchased allowances | 80,000 | 80,000 |
| Provision: covered emissions at carrying amount | 374,000 | 80,000 |
| Provision: 1,000 shortfall at £45 | 45,000 | 45,000 |
| Grant income released | (294,000) | Nil |
| Net charge to profit or loss | 125,000 | 125,000 |
The profit charge is the same here, but the fair value approach shows larger assets, liabilities and gross income and expense. The figures diverge if allowances are sold, prices move, or free allowances arrive in a different period from the related emissions.
How are voluntary carbon credits treated?
With no obligation to surrender, there is no provision. A voluntary credit bought and retired in the same period is simply an expense. Credits held at the reporting date for retirement in a later period are a separately acquired intangible under Section 18, subject to impairment if their value falls, and are expensed when retired. Credits held for resale by a dealer are inventories under Section 13. A commitment to buy credits in future is not itself an obligation to recognise unless it becomes onerous.
What should be disclosed, and how does tax follow?
Paragraph 8.6 requires disclosure of the judgements with the most significant effect on the amounts recognised, and paragraph 8.7 requires information about key sources of estimation uncertainty, which can include the price used for any shortfall. Where free allowances are treated as grants, paragraph 24.6 requires the policy, the nature and extent of grants recognised and any unfulfilled conditions to be disclosed.
For tax, section 46 of the Corporation Tax Act 2009 requires trading profits to be calculated in accordance with generally accepted accounting practice, subject to adjustments required or authorised by law, so the accounting policy chosen generally drives the timing of deductions and receipts. The treatment of allowances for tax should still be checked separately rather than assumed. For the wider intangibles framework see FRS 102 Section 18, and for falls in value see impairment of assets.
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Related Accountapedia entries
- Capital allowances on cars and CO2 emissions
- Accounting for R&D tax credits and the expenditure credit
- The UK carbon border adjustment mechanism
- Debits and credits: the rules explained
- Streamlined energy and carbon reporting (SECR)
Sources
- GOV.UK: Participating in the uk ets
- IFRS Foundation: Pollutant pricing mechanisms
- Financial Reporting Council: FRS 102 September 2024 tmKYWO6
- legislation.gov.uk: Act 2009 c. 4, section 46
Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.