Corporate Carbon Emission Statements

Stefan Reichelstein 1

Mannheim Institute for Sustainable Energy Studies, University of Mannheim

ZEW-Leibniz Centre for European Economic Research
and
Stanford Graduate School of Business
[email protected]

January 2023

1
I am grateful to G. Glenk, J. Kurtz, R. Meier, S. Penman and A. Pistillo for helpful comments and suggestions.
Special thanks to R. Kaplan and K. Ramanna for many productive conversations on the subject of carbon
accounting during the gestation of this paper.
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Corporate Carbon Emission Statements

Abstract

Current corporate disclosures regarding carbon emissions lack commonly accepted accounting
rules. The accrual accounting system for carbon emissions described here takes the rules of
historical cost accounting for operating assets as a template for generating a Carbon Emissions
(CE) balance sheet and flow statement. The asset side of the CE balance sheet reports the
carbon emissions embodied in operating assets. The liability side conveys the firm’s cumulative
direct emissions into the atmosphere as well as the cumulative emissions embodied in goods
acquired from suppliers less those sold to customers. Flow statements report the cradle-to-gate
carbon footprint of goods sold during the current period. Taken together, balance sheets and
flow statements generate key indicators of a company’s past, current and future performance
with regard to carbon emissions.

JEL classification: M41, M48, Q53, Q54.

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 1. Introduction

Recent years have witnessed numerous companies around the world issuing voluntary “net-
zero pledges” with regard to their greenhouse gas emissions. According to a recent survey,
more than two-thirds of the Fortune 500 firms have now articulated the goal of reaching a net-
zero position by 2050. 1 Beyond pledging to drive their corporate carbon footprints to zero in
the future, companies increasingly advertise select products as being already “carbon-neutral”.
While these announcements have been heralded as a potentially significant step in the global
decarbonization effort, some analysts have argued that the lack of commonly accepted
reporting standards for greenhouse gas emissions ultimately obscures the credibility of
corporate claims and commitments to a net-zero position. 2,3

This perspective article argues that corporate carbon emission reports would become more
transparent and credible if companies were to adopt a carbon accrual accounting system that
mirrors the accounting for operating assets in financial reports. Traditional accrual accounting
enables the separation of stock from flow variables. In direct analogy, an accrual accounting
system for carbon emissions enables a CE balance sheet and a CE flow statement, the latter
being the pendant to an income statement. We emphasize that, in contrast to financial
reporting, the asset side of the CE balance sheet does not report conventional asset values, but
instead records the emissions embodied in the firm’s operating assets. The sources of these
emissions, recorded on the liability side of the balance sheet, are either the firm’s own direct
(Scope 1) emissions or those incurred by companies along the firm’s upstream supply chain.

Just as balance sheets and income statements convey essential information about a firm’s
financial position, CE statements yield several key indicators of a firm’s past, current and future
performance in the domain of greenhouse gas emissions. Among the key carbon performance
indicators, two central ‘stock variables’ emerge from the balance sheet. First, the asset side of
the CE balance sheet conveys the emissions embodied in the firm’s long-term operating assets,
e.g., machinery and equipment, as well as in short-term assets, e.g., inventories. The
significance of this indicator is that the emissions recorded in operating assets will flow through
3
to the firm’s sales products in future periods. Second, the liability side of the CE balance sheet
tallies a firm’s cumulative direct net emissions, that is, cumulative direct emissions less any
applicable carbon dioxide removals, accumulated after some reference date. Cumulative direct
emissions are a key performance indictor for technology firms like Google and Microsoft that
have set the more ambitious goal of removing from the atmosphere their entire legacy
(cumulative) emissions, that is, all net emissions accumulated after some reference date.

With concerns about climate change intensifying, customers increasingly seek information
about, and take responsibility for, the emissions that have gone into purchased products and
services. Consistent with Kaplan and Ramanna’s (2021) E- liability framework, a growing
number of companies now report so-called cradle-to-gate carbon footprints for their sales
products. For multiproduct firms, the reporting of cradle-to-gate carbon footprints requires an
accrual accounting system akin to that used for inventory costing in cost accounting. In direct
analogy to Cost of Goods Sold in income statements, Carbon Emissions in Goods Sold (CEGS)
represents the aggregate carbon footprint of a firm’s sales products in any given year. This flow
variable effectively measures a firm’s upstream Scope 3 emissions, including its direct (Scope 1)
emissions and the indirect emissions embodied in acquired production inputs.

In today’s reporting environment, the most common carbon ‘flow measure’ is a company’s
direct emissions, adjusted for any recognized CO2 offsets in the current year. This measure
emerges directly from the CE balance sheet as the difference between the beginning and the
ending balance of the direct emissions liability account. Any claim for a company to be on a
path to net-zero according to the CEGS metric is generally more stringent than a corresponding
claim when corporate carbon footprints only comprise direct net emissions. For such a firm to
drive CEGS to zero, both its direct emissions and the indirect emissions acquired from suppliers
in its production inputs must go to zero.

Since the carbon accrual accounting system described here builds directly on the principles
underlying financial accounting, existing accounting enterprise software can easily be adapted
to keep the books for carbon accounting. Further, it will be relatively straightforward for
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external auditors to certify that CE statements were prepared in accordance with principles that
mirror the generally accepted accounting principles for operating assets. Auditor certification
will be particularly useful for the determination of carbon import duties, as anticipated for the
year 2026 by the European Union under its Carbon Border Adjustment Mechanism. 4

2. Corporate Carbon Accounting

The Greenhouse Gas (GHG) Protocol currently is the commonly accepted reference framework
for assessing corporate carbon footprints. The Protocol classifies direct (Scope 1) emissions as
those stemming from flue gases and tailpipe exhaust streams at a firm’s own production
facilities. Indirect emissions (Scope 2 and 3) are those emanating from operations in a
company’s upstream supply chain as well as those generated by the company’s customers and
end-use consumers. 5 Scope 2 is a carve-out from the broader category of indirect emissions, as
Scope 2 pertains exclusively to the generation of electricity and heat provided by external
suppliers.

While Scope 1 emissions are widely measured and verified in jurisdictions that have adopted
carbon pricing regulations 6, the assessment of Scope 3 emissions has been uneven in practice.
A recent study found that in a sample of 417 companies, the vast majority disclosed their Scope
1 and 2 emissions, and about 20% included some Scope 3 figures. 7 Technology firms like Google
indicate that they limit their count of Scope 3 emissions to employee commuting and travel. A
survey of the entire computer technology sector found that firms underreport their Scope 3
emissions by about half relative to the standards of the GHG Protocol. 8

It is widely acknowledged that assessing a company’s Scope 3 emissions entails enormous data
collection challenges. Most companies hire outside consultants that perform life-cycle analyses
of the goods and services transacted by the company. However, outside consultants usually
must rely on industry-wide emission estimates rather than the primary data reflecting the
actual emissions incurred by the parties along a company’s supply chain. 9 A further issue with
Scope 3 assessments is that the carbon emissions incurred along a company’s downstream
5
supply chain cannot be measured reliably at the time a sales product leaves the company’s
gates. To illustrate, consider the sale of an aircraft to an airline. According to the GHG protocol,
the manufacturer should take a life-cycle perspective in estimating the total lifetime emissions -
from cradle to grave - generated by operating the aircraft. Such estimates, however, must
remain speculative, as they require forecasts for both routes and miles flown in future years as
well as the type of fuel, e.g., kerosene versus sustainable aviation fuels, the aircraft will be
using. These considerations explain in part why the current SEC exposure draft envisions a safe
harbor provision for corporate Scope 3 disclosures. 10

The central idea underlying the E-Liability concept of Kaplan and Ramanna (2021) is that
companies can reliably measure the actual carbon emissions embodies in their sales products,
provided they receive reliable information on the carbon balances embodied in the inputs
received from suppliers. 11 At each link in the chain, firms rely on primary data regarding their
own production activities, their own direct emissions and the indirect emissions represented by
the carbon balances of their production inputs, the latter determined recursively by the firm’s
upstream suppliers. 12,13,14 Several multinational firms have recently developed internal carbon
accounting systems with the aim of calculating cradle-to-gate product carbon footprints in a
recursive manner relying on local company-level emissions data at each link of the supply
chain. 15

Returning to the sale of aircraft example, suppose the airline receives a cradle-to-gate footprint
measure from the manufacturer. This figure reflects the actual upstream emissions embodied
in the constituent aircraft parts as well as the emissions accumulated in the aircraft’s assembly.
The airline, in turn, calculates the carbon footprint of individual flights by including the
emissions associated with fuel combustion, other variable inputs and a depreciation charge for
the emissions embodied in the aircraft. Just as the cost of a flight is calculated by relying on
internal cost accounting, a carbon accrual accounting system can determine the emissions
embodied in a particular flight from the cradle of all requisite inputs to the airline’s gate, i.e.,
the delivery of the flight. Aggregating across all cradle-to-gate figures, the airline calculates its

6
Carbon Emissions in Goods Sold (CEGS) during a particular year. This metric effectively captures
the airline’s upstream Scope 3 emissions, including its Scope 1-2 emissions.

The reporting of upstream Scope 3 emissions in accordance with the E-liability concept in no
way prevents companies from issuing separate estimates for the downstream Scope 3
emissions associated with the use of their products. While these assessments must intrinsically
be estimates, upstream Scope 3 reports can be based on actual emissions incurred along the
upstream supply chain as more firms along the supply chain calculate the cradle-to-gate carbon
footprints of their own products. Firms seeking to disclose cradle-to-grave carbon footprint
measures in accordance with the GHG Protocol standard may therefore find it useful to split
these disclosures into cradle-to-gate actuals and gate-to-grave estimates.

A key advantage of determining product carbon footprints in a recursive and informationally

decentralized manner along a firm’s supply chain is that reliance on primary data creates
incentives for firms not only to reduce their own direct emissions but also to exert pressure on
their suppliers to reduce their emissions. 16 To witness, Microsoft Corporation has indicated that
the carbon emissions attributed to products and services included in the firm’s Scope 3 count
will become a criterion for supplier selection in the future. 17

3. Carbon Balance Sheets and Flow Statements

The fundamental identity underlying financial balance sheets maintains that:

𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 = 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 + 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸
at all points in time. The corresponding identity for Carbon Emissions (CE) balance sheets
maintains that:
𝐶𝐶𝐶𝐶 𝑖𝑖𝑖𝑖 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 = 𝐶𝐶𝐶𝐶 𝑖𝑖𝑖𝑖 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿.
The unit of measurement for all accounts is one ton of CO2. For greenhouse gases other than
CO2, the IPCC has recommended conversion factors to arrive at CO2 equivalents, abbreviated as
CO2e from hereon. We note that the CE balance sheet does not record conventional asset or
liability values. Instead, the accounts on the left-hand side record the emissions embodied in
the firm’s operating assets. The sources of these emissions, recorded on the liability side, are

7
either the firm’s own direct (Scope 1) emissions or those incurred by companies along the
firm’s upstream supply chain.

To illustrate the bookkeeping for carbon accrual accounting, we present a sequence of sample
transactions undertaken by the imaginary A-Corp. As shown in Table 1, A Corp. maintains on
the asset side of its CE balance sheet accounts for Plant, Property and Equipment (PPE) and
Materials (MAT). For illustrative purposes, Table 1 shows only one PPE and one MAT account,
but m different Work-in-Process accounts (WIP1, WIP2, … ,WIPm), and n different Finished Goods
accounts (FG1, FG2, …. ,FGn). The second row of Table 1 shows the balances of these stock
variables at the beginning of the year (BB). The ending balances (EB) at the bottom of Table 1
reflect the cumulative impact of transactions undertaken during the year. In total, these
balances reflect the emissions embodied in operating assets that the company assumes
responsibility for (it ‘owns’) as it acquires production inputs and carries out its operations.

On the liability side of A-Corp.’s balance sheet are the accounts Emissions Transferred In (ETI),
Emissions Transferred Out (ETO) and Direct Emissions (DE). Direct emissions arising from A-
Corp’s operations during the year are added to the balances in the Work-in-Process (WIP)
accounts, with the corresponding liability recorded in Direct Emissions (DE). Thus, the DE
account tallies cumulative direct emissions incurred in past periods, following some initial
reference date.

Emission transfers across companies are recorded in a manner analogous to receivables and
payables of cash in financial accounting. Emissions embodied in goods acquired from suppliers
are added to the account balances for PPE and MAT, while the corresponding CE liabilities are
recorded in Emissions Transferred In (ETI). The suppliers, in turn, reduce the carbon balances of
their own finished goods account by a corresponding number of tons of CO2, with the same
amount reflected in their Emissions Transferred Out (ETO) accounts. While one might expect to
find ETO on the opposite balance sheet side of the ETI account, we adopt the convention of
recording ETO on the liability side, albeit with a negative sign. That way, the left-hand side of
the CE balance sheet exclusively carries the emissions embodied in the firm’s operating assets,
emissions that will flow through to the firm’s sales products in future periods.
8
Among the six sample transactions recorded in Table 1, the first pertains to the purchase of
materials. Ideally, the carbon balances of these materials will be reported by A-Corp’s
suppliers. Otherwise A-Corp. will need to form an estimate based on industry-level data. In
accordance with double-entry bookkeeping, the carbon balance in both the Materials and ETI
accounts are increased by x1 tons (Transaction 1).

When A-Corp transfers materials from inventory to production, the corresponding emissions
are transferred to the WIP accounts (Transaction 2). In our illustration, the total carbon balance
of materials transferred is x2= x21 + x22+ … + x2m tons. There are no liabilities associated the
internal transfer of emissions across operating assets. Similarly, no liability is incurred when
depreciation charges reduce the book value of the PPE account (Transaction 3). The beginning
balance of the PPE account, BBPPE, represents current book value, that is, initial emissions
embodied in acquired machinery and equipment less depreciation charges accumulated in
previous periods. Accordingly, the WIPi accounts absorb depreciation charges in amounts of x3i
tons, with the corresponding credit of x3 going to the PPE account, such that x3 = x31 + x32+ … +
x3m.

Suppose A-Corp. generates x4 tons of direct carbon emissions during its annual operations. The
corresponding bookkeeping entries increase the cumulative liability Direct Emissions (DE) by x4
tons, while the carbon balances in the accounts WIPi are increased by x4i, such that x4 = x41 +x42+
… + x4m.

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10
The bookkeeping entries for Transactions 2-4 reflect internal allocation rules that assign carbon
emissions to products, akin to cost accounting rules that assign overhead costs to different
products. In the context of carbon accounting, such an assignment rule can be conceptualized
as a mapping:

f: (DE, CE Inputs) → CE Outputs (1)

Here, the CE balance of inputs reflects the indirect emissions accumulated by the firm’s
suppliers, their suppliers and so forth. Inputs generally comprise consumable goods, like
components that go into a product, and the periodic use of capital goods, in which case the
corresponding carbon balance is prorated through annual depreciation charges. We refer to the
mapping f(.) in (1) as a Product Carbon Footprint (PCF) allocation system.

The central role of the PCF allocation system is to determine how “overhead” items like direct
(Scope 1) and indirect (Scope 2 and 3) emissions are allocated (prorated) among different sales
products. To that end, the allocation rules should reflect the specifics of the firm’s production
processes in order to capture the causal relation between emissions associated with specific
production activities and the extent to which different products require these activities. 18 Just
as companies generally have discretion in choosing their inventory costing rules for financial
reporting purposes, companies will need discretion in tailoring their internal carbon allocation
rules to the operational structure of their business. A basic requirement for any allocation
system is balancedness: the sum of direct emissions and indirect emissions embodied in
production inputs equals the emissions assigned to outputs. This balancing property was
maintained in the bookkeeping entries for transactions T2-T4 above, as “debits” always equaled
“credits”. Beyond balancedness, the allocation bases (drivers) underlying a company’s internal
PCF allocation rules should be proxy measures for resources consumed and their associated
carbon emissions. 19 The Appendix illustrates how standard cost accounting concepts, such as
activity-based costing, joint cost allocation and ISO rules, have been used to configure the
internal carbon allocation systems of companies in the cement and chemicals industry. 20,21

11
As more companies along a supply’s chain adopt their own internal PCF allocation systems, the
measurement of carbon footprint for products moving along the supply chain will increasingly
reflect an allocated share of each company’s actual direct emissions, an allocated share of
those actually incurred by its immediate suppliers, their suppliers’ suppliers, and so forth up the
entire supply chain. Importantly, this recursive calculation process will be based on firm-level
data that reflect the actual direct emissions incurred at each stage. To illustrate, the chemicals
company BASF determines the PCF of its roughly 40,000 BASF sales products with its internal
digital tool SCOTT (acronym for Strategic CO2 Transparency Tool). 22 By licensing this tool, BASF
seeks to make its own internal carbon accounting system “interoperable” with the company’s
suppliers. 23

Once work-in-process is completed, the carbon balances accumulated in the WIP accounts are
transferred to the corresponding FG accounts on the asset side of the CE balance sheet. Thus,
x51+x52+ … + x5m = z51+z52+ … + z5n, reflecting again the balancing property of the underlying
allocation system. When finished goods are finally sold, the customers of product i assume
responsibility for x6i tons of CO2. The ETO records these sales transactions as x6 tons transferred
out, where x6 = x61+x62+ … + x6n (Transaction 6). Since the ETO accounts maintains cumulative
balances, the carbon emissions in goods sold from previous years remain on the CE balance
sheet.

In summary, double-entry bookkeeping ensures that for each transaction the entries on the
left-hand side of the CE balance sheet sum up to those on the right-hand side. For each balance
sheet account (column), the ending balance equals the beginning balance plus the sum of all
transaction entries. All ending balances are non-negative, with the exception of the ETO
account, which only carries negative balances to reflect emissions transferred out to customers.
While our illustration here has focused on tangible goods like materials and equipment, the
accounting can include emissions associated with intangible goods, such as employee travel.
These would be charged to the WIP accounts, with the corresponding entries recorded in ETI.

The CE flow statement provides customers and the public with line-item information on the
carbon emissions the firm has accumulated in the goods it sold in the current period. Extracting

12
the entries for the final Transaction 6, Table 2 shows the CE flow statement for A-Corp.,
assuming the company discloses all line items for emissions embodied in its n sales products.

The balance x6i reflects product i’s calculated carbon intensity, CIi, that is, the tons of CO2
embodied in one unit of product i. Equivalently, x6i = CIi * (Units of Product i sold). CI metrics are
becoming an increasingly important disclosure item. In some European countries, for instance,
bidders in public procurement auctions are now required to report and certify the carbon
intensity of the products they offer in public tenders. 24

Carbon Emissions in Goods Sold (CEGS) measures the aggregate cradle-to-gate footprint of the
portfolio of products sold in any given time period. As such, the CEGS metric effectively
captures a firm’s entire “Upstream Scope 3” emissions, including its Scope 1 and 2 emissions.
Companies generally will need discretion in tailoring their internal PCF allocation systems to
reflect their own operational structure and the different point sources of emissions. Such
latitude leaves open the possibility of downward biases in the carbon intensities of select
products. Absent any build-ups or depletions of inventories, however, the aggregate CEGS is
unaffected by the specifics of the internal allocation system, provided balancedness is
maintained. Any downward bias in the reported carbon intensity of select customer-sensitive
products will then be accompanied by a corresponding upward bias in other products shown on
the CE flow statement.

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In closing this section, we note that while in financial accounting ‘income’ is calculated as the
difference between sales revenue and costs (period expenses), emissions embodied in goods
sold are transferred “at cost” in the carbon accounting system described here. Thus, the
carbon accounting analogue of the flow variable “income” is, by construction, always equal to
zero, that is (EBETO - BBETO) - CEGS = 0. To show a “profit” in the sense of having positively
contributed to the world’s climate, the CEGS metric would need to turn negative, at least for
companies that assume responsibility for the emissions embodied in acquired production
inputs. Turning CEGS into a negative number, however, will require the use of carbon offsets.

4. Accounting for Carbon Offsets

Most multinational firms that have pledged to cease emitting greenhouse gases by 2050 have
made their pledge on a net-zero basis. Thus, any gross emissions remaining at the target date
must be compensated by carbon offsets. Recent years have witnessed a boom in the voluntary
carbon markets, fueled by companies purchasing carbon offsets. 25 Offset claims are frequently
grouped into avoidance and removal offsets. Avoidance offsets are generated, for instance,
through investments in renewable energy facilities. The reasoning underlying such offset
accounting is that the renewable energy facility will induce other economic parties to consume
less electricity from the grid, thereby avoiding the emissions associated with grid-based
electricity.

The responsibility accounting framework described here posits that a company investing in
renewable energy will record lower indirect emissions to the extent that clean electricity
actually replaces carbon-intensive electricity previously obtained from the grid. If the clean
electricity is sold to third parties, however, the investor should not claim the reduction in the
carbon footprint of the third party as an offset for itself. That would entail double counting,
unless the third party were to record on its books the same amount of carbon-intensive
electricity as it did before the investment in the renewable energy facility. 26 These
considerations have led organizations like the Science Based Target Initiative and companies
like Microsoft and Stripe not to recognize avoidance offsets in the calculation of corporate
carbon footprints. 27
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There are multiple ways of extending the accrual accounting system introduced above to
include negative emissions through CO2 removals. Here, we illustrate one conservative
approach to recognizing “durable” removals. The illustration assumes the same transactions T1-
T4 shown in Table 1. Suppose now that A-Corp. acquires an offset from a provider that claims
to have “durably” removed u5 tons of CO2 from the atmosphere. The criterion for durability
here refers to an assurance that the CO2 absorbed will not be released back into the
atmosphere for a sufficiently long period of time, say hundreds of years. The removal activity
could be nature-based, e.g., a piece of land that is being afforested, or engineered, e.g., direct
air capture combined with geological sequestration. 28

Table 4 shows Direct Removals (DR) as a new account on the CE balance sheet. While the
acquired removal of u5 tons could have been recorded with a negative sign in the liability
account Direct Emissions (DE), the continuing controversy surrounding the legitimacy of
removal activities suggests that companies report gross direct emissions separately from
removals. 29 Recognizing the removal of u5 tons of negative emissions, A-Corp. correspondingly
reduces the carbon balance of its WIPi account by u5i tons such that such u5 = u51+u52+ … + u5m.
Assuming there is no inherent link between A-Corp.’s production process and the removal
activity undertaken by the third party provider, A-Corp. would generally retain full flexibility in
allocating u5 tons of CO2 among its WIP accounts. The remaining transactions in Table 3 parallel
those in Table 1. In particular, the balancing constraints v61+v62+ … + v6m = w61+w62+ … + w6n and
x7 = x71+ x72+ … + x7n are met.

To date, few companies have been explicit regarding the threshold required for removals to be
considered sufficiently durable to merit offset recognition. 30 In the absence of a generally
accepted accounting standard, companies can supplement their CE statements with disclosures
regarding the duration profile of the portfolio of removal acquisitions that the company has
recognized on its books.

15
16
The accounting illustrated in Table 3 is conservative to the extent that the recognition of u5 tons
of CO2 removed immediately reduces the carbon balances in the firm’s inventory accounts in
the same period. Less conservative accounting would allow companies to capitalize any
acquired removals and expense them in future periods at their discretion. In particular, if the
operating assets delivering the CO2 removals are owned by the company in question,
accumulated removals could be carried on the asset side of the CE balance sheet with a
negative sign.

5. CE Statements to Assess Corporate Net-Zero Pledges

Corporate carbon emission statements, comprising CE balance sheets and flow statements, will
enable analysts to gauge multiple indicators of a company’s past, current and future carbon
performance. In particular, CE statements will be effective in monitoring firms’ progress on
their paths towards net zero emissions.

Some technology firms, including Google and Microsoft, have articulated emission reduction
goals that go beyond simply achieving a net-zero position by 2050. These companies aspire to
become “climate neutral” in terms of removing, by a specific target date, their entire legacy
emissions accumulated after their inception date. CE balance sheets allow the public to monitor
progress towards achieving such goals. Specifically, the account balances for EBDE + EBDR, that is,
cumulative direct net emissions, would need to turn negative at the target date and stay
negative thereafter.

For companies that consider themselves responsible for the indirect emissions acquired
through their upstream supply chains, “climate neutrality” becomes a more stringent goal. The
sum of the account balances EBDE + EBDR +EBETI must then turn negative at the target date and
remain negative thereafter. On the asset side of the balance sheet, the stock variable total
emissions in operating assets provides a lower bound on the emissions that will materialize in
CEGS in future periods, as these emissions, in addition to future direct emissions, will flow
through to goods sold in future periods.

17
Direct net emissions, i.e., direct emissions minus direct removals, in any given period is
currently the most common flow measure of a company’s carbon footprint. This flow measure
emerges from the CE balance sheet as the difference EBDE + EBDR – (BBDE + BBDR). From a global
climate change perspective, the significance of this metric is that the sum of all direct net
emissions in any given year, when added up across all economic entities, including firms,
households, and other carbon emitting entities, yields the net addition of CO2 to the
atmosphere. However, because this metric only accounts for emissions within a company’s
gates, it can be “managed” downward by outsourcing carbon-intensive activities to outside
vendors.

The aggregate CEGS metric, in contrast, is invariant to outsourcing emission-intensive activities,

precisely because companies assume responsibility for their own direct emissions and their
acquired indirect upstream Scope 3 emissions. Further, a net-zero trajectory according to the
CEGS metric generally requires direct emissions to approach zero. Specifically, suppose a
company is in a steady state in terms of the volume of production and sales. Further, if the
company does not engage in carbon removals, an emissions trajectory for which CEGS goes to
zero implies that both current direct emissions as well as the carbon balance in acquired assets,
i.e., EBPPE + EBMAT, go to zero. For firms not in a steady state in terms of production and sales
volume, CEGS may go to zero, while there is a compensating build-up of emissions in FG or WIP.
Any such build-up, however, would be detectable from the CE balance sheet.

Well ahead of the 2050 target date, consumer-oriented companies like Shell, Nestle and Total
have increasingly begun to market select products as “carbon neutral”. 31 The accounting
framework described here enables firms to back up such claims with additional disclosures.
Specifically, any claim that the carbon intensity of a particular product is already zero will be
substantiated by decomposing its carbon intensity measure, CI, into product-specific
components: direct and indirect emissions as well as direct removals. Additional disclosures on
how the firm’s direct removals were allocated among the products labeled “carbon neutral”
would lend further credibility to such claims.
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 6. Concluding Remarks
Recent “Net Zero by 2050” pledges by major companies have been received with some
skepticism, in part because of the lack of common metrics to assess corporate carbon
footprints. This paper has argued that the time-tested principles of historical cost accounting
for operating assets can serve as a template for corporate carbon accounting.

An essential building block of the accrual accounting system advocated here is the cradle-to-
gate carbon footprint of individual products. The aggregate emissions in goods sold provide a
comprehensive flow measure of the annual carbon footprint of companies that assume
responsibility for the emissions embodied in acquired production inputs. CE balance sheets
track a firm’s carbon performance over time. Specifically, cumulative direct emissions,
cumulative direct removals as well as the carbon emissions embedded in operating assets are
key indicators of a firm’s past and future carbon emissions.

The cost of adopting the carbon accrual accounting rules described in this paper should prove
modest. Since these rules essentially copy the rules of historical cost accounting for operating
assets, existing financial accounting software should only require limited modifications. Further,
auditors should face no conceptual barriers in certifying that a carbon emission statement has
been prepared in accordance with accounting principles consistent with those used in
preparing financial statements.

19
References

1
Gill, K. (2022) “Understanding the Real Hurdles to Jump Before Reaching Net-zero Emission Goals” Fortune
Magazine, June 2022. https://fortune.com/2022/06/15/climate-change-carbon-emissions-net-zero-goals/
2
Tollefson, J. (2022) “Climate Pledges from Top Companies Crumble under Scrutiny.” Nature.
https://doi.org/10.1038/d41586-022-00366-2
3
Fankhauser, S. et al. (2022) “The Meaning of Net Zero and How To Get it Right.” Nature Climate Change, 12(1),
15-21. https://doi.org/10.1038/s41558-021-01245-w
4
European Union (2023) “Carbon Border Adjustment Mechanism” EU Green Deal. https://taxation-
customs.ec.europa.eu/green-taxation-0/carbon-border-adjustment-mechanism_en
5
World Resources Institute (2004) “The Greenhouse Gas Protocol: A Corporate Accounting and Reporting
Standard, Revised Edition.” https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf
6
Downar, B. et al. (2021) “The Impact of Carbon Disclosure Mandates on Emissions and Financial Operating
Performance.” Review of Accounting Studies, 26(3), 1137-1175. https://doi.org/10.1007/s11142-021-09611-x
7
Hale, T. et al. (2021) “Assessing the Rapidly Emerging Landscape of Net Zero Targets.” Climate Policy, 22(1), 18-
29. https://doi.org/10.1080/14693062.2021.2013155
8
Klaassen, L. and C. Stoll (2021) “Harmonizing Corporate Carbon Footprints.” Nature Communications, 12(1), 1-13.
https://doi.org/10.1038/s41467-021-26349-x
9
Kaplan, R., Ramanna, K. and S. Reichelstein (2022) “Measuring Product Carbon Footprints from Cradle to Gate.”
https://madoc.bib.uni-mannheim.de/63375
10
Security and Exchange Commission (2022) “SEC Proposes Rules to Enhance and Standardize Climate-Related
Disclosures for Investors.” https://Sec.gov/news/press-release/2022-46
11
Kaplan, R. and K. Ramanna (2021) “Accounting for Climate Change.” Harvard Business Review, 99(6), 120-131.
https://www.hbs.edu/faculty/Pages/item.aspx?num=61445
12
Kaplan, R. Ramanna, K. and S. Reichelstein (2022), ibid.
13
Kurtz, Jochen. “Product Carbon Footprints: Zur Vergleichbarkeit der Produkte die Wir Kaufen?” Controlling-
Zeitschrift fuer Erfolgsorientierte Unternehmensfuehrung. 2022
14
Meier, R. (2022) “Global Warming Potential of Cement Products.” Mannheim Institute for Sustainable Energy
Studies, University of Mannheim, Working Paper
15
BASF (2021) “Product Carbon Footprint Partnerships.”
https://www.basf.com/global/en/who-we-are/sustainability/we-drive-sustainable-solutions/quantifying-
sustainability/product-carbon-footprint/partnerships.html
16
Kaplan, R. Ramanna, K. and S. Reichelstein (2022), ibid.
17
Microsoft (2021) “Microsoft Carbon Removal: Lessons from an Early Corporate Carbon Purchase.”
https://query.prod.cms.rt.microsoft.com/cms/api/am/binary/RE4MDlc
18
Kaplan, R. and R. Cooper (1998) “Cost and Effect: Using Integrated Cost Systems to Drive Profitability and
Performance.” Harvard Business School Press.
19
Kaplan, R. and S. Anderson (2004) “Time-Driven Activity-Based Costing”. Harvard Business Review.
https://hbr.org/2004/11/time-driven-activity-based-costing.
20
Kurtz, J. (2022). ibid.
21
Meier, R. (2022). ibid.
22
BASF (2021), ibid.
23
Luers, A. et al. (2022) “Make Greenhouse-Gas Accounting Reliable-Build Interoperable Systems.” Nature,
607(7920), 653-656. https://doi.org/10.1038/d41586-022-02033-y
24
HeidelbergCement AG (2021) “Umwelt-Produktdeklaration. CEM III/B 42,5 N LH/SR. EPD-HCG-20210008-CAA1-
DE.“ https://www.heidelbergmaterials.com/de/nachhaltigkeitsbericht
25
Bloomberg Green (2021) “Wall Street’s Favorite Climate Solution is Mired in Disagreements.”
https://www.bloomberg.com/news/features/2021-06-02/carbon-offsets-new-100-billion-market-faces-disputes-
over-trading-rules

20
26
Comello, S., Reichelstein, J. and S. Reichelstein (2023) “Transparency and Accountability on the Path to Net-
Zero.” Working Paper. Stanford University.
27
Microsoft (2021) “Microsoft Carbon Removal: Lessons from an Early Corporate Carbon Purchase.”
https://query.prod.cms.rt.microsoft.com/cms/api/am/binary/RE4MDlc
28
Wilcox, J., Kolosz, B. and J. Freeman (eds.) (2021) “Carbon Dioxide Removal Primer.” https://cdrprimer.org
29
Fankhauser S. et al. (2022).ibid.
30
Joppa, L. et al. (2021) “Microsoft’s Million-Tonne CO2-Removal Purchase – Lessons for Net Zero.” Nature,
597(7878), 629-632. https://doi.org/10.1038/d41586-021-02606
31
Bloomberg Green (2021). ibid.

21
Appendix
Supplementary Material: Corporate Carbon Emission Statements
This appendix elaborates on the material in Section 3, arguing that the general principles
underlying firms’ cost accounting systems can guide the design of an internal PCF allocation
system. The primary role of cost accounting is to assign values to a company’s inventory of
intermediate and finished goods. 1 Upon sale, these cost values transfer from the balance sheet
to the income statements as Cost of Goods Sold.

Conceptually, a cost accounting system can be represented as a function f: Rm→ Rn that map m
different expenditure line items to the firm’s n different sales products and/or services. Cost
line items are generally classified as either direct or overhead. As the name suggests, direct
costs are immediately attributable to a product and therefore do not require an allocation rule.
For instance, the payment made to a supplier for a part that goes exclusively into one sales
product is charged directly, i.e., dollar for dollar, to the sales product. In contrast, overhead
costs represent expenditures for resources that serve multiple products and therefore require
allocation among these products. These allocations are calculated according to an allocation
base (driver) such as a physical measure (e.g., volume, weight, square footage), time, or an
economic measure (e.g., the market prices of the sales products). 2,3

For external reporting purposes, companies have considerable discretion in structuring their
internal cost accounting systems. Specifically, the inherent jointness of overhead costs makes it
impossible in most industries to identify a product’s “true cost.” As a consequence, companies
regularly revise their cost accounting procedures with the goal of obtaining better predictions
for the overhead costs that will be incurred when there are changes either in the production
technology or the mix of the firm’s sales products. Aside from this forecasting purpose, cost
accounting also provides a tool for ex-post cost control by enabling managers to attribute cost
overruns to particular production steps and/or products.

In the context of carbon accounting, the carbon balance of a part (component) that belongs
exclusively to one product should also be fully absorbed by that product, akin to the treatment
22
of a direct cost item. As mentioned in connection with transaction T1 in Section 3, the carbon
footprint measure of a part (component) is ideally reported by the part’s supplier based on its
own carbon footprint measurement system. Otherwise, the buyer of the part must form its
own proxy-measure based on secondary, industry-wide data.

A company’s Scope 1 and Scope 2 emissions will generally be overhead items that require
meaningful allocations among the company’s different products. To that end, companies
already collect the requisite data on direct process and tailpipe emissions (Scope 1) incurred at
specific production steps. Similarly, most companies continuously trace the usage of electricity
and heat energy to particular production steps and activities, allowing them to attribute the
Scope 2 emissions associated with electricity and heat obtained from external vendors to those
production activities. Scope 3 emissions embodied in machinery and equipment can also be
attributed to the production activities where the assets are located. For these types of
production inputs, the corresponding emission charges require an intertemporal allocation, i.e.,
a depreciation charge, that reflects the useful life of the asset in question. The emissions
accumulated in different production activities are ultimately assigned to the firm’s products.
This assignment can be the outcome of a multi-step procedure that reflects each product’s
usage of different production activities. Below, we illustrate such activity-based allocation rules
in the context of the cement industry where companies seek to measure and report the carbon
intensity of alternative cementitious materials, i.e., tons of CO2 per ton of cementitious
material.

As more companies along a supply’s chain adopt their own PCF allocation system, the resulting
carbon footprint measures of products moving along the supply chain will increasingly reflect
an allocated share of each company’s actual direct emissions, an allocated share of those
actually incurred by its immediate suppliers, their suppliers’ suppliers, and so forth up the
entire supply chain. Importantly, this recursive calculation process is based on firm-level data
that reflect the actual direct emissions incurred at each stage. Except for the hypothetical
scenario of single-product firms, there will be a need for carbon allocations. To illustrate such a
hypothetical scenario, suppose that every firm along a supply chain produces and sells only one
product, which may require the external supply of multiple inputs. Suppose further that the
23
production processes require no capital goods and therefore there are no intertemporal
allocations in the form of periodic depreciation charges for the carbon balances embodied in
long-term assets. Firms simply assemble parts acquired from suppliers in their sales products,
and in doing so incur direct emissions in the process. In such a hypothetical environment, the
resulting cradle-to-gate carbon footprint measure of each sales product will exactly be equal to
the total direct emissions accumulated from all parts and components going into that product. 4

As one of Europe’s largest CO2 emitters, the chemical company BASF faces increasing demands
from customers to calculate carbon footprint measures for its more than 40,000 chemical sales
products. 5 As mentioned in Section 3, the company’s product carbon allocation system has
been automated through its online tool SCOTT (Strategic CO2 Transparency Tool). Figure 1
illustrates the flow of intermediate products and their accompanying carbon balances through
the firm’s network of production sites.

Figure 1: Product carbon footprint accounting at a chemical company

Source: Kurtz (2022b) 6

For its 700 plants worldwide, BASF procures about 20,000 different raw materials and about 10
TWh of energy annually from external vendors. The manufacture of chemicals frequently

24
involves joint production processes, that is, work-in-process batches comprise multiple
products moving in tandem through a particular production step. BASF discloses that it relies on
ISO-compliant allocation bases to assign the carbon emissions associated with joint production
processes to individual products. 7 Applicable examples include physical- and revenue-based
allocation bases (drivers). These allocation methods are commonly featured in cost accounting
textbooks. The use of a particular allocation base for costing purposes, though, does not
necessarily mean that the same allocation base is used for carbon accounting purposes. 8 The
emissions assigned to products include a periodic depreciation charge for the carbon balances
of plant, property and equipment. SCOTT enables management at BASF to decompose a
product’s overall carbon footprint into its Scope 1-2-3 components, and to trace the
accumulated emissions back to production steps that were major emission contributors. 9

BASF has indicated in direct communication that as of late 2022 only a minority of the
company’s suppliers provide their own in-house carbon footprint measure for raw materials
sold to BASF. For most of its raw materials, the company currently relies on carbon footprint
measures provided by external LCA consultants. 10 By licensing the SCOTT tool to independent
software companies, BASF seeks to standardize the calculation of product carbon footprints
among its suppliers in the chemical industry. A comprehensive adoption of internal carbon
allocation systems along the supply chain would ensure that cradle-to-gate product carbon
footprints are increasingly based on actual company-level emissions data.

Several recent studies have argued that the principles of activity-based costing 11,12 can serve as
a template for the design of product carbon allocation systems (PCAS) in the cement industry 13.
The main ingredient in traditional cement is clinker, which is obtained by heating crushed
limestone in a kiln, a process that releases large quantities of CO2. Cement producers have
increasingly sought to replace clinker with low-carbon additives such as slag or calcined clay.
The following description draws on a recent study of carbon accounting for a cement plant of
Heidelberg Materials, formerly Heidelberg Cement. 14 The company commissioned the study in
the face of new regulations at the German and European level to provide reliable carbon
footprint measures for cement products offered in auctions for public construction
projects. 15,16
25
The top two rows in Figure 2 show the annual direct (Scope 1) and indirect emissions (Scope 2
and 3) incurred at the plant. With the exception of external power consumption, the indirect
emission figures were based on third-party estimates that Heidelberg Materials made available
for the study. The relatively minor depreciation charge in Figure 2 reflects that the company
confined this category to emissions embedded in the steel required to build the cement plant.
Further, this carbon balance was divided equally by the number of years the plant is assumed to
be operational. Because slag, originating from the manufacture of steel, has traditionally been
considered a waste product, the study followed the guidelines of the Energy Accounting and
Reporting Standard of the Cement Industry by assigning slag a carbon balance of zero. 17

Exhibit 2: Activity-Based Emission Allocations for Cement Products

Source: Landaverde et al. (2022) 18

The plant in question delivers four products comprising three cement recipes, labeled CEM I-III,
and clinker which is subsequently transferred to other cement plants for further processing.
The carbon allocation system examined in the study proceeds in two steps. First, all direct and
indirect emissions are assigned to three manufacturing activities: clinker production, slag
grinding and milling, where clinker and slag were mixed and milled into cement powder. In this
first step, the emissions associated with the processing of limestone are charged exclusively to

26
clinker production. The company relied on its own records to allocate the emissions embodied
in fuels among the two activities clinker production and cement milling.

In the second step, the emissions accumulated in each of the three activities are assigned to the
four products. The emissions from clinker production are prorated among clinker and the three
cement products in proportion to each product’s clinker percentage, ranging from 89% for CEM
1 to 23% for CEM III. Slag grinding emissions are distributed to CEM II and CEM III based on
their slag percentages, 28% and 68%, respectively. Finally, milling emissions are spread
uniformly across the three cement products since milling time and energy consumption were
regarded as independent of the ingredient mix.

The resulting carbon intensities, i.e., tons of CO2 per ton of cementitious material, in Figure 2
demonstrate the potential for reducing the reported carbon content of CEM II and III by
substituting slag for clinker in the cement recipe. At the same time, these cementitious
materials involve a tradeoff for the manufacturer because, when mixed with water and gravel,
CEM II and III require longer waiting times for concrete to harden. 19

With slag becoming increasingly attractive as a substitute for clinker in the manufacture of
cement, the steel industry association has argued that slag is no longer a waste product.
Correspondingly, the joint production process that yields steel and slag in fixed proportions
should no longer assign zero carbon emissions to slag. 20 While the World Steel Association
prefers to allocate emissions in proportion to the relative mass of steel and slag produced, the
Global Cement and Concrete Association prefers an allocation based on the relative value of
steel and slag. 21 Such discrepancies entail the potential for significant under-counting of
emissions if the two industries were to adopt different allocation methods in calculating the
product carbon footprints of steel and cement, respectively. Similar issues arise when multiple
natural resources are jointly extracted in a mining operation and the extracted resources are
sold to different industries. 22 Of course, under-counting of emissions will not be an issue in a
system where carbon-to-gate product carbon footprints are determined sequentially such that
the buyer accepts the carbon balance (E-Liability”) of the acquired input, e.g. slag, which has
been determined according to the supplier’s own PCF allocation rules.

27
References for the Appendix
1
Datar, S., and M. Rajan (2019) “Horngren’s Cost Accounting.” Upper Saddle River, NJ: Prentice Hall.
2
Datar, S. and M. Rajan (2019). ibid.
3
Kaplan, R. and S. Anderson (2004) “Time-Driven Activity-Based Costing”. Harvard Business Review.
https://hbr.org/2004/11/time-driven-activity-based-costing
4
Kaplan, R. and K. Ramanna (2021) “Accounting for Climate Change.” Harvard Business Review, 99(6), 120-131.
https://www.hbs.edu/faculty/Pages/item.aspx?num=61445
5
Kurtz, J. (2022a) “Product Carbon Footprints: Zur Vergleichbarkeit der Produkte die Wir Kaufen?” Controlling-
Zeitschrift fuer Erfolgsorientierte Unternehmensfuehrung.
6
Kurtz, J. (2022b). Presentation at the Horvath Fachkonferenz, Berlin. March 2022.
7
BASF (2021). “Partnership for Product Carbon Footprint Methodology”, https://www.basf.com/global/en/who-
we-are/sustainability/we-drive-sustainable-solutions/quantifying-sustainability/product-carbon-
footprint/partnerships.html
8
Kurtz, J. (2022b). ibid.
9
Kurtz, J. (2022a).ibid.
10
Kaplan, R., Ramanna, K. and S. Reichelstein (2022) “Measuring Product Carbon Footprints from Cradle to Gate.”
https://madoc.bib.uni-mannheim.de/63375
11
Kaplan, R. and R. Cooper (1998) “Cause and Effect: Using Integrated Cost Systems to Drive Profitability and
Performance.” Harvard Business School Press.
12
Kaplan, R. and S. Anderson (2004). ibid.
13
Meier, R. (2022) “Global Warming Potential of Cement Products.” Mannheim Institute for Sustainable Energy
Studies, University of Mannheim, Working Paper
14
Landaverde, T., Liebmann, P., Meier, R. and S. Reichelstein (2023) “Heidelberg Materials: Assessing Product
Carbon Footprints”. Stanford Business School Case Study SM-365.
15
Landaverde, T. et al. (2023). ibid.
16
HeidelbergCement AG (2021) “Umwelt-Produktdeklaration. CEM III/B 42,5 N LH/SR. EPD-HCG-20210008-CAA1-
DE.“ https://www.heidelbergmaterials.com/de/nachhaltigkeitsbericht
17
WBCSD (2011). “CO2 and Energy Accounting and Reporting Standard for the Cement Industry: The Cement CO2
and Energy Protocol”. https://cement-co2-
protocol.org/en/Content/Resources/Downloads/WBCSD_CO2_Protocol_En.pdf.
18
Landaverde, T. et al. (2023). ibid.
19
Kaplan, R. and K. Ramanna (2021).ibid
20
Meier, R. (2022).ibid
21
World Steel Association. (2014). Methodology for slag LCI calculation. https://worldsteel.org/steel-topics/life-
cycle-thinking/methodology-for-slag-lci-calculation/
22
Cannon, C., et al. (2020) “The Next Frontier in Carbon Accounting: A Unified Approach for Unlocking Systemic
Change.” Rocky Mountain Institute. https://rmi.org/insight/the-next-frontier-of-carbon-accounting/

28