How are onerous contracts recognised and measured under IAS 37?

Core rule Under IAS 37 Onerous Contracts, an entity must recognise a provision immediately when a contract becomes onerous — that is, when the unavoidable costs of meeting the contractual obligations exceed the economic benefits expected to be received from it. How it works - Definition of an onerous contract (IAS 37.10): A contract is onerous when the unavoidable costs of fulfilling it exceed the economic benefits. Unavoidable costs are the lower of: (a) the cost of fulfilling the contract, and (b) any compensation or penalties payable on exit. This is the "least net cost of exit" concept central to measurement. - Recognition trigger (IAS 37.66): Before establishing a specific onerous contract provision, the entity must first recognise any impairment loss on dedicated assets under IAS 36. This sequencing is mandatory — impair assets first, then assess the residual obligation. - Measurement (IAS 37.68): The provision is measured at the lower of: the net cost to fulfil (i.e., direct costs including materials, labour, and allocated incremental overheads directly attributable to the contract), and the net cost to exit (penalties, termination fees, or damages). Allocated fixed overheads are inclu

How does the 2020 amendment to IAS 37 paragraph 68A clarify which costs are included in 'cost of fulfilling a contract', and what changed in practice?

ded only where they are incremental to fulfilling that specific contract — general and administrative overheads are excluded. - Discounting (IAS 37.45–47): Where the time value of money is material — typically provisions settling beyond 12 months — the obligation must be discounted using a pre-tax rate reflecting current market assessments of the time value and specific risks. The unwinding of discount is classified as a finance cost. - Presentation (IAS 37.84): The onerous contract provision is presented as a current or non-current liability depending on the expected settlement date. It is not netted against any related asset. - Disclosure (IAS 37.85–86): For each class of provision, entities disclose: opening and closing balances, additions and utilisations during the period, nature and expected timing of outflows, and key assumptions. Where disclosing the obligation might seriously prejudice the entity's position in a dispute, limited disclosure is permitted under the "prejudicial exemption" (IAS 37.92). Practical example Scenario: A manufacturing company holds a purchase contract obligating it to buy 10,000 tonnes of raw material at €120/tonne (total €1.2m). Market prices have fallen to €

When a long-term lease becomes onerous under IFRS 16, should the lessee recognise an IAS 37 onerous contract provision in addition to any right-of-use asset impairment?

95/tonne. The cost to cancel the contract (penalty clause) is €180,000. Step 1 — Assess onerousness: - Cost to fulfil: Loss per tonne = €120 − €95 = €25 × 10,000 = €250,000 (net unavoidable loss) - Cost to exit: €180,000 penalty Step 2 — Measure the provision: Lower of €250,000 and €180,000 = €180,000 (exit is cheaper). Step 3 — Journal entry at recognition date: | Account | Dr (€) | Cr (€) | |---|---|---| | Profit or loss — Onerous contract expense | 180,000 | | | Provision for onerous contract (liability) | | 180,000 | If the company subsequently exits the contract and pays the penalty: | Account | Dr (€) | Cr (€) | |---|---|---| | Provision for onerous contract | 180,000 | | | Cash | | 180,000 | Common pitfalls - Including non-incremental overhead in fulfillment costs: Practitioners frequently load provisions with fixed overhead allocations that would be incurred regardless of whether the contract exists. IAS 37.68 restricts fulfillment costs to costs that would not be incurred but for the contract — misallocation inflates the provision and may trigger restatements under audit scrutiny. - Forgetting the IAS 36 sequencing rule: Recognising an onerous contract provision before impairing dedi

How should an entity account for the unwinding of discount on an onerous contract provision recognised at present value — and where does it appear in the income statement?

cated assets (e.g., purpose-built equipment) violates IAS 37.66. Auditors will challenge this ordering; the correct sequence is always impair assets first under IAS 36, then recognise any residual onerous provision. - Applying IFRS 15 / IFRS 16 contracts without considering IAS 37 interaction: Revenue contracts with unavoidable losses (e.g., long-term fixed-price supply agreements where input costs have spiked) are a common onerous contract scenario. Many preparers focus exclusively on IFRS 15 contract modification analysis and overlook the parallel IAS 37 obligation — both standards must be assessed concurrently. Key paragraphs to know - IAS 37.10 — Definition of an onerous contract and the unavoidable costs concept. - IAS 37.66 — Requirement to recognise impairment of dedicated assets (IAS 36) before establishing the onerous contract provision. - IAS 37.68 — Measurement at the lower of cost to fulfil vs. cost to exit (least net cost of exit). - IAS 37.45–47 — Discounting requirements: pre-tax discount rate, materiality threshold, and unwinding classified as finance cost. - IAS 37.85–86 — Disclosure requirements: movement schedule, nature, timing, and key assumptions for each provision class

IAS 37 Onerous Contracts

IAS 37 Onerous — Core Rule

Under IAS 37 Onerous Contracts, an entity must recognise a provision immediately when a contract becomes onerous — that is, when the unavoidable costs of meeting the contractual obligations exceed the economic benefits expected to be received from it.

How IAS 37 Onerous Works

Definition of an onerous contract (IAS 37.10): A contract is onerous when the unavoidable costs of fulfilling it exceed the economic benefits. Unavoidable costs are the lower of: (a) the cost of fulfilling the contract, and (b) any compensation or penalties payable on exit. This is the "least net cost of exit" concept central to measurement.

Recognition trigger (IAS 37.66): Before establishing a specific onerous contract provision, the entity must first recognise any impairment loss on dedicated assets under IAS 36. This sequencing is mandatory — impair assets first, then assess the residual obligation.

Measurement (IAS 37.68): The provision is measured at the lower of: the net cost to fulfil (i.e., direct costs including materials, labour, and allocated incremental overheads directly attributable to the contract), and the net cost to exit (penalties, termination fees, or damages). Allocated fixed overheads are included only where they are incremental to fulfilling that specific contract — general and administrative overheads are excluded.

Discounting (IAS 37.45–47): Where the time value of money is material — typically provisions settling beyond 12 months — the obligation must be discounted using a pre-tax rate reflecting current market assessments of the time value and specific risks. The unwinding of discount is classified as a finance cost.

Presentation (IAS 37.84): The onerous contract provision is presented as a current or non-current liability depending on the expected settlement date. It is not netted against any related asset.

Disclosure (IAS 37.85–86): For each class of provision, entities disclose: opening and closing balances, additions and utilisations during the period, nature and expected timing of outflows, and key assumptions. Where disclosing the obligation might seriously prejudice the entity's position in a dispute, limited disclosure is permitted under the "prejudicial exemption" (IAS 37.92).

IAS 37 Onerous — Practical Example

Scenario: A manufacturing company holds a purchase contract obligating it to buy 10,000 tonnes of raw material at €120/tonne (total €1.2m). Market prices have fallen to €95/tonne. The cost to cancel the contract (penalty clause) is €180,000.

Step 1 — Assess onerousness

Cost to fulfil: Loss per tonne = €120 − €95 = €25 × 10,000 = €250,000 (net unavoidable loss)
Cost to exit: €180,000 penalty

Step 2 — Measure the provision: Lower of €250,000 and €180,000 = €180,000 (exit is cheaper).

Step 3 — Journal entry at recognition date

Account	Dr (€)	Cr (€)
Profit or loss — Onerous contract expense	180,000
Provision for onerous contract (liability)		180,000

If the company subsequently exits the contract and pays the penalty:

Account	Dr (€)	Cr (€)
Provision for onerous contract	180,000
Cash		180,000

IAS 37 Onerous — Common Pitfalls

Including non-incremental overhead in fulfillment costs: Practitioners frequently load provisions with fixed overhead allocations that would be incurred regardless of whether the contract exists. IAS 37.68 restricts fulfillment costs to costs that would not be incurred but for the contract — misallocation inflates the provision and may trigger restatements under audit scrutiny.

Forgetting the IAS 36 sequencing rule: Recognising an onerous contract provision before impairing dedicated assets (e.g., purpose-built equipment) violates IAS 37.66. Auditors will challenge this ordering; the correct sequence is always impair assets first under IAS 36, then recognise any residual onerous provision.

Applying IFRS 15 / IFRS 16 contracts without considering IAS 37 interaction: Revenue contracts with unavoidable losses (e.g., long-term fixed-price supply agreements where input costs have spiked) are a common onerous contract scenario. Many preparers focus exclusively on IFRS 15 contract modification analysis and overlook the parallel IAS 37 obligation — both standards must be assessed concurrently.

IAS 37 Onerous — Key Paragraphs

IAS 37.10 — Definition of an onerous contract and the unavoidable costs concept.
IAS 37.66 — Requirement to recognise impairment of dedicated assets (IAS 36) before establishing the onerous contract provision.
IAS 37.68 — Measurement at the lower of cost to fulfil vs. cost to exit (least net cost of exit).
IAS 37.45–47 — Discounting requirements: pre-tax discount rate, materiality threshold, and unwinding classified as finance cost.
IAS 37.85–86 — Disclosure requirements: movement schedule, nature, timing, and key assumptions for each provision class.