12.
What is carbon accounting?

12.1 Introduction

Carbon accounting is the process of quantifying and tracking greenhouse gas emissions, akin to measuring a tangible currency like money, but in terms of the equivalent to metric tonnes of carbon emissions, providing a concrete representation of environmental impact.

12.2 Why should accountants care about carbon accounting?

Climate change is an immediate and pressing societal issue and governments around the world are enacting stricter regulations on carbon emissions with reporting increasingly being required for external reporting. The requirements mean that there is a trickle-down effect as large companies are now being asked to provide details related to emissions throughout their supply chain. This means that many small businesses that are not in scope for preparing IFRS accounts are now being required to provide details of their carbon emissions.

Carbon accounting recognises that climate change presents a major business risk. For example, the valuation of assets located on a flood plain is contentious due to climate change, and insurance costs against extreme weather or even rising energy prices create real costs that need to be managed.

Accounting for greenhouse gas (GHG) emissions is like accounting for costs. It starts with an estimation of the total GHG emissions for a business split into categories. From this categorisation, the causes of the emissions can be identified. Once identified, options for reducing GHG emissions are evaluated and organisations can be held accountable for reducing their impact on the planet.

Many organisations have pledged to become net zero (whereby emissions are reduced to zero) or carbon neutral (whereby emissions are offset by purchasing carbon reduction activities from other organisations). Other organisations are struggling to meet the long-term targets they have set or even retracting their carbon commitments.

12.3 The urgency of accounting for carbon

Many parts of the world are already experiencing the effects of climate change and biodiversity loss. For example, the consequences of increasingly frequent extreme weather events, fires and droughts are now reducing the ability to produce food and are making more and more populated areas unhabitable. The consequent social disruption is leading to conflict, migration and massive distress for millions of people as reported by the Intergovernmental Panel on Climate Change (IPCC).

Global warming is accelerating and is a direct result of industrialisation and changes in land use since the 1850s. The average temperature for 2023 alone was 1.48°C warmer than pre-industrial levels for the first time.

Climate science suggests that every fraction of a degree that the world warms above 1.5°C, the worse the impact will be on the planet, its wildlife and human beings. In that case, inaction is not an option, as emphasised by the World Economic Forum.

Carbon dioxide emissions are a major factor in this process, acting like a blanket, trapping heat radiating from the sun and increasing temperatures. The scientific community overwhelmingly agrees that the increase in CO₂ is the primary driver of global warming.¹

Atmospheric levels of CO₂ are monitored in parts per million (ppm). Analysis shows that for 800,000 years, atmospheric CO₂ did not rise above 300 ppm. However, since the Industrial Revolution, the CO₂ concentration in the atmosphere has soared to its current levels of around 420 ppm.

The internationally agreed Remaining Carbon Budget is significant in this context. It represents the amount of carbon dioxide that can be emitted before we exceed 1.5°C warming. This budget was slashed from 400 to 250 gigatonnes in October 2023. At our current emission rates, this will be breached by 2027. The urgency of this situation cannot be overstated.

12.4 What are greenhouse gases?

greenhouse gas (GHGs)

Gases in Earth’s atmosphere that trap heat. They let sunlight pass through the atmosphere but prevent the heat that the sunlight brings from leaving the atmosphere. The main greenhouse gases are: carbon dioxide (CO₂), methane (CH₄), nitrous oxide (N₂O), chlorofluorocarbons (Man-made F-Gases).

Greenhouse gases (GHGs) are gases that trap heat in the Earth’s atmosphere, contributing to global warming. Major GHGs include carbon dioxide, methane, nitrous oxide and fluorinated gases.

The Greenhouse Gas Protocol has established comprehensive global standardised frameworks to measure and manage GHG emissions from private and public sector operations. Building on a 20-year partnership between the World Resources Institute and the World Business Council for Sustainable Development, GHG Protocol works with governments, industry associations, NGOs, businesses and other organisations. They split these emissions into three types: Scope 1, Scope 2 and Scope 3.

• Scope 1 emissions, which are direct emissions from sources of fossil fuels that an organisation owns or controls, such as diesel vans or gas boilers for heating and water.
• Scope 2 emissions, which cover indirect emissions relating to purchased energy or power that was produced from burning fossil fuels elsewhere on a business’s behalf, such as the consumption of purchased electricity, steam, heat and cooling.
• Scope 3 emissions, which encompass all other indirect emissions that do not fall under Scope 2, including upstream and downstream emissions from purchased goods and services, capital goods, upstream transport, downstream distribution, waste and water consumption, processing of sold products, business travel, and commuting (value chain emissions). Put simply, they are emissions resulting from everything we buy and as a consequence of everything we sell. Measuring Scope 3 is often challenging but in many cases it represents over 60% to 80% of a business’s estimated emissions. By measuring Scope 3 emissions, we can accelerate the global net zero target by putting pressure on suppliers and designers of products and services to decarbonise and work towards a circular economy. No matter how small the organisation is, if it is in the supply chain of a regulated large organisation, it will likely need to show greenhouse gas measurements and a carbon reporting plan as a minimum to keep its contract. Increasingly, new tenders are subject to carbon reduction plans or similar policies.

Watch the short video What are Scope 1,2,3 emissions? for an illustration of the various categories of emissions.

12.5 How to measure greenhouse gas emissions

GHG emissions are recorded as tonnes of carbon dioxide equivalent (CO₂e) using this formula:

\[\text{tonnes of GHG emissions = activity × emissions conversion factor}\]

Every business or organisational activity can be measured against an emissions factor. This might be litres of fuel used, tonnes of waste disposed, distance travelled, or tonnes of steel purchased. Greenhouse gas emissions conversion factors are typically agreed upon by international organisations and national governments. These conversion factors are based on scientific research and data analysis to estimate the amount of greenhouse gases emitted by various activities or sources.

The IPCC, for example, regularly updates guidelines and factors to help countries calculate and report their greenhouse gas emissions accurately. In the UK, the Department for Energy Security and Net Zero (DESNZ) produces a new set of conversion factors each year, together with a methodology paper explaining how the conversion factors are derived, and a paper explaining the major changes in the latest year’s factors. Alongside this, DESNZ publishes conversion factor spreadsheets providing the values to be used for such conversions, and step-by-step guidance on how to use them.

Some organisations that produce more specific greenhouse gas emissions conversion factors may charge for access to their data or tools. These organisations invest heavily in research and data collection to develop accurate conversion factors for different activities and sources of emissions. This is why many accountancy practices pay a fee to specialist carbon accounting platforms that have licences to access these more accurate conversion factors. The carbon accounting software market is expected to be worth $65 billion by 2030.

There are various methods for calculating activity, some of which are shown below. Organisations may use a combination of these methods to get a comprehensive understanding of their greenhouse gas emissions.

• Spend-based method: This method calculates emissions based on the amount of money spent on goods and services. It involves analysing the financial transactions of an organisation to estimate the emissions associated with its purchases. This method is useful when detailed activity data is not available but financial records are accessible. It is mainly used for measuring Scope 3 supply chain emissions.

This is not the best approach but is very accessible to accountants used to scrutinising the financial data and therefore an easy way of getting started and creating a baseline measurement. The downside is that while an organisation switching to a supplier with lower carbon intensity or investing in energy-efficient technologies will definitely reduce its emission over time, the initial increase in spending will appear as an increase in emissions. This is where a supporting emissions narrative is important to explain changes in emissions.

• Activity-based method: The activity-based method involves calculating emissions based on the specific activities or processes within an organisation that generate greenhouse gas emissions. This method requires detailed data on activities such as energy consumption, transportation and waste generation to estimate emissions accurately. It could be thought of as similar to activity-based costing.
• Average-based method: The average-based method uses standard emission factors or averages to estimate greenhouse gas emissions. This method is often used when detailed activity data is not available and organisations rely on industry averages or standard emission factors to calculate their emissions.
• Using the Greenhouse Gas Protocol measurement tools. The tools on the Greenhouse Gas Protocol website are open source and include cross-sector tools or more specific tools for countries, cities and industry sectors.

Most businesses and accountants in practice are likely to use an outsourced consultant or platform that may also provide third-party verification for the measurements that they use. This table gives some examples of what is available.

Carbon-tracking software platforms (aligned with cloud accounting solutions) are designed to simplify emission estimations. They only require a small amount of activity-based data such as heat, power, fuel and water consumption, employee commuting estimates and data on waste. While they are easy to use, there may be limitations associated with such platforms that simplify the estimation process. It is important to consider the benefits of using such platforms with their known limitations in mind.

12.6 Developing a net zero strategy

With increasing pressure from investors, customers and the government to quantify sustainability strategies, there is an increasing need for organisations to develop the ability to account for their emissions. In addition to this, working to lower carbon emissions can reduce costs (both for energy and to access lower insurance premiums); attract customers, investors, lenders and employees; and help a company stay ahead of legal requirements. Accreditations can signal an organisation’s ethos to it customers. Options include: ISO 14064 (based on Greenhouse Gas Protocol), B-Corp (broader and overlaps with ESG), and SBTi Carbon Footprint Certification (certified carbon neutrality).

12.7 Investment in net zero

Carbon emissions remain outside the financial accounts of organisations. Despite the additional accountability that assurance over such disclosures brings, they do not explain the investment required to reach net zero and, as a result, can remain disconnected.

How should organisations account for the investment required to reach net zero?

Achieving net zero is important to the long-term survival of an organisation. Should we then create a provision for the costs of achieving net zero if it is unavoidable? To date, we have not seen many provisions created for this purpose. This is primarily because of the current recognition criteria for the creation of a provision reflect the liability. Under IFRS, a provision can only be created where three conditions are met:

• A present obligation as a result of a past event; for example, damage incurred by corporate behaviour or a similar trigger event
• Payment is probable (more likely than not)
• The amount can be estimated reliably.

Many companies set targets of 2030 or beyond and consider the costs of achieving net zero as part of the ongoing evolution of their business rather than something that they can isolate.

Read this KPMG guide to deciding whether to make a provision for net zero. The guide complements the IASB’s recent decision on provisions for climate pledges.

12.8 Summary

• Carbon accounting is a natural extension of accounting, aiming to measure the financial impact of greenhouse gas emissions.
• Measuring Scope 1, 2 and 3 emissions establishes accountability for organisations.
• It is generally accepted that Scope 3 emissions are harder to report accurately given the size of global supply chains.
• Company net zero strategies are an important step in addressing carbon emissions.