Understanding and Auditing Carbon Credit: A Major Issue for the Accounting Profession

Reading time: 17 minutes

In a context where climate transition is a major challenge for businesses, carbon credits and emission allowances now occupy a strategic place in accounts, sustainability relationships and societal accountability discourses.

However, behind these instruments, presented as simple "carbon units", are complex mechanisms, high risks and new transparency requirements.

LAccountant and External Auditor This is the first line: secure accounting, verify the reality of transactions, prevent greenwashing and guarantee the sincerity of financial and extra-financial information.

Let us make a clear, structured and accessible reading of this still unknown field, in order to give the professionals the necessary keys to address calmly, and with mastery, the missions related to carbon credit

The accountant and the auditor will be increasingly confronted with carbon credit, whether in the Accounts, in sustainability reports or in the Communication from enterprises. For many, this subject remains unclear, technical and "only for climate specialists".

Let us propose a clear, structured and concrete vision of carbon credit, seen since the profession of accountant or auditor, to enable:

• to understand what it really is,
• identify accounting and audit impacts,
• secure missions and avoid pitfalls (fraud, greenwashing, overvaluation, etc.).

1. What exactly are we talking about? Carbon credit, quotas, compensation...

1.1. One ton of CO2 "avoid" or "withdrawn"

One carbon credit, it is first a unit of measurement : in principle, 1 credit = 1 tonne CO2 (or equivalent) avoided or removed from the atmosphere.

In concrete terms, this can come from:

• of reduction project For example, a solar park that replaces a coal-fired power plant, cleaner cooking plants, a project to combat deforestation;
• of withdrawal/sequestration project : reforestation, restoration of mangroves, geological storage of CO2, biochar, etc.

Basic idea: a project avoids or withdraws emissions; this "climate performance" is converted into units (credits) that can be sold to a company.

1.2. Two great worlds to distinguish

For the accountant and the ACC, it is essential to distinguish two universes:

1. Regulated markets (EU ETS, other cap-and-trade systems)
   • The State shall emission ceiling and distributes or auctions quotas ;
   • the undertakings concerned must return an annual number of allowances equal to their verified emissions;
   • quotas are traded on organised markets.
2. Voluntary contracts (voluntary carbon markets)
   • no legal obligation;
   • companies buy voluntary carbon credits to "compensate" their emissions, green their products, display "net zero" commitments, etc.
   • The quality and seriousness of projects vary greatly.

In the current language we talk about "carbon credits" for both, but the logic is different:

• on quotas for a regulated market are an instrument of conformity;
• on Voluntary appropriations are a tool for communication and climate strategy... more or less credible.

2. Why does carbon credit directly concern the accountant and the CAC?

One might think it's a "climate engineer" subject. In reality, it has very concrete consequences in the missions of the professionals of the figure:

• In the accounts :
  • quota entry and exit;
  • stocks of appropriations held;
  • liabilities related to future issues;
  • gains/losses on disposal;
  • choice of processing in IFRS or French standards.
• In statutory audit :
  • the reality of the quotas/credits on the balance sheet;
  • valuation (very volatile market, uneven quality);
  • fraud risks (heavy history in carbon);
  • consistency between carbon fluxes, writings and annexes.
• In extra-financial reporting (CSRD, sustainability, climate) :
  • control of emission reports (scopes 1, 2, 3);
  • verification of the compensation announced;
  • risk assessment of greenwashing.

In other words: carbon credit is both an asset, liability, risk and communication tool. We're right at the core of the profession.

3. See the company through the "carbon" prism

To address a mission, it is useful to begin by classifying the entity profile. Generally, clients enter one (or more) of the following:

1. Undertaking subject to a quota system (EU ETS, etc.)
   • it receives allowances (free of charge and/or at auction);
   • it buys/sells;
   • It must return it annually to the State.
2. Company not subject but buying voluntary credits
   • to offset part of its emissions;
   • to display a "carbon neutral" product;
   • to feed a CSR speech.
3. Trader or intermediary in carbon credits
   • full market activity;
   • frequent purchases/sales, trading positions, valuation at the price.
4. Group combining several cases
   • e.g. an energy company that is both subject to EU ETS, buys voluntary credits, and operates a carbon market room.

The first task, as an accountant or CAC, is therefore to:

Mapping the customer's "carbon business":

who buys what, to whom, why, and in what framework (regulatory or voluntary)?

From there, we can reason about accounting impacts and audit risks.

4. Accounting issues: simplifying without caricature

4.1. In French standards: emission allowances (EU ETS)

In France, regulated emission allowances (EU ETS, assimilated) are regulated by a specific regulation of theAccounting Standards Authority. The spirit of the device is as follows (by simplifying):

• The free allowances by the State are registered in stock, but for zero value.
• The Quotas purchased are entered in stock for the acquisition cost.
• At closure, if the company issued more than it holds quotas:
  • it must buy some to fill the deficit:→ Liabilities (quotas to be acquired) and load the same.
• The surplus quotas can be resold:→ finding a disposal product and the cost of leaving the stock.

In practice, the accountant should:

• ensure that quota flows (inputs, exits, refunds) are well monitored in quantity and value ;
• ensure that the emission liability (quota to be purchased) is properly assessed;
• secure the processing of disposal gains.

The ACC will have to test the reality of quotas, the consistency between emissions and allowances held, and relevance of assessment methods.

4.2. In IFRS: mosaic of practices

In IFRS, the situation is more complex: there is no single and definitive standard. Practices are often divided as follows:

• allowances and credits treated as intangible assets or stocks,
• liabilities related to issues treated as provisions / liabilities (IAS 37),
• trading activities treated as Financial instruments.

What counts:

• on economic model premium on pure technique:
  • possession for consumption (compliance),
  • holding for resale (trading),
  • holding for voluntary compensation (image, CSR).
• the consistency of choices : no DIY "on a case by case" without overall logic;
• the transparency in the Annex - clearly explain accounting policy, risks, variations.

4.3. Voluntary credits: assets, expenses, or both?

For voluntary credits (excluding ETS), three common situations:

1. Loans held for resale→ assimilated to stocks of goods ;→ valuation at net realizable value.
2. Loans held to offset the company's own issues
   • some first register them as intangible asset then note a charge at the time of the "withdrawal" of the credit (effective compensation);
   • other accounts directly in load the purchase of credit.
3. Loans held as speculative investment→ close treatmentFinancial instrument (just value via result).

In any case, issue 1 is the Caution :

• do not overvalue assets whose value may collapse (sandals, change of regulation, challenge of projects);
• do not present credits of dubious quality as acquired and definitive "mission reductions".

5. The role of the accountant: structure, secure, popularize

The accountant is at the crossroads of three needs of his client:

1. Establishing a strong accounting framework
   • organise monitoring of quotas/credits in quantities and values;
   • develop an adapted account plan (inventory, revenue, specific expenses accounts);
   • clarify valuation and depreciation rules.
2. Ensure coherence with the company's climate strategy
   • if the undertaking communicates on the "carbon neutral", verify that this is based on traceable elements;
   • ensure that the use of credits is presented as a Supplement internal reductions, not as a substitute.
3. Accompany management in their communication
   • provide explanatory information in the Annex;
   • harmonising accounts, management report, sustainability report;
   • raise awareness of the carbon limit to avoid greenwashing.

In practice, the accountant may propose:

• a internal procedural note "carbon quotas and credits";
• one Follow-up table template (quantities / value / dates / origins);
• one standard scheme of writings for the most frequent cases (free allowance, purchase, sale, refund, voluntary withdrawal, etc.).

6. The role of the auditor: reality, valuation, greenwashing

On the ACC side, the topic focuses on some key issues:

1. Are the quotas/credits actually available?
   • external confirmations with registries, brokers, banks;
   • reconciliation between registers, accounts, and financial flows.
2. Does the company really own it?
   • records on behalf of the company;
   • purchase and disposal contracts;
   • absence of arrangements where a third party holds the credits "on behalf of".
3. Are all significant flows well recorded?
   • systematic reconciliation of the accounts account;
   • search for off-balance sheet transactions or carried out in peripheral entities (PVS, unconsolidated subsidiaries, etc.).
4. Is valuation prudent and justifiable?
   • control of courses used;
   • sensitivity test: what happens if the price drops sharply?
   • take into account specific risks (contested project, weakened standard, regulatory change).
5. Is communication not misleading? (greenwashing)
   • consistency between:
     • appropriations held and actual withdrawn (withdrawals),
     • the emissions actually calculated,
     • allegations of neutrality or compensation.
   • review of entries in the management report, website, marketing documents.

Again, the CAC does not become "climate engineer", but:

verifies that what is written in the accounts and reports is sincere, traceable and substantiated.

7. Practical approach: how to approach a "carbon" mission step by step

The following is an operational outline for missions:

Step 1 – Understanding the customer's carbon profile

• Is he subject to an ETS?
• Does he buy any voluntary credits? What for?
• Does it have a carbon trading activity?

Step 2 – Mapping flows

• Entries (quotas allocated, purchases, internal projects);
• Exits (transfers, State refunds, voluntary withdrawals);
• Opening and closing stocks;
• Chain of significant operations.

Step 3 – Identify key systems and documents

• Official registers (EUTL, Verra, Gold Standard, etc.);
• Emission reports, verification certificates;
• Contracts, invoices, contract confirmations;
• Internal tables for monitoring quantities and values.

Step 4 – Analyze accounting choices

• Treatment of quotas (stocks, liabilities);
• Treatment of voluntary credits (assets, charges, financial instruments);
• Assessment methods used;
• Any depreciation tests.

Step 5 – Set up / test controls

For EC: formalize the internal procedure.

For the CAC: test the effectiveness of these controls, and compensate the weaknesses with residual tests (confirmations, reconciliations, etc.).

Step 6 – Examine external communication

• Annexes, management report, sustainability report;
• Allegations on carbon neutrality, green products;
• Consistency between commitments posted and audited items.

8. Conventional traps and warning signals

Some points of vigilance that any EC/CAC should keep in mind:

• "Too good to be true" credits : very cheap projects, in countries with fragile governance, with spectacular promises and difficult to verify.
• Very ambitious communication, very weak documentation : a company that places massive emphasis on its "carbon neutrality", but struggles to provide detailed evidence on credits, withdrawals, methodologies.
• Lack of quantitative monitoring : carbon flux only monitored in value without accurate monitoring of quantities; incomplete or approximate inventory.
• Poorly controlled trading activity : numerous operations, incomplete documentation, non-existent or weak front/midddle/back-office separation, approximate valuation.
• Risk of fraud : history of VAT fraud, phishing and quota theft in carbon markets; special attention to complex cross-border operations.

9. Step by step: some tips

The accountant and the auditor are not intended to become a climatologist, but they can:

• Mastering basic concepts : difference between ETS quota and voluntary credit, between reduction and withdrawal, between regulated and voluntary market.
• Formalizing Home Tools :
  • Internal fact sheets;
  • checklists for sensitive folders;
  • Standard templates of notes of annex.
• Working in pairs with climate specialists / sustainability when issues become important (large portfolios, complex projects, very committed communication).
• Ensure minimum watch on:
  • the development of accounting rules,
  • recent scandals (which show the traps to avoid),
  • new sustainability requirements (CSRD, ESRS standards).

Conclusion: a new playground... and risk to the profession

Carbon credit is not a marginal subject or "accessory". It's:

• one accounting support (assets, liabilities, revenues, expenses);
• one lever for climate trajectories enterprises;
• one risk vector (financial, legal, reputational);
• one possible place of fraud and misleading communication.

In response, the accountant and the auditor have a central role:

• bring rigour in accounting,
• imposing traceability in flows and documents,
• require consistency between numbers and speeches,
• protect the enterprise against fragile positions (overvalued assets, unsustainable climate promises),
• protect the public against the illusions of "cheap" carbon neutrality.

By mastering this subject in a clear and pragmatic way, the figure professional becomes not only the guarantor of the quality of financial and extra-financial information, but also a reference point for its clients on one of the structuring issues of the coming decades: climate transition.

Annex: Carbon Credit, Quotas and Audit: The Concepts to Know

Concept	Simple and clear definition
Carbon credit	Representative unit 1 tonne CO2 avoided or removed through a project (e.g. reforestation, renewable energy). Used especially in voluntary markets.
Quota of issue (Allowance / EUA)	Official State authorization to issue 1 tonne CO2 in regulated markets (e.g. EU ETS). Mandatory for the undertakings concerned.
EU ETS (European Union Emissions Trading System)	European emission allowance scheme where a emission ceiling is set and where companies have to return allowances equal to their emissions each year.
Cap-and-trade	Mechanism where a ceiling (cap) limits global emissions and where companies can exchange (trade) quotas.
Regulated market	A market regulated by law (e.g. EU ETS) where quotas are mandatory.
Voluntary Carbon Market (VCM)	Non-mandatory market where companies buy carbon credits to offset their emissions or improve their climate image.
Offsetting	Action to "neutralize" emissions by purchasing carbon credits from external projects.
Carbon neutrality (Net Zero)	Where the residual emissions of an entity are equal to zero, after internal reduction and offsetting by reliable credits.
Scope 1, 2, 3 (carbon emissions)	Method of classification: Scope 1 = direct emissions, Scope 2 = electricity consumption/heat, Scope 3 = indirect emissions from the value chain.
Additionality	Essential criterion: emission reduction would be Not without carbon financing.
Permanence	Guarantee that the reduction is sustainable over time (e.g. replanted forest that will not burn).
Carbon leakage (Leakage)	Moving emissions elsewhere as a result of the project (e.g. deforestation moving to an unprotected area).
Double counting	Where the same emission reduction is reported by two actors (e.g. a State and an enterprise, or two enterprises). Forbidden.
MRV (Monitoring, Reporting, Verification)	Process measurement, of Declaration and verification emissions or reductions. Indispensable for quotas and credits.
Certificate of verified emissions	Certification issued by an accredited body confirming the actual emissions of a company (mandatory in EU ETS).
Withdrawal of carbon credit (withdrawal)	Action which permanently cancel a carbon credit in a registry. Once withdrawn, it can no longer be sold.
Carbon register	Official or private platform where quotas and credits are registered (e.g. EUTL, Verra Registry). Proof of ownership and traceability.
Project Design Document (PDD)	Technical document describing a carbon project: baseline, calculations, methodology, impacts, etc. Basis of certification.
Baseline	Baseline to calculate emissions avoided by a project.
Carbon certification standard	Organization that validates and verifies projects (e.g. Verra, Gold Standard).
Avoidance credit	Credit from a project avoid future emissions (e.g. clean cooking).
Withdrawal credit (Removal)	Credit from a project withdraw CO2 from the atmosphere (e.g. reforestation). Considered more credible.
ESG / Sustainability	Global framework of environmental, social and governance issues to which companies must respond.
Greenwashing	Practice of presenting a company as "green" or "carbon neutral" without solid evidence or exaggerating environmental benefits.
CSRD / ESRS	New European legislation imposing a detailed reporting on sustainability, including carbon emissions and credit usage.
ANC 2012-03 (France)	Regulation defining the accounting of emission allowances in French standards.
IAS 37 / IAS 38 / IAS 2	IFRS standards governing provisions and liabilities, intangible assets and inventories respectively. Useful for carbon credits.
Liabilities related to emissions	Registered accounting obligation where the company has to purchase allowances to cover its issues.
Market Stability Reserve (MSR)	European mechanism regulating the supply of ETS quotas to stabilise prices and avoid overabundance.
CORSIA	International system to reduce civil aviation emissions through the mandatory use of certified carbon credits.
Article 6 of the Paris Agreement	International framework for trade in emission reductions between States (ITMOs) and the creation of a new carbon mechanism.
ITMO (Internationally Transferred Mediation Outcome)	Carbon unit transferred between States under the Paris Agreement (Article 6).
Internal / external Leakage	Transfer of emissions within the project (internal) or to another (external) territory.
Carbon fraud (caousel fraud)	Former massive VAT fraud on carbon quotas, based on fictitious company schemes and undistributed VAT.
Certified Auditor	Independent body responsible for validating reported emissions or credits generated by a project.
Co-benefits	Positive effects of a project in addition to carbon: biodiversity, health, local employment, etc.
Ghost Credit	Carbon credit of very low integrity, not additional or based on exaggerated assumptions.