Cap And Trade Allowance Accounting: A Divergence Between Theory And Practice

Abstract

This study concerns one of the most significant and glaring divergences between theory and practice that has emerged since the accounting discipline’s conceptual framework was developed in the late 1970s. Through an extensive empirical examination of extant practices with respect to cap and trade allowances allotted to U.S. electric utilities under the Clean Air Act Amendments of 1990, this research demonstrates a surprising—and possibly unsupportable—divergence between expected and actual practice. The results of this research show that practice and theory diverge in a substantial and negative way. EPA-issued emissions allowances meet the accepted definition of an economic resource that will provide a future benefit, i.e., an asset. Yet, examination of five years’ of public financial disclosures for the entities affected by the CAAA shows scant recognition for the acquisition, disposition, or year-end existence of these tradable emissions permits. Financial statement users and other stakeholders of the affected entities may be seriously misled by the failure to recognize the allowances. This divergence between theory and practice does not appear to be justifiable.