The problem with reporting pollution allowances

Abstract

Current Federal Energy Regulatory Commissions (FERC) guidelines states pollution allowances should be recognized on the cost basis. Since pollution allowances issued by the Environmental Protection Agency (EPA) do not have a cost basis, they are not included on the financial statements of the receiving firm. This paper recommends that pollution allowances issued by the EPA be treated like donated assets. Donated assets are valued at market when received, with a corresponding increase in contributed capital. When issued allowances are used to compensate for pollution, the book value of the allowances are considered part of the cost of production. These "costs" are subsequently closed to retained earnings at the end of the fiscal period. Accounting for pollution allowances as donated assets allows recognition of EPA issued allowances, thus more effectively estimating the cost of pollution on the financial statements and more fully implementing the market mechanism envisioned by the 1990 Clean Air Act. © 1996 Academic Press Limited.