Environmental credits have become more prominent in recent years, as businesses focus on their environmental goals and regulatory factors move toward increasingly sustainable efforts. However, there has been no specific authoritative standard for accounting for such environmental credits and related obligations under accounting principles generally accepted in the United States. While entities looked to other standards for applicable accounting analogies, it became apparent that there was a significant lack of comparability in some areas.
In recent years, the Financial Accounting Standards Board (FASB) began working to address these complexities through the creation of the Accounting for Environmental Credit Programs project. This work progressed to the proposed Accounting Standards Update (ASU) that the FASB released for public comments in December 2024. In August 2025, the FASB addressed the received feedback and directed its staff to prepare a final ASU for vote. The tentative FASB decisions, described below, are tentative in nature and subject to change, and the final ASU is subject to a vote by the board before being considered final. For a detailed breakdown of the FASB board meeting and history of the project, see the FASB’s webpage on the Accounting for Environmental Credits Programs project.
Scope and definition
An environmental credit can be summarized as an enforceable right that’s either acquired, granted, or internally generated that meets certain criteria. Generally, an environmental credit:
- Lacks physical substance and isn’t a financial asset.
- Is represented to reduce, control, remove, or prevent emissions or pollution.
- Is separately transferable.
- Isn’t an income tax credit that may be used to settle an income tax obligation.
Examples of environmental credits and related compliance programs that may be in scope include emissions allowances, renewable identification numbers associated with renewable fuel standards, carbon offsets, renewable energy certificates, and other environmental allowances.
Recognition and measurement of environmental credits
Environmental credits should be recognized as assets when their use is probable for settling an environmental credit obligation (ECO) or when they’re transferred in an exchange transaction. Costs to obtain other environmental credits, such as those associated with voluntary environmental commitments, are to be expenses as incurred.
For initial measurement, environmental credits that are internally generated or granted by a regulatory body are valued at the amount of transaction costs incurred, if any. Purchased credits are to generally be measured at a cost. Subsequent measurement is driven by whether it’s probable the environmental credit is being used to settle an ECO (compliance credit) or not (noncompliance credit). Compliance credits aren’t subject to remeasurement while noncompliance credits should be tested at each reporting date for impairment. Impairment should be recognized for noncompliance credits as the excess carrying value over the credit’s fair value. Any impairment loss is irreversible.
Entities have the flexibility to use average cost (first-in, first-out), or specific identification methods for costing, with costing applied separately to compliance credits and noncompliance credits. A fair value accounting policy election is available for the subsequent measurement of noncompliance credits that were obtained through an exchange transaction or nonreciprocal transfer that’s not a grant. If elected, the noncompliance credits are subsequently measured at fair value each reporting period with changes recognized through earnings.
Derecognition of the environmental credits generally aligns with the provisions of Accounting Standards Codification Topic 610-20, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets, unless a scope exception applies, which generally results in a gain or loss computed as the difference between the amount of consideration compared to the credits carrying value. Additionally, credits obtained through business combinations should generally be recognized as assets even if they’re not probable for use or transfer, with certain scoping considerations.
Recognition and measurement of environmental credit obligations
By definition, an ECO is an obligation arising from enacted or existing laws and similar legislation and regulation to prevent, control, or otherwise reduce pollution that may be settled with environmental credits. A liability is to be recognized when events occur on or before the reporting date that results in an ECO. If a reporting date and a compliance period don’t align, the ECO should be determined as if the reporting date is the end of the compliance period.
ECOs comprise funded and unfunded portions. Funded ECOs are the portion for which an entity currently has associated compliance environmental credits, while unfunded ECOs are the portion for which there aren’t sufficient associated compliance environmental credits. Funded ECOs are measured, initially and subsequently, at the carrying amount of the associated compliance environmental credits expected to be derecognized at settlement of the obligation. Unfunded ECOs should generally be measured, initially and subsequently, using the fair value of the environmental credits necessary to settle that portion of the liability on the reporting date, unless there’s a cash settlement feature present, in which the expected cash settlement amount should be used, or certain unconditional purchase commitments or unconditional right to receive environmental credits rights are present, in which the expected cost basis of the environmental credits should be used. The ECO liabilities should be recognized through earnings, or as part of the carrying amount of another asset such as inventory, and they’re not to be offset with any environmental credits.
Presentation and disclosure
Entities are required to disclose qualitative facts, including how the entity obtained the environmental credits, how the entity intends to use the environmental credits, subsequent measurement methods, and significant estimates and judgments made in accounting for the environmental credits. For ECOs, qualitative disclosures include a description of the ECO liabilities and credits required by the associated programs, nature and timing of settlement provisions, significant estimates and judgments in accounting for the ECOs, and how the unfunded portion of an ECO liability is measured. Other qualitative disclosures associated with the environmental credits and ECOs are also required, including those associated with voluntary credits and fair value measurements.
Future impact and implementation timeline
Implementation deadlines are expected for public business entities (annual periods beginning after Dec. 15, 2027), and for other entities (annual periods beginning after Dec. 15, 2028), with early adoption permitted for any financial statements that haven’t been issued or available for issuance. An entitywide transition election for internally generated and granted environmental credits recognized as assets at the date of initial application would allow an entity to measure those assets at the transaction costs incurred, if any. Any adjustments upon adoption should be applied to the opening balance of retained earnings as of the beginning of the annual reporting period when the guidance is first applied. A full retrospective application is prohibited.
Act now to prepare for the final ASU
As mentioned earlier, this summary is based on tentative FASB decisions and is inherently tentative until a final decision from the board is made. The FASB is expected to have a final ASU for vote by the end of calendar year 2025. If your entity hasn’t started analyzing its environmental credit programs for impact by the expected ASU, a near-term analysis of the tentative standard is recommended to help understand the financial statement impact of the released final ASU.
