Accounting for Self-generated Certified Emission Reductions (CERs)

CA Bhawna Grover & CA Prajwal Jha – [2026] 186 taxmann.com 953 (Article)

1. Introduction

Climate change and rising greenhouse gas emissions have become central concerns for governments, businesses and regulators across the world. As industries continue to grow, so does the challenge of balancing economic development with environmental responsibility. To address this concern, international mechanisms were developed to encourage the reduction of greenhouse gas emissions while allowing flexibility in how such reductions are achieved.

One such mechanism gave rise to what is commonly known as carbon credits. For many Indian entities that implemented environmentally friendly projects, carbon credits became not merely an environmental achievement but also a source of additional revenue. However, the emergence of carbon trading raised an important accounting question – how should self-generated carbon credits be recognised and measured in financial statements?

The ICAI’s Guidance Note on Accounting for Self-generated Certified Emission Reductions (CERs) addresses this issue. Understanding this Guidance Note requires first understanding how Certified Emission Reductions (CERs) come into existence.

2. Understanding Carbon Credits and the Kyoto Framework

The global response to climate change gained momentum with the United Nations Framework Convention on Climate Change (UNFCCC), which was adopted in 1992. Subsequently, the Kyoto Protocol, which came into force in 2005, established emission reduction commitments for developed countries.

Under the Kyoto Protocol, certain developed countries were required to reduce greenhouse gas emissions below prescribed limits. Since emission reduction can be expensive, the Protocol introduced market-based mechanisms allowing countries and entities to meet targets more efficiently.

Among these mechanisms, the Clean Development Mechanism (CDM) became particularly relevant for developing countries such as India. Under CDM, an entity in a developing country may undertake a project that reduces greenhouse gas emissions. If the project satisfies prescribed conditions and the reduction is verified, the entity receives Certified Emission Reductions (CERs).

A CER represents the reduction of one metric tonne of carbon dioxide equivalent. These CERs can subsequently be sold to entities or countries that require them to meet emission reduction commitments. This process forms the basis of carbon trading.

3. How CERs are Generated?

Generating CERs is not as simple as merely reducing pollution. The process involves multiple stages and regulatory oversight. An entity intending to generate CERs must first develop a qualifying emission reduction project and obtain registration under the CDM framework. The project must satisfy the principle of additionality, meaning the reduction in emissions must be over and above what would ordinarily occur.

Suppose a manufacturing company voluntarily installs a waste heat recovery system that significantly reduces fuel consumption and carbon emissions. Since the project results in additional emission reduction, it may qualify for CER generation.

However, consider another situation where environmental law already mandates the installation of such equipment. In that case, the reduction is not regarded as “additional”, and the project generally would not qualify for CER benefits.

After registration, the project’s performance is monitored and independently verified by accredited agencies. Only after successful verification does the UNFCCC certify and issue CERs.

This certification stage becomes critical for accounting purposes.

4. When Do CERs Become an Asset?

One of the most significant questions addressed by the Guidance Note is whether CERs qualify as an asset and, if so, at what point.

The Framework for Preparation and Presentation of Financial Statements defines an asset as a resource controlled by an enterprise arising from past events and from which future economic benefits are expected to flow.

At first glance, it may appear that CERs arise as soon as emission reductions occur. After all, the entity has already undertaken the environmental activity and reduced emissions.

However, the Guidance Note takes a more careful view. Emission reductions alone do not create CERs. Although an entity may successfully reduce emissions, issuance of CERs remains subject to verification and approval by the UNFCCC. Until certification is completed, it remains uncertain whether CERs will ultimately be granted.

Accordingly, during the period in which emission reductions are taking place, but certification has not yet occurred, the expected CERs are merely contingent assets. CERs become an asset only when the UNFCCC certifies and credits them to the generating entity. This distinction is fundamental.

Let us understand it with some illustrations.

Illustration 1 – Emission Reduction versus Asset Recognition

Assume Green Energy Ltd. installs a biomass-based power plant. During FY 2025–26, the project reduces emissions equivalent to 10,000 tonnes of CO₂. The company applies for certification. However, the UNFCCC completes verification and credits 9,800 CERs only in August 2026.

Although the environmental reduction occurred during FY 2025–26, the CER asset does not arise merely because emissions were reduced. Until certification and credit take place, uncertainty exists.

Therefore, CERs are recognised only when the 9,800 CERs are officially credited. This approach avoids recognising uncertain assets prematurely.

5. Are CERs Intangible Assets or Inventory?

Once CERs are recognised as assets, the next issue is determining their nature. CERs possess no physical form and are identifiable non-monetary resources. This may initially suggest that they are intangible assets. However, the Guidance Note ultimately concludes otherwise.

Accounting Standard (AS) 26 defines intangible assets as assets held for use in production, supply of goods or services, rental or administrative purposes. CERs are not generated for use in production or administration. Instead, they are generally generated for sale.

This characteristic becomes decisive.

AS 26 excludes intangible assets held for sale in the ordinary course of business, and such assets are instead dealt with under AS 2, Valuation of Inventories. Therefore, despite lacking physical substance, self-generated CERs are treated as inventory.

This conclusion may appear unusual at first, since inventories are often associated with tangible goods. Yet accounting classification depends not on physical appearance but on purpose and economic substance.

Since CERs are generated and held for sale, they are accounted for as inventory.