Executory contract – A contract that is equally unperformed: neither party has fulfilled any of its obligations, or both parties have fulfilled their obligations partially and to an equal extent.
An executory contract is a contract that has been signed but not yet executed. Such a contract, for example an agreement to buy a car that will be delivered in three months’ time, will appear in the income statement when the transaction is performed and the goods or services are passed to the client. A forward contract to buy currency is another form of executory contract.
The Conceptual Framework provides the following guidance [Conceptual Framework 4.57 – 4.58]:
An executory contract establishes a combined right and obligation to exchange economic resources. The right and obligation are interdependent and cannot be separated. Hence, the combined right and obligation constitute a single asset or liability. The entity has an asset if the terms of the exchange are currently favourable; it has a liability if the terms of the exchange are currently unfavourable. Whether such an asset or liability is included in the financial statements depends on both the recognition criteria and the measurement basis selected for the asset or liability, including, if applicable, any test for whether the contract is onerous.
To the extent that either party fulfils its obligations under the contract, the contract is no longer executory. If the reporting entity performs first under the contract, that performance is the event that changes the reporting entity’s right and obligation to exchange economic resources into a right to receive an economic resource.
That right is an asset. If the other party performs first, that performance is the event that changes the reporting entity’s right and obligation to exchange economic resources into an obligation to transfer an economic resource. That obligation is a liability.
Such contracts are not significant in all sectors: a retailer has few such contracts with customers but may have more with suppliers. However, the value of executory contracts could be an important piece of information for investors about future cash flows. Traditionally the only executory contract that is acknowledged in financial reporting is what IAS 37 Provisions, contingent liabilities and contingent assets would refer to as an ‘onerous contract’.
Conventional prudence requires that a foreseeable loss is recognized when it can be predicted, and so where an executory contract is perceived to be loss-making, the full expected loss should be provided for at once. Transaction-based standard-setters would say that you recognize nothing until the transaction is complete, except for reflecting a prudence override (impairment/loss recognition).
If an entity today (e.g., 25 June 2014) enters into a contract to purchase gold at a fixed price (e.g., CU965 per ounce) at a certain date in the future (e.g., 31 October 2014), the contract would be within the scope of IFRS 9, if the entity could settle the contract net in cash and the entity does not expect to use the gold in its business activities. In such case, the contract is sufficiently similar to a derivative financial instrument that it is appropriate to recognise and measure in accordance with IFRS 9.
If, however, the entity enters into a contract to purchase electricity and the purpose is to take delivery of the electricity in accordance with the entity’s expected usage requirements, that contract would be outside the scope of IFRS 9. Such a contract would instead be accounted for as an executory contract, and such arrangements are usually not formally recognised until one of the parties has performed under the contract. Disclosure would, however, be required, if deemed to be material to an understanding of the reporting entity’s operations, including how it handles risk.
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