IAS 37: Recognizing Provisions for Onerous Contracts

Definition of an Onerous Contract

Under IAS 37, an onerous contract is defined as a contract in which the unavoidable costs of fulfilling it outweigh the economic benefits that will be received.

Assessment of On-erosity

When assessing whether a contract is onerous, companies must consider both the incremental costs of fulfilling the contract and other relevant costs, such as termination penalties.

If the combined costs of fulfilling the contract are expected to exceed the economic benefits, then the contract is considered onerous and a provision must be recognized.

Implications for Financial Statements

When a contract is determined to be onerous, the company must recognize a provision in its financial statements. This provision represents the estimated future costs of fulfilling the contract and reduces the company's net income.

The recognition of a provision for an onerous contract can have a significant impact on a company's financial performance and may lead to reduced profitability and lower shareholder returns.

Conclusion

IAS 37 provides guidance on recognizing provisions for onerous contracts, which are contracts that have become economically disadvantageous for companies to fulfill. By carefully assessing the costs and benefits associated with contracts, companies can ensure that their financial statements accurately reflect the risks and uncertainties involved in their operations.