What Is an Onerous Contract?
An onerous contract is one where the unavoidable costs of meeting it exceed the benefits expected from it — and IAS 37 requires a provision for the loss. Here's what to know.
An onerous contract is a contract in which the unavoidable costs of meeting the obligations exceed the economic benefits expected to be received under it. IAS 37 requires the present obligation under an onerous contract to be recognised and measured as a provision.
How the provision is measured
The provision is the lower of:
- The cost of fulfilling the contract, and
- Any compensation or penalty arising from failing to fulfil it.
The unavoidable costs are the least net cost of exiting the contract — that is, the lower of the cost of performing and any penalty for non-performance.
A worked example
Suppose a company has leased premises it no longer uses, with two years of non-cancellable rent left and no ability to sublet. Because it will receive no benefit but must still pay the rent, the contract is onerous and a provision is recognised for the unavoidable rent.
Watch the interaction with assets
IAS 37 requires any impairment loss on assets dedicated to the contract to be recognised before setting up an onerous-contract provision, to avoid double counting.
In FR and SBR, the marks are in identifying the onerous contract and measuring the provision correctly. Marking a full answer against the official ACCA scheme with The 50% Club shows you exactly which points scored.