This is an overview of the use of onerous in the IFRS Standards, the major Standard being IAS 37 (see below).
IAS 37: ‘Onerous Contracts – Cost of Fulfilling a Contract’
IAS 37 defines an onerous contract as one in which the unavoidable costs of meeting the entity’s obligations exceed the economic benefits to be received under that contract. If an entity has a contract that is onerous the present obligation under the contract should be recognized and measured as a provision. An onerous contract is one in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
The amendment to IAS 37, that will become effective 1 January 2022, clarifies the meaning of ‘costs to fulfil a contract’.The amendment was part of some narrow-scope amendments issued by IASB in May 2020.
The amendment explains that the direct cost of fulfilling a contract comprises:
- the incremental costs of fulfilling that contract (for example, direct labour and materials); and
- an allocation of other costs that relate directly to fulfilling contracts (for example, an allocation of the depreciation charge for an item of PP&E used to fulfil the contract). (IAS 37.68A)
The amendment also clarifies that, before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets used in fulfilling the contract, rather than on assets dedicated to that contract.
The amendment could result in the recognition of more onerous contract provisions, because previously some entities only included incremental costs in the costs to fulfil a contract.