IAS 37 defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. IAS 37 also states that the unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it. However, IAS 37 does not specify which costs to include in determining the cost of fulfilling a contract.
The IFRS Interpretations Committee (Committee) received a request to clarify which costs to include in determining the cost of fulfilling a contract.
What triggered this amendmentThe Committee observed that there were different views on which costs to include applying IAS 37. Such different views could lead to material differences in the financial statements of entities that enter into some types of contracts. Consequently, the Committee recommended that the Board clarify which costs to include in determining the cost of fulfilling a contract.
The Committee’s research on IAS 37 also identified that operating leases (as defined in IAS 17 Leases) made up a significant proportion of the contracts identified as onerous applying IAS 37. The volume of leases that lessees account for similarly to operating leases decreased significantly when IFRS 16 Leases became effective
What is an onerous contract
This Standard defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it. The cost of fulfilling a contract comprises the costs that relate directly to the contract.
What is the change
IAS 37 has been amended to specify only direct costs related to a contract need to be considered in determining the costs in an onerous contract. Examples of costs that relate directly to a contract to provide goods or services include:
- direct labor (for example, salaries and wages of employees who manufacture and deliver the goods or provide the services directly to the counterparty);
- direct materials (for example, supplies used in fulfilling the contract);
- allocations of costs that relate directly to contract activities (for example, costs of contract management and supervision; insurance; and depreciation of tools, equipment and right-of-use assets used in fulfilling the contract);
- costs explicitly chargeable to the counterparty under the contract; and
- other costs incurred only because an entity entered into the contract (for example, payments to subcontractors).
- General and administrative costs do not relate directly to a contract unless they are explicitly chargeable to the counterparty under the contract.
The Board decided not to propose any new disclosure requirements. This is because:
- the proposed amendments are narrow in scope. They would not change the underlying principles or general requirements for onerous contracts.
- onerous contracts previously in the scope of IAS 11 are now in the scope of IAS 37. IAS 11 did not contain disclosure requirements specifically for onerous contracts, so applying IAS 37 does not result in a loss of information about those contracts.
- determining the cost of fulfilling a contract could, in some cases, require the use of estimates. However, this is also the case without the proposed amendments. Paragraph 85(b) of IAS 37 and paragraph 125 of IAS 1 Presentation of Financial Statements already require an entity to disclose particular information about uncertainties.
Should you be applying IAS 8 to effect this change
No, Often a contract will become onerous only once in its lifetime; retrospective application of the proposed amendments applying IAS 8 would therefore not generally provide users of financial statements with trend information. Indeed, information about when a contract becomes onerous is more useful to users than trend information. Users may obtain some useful information that was a retrospective application to highlight a point in the fulfillment of contracts that repeatedly causes an entity’s contracts to become onerous. However, there is no evidence to suggest that this situation is common. Instead, entities can apply the amendments retrospectively from the date of first applying the amendments. The entity shall not restate comparative information. Instead, the entity shall recognize the cumulative effect of initially applying the amendments as an adjustment to the opening balance of retained earnings (or other components of equity, as appropriate) at the date of the initial application.
Effective date - The amendments are effective for annual periods beginning on or after 1 January 2022. Early application is permitted.