Case 21-5 Accounting for Emission Allowances Traded on a Blockchain Electro-Phi Inc. (the Company) is a utility provider that sells electricity to the public. The Company produces the electricity using various forms of power generation, including the burning of fossil fuels such as coal and natural gas. A natural by-product of the burning of fossil fuels is carbon dioxide (CO2), a greenhouse gas. The Companys power generation facilities and related customer base are located in the state of Nova Anglia, which subjects the Company to regulation by the state government. However, the Company is domiciled in the United States and reports financial results under U.S. GAAP. The Company is in compliance with the rules and regulations of the Federal Energy Regulatory Commission (FERC), which are set by the U.S. Department of Energy. The Nova Anglia state government has recently implemented a new emission allowance (EA) trading program that requires companies within its jurisdiction to provide a sufficient number of allowances to offset emissions of CO2 and other greenhouse gases within a given calendar year, referred to as a vintage. These allowances are effectively permits that allow a company to continue to emit greenhouse gases in certain quantities, with a long-term strategy to decrease the emissions over time through a gradual corresponding decrease in allowances issued for future vintages. Each allowance issued by Nova Anglia allows the holder to emit one metric ton of CO2 within a given calendar year. If a company expects that it will require additional allowances beyond those originally issued, it may purchase from or trade additional allowances with other companies that participate in the Nova Anglia program. If a company ultimately emits more greenhouse gases than it can offset with allowances in a given vintage, the government of Nova Anglia will impose fines. The government of Nova Anglia initially issued EAs for the 20X8, 20X9, and 20Y0 vintages to all companies within its regulatory jurisdiction in return for their registering for the EA program. There were no taxes or fees levied on the companies receiving these allowances. Nova Anglia uses a blockchain to allow for greater data integrity, transparency, and efficiency in trading. The blockchain serves as the sole medium through which EAs are issued, used, and exchanged between entities. Each individual allowance is represented by a token on the blockchain, which is called a Carbon perMission or CPM. Each CPM has a specific identification code so that holders of the CPM and governmental authorities know its origin and vintage. The first CPMs were issued on July 1, 20X8, and pertained to the 20X8, 20X9, and 20Y0 vintages. At that time, there was not yet an active market for the purchase, sale, or trading of these allowances. The Company estimates that as of July 1, 20X8, the fair value of a CPM was $750. This estimate is based on subjective evidence, such as observations of different EAs in other states, since trading of CPMs did not begin until late August 20X8. The number of allowances issued was set as a baseline against each companys annual CO2 emissions for the 12-month period ended December 31, 20X7. Allowances for the 20X8 vintage were issued in a quantity that would offset the same level of emissions by the holder from 20X7, while allowances for 20X9 and 20Y0 vintages were issued in amounts that successively decrease from the 20X7 emissions baseline by 1 percent and 2 percent, respectivelyA companys failure to produce a sufficient number of allowances of the 20X8 vintage for emissions during the 20X8 year will result in the imposition of penalties of $2,500 per metric ton of CO2 emitted in excess of the emission allowances held. Historically, the Company emits approximately 4 million tons of CO2 annually. Thus, on July 1, 20X8, the government of Nova Anglia issued the Company 4 million 20X8 vintage CPMs, 3.96 million 20X9 vintage CPMs, and 3.92 million 20Y0 vintage CPMs. On September 1, 20X8, the Company anticipates it will emit 4.1 million metric tons of CO2 during the 20X8 year. On the same day, CPMs pertaining to the 20X8 vintage are trading on the open market for $1,000 per CPM. Competitor EZGreen projects that it will have a surplus of CPMs because of the success of a new low-emission hydroelectric plant activated in 20X8. On September 1, 20X8, EZGreen agrees to sell 100,000 CPMs to the Company for $100 million. This transaction is recorded on the blockchain, and the Company now holds 4.1 million CPMs for the 20X8 year. By November 30, 20X8, the Company projects that it will emit only 4.025 million metric tons of CO2 for the 20X8 year and decides to sell 50,000 20X8 vintage CPMs. Competitor Kohlberner Electric (KBE) is in need of 20X8 vintage CPMs but expects that it will have a surplus of the 20Y0 vintage. Rather than pay the Company cash, KBE proposes a swap with the Company whereby the Company receives 20Y0 vintage CPMs in return for transferring 20X8 vintage CPMs to KBE. On November 30, 20X8, the 20Y0 vintage CPMs trade for $800 per CPM, while 20X8 vintage CPMs trade for $1,200 per CPM. Thus, KBE and the Company agree to swap 75,000 of KBEs 20Y0 vintage CPMs in exchange for 50,000 of the Companys 20X8 vintage CPMs originally purchased from EZGreen (identifiable by the specific identification codes). The transaction is recorded on the blockchain, and the Company now holds 4.05 million 20X8 vintage CPMs, 3.96 million 20X9 vintage CPMs, and 3.995 million 20Y0 vintage CPMs. Required: 1. On July 1, 20X8, how should the Company classify and account for its receipt of CPMs from the Nova Anglia government? 2. How should the Company account for its purchase of 100,000 CPMs from EZGreen on September 1, 20X8? 3. On November 30, 20X8, how should the Company account for the swap of 50,000 20X8 vintage CPMs transferred to KBE in return for 75,000 20Y0 vintage CPMs?