DATE: December 7, 2012
TO: Polluter Corp.
SUBJECT: Emissions Allowances
Polluter Corp, has recently spent $3 million to purchase emission allowances, with a vintage year of 2012, in order to meet the need for additional EAs in the fiscal years 2010-2014. They will also need to sell EAs, with a vintage year of 2016, in order to offset the costs of the purchase. It is to my understanding that the need for EAs arose because of the significant amount of greenhouse gases emitted by the Company's antiquated manufacturing facilities. In order to remedy this situation, plans were made to upgrade the facilities in 2014. The reduced gas emissions that the upgraded facilities are expected to provide will render EAs with vintage years beyond 2014, useless, as they would no longer be needed to meet the gas emission standards. Consequently, the Company took action as explained above.
Polluter Corp entered into two separate transactions in the fiscal year 2010, which must be appropriately classified on the statement of cash flows. Each transaction can be recorded as an operating, investing, or financing activity on the statement of cash flows.
Financing activities consist of obtaining cash from issuing debt and repaying the amounts borrowed. This also includes equity transactions, such as obtaining cash from stockholders, the purchase of treasury stock, and paying shareholders. Investing activities include the purchase or disposal of property, plant, and equipment as well as other productive assets, which are held for use in the production of goods or services. Investing activities also include the lending of money and collecting of loans. Operating activities consist of all transactions that are not classified as investing or financing. In general, this includes any activities involving the production and sale of goods or services that generate revenue. Operating activities also include transactions that affect net income .
After thorough research, it is apparent that Emissions Allowances are an unusual asset, whose recording and classification can occur in various ways. In order to determine how the asset will be classified on the statement of cash flows, it is important to decide what type of asset this will be and whether or not it is held or used in the production of good and services.
If Emissions Allowances were being recorded as inventory, they would be classified as an operating activity on the statement of cash flows. Additionally, the amortization of an intangible asset affects net income, and would therefore be an operating activity. This aligns with the requirements of operating activities because their impact on cost of goods sold will affect net income.
Unless the Emissions Allowances are recorded as derivatives, the purchase or sale of Emissions Allowances would not be recorded as a financing activity because it does not involve the issuing or repayment of debt, nor does it include any transaction that would impact the equity accounts such as dividends or stocks.
Polluter Corp specifically states that the purchase and sale of Emissions Allowances are being recorded as intangible assets. Under this model, their inflows and outflows must be classified as an investing activity. This aligns with the requirements of investing activities, which include productive assets. Emissions Allowances are necessary in Polluter Corp’s manufacturing processes; therefore, they are considered an asset that is needed for production.
As stated previously, Emissions Allowances are considered intangible assets that are used directly in the production of household cleaning products. During the production process, the role of the EAs is to offset the pollutants and greenhouse gasses that are being released into the environment. If Polluter Corp used up all of its Emissions Allowances and did not have the ability to purchase more, production would have to be put on hold. Since...
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