As interest in environmental, social, and governance (ESG) matters increases, so does demand for electricity from renewable sources. As a result, many companies are turning to renewable energy sources to power their operations. While this can be costly, government and independent third-party agencies encourage this shift through the creation of financial incentives such as renewable energy certificates/credits (RECs). These financial instruments can be complex, especially given the sparse guidance that currently exists. This article discusses accounting for RECs in more detail and how they compare to other ESG-related credits.
Issuance of Renewable Energy Certificates
A renewable energy certificate/credit (REC) is issued for each megawatt hour of electricity generated and delivered to the electricity grid from a qualified renewable energy resource. These qualifying renewable energy sources include solar, wind, geothermal, hydroelectric power, and biofuel. The RECs are separate from the electricity itself and may be sold with the underlying power or on its own. RECs are usually certified by a government or an independent third-party agency. Some certification processes even require third-party verification to be performed by an independent certified public accountant or a certified internal auditor.
Upon the creation and issuance of an REC, the unique nature of the REC allows it to be accounted for as either an intangible asset or inventory. If the REC is being held for sale, then it is generally classified as inventory. If the REC is being held for use, then it can be classified as either an intangible asset or inventory as long as the classification is applied consistently, is reasonable, and is properly disclosed. While there is no authoritative accounting guidance regarding RECs, most companies follow these two models when a REC is created and issued.
If the REC is classified as an intangible asset, then it would be considered to have a finite life and would be subject to amortization since RECs are typically required to be claimed or retired within a short period of time.
Purchase and Sale of RECs
RECs are purchased in two types of markets: compliance and voluntary. Compliance markets consist of companies, such as utilities, that are required to obtain RECs to meet state requirements. Compliance markets exist because some states in the United States have Renewable Portfolio Standards (RPS) that set requirements for renewable energy use. These standards require that electrical utilities supply consumers with a minimum amount of electricity from renewable resources, with RECs providing proof of compliance. The utility company may generate the RECs themselves by using renewable energy sources. However, if they do not generate enough on their own, they must purchase the RECs to meet state requirements. The compliance market has higher standards than the voluntary market because states make additional requirements and regulations regarding the quality and nature of the RECs. This makes compliance RECs relatively more expensive than RECs purchased in the voluntary market.
The voluntary market consists of buyers that are environmentally conscious and choose to purchase the RECs voluntarily. These organizations have many different motives or reasons for purchasing RECs, such as achieving emission goals or receiving the social and/or financial benefits that come from being a “green company.” While there are some standards, such as the requirements provided by programs like Green-e, the voluntary market is highly unregulated and faces little restrictions. This makes the voluntary market RECs cheaper and easier to obtain.
Upon the purchase of a REC in a compliance or voluntary market, the buyer records the asset on its books at the amount paid. The seller records a gain/loss on the sale to the extent the purchase price is above/below the book value of the REC. When a power plant entity is the seller, the sale of a REC is recorded as revenue and certain considerations will need to be made to determine proper revenue recognition. For example, most utility companies pick one of two methods when determining the timing of revenue recognition. Some companies will determine the REC is recognized when the energy associated with the REC is generated. Others determine a REC is recognized upon REC transfer to a counter party purchasing the REC. The first method is based on output, while the latter method delays revenue recognition until a performance obligation has been satisfied. Either is appropriate if consistently applied. When a REC is created at generation, revenue is recorded at sales price if under contract for sale. If uncontracted, unearned revenue is recognized at the expected sales price and adjustments can be made once the REC is actually sold. If the REC is created at asset transfer, revenue will be recognized at the agreed-upon price at time of transfer.
Upon sale of the REC, the utility also needs to consider expense recognition (i.e., cost of goods sold). In most circumstances, the cost of RECs should be recorded as an expense when sold. However, in some cases, like those in which the REC is part of a lease or derivative, cost allocation may not be applicable. Furthermore, cost allocation may not be meaningful if the REC revenue is recognized at the same time as the related power revenue.
Additionally, since RECs that are generated for sale are generally accounted for as inventory, the utility entity should adopt an appropriate inventory model such as FIFO, LIFO, Average Cost, or Specific Identification for expense recognition.
Impairment of RECs
Impairment of a REC will depend on whether the REC is classified as inventory or as an intangible asset. If the REC is classified as inventory, in accordance with Accounting Standards Codification (ASC) 330-10-35, the REC will be kept on the books at the lower of cost, market, or net realizable value. A company should keep track of the market price of RECs to ensure that it is kept at the lowest of the allowable prices and record an impairment loss when necessary— which is recognized in cost of sales.
RECs classified as intangible assets subject to amortization should be reviewed for impairment based on the guidance found in ASC 360. Impairment evaluation is required when events or changes in circumstances suggest that the carrying value of the REC may not be recoverable. According to PwC, impairment indicators include:
- A significant decline in the price of RECs
- A significant change in the business or regulatory environment, such as regulatory actions or other changes impacting the need for RECs (e.g., softening or delay in mandates or expansion of allowable technologies)
If the RECs classified as intangible assets are impaired, the company would decrease the recorded amount with a corresponding debit to impairment expense. Impairment is only necessary if the asset is recorded above zero cost.
Using/Retiring the REC
Companies in the compliance markets that are required by state targets and regulations to obtain the RECs, should expense the cost of purchased RECs when they are submitted to meet the compliance obligation. Under inventory, the costs are a reduction to operating income and may be included in costs of sales. Under intangible assets, the RECs are amortized as they are used.
Companies that are in the voluntary market, and do not have to submit the RECs to a regulatory agency, need to determine when a REC is considered “used” and remove it from the books. General practice is to expense the REC when the company voluntarily surrenderers the REC to the applicable agency. The REC would not be amortized over a period of time.
Other Accounting Considerations
There may be other accounting and reporting considerations for RECs depending on the details of the transaction. For example, RECs can become more complex when they are purchased in a contract with other products or services. Since many RECs are sold in combination with the energy itself or other products, companies will need to consider whether lease or derivative accounting is applicable under the agreement. There may also be tax considerations and benefits given the unique nature of the REC.
Comparison to Other ESG-Related Credits
The accounting for RECs is similar to the accounting for other ESG-related credits such as emission allowance credits and carbon offset credits in the sense that these credits also are classified as either inventory or intangible assets upon acquisition. However, RECs differ in that they can be sold in conjunction with the renewable energy. Renewable identification numbers (RINs), on the other hand, are very similar to RECs. The only difference is that RINs are credits created when one gallon of renewable fuel is produced rather than the generation and delivery of one megawatt hour of electricity. RINs, like RECs, can also be sold separately or with the underlying good itself. Despite the similarities, each ESG-related credit has different regulations, and companies need to understand the substance of the transaction to understand the related accounting implications.
The market for RECs and other ESG-related credits is growing as interest in ESG matters increases. Understanding how to account for these credits is important given their complexity and a lack of authoritative guidance. As such, this article provides an overview of the accounting for RECs.
PWC, “Utilities and Power Companies Guide.” December 2018. Chapter 7.
Accounting for Energy Credits & Other Intangible Certificates, American Public Power Association Accounting and Finance Spring Meeting April 25-26, 2019