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Accounting for onerous contracts – IASB suggests changes to IAS 37

15 February 2019

The International Accounting Standards Board (IASB) has published proposed amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets to specify which costs a company should include when assessing if a contract is onerous.

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. Currently, there are different views about which costs should be included in a company’s assessment of the unavoidable costs of meeting the obligations under a contract. Some companies include only incremental costs whereas others include only directly related costs.

The proposed amendments clarify that the costs of fulfilling a contract include both:

  • Incremental costs, such as the costs of direct materials and direct labour, and
  • An allocation of costs directly related to the contract, such as costs of contract management and supervision, insurance, and depreciation of tools, equipment and right of use assets used in fulfilling the contract.

The IASB expects the amendment will be most relevant to companies in the manufacturing, construction and service sectors. The inclusion of an allocation of direct costs will be a change in approach for some companies and may lead to earlier recognition of a provision, and potentially a larger provision.

The proposals include transitional requirements that will require a company to apply the amendments to contracts existing at the beginning of the annual reporting period in which it applies the amendments. Comparative information will not be restated and the cumulative effect of initially applying the amendments will be recognised as an adjustment to the opening balance of retained earnings.

The effective date of the proposed amendments is to be determined after the exposure draft consultation. The consultation period is open until 15 April 2019; more details can be found on the IASB’s website.

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